Fitch revises outlook on Abans to negative on Coronavirus stress; Affirms ‘BBB+(lka)’ rating

Fitch-Ratings

Apr 16, 2020 (LBO) – Fitch Ratings has revised the Outlook on Sri Lankan consumer-durable retailer Abans PLC’s National Long-Term Rating to Negative from Stable.

Fitch has simultaneously affirmed the National Long-Term Rating at ‘BBB+(lka)’, the ‘BBB+(lka)’ rating on Abans’ outstanding senior unsecured debentures and the ‘F2(lka)’ National Short-Term Rating on its commercial paper.

The Negative Outlook reflect the significant business interruption from the coronavirus pandemic and the implications of a downturn in discretionary spending that Fitch expects could extend well into 2021. We expect Abans’ leverage to weaken to 7.8x in the financial year ending March 2021 (FY21) from 4.1x in the last 12 months to 9MFY20 – materially above 5.5x – the level at which we would consider negative rating action. We expect net leverage to fall below 5.0x by FY22, but the risks to our forecast are high, including a prolonged continuation of the pandemic, an extended ban on product importation and potential cash flow requirements for its real-estate project.

The Negative Outlook also reflects Abans’s tight liquidity in the next few quarters, which is contingent on banks’ willingness to refinance maturing debt, thereby maintaining exposure to Abans amid the current downturn. The company has a track record of accessing domestic banks through all points in the cycle. As an additional measure, the company has arranged for extended payment terms with their global vendors who supply most of their products which should also help near-term liquidity. However we may take further negative rating action if Abans’s liquidity weakens further.

KEY RATING DRIVERS

COVID-19 to Impair Cash Flows: We expect Abans’ revenue to decline by almost 40% in FY21 as indefinite island-wide lockdowns have closed its more than 380 store network. We do not expect lockdowns to be completely lifted at least till May, leading to a significant revenue hit in 1QFY21. We expect weak sales to continue for the rest of FY21, albeit at a moderate pace, as It will take time for footfall and discretionary spending to normalise, even if the lockdowns are lifted, amid economic hardship, leaving little room for non-essential purchases. We also do not expect a meaningful earnings improvement from the agricultural sector, which forms a large portion of Abans’ customer base, despite a recent improvement in harvests, due to lower overall demand.

A full recovery of the sector may only materialise well into 2021 even if the pandemic is contained over the next few quarters, as consumers will likely defer discretionary purchases until economic activity and income levels normalise. We expect demand to recover to levels seen in FY20, starting in 2HFY22, helped by the pent-up demand from almost nine-to-12 months and the prevailing low interest rate environment continuing into FY21.

However, continuation of the pandemic beyond 1HFY21, resulting in extended restrictions on consumer movement and earnings capacity, could cause cash flows to fall further in FY22. Leverage to Weaken: We expect Abans’ leverage – defined as net lease adjusted debt/operating EBITDAR excluding its finance subsidiary – to worsen to 7.8x in FY21 amid weaker EBITDAR generation. We expect EBIT margins to contract around 300bp in FY21 due to lower volume, higher discount sales to counter weak demand and a substantial fixed-cost base despite management’s efforts to operate on a bare-minimum cost structure.

The company expects to cut down on all its promotional activities and other discretionary expenses until recovery prospects improve, which we believe will save around LKR2.0 billion, or 10% of revenue, in FY21. Inability to execute these cost-saving measures could further weaken leverage expectations for FY21 and beyond. Supply Disruptions: The Central Bank of Sri Lanka has imposed restrictions on the import of non-essential goods to the country till end-June 2020 to control currency depreciation and avert a balance of payment crisis. Consumer-durable retailers, which import 90%- 95% of the products they sell, will face sourcing difficulties.

