Sri Lanka Sunshine Holdings gets 'A(lka)' Fitch rating

ECONOMYNEXT - Fitch Ratings Lanka said it has given Sri Lanka’s Sunshine Holdings PLC a National Long-Term Rating of 'A(lka)' with a Stable Outlook.

“Sunshine Holdings' rating reflects the defensive nature of its key operating subsidiaries, their leading market positions and strong free cash flow (FCF) generation,” a statement said.

Despite its exposure to the weak tea market, the holding company benefits from strong earnings from its palm oil, fast-moving consumer goods and healthcare businesses.

The full rating report follows: 

Fitch Ratings-Colombo-10 December 2015: 

Fitch Ratings Lanka has assigned Sri Lanka-based Sunshine Holdings PLC (Sunshine Holdings) a National Long-Term Rating of 'A(lka)' with a Stable Outlook.

Sunshine Holdings' rating reflects the defensive nature of its key operating subsidiaries, their leading market positions and strong free cash flow (FCF) generation. The rating also takes into account Sunshine Holdings' low group leverage, which Fitch expects to remain intact despite significant expansion. Sunshine Holdings, however, is exposed to the weak tea sector and its investments in ventures that are outside the company's core competencies could increase the business risk of the group as a whole.

KEY RATING DRIVERS

Strong Group Balance Sheet: Fitch expects Sunshine Holdings to maintain leverage - the ratio of gross adjusted debt to operating EBITDAR - at less than 3.0x over the medium-term (1.34x at end of the financial year to 31 March 2015 or FY15). The holding company benefits from strong EBITDAR contributions from the palm oil and fast-moving consumer goods (FMCG) sectors and the defensive healthcare sector. Fitch consolidates 33.15% of the financials of Estate Management Services Pvt Ltd (EMSPL), the holding company of agriculture and FMCG subsidiaries in its calculations of Sunshine Holdings' ratios.

We expect the company to maintain leverage at these levels despite higher than historical capex and spending on growth opportunities over FY16-FY19, which will be partly funded by strong internally generated funds.

Healthcare to Provide Stability: Fitch expects the healthcare segment to remain the largest contributor to dividends received by Sunshine Holdings' given stable FCF generation and low capex requirements. We expect growth in the healthcare segment over FY16-FY19 to be driven mainly by the expansion of the pharmacy chain, with growth in the high-margin diagnostic and wellness segments also contributing. Risks to the pharmacy chain include changes to regulated pricing for the drugs sold and volatility in foreign-currency rates as the company imports almost all the products it distributes.

Growth from FMCG and Palm Oil: Sunshine Holdings should continue to benefit from strong growth prospects in the palm oil and FMCG segments, which are driven by favourable macroeconomic trends that increase demand for the segments' products. Furthermore increased contributions from these segments should translate to improved group EBITDAR margins given both FMCG and palm oil carry high margins compared with rest of the group.

Continued Losses from Tea: The unprofitable tea business will continue to weigh on the rating as Fitch does not expect the segment to turn around in the foreseeable future. This view reflects the low global tea prices and escalating operating costs due to regular wage increases, which are not linked to any productivity measures.

New Project Risk: Sunshine Holdings is undertaking various projects across different sectors that we believe will increase the company's business risk. Even though new investments are supported by equity partnerships and Sunshine Holdings' strong balance sheet, any delays in construction of the projects or delays in breaking even could adversely impact the company's profitability and cash flow generation, and weigh on the rating.

Structural Subordination Not Material: Claims of creditors at the holding company level are structurally subordinated to creditors of the operating subsidiaries. Consequently, an increase in leverage at operating subsidiaries would weigh on Sunshine Holdings' rating. As of end-FY15 the ratio of Sunshine Holdings' prior ranking debt to proportionally consolidated EBITDA was 1.60x, which is below the 2.0x level at which Fitch would notch down the rating.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for the issuer include:

- Revenue growth to recover to low double-digit levels from FY17 driven by organic growth in existing businesses and contributions from new business ventures.

- EBITDAR margins to broadly settle in the low-double digit range in the medium term.

- Capex and growth-opportunity investments of LKR6bn during the rating horizon, including investments in the power, packaging and healthcare sectors

- Sunshine Holdings to maintain its current dividend policy

RATING SENSITIVITIES

Positive: No positive rating action is expected in the next 12-18 months given the cyclical risks of commodity-based business segments and risks associated with new investments.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- A sustained increase in Sunshine Holdings' adjusted gross debt/EBITDAR (considering only a 33.15% consolidation of EMSPL) to over 3.0x

- Sunshine Holdings' consolidated EBITDAR coverage (considering only a 33.15% consolidation of EMSPL), reducing below 2.5x on a sustained basis (8.40x as at end FY15).

