Financial News: Fitch Ratings has affirmed Sri Lanka-based consumer and healthcare company Hemas Holdings PLC’s National Long-Term Rating at ‘AA-(lka)’ with a Stable Outlook.
The affirmation reflects the limited vulnerability of the company’s largely defensive operating cash flows to disruptions from the coronavirus pandemic and the resultant economic downturn. Pharmaceutical trading and manufacturing as well as fast-moving consumer goods (FMCG) in home and personal care, and stationery account for over 80% of the group’s EBIT.
The rating also benefits from the company’s exceptionally strong balance sheet and high rating headroom before the economic downturn, and we estimate steady leverage of around 0.4x-0.5x in the year ended March (FY20) and FY21 compared with the 3.0x leverage threshold for the current rating. Hemas also disposed of two of its smaller noncore businesses in FY20, which will improve the group’s profitability starting FY21, even as its exposure to the hotel sector weighs on its financial profile.
Fitch expects Hemas’ pharmaceutical sales to remain stable throughout FY21 due to defensive demand and the government classifying pharmaceutical imports as essential goods, even as it imposed restrictions on a wide range of other imports to preserve foreign exchange.
Hemas continued its distribution operations during the country’s lockdown starting in March through third-party pharmacies, delivery partners and its own delivery platform. The business also has adequate inventory, providing a buffer against any supply shortages although supplies have so far held up. It expects Hemas to be able to pass on rising costs from a weaker exchange rate due to its contractual arrangements with global suppliers, price revisions and cost efficiencies.
The company’s domestic pharmaceutical-manufacturing business was disrupted in the early part of Sri Lanka’s lockdown due to social distancing requirements. However, Hemas says production capacity utilisation is improving and should normalise with the lifting of the lockdown in early May.
Fitch expects demand for domestic pharmaceutical manufacturing to increase in the medium term as Sri Lanka seeks to reduce foreign exchange outflows and foreign suppliers attempt to improve profitability, which is curbed by domestic price controls on imported pharmaceuticals.
Sales disruptions in Hemas’ consumer segment, which accounts for around 45% of group EBIT and is largely based in Sri Lanka, have been limited across most product categories since the lockdown. The closure of grocery stores nationwide affected Hemas’ customer reach but stronger sales through supermarkets and online platforms helped to mitigate the impact.
Fitch expects the distribution network to be fully operational by mid-2020 and sales to normalise from 2HFY21, assuming the country-wide lockdown will ease gradually from May. It does not expect a significant weakening in demand for the consumer segment in spite of slower economic activity due to its essential nature and its products’ low ticket value.
The segment’s production facilities are currently closed or operating at lower utilisation levels due to social distancing, but Fitch believes the impact is manageable as the segment has sufficient finished goods inventory. Hemas’ Bangladesh operations will remain muted for most of FY21 as the product portfolio is less defensive.
Hemas’ 300-room hotel chain would be the hardest-hit segment from the pandemic due to the indefinite closing of Sri Lanka’s borders and global travel restrictions. Hotels currently generate minimal revenue, which is insufficient to cover the high fixed costs.
Fitch expects a continued cash burn, even with a minimal cost structure, until tourism picks up, which could be at least 12 months away. However, the impact on Hemas’ cash flows should be manageable as the sector accounts for less than 5% of consolidated revenue and it expects its operating losses from hotels to lower group EBIT margins by less than 100bp in FY21.
Margins to fall in FY21: Fitch expects Hemas’ EBIT margins to contract to 5.5% in FY21 from around 8% historically amid lower sales and near-term cost pressures in the consumer segment and hospitals and losses in leisure, mitigated by the company’s cost-cutting measures.
Cost-saving measures across the group include pay cuts to preserve cash. It expects margins to recover to historical levels from FY22, helped by a strong rebound in the consumer segment’s volume, improved capacity utilisation in hospitals and the logistics business, and a slow but gradual pick-up in leisure.
Fitch expects Hemas’ net debt/EBITDA to remain comfortably below 1.0x over the next two years (9MFY20: 0.9x) amid lower capex and dividends to preserve cash, despite our expectations of weak operating performance in FY21.
Fitch expects Hemas’ cash flow from operations to cover its capacity expansion and dividends over the next few years without depending on external funding. The company says its medium-term expansion would mostly focus on its core businesses with the ability to leverage on the existing infrastructure without significant capital outlay.
Key assumptions
Fitch’s key assumptions within the rating case for the issuers:
- Revenue decline of around 9% in FY21 despite an 80% decline for hotels and a 5% drop for the consumer segment, mitigated by a 2% increase in healthcare
- Revenue to rebound by 14% in FY22, helped by strong growth in pharmaceutical distribution and manufacturing, improving demand for consumer products and logistics services, with only marginal growth in leisure sector revenue
- EBIT margin to fall to 5.5% in FY21 amid COVID-19. EBIT margins to recover from FY22 to historical levels of around 8.0%
- Capex to reduce to around Rs. 1 billion in FY21 to primarily cover maintenance capex and increasing to around Rs. 2 billion per annum over FY22-CY23 once the company resumes its planned expansion
- Dividend pay-out of around Rs. 500 million in FY21, increasing to Rs. 1 billion from FY22 once the operating environment stabilises
Rating sensitivities
Factor that could, individually or collectively, lead to positive rating action/upgrade: Improvement in business risk profile while maintaining a strong financial profile.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- Group net debt/EBITDA rising above 3.0x on a sustained basis
- Any deviation from the company’s conservative approach to new investment
Liquidity and debt structure
Comfortable liquidity position: Hemas had about Rs. 6.8 billion of unrestricted cash at end-December 2019 to meet Rs. 7.4 billion of debt maturing in the next 12 months. Around Rs. 6.7 billion of its near-term maturities consist of short-term working capital lines, which Fitch expects banks to roll over as they are backed by Rs. 12 billion of net working capital with a healthy cash conversion cycle of around 65 days.
Hemas had unutilised but uncommitted credit lines of Rs. 11.5 billion at end-December 2019, which also supports liquidity as Fitch expects most local banks to honour these uncommitted lines amid the current downturn in light of Hemas’ healthy credit profile and defensive cash flows compared with many local corporates.
