(The following statement was released by the rating agency)
Jan 15 - Fitch Ratings has downgraded DSI Holdings Limited's (DSIHL) National Long-Term
rating to 'BBB+(lka)' from 'A-(lka)'. The Outlook is Negative.
The downgrade reflects Fitch's view that DSIHL's medium-term net leverage - measured as
consolidated lease-adjusted debt net of cash/operating EBTIDAR - is likely to remain over 3x.
This follows the company's recent guidance for increased capex and Fitch's expectations of only
a gradual improvement in its inventory days. Leverage was 3.42x for the financial year ended
March 2012. Such leverage is more in line with a 'BBB+(lka)' rating, given the company's
business risk profile.
The Negative Outlook indicates that a further downgrade is possible in the next 12 - 18
months if expected operational improvements take longer than expected, resulting in net leverage
being sustained beyond 4.25x, or interest and operating lease rental coverage (measured as
operating EBITDAR/gross interest expense + operating lease rentals) falling below 1.5x. The
latter was 1.53x at end-Q2FY13 and 2.56x at FYE12.
DSIHL's rating continues to reflect its market leadership in the Sri Lankan footwear
industry, its strong brands, a diverse product range, as well as its wide retail- and
distribution network. Key risks include competitive pressure from small- and medium-scale
manufacturers, and exposure to global crude oil- and rubber prices through its raw materials.
The company is also exposed to exchange rate risk as a significant portion of its raw materials
In common with other domestic footwear manufacturers, DSIHL is protected by high tariffs on
imported footwear. A sharp reduction or removal of tariffs seems unlikely given Sri Lanka's weak
balance of payments. Fitch also believes DSIHL's brand- and distribution strengths should, to a
certain extent, help protect its market position, if import tariffs were removed or reduced
DSIHL's net leverage increased in FY12 mostly on account of higher debt utilised to fund
higher inventory days and capex, as sales fell below expectations. Weaker sales were in turn due
to weaker demand since end-2011 stemming from higher inflationary pressures, as well greater
price competition within the industry. Consequently DSIHL's consolidated EBITDAR margins fell to
14% at FYE12 (FYE11: 17%). Fitch expects DSIHL's EBITDAR margins to reduce further in FY13 as
the company winds down its inventory, before stabilising at around 13%-14% over the medium-term,
helped by the group's revised pricing strategies and a shift towards franchised sales-outlets.
DSIHL expects to raise capital expenditure for FY13-FY15 to an estimated 7% of revenue
compared with a historical average of around 4% over FY05-FY10, driven primarily by construction
of a head office building for its retail division. Capex also includes improvements to DSIHL's
retail network and a LKR350m investment in a 2MW hydro power generation plant. Fitch expects
capex to be debt-funded, which could weaken DSIHL's interest and operating lease rental coverage
further as interest rates on bank borrowings are unlikely to fall at least in the near-term.
At end-Q2FY13, DSIHL had sufficient cash reserves and approved, but unutilised, bank lines
(LKR85.3m and LKR870.8m respectively) to meet an estimated LKR321m of term debt maturing in FY14
and FY15. However, Fitch expects DSIHL to generate negative free cash flow (operating cash
inflows after deducting capex and dividends) in the medium-term due to high capex, which means
that the company will have to draw down on additional bank credit to fund the deficit.
Nevertheless, liquidity risk is not a serious risk given DSIHL's access to domestic banks, and
projected improvements in working capital management.
DSIHL is wholly owned by the D. Samson Group (DSG). DSG's operations mainly consist of DSIHL
and a company that manufactures and exports bicycle tyres. Fitch views the business risk of this
exporter as being higher than DSIHL, given its evolving share in key export markets, and greater
demand volatility for bicycle tyres across economic cycles, compared with footwear. DSG has full
control of DSIHL's cashflow, and therefore a material weakening of DSG's credit profile can also
result in pressure on DSIHL's rating.
WHAT COULD TRIGGER A RATING ACTION?
Negative: Future developments that may, individually or collectively, lead to a negative
rating action include:
-Net leverage above 4.25x on a sustained basis or
-Interest and operating lease rental coverage falling below 1.5x
-A weakening of DSG's credit profile
Positive: Future developments that may, individually or collectively, lead to a Positive
rating action include:
-Net Leverage sustained below 4.25x and
-Interest and operating lease rental coverage sustained above 1.5x