Bangkok--27 Jan--Fitch Ratings
Fitch Ratings (Thailand) Limited has maintained the Rating Watch Negative (RWN) on Siam City Cement Public Company Limited's (SCCC, A(tha)) ratings, pending confirmation regarding its new capital structure following its latest acquisitions. We expect to resolve the RWN once the details of the transaction-financing plan are finalised and the agency reviews SCCC's post-acquisition capital structure, which is likely to be completed within the next one to two months, according to the company. A full list of ratings follows at the end of this release.
The RWN reflects the uncertainty over the company's new capital-increase plan which could reduce financial risk relating to the announced acquisitions. The financing structure, based on the recent disclosure of its preliminary financing plan, is likely to be a combination of equity and debt financing. This, together with operating cash flows from the acquired businesses, should enable SCCC to bring down its financial leverage (as measured by FFO-adjusted net leverage) to below 2.5x in 2019. In addition, its business profile will be strengthened by significantly broader geographical diversification.
Fitch placed SCCC on RWN following the July 2016 announcement by SCCC to acquire a 99% stake in Sri Lanka-based Holcim (Lanka) Limited (HLL) from LafargeHolcim Ltd (BBB/Stable), and the RWN has remained after the August 2016 announcement to acquire 65% charter capital of Holcim (Vietnam) Co., Ltd. (HVL) from the same seller. The total investment value is approximately USD900m (about THB32bn equivalent).
KEY RATING DRIVERS
New Capital Structure: The level of SCCC's capital increase will be a key determinant in the resolution of the RWN. The acquisitions are likely to weaken SCCC's credit metrics. Nonetheless, the planned capital increase should mitigate the impact, and may enable the company to maintain its FFO-adjusted net leverage to be consistent with an 'A(tha)' rating over the medium term.
Benefits from Increasing Diversification: Fitch expects SCCC's broader geographical diversification to help reduce the constraint of single-market concentration. SCCC has aggressively expanded its regional footprint through greenfield investment in Cambodia and acquisitions in Bangladesh, Sri Lanka, and Vietnam over the past year. The revenue contribution outside Thailand will grow significantly to above THB20bn in 2017 from THB6bn in 2015. That would then represent almost 50% of total revenue. We expect the transition to be smooth, as SCCC and both ex-Holcim entities are familiar with being under the Holcim umbrella and with a shared common working procedure and systems.
Strong Market Position: SCCC is Thailand's second-largest cement producer, with a stable market share of 27% based on sales. Fitch expects the company to defend its market position against capacity expansion by the third-largest producer, due to its strong brand in cement and ready-mixed concrete. Its relatively wide profit margin should provide pricing flexibility to respond to heightened competition. The market position of the entities acquired are also strong as the sole clinker producer and largest cement producer with about a 37% market share (by sales volume) in Sri Lanka in 2016, and is the second-largest player in southern Vietnam, with a market share (by sales volume) maintained at about 23%.
Competition to Affect Profitability: Fitch expects the intensified local market competition to narrow SCCC's EBITDA margin due to its efforts to defend its market share in 2016. The EBITDA margin was about 21.7% in 9M16, down from 23.3% in 2015, due partly to the impact of the consolidation of lower-margin Bangladesh operations. We see Thai cement demand improving only slightly in 2017 due to a delayed demand recovery in the residential and commercial segments. We expect stronger demand in the private segments, which should drive earnings growth in 2018.
Vulnerable to Energy Prices: SCCC's EBITDA margin is highly sensitive to coal and electricity energy costs, which account for more than 70% of total production costs. Average benchmark coal prices surged by 56% in 2H16 (relative to 1H16), due to a supply deficit - mainly in China. This should put some pressure on SCCC's profitability in 4Q16. However, Fitch expects the pressure to soften in 2017 as Chinese government has relaxed restrictions on coal mining since December 2016.
DERIVATION SUMMARY
The RWN reflects the uncertainty over the company's new capital increase plan which may enable the company to maintain its financial leverage commensurate with an 'A(tha)' rating. SCCC's higher financial leverage from its acquisition plan is likely to be somewhat offset by enhancing its business profile with significant geographical diversification. The investments could drive FFO-adjusted net leverage higher, but is likely to be sustained below 2.5x over the medium term. This level of financial leverage is still stronger than the average leverage of its closest peer, The Siam Cement Public Company Limited (SCC, A(tha)/Stable), which is significantly larger and has a stronger domestic market position and diversification profile. SCC's FFO-adjusted net leverage guideline for 'A(tha)' is between 2.75x-3.75x on a sustained basis.
SCCC's financial leverage could be higher than that of Tipco Asphalt Public Company Limited (TASCO, A-(tha)/Stable), a leading asphalt producer in Thailand. However, SCCC has a stronger business profile than TASCO. SCCC's larger operating scale from acquisitions and healthier profitability will make its operating cash flows triple larger than that of TASCO. In addition, TASCO is also vulnerable to fluctuations in the prices of raw materials, mainly crude oil.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
-- Domestic cement sales to slightly grow in 2017 and improve more solidly in 2018
-- Total revenue to grow by about 40%-50% in 2017 after acquisitions of the Siam City Cement (Lanka) and HVL
-- EBITDA margin at 22%-24% in 2017-2018
-- A dividend payout ratio of about 60% in 2017-2018.
RATING SENSITIVITIES
POSITIVE: Developments that may lead to a positive rating action include:
-- Factors that could lead to Fitch resolving the Rating Watch Negative and assigning a Stable Outlook include SCCC's capital increase plan enabling SCCC's FFO-adjusted net leverage to be sustainable at below 2.5x over the medium term.
NEGATIVE: Developments that may, individually or collectively, lead to negative rating action include:
-- FFO-adjusted net leverage above 2.5x on a sustained basis.
-- A weakening of SCCC's profit margins.
LIQUIDITY
Large Refinancing Required: SCCC had THB20.7bn of debt maturing within the next 12 months as of end-September 2016. The maturing debt consists mainly of a short-term bridge loan for acquisitions from financial institutions of about THB13bn, and debentures of THB4bn. The company expects to access the capital market via both equity and debt issuance to refinance some of this debt. Refinancing risk should be low, given the company's strong shareholder and its track record of accessibility to debt capital market. Its liquidity is also supported by a cash balance of THB2.8bn at end-September 2016, and healthy operating cash flow of about THB8bn-10bn per year.
FULL LIST OF RATING ACTIONS
Siam City Cement Public Company Limited
-- Rating Watch Negative (RWN) on the company's ratings include:
-- National Long-Term Rating of 'A(tha)'
-- Senior unsecured debentures' National Long-Term Rating of 'A(tha)'
-- National Short-Term Rating of 'F1(tha)'