Hayleys is one of Sri Lanka's old conglomerates with diversified interest including the making and exporting fibre-based products, rubber gloves and coconut-based activated carbon, sale of agriculture-related equipment and consumer durables, ship-owning and other transportation and logistics services, agricultural produce and plantations.
The group's credit outlook has been rated 'stable', following the downgrade.
"The downgrade reflects the continued weakening of Hayleys' creditor protection metrics and the lack of a sound strategy to address these developments," the rating agency said.
The agency recognises that FY06 was a particularly difficult year for the company as its earnings were seriously affected by high raw material prices and adverse currency volatilities.
The agency, however, expects some relief in raw material prices and relatively benign currency movements in FY07, which should lead to better earnings and operating cash flow generation.
"Any improvements in the creditor protection measures are expected to be limited given the continuing capital expenditure and the high incremental working capital requirement."
The rating continues to incorporate the diversified nature of Hayleys' business operations and its established brand name in its respective businesses.
Hayleys has achieved robust sales growth in recent years through the expansion of its traditional businesses and by venturing into new areas.
The company has taken initiatives to set up offshore manufacturing units to broaden its manufacturing capacity and ensure better access to raw materials in several business sectors.
Fitch expects this to add more stability to the operating results of the company.
The agency, however, notes that much of Hayleys' investments have been debt-financed.
Moreover, the annual incremental working capital requirement of some of the company's businesses absorbs around 40 percent to 60 percent of its cash flows generated, adding further pressure on its free cash flows.
Fitch expects Hayleys to maintain its capex at an increased level of about six to seven percent of annual group sales.
At the same time, the agency believes that its management recognises the need to prune some of the underperforming business units that are a drag on the group's performance and to critically review the investment portfolio of the company.
The agency notes that Hayleys' equity infusions have been limited to annual rights issues of about 100 million rupees.
"Although a sizeable equity infusion is helpful, it will require the existing key shareholders to commit required funding or agree to a dilution of ownership share."
Leverage measured by net debt/EBITDA was 2.3 times for FY05, which increased to 2.8 times at FYE06, reflecting an increased in debt and a weakened earnings.
The Stable Outlook underpins Fitch's view that the expected improvements in the operating conditions will benefit the group in FY07 and lead to improved credit metrics.
That said, capital expenditure will have to be conservative, particularly if they are to be mainly debt-financed, to avoid further pressure on the rating or its outlook.
Fitch had revised Hayleys' rating Outlook to Negative in January 2005, reflecting the increasing leverage of the company driven by large debt funded investments.
Hayleys' total debt was 9.8 billion rupees at FYE06 (up from 8.
1 billion rupees at FYE05).
Broadly, two-thirds of its debt consists of short-term and floating rate facilities, and exposes the group to changes in interest rates.
Maturity profile of its long-term debt is spread out and is manageable.
The group had cash reserves of 2.0 billion rupees and some 6.0 billion rupees of committed, undrawn credit facilities at FYE06.
Although the group's borrowing capacity with a few large local banks is stretched owing to single borrower restrictions, its liquidity and financial flexibility appear adequate under current circumstances.
Hayleys Limited is one of Sri Lanka's largest and most diversified conglomerates and has been established for more than 125 years.
About 60 percent of the company's revenue is derived from sales to overseas markets.