Fitch Ratings has downgraded John Keells Holdings PLC's (JKH) National Long-Term Rating to 'AA+(lka)' from 'AAA(lka)'. The Outlook is Stable. JKH is a holding company with interests in transportation, leisure, property, consumer foods, retail and financial services, and it depends largely on dividend income to meet its financial obligations.

The downgrade reflects the deterioration in JKH's business risk profile, driven by the weakening competitive position of its key dividend-paying associate, South Asia Gateway Terminals (SAGT), in which JKH owns 42%. Dividends from SAGT accounted for 37% of JKH's EBITDAR in the financial year ended 31 March 2014 (FY14) (FY12: 50%; FY13: 33%) Fitch expects increasing dividend income from JKH's other businesses to compensate for the drop in SAGT's cash flows, but these other segments have higher business risk profiles. The rating is supported by the diversity of JKH's dividend income streams, the company's strong liquidity profile and its conservative capital structure

JKH is also investing in excess of USD650m in an integrated resort project in Colombo, which is not likely to start generating income until FY19. The project carries considerable project-related risks, such as the possibility of cost- and time-overruns, which could delay the repayment of debt used to finance it. However, these risks are offset by JKH's decision to fund the project by raising capital ahead of major investment and the substantial cash balances at the holding company, which could be used to pay for reasonable cost overruns, should they occur.

KEY RATING DRIVERS

Transportation Sector Under Pressure: Volumes at SAGT, a privately owned container terminal at the Port of Colombo, fell 11% in FY14 after several shipping lines switched to using another terminal. SAGT faces tougher competition from the newly built Colombo International Container Terminal, which can handle larger vessels, and state-owned Jaya Container Terminal (JCT). SAGT's volumes could further decline if key customers use larger vessels that require additional draft and crane size, which are offered by the newer terminal. JKH's 99%-owned bunker fuel supplier Lanka Marine Services, which accounted for 5% of the holding company EBITDAR in FY14, is also facing top line and margin pressure as a result of increased competition.

Higher Business Risk: The property sector will contribute significant dividends to JKH in FY15 and FY16 once two new properties are completed in 2014 and 2015. However, cash flow from the sector will be limited after that until earnings are realised from completion of the residential apartments at the integrated resort project in FY19. The property development business is inherently cyclical and volatile, and consequently the increased exposure to this sector has weakened JKH's overall business profile.

Rising tourist arrivals are likely to boost dividends from the leisure sector, which accounted for 29% of JKH's EBITDAR in FY14. Cash flows from the sector will be strengthened by the addition of a new business hotel, Cinnamon Red, in September 2014 and supported by continuing strong performance of its five-star city hotels and resorts in Sri Lanka and the Maldives for which most of the capex has been already incurred.

Real-estate Project Risks: JKH's integrated resort comprises a hotel and conference centre as well as residential, retail and entertainment spaces. Construction on the project has started and JKH has continued to demonstrate a conservative approach to raising equity ahead of major investment. It raised USD175m in November 2013 through a rights issue and plans to raise a further USD125m by way of warrants in FY16 and FY17. The project is held by a new subsidiary, Waterfront Properties (Pvt) Ltd., which will issue debt in order to improve returns for JKH's shareholders from the project. This, combined with the reputation risk to JKH that may arise if the project fails, could mean higher financial risk to the holding company. However this is likely to fall outside the rating horizon. Fitch takes comfort from the high cash balance at the holding company, which will help to offset risks from the integrated resort project.

Strong Liquidity, Capital-market Access: JKH has a strong track record of raising shareholder funds ahead of major investments across the group. This has enabled the company to maintain a conservative capital structure with holding company cash reserves exceeding debt. JKH's conservative policies are supported by its diverse shareholding structure in which no single shareholder or group controls more than 14% of the company. A material increase in shareholder concentration that could lead to an adverse shift in holding company and group leverage could be credit negative.

RATING SENSITIVITIES

Negative: Future developments that may individually, or collectively, lead to a further negative rating action include:

- Net adjusted debt/operating EBITDAR being sustained above 1.5x at holding company or consolidated level (FYE14: surplus cash at both holding company and group)

- Gross adjusted debt/EBITDAR at holding company being sustained above 2.0x (FYE14: 0. 62x)

- Inability to maintain sufficient liquidity in the form of cash to meet any cost overruns or time delays at the integrated resort project

- Impairment of SAGT's business risk profile due to higher competition from rival terminals that result in a material reduction in dividend payouts to JKH

Positive: Fitch does not expect any positive rating action in the next 24 months. Future developments that may individually, or collectively, lead to a positive rating action include clarity on the execution of the company's integrated resort project and a higher level of dividends from the transportation sector.