Fitch downgrades John Keells Holdings to ‘AA+’ from AAA

Tuesday, 9 September 2014 01:04 - - {{hitsCtrl.values.hits}}

Fitch Ratings has downgraded John Keells Holdings PLC’s (JKH) National Long-Term Rating to ‘AA+(lka)’ from ‘AAA(lka)’. The Outlook is Stable. JKH is a holding company with interests in transportation, leisure, property, consumer foods, retail and financial services, and it depends largely on dividend income to meet its financial obligations. The downgrade reflects the deterioration in JKH’s business risk profile, driven by the weakening competitive position of its key dividend-paying associate, South Asia Gateway Terminals (SAGT), in which JKH owns 42%. Dividends from SAGT accounted for 37% of JKH’s EBITDAR in the financial year ended 31 March (FY14) (FY12: 50%; FY13: 33%) Fitch expects increasing dividend income from JKH’s other businesses to compensate for the drop in SAGT’s cash flows, but these other segments have higher business risk profiles. The rating is supported by the diversity of JKH’s dividend income streams, the company’s strong liquidity profile and its conservative capital structure.

JKH issues statement on confident outlook Subsequent to rating downgrade by Fitch, John Keells Holdings PLC Group Finance Director Ronnie Peiris issued the following statement. John Keells Holdings (JKH) has been one of the largest investors in Sri Lanka, particularly in the post-conflict period where the Group has invested heavily in its existing portfolio of businesses in addition to its investment in the Waterfront Integrated Resort Project. The recent investments of JKH are in industries with high growth prospects having considered the risk/reward factors, particularly in the current context of a post-conflict Sri Lanka with a strong economic growth outlook. The proactive steps taken by JKH in the past 10 years through aggressive investments, particularly in areas such as leisure, consumer foods and retail, property and financial services, have borne fruit and have resulted in a balanced portfolio and a diverse stream of healthy cash flows. Whilst the transportation business has seen a moderation in its performance over the past few years as anticipated, JKH is of the view that SAGT will benefit from the overall prospects for the Port of Colombo where volumes are bound to increase in the medium term with the commissioning of deep-water berths in the south port. SAGT’s current performance continues to be well above the Group’s hurdle rates. The Waterfront Project, the construction of which began in March 2014, is in progress with piling work currently underway. The pre-sales of the residential apartments and commercial spaces have been beyond expectations. While the project is well funded, with contingencies inbuilt at the project level itself, JKH’s current, and expected, financial strength is more than sufficient in meeting any unanticipated obligations.

JKH is also investing in excess of $ 650 million in an integrated resort project in Colombo, which is not likely to start generating income until FY19. The project carries considerable project-related risks, such as the possibility of cost-and-time-overruns, which could delay the repayment of debt used to finance it. However, these risks are offset by JKH’s decision to fund the project by raising capital ahead of major investment and the substantial cash balances at the holding company, which could be used to pay for reasonable cost overruns, should they occur. Key rating drivers Transportation sector under pressure: Volumes at SAGT, a privately owned container terminal at the Port of Colombo, fell 11% in FY14 after several shipping lines switched to using another terminal. SAGT faces tougher competition from the newly built Colombo International Container Terminal, which can handle larger vessels, and state-owned Jaya Container Terminal (JCT). SAGT’s volumes could further decline if key customers use larger vessels that require additional draft and crane size, which are offered by the newer terminal. JKH’s 99%-owned bunker fuel supplier Lanka Marine Services, which accounted for 5% of the holding company EBITDAR in FY14, is also facing top line and margin pressure as a result of increased competition. Higher business risk: The property sector will contribute significant dividends to JKH in FY15 and FY16 once two new properties are completed in 2014 and 2015. However, cash flow from the sector will be limited after that until earnings are realised from completion of the residential apartments at the integrated resort project in FY19. The property development business is inherently cyclical and volatile, and consequently the increased exposure to this sector has weakened JKH’s overall business profile. Rising tourist arrivals are likely to boost dividends from the leisure sector, which accounted for 29% of JKH’s EBITDAR in FY14. Cash flows from the sector will be strengthened by the addition of a new business hotel, Cinnamon Red, in September 2014 and supported by continuing strong performance of its five-star city hotels and resorts in Sri Lanka and the Maldives for which most of the capex has been already incurred. Real-estate Project Risks: JKH’s integrated resort comprises a hotel and conference centre as well as residential, retail and entertainment spaces. Construction on the project has started and JKH has continued to demonstrate a conservative approach to raising equity ahead of major investment. It raised $ 175 million in November 2013 through a rights issue and plans to raise a further $ 125 million by way of warrants in FY16 and FY17. The project is held by a new subsidiary, Waterfront Properties Ltd., which will issue debt in order to improve returns for JKH’s shareholders from the project. This, combined with the reputation risk to JKH that may arise if the project fails, could mean higher financial risk to the holding company. However this is likely to fall outside the rating horizon. Fitch takes comfort from the high cash balance at the holding company, which will help to offset risks from the integrated resort project. Strong Liquidity, Capital-market Access: JKH has a strong track record of raising shareholder funds ahead of major investments across the group. This has enabled the company to maintain a conservative capital structure with holding company cash reserves exceeding debt. JKH’s conservative policies are supported by its diverse shareholding structure in which no single shareholder or group controls more than 14% of the company. A material increase in shareholder concentration that could lead to an adverse shift in holding company and group leverage could be credit negative. Rating sensitivities Negative: Future developments that may individually, or collectively, lead to a further negative rating action include: - Net adjusted debt/operating EBITDAR being sustained above 1.5x at holding company or consolidated level (FYE14: surplus cash at both holding company and group) - Gross adjusted debt/EBITDAR at holding company being sustained above 2.0x (FYE14: 0. 62x) - Inability to maintain sufficient liquidity in the form of cash to meet any cost overruns or time delays at the integrated resort project - Impairment of SAGT’s business risk profile due to higher competition from rival terminals that result in a material reduction in dividend payouts to JKH. Positive: Fitch does not expect any positive rating action in the next 24 months. Future developments that may individually, or collectively, lead to a positive rating action include clarity on the execution of the company’s integrated resort project and a higher level of dividends from the transportation sector.