ECONOMYNEXT - Sri Lanka DSI Samson group, a rubber products group is planning to boost solid tyre sale as it faces domestic competition from small scale footware producers, Fitch Ratings confirming 'BBB+(lka)' rating said.
The outlook on the rating is stable.
Fitch said there is a recovery in domestic sales in the nine months to December, after revenues weakened in the year to March.
"The recovery was underpinned by the growth in domestic sales of school shoes and solid rubber tyre exports, which has helped to offset the decline in rubber slipper sales and pneumatic tyres sold to original equipment manufacturers (OEMs)," Fitch said.
"DSG's rating also factors in our expectation that the company's plans to grow its value-added footwear and solid tyre businesses over the medium term to diversify its product offering will help to counterbalance competitive pressures to an extent."
DSG's domestic tyre and tube volumes had fallen 7 percent in FY17 (13 percent growth in FY16) due to a slowdown in the demand for bicycle tyres and a reduction of the maximum loan-to-value (LTV) ratio on three-wheeler leases.
"We expect domestic sales of pneumatic tyres to the OEM three-wheeler market to remain under pressure over the medium term due to the tightening of three-wheeler financing regulations in 2017," Fitch said.
"However, DSG's exposure to the replacement market (65% of domestic pneumatic tyre volumes in FY17) mitigates this risk."
Sri Lanka has high import taxes on shoes and tyres which helps domestic producers to easily exploit consumers with high prices.
DSI is facing competition from a number of small producer as well as imports, Fitch said. But it had a strong brand and wide distribution network.
The full statement is reproduced below:
Fitch Ratings-Colombo-27 February 2018: Fitch Ratings has affirmed Sri Lanka-based DSI Samson Group (Private) Limited's (DSG) National Long-Term Rating at 'BBB+(lka)'. The Outlook is Stable.
The rating affirmation reflects the moderate recovery in DSG's revenue and EBITDA in the nine months to 31 December 2017 following a weakening in the financial year ended 31 March 2017 (FY17).
The recovery was underpinned by the growth in domestic sales of school shoes and solid rubber tyre exports, which has helped to offset the decline in rubber slipper sales and pneumatic tyres sold to original equipment manufacturers (OEMs).
DSG's rating also factors in our expectation that the company's plans to grow its value-added footwear and solid tyre businesses over the medium term to diversify its product offering will help to counterbalance competitive pressures to an extent.
Fitch has tightened DSG's rating sensitivity on leverage (defined as lease-adjusted debt net of cash/operating EBITDAR) to 4.5x from 5.0x to capture the increased business risk from fiercer competition and slower domestic sales volumes in several of its key segments. We expect DSG's rating headroom to be limited over the medium term, with net leverage hovering only just below the 4.5x threshold at which Fitch would consider negative rating action.
DSG's 'BBB+(lka)' rating continues to reflect its leading positions in domestically sold pneumatic tyres to the replacement market and footwear, which are supported by its well-known brand and widespread distribution network. DSG's market share also benefits, to an extent, from high tariffs on imports of tyres and footwear.
KEY RATING DRIVERS
Pressure on Domestic Tyre Volumes: We expect domestic sales of pneumatic tyres to the OEM three-wheeler market to remain under pressure over the medium term due to the tightening of three-wheeler financing regulations in 2017. However, DSG's exposure to the replacement market (65% of domestic pneumatic tyre volumes in FY17) mitigates this risk.
DSG's domestic tyre and tube volumes declined by 7% in FY17 (13% growth in FY16) due to a slowdown in the demand for bicycle tyres and a reduction of the maximum loan-to-value (LTV) ratio on three-wheeler leases. In 2017, the regulator lowered the upper band of LTV ratios associated with three-wheeler leases to 25% from 70% to curb vehicle imports, which led to a 13% drop in DSG's three-wheeler segment volume.
Leverage to Remain High: We expect DSG's net leverage to hover just below 4.5x over the medium term, which is high for its rating, due to competitive pressure in some of its operating segments, while the company's bid to diversify its cash flows via exports and value-added footwear may take time to yield results.
