Fitch Ratings has affirmed Sri Lanka Telecom PLC’s (SLT) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at ‘B+’ and its National Long-Term Rating at ‘AAA(lka)’. The Outlook is Stable.
SLT’s IDRs are constrained by Sri Lanka’s IDRs of ‘B+’, as the government directly and indirectly holds a majority stake in SLT and exercises significant influence on its operating and financial profile. SLT’s second-biggest 44.9% shareholder, Malaysia’s Usaha Tegas Sdn Bhd, does not have special provisions in its shareholder agreement to dilute the government’s significant influence over SLT.
KEY RATING DRIVERS
Proposed Tax Credit Negative: Fitch believes SLT’s 2018 operating EBITDAR margin could decline to 24% (2017 forecast: 29%) and its funds flow from operations (FFO) adjusted net leverage could deteriorate to 2.5x (2017 forecast: 1.9x) if it were to pay an additional LKR3 billion tax for its mobile towers. The proposed monthly tax of LKR 200,000 per mobile tower was announced on 9 November 2017 in Sri Lanka’s 2018 budget. SLT’s fully owned subsidiary, Mobitel (Pvt) Ltd., owns over 1,500 towers. We expect SLT’s ratings to remain unaffected, as it has sufficient headroom to absorb the proposed tax. However, Fitch has not factored in the impact of the tower tax in its base case, as the budget proposal has not been finalised.
Negative FCF; Large Capex: We expect SLT to have a free cash flow (FCF) deficit during 2017-2020 (2017 forecast: LKR 7 billion deficit), as cash flow from operation could fall short in funding large capex plans to expand the group’s optical fibre infrastructure and 3G/4G mobile networks. We expect SLT’s 2017 capex to reach about LKR25 billion, or 34% of revenue, before moderating to LKR 20 billion-23 billion per year. SLT’s fibre investments are likely to have low returns due to the country’s low broadband tariffs. Dividends are likely to remain similar to historical levels of LKR 1.6 billion.
Data Drives Growth: SLT’s data revenue growth will improve following the removal of the telco levy on data services from September 2017, which will lower the effective tax rate to around 20% from 32%. However, we forecast SLT’s EBITDA margin to dilute by about 50bp each year over 2018-2020, as improving profitability on fixed-broadband and mobile internet usage will only partly offset margin dilution from a falling share of profitable fixed-voice and international operations.
Overall revenue growth is likely to slow to 1.5% in 2017 (9M17: 1.3%, 2016: 8.5%) due to the reintroduction of value added tax and nation building tax on telecom services, but should recover to the mid-single digits in 2018-2019 along with better mobile-voice revenue and the robust data growth.
Solid Market Position: SLT’s ratings are underpinned by its market-leading position in fixed-line services and second-largest position mobile, along with its ownership of an extensive optical fibre network. The company’s stable cash generation benefits from its diversified service offerings, including fixed-voice, broadband, mobile, pay-tv, enterprise and international operations. We believe SLT’s market position will strengthen, as it plans to expand its mobile and fibre infrastructure.
Market Consolidation, M&A Risk: We expect some industry consolidation due to ongoing intense competition, especially in the mobile segment; this segment has five operators that face still-high investment requirements and of which the smaller operators are unprofitable. SLT’s National Long-Term Rating could come under pressure if it were to perform a debt-funded acquisition of a smaller operator; any rating action will be based on the acquisition price, funding structure and the financial and operating profile of the combined entity. The international ratings, which are constrained by the sovereign ratings, have sufficient headroom to absorb a debt-funded acquisition.