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Fitch Publishes Indonesia's Pan Brothers' 'B' Rating; Outlook Positive
January 13, 2017 / 4:00 AM / a year ago

Fitch Publishes Indonesia's Pan Brothers' 'B' Rating; Outlook Positive

(The following statement was released by the rating agency) SINGAPORE/JAKARTA, January 12 (Fitch) Fitch Ratings has published Indonesia-based garment manufacturer PT Pan Brothers Tbk's (Pan Brothers) Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'B' with Positive Outlook. At the same time, Fitch has published the expected 'B(EXP)' rating and Recovery Rating of 'RR4' on Pan Brothers' proposed senior unsecured notes. The notes will be issued by Pan Brothers' wholly owned subsidiary, PB International B.V., and guaranteed by Pan Brothers and certain subsidiaries. The proposed notes will rank pari passu with senior unsecured obligations of Pan Brothers and its subsidiaries, as they represent the company's unconditional, unsecured and unsubordinated obligations. The final rating is contingent upon the receipt of documents conforming to information already received. KEY RATING DRIVERS Product Range, Revenue Visibility: Pan Brothers' rating is underpinned by its position as Indonesia's largest publicly listed garment manufacturer by capacity, its established relationships with global apparel brands, and its contractual revenue visibility over a 12-18 month horizon. Pan Brothers' growing expertise in apparel manufacturing and its ability to cater to a wide range of products have attracted global apparel brands, with which it has longstanding relationships. High Working Capital: The above strengths are balanced by the company's limited bargaining power with its top customers, which has resulted in high working capital requirements and negative cash flow from operations (CFO). For example the company has increased advance payments to secure raw materials on behalf of its key customers in 2015 and 2016 in line with its capacity expansion. We expect Pan Brothers' CFO to remain negative until end-2017. Positive Outlook on Expected Deleveraging: The Positive Outlook on Pan Brothers' rating reflects Fitch's expectation that the company's ongoing capacity expansion would lead to better bargaining power with its customers as well as a more diversified customer base, allowing for better working-capital management. Fitch forecasts Pan Brothers' leverage, as measured by lease-adjusted debt net of seasonally adjusted cash/ EBITDAR, to fall to around 3.5x in 2018 from around 4.5x in 2017. Capacity Expansion: Pan Brothers expects to increase its installed capacity from 84 million pieces (polo shirt-based) a year to 117 million by end-2019. Fitch expects this to increase existing customers' reliance on Pan Brothers, and expand its customer base. Pan Brothers' expanded production capacity will also position it to benefit from the trend in consolidation among the vendors of global apparel brands. Cost Pass-Through Ability: Pan Brothers operates under a cost-plus pricing mechanism, where the price of its products is mostly derived from the cost of raw materials plus a mark-up margin. This allows Pan Brothers to pass through cost fluctuations to its customers. However, margins may be pressured during prolonged cyclical downturns. Fitch expects the EBITDA margin to remain stable at 7%-8% in the short to medium term. Seasonal Cash Flows: Pan Brothers' working-capital cycle is longer in the first half of the year due to purchases of materials to cater for woven outerwear clothing, in particular down jackets, to be ready for the peak production season between April and September. Pan Brothers' knitwear sales are rising, which will provide some earnings stability. To reflect the seasonality, Fitch has excluded an estimated USD25m from Pan Brothers' year-end cash balance from the year-end leverage ratio. Manageable Currency Exposure: Close to 90% of Pan Brothers' sales in 2015 were from exports, while around 80% of its raw materials are imported. This provides the company with a natural hedge against currency volatility, as evident in 2015 when Pan Brothers' EBITDA margin remained relatively intact in the face of severe volatility of the local exchange rate. Raw material costs make up 65% of the company's total costs. DERIVATION SUMMARY Pan Brothers has a weaker credit profile compared with Fitch-rated peers in the same industry, such as PT Sri Rejeki Isman Tbk (Sritex, BB-/Stable). Pan Brothers' business profile is solid, but its ability to generate cash flow has been weakened by growing working-capital requirements, which stem from its still-limited bargaining power with its top customers. Sritex has wider EBITDA margins and lower working capital requirements, which contribute to lower leverage and better cash-flow generation compared to Pan Brothers. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Net sales growth of around 15%-19% in 2016-2019; - Average selling price to increase 0%-2% in 2016-2017; - Capex of USD17m and USD49m in 2016 and 2017, respectively RATING SENSITIVITIES Positive: Future developments that may, individually or collectively, lead to positive rating action include: - Leverage sustained below 3.5x (end-2015: 3.3x) - Ability to maintain neutral cash flow from operations Negative: Future developments that may, individually or collectively, lead the Outlook being revised to Stable include: - Not meeting the above positive triggers for an extended period LIQUIDITY Sufficient Liquidity: Readily available cash was USD49m as at end-December 2015, with gross debt of USD141m and a committed unused working-capital facility of around USD100m. Pan Brothers is in the process of issuing a US dollar bond, with most of the proceeds to redeem outstanding debt. A natural currency hedge arises from close to 90% of 2015 sales being export-based, while around 80% of raw materials (where raw materials made up 65% of total costs) are imported. Pan Brothers also plans to retain more than USD100m of its syndicated working-capital loan facility (current limit USD230m) as a back-up for any working-capital requirement in the future. Contact: Primary Analyst Hasira De Silva, CFA Director +65 6796 7240 Fitch Ratings Singapore Pte Ltd One Raffles Quay South Tower #22-11 Singapore 048583 Secondary Analyst Bernard Kie Analyst +62 21 2988 6815 Committee Chairperson Vicky Melbourne Senior Director +61 2 8256 0325 Summary of Financial Statement Adjustments: - Fitch includes "advance payments" in current assets, which is mostly payments for raw materials, as part of the working-capital calculation - Fitch assumed USD25m of cash to be "restricted cash", to reflect cash set aside for seasonal working capital purposes Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: Additional information is available on Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Parent and Subsidiary Rating Linkage (pub. 31 Aug 2016) here Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 21 Nov 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1017499 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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