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Tuesday February 27th, 2024

Sri Lanka Fitch confirms Sunshine Holdings at ‘A(lka)’

ECONOMYNEXT – Fitch Ratings said it has confirmed the National Long-Term Rating of Sri Lankan diversified conglomerate Sunshine Holdings at ‘AA+(lka)’ with a stable outlook.

“The affirmation and Stable Outlook reflect Fitch’s view that Sunshine’s exposure to defensive cash flow will support its financial metrics in the next 12-18 months, despite challenging operating conditions,” the rating agency said.

The full statement follows:

Fitch Affirms Sunshine Holdings at ‘AA+(lka)’; Outlook Stable

Fitch Ratings – Colombo – 04 May 2023: Fitch Ratings has affirmed Sri Lanka-based Sunshine Holdings PLC’s National Long-Term Rating at ‘AA+(lka)’. The Outlook is Stable.

The affirmation and Stable Outlook reflect Fitch’s view that Sunshine’s exposure to defensive cash flow will support its financial metrics in the next 12-18 months, despite challenging operating conditions.

Sunshine’s rating reflects its strong financial profile and solid market positions in healthcare, fast- moving consumer goods, such as packaged tea and confectionary, and palm oil plantations. The rating is constrained by a small operating scale, commodity-price volatility in Sunshine’s palm-oil business and regulatory risks in healthcare.

KEY RATING DRIVERS

Strong Balance Sheet: We expect leverage to remain below 1.5x through to the financial year ending March 2026 (FY26), after a rise to 1.4x in FY23 (FY22: 0.1x) due to higher working capital after Sunshine invested in inventory to manage supply disruptions amid the country’s foreign-currency shortage.

Leverage has also increased following the acquisition of Sunshine Tea (Private) Limited (STL), but much of the debt at STL is for working capital purposes and is backed by adequate net working capital assets.

We expect positive free cash flow in FY24 to improve Sunshine’s leverage, as its working capital cycle reverts to historical levels amid easing supply-chain disruption. Fitch believes Sunshine has sufficient headroom under its current rating sensitivities to engage in M&A, if required. However, large leveraged buy-outs or higher dividend payments than what we project pose medium-term risks.

Manageable Interest-Rate Risk: We expect EBITDA interest coverage to drop to around 3.0x in FY24, from 16.1x in FY22, owing to the high interest rate environment, but to remain above our negative sensitivity of 2.3x.

The average weighted prime lending rate reached 27% by December 2022, from 10% in March 2022, which saw Sunshine’s interest expense increase to LKR1.1 billion in 9MFY23 (9MFY22: LKR178 million).

We expect interest cover to improve beyond FY24, helped by lower debt stock and moderating interest rates.

Defensive Demand: We expect cash flow to be supported by consumers prioritising spending on essentials, such as pharmaceuticals and consumer staples, like tea. Nevertheless, revenue growth is likely to slow to the high-single digits in FY24, from 63% in 9MFY23, amid weaker consumer spending and moderating crude palm-oil (CPO) prices. The growth in 9MFY23 stemmed from higher prices to compensate for input cost inflation and rupee depreciation, while sales volume of most products declined as affordability waned.

Inflation to Pressure Margin: We expect the EBITDA margin to contract by around 200bp and to stabilise at 11%-12% over FY24-FY26 (9MFY23: 13.6%). Weak demand and inflation are likely to pressure the margins of the healthcare and consumer segments in the next 12-18 months.

About 65% of Sunshine’s pharmaceuticals are subject to regulatory price ceilings, limiting timely cost pass-through. Increasing operational efficiency, softening of imported input prices and a reduced exchange rate volatility should offset margin pressure to a certain extent.

We estimate that the palm-oil EBITDA margin will shrink by around 400bp to 43% from FY24 amid lower global CPO prices; we expect Malaysian CPO prices to fall to around USD600/tonne in 2024, from around USD915/tonne in 1Q23, on an output rebound. The domestic palm-oil price is also impacted by the weaker Sri Lankan rupee, as the price is pegged to the US dollar, but higher taxes on CPO imports provide support for price and sales volume.

Regulatory Risk in Palm Oil: The Sri Lankan government has banned the planting of oil palm since late 2019. However, this is unlikely to have a material impact on Sunshine’s cash flows during the FY24-FY26, as the average age of its oil-palm plantations is 12 years and the percentage of trees entering the prime productivity age of 8-20 years will continue to rise. We expect yield per hectare to increase in the medium term, providing adequate revenue visibility.

