Fitch Ratings-Singapore/Colombo-10 April 2017: Fitch Ratings has affirmed Sri Lanka-based telecom company Dialog Axiata PLC's National Long-Term Rating at 'AAA(lka)'. The Outlook is Stable. 

KEY RATING DRIVERS

Market-Leading Position: Dialog's standalone credit profile of 'AAA(lka)' is underpinned by its market leadership in the expanding mobile and pay-TV segments. We believe Dialog is in a position to gain revenue market share from smaller telcos in light of its superior 3G/4G network capability. Its financial profile is solid, with moderate 2017 forecast FFO-adjusted net leverage of 1.2x-1.4x and stable operating EBITDAR margin of 34%-35% (2016: 35%).

High Ratings Headroom: We believe Dialog could potentially receive support from its 83% Malaysian parent, Axiata Group Berhad (Axiata), if its standalone credit profile were to weaken. Dialog and its parent have moderate linkages, which include sharing key management personnel, a common brand name and common creditors. This could lead to reputational risk to Axiata should Dialog fail.

Lower Revenue Growth: We expect Dialog's revenue growth to slow to around 5%-6% in 2017 (2016: 17%), as consumers are likely to curb their voice and data usage due to higher taxes. The government budget for 2017, announced in November 2016, proposed increases in effective taxes on data services to 50%; effective taxes on voice and text were increased to 50% in November 2016. However, revenue growth is likely to recover in 2018, increasing by high-single-digit percentages, due to fast-growing data services. 

Stable Profitability: We forecast Dialog's operating EBITDAR margin to remain stable at around 34%-35%, as larger economies of scale in the data segment offset falling profitability on voice and text segments. Strong data growth is supported by the proliferation of smartphones, with most new handsets sold being 4G-enabled.

Negative FCF: We forecast Dialog to have negative FCF during 2017-2018, as cash flow from operations could fall short of the company's ongoing large capex plan and dividend commitments. Dialog will continue to invest about 28%-30% of its revenue in capex annually to expand its 3G/4G networks and optical fibre infrastructure. Dividends are likely to increase to around LKR3.2 billion (2016: LKR2.6 billion).

Debt-Funded Mergers and Acquisitions: Some industry consolidation is likely with ongoing intense competition in the mobile segment, where smaller telcos are unprofitable and face high investment requirements. Dialog and Sri Lanka Telecom PLC (SLT, B+/AAA(lka)/Stable) could acquire smaller telcos to strengthen their market position and consolidate spectrum assets. Dialog's ratings have sufficient headroom for a debt-funded acquisition of a smaller telco for around LKR10 billion-12 billion. 

DERIVATION SUMMARY

Dialog's business profile is better than similarly rated national peers and is supported by its market leadership in Sri Lanka's mobile industry, stable cash generation and integrated service offerings. Dialog has higher revenue and better operating EBITDAR margin than the fixed-line market leader, SLT, but this is offset by Dialog's higher exposure to the crowded mobile market. Dialog's forecast 2017 FFO-adjusted net leverage and FCF profile is better than that of SLT. SLT also has a larger capex plan relative to its EBITDA to expand fibre networks across Sri Lanka.

Liquor company, Distilleries Company of Sri Lanka PLC (DIST, AAA(lka)/Rating Watch Negative) is Sri Lanka's market leader in alcoholic beverage production. It benefits from a higher operating EBITDAR margin and stronger FCF generation than Dialog, supported by its ability to pass on tax increases to consumers. Dialog's forecast leverage is similar to DIST, but compared with telcos, DIST faces higher regulatory risk, with frequent excise tax hikes. The Rating Watch Negative on DIST reflects a worsening financial profile and the risk of higher dividends to its parent.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for Dialog include:
- Slower revenue growth of 5%-6% in 2017 (2016: 17%) due to higher taxes.
- Growth to recover from 2018 to a high-single-digit percentage, driven by data services.
- Operating EBITDAR margin to remain stable at around 34%-35% during 2017-2018.
- Capex/revenue to remain high at around 28%-30%.
- Higher dividend payout during 2017-2018 of 3.2 billion (2016: LKR2.6 billion).
- Negative FCF during 2017-2018.

RATING SENSITIVITIES

Developments that May, Individually or Collectively, Lead to Positive Rating Action
There is no scope for an upgrade as Dialog is at the highest rating on the Sri Lankan national ratings scale.

Developments that May, Individually or Collectively, Lead to Negative Rating Action
- A significant dilution in Axiata's ownership or board control of Dialog, removal of the common brand name or a weakening of the current moderate ties between the companies.
- A decline in operating EBITDAR margin to below 20%, along with FFO-adjusted net leverage above 3.5x.

LIQUIDITY

Solid Liquidity: Dialog had a sufficient unrestricted cash balance of LKR7.2 billion and undrawn committed bank facilities of LKR19.5 billion at end-2016 to pay for its short-term debt maturities of about LKR7.9 billion. Dialog has strong access to local banks given it is among Sri Lanka's largest corporates. Dialog's debt mainly comprises of a USD150 million syndicated facility and LKR10 billion bank loan.