Sri Lanka Equity Research

Diesel & Motor Engineering PLC

noreply@blogger.com (Sri Lanka Equity Analytics) — Tue, 12 Apr 2011 02:10:00 +0000

Overview of the company

Diesel & Motor Engineering PLC was established in 1939 as apartnership and probably the oldest sole distributor for Mercedes-Benz Passenger and Commercial Vehicles, in the Asian Region. InSri Lanka, DIMO is colloquially known as the “Benz Company”.

The Company has a record of 68 years experience in theautomobile and engineering industry and over the years has made a major contribution towards the development of thetransportation sector in Sri Lanka. DIMO represents many prestigious principals such as Daimler, TATA, Chrysler, MTU,Bosh, Komatsu, Siemens, Michelin, Osram, and Mahindra &Mahindra. Dimo group has diversified its business segments intothe areas of Power Engineering, Building Technologies, PowerSystems, Agricultural Machinery, Lighting Systems and WaterManagement Solutions.

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CHEMICAL INDUSTRIES: Impressive 58.7% YoY Growth in 3QFY11

noreply@blogger.com (Sri Lanka Equity Analytics) — Tue, 12 Apr 2011 02:05:00 +0000

Earnings Reach LKR759mn Posting an Impressive 58.7% YoY Growth

Chemical industries (CIC.N.LKR154.70,CIC.X.LKR109.00), posted a net profit of LKR759.0mn for 1-3QFY11 (vs. a net profit of LKR485.3mn for 1-3QFY10), reflecting a growth of 56.4% YoY, where company achieved net earnings of LKR382.7mn for 3QFY11.
Growth was supported primarily by strong growth in agricultural & livestock segment earnings ( 42.7% YoY growth). Further triggered by impressive performance from construction, consumer & pharmaceutical segments posting YoY growth rates of 46.8% and 37.6% respectively.
With country’s agricultural sector showing significant growth with improved economic conditions (agricultural sector grew at an impressive 7.0% for the FY2010), where the growth is expected to continue(according to rice research & development institute, Sri Lankan Demand for rice for local consumption in 2020 expected to be 4.6mn tons. Production should increase by 50% in both dry & wet zone to meet this target), also with the improved performance of Poultry & Feed segments with the increasing consumption levels.
Further with the boost in construction industry expected to continue with the rebuilding efforts and major undertakings in leisure industry, and with CIC’s plans expand overseas, counter is poised to benefit with the strong presence in Agricultural, Construction, consumer & pharmaceutical segments. Against this backdrop we expect CIC to record LKR935.2mn in FY11E (up by 56% YoY) and net earnings of LKR1, 143.4mn in FY12E (22% YoY growth).
CIC (voting) currently trades at 15.7X forecasted FY11E net profit, 12.8X estimated FY12E net profit and 3.1X PBV. CIC non- voting currently trades at 11.4X forecasted FY11E net profit and 9.3X forecasted FY12E net profit, as opposed to a chemical & pharmaceutical sector PE of circa 17.7X and a current trailing market P/E of 18.7X. We believe counter holds strong upside.

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Banking Sector – Riding the Growth Wave

noreply@blogger.com (Sri Lanka Equity Analytics) — Tue, 12 Apr 2011 02:01:00 +0000

Upside to loan growth

We expect the listed licensed commercial banks (LCBs) to book anaverage loan growth of 25% in FY11, picking up from the average lending growth of 22.52% YOY recorded in FY10Q4.We believethe positive macro economic outlook will translate to higher demand for credit aided by the low interest rates.

We feel following sectors are likely to boost the loan growth; SME– construction, agriculture, Corporate – leisure, energy,construction, trade, Personal – pawning, housing and leasing.

NPLs – An unlikely cause for concern

Despite a high loan growth forecast, we anticipate the gross nonperforming loans (NPLs) to reside around 6% in FY11 due to the improving debt servicing capacity of borrowers. Exceptionallyhigh NPLs are expected to decline in FY11, which will contribute to lower overall NPLs.

Tax cuts to help the industry

The proposed tax cuts (Financial Services VAT (FS VAT) from20% to 12% and the Income Tax from 35% to 28%) are expected to boost industry lending and thereby resulting in higher profits.

Our picks

We recommend SAMP and NTB on the basis of low P/Es, PBVand attractive growth prospects over the next 12 months.

*Since NDB Bank PLC is the parent company, it is excluded from the recommendation analysis as a company policy.

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Sri Lanka - Country Report 2011

noreply@blogger.com (Sri Lanka Equity Analytics) — Tue, 12 Apr 2011 01:57:00 +0000

The year 2010, when the thirty year civil war ended, generated much optimism regarding Sri Lanka’s economic prospects. The real GNP growth at this time seemed to bear this out. The first nine months of 2010 recorded a 7.9 percent real GDP growth, compared to 3.5 percent in 2009, and as against an expected growth rate of 7.5 percent in 2011. The business conglomerates that incurred losses in 2009 recorded nearly a 50 percent year over year growth in net earnings during the first three quarters of 2010. Having displayed this striking buoyancy the private sector is expected to do even better in 2011.

These signs of a turn-around have been widely attributed foremost to the ending of the prolonged civil war. With this presumption there is the hope that the next few years’ growth rate will increase further, having performed poorly during the war and because of the war. Yet, a comparison with Sri Lanka’s war time economy hardly provides ground for this optimism which the mere ending of war has generated. Respectable rates of growth were achieved even during the war years of 1983 to 2008. During this 26 year period the average annual growth of the real GDP averaged 5.8 percent, considerably higher than in the twenty one years preceding the war from 1961-1982, when the growth rate was only 3.8 percent (Table 1). In this connection it is also important to note that this commendable growth rate during conflict years was realized even without the tourist boom –the offspring of peace- which helped the economy to reach 7.9 percent growth in the immediate post-war year 2010.

The relatively high average annual increment in GDP during the war, suggests that growth was not adversely affected by the conflict if growth is measured in conventional terms. It might not be wrong to say that, the economy reaped what may be considered to be a ‘war dividend’ much larger until now than the ‘peace dividend’ which was expected to accrue once the war was over. On this reckoning, contrary to what is commonly supposed is borne out: the war had not unduly depressed economic growth, with the economy waiting to take off when peace and political stability returned. The war seemed in fact to have enhanced growth rather than curtailed it.

Further, the growth of 7.9 percent in 2010 – the immediate post conflict year – is only marginally above the average growth rate of 7.3 percent during 2006/2007, the years of intensified fighting (Table 2) and escalating defense expenditure. The GDP growth of 7.3 percent in these two years was all the more notable since it took place after a high-base output growth of 6.2 percent in 2005, as opposed to 2010 in which year the growth performance occurred from a low base of 3.5 percent. Hence, even the average growth rate achieved during the severely war ravaged years of 2006/07, proved to be more robust than that during the post-conflict year – 2010, allowing for a clear twelve months period.

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Namunukula Plantations (NAMU) – Stronger Earnings Through Crop Diversification

noreply@blogger.com (Sri Lanka Equity Analytics) — Tue, 22 Feb 2011 09:27:00 +0000

Namunukula Plantations (NAMU.LKR127.60) recorded a net profit of LKR146.7mn in FY10 (vs. net earnings of LKR40.7mn in FY09) mainly on the back of the 19.2% YoY growth in top line backed by attractive Net Sales Averages ( NSA’ s) achieved for all 3 main crops (Tea, Rubber and Oil Palm) of the company.
NAMU, one of the well diversified plantation company’s in Sri Lanka has a distinct advantage over its competitors in terms of balanced crop mix. NAMU which is renowned for its quality low grown type of tea, focuses heavily on maintaining the quality of end product consistently, which would enable them to grab high prices for their products.
With Plantation worker wage revision due in April 2011 (current agreement will expire in March 2011), it’ll have a considerable impact on Profit margins in tea segment as a whole (tea is a highly labour intensive commodity). But since tea segment contributes only up to circa 20% of gross profit of NAMU, where Oil Palm and rubber which are less labour intensive crops constitute major portion of Profits, NAMU’s profit margins would have a lesser impact compared to its competitor firms which rely highly on tea.
We believe NAMU has strong earnings growth potential on the back of, strong demand for low grown tea ( particularly from Middle East & Russia ) together with premium prices expected to boost earnings, recovery of crude oil prices leading the demand and prices of natural rubber to recover strongly and sustain at current attractive levels (global NR supply is expected to fall behind its consumption up to 2020), backed by enhanced contribution from Oil Palm segment (area cultivated under Oil Palm expected to go beyond 1,600hectares Within next 3 years). In line with this, we expect NAMU to record LKR460.7mn in FY11E (up by 214% YoY) and net earnings of LKR539.5mn in FY12E (17% YoY growth).
NAMU (voting) currently trades at 6.6X forecasted FY11E net profit, 5.6X estimated FY12E net profit and 3.3X PBV, as opposed to a Plantation sector PE of circa 27.5X and a current trailing market P/E of 22X. Hence we see great value potential in the counter.

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Lanka Walltile (LWL) - The Wall-Tile Giant

noreply@blogger.com (Sri Lanka Equity Analytics) — Tue, 22 Feb 2011 09:25:00 +0000

The wall-tile giant encompasses Lanka Tiles PLC (54.5% ownership) and Uni-Dil Packaging (52.9%) whilst having a controlling interest in Horana Plantations PLC with a 27% effective holdings (Through Ceytea Plantations). Furthermore, LWL has an associate interest of 34.6% on Parquet (Ceylon) PLC, which changed its core business to production of Grout and Mortar.

LWL recorded a 14% incline to LKR6,444.3 mn in the top line for the cumulative 3QFY11 on the back of the increased demand by the local market. 60% of the top line was contributed by the tile segment followed by packaging materials which contributed circa 18% of the counter‟s turnover.

Going forward, with the construction sector boom together with strong investment inflow and higher activity levels in the country the „tile giant‟ pertains value as a potential growth stock.

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Kegalle Plantations (KGAL) – Towards a Promising future

noreply@blogger.com (Sri Lanka Equity Analytics) — Tue, 22 Feb 2011 09:23:00 +0000

Despite the impact from a 40% wage hike, Kegalle Plantations (KGAL.LKR204.80) managed to record an impressive net profit of LKR376.0mn in FY10 (83.4% YoY growth). Favorable market conditions for tea & rubber during the 2nd half of the year and changing the tea and rubber grade mix to suit market conditions contributed to this achievement.

At the same time company achieved an overall NSA (Net Sales Average) of LKR279.12 in FY10 for rubber (vs. an overall Sri Lankan average of LKR212.0) which is a 18% increase compared to last season in spite of the drop in rubber market during first half.

In FY10, KGAL invested LKR183 mn as Capital Expenditure, out of which LKR114mn was spent on field development including replanting and maintaining tea and rubber focusing on long term benefits. Replanting rubber will continue to have priority which will increase its production in the long term.

We believe KGAL has strong earnings growth potential on the back of, the rising world rubber prices, a full recovery from global recession; would place KGAL at a definite advantage as the largest rubber producer in Sri Lanka, and with KGAL’s ability to adjust tea grade mix to exploit market trends. Against this backdrop we expect KGAL to record LKR537.5mn in FY11E (up by 43% YoY) and net earnings of LKR796.1mn in FY12E (48% YoY growth).

KGAL (voting) currently trades at 9.5X forecasted FY11E net profit, 6.4X estimated FY12E net profit and 3.0X PBV, as opposed to a Plantation sector PE of circa 23.3X and a current trailing market P/E of 22X. We believe counter holds strong upside. Hence we rate KGAL a BUY.

the full report

Vallibel One: the growing conglomerate with a Rs.1.2 billion net profit in 2010 and beyond

noreply@blogger.com (J.A. Fernando) — Fri, 04 Feb 2011 17:17:00 +0000

Vallibel One Limited is a diversified holding company incorporated on 09th June 2010. Prior to the proposed private placement and initial public offering 100% of the shares in issue are held by the business tycoon Dhammika Perera and companies controlled by him. Through its subsidiary companies Vallibel One has made strategic investments in financial services,manufacturing and leisure industry.

