OREANDA-NEWS. Fitch Ratings has assigned Indonesia-based garment and textile manufacturer PT Sri Rejeki Isman Tbk's (Sritex, BB-/A+(idn)/Stable) proposed US dollar-denominated five-year senior unsecured notes an expected rating of 'BB-(EXP)'. The notes will be issued by Sritex's wholly owned subsidiary Golden Legacy Pte Ltd and guaranteed by Sritex and its operating subsidiaries.

The final rating on the notes is contingent upon the receipt of final documents conforming to information already received. Sritex expects to use most of the proposed-bond proceeds to refinance its existing debt, including its existing USD270m five-year 9% guaranteed senior unsecured notes maturing in 2019.

At end-2015, Sritex had senior secured debt of USD153m which would rank ahead of senior unsecured debtholders in a hypothetical liquidation scenario, compared with an EBITDA of USD119m - providing for a ratio of prior ranking debt / EBITDA of 1.3x. This is well below the 2x-2.5x threshold beyond which Fitch would view the senior unsecured debtholders as materially subordinated to senior secured creditors. Therefore we have rated the proposed bond at the same level as Sritex's 'BB-' Long-Term Issuer Default Rating.

Strong Operating Cash Flow: Sritex's operating cash flow margin improved to 9% in 2015 from 1% in 2014, supported by improved working-capital management and stable profit margins. We expect the company to continue to generate robust CFO margins of between 7%-10% over the next three years. This should support healthy FCF and allow Sritex to deleverage, as its capacity expansion comes to a close this year.

Small, but Growing, Scale: Sritex has relatively small operating scale compared with its international peers in the competitive and fragmented textile sector. However, the company has significantly expanded its production such that we expect EBITDA to grow by more than 50% at the completion of the investment cycle. Sritex is vertically integrated despite its size, producing yarn, greige, finished fabrics and apparel, while many of its competitors produce only one or two of these products. This has helped Sritex to maintain higher and more stable profit margins than some of its international peers.

Vertical Integration, Growing Exports: Sritex is vertically integrated, with around 50% of its sales stemming from selling garments and finished fabric, for which it sources yarn and raw fabric from its own factories. The company also sells part of its yarn and raw fabric. Sritex also sells speciality garments such as military uniforms in addition to fashion retail, which supports higher and more stable EBITDA margins and better economies of scale. In addition, about 15% of sales came from orders by foreign and domestic governments in 2015, which are less cyclical.

Sufficient Production Capacity: Sritex's production capacity will increase to 30 million pieces of garments, 240 million metres of finished fabric, 180 million metres of raw fabric, and 654 thousand bales of yarn at the end of 2018. Much of this will be paid for by end-2016. The company expects this capacity to support demand through 2019. About 30% of yarn and 60% greige production is used internally, so the company may require spinning capacity from 2018, subject to the level of external demand.

Currency Risk Mostly Hedged: Nearly half of Sritex's sales in 2015 were exported directly, up from 39% two years ago. Most of its sales to domestic customers are also "US Dollar-linked", as much of this is exported as well. Consequently, the company has a significant natural hedge against its foreign-currency costs. This was evident in 2015 when Sritex's EBITDA margin remained largely intact in the face of severe currency volatility.

Fitch's key assumptions within the rating case for Sritex include:
- Revenue growth of 9% in 2016 and 12.5% in 2017
- EBITDA margin to remain around 18%
- CFO margin to remain between 7%-10%
- FCF to remain neutral to positive

Negative: Developments that may, individually or collectively, lead to negative rating action include:
- A sustained increase in net debt/EBITDA more than 3x (LTM1Q16: 3.0x)
- A sustained decrease in CFO margin to less than 7%

Positive: Fitch expects no positive rating action in the next 24 months because of Sritex's scale of operations which is still smaller than its higher-rated peers.

Sritex has robust liquidity, with cash and committed undrawn credit lines, respectively, of USD77m and USD131m at end-2015; expected FCF generation of around USD12m in 2016; and its nearest significant debt maturity of USD270m due in 2019. We expect Sritex to be able to generate positive FCF in the next two years, supported by waning expansionary capex and strong earnings growth.