- Significant delays or protracted break even period of new projects/investments which could adversely impact profitability or require additional capital calls

LIQUIDITY

As at end-September 2015, Sunshine Holdings' unrestricted cash on hand and committed but unutilised credit lines comfortably covered short-term debt falling due in the next 12 months.

Sri Lankan shares end lower; turnover hits 16-mth high on block deal

Reuters: Sri Lankan shares closed lower for a fifth straight session on Thursday, led by beverage and diversified shares, after a block deal in a key healthcare stock helped turnover hit a 16-month high, brokers said.

The main stock index ended down 0.26 percent at 6,823.91, its lowest close since March 31.

Turnover on the bourse hit the highest since Aug. 19, 2014 on a block trade in Asiri Hospital Holdings Plc.

TPG Growth III SF Pte. Ltd acquired 317.1 million ordinary shares or 27.87 percent stake in Asiri at 24 rupees a share, TPG Growth said in a stock exchange filing.

The block deal accounted for 94.2 percent of the day's turnover of 8.08 billion rupees ($56.44 million), well above this year's daily average turnover of 1.1 billion rupees.

Asiri closed 1.2 percent lower at 24.80 rupees a share.

"Select healthcare, construction, banking, and diversified counters led activity levels with additional crossings," JKH stock brokers said in a note to investors.

A crossing is a term market participants use to refer to a block deal.

Sri Lanka's stock market has fallen for 11 out of the last 12 trading sessions, with investor sentiment subdued after Prime Minister Ranil Wickremesinghe last week warned of lower economic growth next year due to the global slowdown.

Foreign investors sold a net 112.1 million rupees worth of shares on Thursday, extending the year to date net foreign outflow to 3.35 billion rupees worth of equities.

Nestle Lanka Plc fell 3.43 percent, while conglomerate John Keells Holdings Plc was 0.61 percent lower at the close. 

($1 = 143.1500 Sri Lankan rupees) 

(Reporting by Ranga Sirilal; Editing by Biju Dwarakanath)

Sri Lanka should be prepared to raise rates, improve 2016 budget: IMF

ECONOMYNEXT - Sri Lanka's should be prepared to tighten monetary policy and raise more taxes to pay higher state worker salaries, and contain spending as economic imbalances and risks are widening, the International Monetary Fund has said.

"With the recent acceleration in private sector credit growth and rising core inflation, there is now little scope for further monetary easing," the IMF's executive board said in an assessment on Sri Lanka.

"Most factors—including the deterioration in the balance of payments and pressures on the rupee—suggest that the CBSL should be prepared to tighten monetary policy in the coming months, albeit at a gradual pace."

Sri Lanka's central bank has a penchant to print money, delay rate increases, generate balance of payments crises and run to the IMF. It is still repaying a loan from the lender, and the latest assessment involves post-program monitoring.

Loose Monetary Policy

This year the Central Bank cut rates despite rising private credit demand, and a budget that deteriorated sharply after January 2015 and then printed money outright to repay maturing government debt by rejecting bids at Treasury bill auctions.

Over the last two weeks, Sri Lanka's central bank seems to have ended its runaway debt monetization operations at least for the moment and appeared to be tightening policy by mopping some of the liquidity that had been created.

Treasury bill yields were also allowed to rise on Wednesday.

Sri Lanka had printed large volumes of money to finance the budget deficit and repay maturing Treasury bill over 2015. The new created money allowed banks to give large volumes of credit outpacing the deposits raise. The excess demand then hit the balance of payments as imports.

The central bank then had to mop up the money in forex markets by spending forex reserves to prevent the rupee collapsing further by spending forex reserves.

Rupee Pressure

The rupee has already collapsed from 131 to 143 to the US dollar over 2016. By mopping up the excess money through the so-called domestic operations, pressure on the currency and runaway credit and imports can be reduced.

IMF said a better budget and better monetary policy can help strengthen the external balance.

"Tighter fiscal and monetary policies could help restrict aggregate demand, contain the recent sharp rise in imports, and strengthen the external balance," the IMF said.

"However, to be more effective, these policies should be supported by greater exchange rate flexibility, reduced foreign exchange intervention, and efforts to deepen the foreign exchange market, as well as structural reforms to enhance competitiveness."

