Deterioration in financial profile prompts rating downgrade for Hela

Fitch Ratings has downgraded Sri Lanka-based Hela Apparel Holdings PLC’s National Long-Term Rating to ‘BB+(lka)’, from ‘AA-(lka)’. The Outlook is Negative. 

The downgrade follows the sharp deterioration in Hela’s financial profile following the apparel manufacturer’s significant adjustment of financial accounts from the interim accounts during its annual audit for the financial year ended March 2023 (FY23). 

Hela reported additional operating costs of more than US$ 6 million, leading to a nearly 80 percent reduction in EBIT and higher finance costs of more than US$ 1.6 million, cutting EBITDA interest cover to 0.3x, from 0.8x. 
The Negative Outlook reflects Fitch’s expectation that interest coverage will stay weak in the next 12 months, leading to continued strain on liquidity. 

The rating agency expects Hela to continue to make EBITDA losses in the next 12 months, leaving the company entirely reliant on the success of its turnaround strategy and the support of external lenders.
Fitch believes that Hela’s financial transparency has weakened after the major adjustment of its annual financial accounts from its FY23 external audit. 

Hela says that during its migration to a new enterprise resource planning system in April 2023, the management identified an overstatement of raw material costs in work in progress, which resulted in a large inventory write down of around US$ 5 million for FY23, but that its internal controls have improved since.

“We expect fund flow from operations (FFO) to remain negative in FY24-FY26 (FY23: negative US$ 14 million), as the pace of recovery in Hela’s EBITDA in the next few years is unlikely to be sufficient to cover interest costs. 
This is underpinned by our belief that demand for apparel imports into the US and the EU - Hela’s key markets - is likely to remain weak as elevated inflation and interest rates pressure consumer purchasing power. The company has embarked on a cost saving strategy, but execution risks are high,” Fitch noted.

Hela had US$ 15 million in cash on hand at end-June 2023, against an estimated US$ 16 million in interest payment due in the 12 months, which the company is unlikely to meet. It has a further US$ 5 million in maturing term debt during the period and over US$ 70 million in short-term working capital lines falling due. 
Hela expects lenders will be supportive of rolling-over its maturing working capital debt and allow it to drawdown a further US$ 72 million in undrawn and uncommitted credit lines.

“However, challenges in improving its EBITDA could weaken lender access. That said, the company demonstrated its ability to raise funds as recently as 1QFY24; raising US$ 14 million from new lenders Norfund, a Norwegian investment fund, and US$ 5 million from Aavishkar Capital, an India-based venture capital firm,” Fitch said.
“We forecast Hela’s revenue to decline by more than 20 percent in FY24 (1Q24: -26 percent), following weak demand from its key markets in the US and Europe due to elevated inflation and interest rates. The regions contributed 58 percent and 38 percent, respectively, to Hela’s revenue in 1Q24. 

We expect revenue to improve by 5 percent in FY25, in line with our global economic outlook for easing inflation and moderating interest rates in the US and Eurozone in 2024-2025,” the rating agency said.

Hela is undertaking a strategy to cut overhead costs that is subject to execution risk. It is switching to single shift operations in major factories, from double shifts; enhancing the supply-chain strategy by reducing lead times, and rationalising selling general & administrative costs. 

Hela scaled up its operation over FY22-FY23 to cater to heightened demand, but if the current period of weak demand persists, it may decide to scale down to secure its margin and maintain its long-term business profile.
“We forecast leverage to remain above 10x in FY24-FY26 (FY23: 24x), as Hela resorts to external financing for its operational requirements and debt servicing in the next 12-18 months amid limited internal cash generation. There company does not have major investment needs in FY24-FY26, as we forecast capex of around US$ 2.5 million-3.5 million for maintenance, subject to funding access. The need for working capital will also be limited considering the weak sales,” Fitch noted.

“Hela business scale is small relative to larger apparel manufacturers, with EBITDA of less than US$ 15 million. Its product segments are in intimate wear (1Q24 revenue contribution: 54 percent), kids wear (23 percent) and active wear (24 percent).

The company’s strategy is careful customer selection and a focus on building long-term and profitable customer relationships, which include some of the world’s leading apparel brands. The top-10 customers generated an average of 80 percent of Hela’s total revenue in FY20-FY23 (1Q24: 83 percent),” it added.