Fitch cuts Singer Sri Lanka’s outlook to Negative; affirms ‘A-(lka)’

• Cites difficulty in cutting debt, weak sales and limited parent support as key reasons for outlook downgrade
• Says firm recovering from import restrictions; but mobile phone sales likely to get hit by ban on Huawei

Fitch Ratings has revised the outlook on Singer (Sri Lanka) PLC’s National Long-Term Rating to Negative from Stable amid difficulties faced by the consumer-durables retailer to cut its debt, weak sales volumes and limited support from the parent.

Fitch has simultaneously affirmed the National Long-Term Rating at ‘A-(lka)’ as well as the ‘A-(lka)’ rating on Singer’s outstanding senior unsecured debentures and ‘F2(lka)’ National Short-Term Rating on its commercial paper.

Fitch said the Negative outlook reflects the challenges Singer may face in reducing its leverage, defined as net adjusted debt/EBITDAR, to below 5.5x - the level at which the rating agency would consider negative rating action - by the financial year ending March 2021 (FY21), from 6.1x in the trailing 12 months to end-June 2019 and 6.4x at FYE19.
“The ban on Huawei Technologies by the US authorities is likely to weaken Singer’s mobile phone sales from a high of around 25 percent of revenue in FY19.
Singer will aim to diversify sales across other brands if the ban continues, but the efficacy of its strategy remains to be seen. It also plans to cut operating costs in the next two years, but this is subject to execution risk,” Fitch said.
The rating agency also noted that the firm’s leverage fell in the year ending June 2019 following the removal of cash margin requirements on imports in mid-March 2019.
“This saw the resumption of Singer’s supplier credit cycle, with a cash inflow of Rs.750 million from improved creditor days in 1Q20,” Fitch said. The cash margin was introduced in November 2018 by the Central Bank to discourage imports in a bid to combat pressure on the local exchange rate. Singer had to increase debt and incur higher interest costs to fund the cash margin requirement so long as letters-of-credit remained unpaid. Consequently, the company opted to repay suppliers early to reduce financing costs at the expense of higher working capital.

Meanwhile, Fitch expects Singer’s sales volume to decline in FY20 due to poor consumer sentiment, but said that there is a possibility that volume may pick up in FY21 if the recovery seen in the agricultural sector continues and domestic interest rates continue to fall.

“Approximately 40 percent of Singer’s revenue is financed by its in-house hire-purchase scheme, which is highly sensitive to domestic interest rates. Rising smartphone penetration and a shorter replacement cycle for mobile phones should also support sales volume growth over the longer term.”

Fitch said the affirmation of the National Long-term Rating is underpinned by Singer’s leading market position in consumer durables retail, its portfolio of products and brands, which are diversified across price points, its large islandwide distribution and retail store network and the well-managed hire-purchase book with limited delinquencies.

Fitch expects Singer’s EBITDA margin to improve by 50bp to 7.1 percent in FY20 and to stabilise at 7.6 percent in FY21 owing to the implementation of cost-saving measures in early FY20.  Singer has improved its warehousing process and logistical operation and has optimised its inventory-management system.

“However, a weakening local exchange rate poses risk to margins, as 80-85 percent of the products Singer sells are imported. Singer’s EBITDA margin contracted by 50bp in FY19 due to the absorption of currency-related costs as a means to compete, rather than fully passing on the cost escalation to customers,” Fitch said.

Meanwhile, the rating agency said it will continue to rate Singer based on its standalone credit profile due to its assessment of the weak linkages between Singer and its parent, Hayleys PLC, under Fitch’s parent and subsidiary rating linkage methodology.

“We do not expect Hayleys to provide any extraordinary support to its subsidiary, despite its 90.4 percent stake, due to the size of Singer’s balance sheet and significant debt as of FY19.”