Sri Lanka-based consumer durable retailers' operating cash flow is likely to weaken following new government regulations that impose a 100% cash margin on the import of most types of consumer durables, Fitch Ratings says. The credit profiles of rated retailers, such as Singer (Sri Lanka) PLC (A-(lka)/Stable) and Abans PLC (BBB+(lka)/Stable), may come under pressure from lower sales volume and higher working capital needs, particularly if the rules remain in place for an extended period.

The cash margins, imposed on 29 September 2018, aim to stem the weakening of Sri Lanka's local currency, which has fallen by 10% year to-date. Previously, retailers were able to open letters of credit with banks without any cash margins. We expect prices of most consumer durables to increase amid local-currency depreciation and higher funding costs from the new margin requirement, depressing sales volume. Demand for consumer durables has already dropped due to the country's contracting discretionary income levels. Retailers could absorb some costs to remain competitive and defend volume in the weak demand environment, but that could further cut into their already weakening operating margins.

We estimate that Singer and Abans import around 80%-85% of the products they sell and believe the regulated items will account for almost 50%-60% of such products. Singer's comparatively larger local-assembly operation for refrigerators and washing machines should help mitigate the impact, as the new margins only apply to finished goods.

The need for additional working capital to fulfil the margin requirement could reverse recent improvements seen in consumer durable retailers' leverage. Singer's net leverage, as defined by lease adjusted net debt/last 12 months trailing EBITDAR, improved to 5.1x as of 30 June 2018, from 5.5x as at 31 March 2018, while Abans' net leverage improved to 6.8x, from 7.2x, over the same period. Abans' rating is likely to be more affected than Singer's, since Abans' leverage is already high for its rating.