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

Fitch Ratings has affirmed Sri Lanka-based conglomerate Richard Pieris and Company PLC’s (RICH) National Long-Term Rating at ‘A(lka)’ with a Stable Outlook.
The affirmation of RICH’s ratings reflect the group’s substantial defensive cash flows stemming from its leading supermarket retail business, and diversification afforded by its export and plastics businesses.

These strengths are counterbalanced by the challenges the company faces in the volatile plantation sector, as well as the structurally declining domestic tyre-retreading business, which together account for around 20 percent of the group’s EBITDA.

Fitch expects RICH’s leverage, defined as net adjusted debt/operating EBITDAR (excluding its finance company subsidiary, Richard Pieris Finance Limited (RPF)) to increase to around 2.6x in the next 12-18 months from 2.2x as at end-December 2018, as operating challenges are likely to continue in its plantation, tyre and plastics sectors, along with elevated capex and shareholder returns.

However, the rating agency expect RICH to maintain leverage below 3.0x, which is in line with its ratings.

Fitch regards RICH’s export segment to be the main growth driver in the medium-term, helped by favourable demand dynamics.

RICH plans to substantially increase the capacity of its natural-foam mattress segment, which contributes around 65 percent of export segment revenue, by the year ending March 2020 (FY20), as the plant is currently running at significantly high capacity utilisation and there is strong customer demand from the US and Europe as well as new markets, such as China.
RICH says it will focus more on exporting high-margin value-added products to China, rather than the more commoditised products sent to other markets, and expects a multi-fold increase in export quantity in the next 12-18 months. This should bode well for the segment’s top-line and margin.

Fitch expects RICH to retain its conservative approach to expanding its retail segment over the next 12-18 months amid a slowdown in consumer-purchasing power. The rating agency believes the pace of RICH’s new-store openings to be moderate - in contrast to the aggressive growth plans of its two closest peers - to preserve margins under the weak demand conditions.

The company’s approach saw it sustain its retail EBIT margin in the mid-single- digits in 9MFY19, while competitor margins fell to low-single-digits. Over the medium-term, Fitch expects RICH’s retail sector to benefit from favourable demand, including higher per capita income, rising urbanisation and low supermarket penetration in the country.

The rating agency expects volatile global tea and rubber prices in the next couple of years stemming from lower demand and oversupply to adversely impact RICH’s plantation sector, which has significant exposure to these two crops at around 80 percent of sector revenue.

Fitch also forecast cost pressure to mount in the short- to medium-term due to higher plantation-sector wages and rising input costs, such as pesticides and weedicides.

RICH’s tea and rubber EBIT margin contracted to 1.5 percent in 9MFY19, from 8.9 percent in FY18, but Fitch expects most of the margin pressure to be absorbed by the steady performance of RICH’s palm-oil operations, which are benefiting from strong domestic demand and price protection.

The majority of the company’s palm-oil crop is entering a high-yield phase, which should boost revenue and profit contribution to the group. However, the sector’s long-term growth has been curtailed with a government ban on new plantations due to environmental concerns, with no visibility as to when the ban will be lifted.

Meanwhile, Fitch expect a turnaround in RICH’s plastic segment, led by polyurethane mattresses, which contribute around 50 percent of segment revenue. The plastic segment is seeing better margins after a significant supply shortage in a key raw material for almost 18 months. However, domestic demand for mattresses as well as water tanks is likely to stay weak due to lower discretionary income and a slowdown in the construction industry. RICH plans to expand into regional markets to offset the low domestic demand, but it may take time to generate meaningful returns. Fitch expects a turnaround in the tyre sector to be much slower than the plastic segment, as the revenue decline in the tyre retreading business may not be fully mitigated for a number of years with a shift to the trading business, which faces intense competition and low margins.

The rating agency expects RICH’s EBITDA margin to remain at around 10.5 percent to 11.0 percent (FY18: 10.9 percent) over the next two to three years, with higher export segment margins offset by pressure in the retail segment caused by rising wages and input costs in the plantation sector.

Fitch does not foresee the group’s EBITDAR margin returning to the historical highs of more than 12 percent owing to continuous margin pressure in the tyre-treading business and across most product categories in the plastic segment due to lower demand.

Fitch also expects RICH’s net leverage to increase to around 2.6x over the next 12-18 months due to the weak operating performance across most segments, capacity expansions in high-growth sectors and high shareholder returns. The rating agency believe internally generated funds will be insufficient to meet its capex requirement of Rs.5.6 billion over FY19 to FY20 and shareholder returns, which mean RICH will require external funding. Net adjusted leverage should improve closer to 2.0x from FY21 if capex pressure eases and core operations turn around as Fitch expects.