Fitch assigns Lion Brewery’s ‘AA-’; rates proposed debt ‘AA’-

Fitch Ratings has published Sri Lanka-based Lion Brewery (Ceylon) PLC’s (Lion) ‘AA-(lka)’ National Long-Term Rating with Stable Outlook. Fitch has also assigned a ‘AA-(lka)’ senior unsecured rating to Lion.

The agency has also assigned an expected National Long-Term rating of ‘AA-(lka)(EXP)’ to Lion’s proposed unsecured redeemable debentures of up to Rs. 3 b. Fitch will assign a final rating to the debenture subject to the receipt of final transaction documents conforming to information already received.

The proposed debentures are rated in line with Lion’s National Long-Term Rating of ‘AA-(lka)’, as they will rank equally with the company’s unsecured creditors. Lion aims to use the proceeds to fund the upgrade and modernisation of its plant in FY14 (ending March).

Key rating drivers

Strong market position: Lion’s ratings reflect its leading market share of the domestic beer industry and its strong operating cash flow generation. Lion’s market position and in turn its credit profile are also supported by its entrenched domestic brands, and limited substitution of its products due to the high technical competence required for brewing beer in contrast to the manufacturing of spirits.

High regulatory risk: Domestic producers of alcoholic beverages face high regulatory risk in the form of high excise duties, which puts legitimate alcoholic beverages outside the reach of a large portion of the population, promoting illicit consumption while stifling the growth of the licit market.

At the same time, however, regulatory restrictions on advertising and the limited issuance of new retail licenses create high entry barriers and benefit entrenched players such as Lion. Continued increase in excise duties on alcoholic beverage producers could become a rating risk if profitability is impacted materially over the longer term.

Industry growth below potential: Lion’s ratings are constrained over the medium-term by the limited breadth and depth of the domestic beer market, given regulatory impediments on advertising and retailing. However, economic growth and lifestyle changes may result in a shift in domestic consumption patterns towards beer over the longer-term.

Concentrated portfolio: Lion’s product portfolio is diverse across price points which enables the company to cater to potential changes in consumer behaviour and makes Lion attractive to its distributors. Lion’s sales reflect industry trends, and is skewed towards its strong beer product, which is targeted towards the mass-market consumer.

Firmer profits starting FY15: Lion’s EBITDAR margin fell to 15% at end-9MFY13 from 28% at FYE12 due to higher taxes paid on imported sales volumes. However, Fitch expects EBITDAR margins to improve after November 2013 as the company will no longer need to import a portion of its sales volumes once the upgrading and modernisation of its plant is complete.

High capex in FY14: Lion spent over Rs. 2.8 b in capex in 9MFY13 (equal to 24% of revenues) on upgrading and modernising its plant, and will spend a further Rs. 5.3 b in FY14.

Balance sheet to improve: Fitch expects Lion’s financial leverage (measured as lease-adjusted net debt/operating EBTIDAR) to peak in FY14 due to lower profitability and high debt-funded capex. Leverage should improve sharply in FY15 and thereafter on lower capex and higher profits.

Satisfactory liquidity: At end-9MFY13, Rs. 3 b of Lion’s borrowings were short-term in nature, used to fund its working capital. A further 2.8 b consisted of term debt, due after 2013. Fitch expects Lion to post negative free cash flows (FCF, after capex and dividends) until FYE14 on account of higher capex, which will mean the company may be required to refinance any term maturities. However, this is not a serious risk given the company’s access to domestic banks, and Fitch’s expectations that Lion will generate strong positive FCF from FY15 onwards.

Rating sensitivities

Negative: Future developments that may individually, or collectively, lead to negative rating action include:

Financial leverage above 1.5x on a sustained basis. Financial leverage stood at an annualised 1.09x at end-9MFY13.

Positive: Future developments that may individually or collectively lead to a positive rating action include:

Lion’s rating is constrained at the current level over the medium-term due to the limited breadth and depth of the domestic beer industry. However this may change over the longer-term if growth in domestic beer industry outpaces growth in spirits.