RAM reaffirms Lankem Ceylon’s A-/P2 ratings

RAM Ratings Lanka has reaffirmed Lankem Ceylon PLC’s long- and short-term corporate credit ratings of A- and P2 respectively. The outlook on the long-term rating is stable.

The ratings are supported by its diversity in business operations, dominant market positions in most of its business lines, the resilient demand for agrochemicals, and above-average debt-protection metrics.

However the ratings are pressured by its exposure to the volatility in the plantation segment and its vulnerability to fluctuations in raw material prices as well as the below-average liquidity profile. Lankem and its subsidiaries are collectively referred to as ‘the Group’.

Lankem, through its subsidiaries, is mainly engaged in the manufacture and distribution of agrochemicals as well as the cultivation of tea and rubber, with a presence in the consumer goods and paints sectors. Its other business ventures include interests in hotels, agriculture, construction and trade.

The diversity has enabled the Group to better withstand downturns in a particular sector, as weaker showing in one sector can be offset by the better performance in another.

The ratings are upheld by the Group’s good market position in its key business lines. Lankem is one of the top three players in the agrochemicals industry.

Furthermore, Lankem is also among the top three players in the paint industry while controlling 60% of the thinner market owing to its exclusive dealership agreements and distribution fleet. Elsewhere, Lankem is a major player in the bitumen industry aided by its established brand name and distribution network.

Meanwhile, the ratings are also upheld by the resilient demand for agrochemicals. Lankem’s agrochemicals division has been one of the main contributors to the Group’s revenue and profits; its revenue is largely derived from its herbicides, which are a crucial input in paddy cultivation. Since rice is the country’s staple food, the demand for herbicides is anticipated to remain relatively resilient.

RAM Ratings Lanka notes that the Group’s performance deteriorated significantly in fiscal 2012, in line with a drop in revenue of its plantation segment and sluggish sales growth in chemicals and hardware; as such its operating profit before interest and tax contracted 34.99% year-on-year.

This, coupled with heavier borrowings, resulted in its funds from operations debt coverage halving to 0.25 times as at 31 FYE March 2012; lower than RAM Rating Lanka’s expectations.

Although Lankem’s debt protection metrics are still opined to be above average, the deterioration is viewed with concern.

Moving ahead, the Group’s FFODC ratio is envisaged to hover around 0.20 times, in line with its rising borrowings; any further weakening of its financial profile beyond RAM Ratings Lanka expectations is likely to result in a negative rating action.

Meanwhile, the ratings continued to be weighed down by its exposure to vagaries in the plantation sector.

The plantation segment is the largest contributor to Lankem’s earnings, accounting for more than 50% of its pre-tax profit in recent years.

Lankem’s performance is highly susceptible to the vagaries of the plantation sector such as weather conditions, cost pressures (particularly wages), rising energy costs and varying fertiliser prices.

In fiscal 2012, the segment’s performance deteriorated owing to adverse weather conditions and an increase in plantation sector wages.

Furthermore, the Group is exposed to the volatilities in raw material prices.

The Group has been able to pass on cost increases to its customers owing to its good market positions in its major businesses. That said its margins could be pressured should its ability to pass on cost increases to its customers on a full and timely basis be affected amid keen competition.

Lankem’s liquidity position is deemed below-average in line with its increased dependency on short-term borrowings and relatively low cash reserves. As at end-June 2012, the Group had cash reserves of Rs. 1.47 billion, compared to Rs. 5.26 billion of short-term borrowings which made up around 66% of its entire borrowings. However, RAM Ratings Lanka derives comfort from its unutilised funding lines amounted to more than Rs. 1 billion.