Fitch revises Outlook on SLT to Negative; affirms at ‘AA+’

Fitch Ratings has revised the Outlook on Sri Lanka Telecom PLC’s (SLT) National Long-Term Rating to Negative from Stable and affirmed the rating at ‘AA+(lka)’. It has also affirmed the National Ratings on SLT’s outstanding senior unsecured debentures at ‘AA+(lka)’.

The rating action follows Fitch’s revision of the Outlook on Sri Lanka’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to Negative from Stable.

Strong State linkages: SLT’s ratings are constrained by the sovereign as per Fitch’s Parent and Subsidiary Rating Linkage criteria. Fitch assesses the relationship between the sovereign and SLT as one of a weaker parent and stronger subsidiary with strong operational and strategic linkages. 

The State holds a majority stake in SLT directly and indirectly, and can exercise significant influence on its operating and financial profile. SLT’s second-biggest shareholder, Malaysia’s Usaha Tegas Sdn Bhd at 44.9%, has no special provisions in its shareholder agreement to dilute the Government’s significant influence over SLT.

High capex, negative FCF: Fitch expects SLT to have negative free cash flow (FCF) during 2019-2020 (2018 negative FCF of Rs. 3.4 billion), as cash flow from operations could be insufficient to fund capex requirements to expand the fibre infrastructure and 4G mobile networks. 

Fitch expects SLT’s 2019 capex to remain high, at around 28%-30% of group revenue (2018: 26%), as it aims to complete its 4G population coverage to around 95% by end-2019. However, management expects its capex/revenue to drop to around 18%-20% in 2019.

Fitch expects SLT to continue to invest in expanding fibre coverage as it aims to connect about one million homes by 2020-2021, from the 70,000 homes currently enabled. SLT would typically need to lay fibre for at least two million homes for half of the households to be connected. Fitch expects SLT’s fibre investments to have low returns due to the country’s low broadband tariffs. Dividends are likely to remain around Rs. 1.6 billion-1.8 billion in the next two to three years.

Data-driven growth: Fitch expects revenue to grow by a mid-single-digit percentage during 2019-2020 (barring any tax shocks), driven by data and fixed-broadband growth. It expects 4G smartphone penetration to improve from the current 25% with the proliferation of cheaper Chinese phones. 

Revenue rose strongly by 7.5% in 2018, driven by fixed-broadband and mobile usage after a temporary usage slump in 2017 due to higher taxes on voice and data. Fitch expects the Government’s recent announcement to reduce tax on telecommunication tariffs by 25% to support top-line growth.

Further consolidation probable: Fitch expects further consolidation, and believes that Airtel Lanka, a subsidiary of Bharti Airtel Ltd. (BBB-/Negative), may seek M&A due to mobile competition, higher taxes and high capex requirements. The recently-concluded merger between Hutch and Etisalat may relieve some competitive pressures that have undermined telecom companies’ revenue and EBITDA growth in recent years.

Stable sector outlook: Fitch’s outlook for the Sri Lankan telco sector is stable as we expect 2020 mean funds from operations (FFO) adjusted net leverage for SLT and mobile leader Dialog Axiata PLC (AAA(lka)/Stable), to remain stable at around 1.7x (2019F: 1.7x). 

Fitch forecasts average cash flow from operations for SLT and Dialog to improve to around Rs. 32 billion in 2020 (2019F: Rs. 28 billion), and for revenue and EBIDTA to rise by 5%-6% and 8%-10%, respectively (2019F: 5% and 10%). The average operating EBITDAR margin should stay stable at around 34% (2019F: 34%), driven by improving economies of scale in the data and home-broadband segments – offsetting the negative effect of a changing revenue mix.

SLT’s unconstrained standalone credit profile is stronger than that of the Government of Sri Lanka, reflecting the company’s market leadership in fixed-line services and second-largest position in mobile, along with its ownership of an extensive optical-fibre network. The standalone profile is also underpinned by its mid-single-digit percentage growth prospects, moderate estimated 2019 FFO adjusted net leverage of 2.1x, and stable operating EBITDAR margin.

SLT has lower exposure to the crowded mobile market and more diverse service platforms than mobile-market leader Dialog. However, Dialog has a larger revenue base, significantly better operating EBITDAR margin, lower forecast FFO adjusted net leverage and a better FCF profile than SLT.