Global Credit Ratings has affirmed the national scale ratings assigned to ARM Cement Limited of A and A1 in the long term and short term respectively; with the outlook accorded as Stable.
The ratings to the Nairobi Securities Exchange listed firm was based on the following key criteria:
ARM has developed into a major player in the East African cement industry, with its market share registering at c.18% in 2015, from 11% in 2010. However, the group’s substantial capex was largely through short term debt, as a result of which ARM found itself with a very high KES24bn debt burden at FYE15 and an unfavourable funding mix, comprising mainly of short term USD facilities. Thus, as the KES depreciated during F15 and liquidity in the market dried up due to the failure of two banks, ARM struggled to service its debt, and was unable to restructure its debt facilities.
To alleviate the funding strain, in May 2016 ARM finalised a USD140m investment by the UK development finance institution, CDC. Of the funding to be received, USD110m will be used to settle outstanding debt (mainly short term facilities), and the remaining USD30m will be provided for working capital requirements. Aside from easing the debt and interest burden and returning the balance sheet to a more sustainable position, introducing CDC as a strategic partner will provide the financial muscle for ARM to continue with its expansion plans.
GCR has sighted the final signed transaction agreement between ARM and CDC, although it is noted that investment funds have not yet been transferred. GCR expects to be informed once this occurs and will monitor ARM funding to ensure debt is repaid timeously.
Notwithstanding the funding constraints, core operating performance remained strong in F15. With the completion of the Tanga plant in F14, ARM has secured clinker sufficiency and is now one of the lowest cost producers in the region, enabling it to compete aggressively in the current competitive environment. Thus, although cement revenue declined, the savings from internal clinker, combined with lower energy costs, saw the group gross margin widen to 29.5% in F15, a four year high. The improved revenue and firmer margin combined to see EBITDA rise 10% to KES3.4bn in F15, at a wider 23% margin (F14: 22.4%). Earnings were also supported by robust growth in income from fertiliser and other minerals. However, this performance was overshadowed by a KES3.5bn net loss before tax in F15, halting almost 10 years of consistent profit growth. This was the result of the substantial rise in net interest paid to KES2.3bn and the KES3.7bn foreign exchange loss on the revaluation of USD debt. The redemption of debt with the CDC proceeds should substantially mitigate the risk associated with these issues.
Despite some challenges due to tough competition, weak prices and volatile currency movements, the demand for cement remains robust and will continue to grow ahead of GDP. Moreover, ARM has identified a number of projects that should sustain long term growth.
Positive rating action could arise from bedding down the CDC investment and relationship, such that it allows ARM to pursue its expansion plans. This should facilitate continued earnings growth amidst more moderate gearing levels. Conversely, complications in completing the CDC transaction, particularly if less debt is redeemed or there are material delays, could result in a ratings downgrade.
Source; GCR
