RAM assigns long and short-term corporate credit ratings of A/P2 to Tokyo Cement

RAM Ratings Lanka has assigned long and short-term corporate credit ratings of A and P2 to Tokyo Cement Company (Lanka) PLC respectively.

The long term rating carries a stable outlook. The ratings are supported by the Group’s strong market position, healthy balance sheet and debt coverage levels; the ratings are however moderated by Tokyo’s dependency on the cyclical construction sector and inability to fully pass on cost increases to consumers.

Tokyo is one of the leading companies in the domestic cement industry. Tokyo has been able to strengthen its market position, supported by its well-known brand and extensive dealer network. Despite cement being a commodity, Tokyo has managed to maintain its premium pricing due to its strong branding.

Furthermore, Tokyo and Holcim are the only cement suppliers in Sri Lanka that operate local manufacturing plants; the rest of the market is populated by importers. In this regard, domestic manufacturers enjoy some tariff protection and logistical advantage compared to importers, which face the risk of hardening cement due to the product’s short shelf life.

On a separate note, capital expenditure for capacity enhancement and investment in a new bio-mass plant had increased the Group’s debt burden by the end of FYE 31 March 2010. With the completion of these projects, however, Tokyo has now begun repaying its debt facilities, thereby improving its overall financial profile.

The Group’s debt burden was reduced from Rs. 4.27 billion as at end-March 2010 to Rs. 3.55 billion as at end-September 2010, thus easing its gearing ratio from 0.75 times to 0.64 times. This, coupled with the environment of receding interest rates, had broadened Tokyo’s interest coverage to a healthy 4.46 times as at end-September 2010 (end-March 2010: 1.94 times). At the same time, its funds from operations debt coverage clocked in at an annualised 0.74 times (end-March 2010: 0.49 times).

With no major capex planned, we expect the Group’s financial profile to improve as its debt level is reduced further.

That said, the Group is exposed to the inherent cyclicality of the construction sector, which is the biggest consumer of cement. Nonetheless, the long-term outlook for the construction industry is positive. The industry expanded 8.5% year-on-year in 1Q 2010 (1Q 2009: 3.0%), followed by another 9.3% in 2Q 2010 (2Q 2009: 5.4%).

Further growth is expected to emanate from government-led infrastructure projects, particularly in the recently liberated northern and eastern regions of the country. Given that Tokyo’s production facility is located in the eastern part of the country, we believe that it is well poised to benefit from such an upturn. Moreover, the improving macroeconomic environment is also expected to propel demand for housing over the medium to long term.

Meanwhile, Cement is classified as an essential commodity by the Consumer Affairs Authority of Sri Lanka; approval is required from the CAASL prior to any revision in the retail price. Cement suppliers are therefore unable to pass on increasing costs to customers, and are thus exposed to potential margin compression. As such, cement manufacturers are vulnerable to adverse price movements in its primary raw material, i.e. clinker, which accounts for around 74% of its total production cost.