ECONOMYNEXT – Fitch Ratings said it was confirming an ‘AAA (lka)’ rating of Sri Lanka’s Lion Brewery, with a stable outlook, despite possible competition from a competitor.
“We expect Lion to maintain its solid market position in the local beer industry over the medium term,” Fitch said.
“Our view is underpinned by Lion’s range of product offerings across price points, which makes cash flow defensive through cycles. It also benefits from prominent shelf space across its sales channels.
“However, we expect competition will increase over the medium-term from the recent new beer product launch, owned by a leading local spirits manufacturer.
“The competition will benefit from an established retail-channel and distribution network, although Fitch believes the impact on Lion’s revenue will be gradual given production capacity will only ramp-up gradually over the medium-term.”
The full statement is reproduced below:
Fitch Affirms Lion Brewery at ‘AAA(lka)’; Outlook Stable’
Fitch Ratings – Singapore – 27 Nov 2024: Fitch Ratings has affirmed Sri Lanka-based Lion Brewery (Ceylon) PLC’s National Long-Term Rating at ‘AAA(lka)’. The Outlook is Stable.
The affirmation and Stable Outlook reflect our view that Lion’s credit metrics will remain commensurate with its rating over the medium-term, as Sri Lanka’s economic environment continues to stabilise. We believe Lion’s strong financial profile will buffer against any weakening in consumer demand.
Lion’s rating reflects its marketing leadership in the domestic beer industry, which is protected by high entry barriers stemming from licensing requirements and a ban on media advertising, strong brand presence and an extensive retail and distribution network.
KEY RATING DRIVERS
Strong Market Position: We expect Lion to maintain its solid market position in the local beer industry over the medium term. Our view is underpinned by Lion’s range of product offerings across price points, which makes cash flow defensive through cycles. It also benefits from prominent shelf space across its sales channels.
However, we expect competition will increase over the medium-term from the recent new beer product launch, owned by a leading local spirits manufacturer. The competition will benefit from an established retail-channel and distribution network, although Fitch believes the impact on Lion’s revenue will be gradual given production capacity will only ramp-up gradually over the medium-term.
Net Cash Position: We expect Lion to maintain a net cash position over the financial years ending March 2025 (FY25) to FY28, supported by steady operating cash flow and minimal expansionary capex plans, as Lion’s capacity is sufficient for medium-term growth. We expect annual capex of around LKR5.0 billion-5.5 billion, mainly for maintenance and minor capacity expansionary plans, as seen in its recent set up of a minibrewery for product research and development and the expansion of warehouse space.
Solid Interest Coverage: We forecast interest cover to remain solid for Lion’s rating (FY24: 6.6x), supported by lower market interest rates than during Sri Lanka’s economic crisis. The country’s average weighted prime lending interest rate declined to around 9.0% as of October 2024. Although we expect interest rates to marginally increase over the next few years, Lion’s reduced borrowings, helped by stable operating cash flow over the past year, allows it to maintain a strong interest coverage ratio.
Weaker Margin: We forecast Lion’s EBITDA margin to decline to 14.5% in FY25 (FY24: 15.9%), driven by challenges in passing on increased costs to end-consumers. We believe the company is likely to partially absorb cost increases, including excise duty hikes, to maintain sales volume, due to weaker consumer purchasing power. We forecast Lion’s EBITDA margin to decline further to around 12%-13% from FY26, on the background of increased competition in the medium-term.
Excise Duty Risk: We expect slower excise duty increases, after a cumulative hike of around 64% over a 12-month period through January 2024. The Sri Lankan government is required to review excise duties, including those on alcohol products, on a yearly basis as part of the International Monetary Fund’s (IMF) extended fund facility programme. Fitch expects further excise duty increases to be in line with Sri Lanka’s inflation rate, but risks to sales volume from higher-than-expected excise duty hikes, as seen in January 2024, remain.
Increasing Overseas Presence: Lion’s incorporation of its Singapore subsidiary, Lion Beer Pte Ltd, extends its overseas activities, on which the company has already spent around LKR100 million in initial funding. Lion expects to continue funding the investment in the medium term, which should facilitate its export operation in south-east Asia. However, we expect revenue from exports to remain around 3%-4% in the medium term.
