Fitch affirms Hemas Holdings at 'AA-(lka)'; Outlook Stable

Fitch Ratings has affirmed Sri Lanka-based conglomerate Hemas Holdings PLC's (Hemas) National Long-Term Rating at 'AA-(lka)' with a Stable Outlook.

The affirmation of Hemas' rating reflects the company's improved business risk profile after the successful integration of Atlas Axillia (Private) Limited (Atlas), a leading school and office stationery manufacturer, which it acquired in early 2018. The acquisition has helped to increase the EBITDAR contribution from the defensive fast-moving consumer-goods (FMCG) segment from 35% to around 55%. However, this positive development is counterbalanced by profitability pressure on Hemas' pharmaceutical-distribution business, a slowdown in its Bangladesh FMCG

operations and weak demand for its leisure segment, which limit any positive rating action in the short term.

The affirmation also reflects Fitch's view that Hemas' net leverage, defined as adjusted net debt/operating EBITDAR, will remain comfortably below 1.0x over the next two years (nine months ended 31 December 2018 (9MFY19): 0.8x) amid moderating capex, barring any significant M&A activity.

Successful Integration of Atlas: We believe Hemas has successfully consolidated Atlas with its FMCG operations over the past 15 months with Atlas contributing around 16% of the group's topline and around 25% to EBIT in 9MFY19, in line with our expectations. Management has said there is room for further synergies as the combining of Atlas' distribution network with that of its parent has yet to be completed. Atlas has introduced a degree of seasonality to Hemas' operations but we believe management has been able to successfully manage the implications by efficiently managing working capital and finance costs.

Atlas is the largest domestic manufacturer and distributor of exercise books, pens, colour products and other school stationery with a strong distribution network spanning over 70,000 outlets islandwide. We believe Atlas' stationery business is defensive across economic cycles, which will help to improve Hemas' overall cash flow stability.

Regulatory Pressure in Pharma: Hemas' pharma-distribution segment has been experiencing significant margin pressure over the past 12-18 months due to currency-led cost escalations across most of its product portfolio. Hemas has absorbed most of the cost increases in the absence of a regulator-approved pricing formula. We do not expect a change in the government's stance in the near term in light of the impact that a price increase will have on consumer costs. Hemas is in the process of introducing cost-efficiency measures to improve its margins.

On the other hand, the introduction of price ceilings by the authorities on certain essential drugs has led to only a limited impact with only a small percentage of the Hemas Pharmaceutical distribution portfolio being regulated. The price ceilings have actually helped Hemas to increase market share with the exit of brands from the market.

Expansion in Other Healthcare Businesses: We expect Hemas' local drug-manufacturing arm and its hospital chain to help offset pressures in the pharma-distribution segment in the medium term. Its new drug manufacturing plant, which would double Hemas' current capacity, will commence commercial operations by 3Q20 and will cater mainly to government demand through long-term contracts. There has also been increasing demand from foreign principals to produce certain drugs locally to counter the currency impact on Hemas' margins, and the company is actively looking at allocating part of its capacity for this purpose. We expect Hemas' hospital chain to maintain its current trajectory of earnings growth in the medium term on the back of favourable demand dynamics and the introduction of value-added services.

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