The company intends to raise SL Rs.4bn by way of a private placement with the option of increasing up to SL Rs.4.5bn in the event of over subscription and approximately a further SL Rs.1.43bn by way of an initial public offer. The capital structure of the company is given below.Objectives of the Issue The company intends to raise funds through this Issue to finance an equity investment of SLRs.3Bn in a new hotel project developed under its full owned subsidiary Greener Water Limited.The total estimated cost of the hotel project is SLRs.5.0 bn.

Operational Overview

Vallibel One’s presence in the financial services sector is through its 51% owned subsidiary LB Finance PLC and strategic investment in Sampath Bank PLC. The company marks its presences in the manufacturing sector through its 51% owned subsidiary Royal Ceramic PLC. Interest in the fast growing leisure industry is through its fully owned subsidiary Greener Water Limited.

L B Finance PLC (LFIN)

L B Finance is public listed company and is rated BBB+ by Ram Rating Sri Lanka. The company offers a range of financial services which includes hire purchase, leasing, mortgage loans, gold loans, fixed deposits, money transfer and Islamic finance products. Its wider distribution network of 31 branches and 84 pawning centers gives an edge over its competitors and the management intends to increase the number of branches to 90 and the pawning centers to 170 by 2015.

According to RAM Ratings LB Finance is the third largest Registered Finance Company (RFC) in Sri Lanka, accounting for nearly 10.47% of the industry assets as at September

2010.Decline in interest rates resulted in a phenomenal growth in credit demand which enabled LFIN to post a strong growth in net interest income during 2010. The recent import duty reduction on motor vehicles boosted the hire purchase and leasing business of LFIN. The reduction of Import duty on industrial machinery as proposed in the 2011 budget and reduction in Value Added Tax (VAT) on imports from 20% to 12% will further facilitate growth in leasing and hire purchase operations.

Sampath Bank PLC (SAMP)

Sampath Bank (SAMP) is the third largest local commercial bank in terms of its asset base of SL Rs.172bn. For FY09 SAMP reported the fourth largest profit in the banking sector. SAMP holds the vision of becoming a leading financial services provider and at present operates through 165 branches in all parts of the country with access to over 219 own Automated Teller Machines (ATM) and 730 other ATMs networked around the country with other bank networks. Currently SAMP holds six subsidiary companies under its umbrella providing a compendium of financial products and services.Banking industry in Sri Lanka remains a lucrative business due to the higher net interest spread and increasing demand for credit as the country has become one of the fastest growing economies in Asia after ending three decades of war which was a major obstacle for growth in many dimensions. As mentioned earlier the importation of motor vehicles to the country boosted with the recent reduction in import duty.

This not only enhanced the leasing business but also fees & commission income of the bank (by way of letter of credit).Amidst these conducive economic conditions, the 2011 budget fortified the banking & finance sector by way of reducing corporation tax from 35% to 28% and Value Added Tax on Financial Services from 20% to 12%.The tax savings arising from these proposals will be transferred to separate investment fund accounts maintained with the CBSL and will be utilized to provide long maturity low interest rate loans which would facilitate growth in loans and advances and interest income.

Royal Ceramic PLC (RCL)

Since its inception in 1990 Royal Ceramics focused its efforts on being a brand leader in its industry. The company made the transition from a private company to a public one in 1994. Today RCL is leading the market, having captured more than 55% of the Sri Lankan market while exporting to numerouscountries across the globe. The Company's marketing operations are supported by a strong distribution network comprising of 40 showrooms and 3 warehouses and 3 state of the art manufacturing facilities.

The construction industry is booming on the back of higher consumer spending amidst low interest rates. Thus consumer spending on housing is anticipated to increase in the ensuing years. Further, reconstruction of north and east, refurbishment and construction of new hotels and resorts are key contributors to this boom with RCL being a key beneficiary.

Greener Water Limited

Greener Water Ltd is the leisure sector investment arm of Vallibel One. The company has already invested SLRs.266.73mn in a 14 acre land located in Kochichikade, Negombo, Sri Lanka. The company intends to build a 382 room, luxurious five star hotel at an estimated cost of SL Rs.5bn of which SLRs.3bn will be financed through the private placement and IPO proceeds.The initial design concept for the hotel was carried out by WATG of Singapore, one of the world’s leading design consultants for the hospitality,leisure and entertainment industry. The first stage architectural designs have already been completed and detailed designing in terms of M&A designs & Landscape designs are currently in progress.

The construction of the hotel is estimated to take two years and commercial operations are planned to commence by end of 2013.

The hotel will be developed as a BOI approved investment which will qualify for 8 years tax holiday, and a concessionary tax rate of 15% thereafter.The hotel will target the high end of the tourist segment and will be positioned as a five star hotel. At commencement gross Average Room Rate will be USD 180 and will increase up to USD 220 by the 5th year of operation.

Valuation

Based on FY11/12 forecasted earnings the share is issued at a PE of 13.65x (FY12/13 at 10.26x) and at a PBV of 0.83x (FY11/12 at 0.73x). Vallibel One is likely to be listed under ‘Diversified Sector’ (DIV) or the ‘Investment Trust’ (INT). DIV sector is trading at a PE of 32.8x and at PBV of 3.6x, while the same for INT sector is 28.6x and 4.0x respectively. Thus Vallibel One shares are issued at a significant discount to its respective sectors.

Recommendation

In this report profits are forecasted using conservative assumptions. With the anticipated growth strategies the profitability of the company can improve further.

On a Forward Earnings based approach and on a forward PBV approach the share is issued at a discount to its intrinsic value. Hence investors can immediately expect capital gains on the counter and better prospects in the long term, thus we recommend a BUY.

Courtesy - Capital Trust Research

ODEL seeking for incessant market expansion in Apparels, growing 26% YOY in 3Q in 2010

noreply@blogger.com (J.A. Fernando) — Thu, 03 Feb 2011 13:20:00 +0000

Background

Odel which was established as a private limited company in 1990 by Otara Guawardene has today evolved as a foremost group of companies in Sri Lanka. It recently obtained the listing on Colombo Stock exchange, whilst being the first fashion retailer to go public in Sri Lanka.

The IPO was successfully oversubscribed by 63.8 times.

Company’s success is underpinned by its correct strategic view on market expansion and diversification. The group is seeking for incessant market expansion especially in concern to the apparel sector where company has expanded up to possessing 13 outlets with 136 square feet of high quality shopping.

The flagship store at the Alexandra Place is witnessed as an enthralling tourist destination.

Today Odel is highlighted amongst the leading apparel giants in Sri Lanka.

Financial Highlights for the 3Q ended 31st December 2010

The top line of Odel Group grew by 15% QoQ while YoY growth amounted to 26%.

Group seems to have imposed control over the cost structure to improve the gross profit margin to 39%.

Other income has declined by 72% to Rs.24 million YoY while QoQ there’s a marginal decline of 9%.

Distribution expenses saw an YoY decline of 18% while administration expenses saw only a marginal increase of 1%, thus operating profit margin improved from 12% to 14.6%.

During the 3Q Bottom line of ODEL reached SLRs.76mn up by 35% YoY, and 19% QoQ.

The remarkable QoQ top and bottom line growth rates posted during the 3Q of the current

financial year are backed by the increased demand and sales that occurred during the Christmas and New Year festive season and the increase in tourist arrivals.

Glance at first 9 months FY 10/11 results of the group

During the period top line grew by a staggering 42% YoY to reach 2.5bn.

Gross profit grew by 53% YoY to SLRs.967mn, with gross profit margin improving to 39%.

Group as a whole expressed a gratifying performance as the profitability of the group shows a strong upward movement with profit before tax increasing by 61% YoY to reach 287mn. Profit After tax for the same period amounted to SLRs.176mn up by 43% YoY however net profit margin remained at 7%.

Future Outlook

With the milestones of success that Odel has marked in its expedition, the group could shunt ahead exposing a significant competition to the existing market players and creating a strapping barrier to the new entrants whilst enhancing and strengthening its brand image impressively. The

key success of the Odel group lies on the apparel sector as Odel outlets are leading as sought after destinations amongst other shopping outlets of the country, reasoning being that its flagship store is becoming comparable to international department stores in any fashion capital.

As the next walk in their massive expansion stratagem, Odel which is acknowledged as the country’s definitive and life style brand, has announced its plan to expand to Kiribathgoda and Wattala regions which are situated in the highest populated Gampaha District, whilst increasing its retail space further by 22,000 square feet and number of outlets to 15. However important consideration is raised on the other hand that such aggressive expansion strategies would lead to the dilution of their “Exclusive” brand value.

During the year Odel alsohas built up several important strategic links with corporate giants. A noteworthy one is the ODEL‐HNB co branded credit card which is a gold card that comes under VISA international brand that offers attractive benefits for the customers shop at Odel. This would strengthen the group’s sales to a greater extent.

Further the sophisticated and award winning Odel website also put in a remarkable contribution for heightening up sales, offering a comprehensive shopping experience through enhanced e‐commerce facilities.

Odel so far has carried out firm differentiation strategy offering a wider product change in their shopping outlets.

It’s products range from ladies ware, gents ware, kids ware, home ware, Sri Lankan souvenirs, food, backstage, embark collection, R&R whilst differentiating its outlets to that of other fashion retailers that Odel is hardly imitable.

An optimistic panorama is put forward specifically for Odel which is a leader in the market, by the augment in the tourism industry which is expected to grow by 40% to 850,000 in 2011 and reach 2.5million tourist arrivals by 2016 as per the Sri Lanka’s tourism authority in which case, Odel shopping outlets would play a key role in providing exceptional quality shopping facilities for the foreigners. This would grant a extraordinary backup for the boost of future demand for Odel apparel.

On 19th of November it was announced that the Odel acquired a prime land 250.4 perches in Thalangama for Rs.257.9 milion through its fully owned subsidiary Odel Lanka (Pvt) Limited witch is incorporated to plan the preliminary activities required to construct a high rise shopping mall complex. This provides an insight of a large scale strategic investment that the Odel is expecting to initiate with its hands on experience and victorious voyage whilst enjoying economies of scale and economies of scope advantages. Ability of the group as a whole for tapping superior profitability in a very healthy context in the upcoming years is thus evident.

The budget proposed on 22nd on November for year 2011 has projected many concessions favorable concessions. It proposed to reduce custom duties on selected goods and raw materials and also with the aim of promoting Sri Lanka as an attractive destination for international shopping for branded items, internationally branded items were exempted from VAT and import duty. Further the economic service charges on BOI enterprises were revised down to 0.1%. These policies would definitely have a positive impact on the Odel group creating a promising future to enhance the business.

Recommendation

Looking at the current performance together with the future outlook of the group the counter looks attractive in the medium to long term. Thus we recommend a BUY.

Courtesy-Capital Trust Research

DISECTING 2010 - Sri Lanka Stock Market Perspective

noreply@blogger.com (Sri Lanka Equity Analytics) — Thu, 06 Jan 2011 03:42:00 +0000

Economic Rewind
GDP growth gathers momentum

The year 2010 showed signs of improvement in the Sri Lankan economic outlook as the year witnessed the highest ever recorded GDP growth since 2002 in the 2Q, 2010 of 8.5 % amounting to Rs.634.9 bn. All three sectors of the economy registered significant growth in 2010 over the same period of previous year. The agriculture sector growth was backed by the improved global market prices and the upward trend in prices of natural rubber. The agriculture sector growth was further fuelled by increase in paddy and fishing production with the addition of North and East to the rest of the economy.

res

Services sector witnessed a sound performance stimulating economic growth. Food & beverages industry fared better in the light of hotel & leisure sector expansion. Commendable performance recorded especially in banking & finance, agriculture and transportation sector backed by positive market sentiment and overall global economic recovery. Industry sector performance was affected by the removal of GSP+ tariff concessions coupled with the rising production cost however it was assisted by the increase in demand for semi precious stones, improvement in construction sector and electricity gas and water. The sector contribution of Agriculture,Industry, and Services to the total GDP in 3Q2010 was 12.0 %, 28.5 % and 59.5 % respectively. The Q3 GDP growth figure was well above expectations of the central bank and appeared optimistic that the momentum would continue well in to next year.

