Fitch Affirms Sunshine Holdings at 'AA+(lka)'; Outlook Stable

Fitch Ratings - Singapore - 01 Jul 2024: Fitch Ratings has affirmed Sunshine Holdings PLC's National Long-Term Rating at 'AA+(lka)'. The Outlook is Stable.

Sunshine's rating reflects its steady business profile, which is anchored by defensive cashflows in its healthcare manufacturing and retail and consumer segments, and its strong balance sheet. This counterbalances weaknesses in its agriculture segment (16% of EBIT) over the next 12-18 months amid moderating palm oil prices.

Sunshine's rating is constrained by its smaller operating scale and modest market positions in its core businesses compared to higher-rated peers.  

KEY RATING DRIVERS

High Rating Headroom: Fitch expects EBITDA net leverage to remain at below 1.0x in FY25-FY26 (financial year ending March), which is comfortably below the 4.0x level above which we would consider negative rating action. We expect a limited drag on leverage from softer EBITDA margins and higher capex. We expect Sunshine's margins to moderate to around 13.5% from FY25 (FY24: 15.5%) as it is not able to fully pass on increased wages, and the higher costs of inputs and electricity in the healthcare and consumer segments, due to consumer sentiment remaining weak.

EBITDA interest coverage is solid, and forecast at 6.8x in FY25 (FY24: 22.3x), in line with lower market interest rates as domestic inflation eases amid abating risks from Sri Lanka's economic challenges in the last 18-24 months.

Healthcare Leads Growth: We forecast a 13% revenue growth in Sunshine's healthcare segment, following the International Finance Corporation's (IFC) LKR3.27 billion investment for a 14.7% stake in subsidiary Sunshine Healthcare Lanka Limited (SHL) in May 2024. Growth in the consumer segment is likely to remain muted at around 2% in the next 12-18 months because consumer spending will be pressured by significant direct and indirect tax hikes on disposable income. Fitch expects Sri Lanka's GDP to expand in the low single-digits in the next two years, which could support consumer sentiment.

Palm Oil Cashflows Pressured: We expect the palm oil segment's EBITDA to fall to LKR2.5 billion in FY25 (FY24: LKR3.0 billion) as Fitch forecasts benchmark global crude palm oil (CPO) prices soften to USD775 per tonne in 2024 and USD700 in 2025. This is because we expect a resumption of La Nina weather patterns in 2H24 to drive higher palm oil production, which will be exacerbated by Sunshine's higher domestic production costs from increased wages.

Capex to Rise: We forecast capex to rise significantly to LKR3.2 billion in FY25, from LKR751 million in FY24, on Sunshine's healthcare and agricultural investments. Funds from IFC's equity injection will be used to bolster SHL's annual production of medical products, such as metered-dose inhalers, and enhance the diagnostic capabilities of its medical devices. Fitch expects Sunshine's share of its 50% joint-venture with Pyramid Wilmar (Pvt) Limited - Watawala Plantations PLC's (WATA) - capex to rise to around LKR1.2 billion to fund its share of an oil effluent management project.

We forecast the effluent project will improve operating efficiency in its palm oil processing and increase the oil extraction rate. This project is debt-funded given WATA's strong balance sheet. We proportionally consolidate WATA's financials in assessing Sunshine's rating given our view that Sunshine and Pyramid Wilmar will jointly support their share of obligations in WATA if required, and to factor in limited cash fungibility.

Geographical Concentration: We expect Sunshine's EBITDA contribution from regions outside of Sri Lanka to remain low over the medium term, despite adding tea exporter, Sunshine Tea Lanka Limited (SST), to its portfolio in early 2022. Sunshine aims to grow its tea export business mainly into China following its equity infusion of LKR500 million into SST in January 2024. However, we estimate SST's contribution to the group will remain flat at 3%-4% of EBIT throughout our forecast horizon.

Risk-Neutral Acquisition Appetite: Sunshine has significant headroom under its current rating sensitivities to engage in M&A, if required. The company has a record of focusing on large acquisitions to raise the group's overall profile instead of small-scale projects, but these have been managed prudently and conservatively funded. However, a larger than expected debt-funded acquisition could pressure its rating.

DERIVATION SUMMARY

Hemas Holdings PLC (AAA(lka)/Stable) is rated one notch above Sunshine, due to its larger operating scale and better competitive positioning across some segments, despite both companies operating in similar businesses. We expect both companies to maintain similarly strong financial profiles over the medium term.

Lion Brewery (Ceylon) PLC (AAA(lka)/Stable) is rated one notch higher than Sunshine, reflecting its stronger business profile with market leadership in the local beer industry, supported by higher barriers to entry, including licensing requirements and a regulatory ban on advertising. Both Lion and Sunshine face a certain degree of regulatory risk, stemming from excise duties and indirect tax hikes on sales of beer for the former, and price ceilings on some pharmaceutical products for the latter. Both companies have solid financial profiles.

Similarly, Melstacorp PLC (AAA(lka)/Stable) is rated one notch above Sunshine. Both companies largely operate in sectors with defensive cash flows. However, Melstacorp has a dominant market position in the alcoholic-beverages segment, which supports its larger scale and stronger free cashflow generation, leading to higher leverage tolerance than for Sunshine.

Ceat Kelani Holdings Pvt Limited (CKH, AA+(lka)/Stable) is rated at the same level as Sunshine. CKH faces competitive pressures from imports and is exposed to cyclical demand for vehicle tyres, compared to Sunshine's largely defensive cashflows from pharmaceuticals and consumer that offset risks from the agriculture sector. Consequently, Sunshine can tolerate higher leverage than CKH for the same rating level.

Sunshine's credit considerations lead to a higher rating than that for large domestic banks, non-bank financial institutions and insurance companies, which are more exposed to sovereign stress due to their large holdings of sovereign-issued securities for regulatory reasons. The large financial institutions also have a broader exposure to the various economic sectors.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

• Revenue growth of 7.5% in FY25, driven by growth in the healthcare segment after the equity infusion by IFC. Revenue growth to slow to around 5% per year from FY26;
• EBITDA margin to decline to 13.5% on a sustained basis from FY25, from 15.5% in FY24;
• Capex of LKR3.2 billion in FY25 driven by IFC's equity infusion and WATA's effluent project. Capex to average LKR1.8 billion per year from FY26;
• Annual dividend payment of 60% of prior year's net income.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

• Increased scale of operations while maintaining a healthy financial profile.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

• An increase in Sunshine's EBITDA net leverage (including proportionate consolidation of Sunshine Wilmar Private Limited, the holding company of WATA) to more than 4.0x over a sustained period;
• Sunshine's EBITDA coverage of gross interest (including proportionate consolidation of Sunshine Wilmar Private Limited, the holding company of WATA) falling below 2.3x over a sustained period.

LIQUIDITY AND DEBT STRUCTURE

Manageable Liquidity: Sunshine had LKR5.4 billion of unrestricted cash as of end-March 2024, compared with LKR7.5 billion of short-term debt falling due in the next 12 months, of which LKR4.5 billion is working-capital and import related. We expect banks to roll over the short-term working capital debt, as it is backed by LKR15.1 billion of net working capital and a steady cash conversion cycle of around 126 days. Furthermore, we expect lenders to honour around LKR9 billion of uncommitted undrawn credit lines given the company's healthy credit profile.

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