However, Abans holds around five months of inventory, which should be sufficient to meet sales to beyond midFY21 due to the lower demand outlook. However, the ban continuing into FY22 could materially constrain Abans’ ability to raise sales to historical levels as we expect. Continued Pressure from Real Estate: We believe construction on its USD184 million real-estate joint venture, Colombo City Center (CCC), will be delayed by 12-24 months amid delays in selling the remaining apartments. CCC has completed the construction of the pre-sold apartments enabling it to collect the outstanding receivables.

We believe these collections will be sufficient to construct the unsold apartments in FY21, which have to be sold in the next couple of years for CCC to be able to service its debt repayments starting from FY23 onwards. We have not factored any capital injections into CCC in the next two years but a prolonged delay in selling additional units could increase capital requirements at the project. We believe CCC has sufficient cash until end-FY22 based on cash at hand, an undrawn portion of the project loan and from the remaining pre-sale collection, even if they do not sell any apartments in FY21 and hotel construction is delayed further. CCC also received a moratorium on interest payments for six months driven by government regulations, which should help to ease the pressure stemming from possible delays in rent collection from the mall which is primarily used to service the interest.

Strong Market Position: We believe Abans’ strong brand portfolio, extensive dealer network and well-managed in-house hire-purchase book will help support the company’s market position through the cycle. Abans has also widened its product portfolio to include low-priced, Abans-branded products, which has made its business model more resilient. Weaker Parent: Fitch rates Abans based on the consolidated profile of its weaker parent, Abans Retail Holdings (Pvt) Limited (ARH), due to strong operational linkages between the two. ARH has full ownership and control of Abans, the main contributor to group consolidated EBITDAR. We expect Abans to contribute more than 90% of the group’s EBITDAR over the medium term.

DERIVATION SUMMARY

Abans is rated one notch below Sunshine Holdings PLC (A-(lka)/Stable) because Abans has higher net leverage and more volatile cash flows due to the higher discretionary demand for consumer durables than for Sunshine’s products. Abans is rated one notch above DSI Samson Group (Private) Limited (BBB(lka)/Positive) to reflect its more robust business profile, while DSI’s sales remain under pressure from increasing competition in its core businesses. DSI’s Positive Outlook reflects its improving financial risk profile, which is in line with that of Abans.

KEY ASSUMPTIONS

Fitch’s Key Assumptions Within Our Rating Case for the Issuer – Severe pandemic during most of 1QFY21, and gradually easing between 2QFY21 and 1QFY22 – Footfall at retail business to fall by 75% yoy in 1QFY21 and gradually increase to historical levels by mid-FY22 – A 70% revenue decline in 1QFY21 easing off to a reduction of around 30% yoy for the rest of FY21. A 40% yoy revenue growth in FY22 reflecting almost full recovery to FY20 levels. – FY21 EBIT margin to contract 300bp to 3.5% owing to lower sales and higher fixed costs and recover to 6% by FY22. – Working capital inflows in FY21, amidst ban on importation of consumer durables and extended supplier credit which will be offset to an extent by higher receivables outstanding from its hire-purchase book. – Equity injections of LKR600 million and LKR250 million in FY21 and FY22, respectively, to help finance subsidiary Abans Finance PLC meet its minimum capital requirements. – Capex to be limited to maintenance capex over the next two years – No dividend payments till FY23

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to the Outlook being revised to Stable – Adjusted net debt/EBITDAR falling below 5.5x by FY22 – Fixed-charge coverage (ratio of EBITDAR to gross interest + rent excluding Abans Finance) increasing to more than 1.3x by FY22 (LTM 9MFY20:1.8x and FY21F:0.9x) Factors that could, individually or collectively, lead to negative rating action/downgrade: – Sustained increase in Abans’ adjusted net debt/operating EBITDAR to over 5.5x – Fixed-charge coverage declining below 1.3x on a sustained basis – A significant weakening in the company’s liquidity position in the next few quarters – Significant investments in non-core operations or large cash outflows to companies outside of ARH – Sustained weakening in ARH’s credit profile.