November 28, 2017 / 9:55 AM / a year ago

Fitch Revises Outlook on Pan Brothers to Stable; Affirms 'B' Rating

(The following statement was released by the rating agency) SINGAPORE/JAKARTA, November 28 (Fitch) Fitch Ratings has revised the Outlook on Indonesia-based garment manufacturer, PT Pan Brothers Tbk, to Stable from Positive and affirmed the company's Long-Term Issuer Default Rating (IDR) at 'B'. At the same time, Fitch Ratings Indonesia has affirmed Pan Brothers' National Long-Term Rating at 'A(idn)' with a Stable Outlook. A full list of rating action is provided at the end of this commentary. The Outlook revision reflects Fitch's expectations of a more gradual deleveraging progress over the next year or two on account of Pan Brothers' intensifying working capital requirements and the delay in capacity addition, which may affect the company's operating scale and hence its bargaining power among global apparel brands. Pan Brothers' net cash collection cycle worsened to 239 days in September 2017, from 169 days in the same period last year. 'A' National Ratings denote expectations of low default risk relative to other issuers or obligations in the same country. However, changes in circumstances or economic conditions may affect the capacity for timely repayment to a greater degree than is the case for financial commitments denoted by a higher rated category. KEY RATING DRIVERS Working Capital Pressure: Fitch believes Pan Brothers' increasing exposure as a logistics partner to its customers has partly contributed to its high working capital requirements, which have resulted in negative cash flow from operations and high leverage. The company's advance payments to secure raw materials rose to over USD100 million as of September 2017, from around USD75 million a year ago, increasing the company's overall working capital intensity, as measured by net working capital/sales, to 58% from 43%. Capacity Expansion Delay, Slower Deleveraging: Pan Brothers has deferred part of its capacity expansion planned in 2017 until 2018. We believe this may affect the company's overall utilisation rate and subsequently, its operating scale, in the short term. In the medium term, Fitch expects the company's ongoing installed production capacity to expand to 117 million polo shirts equivalent per year by end-2019, from 90 million shirts as of September 2017. This should improve its bargaining power with customers and create a more diversified customer base, allowing for better working-capital management. The company's expanded capacity will also position it to benefit from the trend in consolidation among vendors of global apparel brands, all of which should improve its financial profile. Fitch expects leverage to progressively decline to around 4.0x in 2019, from around 5.0x in 2017. Product Range, Strong Market Position: Pan Brothers' ratings are underpinned by its position as Indonesia's largest publicly listed garment manufacturer by capacity, its established relationships with global apparel brands and its non-contractual revenue visibility over the next 12 to 18 months. Fitch believes the company's improving expertise in apparel manufacturing, its ability to cater for a wide product range and longstanding relationships with global apparel brands are credit positive. Cost Pass-Through Ability: Pan Brothers' operates under a cost-plus pricing mechanism, where the price of its products is mostly derived from the cost of raw materials plus a mark-up margin. This allows Pan Brothers to pass through cost fluctuations to customers. However, margins may be pressured during prolonged cyclical downturns. Fitch expects the EBITDA margin to remain stable at around 8% in the medium term. Seasonal Cash Flow: Pan Brothers' working-capital cycle is longer in the first half of the year due to purchases of materials to cater for woven outerwear clothing, in particular, down jackets, to be ready for the peak production season between April and September. Its knitwear sales are rising, which will provide some earning stability. Fitch has excluded an estimated USD25 million from Pan Brothers' year-end cash balance from the year-end leverage ratio to reflect the seasonality. Manageable Currency Exposure: Close to 90% of Pan Brothers' sales were from exports, while around 80% of its raw materials are imported. This provides a natural hedge against currency volatility, as was evident in 2015 when Pan Brothers' EBITDA margin remained intact in the face of severe local exchange rate volatility. Raw material costs make up around 65% of the company's total costs. DERIVATION SUMMARY Pan Brothers' IDR is well-positioned compared with higher-rated peers, such as PT Sri Rejeki Isman Tbk (Sritex; BB-/Stable). Both companies' ratings are underpinned by dominant market positions. However, Fitch believes Sritex's lower working capital pressure, larger scale, wider profit margin and stronger financial profile, as indicated by its lower leverage and higher interest coverage, warrants a multiple-notch rating difference to Pan Brothers. Pan Brothers' 'A(idn)' National Long-Term Rating