ECONOMYNEXT – Fitch Ratings said it has confirmed Sri Lanka Telecom's (SLT) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B+' and its National Long-Term Rating at 'AAA(lka)'.
Both ratings have a stable outlook, the rating agency said in a statement.
Anticipated industry consolidation, with the recently announced merger between Hutchison Telecommunications Lanka (Private) Ltd and Etisalat Lanka (Private) Ltd could relieve some competitive pressures on telecom companies, Fitch said.
The full statement follows:
Fitch Ratings - Singapore - 21 November 2018: Fitch Ratings has affirmed Sri Lanka Telecom PLC's (SLT) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'B+' and its National Long-Term Rating at 'AAA(lka)'. The Outlook is Stable. We have also affirmed the 'AAA(lka)' national rating on the company's LKR7 billion debt programme. SLT's senior unsecured debt of up to LKR7 billion is rated at the same level as its National Long-Term Rating as the debentures rank equally with other senior unsecured obligations.
SLT's IDRs are constrained by Sri Lanka's IDRs (B+/Stable), per Fitch's Government-Related Entities Rating Criteria, as the state holds a majority stake in SLT directly and indirectly, and exercises significant influence on its operating and financial profile. SLT's second-biggest shareholder, Malaysia's Usaha Tegas Sdn Bhd with 44.9%, has no special provisions in its shareholder agreement that would dilute the government's significant influence over SLT.
SLT's standalone credit profile, assessed by Fitch at 'BB', is stronger than that of its owner, reflecting the company's market-leading position in fixed-line services and second-largest position in mobile, along with its ownership of an extensive optical-fibre network. The standalone profile is also underpinned by its mid-single-digit percentage growth prospects, moderate estimated 2018 FFO adjusted net leverage of 1.7x and stable operating EBITDAR margin.
KEY RATING DRIVERS
Strong State Linkages: Fitch sees SLT's status, ownership and control by the Sri Lankan sovereign as 'Strong'. The state's ownership of SLT gives it significant influence over the company's operating and financial policies. We view the support track record and expectations for the likelihood of state support for SLT as 'Strong', given its strategic importance in expanding the country's fibre infrastructure. Historically, SLT has not required tangible financial support due to its strong financial profile.
State's Incentive to Support: Fitch sees the socio-political implications of a default by SLT as 'Moderate' due to the presence of three other privately owned telcos. However, it could affect the fixed-line market because SLT acts as a policy company to invest in fibre networks across the island to support the government's vision of fibre-based internet for all households. Fitch also sees the financial implications of a default as 'Strong' as a financial default by SLT may have a strong impact on the availability and cost of financing options for other government-related entities.
High Capex, Negative FCF: We expect SLT to have negative free cash flow (FCF) during 2019-2020 (estimated 2018 negative FCF of LK2 billion-3 billion) as cash flow from operations may be insufficent to fund large capex plans to expand the fibre infrastructure and 4G mobile networks. SLT's 2019 capex will likely remain high, around 28%-30% of revenue, as it aims to complete its 4G population coverage to around 95% by end-2019.
We expect SLT to continue to invest in expanding fibre coverage as it targets to connect about 1 million homes by 2020-2021 from an existing 70,000 homes currently. Typically, SLT would need to lay fibre for at least 2 million homes to get half of the households connected. We expect SLT's fibre investments to have low returns due to the country's low broadband tariffs. Dividends are likely to remain around LKR1.6 billion-1.8 billion in the next two to three years.
Data Drives Growth: Barring any tax shocks, we expect revenue to grow by a mid-single-digit percentage during 2019-2020, driven by data and fixed-broadband growth. We expect 4G smartphone penetration to improve from the current 25% with the proliferation of cheaper Chinese phones. Revenue rose strongly by 6.5% in the first nine months of 2018, driven by fixed-broadband and mobile usage after a temporary usage slump in 2017 due to higher taxes on voice and data. We expect the government's recent announcement on the removal of floor rates for voice call charges to have a limited impact on growth.
Industry Consolidation, M&A Risk: We believe the recently announced merger between Hutchison Telecommunications Lanka (Private) Ltd and Etisalat Lanka (Private) Ltd is likely to relieve some competitive pressures that have undermined telecom companies' revenue and EBITDA growth in recent years. The merger is pending regulatory approval. Industry consolidation is likely to provide some relief from pricing pressure, especially in the data segment where telcos have not been able to fully capture the strong growth in data traffic.
