Feb 14, Colombo: Fitch Ratings has revised the Outlook on Sri Lanka Telecom PLC's (SLT) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to Stable from Negative and affirmed the IDRs at 'B+'.
The rating actions follow the Outlook revision on Sri Lanka's Long-Term Foreign- and Local-Currency IDRs to Stable from Negative on 9 February 2017. The agency also affirmed SLT's National Long-Term Rating at 'AAA(lka)' with a Stable Outlook.
KEY RATING DRIVERS
Ratings Constrained by Sovereign: SLT's IDRs are constrained by the sovereign's IDRs of 'B+', as the government directly and indirectly holds a majority stake in SLT and exercises significant influence on its operating and financial profile. Therefore the Outlook has been revised to Stable, following the revision of the sovereign Outlook to Stable. SLT's second-biggest shareholder, Malaysia's Usaha Tegas - which owns 44.9% of SLT - does not have any special provisions in its shareholder agreement that dilute the government's significant influence over SLT.
Negative FCF, Large Capex: We expect SLT to have negative FCF in 2017-2018 (2016 estimated FCF deficit: LKR7bn-8bn), as cash flow from operations will be insufficient to fund its large capex plan. We expect SLT to invest about LKR20bn-22bn, or 28%-30% of revenue, in capex each year to expand its optical fibre and 3G/4G mobile networks.
Taxes Hinder Growth: We expect SLT's revenue growth to slow to 2%-3% in 2017 (2016 estimated: 9%), as consumers will likely curb usage due to the reintroduction of value-added tax and nation-building tax on telecom services from November 2016. The effective tax rate for voice and SMS services increased to about 50%, from 28%. The effective tax on data services increased to 32% from 12%, and will further increase to 50% when the telecommunications levy increase becomes effective from April 2017. Revenue growth from increased use of data services is likely to be more than offset by declines in revenue from fixed-voice, code division multiple access and international operations.
We forecast SLT's EBITDA margin to narrow by about 50bp over 2017-2018, from an estimated 29% in 2016, as improving profitability of fixed-broadband and mobile internet usage will only partly offset margin erosion from a change in revenue mix and the tax hikes.
Solid Market Position: SLT's ratings are underpinned by its market-leading position in the fixed-line services and second-largest position in the mobile market, along with its ownership of the country's extensive optical fibre network. The company benefits from a diverse service offering, which includes fixed-voice, broadband, mobile, pay-tv, enterprise, international terminations and international data services. We believe SLT's market position will strengthen from its planned mobile and fibre infrastructure expansion.
Market Consolidation, M&A Risk: We believe some industry consolidation is likely with ongoing intense competition - especially in the mobile segment where there are five operators, of which the smaller operators are unprofitable, and all of them face still-high investment requirements. SLT's National Long-Term Rating could come under pressure if it were to do a debt-funded acquisition of a smaller operator; any rating action will be based on the acquisition price, funding structure and the financial and operating profile of the combined entity. The international ratings, which are constrained by the sovereign ratings, have sufficient headroom to absorb a debt-funded acquisition.
SLT's Foreign-Currency and Local-Currency IDRs are constrained by Sri Lanka's IDRs of 'B+', given the government's ownership and significant influence on its operating and financial profile. SLT's National Long-Term Rating is based on a relative comparison of domestic peers. SLT has a lower exposure to the crowded mobile market and more diverse service platforms than Sri Lanka's mobile market-leader, Dialog Axiata PLC (AAA(lka)/Stable). Distilleries Company of Sri Lanka PLC (DIST, AAA(lka)/Rating Watch Negative) faces high regulatory risk, with frequent excise tax hikes. However, it benefits from a higher EBITDAR margin and stronger FCF generation than SLT. SLT's estimated 2016 FFO-adjusted net leverage of 1.5x is broadly similar to that of Dialog Axiata and DIST.
Fitch's key assumptions within our rating case for the issuer include:
- Slower revenue growth of 2%-3% in 2017 (2016: 9%) on higher taxes.
- Growth to recover from 2018 to a mid-single-digit percentage, driven by fixed-broadband and mobile data services.
- Operating EBITDAR margin to fall by about 50bp in 2017-2018, due to a change in revenue mix and higher taxes.
- Capex/revenue to remain high around 28%-30%, as SLT expands it fibre and 3G/4G networks.
- Dividend payout to remain similar to 2016, at LKR1.6bn.
- Negative FCF during 2017-2018, resulting in gradual increase in FFO-adjusted net leverage.
Developments that may, individually or collectively, lead to positive rating action include:
-A change in Sri Lanka's IDRs will result in a corresponding action on SLT's IDRs.
-A weakening of links between SLT and the sovereign could result in SLT's Local-Currency IDR being upgraded above Sri Lanka's Local-Currency IDR. However, SLT's Foreign-Currency IDR will remain constrained by the Country Ceiling of 'B+'.
Developments that may, individually or collectively, lead to negative rating action include:
- A downgrade in Sri Lanka's IDRs will result in a corresponding action on SLT's IDRs.
- A debt-funded acquisition of a smaller operator could threaten SLT's National Long-Term Rating, depending on the acquisition price and the financial profile of the combined entity.
Solid Access to Capital: Cash of LKR5.8bn and committed undrawn bank lines of LKR7.9bn were insufficient to fund its short-term debt of LKR12.7bn and annual FCF deficit of LKR3bn-5bn. However, SLT is in the process of raising LKR6bn to refinance its short-term debt and has demonstrated a solid record of accessing capital from local banks and capital markets.