Sri Lanka Dialog Axiata retains ‘AAA’ rating despite new taxes
COLOMBO (EconomyNext) – Fitch Ratings has confirmed Sri Lanka-based telecoms company Dialog Axiata PLC’s (Dialog) ‘AAA(lka)’ National Long-Term Rating with a stable outlook despite it being slapped with hefty new taxes.
The rating agency said it believes that Dialog’s 2015 operating profit margin will decline owing to the new taxes but that the rating was retained given the support of its Malaysia parent.
It also said Dialog’s leading market position should strengthen as the new taxes force out smaller players.
The full rating report follows:
Fitch Affirms Dialog Axiata’s ‘AAA(lka)’ Rating Despite Tax Change
Fitch Ratings-Singapore/Colombo/Sydney-13 March 2015: Fitch Ratings has affirmed Sri Lanka-based telecoms company Dialog Axiata PLC’s (Dialog) ‘AAA(lka)’ National Long-Term Rating. The Outlook is Stable.
KEY RATING DRIVERS
Stand-Alone Profile Under Pressure: Fitch believes that Dialog’s stand-alone credit profile of ‘AA+(lka)’ will come under pressure if it were to pay additional recurring and one-off taxes proposed in the Sri Lankan government’s interim budget announced in February 2015. We believe that Dialog’s 2015 operating EBITDAR margin will decline to around 23%-24% (2014: 33%) and its funds flow from operation (FFO)-adjusted net leverage will deteriorate to around 3.0x (2014: 1.3x), if it were to pay around LKR10bn in additional taxes – including LKR7bn-8bn in recurring and LKR3bn in one-off taxes.
Tax Changes Credit Negative: The proposed one-off and recurring taxes on the Sri Lankan telecoms sector raise regulatory risks and could result in lower profitability and higher financial leverage for all Sri Lankan telcos. The agency has revised its outlook on the sector to negative from stable.
The interim budget proposes a one-off "super gains" tax of 25% on profit, and a tax of LKR250m (USD1.8m) on each mobile operator. The proposals also shift the burden of recurring telecom levies of 25% on prepaid voice and 10% on data revenue on to the telcos from consumers. Any increase in tariffs by a telco is subject to approval by the telecoms regulator. A one-off tax of LKR1bn (USD7.5m) is also proposed on companies offering satellite direct-to-home (DTH) TV with more than 50,000 subscribers.
Rating Still AAA(lka): Fitch believes that Dialog still warrants a ‘AAA(lka)’ support-driven rating despite pressure on its stand-alone credit profile. The support-driven rating is based on Fitch’s assessment of strong operational and strategic linkages with its 83% parent, Axiata Group Berhad (Axiata) of Malaysia, which has a stronger credit profile. Linkages include sharing key management personnel, a common brand name and common creditors, which can result in reputation risk to Axiata should Dialog fail.
Market Position Intact: Dialog’s stand-alone profile is still underpinned by its market-leading position in Sri Lanka’s mobile and pay-TV industries. Its market position will probably strengthen following the tax changes as smaller telcos that are unprofitable could look to exit the market. Fitch expects Dialog’s leverage will start improving from 2016 towards 2.6x-2.7x in the absence of any further one-off taxes. Also, we believe that Dialog could reduce its capital expenditure in response to the additional taxes. The company’s capex/revenue ratio fell to 23% in 2014 from 44% in 2013.
Industry to Consolidate: We believe that the dramatic tax changes will hasten industry consolidation with the number of telcos possibly reducing to three from five. Two smaller unprofitable operators – Hutchison Lanka and Bharti Airtel Limited’s (BBB-/Stable) Sri Lanka subsidiary, Airtel Lanka – may exit the industry. We believe that market leaders Dialog and Sri Lanka Telecom PLC (BB-/Stable) could acquire the smaller operators to reduce price-based competition and consolidate spectrum assets.
Fitch’s key assumptions within our rating case for the issuer include:
– The tax changes proposed in the February 2015 budget come into force from 1 April 2015.
– Revenue to rise by high single-digits, driven by higher voice usage thanks to telecom levy savings and fast-growing data services.
– Operating EBITDAR margin to decline by 900bp-1,000bp due to higher recurring taxes and a change in revenue mix as a low-margin data revenue replaces more profitable voice and international service revenues.
– Capex/revenue to remain high at around 25%-30% on account of network expansion.
Negative: Future developments that may individually, or collectively, lead to negative rating action include:
– A material dilution in Axiata’s ownership or board control in Dialog, removal of the common brand name, or a weakening of the current strategic and operational ties between the companies.
– A decline in operating EBITDAR margin to below 20% along with FFO-adjusted net leverage above 3.5x on a sustained basis.
Positive: There is no scope for an upgrade as Dialog is at the highest rating on the Sri Lankan National Ratings scale.