Fitch revises ASP outlook to negative

Affirms at ‘AA(lka)’:

Fitch Ratings has revised the outlook on Sri Lanka’s Aitken Spence PLC’s (ASP) senior unsecured Rupees notes to negative from stable. The national long-term rating on the notes has been affirmed at ‘AA(lka)’.

The negative outlook reflects Fitch’s concerns over the probability of a sizeable reduction in the scale of ASP’s existing power sector operations and the expectation of the more volatile hotel sector dividend that needs to be consistently upstreamed to the holding company having to replace the power sector dividend over the longer term.

The affirmation reflects Fitch’s expectation that ASP’s core business segments will continue to generate adequate operating cash in the near term from its geographically and industry-wise diversified revenue and profit streams. Although ASP is expected to incur significant investments for its port venture (30 percent ownership), Fitch expects its next 24-month operating cash generation to be sufficient for its corresponding cash requirement including the repayment of these notes. The affirmation also reflects the current headroom availability for financial leverage (total adjusted net debt/operating EBITDAR) at the holding company level. ASP’s rating remains exposed to the state-owned Ceylon Electricity Board’s (CEB) financial strength, which is the sole purchaser of its power output, albeit the latter’s financials improved in 2010.

The power purchase agreements (PPAs) have built-in safeguards along with the non-recourse nature of power sector debt to the holding company. However, Fitch notes that there has been no finalization of discussions with CEB for the continuation of ASP’s PPAs for its two 20MW plants, which will expire in 2012. CEB’s own capacity is expected to improve with the new coal and hydro projects (450MW) and these two thermal power plants will be the first to come in for renegotiation, providing direction for CEB’s future use of private thermal power plants.

Furthermore, the recent declaration by ASP of the possibility of future dilution of its ownership and/or control of its 100MW thermal plant (74 percent owned) as may be determined by the Treasury Secretary based on the Sri Lanka Electricity Act No.20 of 2009, exposes the company to a significant event risk, which if triggered will warrant an immediate rating review.

Additionally, although ASP’s power sector long-term debt was to be fully paid off by FYE12, the new wind and mini hydro power projects will bring in additional debt of around Rs 830 million, which will keep the sector leverage at current levels. Fitch highlights that ASP will have to maintain its current high power dividend (over 80 percent of total dividend income) through free cash flows generated from its 100MW plant, and continue this till 2015. Fitch sees that any decrease in this dividend inflow to be a negative rating driver.

ASP’s hotels sector operating performance has improved based on the increased profitability of its Sri Lankan resorts. Stable cash generation and expected low capital expenditure from ASP’s Maldivian assets also will add to the cash generated in Sri Lanka. Although ASP has acquired several new resorts, postponement of some major hotel projects planned last year will allow these acquisitions and new capital expenditure to be funded by the cash received through the 2010 rights issue (Rupees 2.5 billion) at the hotel subsidiary.

However, Fitch highlights that ASP’s holding company has received only a small percentage of dividend from its main hotels subsidiary within the last three years, and this may have to change for the holding company to fund its port project. While Fitch has factored in ASP’s ability to control is hotel dividend policy (74 percent ownership), if a stable dividend stream is not upstreamed from now on to compensate for the potential reduction in power dividend, this can also become a rating concern for the holding company.

The 30 percent associate investment in the south terminal management JV will require an US$ 45 million investment over the next four years on a staggered basis, while this project will start adding to ASP’s profitability and cash inflows only from five-six years to the future. However, this project’s debt will remain off balance sheet. As of FYE11, the holding company total adjusted debt was Rupees 3.5 billion and its leverage was 0.4x due to the strong cash balance (Rupees 2.7 billion). Fitch notes that the scheduled debt repayments of above Rupees 500 million per annum during FY12 and FY13 and port project investment (over Rupees 2.2 billion) would necessitate adequate dividend inflow from all three sectors into the holding company to maintain its financial profile. As of December 31, 2010, the holding company had adequate unutilised debt facilities of Rupees 4.5 billion which provides comfort for the repayment schedule.

Fitch notes that any significant additional borrowings for sizeable new projects or any reduction in dividend income to group parent against Fitch’s expectations can act as negative rating triggers. However, if ASP were to generate a sizeable cash balance through an equity rights issue, power plant sale or if the power sector were to continue after renegotiations at similar profit levels, this may relieve pressure on the holding company’s cash outflows.