Johannesburg, 31 October 2019 – GCR Ratings (“GCR”) has revised the long-term National Scale Issuer rating accorded to H. Young and Company (East Africa) Limited to BBB-(KE) from BBB (KE) and affirmed the short-term National Scale Issuer rating at A3(KE); with a Stable Outlook.
|Rated Entity / Issue||Rating class||Rating scale||Rating||Outlook / Watch|
|H. Young and Company (East Africa) Limited||Issuer Long Term||National||BBB-(KE)||Stable Outlook|
|Issuer Short Term||National||A3(KE)|
On May 22, 2019 GCR announced that it had released a new rating framework and sectoral criteria. As a result, the ratings were placed “Under Criteria Observation”. Subsequently, GCR has finalised the H. Young and Company (East Africa) Limited (“H. Young”) rating review under the new Criteria for Rating Corporate Entities. As a result, the ratings have been removed from ‘Under Criteria Observation’ and the rating reviewed in line with the new methodology.
The ratings reflect H. Young’s continued sound earnings performance, underpinned by a substantial order book, albeit counterbalanced by the high gearing and limited geographic diversification.
H. Young’s ratings are supported by the company’s sustained sound revenue and earnings growth, underpinned by a sizeable order book of both government and private sector work, which provides a good level of revenue predictability over the medium term. Despite the intense bidding competition in the industry, H Young’s profit margins have evidenced resilience, supported by a focus on cost control and prudent risk management that enables efficient project delivery. Nevertheless, note is taken of the potential for earnings volatility in the industry and the high reliance on government contracts and payment schedules. That said, GCR expects the operating margin to be maintained within the 15-20% range over the rating horizon as the company runs down the existing contracts.
The ratings are constrained by high gearing, as H. Young’s debt increased during FY18 to finance the acquisition of capital equipment to meet the new contracts. Thus, despite the steady improvement in earnings, net debt to EBITDA remained flat at 3.0x at FY19, while the EBITDA coverage of interest remained somewhat low at 2.8x. In particular, the operating cash flow coverage of debt remains very low at 5.1% in FY19 (FY18: 17.1%), due to the sizeable working capital absorption associated with the new contracts. As no significant capital expenditure is planned over the rating horizon, GCR expects the credit metrics to improve gradually, as debt is amortised, with the net debt to EBITDA declining below 2.5x and EBITDA coverage of interest increasing to over 3.5x. Cash flow coverage of debt is also expected to improve to above 20% as the working capital position unwinds.
H. Young’s liquidity profile is considered to be sound, underpinned by c.KSh1bn in committed debtors discounting facilities at 1H FY20. Note is also taken of the terming out of the debt maturity profile, following the refinancing of some short-term facilities by four-year amortising term loans during 1H FY20. Thus, the company is expected to achieve liquidity coverage of at least 1x in respect of its one-year requirements, on the back of small near-term debt maturities and negligible capital expenditure requirements. GCR is also of the view that long established funding relationships with highly rated domestic financial institutions somewhat mitigate the refinancing risk.
The ratings take cognisance of H. Young’s established position as a mid-tier construction company in Kenya, backed by a good track record of successful completion of big projects. The company has over the years successfully carved a defendable niche focussing on mid-size road and infrastructure projects for which a large part of the funding is from the government or from international development finance agencies. Nevertheless, the lack of geographic diversification and concentration of the order book to a few contracts somewhat constrains the business profile assessment. Moreover, GCR considers corporate governance structures to be under-established, with the board inadequately constituted to provide independent oversight of management performance and hold management accountable to shareholders and creditors.
The Stable Outlook reflects GCR’s expectation that earnings will continue to evidence growth over the rating horizon as projects in the pipeline progress, while gearing metrics will gradually improve as debt is amortized.
Positive rating action could arise from a significant improvement in gearing metrics, resulting in net debt to EBITDA of 2x—2.5x or better and interest coverage above 4x, achieved together with much improved cash flow coverage of debt (c20%-30%). Conversely, a downgrade could arise from earnings underperformance or higher leverage due to aggressive funding for growth. Failure to sustain a smoothed-out, medium term debt expiry profile would be viewed negatively.
|Primary analyst||Tavonga Muchemedzi||Analyst: Corporate Ratings|
|Johannesburg, ZA||tavongam@GCRratings.com||+27 11 784 1771|
|Secondary analyst||Eyal Shevel||Sector Head: Corporate Ratings|
|Johannesburg, ZA||shevel@GCRratings.com||+27 11 784 1771|
|Committee chair||Mathew Pirnie||Sector Head: Financial Institutions|
|Johannesburg, ZA||MathewP@GCRratings.com||+27 11 784 1771|
Related Criteria and Research
|Criteria for the GCR Ratings Framework, May 2019|
|Criteria for Rating Real Investment Trusts and Other Commercial Property Companies, May 2019|
|GCR’s Country Risk Score report, published June 2019|
|GCR’s Corporate Sector Risk Score reports/Market Alerts, published September 2019|
H. Young and Company (East Africa) Limited
|Rating class||Review||Rating scale||Rating||Outlook/Watch||Date|
|Issuer Long term||Initial||National||BB+(KE)||Positive Outlook||October 2014|
|Issuer Short Term||Initial||National||B(KE)|
|Issuer Long term||Last||National||BBB(KE)||Stable Outlook||October 2018|
|Issuer Short Term||Last||National||A3(KE)|
Risk Score Summary
|Credit Rating||An opinion regarding the creditworthiness of an entity, a security or financial instrument, or an issuer of securities or financial
Instruments, using an established and defined ranking system of rating categories.
