Sri Lanka’s Home Lands Skyline rated ‘A(lka)’ despite macro challenges: Fitch

Date:

ECONOMYNEXT – Fitch has assigned Home Lands Skyline pvt Ltd, a real estate developer, a national Long-term rating of ‘A(lka)’ with a stable outlook despite the weak domestic economy.

Home Lands Skyline, a subsidiary of Home Lands group of companies, was founded in 2003.

The rating agency said it expects the company’s annual cash collection from contracted sales to reach around 10 billion rupees bythe financial year ending March 31, 2022 from Seven billion rupees in in 2021 and four billion rupees in 2020.

“We expect the company to face near-term challenges from the weak domestic economy,reflected in accelerating inflation, rising interest rates and difficulties in importing raw materials, which could dampen timely cash collection and project completion” the agency said.

“HLSL’shealthy financial profile provides a buffer against these risks in the next 12-18 months.”
The rating agency said, Economy in the country is expected to weakened in 2022 mainly due to forex issue and expects the GDP growth of the country to be around 2 percent for the year.

“We therefore expect demand for housing to moderate and have assumed sales and cashcollection at HLSL’s new projects will slow in the next 12-18 months compared with the last two years, with further downside a possibility” the agency said.

The full statement is reproduced below:

Fitch Assigns Home Lands Skyline First-Time ‘A(lka)’

National Rating; Outlook Stable

Fitch Ratings – Colombo – 14 Feb 2022: Fitch Ratings has assigned Sri Lankan real-estate
developer Home Lands Skyline (Pvt) Ltd. (HLSL) a National Long-Term Rating of
‘A(lka)’. The Outlook is Stable.

HLSL’s rating reflects the company’s limited record of operating at its current scale. Fitch
expects its annual cash collection from contracted sales to reach around LKR10 billion by
the financial year ending 31 March 2022 (FY23) from LKR7.0 billion in FY21 and
LKR4.0 billion in FY20.

We expect the company to face near-term challenges from the weak domestic economy,
reflected in accelerating inflation, rising interest rates and difficulties in importing raw
materials, which could dampen timely cash collection and project completion. HLSL’s
healthy financial profile provides a buffer against these risks in the next 12-18 months.

KEY RATING DRIVERS

Limited Sales Record: HLSL has a growing pipeline of around 1,500 new housing units
in the next three years compared with 2,000 units sold since it started operations in 2014.

However, our forecasts are subject to execution risks due to its limited record of operating
at the projected scale. HLSL’s pipeline includes several large projects of 200-300 units,
which would require it to balance the maintenance of cash collection, timely construction
and fund raising.

Challenging Economic Environment: Sri Lanka’s economy is likely to weaken in 2022,
as the challenging external position and exchange-rate pressure will have knock-on effects
on economic activity. Foreign-currency shortages have hampered food and fuel imports,
and continued external liquidity stress could worsen supply shortages. We expect GDP
growth to slow to 2.0% in 2022, from an estimated 3.6% in 2021, before recovering to
4.3% in 2023 due to base effects and a gradual easing of domestic pressure, but downside
risks to our forecasts remain.

We therefore expect demand for housing to moderate and have assumed sales and cash
collection at HLSL’s new projects will slow in the next 12-18 months compared with the
last two years, with further downside a possibility. HLSL’s inability to sell and collect
cash in a timely manner could tighten liquidity and increase leverage as it typically uses
the cash collected from sales to fund 30%-35% of its project costs.

Improving Market Position: HLSL is a leading property developer in the middle-
income segment, selling homes priced between LKR15 million and LKR30 million to
consumers looking for modern living options in suburban areas. The company is focused
on the concept of “themed resort living” where each project is based on a particular
recreational activity and the necessary infrastructure. Most of HLSL’s competitors operate
in the crowded urban market where there is little differentiation unless they are catering to
the high-end customer.

Land Sales Boost Cash Collection:HLSL derives around 25%-30% of its cash
collection from the land sales of its 100%-owned subsidiary, boosting its consolidated
cash collection. HLSL has a record of more than 20 years in land sales, where it collects
the cash within 12-18 months, compared with two-three years for home sales. Land sales
do not require significant development costs, which means the company does not have to
invest in large working capital compared with residential development.

Supply Pressure: Sri Lankan homebuilders are facing a shortage of construction
materials due to the country’s weak external finances, which has made imports
challenging. Around 20% of HLSL’s construction inputs are imported and we believe the
company may face increasing challenges when arranging funding facilities as banks are
prioritising essentials goods such as fuel, food and medicine, and intermediary goods used
for exports. We believe further supply pressure could drive cost increases and weaken
profitability.

