Fitch Affirms Sri Lanka's Aitken Spence's Senior Unsecured Notes at 'AA(lka)'

Fitch Ratings has today affirmed Sri Lanka's Aitken Spence PLC's (ASP) senior unsecured notes at National Long-term 'AA(lka)'. The Outlook is Stable.

The rating reflects the strong operating cash generational ability of ASP's core business segments, the geographical diversification of its revenue and profit streams, and the low leverage in two of its business segments. Although ASP is expected to increase its debt at the group and holding-company level as at FYE10 (holding company by approximately LKR2.0bn), Fitch notes that scheduled debt repayments (FY11: LKR2.2bn) are expected to reduce leverage over the medium-term. The debt repayments, coupled with the stable and strong dividend receipts from the power sector (accounting for most of ASP's Q310 dividend) and expected improvements in its Sri Lankan tourism assets, underpin the rating and the Outlook.

Constraining ASP's rating is its exposure to the state-owned and financially weak Ceylon Electricity Board (CEB) which is the sole purchaser of ASP's power output. The power purchase agreements (PPAs) with built in safeguards provide some comfort to the rating, while penalty charges for delay in payments by CEB, and the non-recourse nature of the power unit's debt act as mitigating factors. State support for CEB as well as CEB's dependence on private thermal power generators, such as ASP, allows the latter to withstand its exposure to CEB. Fitch notes that despite delays in payments, historically CEB has never defaulted on its payments to ASP.

With ASP's power unit fully paying off its long-term debt by FY11, Fitch expects dividend flows to become more stable leading up to FY12. However, almost all proposed new power generation projects in the pipeline are CEB-owned and are expected to add about 20% new capacity by 2012, which would be concurrent to the termination of existing PPAs; this highlights the renewal risk for the company's initial PPAs after 2012. Nonetheless, Fitch notes that ASP's largest power plant's earnings and dividends (a 100Mw thermal power plant in which ASP has a 74% ownership) will continue till mid-2015.

ASP's hotel unit is expected to recover on the back of improvements in its Maldives operations, and from better profitability at the Sri Lankan resorts. This is a result of the improved domestic security situation, ASP's strengths in its brand name, geographical coverage, market share and from available synergies with the travel segment. The hotel sector is expected to incur close to LKR5.0bn capex during the next two years, and funding for these projects is planned through a rights issue at the hotel subsidiary as well as project based debt. The agency notes that while the increase in the hotel unit's contribution can somewhat mitigate the renewal risk of the power unit, ASP's rating can be negatively affected by its increased dependence on the tourism industry if the contribution from its power unit wanes over the medium-term.

ASP's cargo sector, which accounts for 17% of group revenue and EBITDA at 3Q10 and employs low debt capitalisation (9M10: LKR6.3m long-term debt), acts as a rating positive with its diversification impact.

As of Q310, ASP group's leverage was 2.5x (3Q09: 2.6x). Holding company debt was LKR1.9bn and its leverage was 0.9x due to a reduction in corporate guarantees to ASP's hotel unit, increased dividends from its power subsidiaries and strong cash balances (LKR1.5bn). Fitch notes that any additional debt borrowings or a reduction in dividend income to the holding-company can act as a negative rating trigger. Furthermore, Fitch notes the scheduled debt repayment of above LKR500m during FY11-FY13 would necessitate adequate dividend inflow from all three sectors to the holding company in order to maintain its leverage.

Applicable Criteria is available on Fitch's website at www.fitchratings.com: "Corporate Rating Methodology", dated November 24, 2009; and "Rating Industrial Investment Holding Companies" dated May 22, 2008.