Fitch affirms Sri Lanka Telecom at ‘BB-’/’AAA(lka)’/Stable
Thursday, 5 March 2015 01:28
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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
Tax changes are Credit Negative: We believe that the Sri Lankan Government’s Interim Budget plan to impose significant recurring and one-off taxes will cause a decline in SLT’s 2015 operating EBITDAR margin to 26% (2014: 30%) and its funds flow from operation (FFO) - adjusted net leverage to deteriorate to 1.8x (2014: 1.3x). SLT is likely to pay around Rs. 3.5 billion-4 billion in additional taxes. However, SLT’s ratings will remain unaffected as headroom is sufficient.
The Interim Budget introduced a one-off super gains tax of 25% on profits and a one-off tax of Rs. 250 million on each mobile operator. It also shifted the burden of a recurring telecom levy of 25% on prepaid revenue on telcos from consumers; operators can no longer pass these taxes onto consumers given retail pricing changes require approval from the telecom regulator. The budget proposals, once enacted, will be effective from 1 April 2015.
Acquisition Risk: We think that SLT’s plan to conduct a debt-funded acquisition of a smaller operator in 2015 has the potential to threaten its National Long-Term Rating, although probably not its IDRs. Any rating action would depend on the acquisition price and forecast financial profile of the combined entity.
We believe that the taxation changes will hasten industry consolidation as the number of telcos may be reduced to three from five. Two smaller loss-making operators, including Hutchison Lanka and Bharti Airtel Ltd.’s (BBB-/Stable) Sri Lanka subsidiary, Airtel Lanka, may exit the industry.
Reduced Ratings Headroom: SLT’s ‘BB-’ IDRs have sufficient ratings headroom to accommodate a debt-funded acquisition of a smaller operator as long as FFO-adjusted net leverage remains below 2.5x. The ratings are underpinned by its market leading position in fixed-line and second largest position in the mobile market, along with its ownership of a country-wide optical fibre network.
Negative FCF to continue: We forecast that SLT will have negative free cash flows (FCF) in 2015-18 given lower EBITDA due to new recurring taxes and a large capex plan. SLT will continue to invest about 25%-28% of revenue in capex each year to expand its optical fibre infrastructure and 3G/4G mobile networks. Dividends would likely remain similar to historical levels at Rs. 1.5 billion.
Profitability to decline: Fitch expects SLT’s 2015 revenue to rise by high single-digits driven by mobile data and fixed-broadband services, which will more than offset declines in fixed-voice and international revenue. Voice usage is likely to grow as subscribers save 25% of their telecom spend as a result of the shift of the telecom levy to telcos. Fitch forecasts that the operating EBITDAR margin will also fall, apart from tax changes, due to a change in the revenue mix as low-margin data services replace relatively higher-margin voice and text revenue.
Key assumptions
Fitch’s key assumptions within our rating case for the issuer include:
- The tax changes proposed in the budget in February 2015 are ratified by Parliament and effectively come in force starting 1 April 2015.
- Revenue to rise by high single-digits, driven by higher voice usage on telecom levy savings and fast-growing data services.
- Operating EBITDAR margin to decline by 400bp-450bp due to higher recurring taxes and a change in revenue mix as a low-margin data revenue replaces more profitable voice and international service revenue.
- Capex/revenue to remain high around 25%-28% as SLT expands its fibre and 3G/4G networks.
Rating sensitivities
Negative: Future developments that may individually, or collectively, lead to negative rating action include:
- A downgrade in the rating on the Sri Lanka sovereign (BB-/Stable) will result in a corresponding action on SLT’s IDRs as the Government directly and indirectly holds a majority stake in SLT.
- FFO-adjusted net leverage increasing to above 2.5x (2014: 1.3x) on a sustained basis would lead to a downgrade of SLT’s Foreign-Currency IDR.
- A debt-funded acquisition of a smaller operator may threaten SLT’s National Long-Term Rating depending on the acquisition price and the financial profile of the combined entity.
Positive: Future developments that may individually or collectively lead to a positive rating action include:
- An upgrade in the rating on the Sri Lanka sovereign is likely to lead to a corresponding upgrade in SLT’s IDRs.
-As the ratings are currently constrained by Government ownership, the weakening of links with the sovereign may 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-’.
