Fitch Ratings has affirmed Sri Lanka-based consumer and healthcare company Hemas Holdings PLC's National Long-Term Rating at 'AAA(lka)' with a Stable Outlook. The affirmation reflects the defensive nature of Hemas' operating cash flows stemming from its pharmaceutical trading and manufacturing, and fast-moving consumer goods (FMCG) businesses, which account for more than 90% of the group's EBIT. The recent exit from the cyclical leisure sector has further reduced the company's business risk. The rating also benefits from Hemas' exceptionally strong balance sheet and high rating headroom, with net leverage likely to remain below 1.0x over the next two years compared with the 4.5x leverage threshold for the current rating.
KEY RATING DRIVERS
Defensive Healthcare Business: We expect Hemas' healthcare business to grow in the low double digits over the medium term, amid strong demand from an ageing population, higher incidents of non-communicable diseases and rising affordability of private healthcare. Hemas is the leader in pharmaceutical distribution in Sri Lanka, supported by strong relationships with global principals and an extensive distribution network. The segment performed well during the Covid-19 pandemic, with revenue and EBIT rising by 21% and 40%, respectively, in the nine months to December 2020. Risks in Pharmaceuticals: The price of pharmaceuticals is regulated, with government approval required to increase prices on all drugs. Local distributors, such as Hemas, import most of the drugs they sell and a weakening rupee could lead to thinner margins when prices remain fixed. The government has revised prices of essential drugs only twice in the past four years, despite a currency depreciation of 35%. We expect Hemas to be able to mitigate the risk from a weaker currency due to its contractual arrangements with global suppliers and cost efficiencies. Growth from Pharma Manufacturing: We expect Hemas' new pharmaceutical manufacturing plant, which is expected to start commercial operations in the financial year ending March 2022 (FY22), to triple pharma manufacturing revenue in the medium term compared with FY20. The new plant has capacity to produce five billion tablets per year, and Hemas will use the new capacity to manufacture drugs under contract with its global principals for the domestic market and for export. Hemas also has the option of selling output to the government under its buy-back programme as the government seeks to reduce drug imports.
Recovery in Consumer Business: We expect Hemas' consumer business in home and personal care (HPC), and stationery to grow in the high single digits in the next two years amid recovery in consumer spending. The segment has been weak since April 2019 due to the Easter Sunday attacks and the Covid-19 pandemic, but HPC revenue has recovered to pre-2019 levels by end-December 2020. Hemas' stationery revenue is still below historical levels as schools were closed for most of FY21, but should recover from FY22 after schools reopened in March 2021.
However, Hemas' Bangladesh consumer business, is under pressure due to competition. The company invested to improve the value proposition of its main product and the distribution network, which helped the business to gain traction. It has also diversified its product offerings to reduce reliance on one product. Bangladesh remains a key growth driver for Hemas in the medium term as it has a much larger market size and the personal care market is under-penetrated compared with Sri Lanka. Benefits from Leisure Exit: Hemas disposed of its leisure business, which accounted for around 7% of group EBIT historically, in 2020 in line with its strategy of stream lining core operations. We believe the exit was timely as the segment would have been a cash drain on the group because tourist arrivals to the country are not expected to normalise until at least 2023.
The segment has been posting operating losses since April 2019 and would have required continuous maintenance capex to compete with larger and newer properties entering the market.
Stable Margins: We expect Hamas' EBITDA margins to stabilise to around 10% from FY22, similar to levels prior to FY20, helped by the recovery in sales in the consumer segment and disposal of the leisure business. However, currency-related cost increases in the pharma distribution and consumer businesses, and start-up costs for the pharma manufacturing plant could put pressure on margins in the near term. Hemas' EBITDA margin improved to 12.2% in 9MFY21 from 8.1% in FY20 amid aggressive cost-cutting and efficiency measures introduced at the height of the pandemic. Low Leverage Despite Investments: We expect Hemas' net leverage, defined as net debt to operating EBITDA, to remain comfortably below 1.0x over the next two years (0.3x in last 12 months to December 2020) amid strong cash flows from operations, which would be more than sufficient to meet the increased capex and dividends. We believe Hemas' annual capex to be around LKR4.5 billion, up from the LKR3.0 billion in the past four years, as it seeks to expand its core businesses organically. However, only around LKR1.5 billion of capex is for committed projects and maintenance.
DERIVATION SUMMARY
Hemas is a well-diversified conglomerate with exposure to the defensive pharmaceutical and consumer sectors, which account for more than 90% of its EBITDA. It is rated at the same level as Lion Brewery (Ceylon) PLC (AAA(lka)/Stable), whose rating reflects market leadership in the local beer industry, helped by high entry barriers and strong EBITDA margins. We expect Hemas to maintain leverage at the same level as Lion in the medium term. Hemas is rated at the same level as leading conglomerate Melstacorp PLC (AAA(lka)/Stable), whose rating reflects its dominant market position in spirits. Melstacorp has about 70% share of the domestic spirits market and substantially higher EBITDA margins than Hemas, which supports strong free cash flow generation (FCF). However, Hemas has maintained a stronger financial risk profile, which is characterised by low leverage and a conservative approach to investments. Hemas is rated one notch above local conglomerate Sunshine Holdings PLC (AA+(lka)/Stable) to reflect Hemas' larger operating scale and stronger market position in similar businesses. We expect both companies to maintain similar financial risk profiles.
KEY ASSUMPTIONS
Fitch's Key Assumptions
Within Our Rating Case for the Issuer
- Revenue growth in the low double digits in the next two years amid demand recovery in consumer, hospital and mobility segments and new capacity additions at the Morison pharma manufacturing plant
- EBITDA margin to stabilise at around 10% from FY22 as currency-led cost pressures in the pharma and consumer segments and start-up costs at the new pharma manufacturing plant would offset the recovery in consumer and mobility margins, savings from costcutting and absence of losses from the leisure sector.
- Capex to average LKR4.5 billion per year over FY22-FY24 with an estimated LKR3.0 billion consisting of discretionary expansion of Hemas' core businesses.
-Dividend pay-out to average LKR1.1 billion per year from FY22.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- There is no scope for an upgrade, as the company is already at the highest rating on the Sri Lankan National Rating scale. Factors that could, individually or collectively, lead to negative rating action/downgrade: - Group net debt/EBITDA rising above 4.5x on a sustained basis; - Group EBITDA/interest cover falling below 2.3x on a sustained basis
LIQUIDITY AND DEBT STRUCTURE
Comfortable Liquidity Position: As at end-December 2020, Hemas had about LKR6.3 billion of unrestricted cash to meet LKR5.7 billion of debt maturing in the next 12 months. Around LKR4.0 billion of its near-term maturities consist of short-term working capital lines, which we expect banks to roll over as they are backed by LKR12 billion of net working capital with a healthy cash conversion cycle of around 75 days. Hemas has unutilised but uncommitted credit lines of LKR22.0 billion at end-December 2020, which also support liquidity during the normal course of business. We believe Hemas will continue to have strong access to banks given its stable cash flow generation from diversified sources compared to most other local corporates.