Fitch upgrades Kotagala Plantations to ‘B+(lka)’; Outlook Negative

Fitch Ratings has upgraded Kotagala Plantations PLC’s National Long-Term Rating to ‘B+(lka)’, from ‘RD(lka)’. The Outlook is Negative. Fitch has simultaneously upgraded the National Long-Term Rating of Kotagala’s outstanding senior unsecured debentures to ‘B+(lka)’, from ‘C(lka)’. 
The upgrade reflects the completion of Kotagala’s debt restructuring process in May 2023. The Negative Outlook considers the company’s weak liquidity given its untested post-restructuring bank access and Fitch’s expectation that Kotagala’s internal funding sources will be insufficient to meet its obligations in the financial year ending March 2024 (FY24).

Kotagala restructured its bank loans by obtaining waivers for accrued and past-due interest and receiving maturity extensions. The company restructured its outstanding Rs.500 million debentures in September 2020 and around Rs.1.2 billion of its bank loans by extending the maturity and reducing interest costs.         In return, some lenders required timely settlement using tripartite agreements that directed revenue of certain estates directly for debt servicing. The company said it is now up to-date on all restructured obligations.

 Kotagala is in discussions with banks for new credit facilities following the completion of its debt restructuring, but its ability to meaningfully access external funding remains untested. We project negative free cash flow (FCF) of around Rs.110 million in FY24 after the payment of Rs.390 million in past-due statutory obligations and annual replanting capex of Rs.109 million. 
Kotagala will face close to Rs.700 million in near-term debt maturities in the next 12 months andit will need access to external financing to meet its obligations.

Kotagala had Rs.1.1 billion due on employee pensions, gratuity provisions and government leases at FYE23. Kotagala has partly settled past-due lease rent on its plantation estates owed to the government and intends to settle the remaining Rs.75 million during FY24. It expects this to be followed by government approval to harvest and sell timber from these estates. The sale of timber trees is likely to generate about Rs.100 million-150 million per annum in additional revenue, although there could be material execution risks and delays.
Kotagala’s EBITDA margin is expected to contract to 16 percent in FY24 from 25 percent in FY23. Domestic tea and rubber auction prices were favourable in 2022, supported by supply shortages and a depreciating local currency as prices are quoted in US dollars. 

However, we expect gradually normalising supply, weak demand
and a modest appreciation in the local exchange rate to exert pressure on prices, weakening profitability in FY24. Higher production yields amid the availability of fertilisers and fuel may limit the negative impact to an extent.
Fitch rates Kotagala on a standalone basis as its stronger ultimate parent, The Colombo Fort Land and Building PLC (CFLB), has limited incentive to provide support, according to our Parent and Subsidiary Linkage Rating Criteria. It assesses CFLB’s legal, strategic and operational incentives to extend support as ‘Weak’. 

The ‘Weak’ legal incentive stems from the absence of corporate guarantees from CFLB on Kotagala’s debt, and the lack of cross-default clauses linking the parent’s debt to that of Kotagala.
Kotagala’s contribution to CFLB’s group EBITDA will remain below 15 percent over FY24-FY26 while factors such as competitive advantages to the parent and CFLB’s growth potential remain low, weakening the overall strategic support incentive. CFLB has provided limited support in the past via working-capital funding, but this has not been sufficient to avoid a default. Operational incentives to support are also weak as CFLB is diversified, with limited operational synergies with Kotagala, with no brand overlap and little common management.