Sri Lanka’s Fitch affirms Abans at BBB+, revises outlook to Stable

Fitch Ratings has affirmed Sri Lanka-based retailer Abans National Long-Term Rating at 'BBB+(lka)' and revised its Outlook to Stable from Negative. Fitch has also affirmed the National Long-Term Rating on Abans' unsecured redeemable debentures at 'BBB+(lka)' and its outstanding commercial paper at National Short-Term Rating of 'F2(lka)'. The Outlook revision reflects improvements in Abans' net leverage due to improvements in the operating environment and its margins, which Fitch considers sustainable in the medium term. The Outlook is also supported by Fitch's expectations that Abans' capex and investments are likely to be minimal in the medium term, which would help sustain improvement in its leverage. KEY RATING DRIVERS Improving Credit Profile: Abans' leverage, as measured by lease-adjusted net debt/operating EBITDAR (excluding Abans Finance PLC), improved to 6.48x in the financial year ended March 2015 (FY15) from 8.04x in FY14, supported by strong top-line growth and a wider EBITDAR margin. However, its leverage remained above 5.5x, the level at which Fitch would consider negative rating action, in FY15 because proceeds from asset sales that were intended for debt repayment did not materialise during the year. Fitch expects Abans' net leverage to fall below 5.5x over the medium term, helped by the favourable operating environment, margin expansion through cost efficiencies and pricing strategies, and low capex requirements. Abans' 1Q16 leverage was 3.33x. Leading Consumer Durable Retailer: Abans is one of the leading retailers of consumer durables in Sri Lanka, and it has a strong brand portfolio and extensive distribution network. Abans' revenue is supported by its in-house hire-purchase operations, which contributed to 46% of revenue in FY15 while maintaining a low delinquency rate. Improved Operating Environment: Consumer durable retailers saw strong top-line growth in 1H15 because of reductions in electricity tariffs and fuel prices implemented in late 2014, a prevailing low interest rate environment, and measures introduced in the February 2015 interim budget to raise salaries for public-sector workers and cut prices for essential items. The discretionary nature of consumer durables and foreign-currency risk on inventory because most products are imported, however, remain key risks. Wider Margins: Abans' EBITDAR margin expanded 90bp to 7.9% in FY15 and 12.0% in 1Q16. Price increases across most categories and efforts to control costs, such as store closures and inventory management, contributed to the improvement. Fitch expects margin improvement to be sustainable given the company's revised pricing strategy and continued cost cutting measures. However, the shift towards lower-margin IT and communication products in the sales mix will mean that margins will not reach pre-FY13 levels. Funding Secured for Property Project: Colombo City Centre (CCC), a mixed-use development in which Abans has invested with Singapore-based Silver Needle Hospitality, will move to the construction phase in October 2015, albeit six months behind the original schedule. The company is confident of making up the lost time during construction. The project has secured most of the required funding, and Fitch does not expect the project to require further capital calls as a result of further significant delays. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Strong revenue growth driven by favourable demand environment - EBITDAR margin to improve to 9% as the company's strategy to increase prices and reduce costs are partially offset by a shift towards low-margin IT and communication products and currency headwinds - Capex and investments to be minimal until the CCC project is completed- Minimal contribution from the CCC project during the forecast period of FY16-FY19 - Abans to provide capital infusion to Abans Finance of LKR500m to strengthen capitalisation above the minimum requirement. RATING SENSITIVITIES Positive: Future developments that may individually or collectively lead to a positive rating action include: - A sustained improvement in Abans' adjusted net debt/EBITDAR, excluding Abans Finance, to below 4.5x - Smooth progress of the Colombo City Centre project, which will limit Abans' financial liability to the initial investment value Negative: Future developments that may, individually or collectively, lead to a negative rating action include: - A sustained increase in Abans' adjusted net debt/EBITDAR, excluding Abans Finance, to over 5.5x - Fixed-charge coverage reducing below 1.25x on a sustained basis - A material delay in progress on the Colombo City Centre project or additional capital calls for the project - Any additional capital infusions to Abans Finance over and above our assumption under the rating case.