DIST's rating is
driven by its market leadership in the domestic alcoholic beverages (spirits)
industry, the relatively inelastic demand for spirits through economic cycles,
high entry barriers stemming from the regulatory ban on advertising and
licensing constraints (which favour established manufacturers over new
entrants), and future growth prospects for the industry amid Sri Lanka's
post-war development.
Fitch views the
high and frequent increases in top-line taxes on spirits as a regulatory risk,
which has created a large illicit spirits market. However, the rating factors
in the agency's expectation that DIST will benefit in the longer term, as the
consumption of legal alcoholic beverages gradually replaces illicit spirits in
line with rising per capita income levels in the country. However, the agency
notes that regulations such as the ban on advertising also impede the natural
growth of the legal alcoholic beverages industry to an extent.
DIST accounted
for a 65% share of local alcoholic beverages produced in 2011 through legal
channels, including nearly 80% of Arrack volumes - the major product consumed.
The company's brand portfolio is diverse and caters to varying tastes of
consumers. However, a majority of DIST's beverage sales are driven by its 'Extra
Special Arrack' product, which is targeted at the price conscious consumer.
Relatively resilient demand for spirits has helped DIST sustain and improve
group EBITDAR margins (FY12 ending March: 33%; FY07: 12.5%), despite frequent
increases in top-line taxes by the authorities.
A sustained
increase in financial risk, as measured by an increase in the group's financial
leverage (defined as lease adjusted debt net of cash / operating EBITDAR,
excluding debt at its licensed finance company subsidiary) is a key medium-term
risk, and could result from potential debt-funded acquisitions or a substantial
weakening in DIST's group EBITDAR margins.
DIST is also
exposed to foreign currency risk on any US dollar denominated debt unless
adequately hedged, due to the group's limited foreign currency related earnings
(approximately 8% of group EBITDAR at FY12). However, Fitch notes that the
group's exposure to foreign currency risk through the planned US dollar term
loan of approximately USD11m is manageable.
WHAT COULD
TRIGGER A RATING ACTION?
Negative: Future
developments that may, individually or collectively, lead to a negative rating
action include:
- Consolidated
financial leverage increasing over 1.5x on a sustained basis (end-September
2012: 0.74x annualised),
- Consolidated
Fund Flow from Operations coverage of interest and fixed charges such as
operating lease rentals weakens to below 4.0x (end-September 2012: 4.03x), on a
sustained basis.
- A structural
change in the domestic alcoholic beverages industry which considerably weakens
DIST's competitive position
Positive: There
is no scope for an upgrade since the company is at the highest rating on the
Sri Lankan National Rating Scale
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