The fiscal position amidst significant fiscal reforms

2009 witnessed a staggering fiscal deficit of 9.9% of GDP well above the target deficit rate of 7% of GDP for the year. In 2010 the government deficit for the period January to October 2010 stood at Rs 376.8bn. The total revenue recorded an increase of 12.6% amounting to Rs. 671.9 bn from Rs. 596.7 bn recorded for the same period in 2009. Tax revenue grew by 14.66%percent to Rs. 580.3 bn from Rs. 506.1 bn accounted for in the same period of 2009. This was largely due to the increase in imports fuelled by reduction in imports duties especially on motor vehicle importation.

The total expenditure for the period grew by 6.87% amounting to Rs. 1,048.7 bn compared to Rs. 981.2 bn recorded for the same period in 2009. Recurrent expenditure during the ten month period increased by 3.07 % to Rs. 787.4 bn from Rs. 763.9 bn a year while capital expenditure increased by 20.24% to Rs. 261.3 bn from Rs. 217.3 bn. The expected approximate figure for year 2010 will reach 8.67% of GDP exceeding the IMF’s recommended target deficit rate of 8% of GDP. However government has made significant fiscal reforms in its 2011 budget proposal and the expected reduction in budget deficit from 9.9 % recorded in 2009 to 8.67% signals that the government is stepping in the right direction. Addressing the fiscal imbalance is however a complex and sensitive issue which ought to be dealt with extra diligence. While adhering to IMF requirements any comprehensive measure which aims at altering the distribution of resources should render special attention to the socio-economic and political impacts.

A gradual rise in inflation

Inflation has witnessed a gradual increase in year 2010. The year started with an annual average of 3.1 % which gradually climbed to 5.8 % in November 2010. The low inflation levels experienced at the beginning of the year was due to the contraction in demand backed by the global economic downturn .However with the gradual recovery of global economy inflation in Sri Lanka increased gradually and the point to point inflation for the month of November increased to 7% from the 6.6% accounted in the previous month. Further the 12 month moving average inflation was reported at 5.8 %, the highest reported since reaching 3. 1% in January 2010. The increase was largely due to supply side constraints which led to the increase of most food prices such as rice, vegetables, sea food and sugar.

Food imports account to circa 14% of the total import cost of the country therefore; the increase in the import cost of staple food items will continue to enforce upward pressure on inflation. The supply constraints are worsened by the rise in oil prices towards the latter part of 2010 which increases production costs. However the gloomy economic outlook which hovers over the western centric economies will keep global demand pressures intact for 2011, in this connection the Central Bank anticipates the inflation to remain within single digits in the coming year.

A widening trade balance

Sri Lanka experienced a trade pattern of continuous increase in the growth rate of imports not matched by a similar increase in the growth rate of exports throughout 2010.

The period January - October 2010 witnessed a trade deficit of USD 4,357.1 mn. There was a 32.8% YoY increase in import expenditure for the period in concern which amounted to USD 10,862.6 mn unmatched by the value of exports that reached USD 6,505.5 mn, an increase of 13.2% YoY.

However in the month of October Sri Lanka’s trade deficit rose by 79.2 % YoY to USD 4,375.1 mn despite export earnings (+27.6% YoY) managing to outpace the flow of imports (+8.4% YoY). Therefore, the export gains recorded during the month of October were partially offset by the overall activity recorded during the year. Crude oil accounts for 25% of the total import costs while food imports accounts for 14% of total imports. The major exports on the other hand mainly comprises of primary commodities making Sri Lanka highly vulnerable to price volatilities of the global market. Trade deficit for the first ten month period of 2010 contracted by 20.9% to USD 328.6 mn compared to the same period of 2009.

The sharp increase in all segments of imports are expected to continue well in to the next year fuelled by the increase in consumption. Western countries continue to be the major destination for Sri Lanka’s exports. Europe and U.S.A together account for 60% of country’s exports. Hence the recent unfavourable economic conditions prevailing in the US coupled with the sovereign debt crisis of Euro zone would have a negative impact on the export earnings given the western economies would continue in experiencing a sluggish economic recovery over the coming year.

atures

Key Events that had a bearing on the market

2010 In Retrospective

The forward march from a stunning year 2009 persisted as the Colombo bourse continued it ‘climb up’ during 2010 to record a YTD return of 96.0%. After being recognized as the second best performing market by Reuters in 2009, CSE sustained the momentum to touch 7,000 levels in October 2010 and overtook Mongolia to emerge as the top performer in the world for 2010.

However, CSE performance lost grounds thereafter shedding nearly 600 basis points till December.

The more liquid Milanka Price Index (MPI) also gained in line with the broader market index by 83% during 2010 and surpassed its 7,000 milestone in September 2010. Despite the dip in the CSE since October 2010, MPI regained its 7,000 levels with the revival that was seen in the bourse over the past couple of weeks.

Features

Turnover levels were concurrent with the market performance taking the YTD average daily turnover to LKR2.4 bn.

The YTD foreign interest recorded an outflow of LKR32.6 bn. Having overcome few of the bottlenecks for investment in Sri Lanka; inclusive of political instability monetary and fiscal disciplines last year, we believe foreigners would revert their attention to Sri Lanka’s equity market.

2010 New Listings

Entities continue to show interest for listing especially from the finance sector due to regulatory obligations. All the Initial Public Offers (IPOs) during 2010, were over-subscribed reflecting the positive investor appetite.

*To Initiate trading in January 2011

Source : Colombo Stock Exchange

Quick Look at Sectoral Performance during 2010

The top five sectors during 2010 are as below :

 Trading  Stores & Supply  Motors  Services  Banks, Finance & Insurance

Among the weak performers during 2010 were :

 Investment Trust  Construction & Engineering  Healthcare  Telecommunication  Power & Energy  Land & Property

Earnings Snapshot

Banks, finance and insurance, one of the heavy weight sector, exhibited strong performance in terms of earnings during the year, majorly due to accelerated economic activities in the country. The same momentum can be expected going forward which would be backed by significant investment in branch expansion and investor friendly policies imposed by the government. The major contributors to this growth are Hatton National Bank, Commercial Bank & LOLC.

The Hotel & Travels sector saw a great revival during the latter part of 2010 as many hotels plunged into operations after their refurbishments in mid 2009. Colombo city hotels such as Galadari, Cinnamon Lakeside and Cinnamon Grand highly benefited with the corporate activity level grabbing in many foreign visitors. Resort hotels were also able to improve their bottom line with the seasonal foreign tourist arrivals. Going ahead, with Sri Lanka having already catered 600,000 tourists mid December, is targeting 2.5 mn tourists by 2016. The hotel and the leisure sector as a whole will be a direct beneficiary of these expectations.

The food & beverage, one of the key sectors listed in CSE, posted positive earnings during the year. Poultry sector players (Bairaha Farms and Three Acre Farms) sustained their growth story benefiting from the increased chicken consumption in the country. Cargills (Ceylon) also contributed to the sector growth with the addition of the North and East markets to its customer base whilst momentum continued in liquor oriented businesses (Distilleries, Lion Brewery and Ceylon Brewery).

The sector would sustain its growth as most of the counters that contributed to the sector’s performance to continue to capitalize on the post war scenario. However, certain counters such the Distilleries, Lion Brewery and Ceylon Brewery; despite increase in their top line the sector would find their net earnings being squeezed with the increment of corporate taxes to 40% from 35% and the upward revision in the excise duty structure.

Throughout the past, earnings of the Manufacturing sector had been highly volatile, which was mainly due to seasonal impacts and unfavorable macroeconomic outcomes in the global economy. Chevron Lubricants, Royal Ceramics and Tokyo Cement further strengthened the sector earnings during 2010.

Though the telecommunication sector includes only 2 counters, it contributed approximately 5% to the total market. The sector witnessed healthy earnings posted by two participants during the year. Going forward the sector has potential in the local context with the technological advances together with the high penetration levels in the island. Further with government reducing the call charges we expect the revenue to grow due to the high elasticity of the product coupled with the growing per capita income.

The Diversified sector earnings approximately doubled during the year. The earnings growth was shouldered by the heavy weight John Keells Holdings with its capital gains through Asian Hotels & Property and Keells Hotels. Even though the sector earnings show high fluctuations on QoQ basis the earnings has usually outperformed the sector and the market. Going forwards we expect the diversified sector to report higher earnings on the back of the high geared local economy. Further the sector would benefit with the low interest rates persistent in the island together with the high investment rate as the sector is prone to diversification.

During June 2010 government reduced import duty for vehicles by 50%.This has immensely helped the stagnant industry to move ahead. With the new budget proposals government has reduced import tax on heavy vehicles. This would positively impact on the earnings of counters like Lanka Ashok Leyland, Dimo, Sathosa Motors and United Motors during the upcoming quarter.

Construction & Engineering sector perform relatively well comparison to the market during 2010. This was mainly backed by increasing income generated through post war developments and increasing demand for land & property in Colombo city limits. The growth was further facilitated by reduction in income tax for construction companies and reduction in custom duties for raw materials and capital equipments.

What’s up 2011? - A year of consolidation The Economy 2011

The inflation picked from a 3.1% annual average in Jan to 5.8% annual average in November 2010, mainly in the back of rising commodity prices and crude oil. Would the rise in the CCPI index lead to an increase in the policy rates during 2011? Sri Lanka just witnessed healthy private credit growth (during 2H of 2010), hence, would a possible increase in the policy rate create any impediment to the near witnessed private credit flows?

Most of the essential commodities are related with import tax and VAT, hence going forward if the country could aim to augmen t its revenues via valued added exports and tourism, the GoSL could look to relax import tax and VAT on essentials and invariably reduce the food price burden of the cosumer. During 2011 the private sector should take the initiative given from the budget to start structurally move up the value chain in terms of export products. Furthermore, Sri Lanka should reduce being western centric in terms of its exports (60% of all exports go to the western nation) and start penetrating the vibrant markets of the Asian powerhouses.

Albeit, certain encouraging tax reductions, the tax authority will have to better manage its tax collections and continue fiscal consolidation ( via cost reforms) to achieve improved fiscal outlook. During 2011 the GoSL would have to encourage more FDI’s and more private sector participation (Via Public Private Partnerships – PPP’s) to fast-track economic growth and capital formation within the economy.

Colombo Bourse 2011

The “Credit” debate

The latest directive issued on 30th December , reads “with effect from 1st January all broker firms shall be required to force-sell by T+5, securities of buyers who are in default of settlement by T+3 days, in order to recover the monies owing to them by such default clients.” T+3 have been an unnecessary fear psychosis, the majority of the market has fallen into. Ironically, the regional more developed markets also operate at T+3/ T+2. Hence, it should not be a huge deterrent on our market. In actual sense, it would prevent the market moving into more “Ponzi” levels, which actually brings more stability to the market during 2011 as well as stock brokering companies.

A flurry of IPO’s

It is very encouraging to hear that the Securities and Exchange Commission endeavors to augment the Colombo bourse market capitalization by 45% during the year 2011. What is more encouraging is that the envisaged increase is via new listings in the market. They foresee approx 75 IPO’s during the year 2011. Hence, it is a monthly average of circa 6 listings. Also it is planned to list gold and metal back ETF’s. Colombo bourse requires more IPO’s (fundamentally strong), liquidity and different options (ETF’s, Derivatives, Short Selling etc.) to give the investors more choice in terms of investing. Invariably making investors look at different stocks/ options to create healthy investing. As opposed to looking at the same counters and pushing them “up” and “selling”.
Sector “Hot-Picks” backed by healthy earnings

We advice the investors to especially watch the counters related to food & beverage consumption, consumer durables (based on expected hyped festive buying), tourism ( based on augmented tourist volumes) and banking counters ,especially the undervalued nonvoting counters (backed by improved credit growth during the past quarters) as short to medium term picks. Manufacturing, Construction and Land & Property would be medium to long term picks.

