Singer Sri Lanka recovering from Nixon shock, Trump’s Huawei ban looms

ECONOMYNEXT – Singer Sri Lanka Plc, the island’s largest consumer durables retailer is starting to recover from credit and import restrictions set by the central bank, but it may lose revenue from the US ban on Huawei technology by America, Fitch, a rating agency, said.

Fitch cut the outlook on Singer Sri Lanka to ‘negative’ from ‘stable’ but confirmed its ‘A(lka)’ rating as it faces challenges in cutting debt.

"The ban on Huawei Technologies by the US authorities is likely to weaken Singer’s mobile phone sales from a high of around 25 percent of revenue in FY19," Fitch Ratings said.

"Singer will aim to diversify sales across other brands if the ban continues, but the efficacy of its strategy remains to be seen. It also plans to cut operating costs in the next two years, but this is subject to execution risk."

Trump administration has ordered US firms such as Google to stop supplying its operating system to Huawei after already blocking other equipment from network, amid fears that China may be using the firm to spying and it was also stealing intellectual property.

The firm has denied the charges.

Singer was also hit by restriction on import letters of credit as the central bank engaged in Nixon shock-style moves in 2018.

Last year the central bank printed money to artificially lower interest rates and triggered a run on the rupee. It then slapped trade controls, such as higher margins on import letters of credit and higher duties on some goods, to avoid or delay policy errors, critics have said.

The rupee anyway fell from 153 to 182 to the US dollar generating a collapse in demand, while rates anyway went up.

Higher cash margins had force Singer to borrow. From March the requirement were cut and the firm is emerging from the controls, Fitch said.

"Leverage fell in the year ending June 2019 following the removal of cash margin requirements on
imports in mid-March 2019," Fitch Ratings said.

"This saw the resumption of Singer’s supplier credit cycle, with a cash inflow of LKR750 million from improved creditor days in 1QFY20.

"The cash margin was introduced in November 2018 to discourage imports in a bid to combat pressure on the local exchange rate.

"The company had to increase debt and incur higher interest costs to fund the cash margin
requirement so long as letters-of-credit remained unpaid.

"Consequently, Singer opted to repay suppliers early to reduce financing costs at the expense of higher working capital."

Fitch confirmed Singer’s ‘A-(lka)’ rating which it said was helped by  leading market position in consumer durables retail, its portfolio of products and brands, which are diversified across price points, its large island-wide distribution and retail store network and the well-managed hire-purchase book with limited delinquencies.

Its financial subsidiary was also well capitalized, Fitch said.

Better harvests in agricultural areas will help sales in the future, the rating agency said.

The full statement is reproduced below:

Fitch Revises Outlook on Singer Sri Lanka to Negative; Affirms at ‘A-(lka)’

Fitch Ratings-Colombo-20 August 2019: Fitch Ratings has revised the Outlook on
consumer-durables retailer Singer (Sri Lanka) PLC’s National Long-Term Rating to Negative from
Stable. Fitch has simultaneously affirmed the National Long-Term Rating at ‘A-(lka)’ as well as the
‘A-(lka)’ rating on Singer’s outstanding senior unsecured debentures and ‘F2(lka)’ National
Short-Term Rating on its commercial paper.

KEY RATING DRIVERS

Difficulty in Reducing Leverage: The Negative Outlook reflects the challenges Singer may face in
reducing its leverage, defined as net adjusted debt/EBITDAR, to below 5.5x – the level at which we
would consider negative rating action – by the financial year ending March 2021 (FY21), from 6.1x
in the trailing 12 months to end-June 2019 and 6.4x at FYE19.

The ban on Huawei Technologies by the US authorities is likely to weaken Singer’s mobile phone sales from a high of around 25% of revenue in FY19. Singer will aim to diversify sales across other brands if the ban continues, but the efficacy of its strategy remains to be seen. It also plans to cut operating costs in the next two years, but this is subject to execution risk.

Leverage fell in the year ending June 2019 following the removal of cash margin requirements on
imports in mid-March 2019. This saw the resumption of Singer’s supplier credit cycle, with a cash
inflow of LKR750 million from improved creditor days in 1QFY20. The cash margin was introduced
in November 2018 to discourage imports in a bid to combat pressure on the local exchange rate.
The company had to increase debt and incur higher interest costs to fund the cash margin
requirement so long as letters-of-credit remained unpaid. Consequently, Singer opted to repay
suppliers early to reduce financing costs at the expense of higher working capital.

Weak Sales Volume: Fitch expects sales volume to decline in FY20 due to poor consumer
sentiment, but there is a possibility that volume may pick up in FY21 if the recovery seen in the
agricultural sector continues and domestic interest rates continue to fall.

Approximately 40% of Singer’s revenue is financed by its in-house hire-purchase scheme, which is highly sensitive to domestic interest rates. Rising smartphone penetration and a shorter replacement cycle for
mobile phones should also support sales volume growth over the longer term.

