ECONOMYNEXT - Sri Lanka's Lion Brewery Plc, has been upgraded to 'AA-(lka)' by Fitch Ratings as cashflows improved with rising sales, after taxes which accelerated over hard liquor were halted, despite a recalibration of the local rating scale downwards.
"Lion's cash flows have improved, helped by a recovery in sales, which was supported by a reversion in the excise duty regime to tax drinks with lower alcohol content at reduced rates compared with spirits," the rating agency said.
"The increased penetration of beer per capita also supports stronger sales.
"At end-September 2018, Lion's latest trailing 12- month net leverage was 1.0x. Lion's business risk profile has also benefitted from the management's efforts to mitigate the flood risk at its main production facility."
"Domestic alcoholic beverage producers face frequent revisions to excise duties, which cause significant operating cash flow volatility.
"In 2015, the government increased the excise duties on alcohol twice, which led to tax on strong beer overtaking the tax on hard liquor on an equivalent-alcohol basis.
"The situation was reversed after 24 months, which resulted in hard liquor being taxed at 34% more than strong and mild beer on an equivalent-alcohol basis.
The full statement is reproduced below:
LION BREWERY (CEYLON) PLC:
The upgrade of Lion's National Long-Term Rating reflects the recalibration of the Sri Lankan
national scale ratings as well as our view that Lion will maintain its leverage - net adjusted debt
/ EBITDAR - in line with a 'AA-(lka)' rating.
Lion's cash flows have improved, helped by a
recovery in sales, which was supported by a reversion in the excise duty regime to tax drinks
with lower alcohol content at reduced rates compared with spirits.
The increased penetration of beer per capita also supports stronger sales. At end-September 2018, Lion's latest trailing 12- month net leverage was 1.0x. Lion's business risk profile has also benefitted from the management's efforts to mitigate the flood risk at its main production facility.
Fitch rates Lion on its standalone strength due to weak linkages between Lion and its stronger
ultimate parent, Carson Cumberbatch PLC, as defined in Fitch's Parent and Subsidiary Rating
Linkage criteria. Lion's rating reflects its leading market position in the domestic beer industry,
which is protected by stringent regulation, its well-established brand and extensive retail
coverage. However, the domestic excise tax regime on alcoholic beverage sales changes
frequently, which inhibits the industry's profitability.
Recovery in Sales Volume: Fitch expects Lion's sales to improve in the medium term after excise
duties were revised to tax manufacturers of spirits at higher rates than beer and wine makers.
The government taxes a litre of strong beer at LKR2,455 compared with LKR3,300 for spirits,
effective from 10 November 2017. The current tax regime is more consistent with the practice
that prevailed before November 2015, when drinks with lower alcohol content such as beer
were taxed at lower rates than spirits. Lion's sales volumes were depressed from November
2015 to October 2017 when a litre of strong beer was taxed at LKR3,580, higher than spirits'
LKR3,246. Fitch expects the current regime, with lower taxes on beer than spirits, to prevail
over the medium term.
Balance Sheet to Strengthen: We believe Lion's net leverage will remain below 1.5x in the
medium term, mainly due to healthy profitability and a likely reduction in capex compared with
past years. The company has sufficient brewing capacity for the next few years following the
expansion in its production capacity, which drove the high capex from FY14-FY16.
Improving EBITDAR Margin: Fitch expects Lion's EBITDAR margins to stabilise at around 29% from
FY20, from 27% in FY18, supported by better sales and operating conditions. Lion's EBITDAR
margin recovered significantly to around 38% by 1H19 from a low of 19.5% in FY17 when
manufacturing was halted temporarily due to floods and Lion had to import inventory at a
higher cost. The margin recovery was driven by the company's efforts to recoup some of the lost
sales volumes and operational efficiencies that reduced costs.
Market Leadership: Lion is the largest beer manufacturer in Sri Lanka, with significant market
share in the domestic beer market. Lion consolidated its market leadership in FY18 by regaining
the shelf space it lost in FY17 due to the temporary halt in production following floods in May
2016. Lion's strong market share is supported by its entrenched brand and widespread retail
coverage, with access to 2,800 retail outlets around Sri Lanka. The company's market position is
protected to some extent by regulations in the form of stringent restrictions on advertising and
limited issuance of new retail licenses.
High Regulatory Risk: Domestic alcoholic beverage producers face frequent revisions to excise
duties, which cause significant operating cash flow volatility. In 2015, the government
increased the excise duties on alcohol twice, which led to tax on strong beer overtaking the tax
on hard liquor on an equivalent-alcohol basis. The situation was reversed after 24 months,
which resulted in hard liquor being taxed at 34% more than strong and mild beer on an
equivalent-alcohol basis. We believe any further tax increases will be gradual, considering the
importance of the industry to government coffers. Excise duties from alcoholic-beverage
makers made up 7% of government tax revenue in 2017.