Courtesy- Asia Research

Sri Lanka: Budget 2011 - The Challenge ahead

noreply@blogger.com (Sri Lanka Equity Analytics) — Tue, 23 Nov 2010 03:18:00 +0000

A Challenge Ahead…

President in his budget speech underscored that production drive in this decade should aim at expanding exports and replacing imports.
The reallocation of the wealth of nation via altering the tax system seems pro investor as well as pro consumer, which is in line with our previous forecasts.
The newly introduced tax measures will wet the investor appetite for further investments and increase future cash flows of the corporate.
Given the inward nature of Sri Lanka’s capital formation, demand for luxury imports such as motor cars (therefore crude oil) will also scrape the skies, compelling the government to remain cautious on the BOP situation.

Synopsis

The 2011 budget proposal of the Government of Sri Lanka was unfolded before the general public yesterday. The overall outlook of the fiscal plan suggests that latter’s main aim is to achieve rapid economic development through import substitution and export expansion while attaining GDP growth and simultaneously curbing the deficit position of the government. President in his budget speech underscored that production drive in this decade should aim at expanding exports and replacing imports. The international trade strategy must aim at phasing out the trade deficit, improved marketing strategies coupled up with improvement in productivity and efficiency of labour and increasing the competitiveness of country’s export and imports.

Performing an active role as the facilitator of free economic activity the government imposed major changes in taxation and transfers as a measure to assist the private sector in achieving above mentioned macroeconomic challenges. The reallocation of the wealth of nation via altering the tax system seems pro investor as well as pro consumer, which is in line with our previous forecasts.

The major tax reforms and subsidies include the exemption of PAYE tax for annual incomes less than LKR 600,000, decreasing the corporate tax from 35% to 28%, reduction of income tax on Venture Capital corporations up to 12%, exemption of Economic Service Charge for investment trusts, reduction of Value Added Tax (VAT) from 20% to 12% for financial services, providing a subsidy of LKR 50,000 to small holder tea growers cultivating in excess of one hectare of land, removal of the Social Responsibility Levy, imposing CESS on primary goods and raw material exports.

The newly introduced tax measures will wet the investor appetite for further investments and increase future cash flows of the corporates. Consequently, it bears the propensity to enforce downward pressure on interest rates as the credit dependency of the corporates will shrink when non-debt based cash flows ooze in to the businesses with newly imposed tax cuts. The deposit base of the banking sector could also expand as a result, increasing the liquidity in the market. The downward pressure on interest rates as well as the tendency for the deposit base to grow could create upward pressure on urban land & property prices (drumming up the demand for construction material as well as home appliances and furniture) and gold prices with the high net worth investors preferring land and gold as a hedge against inflation. Also, given the inward nature of Sri Lanka’s capital formation, demand for luxury imports such as motor cars and all other passenger transport vehicles which benefited via the dip in vehicle tax (therefore crude oil) will also scrape the skies, compelling the government to remain cautious on the BOP situation.

Meanwhile, domestic and foreign investments would further flow into sectors supplying luxury and semi-luxury goods and services such as leisure and processed food, exploiting the newly created potential in the home market. Exemption of PAYE taxes for middle income earners and 5% pay hike for state employees (non pensionablewill also feed the effective demand in the system and further increase profitability of the corporate sector. In addition, an Employees’ Pension Fund to provide post retirement pension benefits to employees in the private and corporate sectors was proposed and 2% contribution from employees and a 2% contribution from employers to this fund were commissioned. Also it was proposed to set up an Overseas Employees’ Pension Fund (OEPF). Each employee is required to contribute at least Rs. 12,000 per annum to this fund. Hence, these funds would invariably creat a low cost funding tool for the government.

Further, the government targets the fiscal deficit to be LKR 433.7 billion, amounting to 6.8% of the 2011 GDP which is currently hovering at 8%. The revenue is expected to grow by LKR 157.8 billion which is 2.8% of 2010 revised GDP. The major portion of the increase in government revenue is expected to be derived from taxes on goods and services (up by LKR 66 bn ) and taxes on external trade (up by LKR 56.3 bn) which is expected to account for LKR 122.3 bn out of the LKR 157.8 billion revenue growth. The rest will be generated through income taxes and non tax revenue. Therefore, it is clear that government is expecting to increase its indirect tax incomes via shrinking its hold on the income taxes.

Furthermore, the figures revealed by the government demonstrate that total foreign financing of the fiscal deficit is expected to contract from LKR 205.5 bn to LKR 94.5 bn recording a staggering 54% YoY fall. In connection, the domestic financing is expected to increase by LKR 98 bn to LKR 339.2 bn from LKR 241.2 bn, marking a 40.6% YoY rise. This would have a positive impact on the banking sector loan book growth creating risk free lending avenue for the commercial banks and activate the excess liquidity of circa LKR 143 bn which is currently lying idle in the system. We forecast the interest rates to remain unaffected albeit the increase of credit demand by the government since the supply of credit remains unexhausted.

The Revenue at 15.2% of GDP

Tax Revenue

The government expects to achieve an increase in tax revenue from LKR 720bn in 2010 to LKR 862.1bn.for 2011

Direct tax revenue

Historically income tax together with the VAT has been the key contributor of government’s tax income. However, the 2011 budgetary proposals suggest a drastic reduction of tax rates in both these components. Tax rates on personal income has reduced from 5%-35% to 4%-24% while the tax free income threshold has increased from Rs.300, 000 to Rs.500,000 .The employee earnings of SLR 600,000 per year would also be exempted from the PAYE tax. However, the budget aims to generate further revenue by subjecting the public sector incomes to the PAYE tax system.

The reduction in tax rates will in turn create an increase in disposable income. This would contribute to an increase in consumption resulting in expansion of the consumer tax income. In this regard, the tax reforms are aligned with the government’s objective of increasing tax revenue by broadening the tax base while reducing the tax rates.

The increase of tax base together with the measures of incorporating tax evaders to the system would further enhance governments revenue generation thereby increasing the possibility of expected tax revenue increase by LKR142.1bn

The income generated by means of Grants has been estimated to increase from LKR16.2bn to LKR22.6bn further facilitating the Revenue generation.

The Cost at 22.4% of GDP

The expected salaries and wages bill for 2011 is forecasted to reach LKR 344.0 bn from LKR 295.3 bn recorded in 2010, stamping an increase of16.5% YoY. The increase in salaries and wages is most welcome as it will ease off the cost of living pressure of the fixed income earners.

The interest expenses have also demonstrated a negligible increase from LKR 350.3 bn to LKR 352.9 bn explicating the positive impact of reduced deficit targets for 2011. In addition, the sharp reduction in interest rates on Government securities from September 2009 coupled with initiatives taken by the government to restructure debt profile to longer maturities help to reduce the growth in interest cost.

The total payments on subsidies for 2011 have recorded an increase of LKR 10.1 bn from LKR 197.2 bn to LKR 207.3 bn marking a growth of 5.1% YoY. The challenge of resettlement of IDPs and demining activities in the North and East and development of basic infrastructure facilities in those areas become the prime objectives of the transfer payments for 2011. Government has allocated budgetary resources further 80,000 houses. Initiatives such as ‘Gama Naguma’ will target building 80,000 housing units for low income rural households each year.

Education and public health allocation for 2011 has increased from LKR 29.4 bn to LKR 54.0 bn marking a YoY growth of 83.7%. The government expects to increase efficiency and productivity of the work force through vocational training and providing technological knowledge. In this regard government expects to train and provide technological knowhow to 300,000 youth with a cost of LKR 16 bn over the course of next three years. Also 500 secondary schools will be constructed as a measure to increase the rural education levels of the country. In addition, further LKR 750 mn will be allocated to establish English as a life skill.

The allocated Defence expenditure for 2011 has witnessed a marginal increase up to LKR 214 bn LKR although the reasons behind the increase are not clearly stated.

Capital expenditure

Infrastructure development has received an increase from LKR 359.0 bn to LKR 413.7 bn marking a YoY growth of LKR 30.1 bn (+ 9.1%). For public investments in roads, electricity, water, irrigation, ports and aviation activities, capital investment in power generation and distribution is likely to exceed LKR 64 bn over the two years. There is also further allocation of LKR 20 bn in support of the provisional road development initiative.

Funding Mix

Furthermore, the figures revealed by the government demonstrates that total foreign financing of the fiscal deficit is expected to contract from LKR 205.5 bn to LKR 94.5 bn recording a staggering 54% YoY fall. The lower dependency on external debt as a measure of financing the fiscal deficit is most welcomed as it will reduce the outflow of foreign exchange from the economy.

In connection, the domestic financing is expected to increase by LKR 98 bn to LKR 339.2 bn from LKR 241.2 bn, marking a 40.6% YoY rise. This would have a positive impact on the banking sector loan book growth creating risk free lending avenue for the commercial banks and activate the excess liquidity of circa LKR 143 bn which is currently lying idle in the system. We forecast the interest rates to remain unaffected albeit the increase of credit demand by the government since the supply of credit remains unexhausted.

Impact on CSE

The first comprehensive budget to be released after the 3 decade war is expected to induce corporate profits via the reduction of several tax revisions. The commercial entities are bound to benefit with the overall reduction in corporate taxation by 7%, to 28%, support lent for SMEs and tax holiday for fresh investments (for investments less than USD5,000 but not more than USD10 mn).

With the current market capitalization capped at LKR2.2 trillion, the government focuses to increase the entities listed on the CSE via Initial Public Offers (IPO). Thus, 1% of the value of IPO has been allowed as a deductible expense for tax purposes. Furthermore, the snap shot below shows the overall cost changes proposed on transactions on CSE:

We view the effective increase in the overall cost of transactions to 1.12% from 1.02% will not majorly restrict investor participation as the capital gains tax still is pegged at 0%. With the YTD foreign interest being an outflow of LKR28.3 bn, we can expect foreigners to revert their attention to Sri Lankan investment market with the relaxation of exchange control restrictions for foreign entities investing in unit trusts coupled with the favorable exchange control facilitation to promote and develop local equity market .

Affected Counters

With the abolition of bank debit tax, reduction in VAT on financial services from 20% to 12%, removal of VAT on leasing assets and the reduction in overall income taxation to 28%; banks and the financial sector stands out as a clear beneficiary of the tax revision.

Tourism, viewed to be a billion dollar business, the government is making moves in charging better rates whilst also reducing taxation by 3% to 12%. We expect the hotel & travels portion of CSE listed entities to post better earnings in the periods to come, as sufficient accommodation to cater the targeted tourists is taken. Thus we believe, the hotel sector counters will have a further run despite being currently expensive.

Most of the counters in the manufacturing sector operate in construction related fields. Thus, counters such as the tile sector (Lanka Tiles, Lanka Walltile, Parquet Ceylon and Royal Ceramics), cable industry (ACL Cables, Kelani Cables and Sierra Cables) and the cement manufactures (Tokyo Cement and Lanka Cement) are all expected to be direct/indirect beneficiaries of the planned rehabilitation and construction programs strongly shouldered by the support lent by international organizations and neighboring countries.

The spirits industry was already hit by the recent upward revision in excise duties, and now with the increase in taxation on profits to 40% from 35%, counters such as Ceylon Tobacco, Lion Brewery and Distilleries, will find their Net Profit margins thinning.

The tax structure of the telecommunication has been simplified favouring local consumption than international calls and tax exemption on imported high tech equipment, the telco sector is bound to face the changes with a general levy of 20% in lieu of the existing levies which are narrowed.

After a general cut on motor vehicle taxes in June 2011, a further reduction of 25% has been proposed on passenger vehicles. However, the annual revenue license fee for motor vehicle is moved up by 10%. Motor sector counters such as Diesel & Motor Engineering, Sathosa Motors, United Motors and Ashok Leyland in specific is expected to benefit.

Export oriented counters such as Haycarb, Richard Exports, Hayleys Exports, Kuruwita Textiles, Dankotuwan Porcelain and printcare are all expected to benefit from the export friendly move in reducing income tax of such entities to 12% from 15% for businesses carrying value additions in the country and holding patent rights in Sri Lanka whilst also benefiting from the moves to mitigate the loss of GSP Plus concessionary scheme.

