(Reuters) Fitch Ratings has downgraded Softlogic Holdings Plc's (SHL) National Long-Term Rating to 'BBB+(lka)' from 'A-(lka)'. The Outlook is Stable. Fitch also downgraded the National Long-Term Rating on SHL's unsecured redeemable debentures to 'BBB+(lka)' from 'A-(lka)'.
The downgrade reflects Fitch's expectation of a sustained weakness in SHL's financial profile at the holding company level, primarily because of debt-funded capital injections into the company's financial services, leisure and expanding retail subsidiaries. Also, higher dividends from SHL's healthcare business did not materialise.
KEY RATING DRIVERS
High Leverage: Fitch expects the holding company's leverage, measured as lease-adjusted debt net of cash to operating EBITDAR, to be 7.4x at 31 March 2014, the end of the financial year. SHL plans to reduce its debt, including through the disposal of an investment property and shifting to raise debt directly at its operating subsidiaries. Despite these plans, Fitch expects leverage at the holding company to remain at more than 3.5x, the threshold above which negative rating action may be considered, over the medium term.
Aside from high leverage at the holding company level, leverage at the group level (which excludes debt at SHL's licensed finance company) is also high relative to companies in the 'A(lka)' category (companies rated 'A-(lka)', 'A(lka)' and 'A+(lka)'). As at end-December 2013, group leverage was 6.5x compared with 5.4x at end-December 2012. While Fitch expects leverage at the group level to reduce over the next two to three years, it will likely remain consistent with levels for a company in the 'BBB(lka)' rating category. Weakness in IT and Retail Business: SHL's IT business continues to face margin decline due to intense competition in the mobile phone and computer hardware markets. SHL holds the distributorship for Nokia phones and Dell computers in Sri Lanka. Earnings at SHL's retail business have also come under pressure due to strong competition.
Strong Healthcare Business: The group has a strong market position in the healthcare segment through its majority interest in the Asiri Hospitals group (Asiri). Asiri accounted for over 60% of SHL's consolidated EBITDA in 9MFY14. Asiri benefits from strong structural demand for private-sector healthcare services in Sri Lanka across economic cycles, and low business risk
. While Fitch expects strong cash generation at Asiri, dividend flow to SHL will be constrained by Asiri's capex requirements and expansion.
Leisure Sector to Contribute to Earnings: The company's two hotel projects are expected to be operational in mid-2014 and late 2015 respectively. Fitch expects these hotels to contribute to group EBITDAR, which will reduce group leverage over the next two to three years.
RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
-Group leverage (excluding Softlogic Finance PLC ) being sustained above 5x
-a weakening in dividends received from the healthcare business
-a collective weakening of coverage and liquidity at both the holding company and group level
Positive: Future developments that may, collectively, lead to a positive rating action include:
-Group leverage (excluding Softlogic Finance PLC) being sustained below 3.5x on a sustained basis
-Group EBTIDAR/interest expense + operating lease rent improving above 1.25x on a sustained basis
-Holding company EBTIDAR/interest expense + operating lease rent improving above 1.4x on a sustained and forward looking basis
The downgrade reflects Fitch's expectation of a sustained weakness in SHL's financial profile at the holding company level, primarily because of debt-funded capital injections into the company's financial services, leisure and expanding retail subsidiaries. Also, higher dividends from SHL's healthcare business did not materialise.
KEY RATING DRIVERS
High Leverage: Fitch expects the holding company's leverage, measured as lease-adjusted debt net of cash to operating EBITDAR, to be 7.4x at 31 March 2014, the end of the financial year. SHL plans to reduce its debt, including through the disposal of an investment property and shifting to raise debt directly at its operating subsidiaries. Despite these plans, Fitch expects leverage at the holding company to remain at more than 3.5x, the threshold above which negative rating action may be considered, over the medium term.
Aside from high leverage at the holding company level, leverage at the group level (which excludes debt at SHL's licensed finance company) is also high relative to companies in the 'A(lka)' category (companies rated 'A-(lka)', 'A(lka)' and 'A+(lka)'). As at end-December 2013, group leverage was 6.5x compared with 5.4x at end-December 2012. While Fitch expects leverage at the group level to reduce over the next two to three years, it will likely remain consistent with levels for a company in the 'BBB(lka)' rating category. Weakness in IT and Retail Business: SHL's IT business continues to face margin decline due to intense competition in the mobile phone and computer hardware markets. SHL holds the distributorship for Nokia phones and Dell computers in Sri Lanka. Earnings at SHL's retail business have also come under pressure due to strong competition.
Strong Healthcare Business: The group has a strong market position in the healthcare segment through its majority interest in the Asiri Hospitals group (Asiri). Asiri accounted for over 60% of SHL's consolidated EBITDA in 9MFY14. Asiri benefits from strong structural demand for private-sector healthcare services in Sri Lanka across economic cycles, and low business risk
. While Fitch expects strong cash generation at Asiri, dividend flow to SHL will be constrained by Asiri's capex requirements and expansion.Leisure Sector to Contribute to Earnings: The company's two hotel projects are expected to be operational in mid-2014 and late 2015 respectively. Fitch expects these hotels to contribute to group EBITDAR, which will reduce group leverage over the next two to three years.
RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
-Group leverage (excluding Softlogic Finance
PLC ) being sustained above 5x-a weakening in dividends received from the healthcare business
-a collective weakening of coverage and liquidity at both the holding company and group level
Positive: Future developments that may, collectively, lead to a positive rating action include:
-Group leverage (excluding Softlogic Finance PLC) being sustained below 3.5x on a sustained basis
-Group EBTIDAR/interest expense + operating lease rent improving above 1.25x on a sustained basis
-Holding company EBTIDAR/interest expense + operating lease rent improving above 1.4x on a sustained and forward looking basis
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