DSG's leverage also weakened on high borrowings for capex and working capital investments in FY17. However, we expect capex to moderate from FY18 due to adequate production capacity and a recovery in EBITDA as a result of greater contribution from high-margin solid tyre exports and higher-value-added footwear.
EBITDA Margin Pressures: We expect DSG's EBITDA margin to remain at around 9% over the next two to three years due to escalating production costs caused by rising commodity prices and domestic currency depreciation. EBITDA margins have declined from 10.2% in FY16 and 13.3% in FY15 on rising input costs and competition. Fitch expects the price of natural and synthetic rubber, which is DSG's key production input, to increase in line with rising crude oil prices.
Growing price competition, particularly in the lower end of the rubber slipper segment, also means that the company is limited in its ability to fully pass on cost increases to its customers.
Leading Market Position: DSG is the market leader in the bicycle, motorcycle and three-wheeler tyre industry in Sri Lanka. The company also holds the leading market position in the footwear segment despite growing competition in the lower end of the market. Nevertheless, we expect the rising competition in the rubber slipper segment from small-scale domestic producers and certain importers who appear to be able to circumvent the current tariff structure to be a key long-term risk.
Limited Structural Subordination Risk: DSG is a holding company that depends on dividends paid by its subsidiaries to service its own obligations. Therefore, a substantial increase in leverage at its operating subsidiaries could increase the structural subordination of DSG's creditors. However, this risk is mitigated by DSG's strong control over operating subsidiaries that accounted for around 80% of consolidated EBITDA in FY17, which increases cash fungibility within the group.
Furthermore, the company indicates that there are no restrictions that would prevent its major operating subsidiaries from paying dividends to DSG and readily available cash at the holding company was more than sufficient to repay holding company borrowings as of FY17.
DERIVATION SUMMARY
DSG's sales are less vulnerable to economic downturns than those of its closest rated peers, Singer (Sri Lanka) PLC (A-(lka)/Stable) and Abans PLC (BBB+(lka)/Stable). However, DSG's slowing domestic footwear and tyre sales due to local market competition and the government's policy decisions are long-term risks, while Singer and Abans enjoy robust market positions in the sale of consumer durables domestically. Therefore, we believe Singer and Abans have stronger business risk profiles than DSG.
We rate Singer one-notch higher than DSG to reflect this strength, while Abans is rated at the same level as DSG because of its higher leverage.
KEY ASSUMPTIONS
Fitch's Key Assumptions Within Our Rating Case for the Issuer
- Revenue to decline by 1.9% in FY18 and to recover modestly to grow at a low-single-digit rate, on average, over the next three years.
- EBITDA margins to moderate at 9.0% on average in the next two years.
- Capex to average at LKR1 billion per year for the next two years.
- Dividend payout to shareholders to remain at around 50% of holding company's dividend income.
RATING SENSITIVITIES
Developments that May, Individually or Collectively, Lead to Positive Rating Action
- Sustained improvement in DSG's adjusted net debt/EBITDAR to less than 3.0x (FY17: 4.4x) and gross adjusted debt/EBITDAR to less than 3.5x (FY17: 4.8x)
- The company's ability to execute its medium-term expansion plans and increase the contribution of its cash flows from exports
Developments that May, Individually or Collectively, Lead to Negative Rating Action
- Sustained weakening of net adjusted debt/EBITDAR to more than 4.5x and gross adjusted debt/EBITDAR to more than 5.0x
- A sustained weakening of fund flow from operations fixed-charge cover to less than 1.3x (FY17: 1.9x)
- A significant increase in the structural subordination of DSG's holding company creditors
LIQUIDITY
Tight Liquidity: DSG had LKR1.0 billion of unrestricted cash and LKR5.5 billion in unutilised credit facilities as at end-FY17, to meet LKR3.6 billion of contractual maturities falling due through FY18, with a further LKR5.1 billion of working capital facilities coming up for roll-over during the same period. This places the company in a tight liquidity position, but we expect this to be manageable given the company's track record of accessing domestic banks.
