Persistently high gearing sees Cargen’s rating downgraded
GCR downgraded Car & General (Kenya) Limited’s (“Cargen”) national KShs long term rating to BBB- (triple B minus) from BBB (triple B), while the short term rating was maintained at A3.
The downgrade was largely the result of persistently net high gearing metrics, which continue to exceed budget. In this regard, debt climbed to KShs1.1bn at FYE10, compared to the forecast net debt of Kshs700m. Accordingly, while net gearing and net debt to EBITDA both declined somewhat to 67% and 229% respectively at FYE10 (FYE09: 70%; 257%), gearing metrics remain close to review period highs. However, earnings improved in F10, with revenue increasing by 10% to KShs4.8bn and operating profit by 27% to KShs413m, on the back of tighter cost management. As such net interest coverage climbed to 3.2x (F09: 2.2x).
Rising debt has largely been driven by working capital absorptions. While the group has expended significant effort to improve cash utilisation, much of the benefits have been offset by expansionary investment in inventories. To this end, Cargen has differentiated between its engineering and motorcycles businesses. Engineering has, historically, been the major source of working capital pressure, as the high-horsepower generator sets are very high value (around US$0.5m per set) and installing them can take up to three months. Thus, while the group will continue to supply and install generators, this is now on much stricter payment terms, resulting in a reduction in debtors. In contrast, Cargen is investing heavily in expanding its two and three wheeler motor cycle business. Management indicated that the group’s products were close to reaching the point of critical mass, whereby they dominate the market. At such critical mass it would be difficult for competitors to enter the market. This would allow Cargen improved pricing power and the ability to pass on exchange rate fluctuations to customers.
Overall, Cargen’s primary objective in F11 will be increasing its market share in the two-wheeler market across Kenya. To this extent, management has indicated that operating margins may be negatively impacted in F11, as the group constrains the selling price of its vehicles to encourage sales. Moreover, this strategy will require working capital investments. Debt requirements are also likely to arise from ancillary investments, such as the expansion of the Kibo Poultry operations and possible property developments. Accordingly, GCR expects gearing to remain around current levels in the short term, albeit with improved earnings strengthening credit protection metrics.
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