Leading Market Position, Distribution Network: The affirmation of the National Long-term Rating is
underpinned by Singer’s leading market position in consumer durables retail, its portfolio of
products and brands, which are diversified across price points, its large island-wide distribution
and retail store network and the well-managed hire-purchase book with limited delinquencies.

Cost Efficiencies Support Margin: Fitch expects the EBITDA margin to improve by 50bp to 7.1% in
FY20 and to stabilise at 7.6% in FY21 owing to the implementation of cost-saving measures in early
FY20; Singer has improved its warehousing process and logistical operation and has optimised its
inventory-management system. However, a weakening local exchange rate poses risk to margins,
as 80%-85% of the products Singer sells are imported. Singer’s EBITDA margin contracted by 50bp
in FY19 due to the absorption of currency-related costs as a means to compete, rather than fully
passing on the cost escalation to customers.

No Extraordinary Support from Parent: Fitch will continue to rate Singer based on its Standalone
Credit Profile due to our assessment of the weak linkages between Singer and its parent, Hayleys
PLC, under Fitch’s Parent and Subsidiary Rating Linkage methodology. We do not expect Hayleys to
provide any extraordinary support to its subsidiary, despite its 90.4% stake, due to the size of
Singer’s balance sheet and significant debt as of FYE19.

Criteria Variation: Fitch’s Corporate Rating Criteria allows for the deconsolidation of subsidiaries
that are regulated banks from the financials of an industrial parent company when assessing the
parent’s credit rating. Singer Finance (Lanka) PLC (SFL, BBB(lka)/Stable), which is 79.93%-owned by
Singer, is a regulated finance company rather than a bank. However, local regulations for finance
companies are similar to those applicable to local banks. Therefore, Fitch has removed SFL’s
borrowings, cash balance and EBITDA from Singer’s consolidated financials. We do not expect
Singer to inject new capital into SFL in light of the subsidiary’s adequate capital adequacy ratio.

DERIVATION SUMMARY

Singer is the market leader in Sri Lanka’s consumer-durable retail industry, backed by a strong
portfolio of well-known brands and an extensive distribution network. Singer is rated one notch
above its closest peer, Abans PLC (BBB+(lka)/Stable), despite the latter’s better financial profile.

This is because Singer has a stronger business-risk profile than Abans due to its higher mix of
domestically manufactured products that insulates Singer’s inventory costs from a weakening local
exchange as well as Singer’s better-capitalised finance subsidiary, which limits the parent’s need to
inject fresh equity over the medium term.

Singer is rated two notches higher than DSI Samson Group (Private) Limited (BBB(lka)/Stable) due
to its more robust business profile, while DSI’s sales remain under pressure from increasing
competition in the local market.

Singer has a stronger business-risk profile than Sunshine Holdings PLC (A-(lka)/Stable) due to its
leading market position in consumer durables and significantly larger operating scale. However,
this is offset by Singer’s higher net leverage and more volatile cash flow because of the higher
discretionary demand for consumer durables than for Sunshine’s products. Therefore we rate
Singer and Sunshine at the same level.

KEY ASSUMPTIONS

– Revenue to decline by 6.8% in FY20 due to weaker sales in Singer’s digital media segment as a
result of the Huawei ban and dampened consumer demand for consumer durables in the short
term.

– Annual revenue growth of 8% during FY21-FY23 assuming a gradual improvement in consumer
sentiment, particularly if the recovery in the agriculture segment continues.

– EBITDA margin to increase by 50bp in FY20 due to internal cost saving measures.
– Capex to average around LKR790 million a year over the next couple of years on account of
investments in store network and maintenance.
– No capital infusions into the financial subsidiary.

RATING SENSITIVITIES

Developments that May, Individually or Collectively, Lead to the Outlook being revised to Stable
– Net adjusted debt/EBITDAR on track to fall to below 5.5x by FY21
– EBITDAR/(interest paid + operating lease rentals) on track to increase to more than 1.2x by FY21
(FY19: 1.1x)

Developments that May, Individually or Collectively, Lead to Negative Rating Action
– Inability to make meaningful progress to reduce net adjusted debt/operating EBITDAR to below
5.5x or improve EBITDAR/(interest paid + operating lease rentals) to more than 1.2x over the next
12-18 months

LIQUIDITY

Tight but Manageable Liquidity: Singer had LKR1.5 billion of cash and LKR4.5 billion in unutilised
credit facilities at FYE19 to meet LKR14.9 billion of debt maturing in the next 12 months, leaving
the company in a tight liquidity position. However, LKR9.1 billion of near-term debt maturities
related to working-capital loans, which we believe Singer will be able to roll over during the normal
course of business in given its healthy working-capital cycle.
(COLOMBO, 21 August 2019)