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Sri Lanka’s Richard Pieris ‘A(lka)’ rating confirmed over supermarkets, palm oil

ECONOMYNEXT- Fitch Ratings has confirmed an ‘A(lka)’ rating Sri Lanka’s Richard Pieris & Company with a ‘stable outlook over its supermarket operations and palm oil, amid a Coronavirus crisis.

The rating was however withdrawn as it was made private.

“The affirmation reflects RICH’s ability to maintain net leverage commensurate with its ‘A(lka)’ rating in the next 12-18 months despite the vulnerability of some of its businesses to the coronavirus pandemic and the resultant economic downturn.” Fitch said.

“We expect operating cash flows from RICH’s supermarket retail business, which accounts for around 45 percent of group EBIT (earnings before interest and tax), and its protected domestic palm-oil plantations to remain resilient in the current environment, offsetting challenges in the export and plastic segment, which are exposed to more volatile end-markets.”

Fitch said it is expecting the revenue decline of 17 percent driven by a 50 percent decline in exports, 30 percent in plastics and 17 percent in supermarkets, mitigated by a 10 percent increase in plantations.

The ratings agency it is expecting the banks will be refinance the group’s short term debt consists of working capital facilities of about 12.7 billion rupees.

The full statement is reproduced below:

KEY RATING DRIVERS

Faster Supermarket Retail Recovery: We expect supermarket revenue to decline
by 15%-20% in FY21, mainly due to weaknesses in 1HFY21. We expect the retail
segment’s same-store sales growth to pick up from 2HFY21 once the curfew
imposed at end-March 2020 is relaxed to a larger extent. The majority of RICH’s
supermarkets, which are in the Western Province, were closed till 11 May due to
the curfew. RICH conducted its sales through online, and call and order channels
in the Western Province but sales were around 30% of normal levels. Stores have
been allowed to reopen, but footfall may not normalise immediately due to
continued social distancing requirements.

We expect consumer spending patterns on essential items such as food and
beverage, grocery items and personal and homecare to regularise starting
2HFY20 resulting in a gradual normalisation of foot fall and basket sizes.

However the supermarket chain will continue to see weakness in certain product
categories such as furniture and electronics as consumers defer such purchases.

Retail revenues should also benefit from new store openings in 2020 which will
start contributing meaningfully from 2HFY21.
Recovery in Plantation: We expect RICH’s plantation sector (15% of EBIT) to
recover in FY21, benefitting from better volumes across all crops and pricing
improvements in tea and palm oil. Demand for tea has been rising in the past few
months amid consumer preference for hot beverages since the pandemic and
supply disruptions in India.

This, together with local currency depreciation, has led
to a material price increase at the Colombo tea auctions. RICH’s tea volume
should also improve in FY21 due to the resumption of the use of pesticides and
weedicides, which were banned for a few years. Volatility in global demand and
prices remains a significant risk to our forecast for the sector.

RICH’s palm-oil volume should benefit in the medium term from an increasing
number of trees entering the higher yielding age bracket. The local palm-oil sector
benefits from tariffs on imports and local palm-oil prices are rising due to
increased import tariffs and the weakening local exchange rate, which offsets our
expectations of a decline in global palm-oil prices. We expect the plantation
sector to contribute around LKR600 million in EBITDA in FY20 and around LKR1
billion in FY21.

Weakness in Exports: RICH’s export segment (20% of group EBIT) will face a
significant revenue impact from the COVID-19. In FY20, the segment derived a
majority of revenue from North America and Europe, which are severely affected
by the pandemic.

Consequently, we expect demand for RICH’s premium-priced
latex mattresses to remain weak for a prolonged period. RICH is planning to shift
some of its sales to the fast-growing Chinese market, but we expect demand to
remain sluggish even in China despite early signs of economic recovery. The
export segment also derives modest revenue from rubber rings used in the food
business, and we expect this revenue to be resilient during the downturn.

Turnaround in Tyre Sales: RICH’s retreading business’s market position has
improved further due to the exit of its main competitor last year. The company has
been able to gain around 10% of market share due to the exit and currently holds
around 60% of the share as the rest of the competition is highly fragmented.