is well-positioned compared with companies rated on the national scale, such as Sritex (A+(idn)/Stable) and PT Steel Pipe Industry of Indonesia Tbk (Spindo; A-(idn)/Stable), one of Indonesia's largest steel pipe manufacturers. Sritex is rated one-notch higher than Pan Brothers due to its larger operating scale, more integrated operations and stronger financial profile. Fitch believes both Pan Brothers and Spindo have similar operating scale, interest coverage, working-capital intensity and each is the market leader in its industry. Nevertheless, Spindo's higher exposure to commodity price fluctuation as well as Pan Brothers' established customer relationships with global apparel brands and stronger financing flexibility warrants a one-notch difference in its National Long-Term Rating. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Net sales growth of around 10%-12% in 2017-2018 (2016: 15%). - EBITDA margin of around 8% in the medium term (2016: 8%). - Capex of USD15 million in 2017 and USD44 million in 2018 (2016: USD21 million). Key Recovery Rating Assumptions: - Pan Brothers would be considered a going concern in bankruptcy and would be reorganised rather than liquidated. - Going-concern EBITDA is equal to our average of estimated EBITDA over 2017-2018 to reflect mid-cycle conditions. An enterprise value (EV) multiple of 8.0x for the manufacturing sector is used to calculate a post-reorganisation EV of USD337 million. - Fully drawn working capital facilities of USD110 million, which have priority over senior unsecured debt. - 10% administrative claim to be applied on the going concern EV. - Going-concern EV to cover 91%-100% of Pan Brothers' unsecured debt, corresponding to a 'RR1' Recovery Rating for the senior unsecured notes after adjusting for administrative claims. Nevertheless, Fitch has rated the senior unsecured bonds 'B/RR4' because, under our Country-Specific Treatment of Recovery Ratings criteria, Indonesia is classified under the Group D countries in terms of creditor friendliness and the instrument ratings of issuers with assets located in this group are subject to a soft cap at the issuer's IDR. RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action -Leverage sustained below 2.0x -Ability to maintain neutral cash flow from operation Developments that May, Individually or Collectively, Lead to Negative Rating Action -Failure to lower leverage to around 4.0x by end-2019 (2017F: 5.0x) LIQUIDITY Sufficient Liquidity: Pan Brothers had readily available cash of USD55 million (reported cash USD80 million), short-term debt maturities of USD2 million and a committed unused working-capital facility of around USD135 million from its syndication revolving-loan facility as of September 2017. The company's order book is seasonal and therefore working capital requirements increase during the second and third quarter of the year. Fitch has conservatively treated USD25 million as cash that is not readily available to service debt, being the minimum cash balance earmarked for meeting seasonal working-capital purposes. Therefore, we exclude USD25 million cash from the calculation of Pan Brothers' leverage. FULL LIST OF RATING ACTIONS PT Pan Brothers Tbk --Long-Term IDR affirmed at 'B'. Outlook revised to Stable from Positive --National Long-Term Rating affirmed at 'A(idn)'. Outlook is Stable PB International B.V. --Senior Unsecured USD200 million 7.625% bond due 2022 affirmed at 'B/RR4'. Contact: Primary Analyst (International Rating) Bernard Kie Associate Director +65 6796 7216 Fitch Ratings Singapore Pte Ltd. One Raffles Quay South Tower #22-11 Singapore 048583 Primary Analyst (National Rating) Olly Prayudi Director +6221 2988 6812 PT Fitch Ratings Indonesia DBS Bank Tower Jl Prof Dr Satrio Kav 3-5 Jakarta 12940 Secondary Analyst Olly Prayudi Director +6221 2988 6812 Committee Chairperson Vicky Melbourne Senior Director +61 2 8256 0325 Summary of Financial Statement Adjustments - Fitch includes advance payments, which are mostly for raw materials, as part of the working-capital calculation. - Fitch assumed USD25 million of cash to be restricted, reflecting cash set aside for seasonal working-capital purposes. - Fitch adds amortised cost of debt back to total debt outstanding. - Fitch has adjusted EBITDA by the net income attributable to minorities to reflect the company's less than complete ownership of a number of subsidiaries. Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: Note to editors: Fitch's National ratings provide a relative measure of creditworthiness for rated entities in countries with relatively low international sovereign ratings and where there is demand for such ratings. The best risk within a country is rated 'AAA' and other credits are rated only relative to this risk. National ratings are designed for use mainly by local investors in local markets and are signified by the addition of an identifier for the country concerned, such as 'AAA(idn)' for National ratings in Indonesia. Specific letter grades are not therefore internationally comparable. 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