TRIS Rating has assigned the rating of “A-” to the proposed issue of up to Bt7,500 million in senior unsecured debentures of CH. Karnchang PLC (CK). At the same time, TRIS Rating has affirmed the company and current senior unsecured debenture ratings of CK at “A-”. The outlook remains “stable”. CK plans to use the proceeds from the new debentures to repay maturing debts and to fund its expansion plans. The credit ratings reflect CK’s position as a top-tier contractor, its ability to undertake large-scale and sophisticated construction projects, as well as the synergy and financial flexibility the company gains from its strategic investments. These strengths are partially offset by the cyclicality of and stiff competition in the engineering and construction (E&C) industry, as well as the company’s high financial leverage.
The “stable” outlook reflects expectations that CK will remain highly competitive in securing new projects on the rise of forthcoming infrastructure projects. CK will be able to sustain its operating margin above 6% on average despite stiff competition. The working capital requirement for the Xayaburi project is expected to fall over time.
The credit upsides are the case that CK could generate stronger-than-expected cash flows and backlog, as well as maintain its debt to capitalization ratio below 60% for a sustained period. The credit downsides will be caused by the significant cost overruns for major projects or unanticipated, extensive financial support provided to its affiliates, which would markedly hurt CK’s cash flow.
Established in 1972 by the Trivisvavet family, CK initially focused on public works projects for government agencies. The company later greatly expanded its scope of work and became a listed company on the Stock Exchange of Thailand (SET) in 1995. CK has a long-established presence in the E&C sector with experience and expertise in all kinds of construction, ranging from general civil works to highly sophisticated projects.
The ratings reflect CK’s leading position in Thailand’s E&C industry. CK is one of the top three contractors listed on the SET, based on revenue. The ratings also recognize its proven record of completing large-scale infrastructure projects and specialized construction projects. CK’s backlog at the end of March 2016 was about Bt78.5 billion. The major projects in the backlog include the Xayaburi hydropower dam project, worth Bt29.1 billion, the double track railroad project from the Chira junction to the KhonKaen section worth Bt15.1 billion, the Purple-line train project contract 4 worth Bt8.4 billion, and the Si-Rat outer ring road expressway project worth Bt3.6 billion. The Xayaburi project accounts for 37% of the total backlog.
Moreover, the ratings take into consideration the synergy and financial flexibility the company gains from its strategic investments. CK’s business model is to invest in infrastructure projects to augment its primary business as an E&C contractor. The goal of the strategic investments is to boost earnings and raise the earnings growth rate. CK holds stakes in other businesses, but its strategic investments are three SET-listed companies: Bangkok Expressway and Metro PLC (BEM), TTW PLC (TTW), and CK Power PLC (CKP). These three firms provide products that meet basic needs (i.e. transportation infrastructure and utilities) under concession contracts or long-term utility purchase contracts. CK expects to earn dividends on a recurring basis from its strategic investments. On top of dividends, these companies provide CK with sizable construction projects as they expand.
Conversely, the ratings are partially offset by cyclicality of the E&C industry and the stiff competition among contractors. Most projects are awarded through competitive bidding, which squeezes the profit margins of contractors. The E&C sector is now heavily reliant on government-sponsored infrastructure projects. The government has a clear policy to launch several mega-projects as part of economic rejuvenation campaign. However, delays in bidding and contract awards remain and are beyond the control of the contractors.
The ratings are also constrained by CK’s high financial leverage. CK’s financial profile in the first quarter of 2016 was slightly lower than TRIS Rating’s expectation. Leverage remained higher than expectation due largely to higher working capital needs for the Xayaburi project and additional debt borrowed to fund for the Purple-line train project. At the end of March 2016, CK’s debt to capitalization ratio was 72.9%. CK’s debt to capitalization ratio is expected to remain elevated in 2016 but will slip below 67% after 2017 when the Purple-line contract 4 is completed. TRIS Rating views CK’s leverage level is higher than other contractors with the same ratings. However, the leverage level is consistent with CK’s credit ratings, taking into consideration the company’s business model as a contractor and an investment company.
TRIS Rating’s base-case scenario expects CK to generate revenue of at least Bt40 billion per annum during 2016-2018. Revenue from the Xayaburi project is expected at Bt7-Bt9 billion per annum, or 15%-20% of the base-case revenues. In addition, CK’s strong backlog will secure about 70% of the base-case revenues in 2016, followed by 45% in 2017, and 25% in 2018. CK’s operating margin (operating income before depreciation and amortization, as a percentage of revenue) during 2016-2018 will stay above 6% on average. Funds from operations (FFO) are expected at least Bt2.3 billion per annum.
CK’s liquidity profile is acceptable. The profile is enhanced by the company’s financial flexibility through its investments in the three SET-listed companies. At the end of March 2016, the fair value of CK’s investments in the SET-listed companies was Bt37.4 billion, or about 67% of the company’s total debt. During 2016-2018, the EBITDA (earnings before interest, tax, depreciation, and amortization) interest coverage ratio is expected to stay above 2.5 times. The FFO to total debt ratio is expected to range from 5%-8%.
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