Fitch: Atlas Acquisition to Boost Hemas’ Defensive Cash Flows

January, 24, 2018

Hemas Holdings PLC's (AA-(lka)/Stable) acquisition of a controlling stake in Sri Lanka's leading school and office stationery manufacturer, Atlas Axillia (Private) Limited, will bolster Hemas' defensive operating cash flows, Fitch Ratings says. We believe the acquisition has no immediate impact on Hemas' rating because we expect the transaction to be largely funded by cash at hand without a material increase in debt.

Fitch views this acquisition as in line with Hemas' strategy of using its significant cash balance to expand its core businesses through M&A. Atlas' stationery business broadly fits into Hemas' fast-moving consumer goods (FMCG) segment, which includes the manufacture and distribution of homecare and personal care products, and contributed to around 38%of Hemas' EBITDA in the fiscal year to end 31 March 2017.

On 19 January 2018, Hemas agreed to buy a 75.1% stake in Atlas for LKR5.7 billion. Atlas is the largest domestic manufacturer and distributor of exercise books, pens, colour products and other school stationery equipment with a strong distribution network spanning over 70,000 outlets island wide. We view the Atlas business as defensive across economic cycles, which would strengthen Hemas' FMCG business.

Fitch expects demand for school stationery to grow over the medium term, supported by both government and private-sector investments in the education sector and rising per capita income in the country. Atlas will be run as a separate subsidiary of Hemas after the acquisition, but may be able to benefit from operational synergies with the group's larger FMCG business once the integration is complete.

As of end-September 2017, Hemas had LKR10.6 billion of cash and cash equivalents at the group level, including LKR 4.4 billion at the holding company to be used for the acquisition. We do not expect a significant deterioration in the holding company's credit quality, once it pays for the acquisition, as it has robust ability to extract dividends from its subsidiaries, many of which it fully controls.

We expect Hemas to maintain its leverage, defined as gross lease-adjusted debt/EBITDAR at less than 2.0x over the medium term, in spite of the acquisition. The 2.0x threshold is the level above which we would consider negative rating action. At 30 September 2017, we estimate that Hemas' leverage, computed using trailing 12 month EBITDAR, stood at 1.4x.