The overall Plantation sector will be highly affected by the proposed CESS on both bulk tea and rubber exports, which amounts to LKR10 and LKR8 per kg respectively, which is proposed by the government with the intention of enhancing the value added export segment in the industry.

The proposed expansion of Laksathosa and Co-op city outlets signals competition for Cargills Ceylon, though the outcome still cannot be quantified.

Entities such as Lanka Milk Foods and Kotmale Holdings investing heavily in capitalizing on the transformation from powdered to liquid milk; are further supported by the government encouraging the import of high yielding diary animals.

Effects on the Banking Finance & Insurance

The most discussed area throughout the budget was, empowering the village & facilitating the rural areas to contribute to economic prosperity. This has opened up avenues for banking finance & insurance sector to expand. The emphasis on micro finance was a key element throughout the post war era in the banking finance and insurance sector which the 2011 budget has taken initiative.

The favorable contributions to the sector from the 2011 budget were basically via abolishing the bank Debit Tax, reducing VAT on financial services from 20% to 12%, reduce tax on profits of banking & finance institutions from 35% to 28%( the reduction of tax on profits is applicable to all offshore & domestic banks, finance companies, leasing, insurance & other specialized banking & financial companies)

Even though the government has brought down the tax rates the banks would not get much benefited in terms of profitability & returns available for fund providers. This is due to the necessity of creating a separate investment fund account with the Central Bank, where all the tax savings to be transferred in to it.

The Central Bank & the Department of Inland Revenue will issue specific regulations requiring banks to adopt low interest rates & longer term maturity for lending.

The higher per capita income, stabilized inflation (6%), reduced poverty, reduced unemployment levels, lower personnel income taxes, reduction of PAYE tax would lead people to save more & there is potential for banks to expand their deposit base, and this will enhance the lending capabilities of banks.

Referring to the government statistics the commercial bank advances to the private sector in June 2010 are as follows- agriculture & fishing 14%, industry 38%, services 21%. Since the agricultural, industrial, & service sectors are to expand with the new budget, the growth potential in the advances to these sectors would also be high.

Leasing companies are to be majorly benefited from the 2011 budget. VAT on leasing of three wheelers, Lorries, trucks, & private busses being removed.

With the aid of the proposed Presidential Commission on Banking & Financial service the government is focusing on transforming Sir Lanka as a regional financial hub.

The budget 2011 is supportive to mobilize savings on unit trust with the exemption of the economic services charge. Further the exchange control restrictions on foreigners & foreign funds investing in Units Trusts are also exempted to promote more funds flowing to the economy.

Fueling Travel & Tourism

Budget adding value

The 2011 Budget has identified Tourism as a “Billion Dollar Business”, as the country has immense potential over achieving such an outcome. Despite the steep growth in arrivals, the income from this segment has been moderate. In order to overcome such a situation a levy of US$20 (App: LKR2,220) is imposed on a per bed basis on all 5 star hotels offering less than US$ 125 per guest nigh from January 2011.Invariably targeting the high caliber tourist by 2016 targeting 2.5mn.

The industry should be enriched with the addition of star class hotels chains, to accommodate such an inflow. Sri Lanka currently has a total room capacity of 14,461 of which the 5 star accounts only a mere 3080. From a hotel income point of view, it has been proposed to reduce tax on income earnings from tourism and related business from 15% to 12%.

It has also being proposed by the government to upgrade and refurbish all the rest-houses and all government circuit bungalows in order to spur the tourism segment locally.

In addition the budget further emphasizes on benefiting other industries related to the tourism sector such as :

Local agriculture and industries
Motor vehicle sector with the reduction in taxes on passenger transportation vehicles by 25%: exempt importation of electric and hybrid vehicles from Excise tax and VAT.
Reduction of Custom duties and VAT on various machinery and equipment not available locally, this will facilitate the expansion and refurbishment process.
Reduce excessive taxes on branded consumer durables which will popularize local and tourist shopping.

Meanwhile from a financial perspective lifting up exchange control restrictions on foreigners and foreign funds investing in unit trust etc, will not only attract the leisure crowd but encourage the business oriented to visit Sri Lanka.

Construction Sector

The construction sector contributes approximately 6 percent of the country’s Gross Domestic Production (GDP).In accordance to Central Bank of Sri Lanka this sector grew at an average rate of 7.5 percent during the 3 years ended 2010.

Further the 2011 Fiscal Budget has identified the importance of providing tax benefits to the construction sector; to invariably elevate construction in the economy. Below mentioned are the tax/fiscal benefits the 2011 budget address.

Reduction of income taxes on construction.
Reduction in custom duties in selected goods and raw materials.
Capital allowances granted at a rate of 33 1/3 percent on the cost of acquisition of plant and machinery and a rate of 10 percent on the cost of construction on new buildings.

The above mentioned tax and fiscal benefits are expected to favorably facilitate;

Reconstruction of electricity and irrigation facilities.
Construction of road and bridges.
Reconstruction of schools, health facilities and other public places. (Especially in the north and east areas)

Furthermore, with the tourist arrivals to the country accelerating, the room capacity of hotels needs to be tripled from a current level of around 15,000 rooms. Therefore, we believe that this would also have favorable impact on the construction sector.

Land & Property

Overall Land & Property segment seems to foresee a growth a in value as a result of the recent developments taking place in the construction sector together with favorable macro economic factors (Low interest rates and inflation).

A large scale construction is taking place within Colombo city limits and other parts of the country with the growth in the construction sector. This would accelerate demand for land. In addition the low interest rates would further strengthen demand for land.

Manufacturing Sector Overview

Budget 2011 has focused heavily to elevate Sri Lanka’s manufacturing sector to a highly diversified and value adding segment. In pursuing this strategy government has taken a major strategic initiative of imposing a CESS on all exports of raw & semi processed form, where all exports of finished goods will be free from such CESS. This would encourage manufacturing organizations to focus more on value added exports whilst the counters already focusing more on value added exports will be highly benefited. This would also lead the domestic manufacturing entities to put more emphasis on building their own brands rather than exporting in bulks.

According to government estimates, the export potential of value added, branded exports exceed US$ 5 bn over the medium term. Subsequently, government has made a provision to reduce Income tax from 15% to 10% for all export companies encouraging export oriented production in general. At the same time government has taken an initiative to reduce the income tax from 15% to 10% for industries with domestic value addition in excess of 65%, and Sri Lankan brand names with patent rights reserved in Sri Lanka. This will encourage the manufacturing entities to base their production facilities mainly within the country itself whilst the counters which are already having a high domestic value addition would benefit immediately.

Budget also includes a provision for reducing duties and taxes on machinery, equipment and raw materials, making modern technology more affordable to manufacturing entities. Furthermore, it will encourage expansion and modernization which will in turn improve the profitability of the counters in the long run. The Government also has decided to reduce the corporate tax from 35% to 28% which will invariably benefit the domestic manufacturers as a whole.

Furthermore the 5 year tax holiday proposed on any company which is undertaking new projects with a minimum investment of US$ 5000 (but not more than US$ 10 mn), would definitely encourage new investments in manufacturing industry particularly with many manufacturing companies looking to take advantage of the construction sector boom.

Powering through tariff empowerment

The pro investor budget seems to have a major emphasis on the infrastructural development in the island in lieu of a total investment target of circa 32%-35% of GDP over the next 6 years. The said budget has allocated LKR413bn for public investments in roads, electricity, water, irrigation ports and aviation activities. A sum exceeding LKR64 bn over the next two years is said to be assign towards capital investments in the expansions of power generation and distribution in the country with a target of electrifying the country 100% by 2015.

Over the years access to electricity in the rural sector has increased from 78.5% in 2006 to 83.2% in 2009 while it has risen from 62.3% to 84% in the estate sector. Further with the development in the power sector the government has been able energize the country with no blackouts since 2006.

Together with the capital improvement in the power and energy segment an 8% increase in tariff was imposed on the consumption excluding small businesses and SME. This would have an impact on the corporate and household sector in the island whilst driving the expenditure high. The manufacturing organizations with high emphasis on power would witness a surge in cost of sales with the above price movement. Further the CCPI index would be negatively affected as clothing electricity and gas sub index reflects 18.3% of the major the index.

Towards a leading information era

With a percept towards a digital future and technologically savvy nation, the government has implemented various projects to usher in the information era to Sri Lanka. Whilst the island is ranked 7th among the 50 best emerging global cities that attract outsourcing, IT and BPO services are ranked as the 5th largest export segment in the country.

With regard to ICT literacy, the government targets to achieve a rate of 75% (literacy) by 2016 in lieu of making the island an emerging IT hub (with USD2 bn exports by 2016).

The telecommunication sector also showed an above average growth comparative to other regional countries (witnessed an YoY incline of 25% in 1st half of 2010) together with a high telephone density (telephone per 100 persons) of 94 in 2010.

A VAT exemption on the high tech equipment and machinery which the telecommunication segment is highly dependent on would attract capital investments further strengthening the industry. Technological growth in telecommunication sector is pivotal to elevating the ICT in an economy.

Thus, the fiscal benefits granted to telecommunication sector would shoulder the growth in the ICT industry as well. Further, a telecommunication levy of 20% together with a 2% license fee on the gross revenue would simplify the previous complex tax structure.

The increased taxation on the industry would be offset by the developments in the technological arena together with the increased literacy rate in ICT. Further the 25% decrease in local call charges would induce the number of local units whilst generating a higher rate of economic activity in the island.

Hatton National Bank (HNB) net profit up 23% YoY in 2Q2010

noreply@blogger.com (Sri Lanka Equity Analytics) — Mon, 16 Aug 2010 09:55:00 +0000

Hatton National Bank's (HNB) net profit has grown 23% YoY to LKR1,220.3 mn in 2Q2010 mainly on the back of a 7% YoY increase in net interest income, 25% YoY increase in non interest income and a 94% YoY reduction in provisioning cost which enabled 1H2010 net profit to grow by 10% YoY to LKR1,888.5 mn. With the economy expected to grow by circa 6%-7% during the next few years and contributions from the previously war affected North and East to the main stream economy the banking sector outlook remains positive with loan growth (grew 2.2% YoY in May) expected to gather momentum from 2H2010 with the low interest rate environment. HNB's net interest margins are expected to be intact at around 5%, whilst continuing to benefit from the wider reach facilitated by 189 branches (20 branches in the North and East) and higher retail focus.

However, we maintain our forecast 2010E net profit at LKR4,101.0 mn (down 9% YoY)with slower credit growth in 1Q2010 than anticipated coupled with high operating costs and projected 2011E net earnings at LKR4,547.8 mn (up 11% YoY).

The voting share is fairly valued at 17.0x forecasted 2010E profit and 15.3x on forecast 2011E whilst trading 2.4x PBV. The non voting share remains attractive on 11.0x forecast 2010E net profit and 10.0x projected 2011E net earnings whilst 1.5x PBV. Maintain BUY.

Interest income has dipped 16% YoY to LKR7,576.7 mn in 2Q2010. HNB’s interest income has dipped 15.6% YoY to LKR7,576.7 mn in 2Q2010, mainly due to a 19.4% YoY dip in interest income from loans and advances to LKR5,827.8 mn. The dip in interest income from loans and advances was on the back of low rates despite performing loans growing by 4.4% during the quarter to LKR164.2 bn. However interest income from fixed income securities remained flat at LKR1,748.8 mn even though treasury bill and bond portfolio (held to maturity) grew by 9.5% to LKR61.6 bn during the quarter which is approx. 21% of the banks’ total asset base.

Interest expenses dipped 31% YoY to LKR3,714.1 mn in 2Q2010. Group’s interest expenses have dipped 30.9% YoY to LKR3,714.1 mn in 2Q2010, on the back of 30.5% YoY drop in interest cost on deposits to LKR3,295.5 mn. The drop in deposit cost is largely attributable to low deposit rates and the shift in the deposit mix from high cost time deposits to low cost CASA products (CASA mix improved to circa 50% of total deposit base from 48% in 1Q2010). Further deposit base also recorded a marginal 1% growth to LKR216.4 bn during the quarter. Interest expenses on other interest bearing liabilities also dipped by 34.3% YoY to LKR418.7 mn.

