Fitch affirms Sri Lanka’s Dialog Axiata at ‘AAA(lka)’; Outlook stable

dialog-axiata

Mar 31, 2020 (LBO) – Fitch Ratings has affirmed the National Long-Term Rating of Sri Lanka-based telecoms company Dialog Axiata PLC at ‘AAA(lka)’.

The Outlook is stable.

AAA’ National Ratings denote the highest rating assigned by the agency in its National Rating scale for that country. This rating is assigned to issuers or obligations with the lowest expectation of default risk relative to all other issuers or obligations in the same country or monetary union KEY

RATING DRIVERS

Mobile-Market Leader: Dialog’s Standalone Credit Profile (SCP) of ‘aaa(lka)’ is underpinned by its market leadership in the expanding mobile and pay-TV segments. We believe Dialog will continue to gain revenue market share from smaller telcos, given its superior execution and mobile networks.

The company has a solid financial profile, with industry-leading revenue growth, a stable operating EBITDA margin of around 36%-38% and a low Fitch-forecast 2020 FFO net leverage of around 0.8x-0.9x (2019 estimate: 0.9x). High Ratings Headroom: We believe Dialog could receive support from its 83% Malaysia-based parent, Axiata Group Berhad (Axiata), if its SCP were to weaken.

We assess the relationship between Axiata and Dialog as one of ‘strong parent, weaker subsidiary and moderate linkages’ under our Parent and Subsidiary Rating Linkage criteria. The linkages include sharing key management personnel, a common name and common creditors, which could result in reputational risk to Axiata should Dialog fail. Revenue Growth Resilient to COVID-19: We forecast 2020 revenue to rise by a highsingle-digit percentage following a 25% tax cut in telecommunication levy, a drop in value-added tax to 8%, from 15%, and the removal of the 2% nation-building tax. Notwithstanding our lower expectations of national GDP growth, we believe demand for 4G data and fixed-broadband will remain strong and online connectivity and remote access will be boosted due to the COVID-19 pandemic.

Revenue rose by 7% and EBITDA by 13% in 2019 – before the introduction of the operating-lease adjustment under Sri-Lankan financial reporting standard 16 -driven by 8% subscriber growth and 16% data growth. We forecast the 2020 operating EBITDA margin to remain stable at 36%-38% (2019 estimate: 36%), as larger economies of scale in the data segment and cost savings offset falling profits in the voice and text segments. Rising Capex Requirements: We forecast capex/revenue to increase to around 27%-28% (2019 estimate: 25%-26%) to address rising demand for 4G network and broadband connectivity due to increased data demand – which was a trend even before the COVID19 pandemic.

The company plans to expand 4G coverage to 95%-96% of the population, from 93% in 2019. However, we expect Dialog to generate an FCF margin of around 2%- 3% during 2020, as cash flow from operation is likely to increase to around LKR41 billion-44 billion (2019 estimate: LKR37 billion), sufficient to fund its large capex plan and dividend commitments. Dividends are likely to be around LKR3.0 billion-4.5 billion (2019: LKR3.0 billion).

Further Consolidation Probable: We expect further industry consolidation and believe Airtel Lanka, a subsidiary of Bharti Airtel Limited (BBB-/Stable), may seek M&A due to mobile competition and high capex requirements. Dialog’s ratings have sufficient headroom for the company to undertake a debt-funded acquisition of a small operator.

However, any rating action would depend on the acquisition price, funding structure and the financial and operating profile of the combined entity. Stable Sector Outlook: Fitch’s outlook for Sri Lanka’s telco sector is stable, as we expect steady mean funds from operation (FFO) net leverage for Dialog and fixed-line market leader and second in mobile, Sri Lanka Telecom PLC (SLT, AA+(lka)/Negative), to remain stable at around 1.6x-1.8x (2019F: 1.6x-1.7x) in 2020.

We expect competitive intensity to remain subdued in 2020 as telcos focus on profitability and a merger between Hutchison Telecommunications Lanka and Etisalat Lanka has relieved some competitive pressure. We forecast average cash flow from operation for Dialog and SLT to improve to around LKR32 billion in 2020 (2019F: LKR28 billion) and for revenue and EBIDTA to rise by 5%-6% and 8%-9%, respectively (2019 average revenue and EBITDA estimates: 5% and 7%).

The average operating EBITDA margin should stay stable at 34%-36% (2019 estimate: 34%-36%), driven by improving economies of scale in the data and home-broadband segments. DERIVATION SUMMARY Dialog’s business risk profile is stronger than that of similarly rated national peers, given its market-leading position in Sri Lanka’s mobile industry, stable cash generation and integrated service offerings.

Dialog’s financial profile is better than that of SLT, with lower 2020 estimated FFO net leverage of 0.8x-0.9x (2020 forecast for SLT: 2.5x), a larger revenue base and a better operating EBITDA margin. Dialog has demonstrated better market execution than SLT, with its expanding market share and rising EBITDA.

Dialog has a comparable business risk profile to leading alcoholic-beverage manufacturer, Melstacorp PLC (AAA(lka)/Stable). Melstacorp’s subsidiary, Distilleries Company of Sri Lanka (AAA(lka)/Stable), controls 60% of Sri Lanka’s spirits production and has maintained its market leadership due to its entrenched brand and access to a country-wide distribution network. Both Dialog and Melstacorp have shown an ability to pass on higher taxes to consumers.

However, Dialog has higher ratings headroom, as its financial profile is stronger than that of Melstacorp. Dialog’s 2020 forecast FFO net leverage of around 0.8x-0.9x is lower than Melstacorp’s 2.0x. Hemas Holdings PLC (AA-(lka)/Stable) is the largest private pharmaceuticals distributor in the country, with a presence in leisure and the fast-moving consumer goods sectors.

Dialog has a significantly stronger business profile, with its market-leading position, larger operating scale and its ability to generate a wider operating EBITDA margin as well as pass on higher taxes to consumers. Hemas’s ratings are constrained by regulatory pressure in the form of price controls in its pharmaceutical business.

However, Hemas’s 2020 FFO net leverage is lower than Dialog’s 0.8x-0.9x. KEY ASSUMPTIONS Fitch’s Key Assumptions Within Our Rating Case for the Issuer – High-single-digit revenue growth during 2020-2021 (2019 estimate: 7%) – Stable operating EBITDA margin at around 36%-38% during 2020-2021 (2019 estimate: 36%) – Capex/revenue to remain high at around 27%-28% (2019 estimate: 26%) – Dividend payout of 40% of previous year’s net income. Dividends to remain at around LKR3.0 billion-4.5 billion during 2020-21 (2019: LKR3.0 billion) – Equity injections of LKR700 million and LKR500 million into Dialog Finance in 2020 and 2021, respectively.

RATING SENSITIVITIES

Developments that May, Individually or Collectively, Lead to Positive Rating Action – There is no scope for an upgrade, as Dialog is rated at the highest end on the Sri Lankan National Ratings scale Developments that May, Individually or Collectively, Lead to Negative Rating Action – We do not envisage any negative rating action in the medium-term given the standalone strength of the business profile, low financial leverage and implied support from the stronger parent.