Rupee depreciation, pharma price ceilings could hurt Hemas FY19 profits: Fitch

The depreciation of the Sri Lankan rupee and regulated pricing on pharmaceutical drugs could threaten the diversified conglomerate Hemas Holdings PLC’s (AA-(lka)/Stable) profitability in FY19, credit rating agency Fitch Ratings said in a brief note.Sri Lanka has already slapped price ceilings on nearly 50 pharmaceutical drugs. The country’s health minister recently indicated that price controls would be introduced on several more drugs in the near future.

Despite the assurances from the Central Bank on the strength of the foreign reserves, the rupee continues to depreciate against the US dollar. The rupee on Monday hit an all-time low of Rs.160.60 against the US dollar on importer dollar demand.

“The depreciation of the Sri Lankan rupee and regulated pricing in Hemas’ pharmaceutical distribution business may threaten the group’s profitability in FY19, unless the industry stakeholders are able to negotiate a better cost pass-through mechanism with the regulator,” Fitch said. 

However, the rating agency believes that the impact could be partly offset by continued solid performance in the group’s logistics and maritime segment and recovery in the hotel sector, in which occupancy levels and yields show signs of improvement.   

Meanwhile, Fitch said the weakness in Hemas’ first-quarter financial results is temporary and is mainly due to the cash flow seasonality of its new school stationery business.

The rating agency expects Hemas’ performance to improve during the remainder of fiscal year to end March 31, 2019 (FY19) and maintains the view that the company will achieve a revenue growth of 21 percent and EBITDAR margin of 13 percent for the full year.   

Hemas acquired its school stationery business, Atlas Axillia (Private) Limited (Atlas) in the last quarter of FY18. The stationery business tends to see a significant pickup in demand towards the latter part of the calendar year as students return to school after holidays. 

Consequently, Hemas’ stationery segment was only able to breakeven on an operating profit basis in the quarter ended June 30, 2018, compared with Fitch’s expectation that this segment will contribute around Rs.1.2 billion to Hemas’ FY19 EBIT, which is around 25 percent of the group’s consolidated operating profit.   

According to Fitch, the operational challenges in Hemas’ fast-moving consumer goods business in Bangladesh also played a part in the company’s underperformance in 1Q19, although Fitch is of the opinion that earnings from this segment should also improve. 

“We expect the Bangladesh operation to benefit from Hemas’ investments in the distribution network and product relaunches in the past few months. 

The segment’s top line already reflects some of these benefits, rising 6 percent YoY in 1Q19, compared with a 10 percent decline in FY18, when the performance was weighed down by issues with its distribution channels and intensifying competition,” Fitch said.  

“As a result of the above, Hemas’ EBITDAR margin fell by 140 bp to 10.2 percent in 1Q19 from 11.6 percent in 1Q18 and compared with our FY19 forecast of 13 percent. 

The company’s lease-adjusted gross debt/trailing 12 month-EBITDAR weakened to 2.0x at end-1Q19, which is the upper limit for its ‘AA-(lka)’ National Long-term Rating, from 1.7x at FYE18 but we maintain our view that leverage will recover to 1.3x by FYE19,” Fitch added.