Fitch affirms Lion Brewery National Long Term Rating at ‘AAA(lka)’ with Stable outlook despite potential decline in sales

• Says issuing of new licenses unlikely to threaten Lion’s market position in the medium term
• Says Lion has fully passed on the recent 44% excise tax increases to customers, which has affected affordability 
• Fitch believes future excise duty increases to be gradual, in a bid to preserve this important source of government revenue

Fitch Ratings has affirmed Sri Lanka-based Lion Brewery (Ceylon) PLC’s National Long Term Rating at ‘AAA(lka)’. The Outlook is Stable. 
The affirmation and Stable Outlook reflect Fitch’s view that Lion’s strong market position and defensive cash flow will continue to support a strong financial profile in the next 12-18 months, despite challenging operating conditions. 

Lion’s rating reflects its market leadership in the Sri Lankan beer industry, which is protected by high entry barriers stemming from the licensing requirements and a ban on media advertising, strong brand presence, and extensive retail and distribution network.
Fitch expects Lion to maintain its strong market position in the beer industry over the medium term underpinned by Lion’s extensive product offerings across price points, which makes its portfolio defensive through the cycle. 

Lion benefits from prominent shelf space across all channels and reasonable competition. 
“The government has recently issued two new beer licences, but we do not believe there is a material threat to Lion’s market position in the medium term, given the company’s strong competitive advantages,” Fitch said.
The rating agency expects Lion’s sales volumes to fall by a low single-digit in the financial year to 31 March 2024 (FY24), amid a 44 percent hike in excise duties since January 2023 and weakening disposable income. 

Lion fully passed on the excise tax increases to customers, affecting consumer affordability. Fitch expects Sri Lanka’s GDP to contract by 1.3 percent in 2023 (2022: -7.8 percent) before recovering towards the latter part of 2024. 
Fitch expects Lion’s mild beer segment to remain defensive, with high single-digit volume growth benefiting from the revival in tourism and a pick-up in on-premise entertainment. 

Lion is pursuing an export strategy to diversify its risks from the volatile local market, focusing on Maldives and the rapidly growing African region. The company expects to increase its export revenue to around 25 percent in the long term, from currently less than 10 percent.
“We expect Lion’s net cash position to be maintained over FY24-FY26 from stable operating cash flow, modest capex and shareholder returns. The company believes the current capacity is sufficient to support growth expectations in the medium term, limiting expansion capex mainly to tackle bottlenecks. 

Our capex expectation of Rs.3.0 billion-3.5 billion over FY24-FY26 will be used for maintenance, certain expansions and efficiency improvements. We believe Lion will use around Rs.3.0 billion of annual free cash flow to repay debt, in the absence of any investments or expansions,” Fitch said.
Meanwhile, Fitch projects Lion’s interest cover to improve to more than 10.0x from FY24 (FY23: 4.7x), helped by easing interest rates and a lower debt stock. 
Market interest rates have fallen to the mid-teens from 30 percent levels in the latter part of 2022. 

Lion saw its working capital rise in FY23 due to the building of buffer stocks and tightening supplier credit, in anticipation of import restrictions. However, supply chain constraints have largely eased and Lion is likely to reverse some of the working capital investments in the near term.
Excise duties on alcohol is a major contributor to government coffers, accounting for 10 percent of the tax revenue in the past few years. The recent 44 percent hike in excise duties stems from the government’s increased need for revenue, and Fitch believes future excise duty increases to be gradual, in a bid to preserve this important source of government revenue. 
According to the Excise Department, excise revenue declined by 20 percent year-on-year in the first five-months of 2023, despite a 20 percent hike in taxes, as consumption dropped due to unaffordability.

Fitch expects Lion’s EBITDA margin to weaken to around 12-13 percent over FY24-FY26, from 16 percent in FY23, amid lower volumes and challenges in cost pass-through. 
“We believe Lion may have to absorb a degree of cost inflation as recent price hikes have materially lowered demand. Lion imports around 70-80 percent of its input materials and, therefore, is exposed to volatile global commodity prices and exchange-rate risk. Historically, Lion has fully passed cost increases to customers to preserve margins,” the rating agency noted.