Fitch Affirms Lion Brewery at ‘AA­(lka)’; Outlook Stable

(PRESS RELEASE) - Colombo­30 August 2016: Fitch Ratings has affirmed Sri Lanka­based Lion Brewery (Ceylon) PLC's (Lion) National Long­Term Rating of 'AA­(lka)' with a Stable Outlook. Fitch has also affirmed the National Long­Term Rating of 'AA­(lka)' on Lion's outstanding senior unsecured debentures. Fitch has maintained a Stable Outlook despite Lion's weakening credit metrics due to the one­time disruption to production caused by floods in May 2016. Fitch believes the brewery is well­placed to recover from the floods and expects its financial profile to remain consistent with its rating. KEY RATING DRIVERS Market Leadership: Lion is Sri Lanka's largest beer producer, with a leading domestic market share in the beer industry. Beer is the country's second most­consumed alcoholic beverage after arrack. Lion's credit profile is supported by its entrenched domestic brands and limited product substitution due to the high technical competence required for brewing beer in contrast to manufacturing spirits. Lion's leading position has helped the company secure new brands and access a wide distribution network. Slow Down in Revenue: Fitch expects revenue to decline in the financial year to 31 March 2017 (FY17) due to higher excise duties on beer introduced in 2015, as well as lost sales due to a temporarily halt in production, as Lion's manufacturing plant was heavily affected by Sri Lanka's adverse weather conditions in May 2016. However, Fitch expects beer sales to recover from FY18 onwards, supported by rising urbanisation, increasing tourist arrivals and increasing per capita income, which will help the segment regain lost market share. Lower EBITDA Margin: We expect Lion's EBITDA margin to normalise to around 27% in the mediumterm, from the high of 33% in FY16, mainly due to taxes on beer overtaking spirits on an equivalentalcohol basis since late 2015. However, Lion's margins should benefit in the long­term from operational efficiencies following an upgrade of its production facilities, which have sufficient capacity for the next five years. Effects From Floods Manageable: Lion's revenue declined 52% yoy in 1QFY17 due to lost inventory and a temporary manufacturing halt caused by the floods. The company is importing beer until local production recommences in late 2016 to mitigate the loss, but this is limited to its main product categories and may negatively affect margins due to the higher costs of imports. Losses on fixed­assets, stock and business interruption are covered by insurance, but the quantum of the claim or when Lion will receive payment is not yet determined. Balance Sheet Improvement Expected: Fitch expects Lion's financial leverage, measured as leaseadjusted net debt/operating EBTIDAR, to weaken in FY17 due to lower profitability from business interruption. However, the company should accelerate its deleveraging from FY18, benefitting from lower capex and normalised returns, bringing its leverage ratios below Fitch's negative triggers. High Regulatory Risk: Domestic producers of alcoholic beverages face high excise duties, which put legitimate alcoholic beverages outside the reach of many people. The 2015 double duty hike led to tax on strong beer ov ertaking the tax on hard liquor on an equivalent­alcohol basis, which we believe will slow the demand shift to beer from hard liquor. Fitch expects further tax increases on beer to moderate, now that beer is taxed more than hard liquor. Alcohol consumption appears to be inelastic to higher taxes, but if this reverts the government may moderate the tax, noting the importance of the sector's contribution to government revenue. The sector is also heavily regulated, with restrictions on advertising and limited issuance of new retail licenses. This creates high entry barriers that benefit entrenched players, such as Lion. KEY ASSUMPTIONS ­ Revenue to decline in FY17 followed by a steep recovery in FY18 and then to normalise to low­singledigit growth during FY19 and FY20, supported by favorable demand dynamics. ­Profitability, measured by EBITDA margin, to stabilise at around 27% during the forecast period. ­Capex of LKR1bn each year in FY17 and FY18, falling to LKR400m per year thereafter mainly for maintenance. ­No dividend in FY17 and current dividend policy maintained thereafter. ­Successful claim on losses in fixed­assets, stock and business interruption through the flood insurance policy. RATING SENSITIVITIES Negative: Future developments that may, individually or collectively, lead to negative rating action include adjusted­net debt/operating EBITDAR rising above 2.0x on a sustained basis (FY16: 1.
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8x, FY15: 2.6x) Positive: No positive rating action is expected over the next two years, as leverage is likely to remain high. However, future developments that may, individually or collectively, lead to a positive rating action include adjusted­net debt/operating EBITDAR falling below 1.5x on a sustained basis. LIQUIDITY Strong Liquidity: Lion had LKR3.4bn of cash and LKR5.3bn in unused credit facilities at FYE16 to meet LKR5.2bn of short­term debt. In addition, Lion has defensive cash flows and reliable access to bank funding as one of Sri Lanka's larger corporates.