The outlook on the rating is stable.
Fitch said there is a recovery in domestic sales in the nine months to December, after revenues weakened in the year to March.
"The recovery was underpinned by the growth in domestic sales of school shoes and solid rubber tyre exports, which has helped to offset the decline in rubber slipper sales and pneumatic tyres sold to original equipment manufacturers (OEMs)," Fitch said.
"DSG's rating also factors in our expectation that the company's plans to grow its value-added footwear and solid tyre businesses over the medium term to diversify its product offering will help to counterbalance competitive pressures to an extent."
DSG's domestic tyre and tube volumes had fallen 7 percent in FY17 (13 percent growth in FY16) due to a slowdown in the demand for bicycle tyres and a reduction of the maximum loan-to-value (LTV) ratio on three-wheeler leases.
"We expect domestic sales of pneumatic tyres to the OEM three-wheeler market to remain under pressure over the medium term due to the tightening of three-wheeler financing regulations in 2017," Fitch said.
"However, DSG's exposure to the replacement market (65% of domestic pneumatic tyre volumes in FY17) mitigates this risk."
Sri Lanka has high import taxes on shoes and tyres which helps domestic producers to easily exploit consumers with high prices.
DSI is facing competition from a number of small producer as well as imports, Fitch said. But it had a strong brand and wide distribution network.
The full statement is reproduced below:
Fitch Affirms DSI Samson Group at 'BBB+(lka)'; Outlook Stable
Fitch Ratings-Colombo-27 February 2018: Fitch Ratings has affirmed Sri Lanka-based DSI Samson Group (Private) Limited's (DSG) National Long-Term Rating at 'BBB+(lka)'. The Outlook is Stable.
The rating affirmation reflects the moderate recovery in DSG's revenue and EBITDA in the nine months to 31 December 2017 following a weakening in the financial year ended 31 March 2017 (FY17).
The recovery was underpinned by the growth in domestic sales of school shoes and solid rubber tyre exports, which has helped to offset the decline in rubber slipper sales and pneumatic tyres sold to original equipment manufacturers (OEMs).
DSG's rating also factors in our expectation that the company's plans to grow its value-added footwear and solid tyre businesses over the medium term to diversify its product offering will help to counterbalance competitive pressures to an extent.
Fitch has tightened DSG's rating sensitivity on leverage (defined as lease-adjusted debt net of cash/operating EBITDAR) to 4.5x from 5.0x to capture the increased business risk from fiercer competition and slower domestic sales volumes in several of its key segments. We expect DSG's rating headroom to be limited over the medium term, with net leverage hovering only just below the 4.5x threshold at which Fitch would consider negative rating action.
DSG's 'BBB+(lka)' rating continues to reflect its leading positions in domestically sold pneumatic tyres to the replacement market and footwear, which are supported by its well-known brand and widespread distribution network. DSG's market share also benefits, to an extent, from high tariffs on imports of tyres and footwear.
KEY RATING DRIVERS
Pressure on Domestic Tyre Volumes: We expect domestic sales of pneumatic tyres to the OEM three-wheeler market to remain under pressure over the medium term due to the tightening of three-wheeler financing regulations in 2017. However, DSG's exposure to the replacement market (65% of domestic pneumatic tyre volumes in FY17) mitigates this risk.
DSG's domestic tyre and tube volumes declined by 7% in FY17 (13% growth in FY16) due to a slowdown in the demand for bicycle tyres and a reduction of the maximum loan-to-value (LTV) ratio on three-wheeler leases. In 2017, the regulator lowered the upper band of LTV ratios associated with three-wheeler leases to 25% from 70% to curb vehicle imports, which led to a 13% drop in DSG's three-wheeler segment volume.
Leverage to Remain High: We expect DSG's net leverage to hover just below 4.5x over the medium term, which is high for its rating, due to competitive pressure in some of its operating segments, while the company's bid to diversify its cash flows via exports and value-added footwear may take time to yield results.
