JKH ratings not immediately affected by LMS ruling

Fitch Ratings has said John Keells Holdings Plc’s (JKH) National Long-term rating of ‘AAA(lka)’ with Stable Outlook and ‘AAA(lka)’ rating for its senior unsecured notes are not immediately affected by the recent Sri Lankan supreme court ruling on Lanka Marine Services (Pvt) Ltd (LMS). LMS is 99.4% owned by JKH.

On July 21, the Supreme Court of Sri Lanka issued a ruling on a case filed against LMS whereby the vesting of approximately 8.64 acres by the Sri Lanka Port Authority (SLPA) to LMS, on which the assets of LMS reside, the granting of investment relief by the Board of Investments (BOI), and the Common User Facility (CUF) agreements entered into between LMS and SLPA, are all retroactively null and void.

Though the share transfer was held as valid by the current ruling and JKH retained the ownership of assets, the court has nevertheless ordered LMS to vacate the said land within one month.

The ruling renders LMS’ future business operations as indeterminate, with several possible outcomes: the possible re-negotiation of access to the land with the SLPA under a lease agreement; the use of the CUF under new agreements leading to possible higher industry competition; or a shift to bunkering services using offshore barges.

The ruling also requires LMS to pay back taxes from 2002/03 onwards; the final tax outlay will depend on the tax rate deemed applicable by the Inland Revenue. Based on the court ruling which calls for greater competition, Fitch believes that the restructured terms of the CUF could lead to a lower level of profitability for LMS over the medium-term. Subject to the timing and the magnitude of accumulated back taxes, JKH’s profit after tax and cash flow is also expected to be affected in the short-term.

LMS is the key, directly-controlled, subsidiary under JKH’s higher contributing transport sector (which also includes smaller logistics and airline subsidiaries). This sector’s cash flows (LKR1.24bn) accounted for approximately 15% of group EBIT in FY08 and approximately 20% of the group’s cash flow from operations (LKR 6.09bn).

Fitch, however, believes that JKH’s high levels of short-term liquid assets and cash (of LKR12.6bn as at FY08) and the resulting cash return from such assets (LKR2.08bn at FY08) provide comfort for JKH’s ratings.

These assets act as a buffer against the above-mentioned negative effects on LMS, and help retain the leverage ratio (as measured by total adjusted debt net of cash to operating EBITDAR) of 0.1x (FY08) and coverage ratio (funds from operations to gross interest expense) of 4.8x (FY08) to within acceptable levels for the ratings, over the near-term.

JKH’s ratings may, however, be negatively affected going forward if these cash assets are deployed into longer-term investments yielding lower rates of return, significantly higher risks or long gestation periods.

Fitch also notes the elevated level of concentration risk on the company’s free cash flows resulting from the possible elimination of LMS as a key contributor, and the greater dependency on dividends from the South Asia Gateway Terminal.