RAM reaffirms Lankem Ceylon’s A-/P2 ratings

RAM Ratings Lanka has reaffirmed Lankem Ceylon PLC’s long- and short-term corporate credit ratings of A- and P2 respectively.

Concurrently, RAM Ratings Lanka has reaffirmed the A- long-term issue rating of Lankem’s Rs. 500 million unsecured unsubordinated redeemable debentures (2010/2015). The outlook on the long-term ratings is stable.

The ratings are supported by its diversity in business operations, major market positions in most of its business lines, the resilient demand for agrochemicals, and adequate debt protection metrics. However the ratings are pressured by its exposure to the volatility in the plantation segment and its vulnerability to fluctuations in raw material prices.

Lankem Group is mainly engaged in the manufacture and distribution of agrochemicals, as well as tea and rubber cultivation, and the manufacture and distribution of paints. Its other business ventures include hotels, agriculture, construction, trading and consumer. With the acquisition of CW Mackie PLC in January 2010, the Group’s presence in the consumer segment has strengthened.

The diversified operation enables the Group to better weather a downturn in any particular sector to a certain extent. As such, while the volatilities of the plantation segment results in fluctuations in the Group’s revenues and profits, the demand for its agrochemicals is more resilient. Meanwhile, Lankem is one of the top three players in the agrochemicals industry. Its market presence is fortified by its extensive marketing efforts and exclusive rights for some of its products.

Furthermore, Lankem is also among the top three players in the paint industry; this has been achieved through its extensive distribution network and high product quality. The Group also controls 60% of the thinner market owing to its exclusive dealership agreements and distribution fleet. Elsewhere, Lankem is a major player in the bitumen industry aided by its established brand name and distribution network.

Lankem’s revenue is chiefly derived from the plantation segment, closely followed by the chemicals segment. The steady revenue for the latter is derived from its herbicidal products, which are a crucial input in paddy cultivation. Since rice is the country’s staple food, paddy is an essential crop in the domestic agricultural economy, occupying nearly 29% of the agricultural land in the country. As such, the demand for herbicides is anticipated to remain relatively resilient.

In line with the stronger showing in FYE 31 March 2011, Lankem’s funds from operations strengthened to Rs. 2.80 billion (FY Mar 2010: Rs. 1.29 billion) with its FFO debt coverage ratio improving to 0.49 times (FY Mar 2010: 0.27 times) despite the increasing debt levels.

Although the ratio declined to 0.28 times in 1Q FY Mar 2012 owing to weaker performance and higher debt levels, the ratio is expected to remain adequate at more than 0.30 times – supported by the better earnings despite increased borrowings to fund its capital expenditure plans in the hotel sector – which is in line with similar-rated peers.

However, as the Group derives significant contributions from the plantation business, it is highly susceptible to changes in weather conditions and cost pressures, particularly wages and rising energy costs. Moreover, prices are dependent on demand conditions, which are broadly linked to global economic fundamentals. As such, the segment’s performance has been fluctuating over the years, with a notable decline in performance in 2009 owing to a sharp decline in global tea prices and adverse weather conditions.

Furthermore, the Group is exposed to the volatilities in raw material prices. The Group has been able to pass on cost increases to its customers owing to its good market positions in its major businesses. That said its margins could be pressured should its ability to pass on cost increases to its customers on a full and timely basis be affected amid keen competition.