Analysts say at the moment there is no sterilized foreign exchange sales where dollars are sold and liquidity is subsequently injected to prevent rates rising, a problem which can be corrected by ending interventions.

The problem is with new liquidity created by central bank purchases of Treasury bills before intervention are made, which is why an attempt to 'float' the currency in September also failed and it simply fizzled out as a devaluation and currency defence had to resume.

A falling rupee would generate a bout of inflation, boost rupee tax revenues and help pay the salaries of state workers and subsidies by boosting nominal revenues.

Analysts say it would impose hardships on private sector workers and the self-employed who will find that their salaries and banks savings are worth less.

This year the current account deficit of the balance of payments would narrow despite non-oil imports rising, the IMF said. Oil import bill would fall.

Analysts had also said earlier that Sri Lanka's external currency account deficit would narrow if net foreign borrowings of the government, which is the key driver of the trade deficit (the largest component of the current account deficit) narrows significantly.

Stability

IMF's staff assessment said it was up to Sri Lanka's authorities to improve spending and monetary policy to bring stability back to the economy.

"The economic outlook remains uncertain, and will depend to a large extent on the course set for economic policies in the coming months," a staff assessment said.

"The risks are tilted to the downside.

With rising the IMF said Sri Lanka needed a better budget for 2016, the IMF said.

"In view of high public debt, fiscal developments this year pose a risk to the economy and call for ambitious measures in the 2016 budget to put Sri Lanka’s fiscal position on a more sustainable footing.

IMF said Sri Lanka's economic imbalances came with rise in state worker salaries and cuts in taxes of several goods including cars, when international conditions were also unstable.

A rise in US interest rates may lead to a further changes in the global economy, the IMF said.

"Despite continued access to international debt markets, these trends suggest that financial risks for Sri Lanka have increased," IMF said.

"To mitigate these risks, the authorities should take appropriate corrective actions to safeguard macroeconomic stability and lay the foundation for durable and inclusive growth.

"Improvements in the business climate, reform of state owned enterprises, and a more open trade regime are key to boosting competitiveness and growth."

TPG Growth buys 28-pct stake in Sri Lanka’s Asiri Hospitals

(LBO) – TPG Growth, a global private investment firm announced it bought a 28 percent stake in Asiri Hospital Holdings Plc, a unit of Sri Lanka’s Softlogic group in a 7.6 billion rupee deal, a statement said.

“We’ve seen significant growth opportunities in healthcare across the globe, and particularly in Asia, as individuals increasingly choose private medical treatment for the quality of care offered by these institutions, Vishal Bali, senior healthcare advisor for TPG Growth in Asia, who will be joining the board of Asiri was quoted as saying in the statement.

“Asiri’s management team is addressing this demand in Sri Lanka in a very meaningful way. We look forward to partnering with the Company to support their growth and help them continue this momentum.”

“This partnership will provide new and diverse experience to the Board as well as access to TPG’s global network and experience making significant investments in healthcare,” Ashok Pathirage, Chairman and Managing Director of Softlogic group said.

“This partnership will help us continue to build our business as well as expand and upgrade operations in Sri Lanka and, perhaps, in other regions in Asia.”

TPG Growth paid 7.6 billion rupees to buy 317 million shares of Asiri Hospital Holding at 24 rupees each.

“Since October of 2012 when Actis invested in Asiri, the Company has grown considerably and expanded its operations,” Asanka Rodrigo, Partner at Actis said.

Deficit expands to US$ 6.1Billon

Ceylon Finance Today: The trade deficit recorded a 3.8% year-on-year (YoY) increase to US$ 6,145.2 million in the first nine months of the year and a 4.1% contraction to $ 764.5 million (still a negative trade balance) in September, largely led by the import of vehicles.

Nonetheless, September's external sector was modest, supported by the healthy growth in tourist earnings and moderate increase in workers' remittances, Central Bank of Sri Lanka (CBSL) said.It further said that in the wake of a possible increase in interest rates in the U.S., net inflows to the financial account moderated, in line with the trend that has been observed across emerging markets.

The external sector is expected to strengthen in the coming months with the recent policy adjustments implemented by CBSL and the Government of Sri Lanka (GoSL), it said.

Exports down
Export earnings at $ 850 million in September 2015 reflected a YoY contraction of 5.9 per cent, the seventh consecutive decline since March 2015. The largest contribution to this drop came from industrial exports which declined by 4.7 per cent, led by subdued performance of rubber products, gems, diamonds and jewellery, machinery and mechanical appliances and printing industry products, which jointly attribution to around 60 per cent of the overall decline in exports.