Palm oil accounted for 31% of EBIT in 9MFY23.

Conservative Approach to M&A: Sunshine has been reducing its exposure to the volatile agriculture segment, primarily tea, since 2019 in favour of more defensive sectors, such as consumer goods and healthcare, through M&A. Sunshine added STL, a tea exporter to its portfolio in early 2022 to diversify its operations and reduce business risks. We do not expect the company to expand outside its core business segments in a manner that would weaken its business profile.

DERIVATION SUMMARY

Hemas Holdings PLC (AAA(lka)/Stable) is rated one notch above Sunshine due to its larger operating scale and better competitive position across some operating segments, despite similarly defensive cash flow. Hemas is a diversified conglomerate with market leadership in defensive sectors, such as healthcare and consumer goods, which account for around 90% of its EBITDA.

Lion Brewery (Ceylon) PLC (AAA(lka)/Stable) is rated one notch higher than Sunshine to reflect its market leadership in the protected beer industry. Its market position is supported by high barriers to entry, including licensing requirements and a regulatory ban on advertising. Sunshine’s palm oil business also operates in a protected segment, due to taxes on imports and restrictions on replanting oil palm trees. However, unlike Lion’s beer business, which we believe will benefit from long-term economic growth and urbanisation, the long-term sustainability of domestic palm oil producers is uncertain given the replanting ban. Both Lion and Sunshine face a degree of regulatory risk in the form of excise duties and indirect tax hikes on Lion’s beer sales and price ceilings on some pharmaceuticals for Sunshine.

Leading conglomerate, Melstacorp PLC (AAA(lka)/Stable), is rated one notch above Sunshine due to its larger operating scale and better competitive position across some operating segments, despite similarly defensive cash flow. Melstacorp holds a dominant market position in spirits, which accounts for around 70% of the domestic alcoholic-beverage market. This supports Melstacorp’s high EBITDA margin and strong free cash flow. Both companies have engaged in acquisitions to expand their businesses, while maintaining balance sheet strength.

Sunshine has more defensive cash flow than Ceat Kelani Holdings Pvt Limited (CKH, AA+(lka)/Stable), as CKH faces competitive pressure from imports and is exposed to cyclical demand for vehicle tyres, although it benefits from a degree of import substitution amid the country’s weak foreign-currency reserves. CKH’s stronger financial profile results in the same rating as Sunshine.

Sunshine is rated one notch above DSI Samson Group (Private) Limited (DSG, AA(lka)/Stable), because DSG faces intense competition in its domestic footwear segment, which contributes around half of its EBITDA. DSG is also exposed to cyclical end markets its tire and rubber product segments, which contribute to the remaining EBITDA.

KEY ASSUMPTIONS

Fitch’s Key Assumptions Within Our Rating Case for the Issuer:

– Revenue growth to slow to high single digits in FY24 amid a continuing weak economic environment and a drop in palm oil prices. Domestic demand to recover from FY25, with revenue growth at close to double digits in FY26.

– EBITDA margin to settle at around 12% from FY24.

– Capex to average LKR1.0 billion-1.5 billion a year over FY24-FY25.

– Annual dividend payment of 40% of net income over FY24-FY25.

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Sri Lanka president appoints Supreme Court-faulted official as police chief after CC clearance

ECONOMYNEXT – Sri Lanka President Ranil Wickremesinghe appointed Deshbandu Tennakoon as the 36th Inspector General of Police (IGP) of the country after the Constitutional Council (CC) cleared the official who along with three other police officers were asked by the Supreme Court to compensate 2 million rupees in a fundamental rights case last year.

“President Ranil Wickremesinghe has appointed Deshbandu Tennakoon as the IGP in accordance with the provisions of the Constitution,” the President’s Media Division (PMD) said.

The island nation’s Supreme Court on December 14 ordered Tennakoon when he was the Acting IGP and three other officials to pay a compensation of 500,000 rupees each for the violation of the fundamental rights of an individual.

The Supreme Court also instructed the Police Commission to take disciplinary action against the said Police officers after it considered the petition filed by W. Ranjith Sumangala who had accused the Police officers of violating his fundamental rights during his detention at Mirihana Police Station in 2011.

