Fitch Ratings - Colombo - 08 Jun 2022: Fitch Ratings has affirmed Sri Lanka-based Kotagala Plantations PLC's National Long-Term Rating at 'RD(lka)' (Restricted Default) and its senior unsecured debentures at 'C(lka)'. The instrument rating reflects Fitch's assessment that the debentures are materially subordinated to the company's secured bank debt and statutory dues.
The affirmations reflect Kotagala's ongoing debt-restructuring process, with the company still in negotiations with a significant number of lenders.
Key Rating Drivers
Restructuring Ongoing: Kotagala has yet to restructure three debt facilities of around LKR670 million in total, or 30% of its debt, at the end of its financial year to March 2022 (FYE22). The company is negotiating with one bank for a waiver of accrued interest and a maturity extension, while negotiations with a second bank have yet to start. The third facility is a LKR225 million revolving commercial paper from a unit trust, which Kotagala is seeking to set off against an investment of similar value with the fund. Kotagala is not servicing interest or capital on some of the loans that have yet to be restructured.
Most Obligations Restructured: The company has been able to restructure its outstanding debentures and some of the bank loans by extending the maturities at reduced interest rates in exchange for timely settlement using a tripartite agreement. This involves tea brokers remitting revenues from designated tea estates of the company directly to the lenders. Consequently, Kotagala has been servicing restructured obligations in a timely manner.
We believe the revenues from the designated tea estates will comfortably cover the debt obligations in the next two years. However, there is a risk that the residual cash flows from these estates, may not be sufficient to meet the rising operating costs, which will affect the long-term sustainability of the estates.
Large Statutory Arrears: At FYE22, Kotagala had LKR1.4 billion of dues in relation to employee pensions, gratuity provisions and government leases. The company has been settling the current dues on time, helped by the improved operations, while negotiating payment plans for the arrears. Kotagala plans to settle the Employee Provident Fund outstanding of LKR400 million by remitting LKR15 million monthly while gratuity dues of LKR300 million will be paid as and when payments are ordered by the courts. We have assumed LKR250 million of cash outflow per year to settle the employee dues.
Kotagala owes around LKR400 million to the government for rent on its plantation estates and plans to settle it via the annual harvesting of timber trees, together with any proceeds from its ongoing legal case against the Urban Development Authority related to one of its estates. Kotagala needs government approval to harvest the trees and has not received such approval for the past two years. We do not believe the company will be able to settle the lease arrears in the next 6-12 months given the uncertainty of the outcome of the court case and sale of timber trees.
High Crop Prices: We expect revenue to rise by 75% in FY23 amid strong crop prices and sharp depreciation of the local currency. The Sri Lankan rupee has depreciated by almost 80% since the currency was floated in March 2022, and this directly boosts plantation companies' revenues. The global prices of rubber and palm oil have also risen due to demand recovery and supply shortages, albeit to a lesser extent. Prices are expected to remain high in the next 6-12 months, which also supports Kotagala's cash flows.
Near-Term EBITDA Recovery: Fitch estimates Kotagala's annual EBITDA at LKR800 million for FY23-24 amid strong crop prices. EBITDA was negative to very low until crop prices started rising in FY21. We expect plantation-sector wages to move up significantly at the next wage revision due to inflation, which will affect the tea and rubber businesses more as they are more labour-intensive than palm oil. Sri Lanka's currency shortage and the rupee depreciation has increased fertiliser prices by more than 10x. However, the high crops prices would more than offset cost pressures in the near term.
Rated on Standalone Basis: Fitch rates Kotagala on a standalone basis as its stronger ultimate parent, The Colombo Fort Land and Building PLC (CFLB), has limited incentive to provide support, according to our Parent and Subsidiary Linkage Rating Criteria. We assess CFLB's legal, strategic and operational incentives to extend support as 'Weak'. The 'Weak' legal incentive stems from the absence of corporate guarantees from CFLB on Kotagala's debt, and the lack of cross-default clauses linking the parent's debt to that of Kotagala.
Parent's Low Incentiveto Support:Kotagala's contribution to CFLB's group EBITDA will remain below 15% over FY22-FY25 while factors such as competitive advantages to the parent and CFLB's growth potential remain low, weakening the overall strategic support incentive. CFLB has provided limited support in the past via working-capital funding, but this has not been sufficient to avoid a default. Operational incentives to support are also weak as CFLB is diversified, with limited operational synergies with Kotagala, with no brand overlap and little common management.
Kotagala's rating is driven by its current debt restructuring process for its bank loans, therefore Kotagala's rating is multiple-notches lower than the ratings of its closest peers on the Sri Lanka national scale.
Fitch's Key Assumptions Within Our Rating Case for the Issuer:
- Revenue to increase by 75% in FY23 to LKR6.0 billion amid the benefit of currency depreciation and stronger crop prices. Revenue growth to slow to low single digits from FY24 once global crop prices moderate.
- EBITDA margin of 15% in FY23, benefitting from strong prices across most crops. Margins to fall to high single digits in FY24 once prices stabilise and owing to rising operating costs, especially in the tea and rubber segments.
- Capex of around LKR300 million a year over FY23-FY25 spent mainly on replanting and mechanisation of the production process.
- Interest rates to increase to 20% over FY23-FY24 in line with the recent hike in policy rates
- No dividend payments over FY23-FY24.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- The 'RD(lka)' rating will be upgraded to reflect the appropriate National Long-Term Rating for the post-restructuring capital structure, risk profile and prospects in accordance with our criteria, upon completion of a financial restructuring and once sufficient information is available.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- Kotagala entering into bankruptcy filings, administration, liquidation or other formal winding-up procedures.
Liquidity and Debt Structure
Weak Liquidity, Debt Restructuring: As of end-March 2022, Kotagala had LKR133 million in cash compared with LKR1.2 billion in debt maturing in the next 12 months. Of this, around LKR560 million of short-term debt is currently being restructured. The remining short-term debt of around LKR200 million is related to broker credit and may be rolled over in the normal course of business because they are backed by tea sales.
Kotagala's contractual maturities in the next 12 months amounts to around LKR450 million, and of this LKR240 million will be directly paid through the tripartite agreements with the tea brokers. However, this will reduce the amount of cash available to fund the group's operating costs in its plantations, especially in the absence of any unutilised credit lines available from banks. The group has around LKR400 million of unutilised broker credit that can be used for working-capital purposes if required, but the debt service cost of this facility is significantly higher than other funding sources.
We expect Kotagala to generate around LKR200 million in negative free cash flow in FY23 amid high capex on replanting and mechanisation of the harvesting process, following a capex slowdown in the last few years to conserve cash, and settlement of statutory dues during the year.
Kotagala is a domestic plantation company engaged in tea, rubber and palm oil.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.