Fitch Assigns Sri Lanka’s Ceat Kelani First Time ‘AA+(lka)’ National Rating

Fitch Ratings has assigned Ceat Kelani Holdings Pvt Limited (CKH) a National Long-Term Rating of ‘AA+(lka)’. The Outlook is Stable.

CKH’s rating reflects its leading market position as one of the largest manufacturers and distributors of vehicle tires in Sri Lanka, and its strong financial profile. Fitch expects CKH’s cash to continue to exceed debt in the next few years. This is counterbalanced by CKH’s price-sensitive products, competition from imports, and exposure to fluctuations in commodity prices on its inputs.

KEY RATING DRIVERS

Leading Market Position: CKH is the largest manufacturer of bias and radial pneumatic tires in Sri Lanka, with an overall market share of around 50%. Most of the rest of the market is supplied by imports, which attract duties of around 60% and are less price-competitive than CKH’s products. The company makes mainly bias tires, as it leads the commercial truck and bus tire market, where mostly bias tires are used. CKH is also steadily increasing its radial tire capacity in the car, van and sports utility vehicle space to cater to growing demand from personal vehicles.

Over 90% of CKH’s revenue stems from the replacement market, where demand is less cyclical than in sales to original equipment manufacturers. The company’s local manufacturing base gives it a cost advantage, which allows it to price its products 15%-20% lower than those of the competition. These reasons underpin Fitch’s belief that CKH’s sales will remain steady despite the weak operating environment, in which sporadic movement restrictions to control the coronavirus pandemic have adversely affected disposable incomes amid an increasing cost of living.

Benign Near-Term Imports: Fitch expects only a limited rise in competition from imports in the next 12-18 months as most high-street importers could face constraints in importing pre-pandemic quantities, amid Sri Lanka’s weak external finances. On 11 June 2021, the authorities removed the requirement for importers to obtain lengthy credit days of 90-180 on most product categories, including vehicle tires.

CKH saw strong revenue and EBITDA growth in the financial year ended March 2021 (FY21) due to a shortage in imports caused by these restrictions that came into effect in May 2020. Over the longer-term, we believe CKH stands to benefit from Sri Lanka’s import substitution drive to shore up the country’s external finances.

Growing Share of Radial-Sales: Fitch expects CKH’s revenue to rise by 6% in FY22 to LKR12.5 billion, as we believe competition from imports will not swiftly return to levels prior to the pandemic. Also, increased radialisation efforts should enable CKH to gain a stronger foothold in the radial market, where 60% of sales volumes are by imported brands. CKH hopes to increase the contribution of radial tires to 30% of sales in FY22 from 20% in FY21, and settle at around 40% in FY23 by expanding production capacity. This should mitigate the long-term structural decline in demand for bias tires.

Lower, But Still-Healthy, Margins: Fitch expects CKH’s EBITDA margins to fall by around 300bp to 18.6% in FY22, but remain above the average of 17% in FY18-FY21. This is because we expect CKH’s input costs to rise in line with commodity prices, while weak demand in the next 12-18 months may limit its ability to pass on cost inflation. The prices of key manufacturing inputs, such as natural rubber, rose by as much as 50% yoy in 1H21 due to strong demand amid disrupted supply. CKH remains exposed to local-currency depreciation and higher freight charges as it imports around 60% of its raw materials.

Strong Financial Profile: Fitch expects the company to maintain a net cash position in FY22-FY25. This is despite our projections of negative free cash flow over FY22 and FY23, due to working capital outflows, capex of around LKR900 million per annum on increasing radial-tire capacity, as well as a 50% dividend pay-out. The increase in working capital is mainly due to the build-up of buffer stocks in the near-term to mitigate disruptions to trade and to support sales growth.

DERIVATION SUMMARY

CKH is rated one-notch below Hemas Holdings PLC (AAA(lka)/Stable) and Lion Brewery Ceylon PLC (AAA(lka)/Stable) given its smaller scale and the less-defensive nature of its end-products. Hemas is a well-diversified conglomerate with exposure to defensive pharmaceutical and consumer sectors, which account for more than 90% of its EBITDA. Lion Brewery’s rating reflects its market leadership in the local beer industry, helped by high entry barriers. All three companies have strong financial profiles.

Sunshine Holdings PLC (AA+(lka)/Stable) has more defensive cash flows than CKH due to its significant exposure to the healthcare and consumer goods segments, which comprise packaged tea retail and confectionary. Meanwhile, CKH faces competitive pressures from imports as well as cyclical demand. However, CKH has a much stronger financial risk profile, which is evident from its net cash position, which counterbalances its business risks. Therefore, we rate both entities at the same level.

The leaders in the consumer durables retail sector in Sri Lanka, Singer (Sri Lanka) PLC (AA(lka)/Stable) and Abans PLC (AA(lka)/Stable), have much larger operating scale than CKH but cater to more discretionary demand and have weaker financial profiles. Therefore, we rate CKH one notch above Singer and Abans.