Fitch Ratings gave SLT a 'stable' outlook and upgraded the grading to BB-.
The outlook revision follows Sri Lanka securing a 'B+' grading from Standard & Poor's and a 'BB-' credit rating from Fitch early this month.
See below for statements from both rating agencies.
S&P Revises Sri Lanka Telecom Outlk; Rtgs Affirmed
Rationale
On Dec. 14, 2005, Standard & Poor's Ratings Services revised its outlook on Sri Lanka Telecom Ltd. (SLT) to stable from negative. At the same time, Standard & Poor's affirmed its 'B+' foreign currency and 'BB-' local currency corporate credit ratings on the company. The outlook revision follows Standard & Poor's assignment of its local and foreign currency ratings on the Democratic Socialist Republic of Sri Lanka (foreign currency B+/Stable/B, local currency BB-/Stable/B) (see "Research Update: Sri Lanka Assigned 'B+' Foreign Currency Rating, 'BB-' Local Currency Rating; Outlook Stable" published Dec. 8, 2005, on RatingsDirect, Standard & Poor's Web-based credit analysis system). SLT's previous negative outlook reflected heightened sovereign risk.
The rating on SLT reflects the following weaknesses: -- Intense competition. The Sri Lankan government's telecommunications policy increasingly favors higher competition in the sector. SLT has lost all regulatory protection that enabled it to operate as monopoly in the past in the fixed-line business and the international segment, which led to a sharp decline in its prices for international calls and settlements. At the sametime, SLT's wireless business faces intense competition and is subject to uncertainties in consumer sentiment and market forces, similar to other wireless service providers elsewhere. -- Weak market position in the wireless business. SLT's ability to capitalize on the strong growth expected in Sri Lanka's wireless telecommunications services market could be constrained by the company's weak market position. It has a share of only about 16% in the modest-size wireless telecommunications market of about 2 million subscribers. SLT might need to resort to aggressive pricing and promotions to improve its market share.
Furthermore, an increase in credit to customers could result in a substantial increase in bad debts.
-- Regulatory uncertainties. There is some uncertainty on SLT's fixedline tariff, as the Court of Appeal has reversed a tariff revision implemented in September 2003. SLT has lodged an appeal, which will be heard by the Supreme Court in March 2006. Pending the hearing of the appeal, the tariff remains unchanged. At the same time, it remains unclear if SLT will receive a refund of the International Operator's Levy amounting to two-thirds of the levy for the development of its network in rural areas, pending regulatory changes.
Nevertheless, SLT has recognized the entire levy in its accounts and has not accounted for any benefits from the possible refunds. -- High capital expenditure requirements. SLT's investment needs are expected to remain high in the medium term due to strong growth forecast in the wireless market, and rollout of the network to cover the entire country.
In the next two to three years, SLT's annual capital expenditure is likely to be Rs. 10 billion-Rs. 12 billion--about the same as its funds from operations (FFO).
Therefore, there is not likely to be any significant pay down of debt using FFO in the near term.
-- Sovereign risks. Sovereign risks-such as the high public sector debt, and the possible resumption of civil unrest-have a negative impact on SLT's foreign currency rating. Like other Sri Lankan corporate entities, SLT is subject to the foreign exchange controls and regulations imposed by the government of Sri Lanka, although the corporate may hold its foreign currency earnings in foreign currency. Most of SLT's assets are within Sri Lanka.
These weaknesses are partly offset by the following strengths: -- Dominant position in the fixed-line business. SLT is the incumbent operator in the fixed-line business with a market share of about 86% as of June 2005.
Based on the experience in other countries, the incumbent company is expected to retain its dominant market position in this business.
Nevertheless, competition is expected to intensify with the introduction of fixed wireless services in 2005. However, in the medium term, growth in the fixed-line business is expected to moderate, in line with the trend in other countries.
Once the affordability of wireless telecommunication service improves, and the penetration rate reaches a certain threshold, growth in the telecommunications markets is driven mainly by growth in wireless subscribers, at the expense of previously expected growth in fixed-line subscribers.
-- Growth potential in wireless business. SLT is expected to benefit from strong growth expected in the wireless telecommunications market in the medium term.
Despite Sri Lanka's good income levels in the Asian context and sustained economic growth, the penetration of wireless telephones remains very low at about 11% of the total population.
-- Adequate cash flow protection measure. SLT's cash flow protection ratios is adequate with FFO to total debt of 57% (annualized) for the first nine months of 2005, compared with the three-year (2002-2004) average of 53%.
