Fitch affirms Distilleries at 'AAA(lka)'

Fitch Ratings has affirmed Distilleries Company of Sri Lanka PLC's (DIST) National Long-Term Rating at ‘AAA(lka)’ and stable outlook.

DIST's strengths are reflected in a high Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) margin of over 30%, reflecting relatively inelastic demand for spirits and the group's ability to pass on tax increases.

DIST is the market leader in the manufacture of alcoholic beverages accounting for about 82% of arrack and 60% of local alcohol production in 2012.

DIST has a portfolio with strong brands, diversification across price points, and good access to retail points across the country, Fitch sources said.

The sector is highly regulated with restrictions on advertising and promotion, and issuance of retail licenses.

While these regulatory measures set high barriers to entry that benefit players such as DIST, they are counterbalanced by the high and frequent increases in top-line taxes. Although the tax increases only have a limited short-term impact on consumption, the increase in average selling prices has encouraged a large illicit spirits market.

The company has historically actively pursued acquisition.

While it has not indicated it is pursuing specific acquisitions, the group recently restructured to consolidate its non-beverage assets under investment holding company Mesltacorp Limited, which will allow management to better focus on the group's other segments.

Potential risks could stem from debt-funded acquisitions that could weaken the group's balance sheet in the near term with benefits accruing potentially only over the longer term. From an operational perspective, entry into business segments with higher risk will change the company's business risk profile and increase cash flow volatility, Fetch sources said