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Fitch Rates Sritex's Proposed US Dollar Notes 'BB-(EXP)'
March 20, 2017 / 5:38 AM / 9 months ago

Fitch Rates Sritex's Proposed US Dollar Notes 'BB-(EXP)'

(The following statement was released by the rating agency) SINGAPORE/JAKARTA, March 20 (Fitch) Fitch Ratings has assigned Indonesia-based integrated fabric and garment manufacturer PT Sri Rejeki Isman Tbk's (Sritex, BB-/Stable) proposed US dollar-denominated senior unsecured notes an expected rating of 'BB-(EXP)'. The notes will be issued by Sritex's wholly-owned subsidiary, Golden Legacy Pte Ltd, and guaranteed by Sritex and its major subsidiary PT Sinar Pantja Djaja. The notes are rated at the same level as Sritex's senior unsecured rating as they represent the company's unconditional, unsecured and unsubordinated obligations. The note guarantors together generate or control 100% of Sritex group's operating cash flows. The final rating on the notes is contingent upon the receipt of final documents conforming to information already received. At end-2016 Sritex's secured debt constituted 0.8x EBITDA, which is well below 2.0x-2.5x EBITDA, a level that would indicate that unsecured debt is materially impaired due to the presence of prior-ranking debt, and therefore may be rated lower than the Long-Term Issuer Default Rating (IDR). The company expects to use up to USD90m of the net proceeds of the proposed US dollar bond to buy back its 2019 senior unsecured bond, and apply any balance to meet near-term maturities and retire bank borrowings. The issuance will lengthen the company's debt maturity profile and provide Sritex with significant cash-flow flexibility to execute its medium-term plans. The earliest significant debt maturity will then be the USD350m 8.25% senior unsecured bond due in 2021. KEY RATING DRIVERS Improving Business Risk, High Leverage: Sritex's 'BB-/Stable' IDR reflects the company's improving business risk profile. Sritex's major capacity expansion programme is drawing to a close, and we expect its EBITDA to increase to around USD150m in 2017 and USD170m in 2018, from USD118m in 2015 before the expansion. However leverage (measured as net adjusted debt /operating EBITDAR) stood at 3.7x at end-2016 and is high for its rating. Leverage rose because the company's working capital cycle lengthened amid increased sales of finished fabric and garments. We expect leverage to fall to around 3.0x by end-2017, supported by higher volumes of export sales, which have a shorter cash cycle. However Fitch may consider negative rating action if Sritex is unable to reduce its leverage to around 3.0x by this deadline. High Working Capital Risks: Sritex's ability to manage its working capital over the next two years, as it markets its new production capacity, is a key credit risk. Its net cash cycle increased to 185 days in 2016, from 150 days in 2015, and we expect a further increase to around 200 days in 2017. The rising mix of finished fabrics and garments in Sritex's sales has lengthened the working capital cycle; however, this is counterbalanced by the company's ability to prioritise export sales over domestic sales. Sritex expects to improve its credit terms with suppliers without negatively affecting profitability, although the efficacy of this strategy remains to be seen. Vertical Integration, Growing Exports: We expect around 55%-60% of Sritex's revenue to stem from the export of finished fabric and garments over the next two years, up from around 50% in 2016. Sritex sources yarn and raw fabric from its own mills and produces speciality garments, such as military uniforms, which have higher profit margins. The company is a nominated supplier to several of its main buyers, which is a key credit strength, and is supported by its record of delivering to customers' required quality and cost and on time. Sufficient Production Capacity: Sritex is Indonesia's largest vertically integrated fabric and garment manufacturer. The company will have an annual production capacity of 654,000 bales of yarn by end-2017, representing a 16% yoy increase; 180 million metres of greige cloth, a 50%-plus yoy increase; 240 million yards of finished fabric, a 100%-plus yoy increase; and 30 million pieces of garments, a 50%-plus yoy increase. The company may expand its spinning capacity further in 2018 or 2019, but this is subject to the level of external demand. Currency Risk Mostly Hedged: Over half of Sritex's 2016 revenue stemmed from exports, up from 42% in 2014. A bulk of its domestic sales is also exported indirectly and is therefore linked to the US dollar exchange rate. Consequently Sritex has a significant natural hedge against foreign-currency costs, which was evident in 2015 and 2016 when its EBITDA margin remained largely intact in the face of severe currency volatility. DERIVATION SUMMARY Sritex's rating sits comfortably in between its main peers, 361 Degrees International Limited (BB/Stable) and PT Pan Brothers Tbk (B/Positive). 361 Degrees is an established Chinese sportswear brand-owner and producer across four brands and four product categories, with a 4% market share in China. It has similar operating scale to Sritex and slightly thinner EBITDA margins. However it has a significantly stronger financial profile, with cash reserves exceeding debt, which justifies its higher rating. Pan Brothers is a small Indonesian garment manufacturer with high leverage due to the aggressive expansion of its production capacity over the last two years. Sritex has a stronger business profile that reflects its larger operating scale and integrated nature of operations, with a solid position in textile manufacturing that limits its operating leverage when compared with Pan Brothers. Sritex's financial profile is also stronger, resulting in a Long-Term IDR that is two notches higher than that of Pan Brothers. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue growth of 9% in 2017 and 15% in 2018 (2016: 8%), as Sritex's capacity expansion comes to a close and sales gain momentum. - EBITDAR margins to remain between 20%-21% (2016:19%) in the next two years. - Net cash collection cycle to increase to 200 days in 2017 and 215 days in 2018 - Capex to remain minimal at maintenance levels of around USD15 million per annum. - A low dividend payout in line with the company's record. RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action We do not expect positive rating action for the next two years, as Sritex's leverage, measured by net adjusted debt/EBITDAR, is likely to remain high for its ratings as it ramps up sales to fill its new production capacity. Developments that May, Individually or Collectively, Lead to Negative Rating Action - Inability to lower leverage to around 3.0x by end-2017 (2016: 3.7x; 2015: 3.2x). - A sustained weakening in EBITDAR margins LIQUIDITY Satisfactory Liquidity: Sritex had readily available cash of USD88 million at end-2016, including cash of around USD28 million, most of which is earmarked as collateral against specific bank borrowings. This compares well with the USD30 million medium-term note maturing in 2017 and our expectation that the company will generate neutral free cash flow in 2017. Sritex also had more than USD100 million in bank loans outstanding for funding working capital requirements, which we expect will be rolled over in the normal course of business, and a further USD215 million of approved but unused bank facilities at end-January 2017, which it could use to fund working capital if required. Contact: Primary Analyst Hasira De Silva, CFA Director +65 6796 7240 Fitch Ratings Singapore Pte Ltd One Raffles Quay South Tower #22-11 Singapore 048583 Secondary Analyst Bernard Kie Associate Director +62 21 2988 6815 Committee Chairperson Vicky Melbourne Senior Director +612 8256 0325 Date of Relevant Rating Committee: 9 March 2017 Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: Additional information is available on Applicable Criteria Criteria for Rating Non-Financial Corporates - Effective from 27 September 2016 to 10 March 2017 (pub. 27 Sep 2016) here National Scale Ratings Criteria (pub. 07 Mar 2017) here Additional Disclosures Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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