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Monday April 22nd, 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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IMF official: Sri Lanka’s road ahead is challenging, critical to keep up with reform momentum

ECONOMYNEXT –International Monetary Fund’s First Deputy Managing Director Gita Gopinath said Sri Lanka’s future with many reforms are challenging, but it is critical to keep up with the reform momentum.

Gopinath stated this after meeting the island nation’s State Finance Minister Shehan Semasinghe Central Bank Governor Nandalal Weerasinghe, and Treasury Secretary Mahinda Siriwardena on the sideline of the IMF/World Bank Spring Meetings in Washington.

“I commended them on hard-won economic gains in the past year. The road ahead is challenging and it’s critical to keep up with the reform momentum,” Gopinath wrote on her X platform.

Under IMF programme, President Ranil Wickremesinghe has implemented a raft of hard reforms including higher taxes.

Sri Lanka agreed to the IMF programme after it declared bankruptcy with sovereign debt default in April 2022.

Semasinghe after the meeting tanks Gopinath for acknowledging Sri Lanka’s economic progress.

“Our discussion was insightful and productive, and we appreciate the opportunity to delve into the challenges and opportunities ahead,” the State Finance minister said in his X platform.

“We remain steadfast in our commitment to our reform agenda and eagerly anticipate continued collaboration with the IMF to advance our shared goals.”

Sri Lanka was compelled to go for IMF after the unprecedented economic crisis which was followed by a political crisis that ousted former president Gotabaya Rajapaksa and his government who were legitimately elected.

The IMF programme has included reforms in state-owned enterprises, fiscal sector and financial sectors to ensure debt sustainability.

The global lender also has pledged its support to speed up the island nation’s lingering debt restructuring process with private creditors including sovereign bond holders. (Colombo/April 22/2021)

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Sri Lanka motor racing crash claims 7 lives, 4 critical

ECONOMYNEXT – A deadly accident at motor Race Sri Lanka’s hill country town of Diyathalawa has claimed at least 7 lives police said, after a racing vehicle, in the seasonal Fox Hill Super Cross ploughed in to spectators after running off the track.

Another 21 spectators were injured Sunday, and hospitalized and at least four were critical, police said.

Thousands of people come to watch the Fox Hill Super Cross race, which is usually held in April, as large numbers of people head to the cooler climes in the hills.

According to footage taken by spectators one car overturned on the side of the track.

Sri Lanka’s Newsfirst television said Marshalls were waving flags to caution other vehicles, when another car went off the track and crashed into spectators. (Colombo/April21/2024)

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Widespread support for Sri Lanka debt workout, reform progress at IMF/WB meet: Minister

ECONOMYNEXT – There was widespread support for Sri Lanka’s debt restructuring and acknowledgement of progress made under an International Monetary Fund program, at meeting of the fund and World Bank, State Minister for Finance Shehan Semasinghe said.

“The strides made in our economic recovery and financial stability have been acknowledged as significant advancements towards our country’s prosperity by our stakeholders and international partners,” Minister Semasinghe said in an x.com (twitter) post after attending the meetings.

“Further, it was heartening to note the widespread appreciation and support for Sri Lanka’s debt restructuring process.

“We remain steadfast in our commitment to reaching the restructuring targets and confident of smooth progress in the continued good-faith engagements for a speedy debt resolution that will ensure debt sustainability and comparability of debt treatment.”

Sri Lanka ended a first round of talks with sovereign bondholders in March without striking a deal but some agreement on the basis for a deal.

An initial deal with bilateral creditors have been reached, but they may be awaiting a deal with private creditors to sign formal agreements.

International partners have appreciated reforms made under President Ranil Wickremesinghe, Minister Semasinghe said.

“It was great to engage in productive bilateral discussions with all of whom appreciated the recent economic developments, progress in debt restructuring, strengthening of tax administration, and ongoing governance reforms,” he said.

Sri Lanka’s rupee has been allowed to re-appreciate by the central bank amid deflationary monetary policy, bringing tangible benefits to people in the form of lower energy and food prices, unlike in past IMF programs.

Electricity prices were cut as a strengthening currency helped reduce the cost of coal imports.

Related Sri Lanka central bank mainly responsible for electricity price cut

The currency appreciation has also allowed losses to the Employment Provident Fund imposed to be partially recouped, helping old workers near retirement, as well as raising disposable incomes of current wage earners on fixed salaries.

Related Sri Lanka EPF gets US$1.85bn in value back as central bank strengthens rupee

The IMF, which was set up after World War II to end devaluations seen in the 1930s after the Fed’s policy rate infected other key central banks, started to actively encourage depreciation after a change to its founding articles in 1978 (the Second Amendment).

The usefulness of money as a store of value, or a denominator of current and future values then decline, leading to loss of real savings, real wages and increases in social unrest.

Before that, members who devalued more than 10 percent after printing money for growth or any other reason, faced the threat of suspension from the organization as punishment.

Sri Lanka’s rupee has appreciated to around 300 to the US dollar now from 370 after a surrender rule was lifted in March 2023.

But there is no transparency on the basis that economic bureaucrats are allowing the currency to gain against the US dollar (the intervention currency of the central bank).

The rupee is currently under pressure, despite broadly prudent monetary policy, due to an ‘oversold position’ in the market after recent appreciation made importers and banks to run negative open positions as the usefulness of the currency as a denominator of future value declined with sudden strenghtening. (Colombo/Apr21/2024)

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