Fitch rates Softlogic Holdings’ debentures ‘A-’

Fitch Ratings has assigned Sri Lanka-based Softlogic Holdings PLC (SHL) a senior unsecured rating of ‘A-(lka)’, and simultaneously assigned its proposed issue of redeemable debentures of up to Rs. 750 m an expected National Long-term ‘A-(lka)(EXP)’ rating. The final rating is contingent upon final transaction documents conforming to information already received.

The debenture issue is expected to have a tenure of three years, with fixed-rate coupon payments, and will help reduce SHL’s exposure to interest rate risk. The proceeds will be used to refinance existing short-term debt at SHL (holding company level).

The senior unsecured rating and proposed debentures are rated in line with SHLs National Long-Term Rating of ‘A-(lka)’, as they will rank equally with the company’s senior unsecured creditors.

Key rating drivers

Strong healthcare segment: SHL’s healthcare business, via its majority stake in Asiri Hospitals Group, benefits from strong structural demand for private-sector healthcare services in Sri Lanka across economic cycles and exhibits low business risk. Robust demand for hospital service should help underpin an increase of dividend income to SHL from Asiri Hospital Group in the medium-term. Asiri Hospitals Group accounts for over 51% of SHL’s consolidated EBITDAR in 9MFY13 (financial year ends March).

High structural subordination: As a holding company, SHL is dependent on dividend income from its core operating assets to service its own obligations. Therefore SHL’s creditors are structurally subordinated to creditors at its operating assets. Furthermore, Fitch does not expect SHL’s leisure-sector assets to upstream dividends until at least 2015 when these assets start generating meaningful cash flows. SHL expects that dividend income from operating assets will increase in 2014, reflecting higher distributions from Asiri Hospitals Group.

Cyclical IT and retail: SHL’s information technology segment, which primarily consists of the distributorship for Nokia phones and Dell computers in Sri Lanka, experienced margin decline in FY12. This is primarily due to a revised pricing strategy within this segment which the management expects will reduce the sizeable domestic grey market for such hardware.

Highly leveraged: Financial leverage at the SHL holding company level is projected to increase to around 5.15x at FYE13 compared with 3.8x at FYE12, largely due to a debt-funded capital injection into SHL’s financial services segment during the period, as well as the transfer of part of SHL’s indirect-ownership in Asiri Hospitals Group directly under SHL. Weaker performance in SHL’s IT segment and subsequently lower dividends to SHL was also a driving factor, mainly due to inflationary cost pressures in 9MFY13. Fitch expects financial leverage at SHL’s holding-company level to reduce to below 3.5x by FYE14, based on higher dividend income expected from the healthcare segment over the medium-term, and also because of Rs. 1.375 b of cash SHL will receive from a part-divestment in March 2013 of its life insurance subsidiary.

Rating sensitivities

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

Financial leverage at the holding company of above 3.5x on a sustained basis.

A structural weakening of the credit profiles of SHL’s key dividend income contributing subsidiaries, including a sustained increase in financial leverage at Asiri Hospitals Group above 3.0x (9MFY13: 2.8x annualised). Fitch expects revenues and profits of Asiri Hospitals Group to improve over the medium-term, which is likely to support lower financial leverage. SHL group’s EBTIDAR/interest expense + operating lease rent (excluding interest costs at its licensed finance company) falling below 1.25x on a sustained basis (end-9MFY13: 1.33x). SHL has long-term credit lines to fund its new leisure projects with grace periods on capital repayment, which limits its medium-term debt-servicing burden to an extent. However, SHL will be required to continue servicing interest on these loans, as well as its long-term lease rentals elsewhere within the group. It has low headroom at the current rating level in the event of an external shock.

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

Holding company financial leverage falling below 2.5x on a sustained basis and dividends from Asiri Hospitals Group increasing to over 50% of the total dividend income to the holding company. However, as leverage is likely to be 5.15x at FYE13, Fitch does not expect positive rating action over the next 12 to 24 months.