Fitch upgrades Dialog to ‘AAA’, Outlook stable

Fitch Ratings has upgraded Sri Lanka’s Dialog Axiata PLC’s (Dialog) National Long-term rating to ‘AAA(lka)’ from ‘AA(lka)’, and simultaneously revised the Outlook to Stable from Negative.The agency has also upgraded the National Long-term rating on Dialog’s outstanding Rs. 2.5 b redeemable preference shares to ‘AA+(lka)’ from ‘AA-(lka)’.

While Dialog’s ratings factor in support from its parent – Axiata Group Berhad (Axiata, 83% ownership) in arriving at the final rating, the upgrade reflects the company’s improved stand-alone credit profile, and liquidity position.

This is in turn a result of Dialog’s successful cost rationalisation exercise, reduced tariff pressure within the local mobile industry at present (which is likely to allow further balance sheet improvements over the short-term), strong market share within the mobile industry amid improving economic conditions, and its improved operating cash flows. Fitch assesses Dialog’s standalone rating at ‘AA(lka)’.

A downgrade of the ratings could be precipitated by unfavourable developments within the local regulatory or competitive environment that would result in a sustained increase in Dialog’s leverage (net adjusted debt/EBITDAR) of above 2.5x, or by the weakening of Axiata’s financial profile.

Conversely, an upgrade of Dialog’s standalone rating may result if the company is able to sustain leverage of below 1.5x, while maintaining an evenly spread out debt maturity profile.

Dialog’s profitability as measured by EBITDAR margin improved to 41% at 30 June 2010 (end-H110), from 26% at end-2008 (FYE08), largely due to the ‘right sizing’ of its operations since early-2009. This included the centralisation of key administrative functions, better utilisation of network and office infrastructure, staff reductions, and network modernisation. The stronger operating cash flow generation that resulted, combined with lower levels of incremental capex, reduced group leverage to 1.7x in end-H110 (FYE08: 3.8x).

“We expect Dialog’s healthy EBITDAR margin, combined with modest revenue growth and relatively low incremental capex, to generate strong pre-dividend free cash flow over the medium term,” said Hasira de Silva, Associate Director with Fitch’s Asia Pacific Corporates team.

This, along with the management’s commitment towards maintaining relatively low leverage levels, is likely to improve Dialog’s ability to absorb competitive pressures over the medium-term.

Over 67% of Dialog’s group revenue and 77% of EBITDA were derived from the mobile segment at end-H110 (December 2007: 84% and 94% respectively), which is prone to competitive pressures barring regulatory intervention at present. In Fitch’s view, Dialog’s alternative revenue sources are unlikely to eclipse cash flow generation from its mobile segment over the long-term.

The recently-implemented regulatory tariff floor has curbed the erstwhile aggressive price competition within the mobile space, and may allow larger operators to deleverage to an extent, or preserve balance sheet quality.

“In our view, the local mobile industry is overcrowded, and therefore we believe that a renewed price war cannot be ruled out should the floor be removed. This could continue to be a key risk to Dialog’s operations over the medium-term,” added De Silva.

Dialog’s liquidity position was sound at end-H110, with around Rs. 7.4 b of committed un-drawn credit lines (in US$) and Rs. 3.6 b of cash available, against Rs. 5.1 b of current maturities including preference share repayments. At end-H110, 65% of group debt was denominated in US$.

Dialog has expressed its intention to maintain a sinking fund from its annual net US$ receipts (H110 net receipts: US$ 17 m), to help mitigate potential currency risk on the scheduled repayments of its US$ debt, which fall due between 2011 and 2015.