JKH risk profile deteriorates - Fitch

Fitch Ratings last week announced it had downgraded ratings of Sri Lanka’s premier blue chip conglomerate John Keells Holdings PLC’s (JKH) due to the deterioration in JKH’s business risk profile, driven by the weakening competitive position of its key dividend-paying associate, South Asia Gateway Terminals (SAGT), in which JKH owns 42%. The rating agency downgraded JKH National Long-Term Rating to ‘AA+(lka)’ from ‘AAA(lka)’ though the Outlook is Stable.

JKH is a holding company with interests in transportation, leisure, property, consumer foods, retail and financial services, and it depends largely on dividend income to meet its financial obligations.

“Dividends from SAGT accounted for 37% of JKH’s EBITDAR in the financial year ended 31 March 2014 (FY14) (FY12: 50%; FY13: 33%). Fitch expects increasing dividend income from JKH’s other businesses to compensate for the drop in SAGT’s cash flows, but these other segments have higher business risk profiles. The rating is supported by the diversity of JKH’s dividend income streams, the company’s strong liquidity profile and its conservative capital structure,” Fitch said.

Fitch noted that JKH is also investing in excess of USD650m in an integrated resort project in Colombo, which is not likely to start generating income until FY19.

“The project carries considerable project-related risks, such as the possibility of cost- and time-overruns, which could delay the repayment of debt used to finance it. However, these risks are offset by JKH’s decision to fund the project by raising capital ahead of major investment and the substantial cash balances at the holding company, which could be used to pay for reasonable cost overruns, should they occur,” the agency pointed out.
The Key Rating Drivers according to a statement released by Fitch is given below.

Transportation Sector under Pressure: Volumes at SAGT, a privately owned container terminal at the Port of Colombo, fell 11% in FY14 after several shipping lines switched to using another terminal. SAGT faces tougher competition from the newly built Colombo International Container Terminal, which can handle larger vessels, and state-owned Jaya Container Terminal (JCT). SAGT’s volumes could further decline if key customers use larger vessels that require additional draft and crane size, which are offered by the newer terminal. JKH’s 99%-owned bunker fuel supplier Lanka Marine Services, which accounted for 5% of the holding company EBITDAR in FY14, is also facing top line and margin pressure as a result of increased competition.

Higher Business Risk: The property sector will contribute significant dividends to JKH in FY15 and FY16 once two new properties are completed in 2014 and 2015. However, cash flow from the sector will be limited after that until earnings are realized from completion of the residential apartments at the integrated resort project in FY19. The property development business is inherently cyclical and volatile, and consequently the increased exposure to this sector has weakened JKH’s overall business profile.

Rising tourist arrivals are likely to boost dividends from the leisure sector, which accounted for 29% of JKH’s EBITDAR in FY14. Cash flows from the sector will be strengthened by the addition of a new business hotel, Cinnamon Red, in September 2014 and supported by continuing strong performance of its five-star city hotels and resorts in Sri Lanka and the Maldives for which most of the capex has been already incurred.

Real-estate Project Risks: JKH’s integrated resort comprises a hotel and conference center as well as residential, retail and entertainment spaces. Construction on the project has started and JKH has continued to demonstrate a conservative approach to raising equity ahead of major investment. It raised USD175m in November 2013 through a rights issue and plans to raise a further USD125m by way of warrants in FY16 and FY17. The project is held by a new subsidiary, Waterfront Properties (Pvt) Ltd., which will issue debt in order to improve returns for JKH’s shareholders from the project. This, combined with the reputation risk to JKH that may arise if the project fails, could mean higher financial risk to the holding company. However, this is likely to fall outside the rating horizon. Fitch takes comfort from the high cash balance at the holding company, which will help to offset risks from the integrated resort project.

Strong Liquidity, Capital-market Access: JKH has a strong track record of raising shareholder funds ahead of major investments across the group. This has enabled the company to maintain a conservative capital structure with holding company cash reserves exceeding debt. JKH’s conservative policies are supported by its diverse shareholding structure in which no single shareholder or group controls more than 14% of the company. A material increase in shareholder concentration that could lead to an adverse shift in holding company and group leverage could be credit negative.

