Fitch affirms Sri Lanka’s Abans at BBB+(lka); outlook stable

Fitch Ratings has affirmed Sri Lanka-based retailer Abans PLC's (Abans) National Long-Term Rating at 'BBB+(lka)' with a Stable outlook. Fitch has also withdrawn the expected rating assigned to Abans' proposed senior unsecured debentures as the debt issuance is no longer expected to convert to final ratings in the near future. A full list of rating actions is at the end of this commentary. The affirmation of Abans' ratings reflects our view that the recent weakening in its leverage is temporary, and that the company will be able to deleverage in the next 12-18 months, underpinned by a recovery in sales across a number of its product segments this year. Abans' ratings also reflect its strong market position in consumer durable retailing in Sri Lanka, its extensive brand portfolio and wide distribution network compared with most peers. We expect Abans' net leverage (defined as lease adjusted debt net of cash/operating EBITDAR) to improve to 6.0x by the end of the financial year to March 2019 (FY19) from 7.7x in FYE17. However, failure to make significant progress towards this target in the next 12 months could result in negative rating action. KEY RATING DRIVERS Recovery in IT, Mobile Sales: Abans' revenue for the five months to August 2017 improved significantly yoy, supported primarily by its exclusive distributorship of Oppo mobile phones since end-2016. Oppo handsets are gaining strong traction in the low to mid-range market. Fitch expects Abans' IT and mobile segment to be the key growth driver in the medium term, aided by increasing smart phone penetration in the country and short replacement cycles compared with most other consumer durables. We believe Abans' IT and mobile portfolio is more balanced now with the introduction of brands in the low to mid-range price categories, which tend to be more defensive during a downturn. Abans has also secured the exclusive distributorship for Apple, the market leader in the premium mobile category. By FYE20 we expect the IT and mobile segment to become the largest contributor to group revenue. Lower Project Risk: We believe the risks to Abans' business profile from the Colombo City Center (CCC) mixed development project have fallen significantly from three years ago. We have therefore relaxed Abans' negative rating sensitivity on leverage to 6.0x from 5.5x previously. The project, a joint venture between Abans and a Singapore-based property developer, made significant progress last year, selling more than half of its residential apartments, and the retail mall is on track to open by early 2018. Abans now expects the apartments and the hotel to be ready for occupation by end-FY19. The project has secured key anchor tenants for around 70% of its retail space. Therefore, we believe the need for Abans to inject incremental capital into the project is minimal and we have not factored any such incremental cash outflows into our rating case forecast. Sluggish Demand Temporary: Abans' FY17 consumer durables revenue growth slowed to 1.7% following two years of double-digit growth. We expect only a moderate recovery in consumer durables sales in the next 9-12 months as we expect the weak operating environment to continue. Rising interest rates, an increase in direct and indirect taxes and currency depreciation, which affects the prices of products sold by retailers, could make consumer durables less affordable. The prevailing drought conditions affecting the livelihoods of a significant proportion of the population would also drive down demand with the lowering of disposable incomes. Further Margin Contraction Unlikely: Fitch believes further margin contraction is unlikely in the medium term due to a volume recovery across most product segments. This should help Abans in reducing discount sales and pass on cost increases which were absorbed by the company previously. Abans' EBITDAR margin contracted almost 400bp in FY17 on lower sales and cost pressures. Margin contraction was seen across most product segments as weak demand compelled the company to offer higher discounts to push through built-up inventory. The company also had to absorb a majority of the tax increases and supply-side cost pressures to sustain its top line. Abans should also see some margin upside from its central air-conditioning business, which has built a strong sales pipeline owing to the boom in the construction sector. The segment made operating losses in FY17. However a weakening local currency and increasing product costs would hamper any significant margin improvement at the group level in the medium term. Credit Metrics to Improve: Abans' net leverage deteriorated to 7.7x in FY17 (FY16: 5.4x) on its weak operating performance. We expect net leverage to drop to around 6.0x by FY19 and 5.6x in FY20 because we expect a significant improvement in demand. We do not expect significant capex or investment outflows in the medium term, which should also help in deleveraging. DERIVATION SUMMARY Abans is a leader in consumer durable retailing in Sri Lanka, with a strong portfolio of well-known brands and an extensive distribution network. Abans is rated one notch below its closest peer, Singer (Sri Lanka) PLC (A-(lka)/Stable) to reflect its comparatively weaker financial profile. Abans' business profile has also weakened relative to Singer due to investments in its large real estate project but we expect the risks to diminish with the project nearing completion. Abans is rated at the same level as DSI Samson Group (Private) Limited (BBB+(lka)/Stable), reflecting the former's stronger business risk profile as the dominant consumer durables retailer in Sri Lanka other than Singer. However, that is offset by Abans' weakening financial risk profile. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue growth to recover and average in the high single digits in the next two years. - EBITDAR margins to stabilise around 6% in the medium term. - Capex to average around LKR200 million a year in the medium term, primarily spent on maintenance - Dividend payout to be maintained at 15% of net profit RATING SENSITIVITIES Developments that may, individually or collectively, lead to positive rating action include: - A sustained improvement in Abans' adjusted net debt/EBITDAR to below 5.0x (FYE17: 7.7x) Developments that may, individually or collectively, lead to negative rating action include: - If Abans is unable to reduce its leverage in the next 12 months at a pace that would allow its adjusted net debt/EBITDAR to fall to 6.0x by FYE19. - Fixed-charge coverage (ratio of EBITDAR to gross interest + rent excluding Abans Finance) sustained below 1.25x (FYE17: 1.1x; Fitch forecast for FY19: 1.3x) LIQUIDITY Comfortable Liquidity Position: As of end-March 2017, Abans had LKR5.5 billion of unutilised but committed credit lines and about LKR700 million of unrestricted cash available to meet LKR2.2 billion of debt maturing in the next 12 months, placing the company in a manageable liquidity position. Abans has another LKR7.5 billion of short-term working capital related debt, which we expect will be rolled over by lenders in the normal course of business. FULL LIST OF RATING ACTIONS Abans PLC - National Long-Term Rating affirmed at 'BBB+(lka)'; Outlook Stable - National Long-Term Rating on outstanding senior unsecured debentures affirmed at 'BBB+(lka)' - National Short-Term Rating on commercial paper affirmed at 'F2(lka)' - Expected National Long-Term Rating of 'BBB+(EXP)(lka)' on proposed senior unsecured debentures withdrawn