TRIS Rating has affirmed the company and senior unsecured debenture ratings of Sri Trang Agro-Industry PLC (STA) at “A-” with “stable” outlook. The ratings reflect the company’s leading position in the natural rubber (NR) industry, diversified customer base, and the extensive track record of its management team. However, these strengths are partially offset by the cyclical nature of NR prices and narrow margins of mid-stream NR producers as well as the fluctuation of foreign exchange.
The “stable” outlook reflects the expectation that STA will maintain its competitive position in the NR industry. The company is also expected to use hedging instruments prudently to mitigate NR price risk and foreign exchange risk. STA should maintain sufficient liquidity and a balance sheet strong enough to withstand the effects of volatile NR prices.
STA’s credit upside could occur if debt serviceability improves noticeably on a sustained basis while the balance sheet stays healthy. The downside risk could occur if the fluctuations in NR prices weaken STA’s debt serviceability for a sustained period. An aggressive debt-funded investment would also be a negative factor for STA’s credit ratings.
STA is the world’s leading processor and merchandiser of NR. The company has 26 processing plants located in Thailand, three plants in Indonesia, and one in Myanmar. As of 30 June 2016, total optimum processing capacity was 1,523,992 tonnes per year. STA’s market share in the global NR industry in the first half of 2016 was 11.6%. Approximately 80% of its products are sold directly to end-users, which are mostly tyre manufacturers. Exports accounted for 85% of STA’s total sales volume for the first six months of 2016. China was the largest export market, accounting for 58% of export volume during the first half of 2016.
As a mid-stream NR producer, STA’s profitability is very thin and fluctuates along with NR prices. STA has entered some derivatives contracts to mitigate the risk from NR price fluctuations and foreign exchange risk. As a result, the operating margin before depreciation (excluding a reversal on the diminution in value of inventories, but including realized gains or losses from derivatives instruments) hovered between 0.59%-3.81% in 2011-2015, compared with 0.64%-2.49% without gains or losses from derivatives. Earnings before interest, tax, depreciation, and amortization (EBITDA) ranged between Bt1,384-Bt4,945 million during the same period.
In 2015, total revenue dropped to Bt61,292 million, a 19% year-on-year (y-o-y) decline. This drop was driven by a 13% decline in NR prices and a 7% drop in STA’s NR shipments since customers delayed orders as NR prices fell. For the first six months of 2016, total revenue rose to Bt35,446 million, a 20% y-o-y rise. Despite an 11% y-o-y decline in NR prices, NR shipments rose by 34% y-o-y. STA shipped 725,190 tonnes of NR to customers for the first six months of 2016. The rise in shipments was driven by both domestic and export market, especially China. The increase in shipment was due to accelerated orders after the improving NR prices.
NR prices continued to fall in 2015 and reached a 10-year low in February 2016. Since then, NR prices recovered gradually in the second quarter. The rise was attributed to rising oil prices, the effect of the El Ni?o in the beginning of 2016, coupled with an announcement from the three major exporting countries that NR exports would be reduced by 15%. As a result, STA’s operating margin improved significantly to 5.92% in the second quarter of 2016 from -0.28% in the first quarter of 2016. However, the softening profitability in the first quarter of 2016 kept the operating margin during the first half of 2016 at 3.00%, lower from 3.69% over the same period of 2015. The lower operating margin pushed down EBITDA to Bt1,357 million in the first six months of 2016, from Bt1,661 million in the first six months of 2015. Looking forward, STA’s operations are expected to improve in the remainder of the year as NR prices recover. NR prices have continued to pick up in the third quarter of 2016 and in October 2016, on the back of a gradual reduction in NR supply and the rebound in oil prices. The price of Standard Thai Rubber (STR20) averaged Bt45.26/kilogram (kg.) in the third quarter of 2016 and Bt49.63/kg. in October 2016, compared with Bt45.36/kg. in the third quarter of 2015 and Bt43.18/kg. in October 2015, according to the Thai Rubber Association.
STA’s balance sheet was moderate. Total debt was Bt19,194 million as of June 2016 and the total debt to capitalization ratio was 47.27% at the end of June 2016. Liquidity is considered good. Almost 60% of STA’s debts, or Bt11,017 million, were short-term debts, which were utilized to finance inventory worth Bt11,086 million as of June 2016. NR inventory is typically highly liquid and marketable. It can be easily liquidated to pay down debts. Cash flow protection remained acceptable during the current industry down cycle. The EBITDA interest coverage ratio was 6.00 times in the first six months of 2016, compared with 3.63-3.76 times in 2014-2015. The funds from operations (FFO) to total debt ratio declined to 7.07% (annualized with trailing 12 months) in the first six months of 2016, compared with 9.79%-14.06% in 2014-2015.
During 2017-2019, STA’s plans to spend Bt1,600-Bt3,200 million per annum in capital expenditures, primarily to build rubber processing plants in Thailand and abroad. STA’s EBITDA is expected to be around Bt2,700-Bt2,900 million per year. TRIS Rating expects that STA can finance the capital expenditures mainly through operating cash flow.
STA is exposed to a litigation risk. In 2014, STA, Rubberland Products Co., Ltd. (STA’s subsidiary), and Siam Sempermed Corp., Ltd. (SSC) were sued by Semperit Technische Produkte Gesellschaft m.b.H. (STPG), an Austrian joint venture (JV) partner in SSC. STPG alleges STA, the JV company, SSC, and SSC’s Thai shareholders, breached the JV agreement and other related agreements. STPG filed three petitions for arbitration proceedings in Switzerland at the ICC International Court of Arbitration. STPG claimed damages and requested the arbitration tribunal issue orders demanding STA, SSC, and other shareholders of SSC undertake or refrain from undertaking certain acts with respect to SSC. Recently, STPG raised the claim in one filing from approximately EUR 35 million, or Bt1,380 million, to approximately EUR 82 million, or Bt3,234 million. As a result, the value of the claims in the three petitions, which STPG submitted to the arbitration tribunal, rose to Bt3,452 million, up from Bt1,598 million. One of the three filings received a final award on 6 May 2016. The arbitration tribunal declared that resolutions of SSC’s board of directors meetings are enforceable and legally binding, according to the JV agreement, despite the fact that the resolutions violated SSC’s Articles of Association. The Tribunal orders STA and Rubberland to compensate STPG with approximately Bt100 million to cover the arbitration fees and other costs relating to the case. The arbitration tribunal has not yet rendered final rulings regarding the compensation in the other two cases. The outcomes of these disputes are uncertain and may take time to be resolved. All final awards made by the tribunal have to be submitted to competent courts for enforcement even if the arbitration tribunal makes awards in favor of STPG.
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