JKH response to rating downgrade

John Keells Holdings (JKH) has been one of the largest investors in Sri Lanka, particularly in the post-conflict period where the Group has invested heavily in its existing portfolio of businesses in addition to its investment in the Waterfront Integrated Resort Project. The recent investments of JKH are in industries with high growth prospects having considered the risk/reward factors, particularly in the current context of a post-conflict Sri Lanka with a strong economic growth outlook. The proactive steps taken by JKH in the past 10 years through aggressive investments, particularly in areas such as Leisure, Consumer Foods and Retail, Property and Financial Services, have borne fruit and have resulted in a balanced portfolio and a diverse stream of healthy cash flows.

Whilst the Transportation business has seen a moderation in its performance over the past few years as anticipated, JKH is of the view that SAGT will benefit from the overall prospects for the Port of Colombo where volumes are bound to increase in the medium term with the commissioning of deep-water berths in the south port. SAGT’s current performance continues to be well above the Group’s hurdle rates. 

The Waterfront Project, construction which began in March 2014, is in progress with piling work currently underway. The pre-sales of the residential apartments and commercial spaces have been beyond expectations. While the Project is well funded, with contingencies in-built at the project level itself, JKH’s current, and expected, financial strength is more than sufficient in meeting any unanticipated obligations.
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TFC hit by decline in pawning income

Sri Lanka’s oldest Non-Bank Financial Institution (NBFI) The Finance Company PLC (TFC), which completed 74 years in operation in financial year 2013, says its losses during the period had mounted due to the drop in the interest income, where the decline in the pawning income was the main contributing factor. The Company during the year ended 31st March 2014 has made a loss after income tax reversal of Rs.1.8 billion against a loss of Rs.1.5 billion reported in the previous year, financials showed. The Company’s interest income dropped by 5 percent YOY compared to an increase of 6 percent recorded in year 2012/13.

“The interest expenses also increased during the year under review by 11% due to the increase in the time deposit intake and the total operating expenses increased marginally by 4%,” TFC Managing Director Aruna P Lekamge said.

He noted that drop in pawning income owing to the downward trend in the market prices of gold was the main contributing factor for the marginal drop recorded whilst the Company expects an increase in pawing income with the upward trend reported in the last quarter of 2013/14.

“The future strategy of the Company is to build up a low cost funding base and to look at new avenues of increasing its lending portfolio to the SME Sector whilst disposing the current real estate stock and investment properties. The Company will also look into joint property development projects on the mega lands projects and properties belonging to the Company thereby converting the non-yielding real estate portfolio to yielding portfolio,” Lekamge, who took over as the Managing Director in May 2014.

In May 2014, Sri Lanka’s financial sector regulator, the Central bank of Sri Lanka announced the commencement of the second phase of the restructuring program for the Company and that a credit line has been arranged for the Company of Rs.6 billion from the Sri Lanka Deposit Insurance and Liquidity Support Scheme in keeping line with the envisaged business model. Further, to implement the future conduct of business under new restructuring plan a new Board was also appointed.

“The Company, started off its operations under the new management with a short-term plan initially drawn up for three months, in order to gear its business activities to the level envisaged to achieve with the volumes once the funding is received. The Board and management of the Company is preparing the five year business plan to be submitted to the Central Bank. The Company has also introduced new products such as Revolving Business Loans, Personal Loans and Top-up Loans in order to penetrate the markets and venture into new avenues of increasing the Investment portfolio,” Lekamge said pointing out that the notable gain that was achieved during the year under review was the Company being able to win the tax appeal made to the Tax Appeal Commission which resulted in a net positive gain of Rs.401 million.

“The Real Estate Income was the main contributor for the increase in total other income by 4% compared to a drop of 63% recorded in the year 2012/2013. The continued customer confidence in the Company is evident from increase in the Public Deposits by Rs.1.88 billion during the year under review,” the newly appointed MD added.
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People’s Leasing to merge with People’s Merchant next month

The People’s Leasing Company (PLC) is gearing to absorb its subsidiary People’s Merchant under the current financial sector consolidation process, officials said.

