TEXT-Fitch rates ESKAY's INR1bn proposed NCD 'BBB+(ind)'

(The following statement was released by the rating agency)

May 25 - Fitch Ratings has today assigned a rating of 'BBB+(ind)' to Eskay Knit India Limited's (ESKA.BO: Quote, Profile, Research) (ESKAY) proposed NCD issue of INR1bn. Also, the agency has affirmed ESKAY's National Long-term rating at 'BBB+(ind)'. The Outlook is Stable. Simultaneously, Fitch has affirmed the ratings of the company's long-term bank loans aggregating INR1,316m and cash credit limits of INR1,200m at 'BBB+(ind)' and its INR40m non-fund based limits at 'F2(ind)' .

The ratings reflect the integrated nature of Eskay's operations from yarn to finished fabric, its focus on the more stable domestic textile market, its long operating history, and demonstrated growth over the past four years. The ratings are supported by the company's comfortable and stable EBITDA margin of 13%-15% during FY06-FY08, compared to margins of around 7%-8% during FY04-FY05. The margin increase over the past few years is primarily due to the INR3.5bn capex programme from Q3FY06-FY08, entailing modernisation of its spinning and knitting equipment, as well as for increases in capacity. This was funded through long-term loans of INR1.5bn under the Textile Upgradation Fund Scheme (TUFS), INR1.45bn in the form of unsecured, subordinated debt from its sponsors, and the rest financed through internal accruals. The demonstrated returns from the expansions have partly offset the risks from increased debt levels.

The ratings factor in the benefits arising from the sizable subordinated loans from the sponsor, although any material reduction could act as a negative rating factor. This, along with the interest rate benefits on loans under the TUFS have supported Eskay's interest coverage, which is currently at 4.9x in the nine-month period to end December 2008 (9MFY09).

The ratings are, however, constrained by Fitch's expectation of pressure on demand growth, lower prices due to increased competition and consequent margin pressures for the domestic textile sector. Although sizable yarn capacity could add to margin volatility given its sensitivity to cotton prices, these risks are partly offset by the company's combined sourcing arrangement with other textile players of the Tayal group, and its long track record in cotton purchasing. The ratings are also constrained by the working capital intensive nature of the business which could put pressure on the company's liquidity and operating cash flows. With most of its sales being undertaken through domestic distributors, the current tight liquidity environment could adversely impact the company's receivable cycle. Increases in working capital requirements could also come from changes in the company's inventory policy, which could expose it to raw material price fluctuations in future.

Risks to the ratings include greater-than-expected pressure on working capital and the announcement of additional debt-led capex plans, which could as negative rating factors. Fitch notes that any material support provided to group companies and/or investments in new initiatives could also put pressure on the ratings. In any case a net debt/EBITDA of more than 4.5x on a sustained basis would result in downward rating actions.

In FY08 ESKAY reported net sales of INR6519m (2007: INR4797m), EBITDA margin of 15% (2007: 14.5%), net profit margin of 3.17% (2007: 3.02%), interest cover of 5.61x (2007: 8.21x) and Debt to EBITDA of 3.74x (2007: 3.54x). Eskay reported net sales of INR5429 (9MFY08: INR4872), EBITDA margin of 17.01% (9MFY08: 15.02%) and interest cover of 4.91x (9MFY08: 7.63x) for the nine months results ended December 2008 (9MFY09).