DSG's leverage also weakened on high borrowings for capex and working capital investments in FY17. However, we expect capex to moderate from FY18 due to adequate production capacity and a recovery in EBITDA as a result of greater contribution from high-margin solid tyre exports and higher-value-added footwear.
EBITDA Margin Pressures: We expect DSG's EBITDA margin to remain at around 9% over the next two to three years due to escalating production costs caused by rising commodity prices and domestic currency depreciation. EBITDA margins have declined from 10.2% in FY16 and 13.3% in FY15 on rising input costs and competition. Fitch expects the price of natural and synthetic rubber, which is DSG's key production input, to increase in line with rising crude oil prices.
Growing price competition, particularly in the lower end of the rubber slipper segment, also means that the company is limited in its ability to fully pass on cost increases to its customers.
Leading Market Position: DSG is the market leader in the bicycle, motorcycle and three-wheeler tyre industry in Sri Lanka. The company also holds the leading market position in the footwear segment despite growing competition in the lower end of the market. Nevertheless, we expect the rising competition in the rubber slipper segment from small-scale domestic producers and certain importers who appear to be able to circumvent the current tariff structure to be a key long-term risk.
Limited Structural Subordination Risk: DSG is a holding company that depends on dividends paid by its subsidiaries to service its own obligations. Therefore, a substantial increase in leverage at its operating subsidiaries could increase the structural subordination of DSG's creditors. However, this risk is mitigated by DSG's strong control over operating subsidiaries that accounted for around 80% of consolidated EBITDA in FY17, which increases cash fungibility within the group.
Furthermore, the company indicates that there are no restrictions that would prevent its major operating subsidiaries from paying dividends to DSG and readily available cash at the holding company was more than sufficient to repay holding company borrowings as of FY17.
DERIVATION SUMMARY
DSG's sales are less vulnerable to economic downturns than those of its closest rated peers, Singer (Sri Lanka) PLC (A-(lka)/Stable) and Abans PLC (BBB+(lka)/Stable). However, DSG's slowing domestic footwear and tyre sales due to local market competition and the government's policy decisions are long-term risks, while Singer and Abans enjoy robust market positions in the sale of consumer durables domestically. Therefore, we believe Singer and Abans have stronger business risk profiles than DSG.
We rate Singer one-notch higher than DSG to reflect this strength, while Abans is rated at the same level as DSG because of its higher leverage.
KEY ASSUMPTIONS
Fitch's Key Assumptions Within Our Rating Case for the Issuer
- Revenue to decline by 1.9% in FY18 and to recover modestly to grow at a low-single-digit rate, on average, over the next three years.
- EBITDA margins to moderate at 9.0% on average in the next two years.
- Capex to average at LKR1 billion per year for the next two years.
- Dividend payout to shareholders to remain at around 50% of holding company's dividend income.
RATING SENSITIVITIES
Developments that May, Individually or Collectively, Lead to Positive Rating Action
- Sustained improvement in DSG's adjusted net debt/EBITDAR to less than 3.0x (FY17: 4.4x) and gross adjusted debt/EBITDAR to less than 3.5x (FY17: 4.8x)
- The company's ability to execute its medium-term expansion plans and increase the contribution of its cash flows from exports
Developments that May, Individually or Collectively, Lead to Negative Rating Action
- Sustained weakening of net adjusted debt/EBITDAR to more than 4.5x and gross adjusted debt/EBITDAR to more than 5.0x
- A sustained weakening of fund flow from operations fixed-charge cover to less than 1.3x (FY17: 1.9x)
- A significant increase in the structural subordination of DSG's holding company creditors
LIQUIDITY
Tight Liquidity: DSG had LKR1.0 billion of unrestricted cash and LKR5.5 billion in unutilised credit facilities as at end-FY17, to meet LKR3.6 billion of contractual maturities falling due through FY18, with a further LKR5.1 billion of working capital facilities coming up for roll-over during the same period. This places the company in a tight liquidity position, but we expect this to be manageable given the company's track record of accessing domestic banks.
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