28 NOV 2019 03:52 AM ET
Fitch Ratings – Colombo – 28 November 2019:
Fitch Ratings has affirmed Sri Lanka-based Lion Brewery (Ceylon) PLC’s National Long-Term Rating at ‘AA-(lka)’ with a Stable Outlook. Fitch has also affirmed the National Long-Term Rating on Lion’s outstanding senior unsecured debentures at ‘AA-(lka)’.
Lion’s National Long-Term Rating reflects its leading market position in the domestic beer industry, which is protected by high entry barriers from the regulatory ban on media advertising, Lion’s well-established brand and extensive retail coverage. However, Lion’s profitability can be affected in the short-term by frequent hikes in excise taxes on alcoholic beverages, although the company has been able to pass on these tax increases to customers with demand normalising within a lag of 12 to 18 months.
We have rated Lion’s debentures at the same level as its National Long-Term Rating as the debentures are not materially subordinated because there is no meaningful prior ranking debt.
KEY RATING DRIVERS
Strong Financial Profile: Lion’s financial profile is strong with Fitch expecting net leverage – defined as lease-adjusted debt net of cash/operating EBITDAR – to remain below 1.0x over the next few years. Leverage has improved considerably, from 2.7x in the financial year ending 31 March 2018 (FY18) to 0.6x in FY19 and 0.5x during the trailing 12 months to end-2QFY20. The improvement is due to better sales volumes that drove strong EBITDA growth, amid the reversion to the previous excise tax regime which taxes beer at a relatively lower rate per unit of alcohol than spirits.
Weak Links with Parent: Fitch rates Lion on its standalone strength due to the weak linkages between its ultimate parent, Carson Cumberbatch PLC, in line with Fitch’s Parent and Subsidiary Rating Linkage criteria. Lion has a stronger credit profile compared to Carson. Although Carson has control over Lion, its influence is mitigated by a large minority shareholder, Carlsberg Breweries A/S (BBB+/Stable), which owns 25% of Lion. Carson and Lion maintain separate financing arrangements and there is no cash fungibility between the two other than for dividends.
Resilient Sales Demand: Fitch expects Lions sales volume to increase by 12% in FY20 due to relatively resilient demand for strong beer, while we expect weak tourist arrivals to affect mild beer sales. Lion’s net revenue rose by 13% yoy in 1HFY20 despite the increase in excise taxes in March 2019 and the challenging operating environment following the Easter Sunday terrorist attacks. We expect mild beer sales to recover from FY21 onwards based on our expectations of a recovery in tourism.
Fitch expects the tourism industry to normalise from FY21 onwards after a faster recovery than the industry had expected – as evident from in-bound tourist arrivals increasing at an average of 38% month-on-month from June to September 2019. A relaxation in key tourist markets of travel advisories on Sri Lanka has supported the growth in visitors.
Adequate Production Capacity: Lion has sufficient brewing capacity for the next few years, with plant capacity utilisation at 64% as of FY19. Lion expanded its production capacity between FY14-FY16, which drove the high capex of around LKR4 billion a year, or 20% of revenue. We expect capex to moderate to around LKR1.5 billion a year in the next two years.
Stable Profitability, Working Capital: We expect the EBITDAR margin to stabilise at around 30% in FY20 and FY21, but lower than the 36% in FY19, due to the challenging operating environment. We expect Lion’s net cash conversion cycle to improve, stabilising at around 110 days in the next few years, which is in line with FY19 and better than the 136 days in FY18. The improvement in working capital will stem mainly from increased sales following the reduction in excise taxes on beer relative to spirits.
High Regulatory Risk: Domestic alcoholic beverage producers face frequent revisions to excise duties, which can cause near- to medium-term operating cash flow volatility. Spirits are taxed 22% higher per proof litre compared with beer, after taxes on beer were increased by 12.5% in March 2019. The current tax regime is more consistent with the practice that prevailed before November 2015, when drinks with lower alcohol content such as beer were taxed at lower rates per proof litre than spirits.
Fitch expects the current excise tax regime to prevail over the medium term as it encourages the consumption of drinks with lower alcohol content and has been the norm historically, except for the period between November 2015 and November 2017. Fitch believes any further tax increases will be gradual, considering the importance of the industry to government revenues. Excise duties from alcoholic-beverage makers made up 7% of government tax revenue in 2018.
Lion is rated at the same level as domestic conglomerate Hemas Holdings PLC (AA-(lka)/Stable). Lion has a leading market share in the local beer industry amid high entry barriers and low leverage, while Hemas is a well-diversified conglomerate with exposure to defensive pharmaceuticals, personal care and homecare products, and stationery products in the fast-moving consumer goods space. Hemas also has similar leverage as Lion.
Lion is rated three notches below Distilleries Company of Sri Lanka PLC (DIST) (AAA(lka)/Stable) – the country’s biggest spirits manufacturer – reflecting DIST’s much larger operating scale and dominant market position in spirits, which are more widely consumed domestically than beer. DIST has about a 70% share of the alcoholic-beverage market. Historically, DIST has been less sensitive to changes in tax regulations than Lion.
Richard Pieris & Company PLC (A(lka)/Stable) is rated two notches below Lion, reflecting its weaker business risk profile due to significant exposure to the volatile agriculture segment; thinner EBITDA margins; and higher leverage.
– Revenue growth to be resilient, rising by around 18% in FY20 and by 11% in FY21, despite the tax increase in March 2019 and a dampened operating environment, and then rising by 5%, on average, during FY22-FY23.
– EBITDAR margin to narrow to 30% in FY20, from 35.7% in FY19, and to stabilise at around 32% from FY21.
– Excise duty on strong and mild beer to increase by 9%, on average, per proof litre a year over FY20-FY23.
– Capex intensity to average around 5% of revenue over FY20-FY23.
– We have assumed the free cash flow generation to be paid as dividends, in the absence of a stated dividend policy.
– Working capital outflows to average around LKR1.3 billion a year in the medium term.
Developments That May, Individually or Collectively, Lead to Positive Rating Action
– No positive rating action is likely unless the company is able to improve its business risk profile and scale of operations significantly while maintaining the current financial profile.
Developments That May, Individually or Collectively, Lead to Negative Rating Action
– An increase in Lion’s lease-adjusted debt net of cash/EBITDAR over 3.0x for a sustained period.
LIQUIDITY AND DEBT STRUCTURE
Comfortable Liquidity: Lion had unrestricted cash and cash equivalents of LKR10.3 billion and unused credit lines of LKR9.7 billion at end-March 2019, to meet LKR9.2 billion of debt maturing within the following 12 months. Working capital debt accounted for around LKR5 billion of near-term maturities – which is backed by a net working capital position of LKR4 billion and supported by a healthy cash conversion cycle of 110 days as of FY19. The company’s strong credit profile and consistent access to bank funding supports liquidity further.
Additional information is available on www.fitchratings.com