Net interest income grew 7% YoY to LKR3,862.6 mn. The dip in interest income was off set by a faster decline in interest cost enabling net interest income to grow by 7.1% YoY to LKR3,862.6 during 2Q2010. Interest margins also improved to 5.3% (up 1.3% QoQ) in 2Q2010.

Non interest income grew 25% YoY to LKR2,000.6 mn in 2Q2010. Non interest income has grown by 24.8% YoY to LKR2,000.6 mn in 2Q2010 due to 31.6% YoY increase in other income to LKR1,764.1 mn. Other income growth was supported by the capital gains made by selling off shares it held in Commercial bank and Distilleries.

Foreign exchange income fell by 9.7% YoY to LKR236.5 mn, due to stagnant exchange rates.

Operating cost has increased by 13% YoY in 2Q2010 to LKR3,400.2 mn. Operating costs have risen by 12.6% YoY to LKR3,400.2 mn, mainly due to a 17.7% YoY increase in personnel costs to LKR1,283.4 mn. Increase in personnel cost was a result of salary revision undertaken across all staff grades of the bank during 2009. Consequently the operating cost per branch stands at LKR18.0 mn per quarter and the cost to income ratio is at circa 58%.

Provisioning cost has dipped 94% YoY to LKR 10.0 mn in 2Q2010. Total provisions have dipped 94.0% YoY to LKR10.0 mn, mainly due to a 160.0% YoY improvement in recoveries and 50.8% reduction in specific provisions. Gross NPL ratio for HNB is at 6.5% (compared to 7.4% in 1Q2010) and net NPL ratio stands at 3.3%. HNB’s non performing loans reduced by 8.0% to LKR13.4 bn during the quarter and the provision cover stood at 42%. (compared to 39% in 1Q2010).

Total tax bill has risen 13% YoY to LKR1,217.9 mn in 2Q2010. Value added tax (VAT) has increased by 19.5% YoY to LKR630.4 mn and corporate tax increased 7.1% to LKR587.5 mn pushing up the total tax bill (VAT and Corporate tax) by 13.2% YoY to LKR1,217.9 mn in 2Q2010. Thus the effective tax rate of the bank is near 50% in 2Q2010.

Net profit up 23% YoY to LKR1,233.1 mn in 2Q2010. Consequent to a 7% YoY increase in net interest income, 25% YoY increase in non interest income and a 94% YoY reduction in provisioning cost helped HNB’s profitability in 2Q2010. Cumulative 1H2010 profits also rose 10% YoY to LKR1,870.1 mn.

Forecast 2010E net profit maintained at LKR4,101.0 mn (Down 9% YoY). With the economy expected to grow by circa 6%-7% during the next few years and contributions from the previously war affected North and East to the main stream economy, the banking sector outlook remains positive where loan growth expected to gather momentum from 2H2010 onwards with the low interest rate environment. HNB’s net interest margins are expected to be intact at around 5%, whilst continuing to benefit from the wider reach facilitated by 189 branches (20 branches in the North and East) and higher retail focus (Retail mix is circa 60%).

However, we maintain our forecast 2010 net profit at LKR4,101.0 mn (down 9% YoY) with slower credit growth in 1Q2010 than anticipated (private sector credit growth in January 2010 was 0.6% MoM and 1.6% MoM in February 2010) coupled with high operating costs. However we expect 2011E net earnings to grow by 11% YoY to LKR4,547.8 mn on the back of loan book expansion (where the private sector credit is expected to grow from 2H2010 onwards) and cost rationalisation strategies expected to be adopted by the bank.

The voting share is fairly valued on 17.0x forecast 2010E net profit. The voting share is trading at 17.0x forecasted 2010E profit and 15.3x on forecasted 2011E whilst trading 2.4x PBV.

The non voting share remains attractive on 11.0x forecast 2010E net profit and 10.0x projected 2011E net earnings whilst 1.5x PBV. Given the stable macro economic outlook and expected credit growth HNB, is in a better position to reap the benefits out of it with its island wide coverage (has the largest presence in North and East). Further HNB’s new branches (specially in North and East) breaking even in the coming years will contribute positively to banks bottom line. Bank also has a divesified product portfolio where they aggressively look at growing areas such as foreign worker remittences, credit card business and pawning. Further we believe HNB would adopt necessary measures to curtail its costs with its newly adopted core banking system in the future. Thus we Maintain BUY.

Ceylon Tobacco (CTC) net earnings up by a sharp 45.1% YoY in 2Q2010

noreply@blogger.com (Sri Lanka Equity Analytics) — Mon, 16 Aug 2010 06:49:00 +0000

Ceylon Tobacco's (CTC) is the monopoly market operator for manufacturing, marketing and importing cigarettes in Sri Lanka. The company segregates the market based on income levels and markets Dunhill and Bensons for high income category along with Gold leaf for the middle income category, followed by Four Aces, Three Roses and Capstan for the low income category and Pall Mall as a value for money product. The company's net profit has increased by a strong 45.1% YoY to LKR1,116 mn in 2Q2010 on the back of high margin brand mix and stabilizing volume levels resulting from improved economic conditions in the country coupled with aggressive cost management initiatives.

Net revenue has increased 16.8% YoY to LKR3,418 mn in 2Q2010. CTC’s gross revenue has increased by a moderate 11.3% YoY to LKR16,300 mn in 2Q2010, resulting in a cumulative figure of LKR30,772 mn for the first half of 2010. Further the top line has risen by 12.6% QoQ owing to the excised price revision which took place in May 2010 where prices of all CTC brands went up by LKR1.00 per stick.

Further the company’s continuous focus on improved sales mix coupled with the grabbing of market share from illegal distributors and improved economic conditions has limited the impact from declining volumes resulting from the ban on smoking in public areas coupled with change in smoking habits amongst the general public.

However, the government’s continuous efforts in curbing the presence of smuggled and counterfeit cigarettes provide some optimism for volume growth in future.

Government levies continued to be nearly 80% of gross revenue, which grew by 10% YoY to LKR12,882 mn during the quarter in concern. Consequently, net revenue has grown by a healthy 16.8% YoY to LKR3,418 mn in 2Q2010 and LKR6,499 mn for 1H2010 (up 15.8% YoY).

Total operating costs have dipped 11.9% YoY to LKR1,572 mn. CTC’s total operating costs have dipped 11.9% YoY to LKR1,572 mn in the quarter in concern whilst recording a dip of 5.3% YoY in 1H2010. This could be directly attributable to the sharp fall of 27.3% YoY in raw material costs and 4.2% YoY dip in operating costs during the quarter in concern. Fall in raw material costs is resulted by lower sourcing costs of tobacco leaves when compared with the corresponding period last year where the company had to import tobacco due to the production shortage in the country.

The company’s productivity improvements have resulted 4.2% YoY dip in operating costs in 2Q2010 and 12% YoY saving for the first half of the year.

Net profit has risen by a strong 45.1% YoY to LKR1,116 mn. Net interest income has fallen by 52.0% YoY to LKR61 mn in the quarter in concern owing to falling interest rates. Nevertheless backed by the strong performance coupled with cost rationalization techniques, the company has recorded a net profit of LKR1,116 mn for 2Q2010, up by a sharp 45.1% YoY and LKR1,754 mn for the first six months of 2010 (up 39% YoY).

Forecast 2010E net profit to reach LKR4,487 mn. We forecast CTC to post a conservative net profit of LKR4,487 mn in 2010E (up by 9.1% YoY) whilst projecting 2010E net profit up by 7.5% to LKR4,823 mn on the back of the company’s continued focus on improving its brand mix coupled with successful cost rationalization exercises.

Fairly valued on 13.2X forecast 2010E net profit. The share is fairly valued on 13.2X forecast 2010E net profit and 12.3X projected 2011E net earnings. Further given the historical dividend payout ratio of nearly 100% and LKR9.7 per share being already declared, we believe the share would continue to be a dividend play - Maintain BUY

John Keells Hotels (KHL) Repositioning hits the bottom line.....

noreply@blogger.com (Sri Lanka Equity Analytics) — Sun, 15 Aug 2010 16:06:00 +0000

John Keells Hotels (KHL), an 82% owned subsidiary of local conglomerate John Keells Holdings (JKH) currently operates 7 hotels in Sri Lanka and 4 in Maldives. Company operates its resort portfolio under three brands; namely the premier brand Cinnamon (2 hotels under this brand), the resort hotel brand Chaya (6 hotels) and John Keells Hotels (3 hotels).

Keells hotels are positioned in all key tourist hot spots in the country and experienced a strong spurt of growth in earnings with the revival of the industry. Further KHL is the hotel chain with highest number of beach hotels located in beaches which are among the top ten in the Asian Continent. Further the company is placing more emphasis on these beach hotels and would complete the repositioning of them in the next couple of years. Nonetheless the company is keen on strengthening their presence in the same area where they are planning to add three more beach hotels to their portfolio by FY13 (In Ahungalla, Beruwala and Trinco).

Financial Performance
KHL's top line has dipped 5% YoY in 1QFY11 mainly on the back of closure of three hotels during the quarter for renovation and repositioning and of the off-peak seasonality effect. Further 60% of the quarterly revenue has been generated by the Tour Operators and Travel Agents according to the rates agreed upon an year before. Hence the real increase in ARRs are not fully reflected in 1QFY11 performance. Closure of Chaya Lagoon Hakuraa in Maldives was the major hit on revenue which has eroded the consolidated revenue by circa 13% YoY in 1QFY11.

However the Sri Lankan resorts have exhibited a sharp increase of 50% YoY to LKR272.6 mn in 1QFY11 on the back of the sharp increase in occupancy rates during the year, despite the closure of Cinnamon Lodge Habarana and Corral Gardens Hikkaduwa.

The dip in revenue has been out paced by the dip in Cost of Sales (down 15% YoY in 1QFY11) leading the company to improve the Gross Profit marginally to LKR758.6 mn in 1QFY11. Subsequently the gross margin has increased 3% YoY to 67% in 1QFY11.

The EBITDA has dipped 28% YoY to LKR64.4 mn on the back of the 12% YoY increase in Operating expenses. However the increase in operating costs have been somewhat weathered by the two fold increase in other income. Other income constitutes the interest received from banking the proceeds from the rights issue during the quarter (The company raised LKR3.6 bn via the rights issue of one ordinary share for every three shares held in order to support the expansion process).

Following the 28% YoY dip in EBITDA and the sharp increase in the tax bill the net profit for the period has dipped 12% YoY to LKR167.1 mn in 1QFY11. Further it is noteworthy that the interest expenses have seen a 21% YoY dip following the tailing off of circa LKR217 mn of debt during the quarter and the slide in interest rates.

The Sri Lankan segment has reduced its losses by 83% YoY supported by the increased arrivals, occupancies and ARRs despite the closure of two hotels for renovation and repositioning. Although the Maldivian segment has seen 128% YoY increase in their losses to LKR153.4 mn mainly due to the closure of Chaya Lagoon Hakuraa in 1QFY11.

Recommendation
KHL passed the break even occupancy level during 4QFY10 and has managed to maintain the occupancies at reasonable levels up to date. During FY10 KHL achieved an overall occupancy of 55% as opposed to 31% in FY09, thus we expect it to reach +65% in FY11. Further with growing occupancy levels KHL is expected to increase their ARRs above the industry expectations. With improvements in ARRs and Occupancies with KHL’s brand image and positioning we saw a complete turnaround in 4QFY10, where the company posted a profit of LKR477.5 mn up 35% YoY. Further the company recorded a 197% YoY increase in cumulative earnings during FY10.

Maldivian segment which hedged the negative earnings of the Sri Lankan segment all throughout, faced severe problems due to the recessionary pressure on the Maldivian tourism industry following the world economic and financial crisis.

