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Lion Brewery Sri Lanka rating lifted to ‘AAA(lka)’ by Fitch, despite 22-pct sales hit on Covid-19

ECONOMYNEXT – The local rating of Sri Lanka’s Lion Brewery (Ceylon) Plc, has been lifted to ‘AAA(lka)’ after a downgrade of the sovereign rating to ‘B-‘ from ‘B’ though sales in 2020 would plunge as much as 20 percent on Coronavirus restrictions, Fitch, a rating agency said.

“The revision of Lion’s National Long-Term Rating reflects the re-calibration of the Sri Lankan national scale ratings as well as Fitch’s assessment that Lion will maintain its leverage commensurate with a ‘AAA(lka)’ rating level,” Fitch Ratings said.

“Lion’s rating reflects of its leading market position in the domestic beer industry, which is protected by high entry barriers from the regulatory ban on media advertising, its well-established brand and retail coverage.”

Sri Lanka’s sovereign rating was cut to ‘B-‘ from ‘B’ after a rate cuts and liquidity injections in a ‘monetary stimulus’, on top a ‘fiscal stimulus’ of tax cuts, which widened the defifict, de-stabilized the rupee and raising concerns over repaying foreign debt.

Fitch said Coroanvirus controls and social distancing would hit sales. Bars, where people sit in close proximity and talk have been a ‘super spreader’ hotspot in some countries.

“Alcoholic beverage companies such as Lion are exposed to the disruption stemming from social-distancing measures – in effect since March 2020 – to help contain the spread of the virus,” Fitch said.

“We expect Lion’s overall sales volumes to decline by around 22% yoy in FY21 as a result of the movement and socialisation restrictions.

“Aside from a weakening economy and lower domestic consumption, Lion’s mild beer category will also be affected by lower tourist arrivals in 2020 and see a more significant drop in volume compared with the strong variants.

“Fitch expects Lion to see a strong recovery once social distancing measures are eased given the increased socialisation of people.”

Leverage was 1 times reflecting a strong balance sheet, the rating agency said.

KEY RATING DRIVERS:

Lion Brewery (Ceylon) PLC:

Lion Brewery (Ceylon) PLC: The revision of Lion’s National Long-Term Rating reflects the re-calibration of the Sri Lankan national scale ratings as well as Fitch’s assessment that Lion will maintain its leverage commensurate with a ‘AAA(lka)’ rating level.

Lion’s rating reflects of its leading market position in the domestic beer industry, which is protected by high entry barriers from the regulatory ban on media advertising, its well-established brand and retail coverage.

Coronavirus Disruption: Alcoholic beverage companies such as Lion are exposed to the disruption stemming from social-distancing measures – in effect since March 2020 – to help contain the spread of the virus. We expect Lion’s overall sales volumes to decline by around 22% yoy in FY21 as a result of the movement and socialisation restrictions. Aside from a weakening economy and lower domestic consumption, Lion’s mild beer category will also be affected by lower tourist arrivals in 2020 and see a more significant drop in volume compared with the strong variants. Fitch expects Lion to see a strong recovery once socialdistancing measures are eased given the increased socialisation of people.

Strong Financial Risk Profile: Lion’s financial profile is strong with Fitch expecting leverage to remain below 1.0x despite the government’s social-distancing measures.

This is even after assuming, on a conservative basis, that Lion will pay out all of its free cash flow as dividends, while maintaining capex levels of around LKR1.3 billion over the rating horizon of FY20-FY23.

Temporary Weakening in EBITDA Margin: Our rating case assumes a contraction in the EBITDA margin by around 400bp to 29% in FY21 due mainly to lower sales volumes.

Fitch expects Lion to lower its administration and distribution costs, by around 9% in FY21 amid the temporary factory closures and lower sales volumes, thereby helping Lion to contain the margin decline. We expect the EBITDA margin to improve gradually, to 31% in FY22, as sales volumes begin to recover.

Linkages with Parent: Fitch rates Lion on its standalone strength due to its financial independence from its ultimate parent, Carson Cumberbatch PLC, and the presence of an influential minority shareholder – Carlsberg Brewery Malaysia Berhad, which owns 25% of Lion and is in-turn a subsidiary of Carlsberg Brewery A/S (BBB+/Stable).

We therefore assess the linkages between Lion and Carsons as weak, as defined in Fitch’s Parent Subsidiary Rating Linkage Criteria. Lion has a stronger credit profile than Carsons.

The two companies operate as separate entities, with separate funding arrangements and separate liquidity management. There are also no cross-default clauses or cross-guarantees between the debt of the two entities.

Adequate Production Capacity: Lion has sufficient brewing capacity for the next few years, with plant capacity utilisation at 64% in 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 LKR1.3 billion a year in the next two years.

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 existed between November 2015 and November 2017, when beer was temporarily taxed higher than spirits per proof litre.

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. Fitch believes any further tax increases will be gradual, considering the importance of the industry to government revenue.

Excise duties from alcoholic-beverage makers made up 7% of government tax revenue in 2018.