Fitch affirms Sri Lanka Telecom at ‘BB-’

Fitch Ratings has affirmed Sri Lanka Telecom PLC’s (SLT) Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at ‘BB-’. The agency also affirmed SLT’s National Long-Term Rating at ‘AAA(lka)’. The Outlook is Stable. Key rating drivers are as follows:

Strong market position: SLT’s ratings reflect its market-leading position in Sri Lanka’s fixed-line services underpinned by its monopoly in wireline and fixed-broadband. They also reflect its number two position in mobile and its evolving share in paid-TV, making the company one of two ‘quadruple-play’ providers in the country.

SLT’s ratings benefit from its strong balance sheet with low funds flow from operations (FFO) adjusted net leverage of 0.64x at end-2012.  Sovereign constraints: SLT’s IDRs are constrained by Sri Lanka’s IDRs, due to the Government directly and indirectly holding a majority stake in SLT. Malaysia’s Usaha Tegas – which owns 44.9% of SLT – does not have any special provisions in its shareholder agreement to dilute the Government’s significant influence over SLT. Therefore any future changes to Sri Lanka’s IDRs will lead to a corresponding change to SLT’s IDRs.

Revenue grows, margins fall: SLT’s revenue grew 10% in 2012, driven by strong growth in mobile and broadband operations, which was partly offset by weak performance in its fixed-wireless segment.

Revenue growth was also supported by a sharp weakening in the exchange rate in early 2012, which increased SLT’s foreign currency revenue in local currency terms. Operating EBITDAR margins fell to 31.9% in 2012 from 33.3% in 2011, due to increased competition and cost inflation. Fitch expects moderate pressure on SLT’s EBITDAR margins to continue in 2013, particularly if domestic energy tariffs increase.

Network investments rise: SLT will continue to invest heavily in the expansion of its broadband and mobile infrastructure in 2013 and 2014, with capex/revenue expected to increase to about 42% in 2013 (2012: 33%). This includes SLT’s plans to provide broadband at speeds of over 20Mbps to over 90% of its wireline subscriber base by end-2014. This is likely to turn free cash flow (after capex and dividends) negative in 2013 and result in higher financial leverage. However, Fitch does not expect negative rating action given SLT’s ample rating headroom.

Strong liquidity: SLT’s liquidity is strong in both local and foreign currencies. Its cash reserves (end-2012: in excess of Rs. 4.9 b) continue to exceed current maturities. SLT also has high FFO coverage of interest costs and operating lease rentals (end-2012: 14.3x), partly due to most of its debt (which includes long-term vendor financing) being denominated in foreign currency. SLT’s annual foreign currency earnings are sufficient to cover interest and principal payments on its foreign currency debt through to 2015.

Rating sensitivities are as follows:

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

A downgrade in Sri Lanka’s IDRs will result in a corresponding action on SLT’s IDRs. However, the sovereign is currently on Stable Outlook, indicating that no such rating change is expected over a one- to two-year period.

FFO-adjusted net leverage increasing above 2.5x on a sustained basis. Fitch currently expects FFO- adjusted leverage to remain below 1.5x in the medium term.

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

An upgrade in the sovereign IDRs is likely to lead to a corresponding upgrade in SLT’s IDRs. However, the sovereign is currently on Stable Outlook, indicating that no such rating change is expected over a one- to two-year period.

As the ratings are currently constrained by government ownership, the weakening of links with the sovereign could result in SLT’s Local Currency IDR being upgraded above Sri Lanka’s Local Currency IDR. However, SLT’s Foreign Currency IDR will remain constrained by the Country Ceiling of ‘BB-’.