Sri Lankan Beer makers to regain market share with tax changes: Fitch

Nov 15, 2017 (LBO) – Sri Lanka's beer industry will regain market share from hard liquor following a more favourable tax regime for the segment announced in the Sri Lankan government's budget on 9 November, Fitch Ratings said. The rating agency, however, expects the ratings on Distilleries Company, the largest hard liquor manufacturer, and Lion Brewery (Ceylon), the leading beer maker, to remain steady. Full statement is reproduced below. Sri Lanka's beer industry will regain market share from hard liquor following a more favourable tax regime for the segment announced in the Sri Lankan government's budget on 9 November, Fitch Ratings says. However we expect the ratings on Distilleries Company of Sri Lanka PLC (DIST, AAA(lka)/Rating Watch Negative), the largest hard liquor manufacturer, and Lion Brewery (Ceylon) PLC (Lion, A+(lka)/Negative Outlook), the leading beer maker, to remain steady. The Sri Lankan government's 2018 budget reduced excise taxes on strong beer by 33% and raised that on hard liquor by 2%, effective immediately. The budget also introduced a Nation Building tax of 2% on all alcoholic beverage sales, which will take effect from April 2018. With the latest tax revisions and barring further changes, we expect beer's market share of total reported alcohol consumption in Sri Lanka, as calculated by Fitch, to increase to around 24%-25% in the medium term, posting an average volume growth of 22% over 2017-2019. We expect hard liquor sales volumes to contract 2% over this period, reversing some of the market share gains it made in the last few years. Hard liquor's share rose to 84% in 2016 from 71% in 2014, after a series of tax increases for beer. The market share for beer fell to 14% from 27% over the same period. Lion accounts for over 80% of Sri Lanka's beer sales, and the lower excise tax has led to a 23% drop in the price of its main strong beer product. This will make it competitively priced per unit of alcohol against hard liquor. Beer makers will also be helped by the removal of a tax on beer cans in the government budget. Fitch expects beer to regain market share lost to hard liquor during the last two years, when frequent tax increases on beer eroded its price advantage. However, we believe beer sales volumes are unlikely to recover fast enough in the next 12 to 18 months for Lion's net leverage (as measured by net debt/operating EBITDAR) to reduce to less than 3.0x (6.3x at end-March 2017), given the already high debt levels. At the same time, we expect sales volumes of hard liquor market leader DIST to drop, as consumers substitute strong beer for arrack, the most popular hard liquor in the country. Effective immediately, spirit producers will also have to pay additional duty on raw materials used for ethanol production, which will increase input costs for hard liquor makers. However, we expect these taxes to have minimal impact on DIST's profit margins because the company has increased the price of its key product, Extra Special Arrack, by around 6% per bottle to reflect both the higher input costs and taxes. Taxes on alcohol makers are hefty with top-line taxes accounting for around 70% and 60% of gross company revenues for DIST and Lion, respectively, in the financial year ended 31 March 2017. We believe the government is unlikely to impose further taxes on the industry to the extent that alcoholic beverages become prohibitively expensive to the average consumer, because the alcohol excise taxes contributed 8% to government tax revenue in 2016. As such, we expect further tax increases to be gradual, especially for hard liquor. The budget also proposes to simplify the issuance and rate structure of liquor retail licenses, which we believe will help sales, although further details are yet to be disclosed. Both Lion and DIST command leadership in their respective segments, given their entrenched brands which continue to benefit from a complete ban on advertising of alcoholic beverages.