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Fitch Assigns to DSI Samson Group First-Time 'BBB+(lka)' Rating
April 7, 2017 / 7:02 AM / 8 months ago

Fitch Assigns to DSI Samson Group First-Time 'BBB+(lka)' Rating

(The following statement was released by the rating agency) COLOMBO, April 07 (Fitch) Fitch Ratings has assigned Sri Lanka-based DSI Samson Group (Private) Limited (DSG) a National Long-Term Rating of 'BBB+(lka)'. The Outlook is Stable. DSG's rating reflects leading positions in the domestic rubber tyre and footwear markets, which are supported by its well-known brand, and an unmatched distribution network of 313 retail and wholesale points and six franchisees. DSG's market share also benefits from high tariffs on imports of tyres and footwear. These strengths are counterbalanced by increasing competition from imported footwear products and the weak local currency, which raises the costs of imported raw materials. KEY RATING DRIVERS Leading Market Position: DSG is the market leader in the bicycle, motorcycle and three-wheeler tyres industry in Sri Lanka, with a 45% export market exposure as of financial year-end 31 March 2016 (FY16). Furthermore, the company also holds the leading market position in the footwear segment despite competition from imported products. However, DSG's gradual loss of market share in flip-flops and designer sandals to imported products, which are sold at much lower prices, is a key long-term risk. Capacity Expansion to Increase Leverage: We expect DSG's consolidated net leverage (defined as lease-adjusted debt net of cash / operating EBITDAR) to increase to 4.3x by FY18, from 3.5x at FYE16, as operating cash flows are unlikely to cover its capex. Capex will be mainly for expanding the company's production capacity of footwear for export. We do not expect capex to translate into substantial cash flows over the medium term, given the moderate-to-high execution risks facing the group's export strategy. This is because DSG has limited brand presence internationally, and the company may encounter stiff competition. EBITDA Margins to Moderate: We expect DSG's consolidated EBITDA margins to moderate in FY17 and FY18 due to the increase in commodity prices globally and a weak local currency, which will drive up its raw material costs. We expect the price of natural and synthetic rubber to increase, in line with rising crude oil prices; 65%-70% of DSG's raw material costs are linked to these commodities. Furthermore, the increase in the domestic Value Added Tax (VAT) rate to 15% from 11% on footwear effective from 1 November 2016 is likely to limit DSG's ability to pass on cost increases to its customers, at least in the near term. Structural Subordination Risk: As a holding company, DSG's cash flows depend on dividend payments by its subsidiaries. Therefore DSG's creditors are structurally subordinated to the creditors of its operating subsidiaries. However this risk is mitigated by DSG's strong control over the key operating subsidiaries that accounted for around 80% of consolidated EBITDA in FY16. The company indicates that there are no restrictions that constrain major operating subsidiaries from paying dividends to DSG. Furthermore, DSG's cash balance was more than sufficient to repay its borrowings at the holding company as of FYE16. However, a substantial increase in structural subordination could put pressure on the rating. Shielded by Import Tariffs: Footwear manufacturers in Sri Lanka rely heavily on imported raw materials, due partly to the limited availability of quality raw materials locally. The manufacturers enjoy duty-free concessions on the imports of leather to be used in the manufacturing of shoes and bags. Locally produced footwear and tyre products are also relatively cheaper due to high import tariffs on competing low-cost products, which help DSG to sustain its leading market position. We have assumed the government will retain the import tariffs, given its intentions to protect the domestic industry and focus on maintaining the country's foreign-currency reserves. DERIVATION SUMMARY DSG's sales are less vulnerable to economic downturns than those of its rating peers Singer (Sri Lanka) PLC Company (A-(lka)/Stable), and Abans PLC (BBB+(lka)/Stable). However DSG's footwear segment faces increasing competition from imports, which is a long-term risk. Singer has a stronger business risk profile than DSG, as it is one of two companies that dominate the consumer durables retail market in Sri Lanka. This is reflected in Singer's higher rating than DSG. Abans is rated at the same level as DSG, which reflects its exposure to more volatile cash flows from its property development projects, despite the company's strong market position in the retailing of consumer durables. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue to grow at a mid-single-digit rate, on average, in 2017 and 2018. - EBITDA margins to moderate to 9% on average in the next two years. - Capex to remain high at around at LKR2 billion per year for the next two years. - Dividend payout to shareholders to remain at around 50% of holding company's dividend income. RATING SENSITIVITIES Future developments that may, individually or collectively, lead to positive rating action include: - Sustained improvement in DSG's adjusted net debt/EBITDAR to less than 3.5x (FY16: 3.5x) and gross adjusted debt/EBITDAR to less than 4.0x (FY16: 3.8x) - The company's ability to execute its medium-term expansion plans, and increase the contribution of its cash flows from exports. Future developments that may, individually or collectively, lead to negative rating action include: - Sustained weakening of net adjusted debt/EBITDAR to more than 5.0x and gross adjusted debt/EBITDAR to more than 5.5x. - A sustained weakening of FFO fixed-charge cover to less than 1.3x (FY16: 3.8x). - A significant increase in the structural subordination of DSG's holding company creditors. LIQUIDITY DSG had LKR942 million of cash and LKR1.63 billion in unutilised facilities at FYE16, compared with LKR1.8 billion of term loans falling due within one year, placing the group in a satisfactory liquidity position. However we expect the company to generate negative free cash flow in FY17 due to its high capex spend. A further LKR 4.7 billion of DSG's short-term borrowings are used to fund its working capital, and we expect these facilities to be rolled over in the normal course of business. Contact: Primary Analyst Rishikesh Sivakumar Analyst + 94 11 254 1900 Fitch Ratings Lanka Ltd No.15-04, East Tower, World Trade Centre, Colombo - 01, Sri Lanka. Secondary Analyst Kanishka De Silva Analyst + 94 11 254 1900 Committee Chairperson Vicky Melbourne Senior Director + 612 8256 0325 Date of Relevant Rating Committee: 15 March 2017 Media Relations: Bindu Menon, Mumbai, Tel: +91 22 4000 1727, Email: Additional information is available on Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 10 Mar 2017) here National Scale Ratings Criteria (pub. 07 Mar 2017) here Additional Disclosures Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT <a href="">WWW.FITCHRATINGS.COM.. 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