Sri Lanka Telecom Rs7bn debt rated AAA(lka): Fitch
ECONOMYNEXT – Fitch Ratings said it assigned a AAA(lka) rating to Lanka Telecom’s proposed 7 billion debenture issue despite a new tax on mobile towers expected to erode margins.
Data is expected to drive growth for Sri Lanka Telecom which will also benefit from its market leadership position in fixed line, second largest mobile operator and extensive fibre network although returns will be lower due to low broadband tariffs.
A 200,000 rupee tax on mobile towers will result in additional taxes amounting to 3 billion rupees and lower earnings margins, but Fitch says the rating will not be affected.
The telco’s lower exposure to the crowded mobile market and diverse business platforms that generate stable cash flows are rating-positives.
The full Fitch Ratings report follows:
Fitch Ratings-Singapore/Colombo-05 April 2018: Fitch Ratings has assigned Sri Lanka Telecom PLC’s (SLT, AAA(lka)/Stable) proposed senior unsecured debenture issue of up to LKR7 billion a National Long-Term Rating of ‘AAA(lka)’.
The debentures will have a tenor of 10 years and carry fixed coupons. The debentures will be listed on the Colombo Stock Exchange, with the proceeds to be used to refinance short-term debt and fund capex plans.
SLT’s senior unsecured debt is rated at the same level as its National Long-Term Rating, as the debentures rank equally with other senior unsecured obligations. The final rating is the same as the expected rating assigned on 2 January 2018, and follows the receipt of documents conforming to information already received.
KEY RATING DRIVERS
Proposed Tax Credit Negative: Fitch believes SLT’s 2018 operating EBITDAR margin could decline to 24% (2017 estimate: 28%) and its funds flow from operations (FFO) adjusted net leverage could deteriorate to 2.5x (2017 estimate: 1.9x) if it were to pay an additional LKR3 billion tax for SLT’s fully owned subsidiary, Mobitel (Pvt) Ltd.’s mobile towers.
However, we believe that such high taxes are unlikely to be implemented in full, and have not therefore factored these into our base case. We expect SLT’s ratings to remain unaffected, even if the taxes are implemented, given the high ratings headroom.
The Sri Lankan government’s 2018 budget, announced on 9 November 2017, proposes to tax mobile operators LKR200,000 per tower each month.
Negative FCF; Large Capex: We expect a free cash flow (FCF) deficit during 2018-2020 (2017 estimate: LKR10 billion deficit), as cash flow from operations could fall short in funding large capex plans to expand the group’s optical fibre infrastructure and 3G/4G mobile networks. We expect capex to moderate to LKR24 billion-25 billion per year after peaking at LKR27 billion, or 36% of revenue, in 2017.
SLT’s fibre investments are likely to have low returns due to the country’s low broadband tariffs. Dividends are likely to remain around LKR1.6 billion-1.8 billion.
Data Drives Growth: SLT’s data revenue growth will improve following the removal of the telco levy on data services from September 2017, which lowered the effective tax rate to around 20% from 32%.
However, we forecast the EBITDA margin to narrow by about 50bp a year over 2018-2020, as improving profitability on fixed-broadband and mobile internet usage will only partly offset margin dilution from a falling share of profitable fixed-voice and international operations.
Overall revenue growth slowed to 2.6% in 2017 (2016: 8.5%) due to the reintroduction of value added tax and nation-building tax on telecom services, but should recover to the mid-single-digits in 2018-2019 along with better mobile-voice revenue and the robust data growth.
Solid Market Position: SLT’s ratings are underpinned by its market-leading position in fixed-line services and second-largest position in mobile, along with its ownership of an extensive optical fibre network.
Stable cash generation benefits from diversified service offerings, including fixed-voice, broadband, mobile, pay-TV, business-to-business and international operations. We believe SLT’s market position will strengthen, as it plans to expand its mobile and fibre infrastructure.
Market Consolidation, M&A Risk: We expect some industry consolidation due to on-going intense competition, especially in the mobile segment; this segment has five operators that face investment requirements that are still high, and the smaller operators are unprofitable.
SLT’s National Long-Term Rating could come under pressure if it were to perform a debt-funded acquisition of a smaller operator; any rating action will be based on the acquisition price, funding structure, and the financial and operating profile of the combined entity.
SLT has lower exposure to the crowded mobile market than Dialog Axiata PLC (AAA(lka)/stable),and more diverse service platforms. However, Dialog has a larger revenue base and better operating EBITDAR margin than SLT. SLT’s forecast FFO adjusted net leverage and FCF profile is worse than that of Dialog. SLT also has a larger capex plan relative to its EBITDA to expand fibre networks across Sri Lanka.
SLT has a larger operating scale compared with hard-liquor market leader Distilleries Company of Sri Lanka PLC (DIST, AAA(lka)/Rating Watch Negative), because a significant portion of the country’s alcoholic beverage consumption occurs outside the formal sector in which DIST operates. DIST is also exposed to more regulatory risk in the form of recurrent increases in indirect taxation, but these risks are counterbalanced by its substantially stronger FCF.
SLT has a larger operating scale and a wider EBITDAR margin than Hemas Holdings PLC (AA-(lka)/Stable), which is a diversified conglomerate with exposure to pharmaceuticals, fast-moving consumer goods, leisure and transport. Hemas is the largest private retail pharmaceuticals distributor in the country and second-largest home care and personal care manufacturer. Hemas’s FFO adjusted net leverage is likely to be better than that of SLT over the medium term.
Fitch’s Key Assumptions Within the Rating Case Include:
– Revenue growth to recover from 2018 to the mid-single-digit percentage, driven by fixed-broadband and mobile data services.
– Proposed mobile tower taxes are not implemented.
– Operating EBITDAR margin to narrow by about 50bp during 2018-2019 due to a change in revenue mix.
– Capex/revenue of around 28%-30% as SLT expands its fibre and 3G/4G networks.
– Dividend payout to remain around LKR1.6 billion-1.8 billion.
– FCF deficit during 2018-2020 resulting in gradual increase in FFO adjusted net leverage
Developments That May, Individually or Collectively, Lead to Positive Rating Action Include:
– There is no scope for SLT’s National Long-Term Rating to be upgraded as SLT is at the highest rating on the Sri Lankan National Ratings scale.
Developments That May, Individually or Collectively, Lead to Negative Rating Action Include:
– A debt-funded acquisition of a smaller operator could threaten SLT’s National Long-Term Rating, depending on the acquisition price and the financial profile of the combined entity.
Strong Access to Banks: SLT’s liquidity was inadequate at end-2017, with unrestricted cash and cash equivalents of around LKR5 billion and committed undrawn bank lines of around LKR8 billion being insufficient to fund short-term debt of LKR27 billion and the forecast 2018 FCF deficit of around LKR5 billion. However, we expect SLT to refinance its short-term debt comfortably, as the company has a demonstrated record of accessing capital from local banks and capital markets. (COLOMBO, 05 April, 2018)