Fitch upgrades Hemas Holdings to AA-; outlook stable

Fitch Ratings has upgraded Sri Lanka-based Hemas Holdings PLC's (Hemas) National Long-Term Rating to 'AA-(lka)' from 'A+(lka)'. The Outlook is Stable. It has also upgraded the National Long-Term Rating on Hemas's senior unsecured debentures to 'AA-(lka) from 'A+(lka)'. The upgrade reflects the company's improved business risk profile, which is aided by its strong presence in the defensive healthcare and fast moving consumer good (FMCG) sectors. It also reflects its increased focus on the high growth leisure sector and its conservative expansion strategy. The rating also takes in to account the stronger balance sheet after a rights issue in 2015, which provides strong support for Hemas's growth strategy. KEY RATING DRIVERS Healthcare Drives Growth: Hemas, which distributes pharmaceuticals and manages hospitals, is the largest private healthcare provider in Sri Lanka. The acquisition of JL Morison (JLM) has significantly strengthened Hemas's local drug manufacturing capabilities, which is poised to benefit from the expansion of a government programme to purchase drugs from local manufacturers. Hemas also aims to expand its hospital chain to take advantage of a rapidly aging population, higher income levels and increasing occurrences of non-communicable diseases. Resilient FMCG Segment: Hemas's FMCG segment, which is the second-largest personal care and homecare manufacturer in Sri Lanka, may face subdued demand in the next six to 12 months due to rising costs of essential items, increased indirect taxes and rising interest rates. However the weakness in the domestic market should be more than offset by the expansion of company's operations in Bangladesh, which benefits from significant scale, rising per-capital income and low market penetration. Additions to Leisure Segment: Hemas will have 705 rooms by the end of the financial year to 31 March 2017(FY17) with the opening of two five-star hotels in collaboration with Minor Group under the Anantara brand. This will make the company one of the leading hotel chains in Sri Lanka. We believe the focus on the leisure sector is timely given the significant growth in tourist arrivals. Competition from new entrants and the rising popularity of informal lodging, for instance via Airbnb, remain key risks. Improved Group Balance Sheet: As of end-Dec 2015, Hemas had a net cash position, which was supported by a LKR4.1bn rights issue that considerably strengthened the company's credit profile. Fitch expects the group to maintain financial leverage at less than 2.0x on a sustained basis (end-2015: 1.6x, FYE15: 1.9x), despite higher than historical capex and M&A spending, because it will be supported by a large cash balance and strong operating cash flows. Low Debt Subordination at Holding Company: Hemas's strong ownership of a majority of its key assets and low leverage at the subsidiary level mitigate the structural subordination of creditors of the holding company. The holding company held LKR2.4bn of debt at end-2015, which accounted for 36% of group debt. However, the holding company's ability to service its obligations may deteriorate should leverage at the operating subsidiaries increase significantly, which would negatively impact the rating. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Hemas include: - Revenue to grow at low double-digit range from FY16-FY19 due to demand growth across most sectors and new capacity expansions - EBITDAR margins to expand 100-150bp over FY16-FY19 because of margin improvements in established businesses and turnaround in unprofitable businesses. - Capex for the group to total LKR7.1bn over FY16-FY19 - M&A spending of LKR6.0bn FY16-FY19 RATING SENSITIVITIES Positive: We do not anticipate any positive rating action for Hemas in the next 12-18 months due to the company's significant investment plans. Negative: Future developments that may, individually or collectively, lead to negative rating action include: - Group gross adjusted debt/ EBITDAR increasing above 2.0x on a sustained basis could lead to a downgrade - Any material integration issues or deviations from company's conservative approach to new investments LIQUIDITY Strong Liquidity: Hemas had LKR9.5bn of unrestricted cash and LKR9.0bn in unutilised credit facilities at end-2015 to meet LKR3.0bn of short-term debt due in the next 12 months, placing the company in a comfortable liquidity position. We believe the company will also benefit from positive FCF in the next 12 months owing to strong operating cash flow generation during the year, which will be more than sufficient to cover company's capex plans.