However, export earnings from textiles and garments, which account for around 48 per cent of total exports increased by 1.8 per cent YoY during the month, reflecting a considerable expansion in garments exports to non-traditional markets such as Canada, Australia, India, UAE and Hong Kong.

Meanwhile, agriculture export earnings in September 2015 declined by 11.3 per cent YoY, mainly due to significant declines recorded in tea and seafood exports as in last few months. Tea exports have been affected by the lower demand from Russia and Middle East countries.

Accordingly, tea export earnings dropped by 20.4 per cent in September 2015 YoY, reflecting declines in both export volumes and export prices. The average tea export price decreased to $ 4.32 per kilogram compared to $ 5.01 per kilogram recorded in September 2014.

Seafood exports also continued to decline in September 2015 due to the European Union ban on sea food imports from Sri Lanka. Accordingly, seafood exports to the EU market dropped by 82.4 per cent YoY in September 2015.

Spices
However, continuing the healthy performance observed in previous months of the year, earnings from spice exports increased by 34.9 per cent during the month, led by exports of pepper and cloves.

On a cumulative basis, export earnings contracted by 3.7 per cent during the first nine months of the year, reflecting declines in both agricultural and industrial exports. The leading markets for merchandise exports of Sri Lanka during the first nine months of 2015 were the USA, the UK, India, Germany, Italy and China which accounted for about 54 per cent of total exports.

Import expenditure declined by 5.1 per cent YoY to $ 1,583 million in September 2015. The largest contribution for this decline came from investment goods, followed by intermediate goods.

Reduction in imports of transport equipment was the main contributor to the decline recorded in investment goods imports. Despite the considerable growth recorded in commercial vehicles such as auto-trishaws, commercial cabs and agricultural tractors, expenditure on imports of transport equipment dropped by 47.9 per cent in September 2015, mainly reflecting the higher import expenditure recorded in September 2014 due to the import of a dredger vessel.

In line with the reduction in fuel prices in the international market, fuel import bill declined continuously, becoming the main contributor to the 4.8 per cent reduction in import expenditure on intermediate goods.

The average crude oil import price which was $ 100.08 per barrel in September 2014, declined to $ 48.65 per barrel in September 2015. Import expenditure on textiles and textile articles, diamonds and precious stones and metals and base metals also dropped significantly during the month.

However, import expenditure on wheat and maize, fertiliser and mineral products which are categorized under intermediate goods, increased significantly in September 2015. Continuing the YoY increases recorded from May 2014, import expenditure on consumer goods increased by 7.4 per cent in September 2015 led by vehicle imports.
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Regular tax revisions increase sector volatility

Excise tax on alcohol constituted around 5% of government revenue in 2014 and successive governments have consistently used it as a tool to boost revenue to bridge budget deficits.

The government increased taxes on liquor twice in 2015, as it did in 2014. Excise duty on locally produced hard liquor has increased 25% in 2015 as a result, compared with 70% for strong beer (more than 5% alcohol).

However, taxes on mild beer (less than 5% alcohol), already taxed more on an equivalent-alcohol basis, increased only 7%, making taxes more comparable on an equivalent-alcohol basis across products.

Fitch in a report said that they expect a slowdown in hard liquor-to-beer substitution in 2016 with excise duties on beer increasing significantly above those on hard liquor. As such, Fitch believes beer manufacturers, such as Lion, would be compelled to increase prices at a faster pace compared with liquor manufacturers to reflect the revised taxes, which could negatively affect demand.

"The duty hike in 2015 has resulted in the taxes on strong beer overtaking that of hard liquor on an equivalent alcohol basis, which we believe would slow down the demand shift to beer as the former gets more expensive," said Fitch. Strong beer constituted 90% of beer production in the country in 2014, and reported the highest growth rate in the industry. Beer production rose 4% in 2014, following a 21% increase in 2013, while hard liquor production has declined 12% in the last two years.

Super taxes
Apart from revenue taxes, effective corporate-tax rate for alcoholic-beverage companies was reduced to 37.5% from 40% under the 2016 budget, but is higher compared to the 15%-30% for other companies. Both DIST and Lion were subjected to a super-gains tax on their previous year's taxable income amounting to LKR2.0bn and LKR300m, respectively, in addition to the normal corporate tax.