"Lion's cash flows have improved, helped by a recovery in sales, which was supported by a reversion in the excise duty regime to tax drinks with lower alcohol content at reduced rates compared with spirits," the rating agency said.
"The increased penetration of beer per capita also supports stronger sales.
"At end-September 2018, Lion's latest trailing 12- month net leverage was 1.0x. Lion's business risk profile has also benefitted from the management's efforts to mitigate the flood risk at its main production facility."
"Domestic alcoholic beverage producers face frequent revisions to excise duties, which cause significant operating cash flow volatility.
"In 2015, the government increased the excise duties on alcohol twice, which led to tax on strong beer overtaking the tax on hard liquor on an equivalent-alcohol basis.
"The situation was reversed after 24 months, which resulted in hard liquor being taxed at 34% more than strong and mild beer on an equivalent-alcohol basis.
The full statement is reproduced below:
LION BREWERY (CEYLON) PLC:
The upgrade of Lion's National Long-Term Rating reflects the recalibration of the Sri Lankan
national scale ratings as well as our view that Lion will maintain its leverage - net adjusted debt
/ EBITDAR - in line with a 'AA-(lka)' rating.
Lion's cash flows have improved, helped by a
recovery in sales, which was supported by a reversion in the excise duty regime to tax drinks
with lower alcohol content at reduced rates compared with spirits.
The increased penetration of beer per capita also supports stronger sales. At end-September 2018, Lion's latest trailing 12- month net leverage was 1.0x. Lion's business risk profile has also benefitted from the management's efforts to mitigate the flood risk at its main production facility.
Fitch rates Lion on its standalone strength due to weak linkages between Lion and its stronger
ultimate parent, Carson Cumberbatch PLC, as defined in Fitch's Parent and Subsidiary Rating
Linkage criteria. Lion's rating reflects its leading market position in the domestic beer industry,
which is protected by stringent regulation, its well-established brand and extensive retail
coverage. However, the domestic excise tax regime on alcoholic beverage sales changes
frequently, which inhibits the industry's profitability.
Recovery in Sales Volume: Fitch expects Lion's sales to improve in the medium term after excise
duties were revised to tax manufacturers of spirits at higher rates than beer and wine makers.
The government taxes a litre of strong beer at LKR2,455 compared with LKR3,300 for spirits,
effective from 10 November 2017. The current tax regime is more consistent with the practice
that prevailed before November 2015, when drinks with lower alcohol content such as beer
were taxed at lower rates than spirits. Lion's sales volumes were depressed from November
2015 to October 2017 when a litre of strong beer was taxed at LKR3,580, higher than spirits'
LKR3,246. Fitch expects the current regime, with lower taxes on beer than spirits, to prevail
over the medium term.
Balance Sheet to Strengthen: We believe Lion's net leverage will remain below 1.5x in the
medium term, mainly due to healthy profitability and a likely reduction in capex compared with
past years. The company has sufficient brewing capacity for the next few years following the
expansion in its production capacity, which drove the high capex from FY14-FY16.
Improving EBITDAR Margin: Fitch expects Lion's EBITDAR margins to stabilise at around 29% from
FY20, from 27% in FY18, supported by better sales and operating conditions. Lion's EBITDAR
margin recovered significantly to around 38% by 1H19 from a low of 19.5% in FY17 when
manufacturing was halted temporarily due to floods and Lion had to import inventory at a
higher cost. The margin recovery was driven by the company's efforts to recoup some of the lost
sales volumes and operational efficiencies that reduced costs.
Market Leadership: Lion is the largest beer manufacturer in Sri Lanka, with significant market
share in the domestic beer market. Lion consolidated its market leadership in FY18 by regaining
the shelf space it lost in FY17 due to the temporary halt in production following floods in May
2016. Lion's strong market share is supported by its entrenched brand and widespread retail
coverage, with access to 2,800 retail outlets around Sri Lanka. The company's market position is
protected to some extent by regulations in the form of stringent restrictions on advertising and
limited issuance of new retail licenses.
High Regulatory Risk: Domestic alcoholic beverage producers face frequent revisions to excise
duties, which cause significant operating cash flow volatility. In 2015, the government
increased the excise duties on alcohol twice, which led to tax on strong beer overtaking the tax
on hard liquor on an equivalent-alcohol basis. The situation was reversed after 24 months,
which resulted in hard liquor being taxed at 34% more than strong and mild beer on an
equivalent-alcohol basis. We believe any further tax increases will be gradual, considering the
importance of the industry to government coffers. Excise duties from alcoholic-beverage
makers made up 7% of government tax revenue in 2017.
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