SLT's National Long-Term Rating could come under pressure if it were to carry out a debt-funded acquisition of the smallest telco - Bharti Airtel Limited's (BBB-/Stable) Sri Lankan subsidiary, Airtel Lanka. However, any rating action will be based on the acquisition price, funding structure, and the financial and operating profile of the combined entity.
Stable Sector Outlook: Fitch's outlook for the Sri Lankan telco sector is stable as we expect the mean net leverage for SLT and mobile market leader, Dialog Axiata PLC (AAA(lka)/Stable), to remain stable at around 1.4x in 2019. We expect the sector's cash generation to improve, driven by higher mobile and broadband data usage, which however, will be insufficient to fund the large capex requirement, leading to negative FCF. We also expect average operating EBITDAR margins to remain stable at around 34% (2018 estimate: 34%), driven by improving economies of scale in the data and home broadband segment, offsetting the negative impact of the changing revenue mix.
SLT's standalone rating reflects its moderate financial profile and strong market position in the fixed-line industry segment and second-largest position in the mobile market. SLT has lower exposure to the crowded mobile market and more diverse service platforms than Dialog.
However, Dialog has a larger revenue base and better operating EBITDAR margin than SLT while SLT's forecast FFO adjusted net leverage and FCF profile are worse than that of Dialog.
SLT has a larger operating scale and a wider EBITDAR margin than Hemas Holdings PLC (AA-(lka)/Stable), which is a diversified conglomerate with exposure to pharmaceuticals, fast-moving consumer goods, leisure and transport. Hemas is the largest private retail pharmaceutical distributor in the country and the second-largest home care and personal care manufacturer. Hemas's FFO adjusted net leverage is likely to be better than SLT's over the medium term.
Fitch's Key Assumptions Within Our Rating Case for the Issuer
- Revenue to grow by mid-single-digit percentage, driven by fixed-broadband and mobile data services in 2018-2019.
- Capex/revenue to remain high at around 28%-30% as SLT expands it fibre and 3G/4G networks.
- Operating EBITDAR margin to remain stable at around 29%-30%.
- Effective tax rate of 28%.
- Dividend payout of LKR1.6 billion-1.8 billion.
Developments That May, Individually or Collectively, Lead to Positive Rating Action
- An upgrade in Sri Lanka's IDRs would result in corresponding action on SLT's IDRs;
- A weakening of links between SLT and the sovereign could result in SLT's Local-Currency IDR being upgraded above Sri Lanka's Local-Currency IDR. However, SLT's Foreign-Currency IDR will remain constrained by Sri Lanka's Country Ceiling of 'B+'
- There is no scope for a national rating upgrade as SLT is at the highest rating on the Sri Lankan scale.
Developments That May, Individually or Collectively, Lead to Negative Rating Action
- A downgrade of Sri Lanka's IDRs would result in corresponding action on SLT's IDRs;
- A debt-funded acquisition of a smaller operator could threaten SLT's National Long-Term Rating, depending on the acquisition price and the financial profile of the combined entity.
For the sovereign rating of Sri Lanka, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 6 February 2018:
The main factors that, individually or collectively, might lead to positive rating action are:
- A further improvement in external finances supported by higher non-debt creating inflows or a reduction in external sovereign refinancing risks from improved liability management.
- Continued improvement in public finances underpinned by a credible medium-term fiscal strategy, including a further broadening of the government revenue base.
- Continued implementation of economic policies that support underlying macrostability
The main factors that could lead to negative rating action, individually or collectively, are:
- Deterioration in policy coherence and credibility, leading to a loss of investor confidence, or a derailment of the IMF supported programme that leads to external funding stress.
- Reversal of fiscal improvements that leads to a failure to stabilise government debt ratios.
LIQUIDITY AND DEBT STRUCTURE
Strong Access to Local Banks: At end-September 2018, SLT's liquidity - cash of LKR12 billion and committed undrawn bank lines of LKR13.5 billion - was sufficient to fund its short-term debt of LKR13.5 billion. We expect SLT to refinance its short-term debt in light of its good access to local banks. It has demonstrated a solid track record of accessing capital from local banks and capital markets. Total debt was about LKR53 billion out of which about 25% was denominated in US dollars.
(COLOMBO, 23 November 2018)