Fitch affirms Distilleries Company of Sri Lanka at ‘AAA’/Stable
Tuesday, 10 March 2015 01:18
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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
Leading alcohol manufacturer DIST continues to be the market leader in alcoholic beverage production in Sri Lanka due to its strong brands, which drive demand and access to retail points across the island. DIST’s diversified product portfolio includes its mass market Extra Special Arrack brand, which accounts for about 80% of sales, as well as licensed international brands channelled through its subsidiary Periceyl Ltd. The Government’s plans to impose a minimum tax of Rs. 200 m per month on liquor manufacturers will deter new players and adversely impact the profitability of smaller players. This is likely to allow the larger producers such as DIST to gain market share.
As of the latest published statistics, DIST accounted for 53% of Sri Lanka’s total alcoholic beverage production and 79% of the country’s total arrack production. DIST’s arrack production accounts for over 95% of its volumes.
Positive outlook for demand: Government measures including increases in public-sector salaries and allowances, and reductions in the prices of essential goods, fuel and electricity are likely to increase real disposable income, which would lead to an uptick in spirit consumption.
Increasing preference for beer: Beer demand continues to grow despite an overall decline in the domestic alcoholic beverage industry. Latest statistics show domestic beer production rose 21% in 2013, compared with growth of 14% in 2012. This reflects increasing demand for strong beer (over 5% alcohol content), which accounted for 89% of total beer production at end-2013. This compares with declines in arrack production of 12% and 9% over 2013 and 2012, resulting in a market share contraction for arrack, the main market for DIST.
Resilient operating profile: Profitability remains resilient, reflected in a high and improving EBITDA margin of 35.6% for the financial year ended 31 March 2014 (FY14), up from 33.5% in FY13, due to sourcing strategies and DIST’s ability to pass on tax increases to the consumer.
Regulatory risk: The industry is highly regulated, with a complete ban on advertising and licensing across the value chain acting as a barrier to entry. The industry is also characterised by high and frequent tax revisions, putting increasing pressure on industry players; this risk is partially mitigated by liquor’s contribution to government coffers, with liquor taxes expected to account for an estimated 5.1% of total government revenue in 2014.
Key assumptions
Fitch’s key assumptions within the rating case for the issuer include:
- Revenue growth driven by improved consumer spending power
- Relatively stable EBITDAR margins driven by lower operating costs and the new bottling line
- No material capex in DIST’s core beverage segment because the new bottling plant is also likely to be able to meet additional demand for arrack over the medium term
Rating sensitivities
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
- Consolidated financial leverage (measured as adjusted net debt/EBITDAR excluding Melsta Regal Finance Ltd (MRF)) increasing to over 1.5x on a sustained basis. (end-March 2014: 1.1x)
- Consolidated funds flow from operations coverage of interest and fixed charges such as operating lease rentals, excluding MRF, weakening to below 4.0x, on a sustained basis. (end-March 2014: 6.1x)
- 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.
