Sri Lanka Telecom rating downgrade follows sovereign: Fitch
ECONOMYNEXT – Credit ratings agency Fitch said it has downgraded the state-owned Sri Lanka Telecom Plc (SLT) and its debentures to ‘AA+ (lka)’ from ‘AAA (lka)’ following a recaliberaltion of local ratings following a recent downgrade of the sovereign to ‘B’ from ‘B+’.
Fitch Ratings said SLT will have negative cash flow over the next financial year as it makes capital expenditure to expand fibre infrastructure and its 4G mobile network.
"We expect revenue to grow by a mid-single-digit percentage during 2019-2020 (barring any tax shocks), driven by data and fixed-broadband growth," Fitch Ratings said.
It also said the recent merger of Hutchison Telecommunications Lanka (Private) Ltd and Etisalat Lanka (Private) Ltd is likely to reduce competitive pressure on SLT.
The full Fitch Ratings statement follows:
Fitch Ratings has taken rating action on non-financial corporates following the recalibration of its Sri Lankan National Rating scale to reflect changes in the relative creditworthiness among the country’s issuers following the downgrade of the sovereign rating to ‘B’ from ‘B+’ on 3 December 2018.
For details, see https://www.fitchratings.com/site/pr/10061317 Fitch Ratings: Recalibration of Sri Lanka National Rating Scale, dated 4 February 2019.
National scale ratings are a risk ranking of issuers in a particular market designed to help local investors differentiate risk. Sri Lanka’s national scale ratings are denoted by the unique identifier ‘(lka)’.
Fitch adds this identifier to reflect the unique nature of the Sri Lankan national scale. National scales are not comparable with Fitch’s international ratings scales or with other countries’ national rating scales.
KEY RATING DRIVERS
SRI LANKA TELECOM PLC:
Sovereign Downgrade: The downgrade of SLT’s National Long-Term Rating to ‘AA+(lka)’ from ‘AAA(lka)’ reflects the downgrade of the sovereign’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘B’ from ‘B+’ with a Stable Outlook.
Simultaneously, Fitch has downgraded the national rating on SLT’s LKR7 billion senior unsecured debt programme to ‘AA+(lka)’ from ‘AAA(lka)’.
SLT’s ratings are constrained by the sovereign as per Fitch’s Parent and Subsidiary Rating Linkage criteria.
We assess the relationship between the sovereign and SLT as one of a weaker parent and stronger subsidiary with strong operational and strategic linkages.
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 at 44.9%, has no special provisions in its shareholder agreement to dilute the government’s significant influence over SLT.
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 could be insufficient to fund capex requirements to expand the fibre infrastructure and 4G mobile networks.
We expect SLT’s 2019 capex to remain high, at around 28%-30% of group revenue (2018 estimated: 30%), as it aims to complete its 4G population coverage to around 95% by end-2019.
However, management expects its capex/revenue to decline to around 18%-20% in 2019.
We expect SLT to continue to invest in expanding fibre coverage as it aims to connect about 1 million homes by 2020-2021, from the 70,000 homes currently enabled.
SLT would typically need to lay fibre for at least 2 million homes for half of the households to be 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-Driven Growth: We expect revenue to grow by a mid-single-digit percentage during 2019-2020 (barring any tax shocks), 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 only a limited impact on growth.
Industry Consolidation: 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.
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 will be insufficient, however, 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 unconstrained standalone credit profile is stronger than that of the government of Sri Lanka, reflecting the company’s market leadership 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.
SLT has lower exposure to the crowded mobile market and more diverse service platforms than mobile-market leader Dialog. However, Dialog has a larger revenue base, better operating EBITDAR margins, lower forecast FFO adjusted net leverage and a better FCF profile than SLT.
– Revenue to grow by a 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 its fibre and 4G network.
– Operating EBITDAR margin to remain stable at around 29%-30%.
– Effective tax rate of 28%.
– Dividend payout of LKR1.6 billion-1.8 billion per year.
Developments that May, Individually or Collectively, Lead to Positive Rating Action
– An upgrade in the Sri Lankan sovereign’s Long-Term IDR would result in an upgrade on SLT’s National Long-Term Rating
Developments that May, Individually or Collectively, Lead to Negative Rating Action
– A downgrade in the Sri Lankan sovereign’s Long-Term IDR would result in a downgrade on SLT’s National Long-Term Rating
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 access to local banks. It has demonstrated a solid track record of accessing capital from local banks and capital markets.