Fitch Ratings has affirmed Sri Lankan paint manufacturer JAT Holdings PLC's National Long-Term Rating at 'AA(lka)'.

The Outlook is Stable.

JAT's rating reflects the company's strong financial profile with low leverage and manageable liquidity. The rating is also supported by its leading position in the domestic wood-coating market and a growing overseas presence. The rating is constrained by JAT's small operating scale and exposure to cyclical end-markets compared with higher-rated peers.

The Stable Outlook reflects Fitch's view that JAT's credit metrics and liquidity will remain adequate in the next 12-18 months, with sufficient buffers to navigate the slow recovery in the domestic economy.

Key Rating Drivers

Leverage to Remain Low: We expect JAT's EBITDA net leverage, to stay below 1.0x in the financial year ending March 2024 (FY24) to FY27. This is in spite of softer EBITDA as the benefit of selling lower-cost inventory in FY23 dissipates, and higher capex into production and R&D facilities in FY24. We expect EBITDA to grow 26% in FY25 on improved margins with more vertical integration from the company's new production facilities, and a demand recovery in the domestic market. Capex is also likely to be lower after FY24 as JAT has no major investment projects in the near-term.

Mild Recovery in Domestic Demand: We expect JAT's domestic sales to improve in FY25 amid signs of recovery in the Sri Lankan economy. Its domestic revenue grew 10% yoy in 3QFY24, reversing a trend of yoy decline that started in 3QFY23. Sri Lanka's purchasing managers' index for the construction sector reached 52.9 in January 2024, entering expansionary territory for the first time since January 2022, as new projects increased and suspended projects were restarted. That said, we believe Sri Lanka's paint consumption recovery will be mild and gradual amid economic challenges.

Margins to Improve: We expect the EBITDA margin to improve during FY25-FY27 after retreating in FY24. The company's EBITDA margin is likely to weaken to below 14% in FY24, from 19% in FY23, as the benefit of selling low-cost inventory faded, while expenses, including advertising and marketing costs, increased significantly. However, we expect JAT's continued efforts in vertical integration, through the launch of a binder plant in Sri Lanka and an alkyd resin plant in Bangladesh, will help it to control costs and lift its EBITDA margin to 14%-15% in FY25-FY27.

In addition, JAT has decreased its reliance on imported raw materials, to 43% in FY23 and 51% in 9MFY24, from 70%-80% in previous years, as it expanded local procurement to cope with import restrictions and the rupee depreciation. Its value of purchases from foreign suppliers are likely to rise as most import restrictions have been lifted. However, we expect its reliance on raw material imports to remain below historical levels in the coming years, given the increased vertical integration and benefits of local sourcing. We expect greater stability in JAT's margins from the reduced exposure to imports.

Strong Brand Portfolio: JAT is the exclusive partner of Sayerlack in south Asia and certain African countries. Sayerlack, accounting for 71% of JAT's gross profit in FY23, has helped JAT become the wood-coating leader in Sri Lanka, with a market share of over 50%, and supported its expansion in Bangladesh's industrial wood-coating market. JAT's long-standing relationship with Sayerlack's principal, The Sherwin-Williams Company (SWC, BBB/Positive), has helped with preferential pricing, product customisation and extended credit periods.

We expect the decorative paint segment to see sustained strong growth over the medium term, with JAT continuing to gain market share. The company has adopted an innovative online strategy of selling directly to customers, by-passing distributors. This has allowed JAT to offer more attractive prices than competitors. JAT entered the decorative paint market in 2021 with the launch of the brilliant white emulsion paint, which acquired a close to 10% market share within a short period of time.

Growing Overseas Presence: We expect JAT to continue expanding its overseas presence in a bid to increase foreign currency-denominated revenue and improve geographical diversification. In addition to a manufacturing plant launched in 2022, JAT recently commenced operations at a new alkyd resin plant in Bangladesh that will further enhance its competitiveness in the country. JAT also aims to penetrate new markets such as Australia and Africa with the launch of showrooms and a manufacturing plant. We expect overseas revenue contribution of around 40% by FY27, against an average of 23% in FY20-FY23.

