Says Lion’s net leverage levels unlikely to fall
Beer volume records large drop between 2014-2016
Fitch Ratings yesterday downgraded the credit rating of Sri Lanka’s largest brewer, Lion Brewery (Ceylon) PLC, amid lower beer sales as a result of the higher taxes imposed by the authorities over the last 18 months.
Accordingly, Lion’s national long-term rating and long-term rating on its outstanding senior unsecured debentures were downgraded to ‘A+(lka)’ from ‘AA-(lka)’. The outlook is negative.
“The downgrade reflects Fitch’s expectations that Lion’s net leverage, defined as lease-adjusted debt net of cash/operating EBITDAR, is unlikely to fall below 2.0x over the next three years due to lower beer sales from the higher taxes imposed over the last 18 months.
We do not expect Lion’s EBITDA to recover to historical levels over the same period. The negative outlook reflects the potential for further downgrades should Lion’s sales volume not recover enough in the next 18 months to reduce leverage to less than 3.0x,” Fitch said.
Lion’s net leverage worsened to 6.3x during the financial year ended-March 2017 (FY17), from 1.9x at end-FY16, as the beer volume dropped by more than 50 percent due to successive tax increases and a six-month halt in domestic production due to floods in 2016.
The beer industry volumes saw a large contraction between 2014 and 2016, while the hard liquor volume increased by almost 27 percent, as excise duties per unit of alcohol of strong beer surpassed that of hard liquor due to the tax increases in 2015.
In addition, the reinstatement of the value-added tax (VAT) on alcohol products and the introduction of taxes on beer cans with effect from November 2016 prompted the consumers to substitute strong beer, which has an alcohol content of more than 8 percent, with the consumption of hard liquor. Strong beer accounted for more than 75 percent of Lion’s sales volume in FY17.
Fitch expects Lion’s EBITDAR margins to recover to around 24 percent in FY18, from 20 percent in FY17, after they were diluted due to a decline in the demand for beer caused by multiple tax increases and floods interrupting production in mid-2016, which led to Lion resorting to costlier imports.
Fitch expects the production to normalise and the sales volume to improve as the company regains most of the retail shelf space it lost last year.
However, margins may remain below historical levels over the medium term because the excise duties on a unit of pure alcohol in beer surpassed that of hard liquor after the back-to-back tax increases, which could pressure beer volumes. We do not expect Lion to further increase beer prices as it may impede volume growth.
Lion has a leading market position in the domestic beer industry. Its market share is supported by its entrenched brand and widespread retail coverage, with access to more than 2,250 outlets around Sri Lanka.
Lion’s market share is protected to some extent by extensive industry entry barriers stemming from stringent restrictions on advertising and retail licences.
Lion also benefits from ample production capacity, which exceeds 1.5 million hectolitres per annum and is sufficient to meet the demand over the medium term.
The Sri Lankan government has consistently used excise taxes as a tool to boost revenue to bridge budget deficits; consequently, from October 2015 to November 2016, the industry – especially the beer makers – was taxed from multiple fronts through higher excise duties, introduction of beer can taxes and reinstatement of VAT, dampening the competitiveness of beer.
Fitch does not expect further drastic tax increases that could weaken the demand, especially given the sector’s large contribution to the government’s tax revenue.