Fitch affirms Distilleries at ‘AAA/Stable’

Thursday, 19 December 2013 00:28 -     - {{hitsCtrl.values.hits}}

Fitch Ratings has affirmed Distilleries Company of Sri Lanka PLC’s (DIST) National Long-Term Rating at ‘AAA(lka)’. The Outlook is Stable. Key rating drivers are as follows: Healthy operating profile: DIST’s strengths are reflected in a high EBITDA margin of over 30%, reflecting relatively inelastic demand for spirits and the group’s ability to pass on tax increases. Strong market share: DIST is the market leader in the manufacture of alcoholic beverages accounting for about 82% of arrack and 60% of local alcohol production in 2012. DIST has a portfolio with strong brands, diversification across price points, and good access to retail points across the country. Regulatory advantages and disadvantages: The sector is highly regulated with restrictions on advertising and promotion, and issuance of retail licenses. While these regulatory measures set high barriers to entry that benefit existing players like DIST, they are counterbalanced by the high and frequent increases in top-line taxes. Although the tax increases only have a limited short term impact on consumption, nonetheless the increase in average selling prices has encouraged a large illicit spirits market. Potential M&A activity: The company has historically actively pursued acquisition. While it has not indicated it is pursuing specific acquisitions, the group recently restructured to consolidate its non-beverage assets under investment holding company Mesltacorp Ltd., which will likely allow management to better focus on the group’s other segments. Potential risks could stem from debt-funded acquisitions that could weaken the group’s balance sheet in the near term with benefits accruing potentially only over the longer term. From an operational perspective, entry into business segments with higher risk will change the company’s business risk profile and increase cash flow volatility.       Rating sensitivities are as follows: Negative: Future developments that may, individually or collectively, lead to a negative rating action include: Consolidated financial leverage increasing to over 1.5x on a sustained basis (end-September 2013: 0.62x annualised); consolidated fund flow from operations coverage of interest and fixed charges such as operating lease rentals weakening to below 4.0x (end-September 2012: 6.83x), on a sustained basis; a structural change in the domestic alcoholic beverage industry that considerably weakens DIST’s competitive position. Positive: There is no scope for an upgrade since the company is at the highest rating on the Sri Lankan National Rating Scale.