Fitch affirms Sri Lanka’s Dialog Axiata at AAA(lka); outlook stable

Apr 02, 2019 (LBO) – Fitch Ratings has affirmed the National Long-Term Rating of Sri Lanka-based telecoms company Dialog Axiata at 'AAA(lka)' with a stable outlook. KEY RATING DRIVERS Mobile-Market Leader: Dialog's standalone credit profile of 'AAA(lka)' is underpinned by its market leadership in the growing mobile and pay-TV market segments. We believe that Dialog is in a position to gain revenue market share from smaller telcos, given its superior execution and mobile networks. High Ratings Headroom: We believe that Dialog could receive support from its 83%-parent, Axiata Group Berhad (Axiata) of Malaysia, if its standalone credit profile were to weaken. Under Fitch's parent-subsidiary linkage criteria, we assess the relationship between Axiata and Dialog as one of a "strong parent, weaker subsidiary and moderate linkages". The linkages include sharing key management personnel, a common name and common creditors, which could result in reputational risk to Axiata should Dialog fail. Solid Financial Profile: The company has a solid financial profile, with industry-leading revenue growth, a stable operating EBITDAR margin of 37%-38%, and a low Fitch-forecast 2019 FFO adjusted net leverage of around 1.0x (estimated 2018: 1.0x). We forecast revenue to grow by the high-single-digit percentage (barring any tax shocks) during 2019-2020, driven by data services revenue growth of 30%-35% (2018: 32%). Revenue and EBITDA grew by 16% and 18%, respectively, during 2018, based on preliminary financial results. We expect the government's 2018 announcement on the removal of floor rates for voice call charges to have only a limited impact on growth. Stable Profitability: We forecast Dialog's operating EBITDAR margin to remain stable, as larger economies of scale in the data segment offset falling profitability in the voice and text segments. Strong data growth is supported by proliferation of smartphones; over 80% of new handsets activated on Dialog's network are 4G-enabled. Telecom tower tax of LKR200,000 per tower (effective from January 2019) will have only a limited impact on operating EBITDAR margin given annual tax liability of around LKR400 million - about 0.4% of 2018's revenue. Limited FCF: We forecast limited FCF during 2019-2020 as cash flow from operations will be just sufficient to fund the large capex plan and dividend commitments. We forecast capex/revenue to be around 28%-30% to expand the 4G networks and optical fibre infrastructure during 2019-2020. Dividends are likely to be around LKR3 billion-4 billion (2018 estimate: LKR3.7 billion). Debt-Funded M&A: Dialog's ratings have sufficient headroom for the company to undertake a debt-funded acquisition of a smaller operator. However, any rating action would depend on the acquisition price, funding structure, and the financial and operating profile of the combined entity. Stable Sector Outlook: Fitch's outlook for the Sri Lankan telco sector is stable, as we expect the mean net leverage for Sri Lanka Telecom PLC (SLT, AA+(lka)/Stable) and Dialog to remain stable at around 1.4x-1.5x in 2019. We expect the sector's cash generation to improve, driven by higher mobile and broadband data usage. This will be insufficient, however, to fund the large capex requirement, leading to negative FCF. We expect average operating EBITDAR margins to remain stable, driven by improving economies of scale in the data and home broadband segment, offsetting the negative impact of the changing revenue mix. We believe the recently announced merger between Hutchison Telecommunications Lanka (Private) Ltd and Etisalat Lanka (Private) Ltd is likely to relieve some competitive pressures that have undermined telecom companies' revenue and EBITDA growth in recent years. The merger is pending regulatory approval. DERIVATION SUMMARY Dialog's business risk profile is stronger than that of similarly rated national peers, given its market-leading position in Sri Lanka's mobile industry, stable cash generation, and integrated service offerings. Dialog's financial profile is better than that of SLT, with lower 2018 FFO adjusted net leverage of 1.0x (SLT: 1.8x for 2018), a larger revenue base and a better operating EBITDAR margin. Dialog has demonstrated better market execution than SLT, with its growing market share and rising EBITDA. Dialog has a comparable business risk profile relative to leading alcoholic-beverage manufacturer Melstacorp PLC (AAA(lka)/Stable). Melstacorp's subsidiary, Distilleries Company of Sri Lanka (DIST: AAA(lka)/Stable), controls 60% of Sri Lanka's spirits production, and has maintained its market leadership due to its entrenched brand and access to a country-wide distribution network. Both Dialog and Melstacorp have shown an ability to pass on the higher taxes to consumers. However, Dialog has higher ratings headroom, given its financial profile is stronger than Melstacorp. Dialog's 2018 FFO adjusted net leverage of 1.0x is lower than Melstacorp's 1.9x-2.0x. Hemas Holdings PLC (AA-(lka)/Stable) is the largest private pharmaceuticals distributor in the country, and has a presence in leisure and the fast-moving consumer goods (FMCG) sectors. Dialog has a significantly stronger business profile with its market position, larger operating scale and ability to generate a wider operating EBITDAR margin, and its ability to pass on higher taxes to consumers. Hemas's ratings are currently constrained due to regulatory pressures in the form of price controls in its pharmaceutical business. Hemas's FFO adjusted net leverage is likely to be similar to that of Dialog over the medium term. KEY ASSUMPTIONS Fitch's Key Assumptions Within Our Rating Case for the Issuer - High-single-digit revenue growth during 2019-2020 (2018 estimates: 16%) - Operating EBITDAR margin to remain stable around 37%-38% during 2019-2020 (2018 estimates: 38%) - Capex/revenue to remain high at around 28%-30% (2018 estimates: 29%) - Dividend payout of LKR3 billion-4 billion during 2019-2020 (2018 estimate: LKR3.7 billion). RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Positive Rating Action - There is no scope for an upgrade as Dialog is at the highest rating on the Sri Lankan National Ratings scale Developments That May, Individually or Collectively, Lead to Negative Rating Action - FFO adjusted net leverage above 3.5x, provided there is no further strengthening of rating linkages with the parent, Axiata. LIQUIDITY AND DEBT STRUCTURE Solid Liquidity: Dialog had sufficient unrestricted cash balance of LKR10 billion and undrawn committed bank facilities of LKR10 billion to pay for its short-term debt maturities of about LKR5 billion as of end-2018, based on preliminary 2018 financial statements. The company has strong access to local banks, being among the largest corporates in Sri Lanka. Debt consists mainly of a USD205 million syndicated facility and LKR14 billion bank term loan.