|Country Risk||The range of risks emerging from the political, legal, economic and social conditions of a country that have adverse consequences affecting investors and creditors with exposure to the country, and may also include negative effects on financial institutions and borrowers in the country.|
|Covenant||A provision that is indicative of performance. Covenants are either positive or negative. Positive covenants are activities that the borrower commits to, typically in its normal course of business. Negative covenants are certain limits and restrictions on the borrowers’ activities.|
|DCM||Debt Capital Market(s).|
|Debt||An obligation to repay a sum of money. More specifically, it is funds passed from a creditor to a debtor in exchange for interest and a commitment to repay the principal in full on a specified date or over a specified period.|
|Debt Service Ratio||A measure of a company’s ability to service its interest and principal redemption costs, expressed as the ratio of earnings or cash flows
over a period to the sum of interest and principal payments over the same timeframe.
|Diversification||Spreading risk by constructing a portfolio that contains different exposures whose returns are relatively uncorrelated. The term also refers to companies which move into markets or products that bear little relation to ones they already operate in.|
|Downgrade||The rating has been lowered on its specific scale.|
|Facility||The grant of availability of money at some future date in return for a fee.|
|Gearing||Gearing (or leverage) refers to the extent to which a company is funded by debt and can be calculated by dividing its debt by shareholders’ funds, EBITDA or operating income.|
|Hedge||A form of risk management aimed at mitigating financial loss or other adverse circumstances. May include taking an offsetting position in addition to an existing position. The correlation between the existing and offsetting position is negative.|
|Interest Cover||Interest cover is a measure of a company’s interest payments relative to its profits. It is calculated by dividing a company’s operating profit by its interest payments for a given period.|
|Interest||Scheduled payments made to a creditor in return for the use of borrowed money. The size of the payments will be determined by the interest rate, the amount borrowed or principal and the duration of the loan.|
|Issuer Ratings||See GCR Rating Scales, Symbols and Definitions.|
|Issuer||The party indebted or the person making repayments for its borrowings.|
|Leverage||With regard to corporate analysis, leverage (or gearing) refers to the extent to which a company is funded by debt.|
|Liquidity||The speed at which assets can be converted to cash. It can also refer to the ability of a company to service its debt obligations due to the presence of liquid assets such as cash and its equivalents. Market liquidity refers to the ease with which a security can be bought or sold quickly and in large volumes without substantially affecting the market price.|
|Margin||A term whose meaning depends on the context. In the widest sense, it means the difference between two values.|
|Market Risk||Volatility in the value of a security/asset due to movements in share prices, interest rates, currencies, commodities or wider economic factors.|
|Market value||An assessment of the property value, with the value being compared to similar properties in the area.|
|Policy||The legal document issued by the company to the policyholder, which outlines the conditions and terms of the insurance.|
|Portfolio||A collection of investments held by an individual investor or financial institution. They may include stocks, bonds, futures contracts, options, real estate investments or any item that the holder believes will retain its value.|
|Rating Horizon||The rating outlook period.|
|Rating Outlook||See GCR Rating Scales, Symbols and Definitions.|
|REIT||Real Estate Investment Trust. A company that owns, operates or finances income-producing real estate.|
|Rent||Payment from a lessee to the lessor for the temporary use of an asset.|
|Retention||The net amount of risk the ceding company keeps for its own account.|
|Risk||The chance of future uncertainty (i.e. deviation from expected earnings or an expected outcome) that will have an impact on objectives.|
|Shareholder||An individual, entity or financial institution that holds shares or stock in an organisation or company.|
|Short Term||Current; ordinarily less than one year.|
|Upgrade||The rating has been raised on its specific scale.|
|Yield||Percentage return on an investment or security, usually calculated at an annual rate.|
Salient Points of Accorded Ratings
GCR affirms that a.) no part of the ratings process was influenced by any other business activities of the credit rating agency; b.) the ratings were based solely on the merits of the rated entity, security or financial instrument being rated; c.) such ratings were an independent evaluation of the risks and merits of the rated entity, security or financial instrument; and d.) the validity of the ratings is for a maximum of 12 months, or earlier as indicated by the applicable credit rating document.
The credit ratings have been disclosed to H. Young and Company (East Africa) Limited. The ratings above were solicited by, or on behalf of, the rated entity, and therefore, GCR has been compensated for the provision of the ratings.
H. Young and Company (East Africa) Limited participated in the rating process via face-to-face management meetings, teleconferences and other written correspondence. Furthermore, the quality of information received was considered adequate and has been independently verified where possible. The information received from H. Young and Company (East Africa) Limited and other reliable third parties to accord the credit ratings included:
- the 2019 audited annual financial statements (plus four years of audited comparative numbers);
- management accounts for 1Q FY20
- a breakdown of debt facilities available and related counterparties at 31 July 2019 (including related debt covenants)
- a breakdown of the order book at 31 July 2019