Brewing battle to intensify with Distilleries’ Heineken purchase 

• Fitch says market leader Lion likely to face more competition, which could erode its market share

Lion Brewery Ceylon PLC (Lion), Sri Lanka’s beer market leader, is likely to face more competition in the medium-term, following the decision by Distilleries Company of Sri Lanka PLC (DIST) to acquire Heineken Lanka Limited, according to Fitch Ratings.
“Heineken is a distant second in Sri Lanka’s beer market for now but we believe DIST has the industry know-how, market access and financial strength to elevate Heineken’s operations to a level that could weigh on Lion’s market share,” Fitch Ratings said in a brief note.

However, the rating agency noted that a large capacity expansion at Heineken Lanka would be required to effectively compete with Lion.
“We estimate the expansion will require significant capital outlay and at least two-to-three years to complete. We believe DIST has the financial strength to fund the expansion, with its annual free cash flow, excluding dividends, averaging Rs.10 billion-Rs.12 billion. 

DIST, as the largest spirits manufacturer in the country, already has extensive market access covering all forms of retail channels, providing easy market penetration compared with a new entrant,” it added.Nevertheless, Fitch Ratings said Lion has the ability to withstand the competitive pressure as a result of its robust 
rating headroom.
As of September 31, 2023, Lion maintained a net cash position, a positive financial stance, compared to the negative rating sensitivity associated with EBITDA net leverage exceeding 5.0x. 

According to Fitch, this financial position affords Lion the flexibility to adopt a more assertive pricing strategy, enabling the company to defend its market share effectively in the face of growing competition.
At the same time, the rating agency expects DIST to face near-term challenges in terms of brand building, given the complete ban on media advertising on alcoholic beverages by the government. 

Lion already has a very strong brand presence in the market compared with Heineken, due to the greater mass-market appeal of its products, with cheaper pricing and customisation to local preferences.
However, Fitch expects the acquisition to be positive for DIST, as it will help the company to strengthen its market position with a presence in both hard and soft 
liquor markets.

“The acquisition will also allow DIST to take advantage of the lower excise duties applicable to beer on an alcohol-equivalent basis. There has been a shift to beer from hard liquor in recent months, due to the significant increase in excise duties. DIST could also benefit from the revival in Sri Lanka’s tourism industry as beer is more popular among tourists than locally made hard liquor,” the rating agency said. 

While the value of the transaction by DIST has not been disclosed, Fitch Ratings believe that it will not exert a significant negative impact on either the company itself or its parent Melstacorp PLC, which holds a stable AAA(lka) credit rating.
Both Lion and DIST have been assigned AAA(lka)/Stable ratings by Fitch Ratings.