Newer Sri Lanka telcos face higher risks in 2013 warns Fitch

Fitch Ratings yesterday said in a special report that the 2013 outlook for incumbent Sri Lankan telecommunications companies (telcos) is stable, but that for smaller operators is negative.

“The industry as a whole will benefit from growing demand across most product segments,” said Hasira De Silva, Vice President in Fitch’s Corporates rating team.

“However the credit profiles of newer entrants are likely to be disproportionately affected by high capex required to improve capacity, as well as high marketing costs,” added De Silva.

The report highlights Fitch’s views on increasing demand, high capex and infrastructure sharing, profitability pressures as well as regulatory and M&A risks.

Here are some highlights of the report from Fitch.

Rating Outlook

Incumbents Stable, Challengers Negative: Fitch Ratings expects the Outlook for incumbent telecoms operators Sri Lanka Telecom (BB−/AAA(lka) /Stable) and Dialog Axiata (AAA(lka) /Stable) to remain Stable, supported by their strong balance sheets and ability to meet planned capex mostly through internally generated funds. High capex may weaken the credit profiles of challengers to a greater degree. The industry as a whole will benefit from rising demand across most product segments.

Rising Demand

Average revenue per user (ARPU) should continue to increase in 2013 from strong growth in minutes of use, supported by Sri Lanka’s post-war (since May 2009) growth and limited tariff competition. The pace of mobile subscriber growth will decelerate further as headline penetration approaches 90% (Q212: 87%), while the ongoing decline in fixed-wireless subscribers and demand is likely to continue.

High Capex/Infrastructure Rentals

Fitch expects operators to invest between 20%-40% of 2013 revenues into modernising the network, and building capacity and coverage to support greater demand. Network infrastructure-sharing is also likely to increase, particularly among challengers, as the benefits of rapid capacity and coverage deployment may compensate for sub-optimal positioning of transmission equipment and lower profitability.

Limited Overall Tariff Competition

Overall, Fitch does not expect a resurgence of tariff-based competition – given the increase in operating costs and inflationary pressures stemming from hikes in energy prices, and the sharp depreciation of the local currency since early 2012. Operators currently charge LKR2/minute on local calls to other networks (off-net) despite the tariff floor being lowered to LKR1.50/minute in 2011. Fitch expects multiple subscriber identity module (SIM) usage to decline if local call tariffs continue to remain uniform across operators.

However, tariff competition is likely to continue across data services, international roaming, and international direct dialling revenue. Yet the negative impact on blended ARPU is likely to be limited, as these segments do not yet account for a major portion of industry revenue.

Moderate Pressure on Profitability

Subscriber acquisition and retention costs (SARCs) are likely to remain high so long as six telecoms operators compete for Sri Lanka’s 21 million population. High SARCs should affect challengers more than incumbents (which benefit from greater economies of scale). Profitability pressure will also stem from higher energy costs and inflationary pressures since early 2012, as well as higher regulatory levies. However, the agency expects the EBITDAR margins of its rated companies to remain above 30% in 2013.

What Could Change the Outlook

Adverse Regulatory Changes: Any unanticipated adverse changes in the regulatory environment can result in the overall industry outlook being revised to negative.

Industry Consolidation: Further consolidation among telecoms operators could lead to the outlook being revised to positive. However, M&A risks – such as debt-funded acquisitions leading to weaker balance sheets – may offset the benefits of consolidation at least in the near term.