“By next month this will be wrapped up,” a People’s Merchant official told the Business Times. He said a voluntary retirement scheme is likely to be given.

During August 2014, many banks and finance and leasing companies (NBFI) were actively involved in the consolidation process, the Central Bank (CB) said.

In a media release it said that Asian Finance Ltd with TKS Finance Ltd, Capital Alliance Finance PLC with Cargills Bank Ltd, Commercial Credit and Finance PLC with Trade Finance and Investments PLC, Bartleet Finance PLC with Orient Finance PLC, Prime Grameen Micro Finance Ltd with Hatton National Bank PLC, and Senkadagala Finance PLC with Newest Capital Ltd, made public announcements of agreed consolidation arrangements.

The Monetary Board approved, another 10 consolidation proposals submitted by banks and NBFIs, and the respective entities were proceeding with the merger/acquisition processes. Hitherto, 29 proposals of seven banks and 22 NBFI have been approved by the CB. “Further consolidation plans of seven NBFIs and one bank are being finalized and will be announced in the coming days,” the release said.

Mergers of DFCC Bank, DFCC Vardhana Bank PLC and the National Development Bank PLC, as well as Merchant Bank of Sri Lanka PLC, MBSL Savings Bank Ltd., and MCSL Finance Services Ltd., continued to progress during the month with a view to completing the transactions by last quarter of this year, the release further said.

“The Panel of Audit Firms continued to assist in Transaction management, by advising Banks and NBFIs on transactions as well as on the smooth transition. The Central Bank has met the professional fees on account of the services rendered by these firms to ensure consistency and independence of the work carried out. In the meantime, banks and NBFIS continued to engage local and international experts to assist in their endeavours to effectively merge and ensure smooth transition after the consolidation.”

The Guidelines on Taxation in terms of the Inland Revenue (Amendment) Act No. 8 of 2014 and Value Added Tax (Amendment) Act No. 7 of 2014 on the tax incentives to support the consolidation process are being finalized through stakeholder engagement, it added. 

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UDA’s Rs. 10 billion debenture by mid-Oct

The Urban Development Authority (UPA) is working with the People’s Bank to launch its Rs. 10 billion debenture issue by mid October, officials said.

“It’ll be a public offer and the rate will be at in the 9.5 per cent range,” a senior official told the Business Times, adding that this is government backed and is for five years. “This will be used for low cost housing.”

The official said next year they intend to launch a Rs. 20 billion debenture also for low-cost housing. “Depending on the requirement, we’ll go up to Rs. 50 billion (in debentures) in the following year,” he said.

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SME Board on the stock exchange likely by this year

By Duruthu Edirimuni Chandrasekera

Now that a separate trading board for Board of Investment (BOI) companies will be a reality, plans by the Colombo Stock Exchange (CSE) to create a similar board for Small and Medium Enterprises (SME) is taking shape. The CSE together with the Securities and Exchange Commission (SEC) in a joint initiative have made far reaching progress on this, CSE officials said.

“We’ve been working on this for about four months and will be making progress this year,” a CSE official told the Business Times, indicating that they are likely to set this up towards the year end.

He said a decision is pending on whether this board will be more favourable to listing debt or equity. “CSE officials visited the BSE Ltd (Bombay Stock Exchange) and some of us went to the Shenzhen Stock Exchange (SZSE) on a fact finding mission and things are on track,” the official said.

CSE officials have been discussing SMEs ‘extensively’, according to CSE officials. “We conducted forums in this regard with the National Chamber of Exporters, Export Development Board and the Industrial Development Board,” a CSE official told the Business Times. He added that this awareness creation exercise has been ‘more than’ successful.

By mid this month the BOI Board in addition to the existing Main Board and the Diri Savi Board is slated to be launched with projects ranging from solar power, hotels and aluminum can manufacturing. This new board aims to allow the BOI companies to list on a separate board without having to wait three years to list on the CSE’s Main Board as is required now. Firms with a BOI status and a capital of US$10 million are allowed on this board, according to the draft rules.
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