Fitch revises Spence’s senior unsecured notes rating outlook to negative

Fitch Ratings said yesterday it has revised the Outlook on Sri Lanka’s Aitken Spence PLC’s (ASP) senior unsecured LKR notes to Negative from Stable. The National Long-Term rating on the notes has been affirmed at ‘AA(lka)’.

The Negative Outlook reflects Fitch’s concerns over the probability of a sizable reduction in the scale of ASP’s existing power sector operations and the expectation of the more volatile hotel sector dividend that needs to be consistently upstreamed to the holding company having to replace the power sector dividend over the longer term.

The affirmation reflects Fitch’s expectation that ASP’s core business segments will continue to generate adequate operating cash in the near term from its geographically and industry-wise diversified revenue and profit streams. Although ASP is expected to incur significant investments for its port venture (30% ownership), Fitch expects its next 24-month operating cash generation to be sufficient for its corresponding cash requirement including the repayment of these notes. The affirmation also reflects the current headroom availability for financial leverage (total adjusted net debt/operating EBITDAR) at the holding company level.

ASP’s rating remains exposed to the state-owned Ceylon Electricity Board’s (CEB) financial strength, which is the sole purchaser of its power output, albeit the latter’s financials improved in 2010. The power purchase agreements (PPAs) have built-in safeguards along with the non-recourse nature of power sector debt to the holding company. However, Fitch notes that there has been no finalisation of discussions with CEB for the continuation of ASP’s PPAs for its two 20MW plants, which will expire in 2012. CEB’s own capacity is expected to improve with the new coal and hydro projects (450MW) and these two thermal power plants will be the first to come in for renegotiation, providing direction for CEB’s future use of private thermal power plants.  Furthermore, the recent declaration by ASP of the possibility of future dilution of its ownership and/or control of its 100MW thermal plant (74% owned) as may be determined by the Secretary to the Treasury based on the Sri Lanka Electricity Act No.20 of 2009, exposes the company to a significant event risk, which if triggered will warrant an immediate rating review.  Additionally, although ASP’s power sector long-term debt was to be fully paid off by FYE12, the new wind and mini hydro power projects will bring in additional debt of around LKR830m, which will keep the sector leverage at current levels. Fitch highlights that ASP will have to maintain its current high power dividend (over 80% of total dividend income) through free cash flows generated from its 100MW plant, and continue this till 2015. Fitch sees that any decrease in this dividend inflow to be a negative rating driver.

ASP’s hotels sector operating performance has improved based on the increased profitability of its Sri Lankan resorts. Stable cash generation and expected low capital expenditure from ASP’s Maldivian assets also will add to the cash generated in Sri Lanka. Although ASP has acquired several new resorts, postponement of some major hotel projects planned last year will allow these acquisitions and new capital expenditure to be funded by the cash received through the 2010 rights issue (LKR2.5bn) at the hotel subsidiary. However, Fitch highlights that ASP’s holding company has received only a small percentage of dividend from its main hotels subsidiary within the last three years, and this may have to change for the holding company to fund its port project. While Fitch has factored in ASP’s ability to control is hotel dividend policy (74% ownership), if a stable dividend stream is not upstreamed from now on to compensate for the potential reduction in power dividend, this can also become a rating concern for the holding company.

The 30% associate investment in the south terminal management JV will require an USD45m investment over the next four years on a staggered basis, while this project will start adding to ASP’s profitability and cash inflows only from five-six years to the future. However, this project’s debt will remain off balance sheet.

As of FYE11, the holding company total adjusted debt was LKR3.5bn and its leverage was 0.4x due to the strong cash balance (LKR2.7bn). Fitch notes that the scheduled debt repayments of above LKR500m per annum during FY12 and FY13 and port project investment (over LKR2.2bn) would necessitate adequate dividend inflow from all three sectors into the holding company to maintain its financial profile. As of 31 December 2010, the holding company had adequate unutilised debt facilities of LKR4.5bn which provides comfort for the repayment schedule.

Fitch notes that any significant additional borrowings for sizable new projects or any reduction in dividend income to group parent against Fitch’s expectations can act as negative rating triggers. However, if ASP were to generate a sizable cash balance through an equity rights issue, power plant sale or if the power sector were to continue after renegotiations at similar profit levels, this may relieve pressure on the holding company’s cash outflows.