Sri Lanka’s Fitch affirms Lion Brewery at ‘AA-(lka)’ with stable outlook

Fitch-Ratings

July 31, 2015 (LBO) – Sri Lanka’s Fitch Ratings has affirmed Lion Brewery (Ceylon) national long-term rating at ‘AA-(lka)’ with a stable outlook.

The agency also affirmed Lion’s senior unsecured rating and the rating on its debentures at ‘AA-(lka)’.

The full text of the announcement is reproduced below.

Fitch Affirms Lion Brewery at ‘AA-(lka)’; Outlook Stable

Fitch Ratings-Colombo-30 July 2015: Fitch Ratings has affirmed Lion Brewery (Ceylon) PLC’s (Lion) National Long-Term Rating at ‘AA-(lka)’. The Outlook is Stable. The agency also affirmed Lion’s senior unsecured rating and the rating on its debentures at ‘AA-(lka)’.

The National Long-Term rating takes into account Lion’s strong business profile as the leading beer producer in Sri Lanka. The rating also factors in the growing demand for beer driven by increasing urbanisation and preference for lower alcohol content beverages. The company faces risks from regulation and financial risk following a debt-funded expansion and acquisition of the second-largest brewer Millers Brewery Limited (MBL).

KEY RATING DRIVERS
Market Leadership: Lion is the largest producer of beer in Sri Lanka, where beer is the second most-consumed alcoholic beverage after arrack. Its flagship brand, Lion, accounts for close to 80% of its revenue, with its domestically produced and imported brands making up the rest. Lion’s leading position helps the company secure new brands and access a wide distribution network.

Debt-Funded Investments: Lion’s leverage increased to 2.9x during the financial year ended 31 March 2015 (FY15) from 2.2x at end-FY14 after the MBL acquisition was completed in October 2014, and following capacity expansion over the last two years. However, Fitch believes the financial risk is partially offset by improvement in its competitive position stemming from the investments. The acquisition of MBL will bring brands such as Three Coins, Sando, and Grande Blonde under Lion’s portfolio.

The added capacity will also support Lion’s business profile. Lion, which is currently operating at around half its capacity, will be able to meet additional demand over the medium term without extensive production-related capex. In the medium term, the company will undertake less capex, which will free up cash flow to pay down debt.
Highly Regulated Sector: The government regulates the alcoholic beverages sector heavily, including a complete ban on advertising and licensing of participants. There is a high risk of regulatory change, with the most recent being a rise in excise duties to make up for the elimination of offsets under the new value-added tax, which increased Lion’s effective tax burden to 50% of gross revenue in FY15 (FY14: 44%). Fitch expects the importance of the sector in terms of its contribution to government revenue to reduce the likelihood of excessive regulation and taxation.

Growing Demand for Beer: Beer production is increasing to meet demand as lifestyle changes stimulate a preference for beer. Fitch expects demand for locally manufactured hard liquor to decline in the longer term, driven by lower alcohol consumption, and the greater affordability of lower-alcohol content beverages.

KEY ASSUMPTIONS
Fitch’s key assumptions within the rating case for Lion include:
– Low double-digit revenue growth in the medium term
– Profitability, as measured by EBITDA margin, of around 24%
– Maintenance of current dividend policy
– Capex of LKR1.5bn-1.7bn to upgrade warehousing and raw material procurement in FY16
– No material capex from FY17

RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
– Adjusted net leverage (adjusted net debt to operating EBITDAR) of over 2.0x on a sustained basis (end-March 2015: 2.9x)

No positive rating action is expected over the next 24 months as leverage is likely to remain high. However, future developments that may individually or collectively lead to a positive rating action include adjusted net leverage of below 1.5x on a sustained basis