Fitch rates Singer Sri Lanka’s proposed debenture ‘A- (lka)(EXP)’

Jul 20, 2018 (LBO) - Fitch Ratings has assigned Singer (Sri Lanka) PLC's (A- (lka)/Stable) proposed senior unsecured redeemable debenture issue of up to LKR1.5 billion an expected National Long-Term Rating of 'A-(lka)(EXP)'. The proposed debenture is rated at the same level as Singer's National Long-Term Rating, fitch said. The full statement follows Fitch Ratings-Colombo-20 July 2018: Fitch Ratings has assigned Singer (Sri Lanka) PLC's (A- (lka)/Stable) proposed senior unsecured redeemable debenture issue of up to LKR1.5 billion an expected National Long-Term Rating of 'A-(lka)(EXP)'. The debenture is to be issued at a fixed rate with a tenor of three years. Proceeds will be used to refinance debt. The proposed debenture is rated at the same level as Singer's National Long-Term Rating, as it ranks equally with its other senior unsecured obligations. The final rating is subject to the receipt of final documents conforming to information already received. KEY RATING DRIVERS Recovery in Sales Volume: We expect demand for consumer durables to pick up in the mediumterm as consumers adjust to higher costs, supported by an earnings recovery in the agricultural sector, continued low personal taxes and stable interest rates. Singer's consumer electronics and home appliance revenue growth slowed to 1% in 2017 on weak demand, after two years of double-digit growth, due to higher indirect taxes and a prolonged drought that affected the livelihood of a significant proportion of Sri Lanka's population. We believe Singer was able to better respond to the weak demand compared with peers due to its defensive product portfolio and strong brand presence. Growth in IT, Digital Media: Fitch expects Singer's IT and mobile segments to be key growth drivers in the medium term, aided by Sri Lanka's increasing smartphone penetration and short replacement cycles compared with most other consumer durables. Singer is the country's largest smartphone retailer and exclusive agent for Huawei, Sri Lanka's second-largest smartphone brand. Singer's IT and digital media revenue has increased at a CAGR of 57% over the past five years. We expect it to maintain its market leadership for the next three years, with the renewal of its contract with Huawei. EBITDAR Margins to Stabilise: Fitch expects Singer's EBITDAR margin to improve by around 50bp60bp from the current level of 9.1%, to stabilise at around 9.5% from 2019, on better sales volume and cost pass-through to customers. Singer's EBITDAR margin contracted by almost 150bp in 2017 due to lower sales as well as higher indirect taxes and sales costs. The margin contraction was seen across most product segments, as weak demand compelled the company to absorb a majority of the tax increases and cost escalations to sustain top-line growth. Leverage to Improve: We expect Singer's leverage to improve meaningfully from 2019 amid the recovery in the operating environment and better margin, but headroom under the current rating will remain low due to high capex, dividend payments and working capital investments, which may limit debt pay down. Higher inventory build-up amid sluggish demand, coupled with lower profitability in 2017, saw leverage worsen to 5.5x, compared with 4.3x at end-2016. No Extraordinary Support from Parent: Fitch will continue to rate Singer on its financial strength due to weak-to-moderate linkages between Singer and its new 81% parent, Hayleys PLC, under Fitch's Parent and Subsidiary Rating Linkage Criteria, as well as the size of Singer's balance sheet and significant debt at end-2017. Hayleys acquired a controlling stake in Singer in 2017. We do not expect additional pressure for higher dividend payments from Hayleys, as Singer's average dividend payout, at around 60% of after-tax profit, is already high on average compared to most corporates. Low Dependence of Singer Finance: We do not believe Singer will be called upon for an additional capital infusion to Singer Finance (Lanka) PLC (BBB(lka)/Stable) due to the 80%- owned finance subsidiary's strong capitalisation, which is well above the regulatory minimum, better-than-peer asset quality and strong funding profile. Singer's last equity infusion of LKR550 million was in 2017 to support the subsidiary's new credit card business. DERIVATION SUMMARY Singer is Sri Lanka's co-market leader in consumer-durable retail, backed by a strong portfolio of well-known brands and an extensive distribution network. Singer is rated one notch above its closest peer, Abans PLC (BBB+(lka)/Stable), to reflect its stronger financial risk profile. Abans' business profile has also weakened relative to Singer due to its investment in a large real-estate project. The one-notch differential between DSI Samson Group (Private) Limited (BBB+(lka)/Stable) and Singer stems from Singer's better business risk profile, as it enjoys a robust market position in the sale of consumer durables domestically, while DSI's sales remain under pressure from rising local-market competition. Sunshine Holdings PLC (A-(lka)/Stable) is rated at the same level as Singer due to Singer's stronger business risk profile and significantly larger operating scale being offset by higher leverage and more volatile operating cash flow stemming from the higher discretionary demand for its products. Richard Pieris & Company PLC (A(lka)/Stable) is rated one notch above Singer due to its stronger business risk profile, reflected in its cash flow diversity, more defensive endmarkets and lower leverage. KEY ASSUMPTIONS Fitch's Key Assumptions Within Our Rating Case for the Issuer - Revenue growth to average in the low double digits from 2019-2021, helped by a volume recovery in consumer electronics and home appliances as well as strong growth in IT and mobile-product sales. - EBITDAR margin to improve and stabilise at around 9.5% from 2019, amid better cost passthrough and volume recovery. - Capex to average around LKR800million per annum over the next couple of years, to be spent on store refurbishment. - Dividend payout to average around LKR820million per year for the next two years. - No equity infusions into Singer Finance. RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action - Singer's leverage - as measured by adjusted net debt/EBITDAR, excluding Singer Finance - falling below 4.5x on a sustained basis (end-2017: 5.5x) - Fixed-charge coverage, as measured by operating EBITDAR/interest paid + rent, sustained above 1.5x (end-2017:1.4x) Developments that May, Individually or Collectively, Lead to Negative Rating Action - A sustained increase in Singer's leverage to over 5.5x - Fixed-charge coverage falling below 1.2x for a sustained period - Any significant equity support to subsidiary, Singer Finance LIQUIDITY Tight but Manageable Liquidity: Singer had LKR1.8 billion of cash and LKR11.2 billion in unutilised credit facilities to meet LKR14.4 billion of long-term debt maturing in 2018 as at end2017, leaving the company in a tight liquidity position. We do not expect the company to generate positive free cash flow in the next 12 months due to high capex and shareholder returns. However, we believe Singer will be able to roll over its short-term working-capitalrelated debt, amounting to LKR9.2 billion, in the normal course of business, leaving thecompany's liquidity position more manageable.