The Supreme Court held that the four police officers violated the fundamental rights of the petitioner by his illegal arrest, detention and subjection to torture at the Mirihana Police Station, which was under the supervision of Tennakoon at the time of the arrest.

President’s Secretary Saman Ekanayake presented the official appointment letter to Tennakoon on Monday (26) at the Presidential Secretariat.

When Tennakoon was asked over if the Supreme Court decision would have an impact on his appointment as the IGP last week, he declined to comment, saying that it was a Supreme Court matter and he does not want to say anything about it.

Tennakoon was also criticized by Colombo Archbishop Cardinal Malcolm Ranjith when he was appointed as the Acting IGP citing allegations against him related to security lapses leading up to the Easter Sunday attacks which killed at least 269 in April 2019.

However, Tennakoon rejected the allegations. (Colombo/Feb 26/2024)

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No water tariff hike in Sri Lanka this year: Minister

Millennium Challenge Corporation Photo.

ECONOMYNEXT – Sri Lanka’s planned water tariff formula is ready, and the government will implement it this year only if the formula’s tariff is lower than the current price, Water Supply Minister Jeevan Thondaman said.

President Ranil Wickremesinghe’s government has been implementing IMF-led pricing policies on utilities and the Water Supply Ministry has already come up with a formula.

“There is a water tariff formula in place right now and we are waiting for it to be drafted and seek approval from the cabinet,” Thondaman told reporters at a media briefing in Colombo on Monday.

“Once this water tariff formula is in place, there will be an annual revision with an option of biannual review.

The formula has been developed with the help of the Asian Development Bank. The formula includes electricity and exchange rate among many others as components like the fuel formula.

The National Water Supply and Drainage Board (NWS&DB) increased the water tariff in August 2023, claiming that the operating cost had been increased owing to high interest payment for bank loans and increased electricity prices.

The last year revision saw the consumers paying 30-50 percent increase from the existing water bill.

Minister Thondaman said he will implement the new formula this year only if there is a reduction.

TARIFF CUT WILL BE IMPLEMENTED 

“We will have to wait to see what the formula is. If the formula shows us there needs to be a reduction in the water tariff, we can implement it. But if there is an increase, why should we burden the people when we are on a road to recovery?” he said.

He said a group of experts including University Professors are working on the formula and the numbers.

“Once they come with the number, we will have to take a decision on whether we are going to impose on the people or not,” he said.

“We have already spoken to the Asian Development Bank and informed them we have established the formula. But according to the ADB requirement of this policy-based loan, the implementation period is only in 2025.”

“But right now, you want to take the approval for the formula for sustainability.”

The Energy Ministry is considering a drastic slash in electricity tariff soon. Thondaman said the exact numbers will be decided on after the finalized electricity tariff.

However, he said that as per the formula, there has to be a up to 10 percent increase in the water tariff as of now.

“Given the current formula set up, there must be around a 9-10 percent increase. It was actually at 14 percent. What we have done is since it is at 14 percent, we also did a calculation to see how we can do a cost cutting,” he said.

“So, despite our cost cutting measures, there will be an increase of 9 or 10 percent. But we will not be imposing it as of now because this year is meant to be policy sector reforms. Next year is meant to be the implementation.”

“As per August 2023 water tariff hike, we are able to come close to sustainable. So right now, there is no issue in the water sector. But a formula eventually needs to be established.” (Colombo/Feb 26/2024)

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Sri Lanka rupee closes at 310.80/311.00 to the US dollar

ECONOMYNEXT – Sri Lanka’s rupee closed at 310.80/311.00 to the US dollar Monday, from 310.95/311.05 on Thursday, dealers said.

Bond yields were down.

A bond maturing on 01.02.2026 closed stable at 10.60/80 percent.

A bond maturing on 15.09.2027 closed at 11.80/90 percent down from 11.90/12.05 percent.

A bond maturing on 15.03.2028 closed at 12.00/12.15 percent down from 12.10/25 percent.

A bond maturing on 15.07.2029 closed at 12.20/70 percent from 12.20/95 percent.

A bond maturing on 15.05.2030 closed at 12.30/70 percent down from 12.40/95 percent.

A bond maturing on 15.05.2031 closed at 12.60/80 percent from 12.45/13.00 percent.

A bond maturing on 01.07.2032 closed at 12.50/90 percent from 12.50/13.30 percent. (Colombo/Feb26/2024)

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