Fitch Affirms Hemas Holdings PLC at 'AA-(lka)'; Outlook Stable
(The following statement was released by the rating agency) COLOMBO, March 30 (Fitch) Fitch Ratings has affirmed Sri Lanka-based conglomerate Hemas Holdings PLC's (Hemas) National Long-Term Rating at 'AA-(lka)' with a Stable Outlook. Fitch has also affirmed the National ratings on Hemas's outstanding senior unsecured debentures at 'AA-(lka)'. Hemas's rating reflects the defensive nature and market leadership of its established businesses; and strong balance sheet with historically low leverage defined as adjusted debt/operating EBITDAR (FY16 ending 31 March: 1.3x). These positives are balanced by our view that the company may remain acquisitive in the medium term, following on from its successful rights issue through which it raised LKR4.1 billion in FY16. Hemas also plans to expand several of its businesses both locally and overseas, which may result in high capex and negative FCF in the next three years. However, Fitch currently expects the company to continue to adopt a conservative approach to acquisitions and expansion over the medium term. KEY RATING DRIVERS Growth Through Conservative Expansion: Fitch expects Hemas' growth in the next few years to stem primarily from capacity additions in pharma manufacturing and transportation services, and continuous market expansion in its fast-moving capital goods (FMCG) business in Bangladesh. We estimate that the expansion may cost around LKR4 billion-LKR5 billion, which can be funded comfortably through a combination of internally generated funds, as well as from cash raised during its rights issue in FY16. Fitch expects Hemas to continue to take a cautious and conservative approach to its expansion over the medium term, which may mitigate any significant execution risks that could arise. Resilient Pharma Segment: Fitch does not expect Hemas' pharmaceutical trading and manufacturing business to be hurt significantly by the government's price controls on 48 essential drugs implemented with effect from October 2016. This is because of the lower mix of original and branded generic drugs in its portfolio, which were the categories mainly affected. We believe the price controls may actually help market participants such as Hemas which sell a higher mix of affordable generic drugs to increase volumes, at the expense of higher-priced drugs which may exit the market. Hemas also has a cost advantage over domestic competition because of its ability to manufacture certain generic drugs locally, which we believe will help boost market share. Weak Domestic FMCG Sales Temporary: Hemas' domestic FMCG segment performance was marginally weaker than our expectations in 9MFY17 due to the increase in value added tax (VAT) on most products from November 2016; rising global palm oil prices (a key input in the manufacturing process); and the 5% yoy weakening of the local exchange rate - which drove up the cost of imported raw materials. Fitch expects the current softness in the domestic FMCG market to continue in the next 12 months as consumers attempt to adjust to current pricing levels amid weaker purchasing power. However, demand may improve over the longer term, supported by rising urbanisation and growing affluence among domestic consumers. Fitch also expects the weakness in domestic FMCG sales to be offset to a large extent by strong growth in FMCG sales in Bangladesh. Sales here have improved significantly due to Hemas expanding its distribution network overseas and introducing new products over the last 12 months. Revenue from Bangladesh grew seven-fold between FY13 and FY16, compared with a compound annual growth rate (CAGR) of 16% for its domestic operations over the same period. However rapid sales in Bangladesh is also off a smaller base, and we expect growth to moderate over the medium term. Hospitals and Leisure to Stabilise: Fitch does not anticipate strong capacity expansions in Hemas's hospital and leisure sectors in the next couple of years, as we believe management will take steps to consolidate these market positions following capacity additions in the last three years. Both segments have been facing a tough operating environment due to intense competition, cost pressures and tax hikes, which have kept profitability under pressure. Fitch expects the cash flow contributions from the hospital sector to improve in the medium term as the group's newer facilities' EBITDA reaches break-even levels. Hospitals are likely to continue to benefit from favourable demand dynamics stemming from a rapidly aging population and inability of the government sector to cater to such demand. However recovery in the leisure sector may be prolonged - given the intensifying competition from informal accommodation targeting the budget traveller, and possible over-supply in the graded hotel rooms due to significant capacity coming on line in the next few years. Balance-Sheet Strength Intact: Fitch expects Hemas to maintain its current net cash position over the medium term, despite our estimate of a LKR2.5 billion-LKR3 billion capex spend per annum between FY17-FY20. We expect strong operating cash flow generation in pharmaceuticals and the FMCG segments; additional cash flow contributions from ongoing expansions; and a high cash balance (LKR11 billion as of end-December 2016) should fund capex requirements comfortably without unduly stressing its balance sheet. Fitch expects the company may remain acquisitive in the medium term, aided by significant cash reserves on hand, and believes there is sufficient headroom under the current rating for around LKR7 billion-LKR8 billion of M&A spend from FY17-FY20. DERIVATION SUMMARY Hemas is a well-diversified conglomerate with exposure to defensive sectors such as healthcare and FMCG. It also has a presence in strong-growth sectors such as leisure and logistics. Hemas is rated two notches above its close peers Sunshine Holdings PLC (A(lka)/Stable) and Richard Pieris & Company PLC (A(lka)/Stable), due to its exposure to comparatively more defensive and stable sectors combined with a stronger financial profile. Hemas is rated at the same level as Lion Brewery (Ceylon) PLC (Lion, AA-(lka)/Stable): Lion has a stronger business risk profile, as reflected in its leading market share in the domestic beer industry, and high entry barriers. However, Lion's financial profile is weaker than that of Hemas, resulting in both being rated the same. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue growth to average in the single digits over FY17-FY20; benefitting from strong growth in the healthcare and transportation segments and international expansion, offset to an extent by the slowdown in the domestic FMCG and leisure businesses. - EBITDAR margin to stabilise at around 12.5% in the medium term amidst expansion in the high-margin businesses and turnaround in loss-making entities. - Capex spend on new projects to total LKR4 billion-LKR5 billion in the next two years - Dividend pay-out ratio to be maintained at 30%. RATING SENSITIVITIES Developments that may, individually or collectively, lead to positive rating action include: - Improvement in business risk profile while maintaining the current financial profile. Developments that may, individually or collectively, lead to negative rating action include: - Group gross adjusted debt/EBITDAR rising above 2.0x on a sustained basis - Any significant integration issues or deviations from the company's conservative approach to new investment. LIQUIDITY As of end-December 2016, Hemas had LKR10.8 billion of unrestricted cash and LKR6.2 billion in committed-but-unutilised credit lines to meet LKR1.5bn of short term debt due in the next 12 months, placing the company in a strong liquidity position. However, we do not expect positive FCF in FY18 due to increased capex and higher dividend payments. Contact: Primary Analyst Nadika Ranasinghe, CFA Vice President +94 11 254 1900 Fitch Ratings Lanka Limited Level 15-04 East Tower World Trade Centre Colombo Secondary Analyst Kanishka De Silva Analyst +94 11 254 1900 Committee Chairperson Hasira De Silva, CFA Director +65 6796 7240 Media Relations: Bindu Menon, Mumbai, Tel: +91 22 4000 1727, Email: bindu.menon@fitchratings.com; Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 10 Mar 2017) here National Scale Ratings Criteria (pub. 07 Mar 2017) here Additional Disclosures Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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