Sargam Retails downgraded to 'Fitch BBB(ind)'/stable

Fitch Ratings has downgraded India-based Sargam Retails Pvt Ltd's (Sargam Retails) National Long-Term rating to 'Fitch BBB(ind)' from 'Fitch A-(ind)' and removed it from Rating Watch Negative. The Outlook is Stable.

Fitch Ratings-Mumbai/Singapore-21 September 2011: Fitch Ratings has downgraded India-based Sargam Retails Pvt Ltd's (Sargam Retails) National Long-Term rating to 'Fitch BBB(ind)' from 'Fitch A-(ind)' and removed it from Rating Watch Negative. The Outlook is Stable. Fitch has also downgraded Sargam Retails' INR955m long-term loans to 'Fitch BBB(ind)' from 'Fitch A-(ind)'.

The rating action reflects the promoters' decision to curtail tobacco trading at Sargam Retails with effect from September 2010 and Fitch's expectation that this change in business policy would have an adverse impact on the company's overall credit profile. Around 70%-75% of the group's tobacco trading revenue is now being generated by the partnership firm Giriraj Enterprises ('Fitch BBB(ind)'/Stable).

The ratings are also constrained by the regulated nature of the tobacco industry and the high level of competition from the large number of unorganised chewing tobacco manufacturers. The risks are however mitigated by the price inelasticity of the product, the brand loyalty displayed by consumers and Sargam Retails' strong distribution network in Maharashtra.
The ratings continue to reflect the strong brand name of the Malpani group's flagship chewing tobacco product - "Gai Chaap" zarda - in India and the market leadership that the brand enjoys in Maharashtra along with a strong position in Karnataka, Andhra Pradesh and Gujarat. The ratings also factor in Sargam Retails' expected stable revenue from wind power generation (around INR170m annually), which along with tobacco trading revenue (expected to be over INR800m for FY12) is likely to generate adequate cash flows for debt servicing. The company has substantially reduced its fixed costs in FY12 till date, which is expected to lead to a large improvement in EBITDA margin to over 30% (FY11: 18.59%).

With the absence of significant capex in the medium term, scheduled debt repayments will result in a strengthening of the company's financial leverage (net adjusted debt/operating EBITDA) in FY13-FY16 over the expected levels of 1.75x-2.0x at FYE12. The liquidity position is likely to remain comfortable considering that the company is expected to turn free cash flow positive in FY12, and given its large cash balances (FY11: INR85.8m). It also enjoys a certain degree of financial flexibility from loans given to group partnership firms Giriraj Enterprises and Malpani Estates (FY11: INR1309.3m), of which some amount may be recalled (subject to availability of cash in those firms) in case of liquidity pressures.

The ratings may be upgraded if Sargam Retails maintains leverage at below 1.5x and fund flow from operations (FFO) fixed charge coverage at over 4.0x on a sustained basis. Conversely, an increase in leverage to over 3.0x or FFO fixed charge coverage falling below 2.5x on a sustained basis may result in a rating downgrade.

Sargam Retails, a distribution arm of the Sangamner-based Malpani group, trades in zarda as well as certain FMCG products. It also distributes liquefied petroleum gas in Sangamner district, besides earning from wind power generation from its 24 windmills located in Gujarat, Karnataka and Maharashtra. For FY11, the company registered (provisional) operating revenues of INR2378.2m (FY10: INR3915.7m), EBITDA margin of 18.59% (23.06%), leverage of 1.62x (0.45x) and FFO interest coverage of 4.0x (10.0x). 

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