Fitch Ratings has affirmed the National Long-Term Rating on Sri Lanka-based telecoms company Dialog Axiata PLC at 'AAA(lka)'. The Outlook is Stable.
KEY RATING DRIVERS
Mobile-Market Leader: Dialog's Standalone Credit Profile (SCP) of 'aaa(lka)' is underpinned by its market leadership in the expanding mobile and pay-TV segments. We believe Dialog will continue to gain revenue market share, given its superior execution and mobile networks. The company has a solid financial profile, with consistent revenue growth, a stable operating EBITDA margin and a low Fitch-forecast 2021 FFO net leverage of 0.4x-0.5x (2020 estimate: 0.5x).
Strong Revenue Growth: Based on unaudited reported results, revenue and EBITDA rose by 3% and 6%, respectively in 2020, before the operating lease adjustment under Sri-Lankan financial reporting standard 16. Dialog's growth outperformed the GDP contraction of 5% in the nine months ending September 2020, amid the pandemic. Dialog increased its mobile subscribers by 9% yoy, its digital TV households by 12% yoy and home broadband subscribers by 45% yoy during 2020.
We forecast 2021 revenue to grow by a mid-single-digit percentage and EBITDA margin to remain stable at 38%-40%, as larger economies of scale in the data segment and cost savings offset falling profits in the voice and text segments. Stronger profitability will be supported by robust growth of data traffic and a likely price hike in the digital TV segment in 2021.
Potential Support from Parent: We believe Dialog could receive support from its 83% Malaysia-based parent, Axiata Group Berhad (Axiata), if its SCP were to weaken. We assess the relationship between Axiata and Dialog as one of 'strong parent, weaker subsidiary and moderate linkages' under our Parent and Subsidiary Linkage Criteria. The linkages include sharing key management personnel, a common name and common creditors, which could result in reputational risk to Axiata should Dialog fail.
Increase in Capex: We forecast 2021 cash capex/revenue to be around 30% (2020 estimate: 16%) to address rising demand for 4G network and broadband connectivity due to increased data demand, which was a trend even before the Covid-19 pandemic. The company plans to expand 4G coverage to 95%-96% of the population, from 94% in 2020. Some of the capex that was committed in 2020 is likely to spill over into 2021 due to import restrictions amid pandemic.
Positive FCF: We expect Dialog to generate an FCF margin of 2%-6% in 2021-2023, despite the increase in capex. This is because cash flow from operations is likely to increase due to strong EBITDA margin and stable working capital requirements, which will be sufficient to fund its large capex plan and dividend commitments. Dividends are likely to be around LKR5 billion-6 billion (2020 estimate: LKR4 billion).
Stable Sector Outlook: We expect mean FFO net leverage for Sri Lanka Telecom PLC (SLT, AA-(lka)/Stable) and Dialog to be stable at around 1.5x. We expect further sector consolidation, and believe Airtel Lanka, a subsidiary of Bharti Airtel Limited (BBB-/Negative), may seek M&A due to mobile competition and higher taxes amid capex needs. Airtel Lanka acquired the 900MHz spectrum that was surrendered when Etisalat Lanka and Hutch Lanka merged in 2018. We expect the telcos to focus on profitability, and price-based competition not to intensify.
We expect 2021 industry revenue to rise by 5%-7%, driven by a surge in data and fixed broadband, following lower growth of 2%-3% in 2020. Mobile data service revenue is likely to expand by 15%-20% (2020F: 25%-30%) on higher smartphone penetration and rising data consumption.
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 a lower 2021 forecast FFO net leverage of 0.4x-0.5x (SLT's 2021 forecast: 1.9x), a larger revenue base and a better operating EBITDA margin. Dialog has demonstrated better market execution than SLT, with expansion of its market share and EBITDA.
Dialog's business risk profile is comparable to that of leading alcoholic-beverage manufacturer Melstacorp PLC (AAA(lka)/Stable). Melstacorp's subsidiary, Distilleries Company of Sri Lanka (DIST: AAA(lka)/Stable), controls 70% 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. However, Dialog has higher ratings headroom - given its financial profile -than Melstacorp. Dialog's forecast 2021 FFO net leverage of 0.4x-0.5x is lower than Melstacorp's around 4.0x.
Hemas Holdings PLC (AAA(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-leading position, larger operating scale and ability to generate a wider operating EBITDA margin, and its ability to pass on higher taxes to consumers. Hemas's ratings are constrained by regulatory pressures in the form of price controls in its pharmaceutical business. We forecast Hemas and Dialog to have similar net leverage ratios of 0.4x-0.5x in 2021.
KEY ASSUMPTIONS
Fitch's Key Assumptions Within Our Rating Case for the Issuer
- Revenue to grow at 5%-7% in 2021-2023
- EBITDA margin to be stable at 38%-40%
- Capex/revenue to be around 30% in 2021 before declining to around 25%. Committed capex for 2020 was higher than cash capex of LKR19.5 billion as part of it will spill over into 2021. As such, capex is committed but will be paid in 2021.
- Effective tax rate of 15%
- Dividends of 45%-50% of previous year's net income
- Annual equity injections of LKR500 million into Dialog Finance
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- There is no scope for an upgrade, as Dialog is rated at the highest end on the Sri Lankan National Ratings scale.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- We do not envisage any negative rating action in the medium term given the standalone strength of the business profile, low financial leverage and implied support from the stronger parent.
LIQUIDITY AND DEBT STRUCTURE
Adequate Liquidity: Dialog had sufficient unrestricted cash of LKR14 billion and undrawn committed bank facilities of LKR19 billion at end-2020 to cover the short-term debt maturities of about LKR21 billion. The company has strong access to local banks, being among the largest corporates in Sri Lanka. Debt consisted mainly of a USD163 million syndicated facility, USD17 million trade facilities and a LKR7 billion bank term loan at end-2020.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS
Dialog's SCP is 'aaa(lka)' and its National Rating therefore does not benefit from any support from its stronger parent, Axiata. However, Dialog's rating will receive a notch of support from its parent if its SCP were to weaken.