Although debt reduction is likely to be limited due to high capital expenditure requirement, SLT's cash flow measures are expected to remain adequate, with FFO to total debt of at least 40%-50% in the near term.
Liquidity
SLT's liquidity is adequate. At June 30, 2005, SLT had unencumbered cash and equivalents of Rs. 11.0 billion and undrawn committed credit lines of about Rs. 1.6 billion, compared with Rs. 3.4 billion of short-term debt due in the next 12 months.
Outlook
The stable outlook on SLT's rating is based on the expectation of continued robust growth in wireless revenues, given the low penetration. A significant improvement in its competitive market position in its increasingly important wireless segment, without any material adverse impact on its financial profile, accompanied by a moderate reduction in sovereign risk would be positive on the rating. Conversely, the rating may be negatively affected if there is a slowdown in demand growth for wireless services, which could weaken the financial profile, particularly because of build-up of capacity. Fitch Upgrades Sri Lanka Telecom to 'BB-'; Outlook Stable
Fitch Ratings-Singapore/Hong Kong-14 December 2005: Fitch Ratings has today upgraded Sri Lanka Telecom's ("SLT") Senior Unsecured foreign currency rating to 'BB-' (BB minus) from 'B+'. The Outlook on the rating is Stable.
At the same time, the 'BB-' (BB minus) Senior Unsecured local currency rating was affirmed with a Stable Outlook.
Today's action follows the recent announcement of sovereign ratings for the Democratic Socialist Republic of Sri Lanka (Long-term foreign and local currency ratings of 'BB-' (BB minus)/Stable), subsequent to which the agency has reviewed the Long-term ratings assigned to SLT.
SLT's ratings reflect its position as Sri Lanka's incumbent and only fully diversified and integrated telecom operator, with a dominant share of direct exchange lines (82%) and international long distance (est.70%), as well as the largest market share in internet and data services (est.50%).
Though mobile services are expected to become the future growth driver, SLT's market position in the segment is still comparatively weak.
During the past year, Mobitel (SLT's wholly-owned mobile subsidiary) faced operational difficulties due to the departure of its CEO, including delays in its network rollout plan.
However, with the appointment of a new CEO, and completion of Phase 1 of the expansion in August 2005 the business is progressing better.
Fitch notes that SLT has a robust financial profile; as at September 2005 net leverage (defined as total adjusted debt net of cash divided by operating EBITDAR) stood at 0.5x, improved from 0.9x as at FYE04, with total adjusted debt to capitalisation of 42.1%.
The company's liquidity position also remains strong; as at September 2005, SLT held cash balances of Rs. 15.4 billion and committed and undrawn credit lines of Rs. 1.6bn, against current maturities of Rs. 3.4bn.
Capex for the nine months ended September 2005 amounted to Rs. 6.4bn, of which a substantial portion (c.45%) was used for mobile network expansion.
Going forward, with increased spend on mobile and CDMA wireless networks, SLT's capex to sales ratio is expected to increase moderately from current levels (of around 27%).
Expected capex of around Rs. 10.7bn for FY06 can be comfortably met from existing cash reserves and operating cashflow.
The ratings also acknowledge that the industry is still in early stages of regulatory development, and uncertainty persists.
After a public hearing in November 2005, the regulator rejected the proposed structure for the transition to the Calling Party Pays ("CPP") regime. This particular delay has not negatively impacted SLT, as the current "sender keeps all" mechanism is slanted in favour of the incumbent.
In a separate development, a Sri Lankan Court of Appeal delivered a tariff ruling in July 2005, which invalidated approvals granted by the regulator for SLT's fifth tariff revision, thereby necessitating the refund of incremental billings since September 2003 (estimated at Rs. 4.5bn).
SLT has been granted special leave by the Supreme Court to appeal the ruling. Fitch notes that even if the ruling is ultimately upheld by the Supreme Court, the one time charge would cause leverage metrics to weaken slightly, but still remain comfortable for the rating level.
The Stable Outlook on the ratings is underpinned by SLT's robust market position and strong growth prospects. Fitch expects that over time, SLT will be able to leverage its leading fixed-line position to improve its share of the mobile market.
Upward rating pressure would be dependent on SLT managing the increasingly competitive environment while sustaining its financial and operating profiles, and will also be subject to the sovereign being upgraded (though SLT is not constrained by the sovereign).
SLT's ratings take into account operating risks inherent in Sri Lanka, such as political instability and civil conflict; factors which have historically suppressed the country's economic and business environment.