The Negative Outlook reflects risks to SCCC deleveraging to a level consistent with its rating by 2021 amid operating performance that was weaker than our expectations in regional markets, particularly Sri Lanka and Vietnam. A series of acquisitions have elevated SCCC's financial leverage since 2016. The company has shown its commitment to reduce its financial leverage via capex and dividend cuts, and improve operating cash flow through several initiatives. The Outlook could revert to Stable if SCCC generates stronger operating cash flows and Fitch is more confident that its FFO adjusted net leverage would drop to below 2.5x by end-2021. The ratings may be downgraded if the deleveraging is delayed.
KEY RATING DRIVERS
High Leverage: Fitch expects SCCC's FFO adjusted net leverage to remain high at around 3.0x-3.5x a year in 2019-2020 (2018: 3.7x), and reduce to 2.5x by 2021. The pace of deleveraging relies highly on the growth of the company's operating cash flow and conservative cash spending for investing and financing.
Increasing Revenue and EBITDA: SCCC's revenue and EBITDA will continue to expand by 8%-12% over the next two years, in Fitch's view, supported mainly by a recovery of its domestic business. Fitch expects stronger demand for cement in Thailand over the next couple of years, following recovery signs in private construction, including increasing residential-property development along mass-transit extensions and a strong pipeline of new commercial buildings, including several mega mixed-use projects in key Bangkok-city areas. Cement sales figures from the Office of Industrial Economics for 3Q18 show the first growth in the last 10 quarters at 3.7% yoy, with further growth of 2.8% yoy in 4Q18.
Challenging Regional Operations: Fitch believes SCCC's regional operations, particularly in Sri Lanka and Vietnam, face more challenges than we previously expected. The instability of Sri Lanka's economy and its currency may put pressure on revenue and earnings over the near term. SCCC's profit margins in Vietnam also declined in 2018, due mainly to an inability to pass on rising clinker costs to product prices amid fierce competition. We expect demand in south Vietnam to continue to rise but we forecast SCCC's EBITDA margin in this market will narrow in 2019. This is due to higher raw material costs as the portion of imported clinkers will increase as sales rise.
Flat Profit Margin: Fitch expects a flat EBITDA margin, which will hover around 20%-21% in 2019-2020 (2018: 19.5%), as the margin improvement in Thailand is likely to be partly offset by softened margins in regional markets. We expect the company's local operation to generate stronger EBITDA margins of 22%-23% as a recovery of demand from the private sector will enhance not only cement sales and selling prices but also those of other building materials, including value-added products.
Geographical Diversification: SCCC's regional diversification, other than Sri Lanka and Vietnam, includes Bangladesh and Cambodia (via a joint venture). Cement capacities outside of Thailand accounted for 36% of the total (excluding the Cambodia joint venture), while revenue generated from overseas represented 47% of total revenue in 2018. Geographical diversification helps reduce the risk of single-market concentration in Thailand and smooths out the company's earnings. Furthermore, the operations in those countries typically generate higher profit margins than exports from Thailand.
Strong Market Position: SCCC is Thailand's second-largest cement producer with a stable market share of 27%-28% by sales. SCCC has defended its market position against increasing supply and heightened competition in its domestic market over the past three years with its strong brand, pricing flexibility and increased sales proportion from the growing government segment, despite lower profit margins. SCCC also has a strong market position for its regional cement operations. It is Sri Lanka's largest player and the sole owner of clinker production in the country with a market share of 35%. It is also south Vietnam's second-largest player with 23% market share.
Vulnerable to Energy Prices: SCCC's EBITDA margin is highly sensitive to coal and electricity energy costs, which account for more than 70% of total production costs. Fitch expects average coal prices to ease in 2019 from a high base in 2018, following the decline since 4Q18. About 60% of SCCC's coal purchases in 2019 are on fixed-price contracts.
DERIVATION SUMMARY
SCCC has a weaker business profile than its closest peer in the cement industry, The Siam Cement Public Company Limited (SCC, A+(tha)/Stable), in terms of operating scale, SCC's domestic market position as the country's largest cement player, and diversification across geographies and businesses. SCC's stronger business profile warrants the one-notch difference in ratings. The notching could widen, subject to SCCC's deleveraging efforts over the near term, which is reflected in the Negative Outlook.
CP ALL Public Company Limited (CPALL, A(tha)/Stable) is a rating peer in the Thai food-retailing industry that has a significantly larger EBITDA and stronger business profile as it is a leading convenience-store chain in Thailand. CPALL, therefore, is able to handle its higher financial leverage, resulting in the same rating as SCCC.
KEY ASSUMPTIONS
Fitch's Key Assumptions Within Our Rating Case for the Issuer
-Revenue from Thai operations to increase by 5%-8% a year in 2019-2020 and slow to 2%-5% in 2021
-Revenue from Sri Lankan operations to rise by 5%-10% a year in 2019-2020, partly supported by capacity expansion, and slow to 2%-5% in 2021
-Revenue from Vietnamese operations to increase by about 5% in 2019, and 8%-12% a year in 2020-2021, partly supported by capacity expansion
-EBITDA margin at 20%-21% in 2019-2021
- Capex of THB6.5 billion over 2019-2021
-Dividend payout ratio to reduce to 65%-70%
RATING SENSITIVITIES
Developments That May, Individually or Collectively, Lead to Positive Rating Action
- The rating Outlook could be revised to Stable if SCCC generates a stronger-than-expected operating cash flow, leading to FFO adjusted net leverage reducing to below 2.5x by 2021 (on a projected basis).
Developments That May, Individually or Collectively, Lead to Negative Rating Action
- A significant weakening of operating cash flow, a large debt-funded investment or dividend payment to shareholders, leading to FFO adjusted net leverage remaining above 2.5x by 2021 (on a projected basis).
LIQUIDITY
Manageable Liquidity: SCCC had THB4.6 billion of debt maturing within the next 12 months as of end-2018, 90% of which were short-term loans and revolving credit facilities for working capital. Its liquidity is supported by cash on hand of THB2.6 billion at end-2018 and strong refinancing ability through its credibility and record of strong access to local debt-capital markets and bank funding.