Cyclical Demand and Small Scale: Demand for JAT's wood coating, decorative paints and paint brushes stems from the cyclical construction sector. The company caters mainly to the less-volatile maintenance market within the construction sector, but demand is still subject to discretionary income. JAT's rating is constrained by its small operational scale, as reflected in EBITDA size, against higher-rated peers. This is because the company is a leader in a niche market within building materials, and has a small share of the larger decorative paint segment.

Derivation Summary

JAT is rated one notch below domestic conglomerate Sunshine Holdings PLC (AA+(lka)/Stable). Sunshine has more defensive cash flow than JAT due to exposure to healthcare and consumer goods, such as packaged-tea retail and confectionary. In contrast, JAT is exposed to the cyclical construction sector with volatile demand for its products. We expect both Sunshine and JAT to maintain similar financial risk profiles, characterised by low leverage and manageable liquidity.

JAT is rated one notch below Ceat Kelani Holdings Pvt Ltd (CKH, AA+(lka)/Stable). CKH is the leading manufacturer and distributor of vehicle tyres in Sri Lanka, but faces competitive pressure from imports. However, CKH operates in the less-cyclical replacement-tyre market and has a larger operating scale than JAT. Therefore, CKH's rating is one notch above that of JAT.

JAT's business risk profile is weaker than that of domestic footwear and tyre manufacturer DSI Samson Group (Private) Limited (AA(lka)/Stable), which is exposed to more defensive end-market demand and benefits significantly from import substitution in the local market. However, JAT's stronger financial risk profile offsets its business risks, resulting in both companies being rated at the same level.

JAT is rated one notch above domestic consumer-durables retailer Abans PLC (AA-(lka)/Stable) to reflect JAT's lower leverage and better liquidity, which offsets more stable demand for Abans' consumer-durable goods and its larger scale. We expect Abans' EBITDAR-adjusted net leverage to hover at around 5.0x-6.0x in the next two years, significantly higher than JAT's EBITDA net leverage of below 1x..

JAT's credit considerations lead to a higher rating than for large domestic banks, non-bank financial institutions and insurance companies, which are more exposed to sovereign stress due to their holdings of large sovereign-issued securities for regulatory reasons. The large financial institutions also have broader exposure to the various economic sectors.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Revenue to grow at the low- to mid-teens over FY24-FY27 amid a recovery in the domestic market and sustained growth in Bangladesh and other overseas markets.

EBITDA margin to moderate to around 13% in FY24 and rise to 14%-15% in FY25-FY27, reflecting a more sustainable cost structure, price increases, and cost savings from increased domestic manufacturing and vertical integration.

LKR600 million-900 million in working-capital outflows per year over FY24-FY27 to support revenue growth.

Capex of LKR780 million in FY24 and LKR400 million per year during FY25-FY27.

Dividend payment of LKR403 million in FY24 and dividend payment of 40% of net income per year during FY25-FY27.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:

We do not anticipate an upgrade in the medium term. The rating may be upgraded in the longer term if there is a material increase in scale while maintaining the current financial risk profile.

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:

EBITDA interest coverage falling below 2.0x on a sustained basis;

A significant weakening in the company's liquidity profile.

Liquidity and Debt Structure

Manageable Liquidity: JAT had LKR1.2 billion of cash and short-term investments as of end-December 2023 to meet LKR2.2 billion of debt maturing in the next 12 months. Over 95% of the outstanding debt was for working-capital purposes. We believe lenders are likely to roll over the short-term debt in the normal course of business so long as JAT's net cash-collection cycle remains steady at around 220 days.

We expect the company to have some flexibility to lengthen its supplier credit, if needed, to lower a degree of pressure in its collection cycle, considering its long-standing relationship with and the credit standing of its main global supplier, SWC. In addition, JAT had LKR820 million in undrawn uncommitted credit lines at end-December 2023. We expect the lenders to honour these credit lines, considering the company's adequate credit profile in a local context.

Issuer Profile

JAT is a Sri Lanka-based paint company with operations in South Asia, the Middle East and Africa.

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.

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