Fitch affirms Sunshine Holdings at ‘A’; outlook stable

Fitch Ratings has affirmed Sri Lanka-based diversified conglomerate Sunshine Holdings Plc’s National Long-Term Rating at ‘A (lka)’, with its outlook stable.

The rating on the company reflects its exposure to defensive end-markets, strong positions in the markets for its key products and strong free cash flow generation despite short-term pressures faced by some its key operating subsidiaries. The rating also reflects Fitch’s expectations that the group is likely to maintain a low level of leverage.

Key rating drivers

Short-term challenges in healthcare: Sunshine Holdings is the second-largest pharmaceutical distributor in Sri Lanka by sales. The Government recently introduced a price control mechanism that Fitch expects will reduce Sunshine Holdings’ pharma revenue by 15%-20%. However, Fitch believes the impact of the new regulation will be temporary and the long-term fundamentals for the segment remain intact as the population is rapidly aging, urbanisation is rising and per capita income is increasing, which will drive spending on healthcare.

Growth from palm oil: We believe Sunshine Holdings’ palm oil segment will be the key growth driver in the medium term and will provide buffer against downturns in most other segments. Sunshine Holdings is the largest palm oil producer in the country and is strongly positioned to benefit from the Government’s policies protecting the sector to expand local production. Higher taxes on imported palm oil, an increase in global palm oil prices due to the recovery in oil prices and continuous capacity expansions by Sunshine Holdings should support the growth trajectory and profitability of the segment in the medium term.

Margin pressure in consumer goods: Margin in Sunshine Holdings’ fast-moving consumer goods segment, which is the largest branded tea company in Sri Lanka, has narrowed due to higher tea prices in the past six months. We expect tea prices to moderate in the next 12 months once supply stabilises, which should benefit Sunshine Holdings’ margins in this segment. Sunshine Holdings’ strategy to tap the higher growth by selling to the hotel, restaurant and catering industry should also help the segment, both in terms of top line growth and profitability.

Tea industry in structural decline: Sunshine Holdings’ tea segment posted operating losses for the third consecutive year in the financial year ended 31 March 2016 (FY16) as low global tea prices and escalating costs made it difficult for tea plantations to break even. Fitch does not expect a meaningful turnaround in the tea segment in the medium term owing to lower demand from Sri Lanka’s key markets, such as Russia, Ukraine, and the Middle East, and cost pressures stemming from wage increases for plantation workers that are not based on productivity.

New investments drive growth: Sunshine Holdings is expanding its capacity in its power and dairy sectors, with the company expecting the majority of the new capacity to come online before end-FY19. Fitch believes the new projects will enable Sunshine Holdings to reduce its dependency on the highly volatile agricultural sector and improve overall margins as the new projects provide higher margins.

Balance sheet strength intact: Sunshine Holdings may face short-term operational pressures, but Fitch expects the company to maintain adjusted gross debt/EBITDAR (including proportionate consolidation of EMSPL, the holding company for the agriculture and consumer goods segments) at less than 3.0x over the medium term (FY16: 1.68x). This will be supported by moderate capex and already low levels of group debt. The holding company holds minimal debt and the main operating subsidiaries have low levels of debt, so Fitch views as immaterial the structural subordination of debt of the holding company.

Key assumptions

Fitch’s key assumptions within the rating case for Sunshine Holdings include:

nRevenue growth to slow down in FY17 to mid-single digits, owing to price controls in the pharma segment, but to recover to high single digits in the medium term, driven by expansion in the palm oil and fast-moving consumer goods segments and contribution from new investments

nEBITDAR margins to remain in the low double digit range in FY17-20 despite challenges faced by the pharma and tea segments

nCapex of Rs. 3.6b over FY17-20 for expansion across the board. Working capital outflow of about Rs. 250 m each year to support growth.

nSunshine Holdings to maintain its current dividend policy

Rating sensitivities

Positive: No positive rating action is expected in the next 12 to 18 months given the regulatory risks in the pharma segment, cyclical risks of the commodity business and execution risks associated with new business ventures.

Negative: Developments that may, individually or collectively, lead to a negative rating action include:

nA sustained increase in Sunshine Holdings’ group adjusted gross debt/EBITDAR (including proportionate consolidation of EMSPL) over 3.0x

nSunshine Holdings’ EBITDAR coverage of gross interest + rent (including proportionate consolidation of EMSPL) reducing below 2.5x on a sustained basis.

nAdverse impact on growth and profitability arising from sustained regulatory pressure in the healthcare and agriculture segments.

Liquidity

As at end-March 2016, Sunshine Holdings had about Rs. 1.5 b of unrestricted cash and Rs 2.7 b in unutilised credit facilities to meet Rs. 880 m of debt falling due in the next 12 months. This places the company in a comfortable liquidity position that will be enough to absorb the impact negative FCF in FY17 owing to high capex and weak operating performance.