Homebuilders are facing cost escalations due to the depreciation of the local currency,
which weakened more than 10% in 2021, hurting their operating margins. Homebuilders
are typically not able to pass on cost increases on units already sold. We believe the
company may find it challenging to increase prices on unsold units to reflect the cost
escalation in the current weak operating environment without affecting sales volume.

Positive Free Cash Flow: HLSL has a record of maintaining positive free cash flow
(FCF) from its prudent balance sheet and conservative cash-flow management. We expect
FCF to tighten in the next few years, but remain positive. Tighter FCF will stem from a
slowdown in cash collection and higher construction costs as most projects are reaching
completion. We estimate HLSL will invest around LKR2.0 billion per year on land
acquisitions to support its growth plans.

Low Leverage Supports Expansion: We expect HLSL net leverage, defined as net debt
to adjusted inventory, to fall below 40% from FY22 (FY21: 52%) due to higher
contracted sales and cash collection, which will provide the company with rating
headroom to invest in new projects. We expect cash collection from ongoing projects to
offset the need for external funding for land acquisitions and construction costs amid the
company’s prudent cash-flow management.

Limited Land Bank: We estimate HLSL’s land bank is sufficient to sustain around three
years of contracted sales at the current scale. We believe this exposes HLSL to rising land
prices, but this is not a material risk in the next 12-18 months given the availability of
land in the suburban areas in which it operates and their relatively benign land price
inflation.

DERIVATION SUMMARY

Domestic cable manufacturer Sierra Cables PLC (A+(lka)/Stable) is rated one notch
above HLSL to reflect its more established record in its market, evident from its profitable
operations over many years. Both companies are exposed to the cyclical construction
sector and could face liquidity pressure if there are material delays in customer payments.
We expect HLSL to maintain better leverage ratios than Sierra over the next few years.

Resus Energy PLC (A+(lka)/Negative), a domestic renewable-energy company, is also
rated one notch above HLSL on account of its cash flow visibility from fixed long-term
contracts and the increasing balance between hydropower and solar assets, which will
mitigate operational volatility arising from climatic conditions. Resus’ Negative Outlook
reflects the pressure on liquidity due to possible payment delays from its sole
counterparty, state-owned Ceylon Electricity Board (AA-(lka)/Stable), whose operations
are dependent on the financial support from the Sri Lankan government (Long-Term
Local-Currency Issuer Default Rating: CCC). HLSL’s customer base is highly granular,
which mitigates its counterparty risk.

KEY ASSUMPTIONS

Fitch’s Key Assumptions Within Our Rating Case for the Issuer:

– Contracted sales of LKR7.9 million in FY22, LKR10.9 billion in FY23 and LKR16.5
billion in FY24

– Cash collection of LKR9.5 billion in FY22, LKR10.3 billion in FY23 and LKR14.1
billion in FY24

– EBITDA margin to improve to 20% by FY24 from 9% in FY21 amid increased revenue
recognition with projects reaching completion, and a greater proportion of high-margin
premium products

– Land acquisition investment of around LKR2.0 billion per annum over FY22-FY24

– No dividend payouts in the medium term as per the company’s policy

RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:

– Implied cash collection (defined as change in customer advances + revenue) above
LKR10 billion on a sustained basis

– Net debt/adjusted inventory maintained below 40% for a sustained period
Factors that could, individually or collectively, lead to negative rating action/downgrade:

– Net debt/adjusted inventory above 50% for a sustained period

– Inability to generate neutral-to-positive FCF (including land acquisition-related cost) on
a sustained basis

LIQUIDITY AND DEBT STRUCTURE
Manageable Liquidity: HLSL had LKR573 million at end-September 2021 to meet
LKR1.6 billion of debt maturities in the next 12 months. Around LKR400 million of the
debt is maturing working-capital lines, which we believe its banks will roll over in the
normal course of business as the amount is supported by the company’s strong cash
collection.

The remaining contractual maturities of around LKR1.2 billion are related to ongoing
projects and can be met through more than LKR2.0 billion in cash flow from operations
(excluding land purchases) in the next 12 months. We have assumed around LKR2.0
billion in annual land acquisitions, which is more conservative than HLSL’s average
spending of around LKR1.0 billion per annum in the last two years. We believe this adds
a liquidity buffer that can absorb a degree of downside risk to cash collection while
allowing HLSL to meet its obligations. HLSL also has access to around LKR155 million
in uncommitted but unutilised credit lines.

ISSUER PROFILE
HLSL is a property developer in Sri Lanka engaged in the development and sale of land,
houses and apartments mainly for the middle-income customers.

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