A weak economic outlook in key export markets and dependence on borrowings at the Hayleys Group, among three of the biggest listed entities in the stock market, has led Fitch Ratings Lanka to downgrade its ratings for this premier stock.
The ratings agency said it has downgraded Hayleys PLC's National Long-Term rating to 'A+(lka)' from 'AA-(lka)' with the outlook being ‘negative’.
Fitch said the downgrade reflects Hayleys' increased appetite for financial leverage at the holding company (HoldCo), as reflected in the company's heightened use of borrowings in 2010 and 2011 to fund its three large acquisitions that have protracted payback periods.
“Hayleys' rating also factors in the heightened risk to the group's cash flows stemming from the weak economic outlook in its key export markets, the European Union and North America (50% of FY11 (end-March 2011) revenue),” it said in a statement. However, Fitch noted that it expects a better performance in Hayleys' consumer, agriculture, power, transport, and leisure segments domestically to help offset export-oriented risks to an extent.
The rating also factored in Fitch's view that Hayleys may need to extend financial support to its textile company - Hayleys MGT Knitting Mills PLC (HMGT, 'BBB(lka)'/Negative, 57% direct-ownership), as the latter is undergoing a restructuring process.
Fitch said the rating will remain constrained over the medium-term due to Hayleys' higher appetite for financial leverage, the uncertainty stemming from weak demand in the company's key export markets, and the uncertainty surrounding the final outcome of HMGT's restructuring process.
“The negative outlook indicates that a further downgrade may occur if the company fails to reduce financial leverage (net debt/EBITDA) at HoldCo to below 3.5x in the near-term (as indicated by the management) from 9.1x at end-September 2011, based on annualized dividend inflows. Negative rating pressure may also occur if financial leverage at Hayleys' key operating subsidiaries increases on a sustained basis, due to weaker-than-expected performance in end-markets, cost overruns in refurbishments, or higher debt-funded dividend payouts or acquisitions, among other factors,” the agency noted.
As a holding company, Hayleys' rating factors in the business strength of, and diverse dividend income from, its key operating subsidiaries. Hayleys exercises control over its key subsidiaries, reducing the structural subordination of HoldCo creditors to an extent. Hayleys' group operating cash flows are also more susceptible to commodity prices fluctuations, weather patterns, and foreign currency risks. At FY11, 63% of group revenues were derived from exports, while most of its production is based in Sri Lanka.
Fitch expects demand pressures from key export markets to constrain profitability, at least through 2012.
“Hayleys' liquidity position within most key operating subsidiaries is adequate, with largely manageable near-term debt maturities covered by healthy operating cash flows or strong access to local banks. The latter along with managements' near-term measures to reduce financial leverage supports the weak liquidity at HoldCo, which is evidenced by its near-term maturities of Rs 2.3 billion at end-September 2011, compared with Rs 25 million in cash reserves and Rs 1 billion of unutilised credit lines,” the statement added.
Hayleys has been in operation for over 125 years, and has interests in over 140 companies, across 12 broad business segments. At end-November 2011, Dhammika Perera, who has interests in financial services and manufacturing, controlled nearly 48% of the group, Fitch said.