Nile Ratings, a member of Fitch Ratings, has affirmed the national senior unsecured debt rating of Eastern Company (EC), the sole cigarette and tobacco manufacturer in Egypt, at AA-. The rating outlook has been revised to positive from stable.
Eastern Company, the largest cigarette producer in Africa and the Middle East, was established in 1927 as an Egyptian joint stock company majority owned by the public sector. The state-owned Holding Company for Chemical Industries is the major shareholder.
Nile Rating believes the government will continue to hold a majority stake in the company for the short to medium-term. EC currently produces some 21 different local cigarette brands. Cleopatra is the company's flagship brand, accounting for 84 percent of sales in FY02. EC held nearly 90 percent and 60 percent market share in cigarette and water pipe tobacco respectively for the same year. In addition to its local brands, EC produces foreign brands for the world's two largest tobacco manufacturers - Philip Morris and British American Tobacco - in return for a manufacturing fee.
The rating reflects EC's leading market position and its monopoly status in the domestic market for the manufacture of cigarettes, supported by a wide portfolio of local brands that cater for the middle and lower end of the market. The rating also reflects EC's strong cash flow generation and the widespread coverage of sales.
Support from the government is likely given the company's substantial contribution to the government budget through taxes, custom duties and dividend payouts. Litigation risk is also minimal due to limited health awareness in Egypt, like most of the developing countries, and Nile Rating believes the government is not likely to push the company into litigation given its major contribution to government revenues.
The agency's revision of EC's rating outlook reflects recent developments in the company's operating environment, which are likely to boost EC's business and financial profile. These developments include: the recent government approved flexible multi-bracket tax system, which expanded the tax tranches to eight instead of two. This gives more pricing flexibility to EC and enables it to raise prices on most brands. The previously imposed rigid tax system required EC to pay high taxes in case it increased its prices.
Another major development is the tariff reduction on imported tobacco leaves. The company imports some of its raw material from the US, China and Argentina where it is subject to a high tariff rate. As such, EC is currently sourcing around 30 percent of its raw materials from the Common Market for Eastern and Southern Africa (COMESA) - a preferential trade area.
An agreement to reduce tariffs on tobacco leaves within this common market to 20 percent from 80 percent will also save EC money on the 30 percent it imports from COMESA. Further tax saving would be made if the company is successful in negotiating with the government to lift the current ban on domestic tobacco production in Egypt.
The company is in the process of consolidating its production operations by moving all production facilities to its newly acquired site at 6th of October City. The new facilities are expected to start operations by 2007. The completed plants will enable EC to improve its margins and compete effectively on prices once WTO policies come into force in 2005, lifting all tariff and non-tariff barriers and opening the market to foreign competition.
Nile Ratings will monitor these developments and what effect they have on EC's fundamentals. Despite the sharp drop in EC's capex requirements in FY02, a massive working capital outflow has impacted EC cash flow from operations. Increases in operating costs in FY02 were largely attributed to a recent series of local currency devaluations.
However, EC's overall financial performance remains strong. EC's coverage, as measured by EBITDA/Net interest expense, is viewed comfortably as a national AA rated entity and has remained very healthy since our initial rating, reflecting EC's relatively stable earnings and its conservative capital structure.
The company is not highly leveraged. A lack of sizeable borrowings enabled EC to report negative net debt figures over the past three years. Net debt/Equity in 2002 was -22.3 percent. EC's last Extraordinary General Assembly Meeting approved the increase of the company's authorized and paid-in capital to 500 million Egyptian pounds ($93.7 million) and EG 375 million respectively. The increase in the paid-in capital will be financed from the legal reserves. — (menareport.com)
© 2003 Mena Report (www.menareport.com)
