Fitch Ratings-Singapore/Colombo-02 January 2018: Fitch Ratings has assigned Sri Lanka Telecom PLC’s (SLT, AAA(lka)/Stable) proposed senior unsecured debenture issue of up to LKR7 billion an expected National Long-Term Rating of ‘AAA(lka)(EXP)’.
The debentures will have a tenor of 10 years and carry fixed coupons. The debentures will be listed on the Colombo Stock Exchange, with the proceeds to be used to refinance its short-term debt and fund SLT’s capex plans.
SLT’s senior unsecured debt is rated at the same level as its National Long-Term Rating, as the debentures rank equally with other senior unsecured obligations. The final rating is subject to the receipt of final documents conforming to information already received.
KEY RATING DRIVERS
Proposed Tax Credit Negative: Fitch believes SLT’s 2018 operating EBITDAR margin could decline to 24% (2017 forecast: 29%) and its funds flow from operations (FFO) adjusted net leverage could deteriorate to 2.5x (2017 forecast: 1.9x) if it were to pay an additional LKR3 billion tax for its mobile towers. The proposed monthly tax of LKR200,000 per mobile tower was announced on 9 November 2017 in Sri Lanka’s 2018 budget. SLT’s fully owned subsidiary, Mobitel (Pvt) Ltd., owns over 1,500 towers. We expect SLT’s ratings to remain unaffected, as it has sufficient headroom to absorb the proposed tax. However, Fitch has not factored in the impact of the tower tax in its base case, as the budget proposal has not been finalised.
Negative FCF; Large Capex: We expect SLT to have a free cash flow (FCF) deficit during 2017-2020 (2017 forecast: LKR7 billion deficit), as cash flow from operation could fall short in funding large capex plans to expand the group’s optical fibre infrastructure and 3G/4G mobile networks. We expect SLT’s 2017 capex to reach about LKR25 billion, or 34% of revenue, before moderating to LKR20 billion-23 billion per year. SLT’s fibre investments are likely to have low returns due to the country’s low broadband tariffs. Dividends are likely to remain similar to historical levels of LKR1.6 billion.
Data Drives Growth: SLT’s data revenue growth will improve following the removal of the telco levy on data services from September 2017, which will lower the effective tax rate to around 20% from 32%. However, we forecast SLT’s EBITDA margin to dilute by about 50bp a year over 2018-2020, as improving profitability on fixed-broadband and mobile internet usage will only partly offset margin dilution from a falling share of profitable fixed-voice and international operations.
Overall revenue growth is likely to slow to 1.5% in 2017 (9M17: 1.3%, 2016: 8.5%) due to the reintroduction of value added tax and nation building tax on telecom services, but should recover to the mid-single digits in 2018-2019 along with better mobile-voice revenue and the robust data growth.
Solid Market Position: SLT’s ratings are underpinned by its market-leading position in fixed-line services and second-largest position in mobile, along with its ownership of an extensive optical fibre network. The company’s stable cash generation benefits from its diversified service offerings, including fixed-voice, broadband, mobile, pay-TV, enterprise and international operations. We believe SLT’s market position will strengthen, as it plans to expand its mobile and fibre infrastructure.
Market Consolidation, M&A Risk: We expect some industry consolidation due to ongoing intense competition, especially in the mobile segment; this segment has five operators that face still-high investment requirements and the smaller operators are unprofitable. SLT’s National Long-Term Rating could come under pressure if it were to perform 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.
DERIVATION SUMMARY
SLT’s National Long-Term Rating is based on a comparison of domestic peers. SLT has 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). Sri Lanka’s hard-liquor market leader, Distilleries Company of Sri Lanka PLC (DIST, AAA(lka)/Rating Watch Negative), has a smaller operating scale compared with SLT because a significant portion of the country’s alcoholic beverage consumption occurs outside the formal sector in which DIST operates. DIST is also exposed to more regulatory risk in the form of recurrent increases in indirect taxation. These risks are counterbalanced by DIST’s substantially stronger free cash flow. SLT’s forecast 2017 FFO adjusted net leverage of 1.9x is slightly higher than that of DIST and Dialog.
KEY ASSUMPTIONS
Fitch’s key assumptions within the rating case include:
– Proposed mobile tower taxes are not implemented.
– Slower revenue growth of 1.5% in 2017 (2016: 8.5%) due to higher taxes. Growth to recover from 2018 to mid-single-digit percentage, driven by fixed-broadband and mobile data services.
– Operating EBITDAR margin to dilute by about 50bp in 2017-2018 due to a change in revenue mix.
– Capex/revenue to peak at 34% in 2017 (9M17: 36%), before moderating to around 28%-30% as SLT expands its fibre and 3G/4G networks.
– Dividend payout to remain similar to 2016 levels of LKR1.6 billion.
– FCF deficit during 2017-2020 resulting in gradual increase in FFO adjusted net leverage.
RATING SENSITIVITIES
Developments that may, individually or collectively, lead to positive rating action include:
– There is no scope for an upgrade as SLT is at the highest rating on the Sri Lankan national ratings scale.
Developments that may, individually or collectively, lead to negative rating action include:
– 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.
LIQUIDITY
Strong Access to Banks: SLT’s liquidity was inadequate as at end-September 2017, with cash of LKR6 billion and committed undrawn bank lines of LKR10 billion being insufficient to fund short-term debt of LKR26 billion and the annual FCF deficit of around LKR7 billion. However, we expect SLT to comfortably refinance its short-term debt, as the company has a demonstrated record of accessing capital from local banks and capital markets.
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