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Thursday, May 25, 2023 at 11:00 am

Thursday, May 25, 2023 at 11:00 am

ECONOMYNEXT – Fitch Ratings announced that it has given Sri Lankan diversified conglomerate Hayleys Plc a “AAA(lka)” national long-term rating with a stable outlook.

"Fitch has also assigned a 'AAA(lka)' National Long-Term Rating to Hayleys senior unsecured debt obligations," the rating agency said.

The rating reflects Hayleys' large local operating scale, due to extensive business and geographic diversification, as well as strong market share in most of its businesses.

“We believe this will result in stable operating cash flows. We expect Hayleys to maintain a measured approach to leveraged acquisitions given a weak domestic operating environment and high borrowing costs.”

The full explanation follows:

Fitch gives Hayleys a national rating of "AAA(lka)" for the first time; Outlook stable

Fitch Ratings - Colombo - 24 May 2023: Fitch Ratings has granted Sri Lankan conglomerate Hayleys PLC a long-term national rating of "AAA(lka)". The outlook is stable. Fitch has also assigned a “AAA(lka)” National Long-Term Rating to Hayleys senior unsecured debt obligations.

The rating reflects Hayleys' large local operating scale, due to extensive business and geographic diversification, as well as strong market share in most of its businesses. We believe this will result in stable operating cash flows. We expect Hayleys to maintain a measured approach to leveraged acquisitions given a weak domestic business environment and high borrowing costs. This should keep the credit metrics for the rating appropriate.

Hayleys Debentures are rated at the same level as the issuer rating as we expect the Company to have senior debt, including debt from its subsidiaries and secured debt of the Company, at between 2.0x and 2.5x that of the Company threshold allowed by us Consider downgrading the rating of the bonds. The ratio was 2.0x for the fiscal year ended March 2023 (FY23).


Strong business, geographic diversification:Hayleys operates in 12 main sectors, serving industrial and retail customers. It has exposure to defensive segments such as agriculture, hand protection, textiles and cleaning, as well as cyclical but growing markets such as transportation, consumer durables retail and construction. Hayleys is geographically diversified and generates more than 50% of its sales from exports, limiting exposure to the weak domestic market. This has resulted in strong EBITDA growth in recent years despite the difficult domestic environment.

Strong market presence:Hayleys is a Sri Lankan leader in the transportation, consumer durables retail, textile, aluminum extrusion and tea production sectors. It also has a significant share of the fragmented global hand protection and activated carbon purification markets. The company has strong customer relationships but has high customer concentration in some businesses, although risk is mitigated by high switching costs and established relationships. Hayleys' competitive position is also strengthened by vertical integration and strong relationships with suppliers.

Tight but adequate coverage:Hayleys' EBITDAR relative to fixed cost recovery should remain around 2.0x (FY23: 2.0x) over the next two years on high but moderate interest rates. Its interest expense tripled in FY23 as around 75% of its debt was at variable rates. We expect Hayleys interest costs to fall in line with our forecast of a weakening in domestic interest rates and the conversion of some local currency debt into cheaper foreign currency debt. Hayleys' lower fixed fee coverage is offset by higher cash flows from exports than its rated peers.

Steady Leverage:We expect Hayleys' EBITDAR net leverage to remain below 3.0x over the medium term, albeit modestly increasing from 2.3x in fiscal 2023 as a result of investments in business expansion. We expect the group to spend around LKR 14-16 billion on investments and acquisitions in FY24-26 and pay 20% of net profit as dividends, largely funded by internal cash flows. The group's balance sheet has strengthened in recent years, reflecting an improvement in operational performance and a more conservative approach to investment.

Pressure on end market demand:For fiscal year 2024, we expect flat sales due to weak demand in most segments. We expect Sri Lanka's GDP to grow 2% in 2023 after contracting 9.2% in 2022. However, there will be a delay before the benefits of growth feed through to consumer and home spending as the country struggles with high inflation, interest rates and taxes. We expect the agriculture segment (12% of EBIT in FY23) to remain resilient, but recovery in domestic durable goods, construction and transportation will take longer.

Fitch forecasts that GDP growth in the US and the eurozone, Hayley's top export markets, will slow to 1% in 2023, which will dampen non-discretionary spending and global trade. This will weigh on cash flow from Hayley's transportation sector (25% of EBIT in FY23), with freight rates falling to pre-pandemic levels. However, demand for hand protection (7%) and cleaning (15%) is expected to remain stable given inventory build-up and demand for air and water cleaning. We expect price pressure in most export segments due to falling raw material prices and an increasingly price-conscious clientele.

Lower, albeit healthy, margins:We expect Hayleys' EBITDAR margin to decline about 200 basis points to 13.0% in FY24 due to lower sales volumes and pricing pressure. Hayleys' EBITDAR margin rose to 15.0% in FY23, the highest in recent years, as export earnings outpaced domestic operating expenses while the local exchange rate depreciated nearly 80%. However, the Sri Lankan rupee has appreciated by around 15% since March 2023, erasing some gains.