"Given the strong cash reserves at both entities, we do not expect the additional tax burden to have a significant impact on entities' leverage or liquidity; neither do we expect such taxes to recur," it said.
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Budget good for big liquor players

Fitch Ratings has assigned a stable outlook to Sri Lanka's alcohol beverage sector, even though government decisions in October and November 2015 to raise excise duties on alcoholic beverages increase prices.It said rising disposable income will absorb the higher duties, and Fitch believes the inelastic demand and increased consumer demand for refined alcohol should allow companies, including Distilleries Company of Sri Lanka PLC (DIST, AAA(lka)/Stable) and Lion Brewery (Ceylon) PLC (Lion, AA-(lka)/Stable), to pass on those charges to consumers without worrying about them shifting to the more affordable illicit market.

Positive Market Dynamics: Fitch expects increased per capita income, driven by the agency's forecast GDP growth for Sri Lanka of over 6% in 2016, the recent increase in public-sector pay, higher tax exemptions for private-sector employees and reduced essential-goods prices to improve the affordability of – and sustain the demand for – alcohol in 2016.

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Sri Lanka’s four challenges

By Paneetha Ameresekere

Ceylon Finance Today: Sri Lanka faces four challenges, IMF Country Representative Eteri Kvintradze, speaking at a forum in Colombo yesterday, said.

One was external, related to the fall of the Chinese economy, the possible rise in US interest rates and the flight of capital, leading to a strain in the island's balance of payments (BoP), while the other three were internal.

One internal matter, which was the second challenge was connected with the fall in government revenue, the third was ease of doing business and the fourth, women's empowerment vis-à-vis labour participation.

On the external front, she said, due to the rebalancing of the Chinese economy, the world's second largest, from one of being export driven to that of being consumption (internal) driven, that has slowed down Chinese economic growth, with a knock on effect on commodity exports to China.

In the long term these changes were good, said Kvintradze.

Nonetheless, that in turn has led to a fall in commodity prices, with oil being the forerunner. She further said that the devaluation of the yuan had had a cascading effect on other currencies, leading to their decline. This, also had had a deleterious effect on the Sri Lankan rupee.

China's fall had both regional and global repercussions.

Matters were made worse, where, compared to peer (emerging and frontier) countries, Sri Lanka has consumed a large amount of its foreign reserves for the defence of the rupee, she said. Kvintradze further said that much of the island's foreign reserves are built on borrowed money. It's not built from economic activity, she said.

Sri Lanka's foreign reserves situation is not healthy, said Kvintradze. She also said that situation had become difficult due to capital flight, both from the financial sector and capital markets. And with the Federal Reserve System set to regularize its policy rates, such outflows will continue, causing further downward pressure on the rupee. The Fed. 
Open Market Committee is set to finalize this matter when they meet for the last time for the year next week (15-16 December).

She also said that Sri Lanka didn't leverage on the opportunity it got due to falling oil prices. This was due to a rise in non oil imports led by durables, of which the market leader was small vehicles. As a result, a possible saving of some US$ 1-1.5 billion was lost, said Kvintradze.

Sri Lanka has a low reserve coverage and a continuous deficit in the BoP in its current account for an extended period of time, the IMF representative said.

She further said because Sri Lanka was a low value commodity exporter, its economy too took a hit due to the decline in commodity prices globally. There was a need for the country to upscale its exports for which innovation is sine qua non, the IMF representative said.

Kvintradze saw Sri Lanka's low revenue base led by poor tax collection as an opportunity to increase collections. If tax collections are increased, then Sri Lanka needn't borrow to meet its social and physical infrastructure needs. The island's revenue collection is the lowest in the region, she said.

She further said BoP difficulties and fiscal deficits are interconnected. Sri Lanka's fiscal situation has been made worse due to salary increases given in Budget 2015, the IMF Representative said.

On "ease of doing business", she said that though Sri Lanka scores high in the region, the South Asian region is regarded as one of the most difficult regions in the world. Sri Lanka has been at peace for the past five years after suffering from a three decade war.

Post war, she has rapidly developed her physical infrastructure, by telescoping what would have taken to be developed in 15 years to five years, said Kvintradze. With the peace dividend, a seeming luxury in this part of the world, it's up to the people of this country to take Sri Lanka forward, the IMF representative said.

She also bemoaned the fact that though the standard of education among women in the island was high, their labour force participation rate was poor, akin to that of India, where, relatively, the women in Sri Lanka were more educated than their Indian counterparts on a percentage basis.

Due to the poor labour force participation rate of women, productivity has been inured.
Reforms and productivity were the way forward for the country, she said. Kvintradze said that Sri Lanka's economy was to grow by 5.5% this year. The seminar which had a focus on the economy was organized by LBO/LBR.

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