Fitch Ratings has upgraded Sri Lanka-based DSI Holdings Limited’s (DSIHL) National Long-term rating and the rating on its senior unsecured notes to ‘A-(lka)’ from ‘BBB+(lka)’. The Outlook is Stable.
The upgrades mainly reflect DSIHL’s improved credit metrics and the resilience of its footwear business through economic cycles. The company benefits from high tariffs on imported footwear which have gradually increased since 2005, and the lack of very strong competition in the market segments it competes in.
The ratings reflect DSIHL’s leadership position in Sri Lanka’s footwear market targeting low-to-medium income earners. Also, demand for footwear has been robust through past economic cycles allowing the company to expand sales and profit margins.
In FY10 (ended March 2010), DSIHL’s leverage, measured by adjusted net debt/operating EBITDAR improved to 2.2x (FY09: 3.3x), while FFO Fixed charge cover improved to 2.6x (FY09: 1.4x). Its revenues grew 11% in FY10 to LKR8.3bn, with 7% coming from sales volume growth. DSIHL also managed to marginally improve its profit margins (as measured by operating EBITDAR/ sales) to 14% in FY10, from 13% in FY09, partly from cost curtailment measures.
Fitch expects DSIHL’s leverage to increase in FY11/12 with expansionary capex currently underway and from an investment in a mini-hydro power plant. However, the agency believes that this increase in leverage is unlikely to be too significant and will taper down given the company’s cash generation profile.
DSIHL’s liquidity position remains healthy with undrawn credit facilities of LKR670m and cash balances of about LKR272m as at March 2010, against LKR114m of long term debt due within a year and LKR168m due within one to two years. Some 66% of DSIHL’s LKR1.9bn of total borrowings as at March 2010 comprised of short term loans and overdrafts, and the company enjoys healthy relationships with banks.
DSIHL’s ratings incorporate the financial profile of its parent company, DSI Samson Group (DSG), which has complete control over the former’s financial and operating policies given its 100% ownership stake. Fitch also notes there are no contractual ring-fencing of DSIHL’s cash flows, and there is a history of inter-company lending between companies of the group. DSG’s earnings — other than that from DSIHL — are mainly derived from exports of bicycle tyres, and are more volatile than DSIHL’s earnings. Furthermore, DSG’s market position in most of these export geographies is weak as demand for products are highly sensitive to economic conditions of these markets.
A sustained increase in DSIHL’s adjusted net debt/Op EBITDAR of over 3.5x can result in a negative rating action. This may occur if DSI faces increased competition, particularly if the protectionist tariffs on imported footwear are lowered, and/or if there are large dividend outflows or loans/ guarantees provided to related companies of the DSG group.
Further positive rating actions are currently constrained by the delays in producing consolidated financial statements for the DSG group.