Fitch downgrades Kotagala rating on worsening liquidity

Fitch Ratings Lanka said yesterday it has downgraded Sri Lanka-based Kotagala Plantations Plc’s National Long-Term rating to ‘CC’ from ‘B+’. 

The agency has also downgraded the National Long-Term rating on Kotagala’s outstanding listed senior secured debentures of Rs. 1 billion to ‘CC’ from ‘B+’.

The downgrade follows continued deterioration in the company’s liquidity, as its operating EBITDA weakened further in the financial year ending-March 2016 (FY16) due to falling tea and rubber prices, high labour costs and poor labour productivity. Consequently, Kotagala’s operating EBITDA of Rs. 30 million was insufficient to cover its borrowing costs of Rs. 503 million and the company had to utilise cash reserves to meet most of its financial obligations.

The company’s EBITDA recovered to Rs. 247 million in 9MFY17, from Rs. 198 million in 9MFY16, driven by improving tea and rubber prices. However, Fitch expects EBITDA to fall short of meeting the company’s borrowing costs and operating lease rent in the next 12-18 months. 

Kotagala has around Rs. 546 million of bank loan maturities due in FY18. The company has benefitted from banks’ willingness to restructure its borrowings in the past. However, principal repayments on its listed senior secured debenture will fall due in FY19, starting with a Rs. 250 million principal due in May 2018.

KEY RATING DRIVERS

Weak Liquidity; High Refinancing Risk: Kotagala faces substantial debt maturities from FY18 and we believe it will be challenging for the company to meet its obligations due to its low cash balance and negative free cash flow generation in the next two years. Further, the company does not have any committed credit lines at its disposal, limiting its financial flexibility and exposing it to significant refinancing risk. The company’s efforts in FY16-FY17 to lower debt via asset disposals and extending the maturity of part of its existing debt has not led to a sustained improvement in liquidity.

Challenging Operating Conditions: The profitability of Kotagala’s tea and rubber plantations has improved in the previous few months with rebounding global prices, but we do not believe the improvement is sufficient to offset the sector’s structural decline stemming from continued supply-side pressure, such as lower productivity and high labour costs. We expect the expansion of Kotagala’s more profitable palm oil operations to support cash flow, but we do not expect a significant contribution in the medium-term as its oil palm plantation are still in an immature stage.

Marginal Recovery in Profitability: We expect Kotagala’s annual EBITDA to improve to around LKR400 million in FY17 and LKR600 million in FY18. Tea prices recovered to an average of $3.8/kg and rubber to $2.3/kg in Q4FY17, from lows of $2.8/kg and $1.4/kg, respectively, in Q4FY16. This is mainly because demand from Russia and key Middle Eastern countries recovered in line with higher global crude oil prices. Our EBITDA forecasts for the next two years are based on the assumptions that tea prices will average at $3/kg and rubber prices will average around $2/kg. However, we expect continued increase in labour costs to partly offset these benefits.

Weak Financial Profile: We expect the company’s leverage, defined as lease-adjusted debt net of cash/operating EBITDAR, to remain unsustainably high over the medium-term, at around 10x-12x (end-2016: 14.6x), and EBITDAR/interest paid plus rents to remain below 1x. We believe local banks may continue to fund the company’s operations to comply with the regulatory requirement to lend to the agricultural sector.

Pressure from Cambodian investment: The company may incur an additional $4.1 million (around LKR635 million) in debt if it completes its acquisition in Cambodia, which was initiated in 2012. This debt will need to be funded through borrowings. The project is not expected to yield significant cash flow in the medium-term, which, together with the additional borrowings, could further weaken the company’s leverage position. However, Kotagala believes it has the flexibility to defer the acquisition or sell it to a third-party if required.