We assume that the drop in freight rates and falling tea prices will also lead to a drop in margins. We expect the group's overheads to remain high given high inflation, rising electricity rates and wage increases that Hayleys may not be able to fully pass on.

Appropriate holding company profile:Hayleys has strong ownership and control over all of its operating subsidiaries, allowing the holding company to extract the subsidiaries' operating cash flows at scale. We therefore expect the Holding Company's EBITDA-Leverage Ratio and EBITDA-Interest Coverage to be maintained at around 4.0x and 1.5x, respectively, in FY24-FY26, supported by a measured approach to investment in recent years and improved cash flow.

Hayleys has a more diversified business than its competitor Dialog Axiata PLC (AAA(lka)/Stable) in terms of business and geographic diversification. Dialog operates exclusively in the domestic market, while Hayleys operates in several overseas markets with strong growth potential. However, Dialog is the market leader in domestic mobile with a 60% share, while Hayleys has a relatively modest position in most of its end markets. Dialog's investment intensity is high and largely non-discretionary, resulting in weaker free cash flow (FCF) generation than Hayley's. However, Dialog has maintained a lower leverage than Hayley's, supported by stronger EBITDA growth, backed by solid market leadership and integrated service platforms, resulting in strong pricing power. As a result, Dialog's rating can withstand weaker financial metrics than Hayley's.

Domestic conglomerate Melstacorp PLC (AAA(lka)/Stable) has a more defensive cash flow and FCF profile than Hayleys due to its leadership in the sheltered domestic alcoholic beverages market. In contrast, Hayleys is exposed to cyclical end markets in some of its businesses, which are also more fragmented. However, Hayleys' greater geographic and end-market diversity mitigates some of these risks, while Melstacorp's operations are largely centered in Sri Lanka. Melstacorp's stronger FCF profile supports its ability to withstand weaker financials than Hayley's at the same rating.

We rate domestic conglomerate Hemas Holdings PLC (AAA(lka)/Stabil) at the same level as Hayleys on Hemas' defensive businesses, a significantly stronger FCF, a balance sheet of measured expansion and stronger liquidity, which reflects its smaller size and im Comparison to compensate for limited geographic diversification with Hayleys. Nearly 90% of Hemas' EBITDA comes from the healthcare and consumer segments, while a number of Hayleys' end markets, such as transportation and consumer discretionary retail, are characterized by more cyclical demand. However, Hayleys is more diversified across businesses and geographies than Hemas, which offsets some of these risks. Hemas' stronger FCF supports broader financial metrics than Hayley's at the same valuation.

Domestic conglomerate Sunshine Holdings PLC (AA+(lka)/Stable) is rated a notch below Hayley's, reflecting its significantly smaller operational scale, limited geographic diversification and regulatory risks in some of its businesses, which are backed by its better financial profile with less leverage be compensated . Sunshine has been more conservative in its expansion than Hayley's, growing only within its core businesses without significantly impacting its balance sheet. In contrast, Hayleys has a history of debt-fuelled growth, resulting in a weaker balance sheet than Sunshine.

Hayleys is much larger and has more defensive cash flows than Ceat Kelani Holdings Pvt Limited (CKH: AA+(lka)/Stabil), which justifies a notch higher valuation for Hayleys. CKH faces competitive import pressures, cyclical demand for vehicle tires, and a relatively small addressable market. However, CKH has a significantly stronger financial profile than Hayleys, as reflected in having cash on hand in excess of debt, which mitigates CKH's business risks.

Hayley's credit considerations result in a higher rating than that of large domestic banks, non-bank financial institutions and insurance companies, which are more exposed to government stress for regulatory reasons due to their holdings of large government securities. The large financial institutions also have broader exposure to different sectors of the economy.


Fitch's most important assumptions in our rating case for the issuer:

– Revenue will be flat in FY24 as any growth from expansion and defensive end markets will be offset by weak demand in key export markets such as the US and Europe and pricing pressures in some segments.

- Sales are expected to grow about 10% over FY25, benefiting from the recovery in demand in most markets.

- EBITDAR margin will decrease by 200 basis points to 13% compared to fiscal 2024 due to lower volume, local currency appreciation and cost increases that the company may not be able to fully pass on due to weak demand.

- Working capital cycle will remain around 100 days in FY24, supported by lower inventory days and a continuation of the days receivables improvement in FY23.

- Annual capital expenditures of around LKR 13 billion in FY24-FY26, mainly for capacity expansions in most segments.

- LKR 3.0 billion per year is spent on mergers and acquisitions to accommodate Hayley's acquisitive nature, although the company has not provided guidance on this.

- Annual dividend payment of LKR 4.0 billion in FY24 as announced and 20% of net profit thereafter, although the company has not publicly committed to a firm dividend policy.


Factors that individually or collectively could result in a positive rating change/improvement:

-There is no room for an upgrade as the company already has the highest rating on Sri Lanka's national rating scale.

Factors that individually or collectively could result in a negative rating change/downgrade:

– Group net debt to EBITDAR ratio increases sustainably to over 4.0x (FY23: 2.3x);

– The Group's EBITDAR fixed cost coverage decreases sustainably below 2.0x (FY23: 2.0x).

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