Melstacorp PLC will continue to look for acquisition and investment opportunities in the non-alcoholic beverage segment as the company is looking to further reduce its over-reliance on its alcohol business, which is largely susceptible to the country’s lopsided and frequently changing public policy.
However, such acquisitions or investments could weigh on the group’s leverage, which has already weakened due to large debt-funded investments in recent times, cautioned Fitch Ratings.
While affirming the conglomerate’s rating at ‘AAA’ with a ‘Stable’ outlook, the rating agency stated that the entity’s net leverage had weakened to 1.8 times during the financial year ended March 31, 2019 from 1.3 times a year ago due to the increased debt.
However, the rating affirmation reflects Fitch’s expectation of the company’s ability to maintain the leverage below 2.0 times over the medium term, despite large investments.
“The ratings of Melstacorp and Distillery Company could come under pressure if Melstacorp continues to make large debt-funded investments that dilute the cash-flow stability of its core spirits business or are not immediately cash-flow accretive,” the rating agency stated.
Fitch measures leverage as net adjusted debt/operating earnings, before, interest, tax, depreciation, amortisation (EBITDA) and rent.
At Melstacorp, net leverage includes its 51 percent share in Aitken Spence PLC’s net debt and EBITDA, but excluding its insurance subsidiary.
Since the restructuring of the conglomerate under Melstacorp through a complex share swap, the company was cleaving off some of its business units such as its finance company and entered into healthcare and cement sectors by investing as much as Rs.1.2 billion.
Meanwhile, Melstacorp has also increased its stake in the country’s largest conglomerate, John Keells Group from 3.5 percent to 9.9 percent spending as much as Rs.12 billion, which was largely debt-funded, Fitch said.
Since its restructuring, the group has been vying for investment opportunities in various sectors as its subsidiary, Distilleries Company of Sri Lanka PLC, is still making 70 percent of the group’s consolidated EBITDA and is expected to be the case in the medium term.
Although Distilleries Company remains the market leader with a market share of 70 percent, up from 65 percent in 2017, the unproportionate tilt towards one business segment, which is also highly contingent on the government policy, has led the company to continue to look for further diversification opportunities in non-alcoholic beverage segment.
“Distillery Company saw a drop in sales volume in 2018 following the 2017 excise-duty revision, which brought down taxes on beer. This led to consumer demand shifting to beer, away from spirits, which has become cheaper on an equivalent-alcohol basis.
Distillery Company has also lost volume to the illicit market owing to the high tax regime and weak economic conditions, which has made its products less affordable. The government reduced the excise tax difference between spirits and beer to 20 percent in March 2018, from 34 percent, which partly contributed to Distillery Company’s net revenue growth of 10 percent in 1Q20, Fitch stated.
Apart from the distiller, Melstacorp has interests to plantations, telecommunication, power generation and leisure.