Fitch affirms Richard Pieris & Co. at ‘A(lka)’; Outlook Stable

Fitch Ratings yesterday affirmed Richard Pieris & Company PLC’s (RICH) national long-term rating at ‘A(lka)’ with a stable outlook. Fitch has also affirmed the national rating on RICH’s outstanding senior unsecured debentures at ‘A(lka)’.   

“The affirmation of RICH’s ratings reflects our view that the improvement in the group’s adjusted net leverage was offset by the underperformance in its tyre business and some segments in the plastics sector over the last 18 months and the risks around their recovery prospects over the medium term, limiting any positive rating action,” Fitch said.

“RICH’s leverage improved to 1.9x by the financial year ended March 31, 2017 (FY17) and 1.7x by December 30, 2017 from 2.5x in FY16, which compares well with the 2.0x level below, which we may take positive rating action on RICH,” Fitch added. 

The rating agency said the leverage improvement was also underpinned by a major increase in global tea prices over the last 
12 months, which has helped

to offset the high cost structure in the plantation business, although the current price levels may not be sustainable over the longer term.  

RICH’s rating also reflects the group’s diversified cash flows, market leadership in several of its segments and the company’s well-established operating history. 

“We also expect the company to increase capex in the next two years in a bid to expand production capacity in the retail, rubber and palm oil segments, which may also keep leverage from improving materially below 2.0x in that period.   

We expect store expansion and a shift in consumer preference towards hypermarkets and supermarkets to lead to double-digit revenue growth for the company’s retail segment in the medium term,” Fitch said.

RICH’s retail revenue growth slowed in 1HFY18 amid a weak macroeconomic environment and higher indirect taxes but these pressures eased in 3Q18 as consumers adjusted to higher costs and Fitch expects the moderate improvement to continue in the next 12-18 months. “We believe the sector’s EBITDA margin will contract slightly to around 7.3 percent in the medium term, from 8.0 percent in FY17, as the opening of new stores and the introduction of a smaller-store format could weigh on costs,” Fitch said.  

Sri Lanka’s supermarket penetration, which is only around 15 percent, indicates a growth potential for the industry. Over the longer term, the increasing per capita income and rising urbanisation will help make the modern grocery retail concept more affordable and accessible to a larger portion of the population.  

However, Fitch said they do not expect a near-term recovery in the company’s plastics business as the domestic demand for its key products, polyurethane (PU) mattresses and water tanks, may remain sluggish amid weak economic conditions. 

“Margin pressure in the PU mattress segment stemming from raw material shortages could also take time to resolve. 

The company is investing to expand export revenues in this sector but we believe the potential risks over establishing its brand name and penetrating distribution networks in new markets could prevent the company from realising substantial returns in a short period of time,” Fitch said.  

Meanwhile, Fitch said RICH’s domestic retreading business, which accounts for the majority of the tyre business’s operating profit, will undergo a structural decline amid stiff competition from Chinese imports. Steps taken by the management to penetrate export markets may take time to generate returns that are sufficient to offset the pressures in the domestic market.  

“We expect RICH’s export revenue to maintain its growth momentum, helped by the capacity expansion in its value-added rubber export segment. 

New market opportunities and the introduction of more value-added products are likely to help absorb the extra capacity coming online in the next few years. We expect growth in export revenue to also help offset the volatility in some of the other segments, such as plastics and tyres, due to the slowdown in the domestic market.”   

Meanwhile, Fitch believes the volatility in the plantation segment will decline in the medium term with increased contribution from a more stable palm oil business. 

“We expect the segment’s EBIT from palm oil to increase significantly in the next few years, helped by the improving maturity profile of the plantations, which will drive yields higher. We have assumed that the global palm oil prices will remain at US $ 665/tonne in FY18 and US $ 675 thereafter.   

RICH’s tea segment has seen a strong rebound recently, helped by the rising global prices but we expect the performance to moderate in the next 12-18 months on the back of more muted prices and rising operating costs. However, the palm oil segment, which benefits from strong domestic demand and regulated pricing, should help to iron out the volatility in other crops.   

We expect leverage at the holding company (2x as at FYE17) to improve over the next few years due to the higher dividend income from subsidiaries and a decision to cut borrowings at the holding company level. Subsidiaries will fund their own expansion, reducing dependency on the holding company. However, an increase in subsidiaries’ leverage could weigh on the rating due to the structural subordination of the holding company’s debt. 

Currently, the structural subordination is minimal due to low subsidiary debt and the holding company’s strong ownership of most of the operating subsidiaries, which provides for a high degree of cash fungibility within the consolidated group,” Fitch said.