However we saw record high arrivals of +200 k per month (up circa 20% YoY) and occupancy levels of 60-70% during 4QFY10 indicating the end of the tourism lull in Maldives. With the revival of the industry in 4QFY10 the Maldivian segment of KHL saw a 10% YoY increase in the bottom line to LKR1.6 bn. Going forward we believe the increase in occupancy coupled with the increase in ARRs would further uplift the contribution from theMaldivian sector.

Therefore we expect KHL to defy industry trends and report a strong earnings growth of 223% YoY to LKR661.8 mn in FY11E and 96% YoY to LKR1,294.2 mn in FY12E. Profit growth is driven by higher occupancy and ARRs, savings on Finance costs and accommodation capacity expansions. Further refurbishment projects carried out in most of the hotels has paid off during 4QFY10 itself and KHL is placing more emphasis on Chaya Blu, Coral Gardens and Benthota Beach Hotel as they are located in beaches which are among the top ten in the Asian Continent. Further they will be constructing three more hotels in the same coastal belt to strengthen their presence.

KHL is fairly valued at 45.3X forecast FY11E net profit and 23.2X projected FY12E earnings whilst it is trading on a PBV of 2.5X FY11E and 2.3X FY12E. Nonetheless the counter is trading at a 8% discount to the EVPS. Further the share has outperformed the market by circa 21% since the end of war on 18th May 2009 albeit has underperformed the sector index by 68%. KHL the second largest hotel chain will expand its portfolio in the coming three years to account for 8% of the total room availability in Sri Lanka. With the said high earnings potential with the expected revival in the tourism industry and increase in occupancy coupled with expected increase in ARRs and the planned expansion of accommodation capacity, KHL would sustain an impressive earnings growth during the next couple of years. Therefore in-view of strong performance, we believe further upside is possible and we maintain – BUY

Nations Trust Bank (NTB) net profit up 86% YoY to LKR280.1 mn in 2Q2010

noreply@blogger.com (Sri Lanka Equity Analytics) — Thu, 12 Aug 2010 08:57:00 +0000

Nations Trust Bank's (NTB) net profit has grown by 86% YoY to LKR280.1 mn in 2Q2010, enabling 1H2010 cumulative net profit to grow by 49% to LKR494.2. Net profit in 2Q2010 grew mainly on the back of 32% YoY increase in net interest income and 55% YoY reduction in provisioning cost. With low interest rates and expected economic boom, banking sector outlook remains positive with loan growth (grew by 2.2% in May) expected to gather momentum from 2H2010 on-wards. Despite slower private sector credit growth NTB recoded circa 15% growth in performing loans from December 2009 where other banks recorded an average growth rate of 8-9%. NTB's net interest margin has improved to near 5.5% whilst the young and dynamic bank is set to grow in the coming years. We are maintaining our forecast 2010E net profit at LKR969.7 mn (up 41% YoY) and projected 2011E net earnings at LKR1,296.9 mn (up 34% YoY). Thus the share offers good value on 14.8x forecast 2010E net profit, 11.0x projected 2011E net earnings, 2.0x PBV. Maintain BUY.

Interest income has dipped 22% YoY to LKR2,541.2 in 2Q2010. NTB’s interest income has dipped 21.9% YoY to LKR2,541.2 mn in 2Q2010, caused by a 19.8% YoY dip in interest income on loans and advances to LKR1,581.1 mn and a 25.2% YoY dip in Interest income on other interest earning assets to LKR960.1 mn. The interest income on loans and advances have dipped despite the 6.4% YoY increase in performing loans during the quarter mainly on the back of low interest rates. Though the government securities portfolio (held to maturity) has remained flat the reduction in Treasury bill rates has impacted the income from fixed income securities negatively.

Interest Expenses has dipped 42% YoY to LKR1,389.0 mn in 2Q2010. Interest expenses has dipped 41.7% YoY to LKR1,389.0 mn mainly on the back of a 48.3% YoY dip in interest expense on other interest bearing liabilities as well as a drop of 33.4% YoY in interest expense on deposit. The interest cost was reduced with low deposit rates and shift in the deposit mix towards low cost
CASA products (CASA contribution improved to 29% from 27%). NTB’s deposit base also grew 4.1% during the quarter to LKR45.9 bn.

Net interest income has increased by 32% YoY to LKR1,152.2 mn in 2Q2010. Despite interest income having dipped by 22% YoY interest cost has dipped at a faster pace by 42% YoY enabling the net interest income to grow by 32% YoY to LKR1,152.2 mn.

Non interest income grew 6% YoY in 2Q2010. Non interest income has grown by 5.7% YoY to LKR477.0 mn in 2Q2010 due to gains made in forex earnings compared to losses suffered in the 2Q2009. However other operating income dipped 66.7% to LKR416.4 mn during 2Q2010.

Operating costs have increased 21% YoY in 2Q2010. Operating costs have increased 20.8% YoY to LKR892.4 mn, which was resulted by 85% YoY increase in personal costs to LKR408.0 mn which could be attributable to the increase in the number of employees. However premises, equipment and
establishment expenses have reduced by 10.1% YoY to LKR188.8 mn. However NTB’s cost to income ratio has improved to 55% from 57% as at 31st March.

Provision for bad and doubtful debts and loans has decreased by 55% YoY in 2Q2010. Provision for bad and doubtful debts and loans has decreased by 55.2% YoY to LKR90.6 mn, which was resulted by the 63.7% YoY decrease in specific-provision to LKR79.1 mn. Further NTB’s gross NPL ratio improved to 6.1% (7.0% in 1Q2010) and net NPL ratio to 3.2% (3.8% in 1Q2010).We believe NTB would be able to improve its NPL’s in the coming quarters with the improvement seen in recoveries.

Total tax bill has increased 57% YoY to LKR366.1 mn in 2Q2010. Value Added Taxation on banking income has increased by 72.6% YoY to LKR139.2 mn whilst tax on consolidated profit has also increased by 49.1% YoY to LKR226.9 mn which increased the total tax bill by 57% YoY to LKR366.1 mn in 2Q2010. Thus the effective tax rate in 2Q2010 is near 57%.

Net profit up 86% YoY to LKR280.1 mn in 2Q2010. Consequently a 32% YoY increase in net interest income and 55% YoY reduction in provisioning cost has pushed up NTB’s net profit by 86% YoY to LKR280.1 mn in 2Q2010.

Forecast 2010 net profit maintained at LKR969.7 mn (up 41% YoY). With the expected growth in the economy and low interest rate environment the banking sector outlook remains positive with loan growth (grew 2.2% in May) expected to gather momentum 2H2010 onwards. Despite slower private sector credit growth NTB recoded circa 15% growth in performing loans from December 2009 where other banks recorded an average growth rate of 8-9%. NTB’s net interest margins is expected to be intact at around 5%, whilst the young and dynamic bank is set to grow in the coming years. Therefore, we are maintaining our forecast 2010E net profit at LKR969.7 mn (up 41% YoY) and projected 2011E net earnings at LKR1,296.9 mn (up 34% YoY).

Share offers good value on 14.8x forecast 2010E net profit. The share offers good value on 14.8x forecast 2010E net profit, 11.0x projected 2011E net earnings, 2.0x PBV. Maintain BUY.

Odel PLC (ODEL): Net Profit has surged two folds in 1QFY11..

noreply@blogger.com (Sri Lanka Equity Analytics) — Thu, 12 Aug 2010 08:35:00 +0000

Odel PLC (ODEL), one of the nation's largest fashion, apparel and cosmetics retailers has exhibited strong performance in 1QFY11, upon being listed in the Colombo bourse during the same quarter. ODEL stores offer a broad selection of merchandise and feature products from both local and exclusive international brand sources. The Company operates 12 stores where the flagship store being located in the heart of Colombo and the rest spanning within the three districts of the Western Province and plans to open three more stores during the year 2010 (possibly in Wattala, Battaramulla and Kandy).

ODEL's revenue has grown by an impressive 62% YoY to LKR691.9 mn in 1QFY11. The expansion of branch net work, increase in tourist arrivals and better macro economic situation have served as the catalysts in driving up the revenue. However the Revenue per Sq. Ft has reduced by circa 5% to LKR5.4 K per Sq.Ft on the back of incremental revenue per Sq.Ft has been relatively lower at LKR5 K per Sq.Ft.

The overall COS per Sq.Ft has reduced 10% YoY to LKR3.4 K in 1QFY11 owing to the lower COS per Sq. Ft in new outlets which stands at LKR2.8 K per Sq.Ft. Subsequently the Gross profit has surged 77% YoY to LKR264.1 mn in 1QFY11 on the back of the faster dip in COS Sq. Ft vs. the Revenue per Sq.Ft. Further the gross profit margin has improved from 35% in 1QFY10 to 38% in 1QFY11.

Subsequent to the 77%YoY increase in Gross Profit the EBITDA has increased by 85% YoY in 1QFY11 due to the relatively slower increase in operating costs, which has recorded an increase of circa 61% YoY in 1QFY11. The increases in operating costs are attributable to the expansion of the branch network and increase in operations. With the expansion move the employee and rental costs have increased by circa 15% YoY and the Sales commissions and advertising costs have increased by circa 10% YoY.

Following the impressive 95% YoY increase in EBIT and the 17% YoY dip in finance costs the Profit before tax has soared 272% YoY to LKR60.2 mn in 1QFY11. However the fivefold YoY increase in the tax bill has diluted the profits of the company resulting in a 199% YoY increase in Net profit of LKR37 mn.

The increased tourist influx following the three decade old war would have a positive impact on ODEL as the company is renowned as favourite Shopping Mall of tourists in Sri Lanka”. Recovery in the economy brought about higher consumer sentiment driven by confidence in the market along with the reduction in unemployment. Thus with the disposable income on the rise local consumers tend to have a higher demand towards premium quality products.

ODEL’s market positioning as a premium department store is a competitive advantage with a lower substitutability and a few number of competitors. With the expansions which are currently carried out, ODEL expands its reach and would have access to a bigger market without dilution. The company’s own brand which yields a higher margin is mainly sold via the outlets in the Colombo suburbs. With the store expansion taking place the contribution from the own brands (at present the contribution is circa 20-30% of the top line) is expected to increase.

Against the backdrop and the 1QFY11 results being in line with our forecasts we maintain our FY11E earnings at LKR189.6 mn (UP 34% YoY) and FY12E earnings at LKR235.5 mn(up 24% YoY).

In terms of earnings based valuations the share is fairly valued on 21.4X forecast FY11E net profit and 17.2X forecast FY12E earnings. The share saw +100% increase in the share price on the first day of trading itself and currently trades at circa 85% premium to the issue price. Going forward we expect the counter to perform on par with the broad market and the downside risk is fairly limited, thus we rate ODEL a HOLD

Tokyo Cement (TKYO): Outlook positive on the back of changing macro dynamics

noreply@blogger.com (Sri Lanka Equity Analytics) — Thu, 12 Aug 2010 07:22:00 +0000

Tokyo Cement's (TKYO) recorded a net profit of LKR240.5 mn in 1QFY11 (vs a loss of LKR (55.9) mn in1QFY10). TKYO posted strong net earnings on the back of 7.2% YoY growth in the top line, improved gross profit margin and 46.8% YoY dip in finance cost.

The resolution to the national conflict would shape up developments in the North & East and thus TKYO would be able to fulfill the demand with its excess capacity. A marked reduction in the cost base is expected through the synergies of the bio mass plant (LKR200 mn savings) and relatively low interest cost. Against this backdrop we expect TKYO to record LKR839.3 mn in FY11E (up 188%YoY). Further, we believe Tokyo cement is poised for demand driven growth especially in FY12E and we expect a conservative 33% YoY increase in net earnings to post LKR1,112.9 mn.

TKYO (voting) currently trades on 11.9X forecast FY11E net profit, 9.0X projected FY12E net profit and 1.2XPBV. TKYO non-voting currently trades on 8.9X forecast FY11E net profit and 6.7X projected FY12E net profit. We believe the share has strong upside given the positive earnings outlook, on the back of rising demand based on North & East developments, reduction in interest cost and favorable effects of Bio Mass plant. However, due to the fluctuating nature of the earnings exhibited in the past and lack of transparency associates a risk factor with the counter.

