25 September 2024 12:04 am Views - 80
Fitch Ratings has assigned Sri Lanka-based Bogawantalawa Tea Estates PLC a first-time National Long-Term Rating of’A(lka)’, with a Stable Outlook.
Fitch has also assigned Bogawantalawa’s outstanding senior unsecured debentures a National Long-Term Rating of ‘A(lka)’.
Bogawantalawa’s ratings are driven by the long-term structural decline at the Sri Lankan tea plantations amid regulatory overhang on costs, which is driving weak profitability and weighing on the industry’s appetite for replanting. These risks are counterbalanced by Bogawantalawa’s healthy financial profile that should act as a buffer against the medium-term challenges.
Key rating drivers
Volatile demand and prices: Global tea prices are sensitive to supply and demand, with the bulk-tea sellers unable to pass on production cost increases. Most of the domestic tea producers are price takers, with the majority of revenue coming from bulk sales. About 45 percent of tea is exported in bulk, without value addition. This also raises the risk of substitution. The high grown tea auction prices have fluctuated in the last four years, although Sri Lanka tea attracts better prices due to its quality. Exports are mainly to politically and economically volatile regions, like the Middle East, Russia and China.
Volatile margin: Fitch forecasts the EBITDA margin to widen to 11 percent in FY25, before declining to 5 percent by FY28, amid structural weaknesses, including an assumption of Rs.1,350 per day wages from September 2024, a 35 percent hike. The margin will be further affected by depressed yields, with produced tea by the company falling for four consecutive years, in line with industry, due to labour and fertiliser shortages and ageing plants. The company says replanting costs are also increasing. Sri Lanka already has the lowest productivity and the highest cost among major tea producing countries.
Strong balance sheet: Fitch expects Bogawantalawa to retain a net cash position, as the company, similar to most industry peers, does not expect major spending on replanting, given the industry challenges. Fitch expects a limited drag on leverage from a narrower EBITDA margin, counterbalanced by moderating capex.
The company does not have significant borrowings, apart from outstanding debentures of Rs.698 million as at end-June 2024 that mature in tranches over the next three years.
The maturity in the financial year ending March 2025 (FY25) has already been settled. A sinking fund is in place to meet debenture obligations. The EBITDA interest coverage is solid and we forecast it to remain above 5x over the next two years in light of the falling debt.
Weak linkage with stronger parent: Fitch believes Bogawantalawa’s stronger 57 percent ultimate parent, Metrocorp (Pvt.) Ltd, has low incentives to provide support to its subsidiary. The legal incentives are ‘Weak’ due to the absence of corporate guarantees and cross-default clauses. Metrocorp accounted for 39 percent of Bogawantalawa’s debt as of end-June 2024 due to its investment in the subsidiary’s listed debentures but this will reduce in the next two years as the subsidiary settles its debentures.
Fitch also assessed strategic incentives as ‘Weak’, due to Bogawantalawa’s limited contribution to the parent’s EBITDA, which stood at 6 percent in FY23.
Meanwhile, ‘Weak’ operational incentives stem from the low avoidance cost should Bogawantalawa’s operations cease, as Metrocorp procures the tea for its tea marketing operations from the general tea auction, rather than from Bogawantalawa, as all tea sales are executed via the Colombo Tea Auction. There is also limited management overlap between the two entities.
Sierra Cables PLC (A+(lka)/Stable), Sri Lanka’s third-largest cable manufacturer, with a 20 percent market share, is rated one notch above Bogawantalawa. Demand for Sierra products depends on the domestic infrastructure and construction industry, with low but increasing exposure to exports. The EBITDA exceeds that of Bogawantalawa and Sierra has a more stable and wider EBITDA margin. Fitch also expects Sierra to generate more stable free cash flow margin, while Bogawantalawa’s margin is set to narrow on structural industry weakness.
Bogawantalawa is a price taker, supplying a commodity with low switching costs that is exposed to climate factors and regulatory wages. Bogawantalawa has better interest coverage and leverage but Sierras’ strong business profile more than off-sets Bogawantalawa’s better financial profile. WindForce PLC (BBB+(lka)/Stable) is rated two notches below Bogawantalawa, due to its speculative strategy and higher execution risk. This stems from its high counterparty risk exposure to the Ceylon Electricity Board (BB+(lka)/Stable), the state-owned utility provider.
Furthermore, its cash flow is negative on continuous capacity additions, which also weaken its interest coverage and leverage. Fitch believes Bogawantalawa’s better business and financial profiles warrants the two-notch higher rating. Kotagala Plantations PLC (B+(lka)/Negative) has a weak liquidity profile with no committed or uncommitted funding lines. This makes a liquidity crisis unavoidable without new banking facilities or renegotiated loan repayments. Kotagala derives 80 percent of its revenue from tea, 14 percent from rubber and the remainder from palm oil.
Bogawantalawa’s credit strengths lead to a higher rating than that of some large domestic banks, non-bank financial institutions and insurance companies, which are more exposed to sovereign stress due to holdings of large sovereign-issued securities for regulatory reasons. The large financial institutions also have a broader exposure to various economic sectors.