OREANDA-NEWS. Fitch Ratings (Thailand) Limited has placed Siam City Cement Public Company Limited's (SCCC) National Long-Term Rating of 'A(tha)', the National Long-Term Rating on its senior unsecured debentures of 'A(tha)' and its National Short-Term Rating of 'F1(tha)' on Rating Watch Negative (RWN) after the board of directors announced a resolution on 25 July 2016 to acquire a 99% stake in Sri Lanka-based Holcim (Lanka) Limited (HLL) and its subsidiaries from LafargeHolcim Ltd (BBB/Stable).

The RWN reflects Fitch's opinion that the announced USD373.5m (THB13.1bn) acquisition of HLL will drive credit metrics away from levels consistent with an 'A(tha)' rating as Fitch had previously envisaged. The agency expects to resolve the RWN once the transaction completes and we obtain the finalised financing structure of the deal.

We view that SCCC's post-transaction financial leverage, measured by FFO-adjusted net leverage, could exceed 3.00x. The pace at which SCCC's leverage will fall below the current negative guidance level of 2.25x largely depends on its operating cash flow after the acquisition. However, the negative effect on the company's financial profile may be partly offset by an improved business profile in terms of operating scale and diversification.

KEY RATING DRIVERS

Deal to Weaken Credit Metrics: The HLL deal's financing structure will be a key determinant in the resolution of the RWN. While details are still to be disclosed, Fitch believes the acquisition is likely to weaken SCCC's credit metrics. The company's FFO-adjusted net leverage could rise above 3.00x in 2016 and remain above 2.25x, the negative guidance for SCCC at 'A(tha)', in the years after; depending on the transaction's debt financing and deleveraging plan.

Fitch expected SCCC's leverage headroom to fall prior to the deal announcement, as it is embarking on significant investment to increase capacity and diversify its business. This will be largely funded by domestic and overseas debt. Fitch expected SCCC's FFO-adjusted net leverage to increase to 1.5x-2.0x in 2016-2017 (1H16: 1.3x, 2015: 0.9x) and fall below 1.5x as operating cash flows continued to increase.

Single-Market Concentration: Fitch expects SCCC's ratings to remain constrained by a lack of geographical diversification, even after the acquisition of HLL, although to a lower degree. HLL's EBITDA accounted for only about 10% of SCCC's EBITDA in 2015. This contribution from HLL will not significantly increase SCCC's diversification, as most of SCCC's earnings will still come from cement and related products sold in Thailand.

Strong Market Position: SCCC is Thailand's second-largest cement producer, with a stable market share of 27% based on sales. Fitch expects the company to defend its market position against capacity expansion by the third-largest producer due to its strong brand in cement and ready-mixed concrete. Its relatively high profit margin should provide pricing flexibility to respond to heightened competition.

Competition to Affect Profitability: Fitch expects competition in the Thai cement market to intensify in 2016 due to new capacity and for SCCC's EBITDA margin to narrow as it defends its market share. Fitch expects the company's EBITDA margin to decline to 21%-22% in 2016, from 23%-24% in 2013-2015; a short-term weakening until demand growth absorbs new supply by 2017.

Vulnerable to Energy Prices: SCCC's EBITDA margin is highly sensitive to coal and electricity energy costs, which account for more than 70% of total production costs. Average benchmark coal prices decreased by almost 20% in 2015 and Fitch expects further declines in 2016 as excess capacity continues to weigh on prices, with only a modest and gradual price recovery over the medium term.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- improving domestic cement sales volumes but lower average selling prices in 2016

- inclusion of HLL acquisition

- exports continue to form 20%-25% of total sales in 2016 and decline in 2017 due to improving domestic sales

- EBITDA margin to fall to about 21%-22% in 2016 and improve to about 22%-23% in 2017

- a dividend payout ratio of about 70%-80%.

RATING SENSITIVITIES

Fitch expects to resolve the RWN once final details of the acquisition financing are known and the agency understands SCCC's post-acquisition capital management policies.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- FFO-adjusted net leverage above 2.25x on a sustained basis

- a weakening of SCCC's profit margins.

Positive: Factors that could lead to Fitch removing the Rating Watch Negative and assigning a Stable Outlook include SCCC abandoning the HLL acquisition or no deterioration in SCCC's credit metrics post-acquisition