RAM says stable but Fitch downgrades Hayleys

A few days after RAM Ratings Lanka assigned respective long- and short-term corporate credit ratings of AA- and P1 to Hayleys PLC; the long term rating has a stable outlook, Fitch yesterday downgraded Hayleys to A+ in addition to declaring diversified bleu chip’s outlook is negative.

In a move that is likely to ruffle some feathers at the traditionally conventional Hayleys Plc, Fitch Ratings Lanka said yesterday it has downgraded Hayleys PLC’s National Long-Term rating to ‘A+ (lka)’ from ‘AA-(lka)’. The Outlook is Negative.

The downgrade reflects Hayleys’ increased appetite for financial leverage at the holding company (HoldCo), as reflected in the company’s heightened use of borrowings in 2010 and 2011 to fund its three large acquisitions that have protracted payback periods.Hayleys’ rating also factors in the heightened risk to the group’s cash flows stemming from the weak economic outlook in its key export markets, the European Union and North America (50% of FY11 (end-March 2011) revenue).

However, Fitch expects better performance in Hayleys’ consumer, agriculture, power, transport, and leisure segments domestically to help offset export-oriented risks to an extent.

The rating also factors in Fitch’s view that Hayleys may need to extend financial support to its textile company – Hayleys MGT Knitting Mills PLC (HMGT, ‘BBB(lka)’/Negative, 57% direct-ownership), as the latter is undergoing a restructuring process.

The rating will remain constrained over the medium-term due to Hayleys’ higher appetite for financial leverage, the uncertainty stemming from weak demand in the company’s key export markets, and the uncertainty surrounding the final outcome of HMGT’s restructuring process.

The Negative Outlook indicates that a further downgrade may occur if the company fails to reduce financial leverage (net debt/EBITDA) at HoldCo to below 3.5x in the near-term (as indicated by the management) from 9.1x at end-September 2011, based on annualised dividend inflows.

Negative rating pressure may also occur if financial leverage at Hayleys’ key operating subsidiaries increases on a sustained basis, due to weaker-than-expected performance in end-markets, cost overruns in refurbishments, or higher debt-funded dividend payouts or acquisitions, among other factors.

As a holding company, Hayleys’ rating factors in the business strength of, and diverse dividend income from, its key operating subsidiaries. Hayleys exercises control over its key subsidiaries, reducing the structural subordination of HoldCo creditors to an extent.

Hayleys’ group operating cash flows are also more susceptible to commodity prices fluctuations, weather patterns, and foreign currency risks. At FY11, 63% of group revenues were derived from exports, while most of its production is based in Sri Lanka.

The group’s revenue grew by +43% yoy to Rs. 54.2 billion in FY11, and by +37% yoy when new acquisitions in construction and leisure are excluded, as most segments’ revenues rebounded post the global credit crisis.

However, the group’s operating EBITDAR margin contracted to 7.4% from 10.6% during the same period, mainly due to HMGT’s weaker performance, lower profitability of some of its new acquisitions, and higher prices paid for, and supply shortages of, key production inputs in other key segments.

Fitch expects demand pressures from key export markets to constrain profitability, at least through 2012.

Hayleys’ liquidity position within most key operating subsidiaries is adequate, with largely manageable near-term debt maturities covered by healthy operating cash flows or strong access to local banks. The latter along with managements’ near-term measures to reduce financial leverage supports the weak liquidity at HoldCo, which is evidenced by its near-term maturities of Rs. 2.3 billion at end-September 2011, compared with LKR25m in cash reserves and Rs. 1 billion of unutilised credit lines.

Hayleys has been in operation for over 125 years, and has interests in over 140 companies, across 12 broad business segments. At end-November 2011, K.D.D. Perera, who has interests in financial services and manufacturing, controlled nearly 48% of the group.

Fitch rating comes a few days after RAM Ratings Lanka said it has assigned respective long- and short-term corporate credit ratings of AA- and P1 to Hayleys PLC; the long term rating has a stable outlook.

The ratings reflect the group’s diversified business portfolio, strong market positions in several key businesses and adequate debt-protection metrics. On the other hand, the ratings are moderated by the Group’s high debt levels, fragile liquidity and a few loss-making operations.

The ratings are further pressured by Hayleys’ exposure to volatile commodity prices and foreign-exchange risk.

However, our concerns on the foreign-exchange risks are somewhat mitigated given a certain level of natural hedging in the Group’s business operations, which has been achieved through vertical integration and diversification.