The government has banned the import of tyres to the country at least for the next
three-six months in an effort to support its external finances. This should drive
demand for retreading in the short-to-medium term. Customers in the transport
and logistics sectors that account for the majority of RICH’s retreading sales
should continue to spend on fleet maintenance to support their livelihoods.

Profits to Decline: We expect RICH’s EBIT to contract by 30% in FY21 amid
weaker sales, counterbalanced by the company’s cost-cutting measures. Retail
EBIT margins will weaken around 150 bp amid relatively large fixed costs.

However, RICH was able to move to a leaner cost structure in FY20 by adopting
cost effective sourcing strategies and rationalising some of its fixed costs, which
should help defend margins in a downturn. Its export, plastic and tyre segments
have variable cost structures and around 30% of fixed costs such as electricity
can also be contained when plant-utilisation levels are low. The company is also

introducing cost-cutting measures at the group level, including pay cuts, which we
estimate will amount to around 1% of FY21 revenue.

Leverage Increase Manageable: We forecast RICH’s leverage, defined as net
adjusted debt/operating EBITDAR (excluding its finance subsidiary), will rise to
3.0x in FY21 amid the weak operating environment. This is after factoring in lower
capex and dividends as RICH takes steps to preserve cash. The company has
decided to restrict capex to critical activities.

Thus, we expect a reduction of around LKR1.0 billion in FY21 compared with historical levels. We expect net leverage to fall to around 2.7x after FY21 on stronger cash flow generation across
all segments. Our forecasts factor in capital injections into RICH’s finance
subsidiary in FY21 and FY22 to meet its regulatory capital requirements.

DERIVATION SUMMARY

RICH is a diversified conglomerate with exposure to both defensive sectors and
growth markets. The company is rated two notches below domestic healthcare
and consumer company Hemas Holdings PLC (AA-(lka)/Stable), and Lion
Brewery (Ceylon) PLC (AA-(lka)/Stable), the country’s leading brewer, to reflect
RICH’s higher exposure to cyclical end-markets and the capital infusions required
at its weak finance subsidiary, which increase its business risks.

Sunshine Holdings PLC (A-(lka)/Stable), another domestic conglomerate, is rated
one notch below RICH to reflect its smaller operating scale due to competing in
somewhat niche markets, higher exposure to the cyclical plantation sector and
regulatory risk in pharmaceuticals, which more than offset Sunshine’s lower
leverage.

KEY ASSUMPTIONS

Revenue decline of 17% in FY21, driven by a 50% decline in exports, 30% in
plastics and 17% in supermarkets, mitigated by a 10% increase in plantations.
Revenue to rebound by 25% in FY22, helped by strong growth in supermarkets
and a gradual improvement in other sectors

EBIT margin to fall below 8.0% in FY21 and to recover to 9%-10% from FY22
Capex to reduce to around LKR800 million in FY21 to primarily cover
maintenance capex and retail expansion and increase to around LKR2.0 billion
per annum over FY22-FY23 once the company resumes its planned expansion.
No dividends in FY21 and payout to resume from FY22 as we expect the
operating environment to stabilise.

RATING SENSITIVITIES

Not applicable as the ratings have been withdrawn.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-
case rating upgrade scenario (defined as the 99th percentile of rating transitions,
measured in a positive direction) of three notches over a three-year rating
horizon; and a worst-case rating downgrade scenario (defined as the 99th
percentile of rating transitions, measured in a negative direction) of four notches
over three years.

The complete span of best- and worst-case scenario credit
ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case
scenario credit ratings are based on historical performance. For more information
about the methodology used to determine sector-specific best- and worst-case
scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Manageable Liquidity: RICH had around LKR4.0 billion of unrestricted cash and
LKR3.5 billion of unutilised but uncommitted credit lines at end-December 2019
compared with LKR13.9 billion of debt (excluding finance subsidiary obligations)
maturing in the next 12 months.

However, around LKR12.7 billion of RICH’s
short-term debt consists of working-capital facilities, which we believe banks will
be willing to refinance even in the current downturn, given the company’s
defensible position in most of its end-markets and diversified cash flows. RICH
has a record of accessing domestic banks through all points in the cycle.