Fitch affirms Dialog at AAA

Fitch Ratings Lanka has affirmed Sri Lanka-based telecom operator Dialog Axiata PLC’s (Dialog) National Long-Term rating at ‘AAA(lka)’.

The Outlook is Stable. At the same time Fitch has affirmed Dialog’s cumulative redeemable preference shares at ‘AA+(lka)’.

Dialog’s ratings incorporate support from its 83% shareholder Axiata Group Berhad (Axiata), underpinned by the latter’s board representation in Dialog, a common brand, and the integration of strategic and some operational functions between the two companies. Axiata has provided tangible support to Dialog throughout its history, most recently in the form of shareholder loan and a corporate guarantee on a long-term offshore bank credit line.

Fitch assesses Dialog’s standalone profile at ‘AA(lka)’, underpinned by its leading market share in the local mobile industry (38% share at end-June 2011), growing diversity in revenues, comfortable operating profit margins, and continuous investments to maintain its technological edge. The agency expects Dialog to generate positive free cash flow (FCF, after deducting capex and dividends) over the medium term, helped by strong operating cash flow generation and selective capital expenditure. Fitch expects Dialog to maintain its financial leverage (defined as adjusted net debt/operating EBITDAR) below 2.5x over the medium term.

Dialog’s revenue and EBITDA growth slowed in H111 to 9% and 2% respectively, largely on account of tariff adjustments within the mobile segment in Q111 (66% of group revenue).

However, group revenue is expected to rebound in H211, as increased demand should more than compensate for lower tariffs.

In June 2011, the regulatory tariff floor on calls to other networks (off-net calls) was lowered to Rs. 1.50 from Rs. 2.00. However at present, all five mobile operators maintain pricing on off-net calls at Rs. 2.00 to preserve profitability. While further tariff reductions (to the floor) cannot be fully discounted, such adjustments are likely to be mitigated by higher demand over the medium term. At end-H111, the proportion of the Dialog’s group revenue exposed to the overcrowded local mobile industry decreased to 66% (2008: 73%), diluting the impact that potential tariff competition could have on its credit profile.

Dialog’s liquidity was comfortable at end-H111, with cash reserves of Rs. 8.4 b and committed unutilised credit lines of around Rs. 6 b, compared with current maturities of Rs. 9.8 b. At end-H111, the share of group debt denominated in USD stood at 65%. However foreign currency risk was limited by a natural hedge in the form of approximately USD 50 m of annual net operating income and USD cash reserves of USD 10 m at end-H111.

Dialog’s ‘AAA(lka)’ rating may face downward pressure if Axiata’s perceived willingness to support diminishes, evidence of which would include a considerable dilution in its ownership stake or control, or a material reduction in other operational and strategic ties. Fitch notes that removal of Axiata’s corporate guarantee on the offshore bank line or the repayment of the shareholder loan will not by themselves result in a downgrade.

The ‘AA+(lka)’ preference share rating is driven by the instrument’s subordination to the company’s senior creditors, and the absence of other instruments that rank in between the preference shares and senior creditors.

 Should such instruments be issued, the preference shares will be downgraded.