Fitch downgrades Abans Plc to ‘BBB+’; Outlook negative

Fitch Ratings has downgraded Sri Lanka-based retailer Abans Plc’s National Long-Term Rating to ‘BBB+(lka)’ from ‘A-(lka)’. Fitch has also downgraded the National Long-Term Rating on Abans’ unsecured redeemable debentures to ‘BBB+(lka)’ from ‘A-(lka)’. Fitch has affirmed Abans’ outstanding commercial paper at National Short-term Rating of ‘F2(lka)’.

The one-notch downgrade reflects Fitch’s view that Abans’ medium-term net leverage is likely to remain above 4.5x, the level at which Fitch would consider negative rating action. The Negative Outlook reflects continued pressure on profitability stemming from a shift towards products with lower margins and risks associated with investments outside the company’s core business.

Abans changed its name from Abans Limited in January 2014.

Key rating drivers

Weakening credit metrics: Abans’ net leverage, as measured by adjusted net debt/EBITDAR (excluding finance subsidiary Abans Finance Plc), increased to 8.05x in the financial year ended 31 March 2014 (FY14) from 5.25x in FY13. Abans’ fixed-charge coverage (EBITDAR/gross interest + rent, excluding finance subsidiary Abans Finance Plc) deteriorated to 0.82x in FY14 from 1.34x in FY13. 

The deterioration was mainly due to EBITDAR margin (excluding Abans Finance Plc) contracting to 6.5% in FY14 from 9.2% in FY13 because of subdued demand, intense competition and a shift towards lower margin products. Although the company has plans to reduce its debt, Fitch expects Abans’ leverage to remain above 4.5x in the medium term due to a weak recovery in EBITDAR margins.

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’ revenues are supported by its in-house hire-purchase operations, which contributed to 40% of the revenues in FY14. Abans’s hire-purchase book is prudently managed with higher down payment requirements and an efficiently and closely monitored recovery system, which has helped the company maintain a low delinquency rate. 

Cyclicality of the industry: Demand for Abans’ products tends to be volatile across business cycles due to the non-essential and relatively high prices of consumer durables. However, the recent reduction in domestic electricity tariffs and substantial decline in lending rates bodes well for the industry’s revenue. Retailers are also affected by foreign-currency risk on inventory because most products are imported. Abans has managed to lower this risk by selling locally produced items, which accounted for 20% of products in FY14.

Real estate project risk: Abans’s investment in a mixed-use development called Colombo City Centre will be capped at Rs. 1.9 b, most of which was incurred in FY14. Even though the equity contribution is capped, any delay in debt funding or pre-sales of the project could result in further capital calls for Abans. Furthermore, any delays to construction, which is due to run from FY15-FY17 could increase the business risk for Abans. Abans is undertaking the project, which has retail, hotel, and apartment components, with Singapore-based Silver Needle Hospitality.

Evolving corporate governance: Abans continues to engage in significant related party transactions with entities outside of the group. However, Abans has taken measures to improve corporate governance, establishing audit and remuneration committees and divesting several non-core entities to help streamline the financial reporting process. 

Rating sensitivities

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 Plc 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 delay in the scheduled repayments from related parties.

Positive: No positive rating action is expected given that the rating is on Negative Outlook. However, future developments that may individually or collectively lead to the Outlook being revised to Stable include:

Smooth progress of the Colombo City Centre project, which will limit Abans’ financial liability to the initial investment value.

Improvement in the retail environment as reflected in sustained improvement in EBITDAR margins above 7%.