Fitch Ratings has downgraded Kotagala Plantations PLC’s National Long-Term Rating to ‘CCC(lka)’, from ‘B+(lka)’, and its listed unsecured debentures of Rs. 251 million due between the financial years ending March 2025 (FY25) and FY27 to ‘CCC-(lka)’, from ‘B+(lka)’. 
The downgrade follows a major weakening in liquidity. The rating agency said it expects the statutory increase in labour costs effective September 2024 to dampen free cash flow (FCF), leading to a high likelihood that Kotagala will amend or extend the terms of its debt facilities as they fall due over the next two years. 
“We are likely to consider such transactions to be distressed debt-exchanges under our rating criteria, as they would significantly reduce the contract terms and allow the issuer to avoid a probable default. This would lead to a downgrade of the National Long-Term Rating to ‘C(lka)’ or ‘RD(lka)’ (restricted default), “ Fitch said in a rating commentary. 
Kotagala’s senior unsecured notes are rated one-notch below the issuer’s rating to reflect the subordination to Kotagala’s secured bank debt, which comprises the large majority of its capital structure.

Fitch said it expects Kotagala to generate thinner annual FCF of around Rs.100 million over FY25 and FY26, significantly below the Rs.130 million in 1QFY25 and an annual average of Rs.300 million over FY23-FY24. 
This, together with cash and cash equivalents of Rs.170 million as of end-June 2024, will be insufficient to repay debt of Rs.540 million and Rs.496 million due in FY25 and FY26, respectively.
Kotagala has weak access to banks, although it was able to borrow around Rs.500 million from two banks backed by corporate guarantees from its immediate parent, Consolidated Tea Plantations Limited, and affiliate, Lankem Ceylon PLC, which are ultimately held by The Colombo Fort Land & Building PLC (CFLB, 41percent effective stake in Kotagala). 
These loans were drawn specifically to fund statutory repayments of Rs.972 million and it is unclear whether CFLB or its affiliates will provide timely support to prevent future payment defaults or amendments to borrowing terms.