Weak Links with Parent: We notch Lion above the consolidated profile of its parent, Carson Cumberbatch PLC, subject to Lion’s Standalone Credit Profile. Our rating approach is supported by an assessment of ‘Insulated’ access and control and ‘Open’ legal ringfencing under our Parent and Subsidiary Linkage Rating Criteria. Lion has a stronger credit profile than Carson, supported by more defensive cash flows and a net cash position.
‘Insulated’ access and control is reflected in Lion’s financial independence and the presence of a large minority shareholder – Carlsberg Brewery Malaysia Berhad – which owns 25%, despite Carson’s controlling stake. Our assessment of ‘Open’ legal ringfencing is based on the lack of regulatory or self-imposed ringfencing of Lion’s cash flow, as there are no formal restrictions in place. Cash outflow from Lion to Carsons has been limited to dividends historically.
DERIVATION SUMMARY
Lion is rated at the same level as Sri Lanka-based conglomerate, Melstacorp PLC (AAA(lka)/Stable), whose rating reflects its dominant market position in spirits, through its subsidiary Distilleries Corporation. Melstacorp’s larger scale and stronger margin is counterbalanced by its more aggressive expansion and investment strategy.
Lion is rated at the same level as Hemas Holdings PLC (AAA(lka)/Stable). Hemas has high exposure to the defensive healthcare and consumer sectors, catering to diversified end-markets. Meanwhile, Lion’s rating reflects its dominant position in the local beer industry. We expect both companies to maintain similar financial risk profiles, characterised by low leverage, in the medium term.
Sunshine Holdings PLC (AA+(lka)/Stable) has leading positions in defensive sectors, but a small scale. Both companies face some regulatory risk; Lion faces risks from excise duties and indirect tax hikes on the sales of beer, while Sunshine faces price ceilings on some pharmaceutical products.
Lion, given its credit strength, is rated higher than a number of large Sri Lankan banks, non-bank financial institutions and insurance companies, which are more exposed to sovereign stress than Lion, despite their individual credit strengths. This is due to the substantial sovereign-issued securities held for regulatory reasons as well as their broader exposure to numerous sectors in the local economy.
KEY ASSUMPTIONS
Fitch’s Key Assumptions Within Our Rating Case for the Issuer:
– Revenue to increase by 14% in FY25 and around 8% from FY26 onwards
– EBITDA margin to contract to around 14.5% in FY25 (FY24: 15.9%)
– Annual working capital investments of around LKR1 billion-2 billion to support revenue growth
– Annual capex of around LKR5 billion-6 billion
– Dividend payout ratio of 40%
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:
-An increase in leverage, measured as EBITDA net leverage, to over 5.0x for a sustained period
-A decrease in EBITDA interest coverage to less than 2.0x for a sustained period
-Stronger links with parent, Carson Cumberbatch, under Fitch’s Parent and Subsidiary Linkage
Rating Criteria or weakening of the parent’s consolidated credit profile.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:
-There is no scope for an upgrade, as Lion is already at the highest rating on our Sri Lankan National Rating scale.
LIQUIDITY AND DEBT STRUCTURE
Strong Liquidity Position: Lion had about LKR15.2 billion in cash and cash equivalents as at end-September 2024 exceeds its short-term debt maturities of around LKR4 billion, as well as its overall debt of LKR4.6 billion.
The majority of Lion’s debt is working capital related and can be rolled over by banks given its strong cash flow generation and steady working capital cycle. Lion also has about LKR15 billion of uncommitted undrawn credit lines that can be used for debt repayment as of end-June 2024. Despite being uncommitted, we expect banks to honour these facilities, due to Lion’s solid credit profile in a local context.
ISSUER PROFILE
Lion is Sri Lanka’s largest brewery, with a strong distribution network of close to 3,000 outlets across the island. In addition to its own brands, Lion brews and markets Carlsberg branded beer.
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