Despite the risk of fluctuating earnings exhibited, we continue to place more weightage on the catalysts for growth (greater home building demand, larger construction projects, location advantage and strong brand equity) and as a proxy to the reconstruction drive we believe the counter holds significant upside. Hence we maintain BUY.

Revenue has grown by 7.2% YoY to LKR3,426.0 mn in 1QFY11. TKYO's top line has grown by 7.2% YoY to LKR3,426.0 mn in 1QFY11 which is mainly due to a near 15% YoY growth in sales volume whilst with marginal variances, the price was maintained at circa LKR730/bag (maximum retail price is circa LKR785/50kg bag).

Operating at a near 65% production capacity (total capacity of 1.8 mn metric tons)complemented by an additional 600,000 MT bagging plant, TKYO is positioned to strengthen its revenue base in the future given the increase in demand.

Gross profit increased by 81.6% YoY to LKR825.8 mn in 1QFY11. Despite the increase in the top line the cost of sales has dipped by 5.1% YoY mainly on the back of relatively lower price of clinker, hence the gross profit has grown by 81.6% YoY during the quarter to post LKR825.8 mn. TKYO’s gross margins have strengthened significantly from 14.2% in 1QFY10 to 24.1% in 1QFY11 backed by strong growth in the top line and the dip in cost of sales.

EBITDA has increased by 43.5% YoY to LKR620.3 mn in 1QFY11. The operating expenses have risen sharply during the quarter (LKR620.3 mn in 1QFY11 vs LKR432.3 mn in 1QFY10) mainly on the back of the Nation Building Tax (3% of Turnover) being charged under the expenses.

PBT has increased by three fold YoY to LKR240.4 mn in 1QFY11. The finance cost during the quarter has dipped 46.8% YoY to LKR146.3 mn on the back of reduced borrowings (23% YoY dip to LKR1,663.0 mn) and lower interest rates (to a near 8.8% from 12.7% an year ago). Further, during 1QFY11 the depreciation cost dipped by 7.6%YoY to LKR233.6 mn. Subsequently, the PBT grew by near three fold to LKR240.4 mn during 1QFY11.

Net profit has grown to LKR240.5 mn in 1QFY11 vs. LKR (55.9) mn in 1QFY11. During the quarter under review TKYO has posted an impressive LKR240.5 mn in net earnings vs. a loss of LKR55.9 mn in 1QFY10.

Expected Growth and developments in the North & East. Following the entirely resolved terrorist conflict, demand is expected to grow (where the growth potential is signaled in this quarter under review) with the new infrastructure and highway developments in the North and developments could be expected to shape up in the rural areas particularly in the North & East. With 1.8 mn MT capacity and at the present 65% utilization levels, TKYO is positioned to exploit the business opportunities in the North & East as it arises.

Due to location advantage and the involvement with the Japanese owners (Nippon Coke Engineering Co, Japan and St Anthony’s Consolidated Ltd owns 27.5% each) bulk of the development projects in the Eastern province could be awarded to TKYO cement. However, the benefits would kick in based on the speed of infrastructure developments whilst we believe that the present excess capacity of the Trincomalee plant will be utilized to cater for the demand created through the East development contracts thereby contributing towards strong earnings growth in the future.

Power generated through the bio mass plant. The new bio mass plant of TKYO currently generates 10MW where as the power requirement to facilitate their internal requirement is circa 7.5MW whilst the company supplies the surplus to the national grid. This facility is expected to generate cost savings of around LKR200 mn from FY11 onwards. Further, the company incorporated a wholly owned subsidiary “Tokyo Cement Power (Lanka) Ltd” during early this year for setting up and operating of power generation, giving an indication that the company would look for more power projects in the future.

FY11E net profit to reach LKR839.3 mn, up 188% YoY. The resolution to the national conflict would shape up developments in the North & East and thus TKYO would be able to fulfill the demand with its excess capacity. A marked reduction in the cost base is expected through the synergies of the bio mass plant (LKR200 mn savings) and relatively low interest cost. Against this backdrop we expect TKYO to record LKR839.3 mn in FY11E (up 188%YoY). Further, we believe Tokyo cement is poised for demand driven growth especially in FY12E and we expect a conservative 33% YoY increase in net earnings to post LKR1,112.9 mn.

Share offers significant value. TKYO (voting) currently trades on 11.9X forecast FY11E net profit, 9.0X projected FY12E net profit and 1.2XPBV. TKYO non-voting currently trades on 8.9X forecast FY11E net profit and 6.7X projected FY12E net profit. We believe the share has strong upside given the positive earnings outlook, on the back of rising demand based on North & East developments, reduction in interest cost and favorable effects of Bio Mass plant.

However, due to the fluctuating nature of the earnings exhibited in the past and lack of transparency associates a risk factor with the counter. Despite the risk of fluctuating earnings exhibited, we continue to place more weightage on the catalysts for growth (greater home building demand, larger construction projects, location advantage and strong brand equity) and as a proxy to the reconstruction drive we believe the counter holds significant upside. Hence we maintain BUY.

Sri Lanka: Aitken Spence PLC net earnings up by a sharp 49.6% YoY in 1QFY2011

noreply@blogger.com (Sri Lanka Equity Analytics) — Tue, 10 Aug 2010 03:09:00 +0000

Conglomerate, Aitken Spence PLC (SPEN) posted a net profit of LKR439.5 mn for 1QFY2011, up by a sharp 49.6% YoY mainly on the back of strong contribution from Sri Lankan leisure business and growing service sector.

SPEN has its major interests in hotels, travel and tourism, cargo logistics and power generation whilst having presence in printing, plantations and financial services. The company continuously seeks avenues to expand its presence regionally and globally whilst looking forward to partner in North and East development projects.

Further, the company along with China Merchant Holdings were the sole bidders to build and operate the first terminal of the Colombo South Harbour (Colombo Port Expansion project) and the government has decided to award the project to them. However this is still in the final phase of discussions which we believe would be finalized in another month's time.

Group revenue up by 12.0% YoY to LKR5,662.8 mn in 1QFY2011 . SPEN's consolidated gross revenue has increased by a moderate 12.0% YoY in 1QFY2011 on the back of increased tourism and cargo logistics sector earnings despite the dip in contribution from Strategic Investments.

The strategic investment sector; the highest contributor to the group's top line (47% of total revenue) has dipped by a marginal 2.1% YoY during 1QFY2011 whilst SPEN's tourism business has marked a sharp growth of 26.2% YoY (30% of total revenue) owing to reviving local tourism despite it being the off season in the world at large.

Group's Cargo Logistics operations which was negatively affected by low activity levels triggered by global recession has shown signs of recovery with revenue increasing by a sharp 28.6% YoY (16% of total revenue) where as the newly formed Services sector has recorded a 10.4% YoY growth in its top line (7% of total revenue).

Further it should be noted that the revenue mix of SPEN has changed considerably with increased contribution from tourism and cargo logistics sectors (4% and 2% increase in contribution to top line in 1QFY2011 compared with 1QFY2010) whilst the largest strategic investments sector recording a dip (6% in 1QFY2011 versus 1QFY2010) mainly on the back of comparatively lower tariffs offered by the CEB
for power generation.

Consequently, the group's net revenue has recorded a rise of 11.9% YoY in 1QFY10 to LKR5,578.4 mn.

Operating costs up 12.9% YoY in 1QFY2011. SPEN’s total operating costs have increased by 12.9% YoY to LKR4,892.1 mn in 1QFY2011 on the back of increased activity levels of the group (especially the hotel operations and cargo logistics) which have pushed up the direct operating costs by a significant 34.6% YoY and employee benefit expenses by 21.8% YoY.

SPEN records an operating profit of LKR714.4 mn for 1QFY2011. SPEN’s operating profit for the quarter in concern has recorded a marginal growth of 5.4% YoY to LKR714.4 mn owing to improved performance in tourism and services sectors of the group.

The company’s biggest profit contributor, Strategic investment sector (57% of the total operating profit) has recorded a dip of 14.7% YoY on the back of lower tariff rates offered by the Ceylon Electricity Board for power generation. SPEN’s tourism sector has converted its operating loss of LKR85.7 mn in 1QFY2010 to a profit of LKR12.7 mn in 1QFY2011 despite this quarter being the off peak for tourism coupled with poor performance in its Maldivian arm. The company’s Cargo logistics sector marked a marginal dip of 1.3% YoY despite the higher contribution to the top line owing to increased non cash expanses which has risen 214.1% YoY.

The services arm continued to grow its operating profits with an increment of 6.6% YoY in 1QFY2011 and a contribution of 23% to the total profits.

SPEN records LKR647.3 mn as pre tax profits for 1QFY2011. SPEN’s 1QFY2011 net finance cost has dipped by a sharp 57.1% YoY in 1QFY2011 on the back of 38.4% YoY increase in finance income coupled with 29.5% YoY dip in finance expenses driven by the fall in interest bearing liabilities and lower rates.

Further, the associate income has marked a two-fold rise owing to stronger performance of its hotel associates coupled with better earnings from plantations. Consequently, the company made a pre tax profit of LKR647.3 mn in 1QFY2011 versus a profit of LKR488.1 mn in corresponding period last year.

SPEN’s bottom line up by a sharp 49.6% YoY to LKR439.5 mn in 1QFY2011. The conglomerate has posted a bottom line of LKR439.5 mn for 1QFY2011, up by a sharp 49.6% YoY on the back of healthy earnings from tourism sector coupled with recovering cargo logistics sector and growing services sector.

Sectoral performance
The Tourism sector has posted a pretax loss of LKR8.9 mn in 1QFY2011 versus a loss of LKR188.7 mn an year ago. However the sector has recorded a postive operating result of LKR12.7 mn in the quarter (versus a loss of LKR85 mn in 1QFY2010) despite this quarter being the worst for tourism industry coupled with poor performance in Maldivian resorts.

SPEN, with primary interest in hotels and tourism has been in search of opportunities to expand its presence both in the country and the region. The company plans to invest LKR9 bn to expand its footprint in the South West Coast coupled with reaching new location such as Trincomalee (where they have 100 acres) Jaffna and
Kalpitiya. In addition, the company is refurbishing “Neptune” its first property in down south (Beruwela), into a wellness resort and a spa specialising in ayurvedic treatments which would commence operations in winter 2010 as “Heritance Mahagedara”. To fund SPEN’s expansion strategies, its subsidiary; Aitken Spence
Hotel Holdings (AHUN: LKR450.00) raised LKR2.5 bn by way of a rights issue in March 2010 and SPEN has invested LKR1.8 bn to retain its effective holding in the subsidiary.

The Cargo Logistics sector’s post tax profit dipped 21.4% YoY in the first three months of the year, despite the growth in top line. This could be attributable to the 214.1% YoY increase in non cash expenses in 1QFY2011.

The Strategic Investments sector has posted a profit after tax of LKR364.4 mn in 1QFY2011, down by 4.0% YoY. Power generation has been driving the sector earnings where its revenue has come down owing to the lower tariffs paid by the Ceylon Electricity Board as per the Power Purchase Agreements.

Furthermore, the gross margins of power generation would deteriorate in coming years as the power agreements of the three thermal plants are nearing expiration. However, the company is positive on its expertise in power generation and plans to enter the power and energy industry in neighbouring countries. Further SPEN has obtained a licence to build and operate a 3MW hydro power plant and plans to connect to the national grid in FY2011.

The Services sector comprising of elevators (OTIS), financial services (MMBL), Operations and maintenance of SPEN’s power plants and insurance businesses has recorded a net profit of LKR601.2 mn in 1QFY2011 (up 5% YoY). SPEN is looking forward to expand this sector in the future focusing more towards IT related services.

Forecast FY2011E earnings up by 18.5% YoY to LKR2,460.7 mn. We forecast FY2011E net profit to reach a conservative LKR2,460.7 mn (up by 18.5% YoY) backed by the turnaround performance in tourism sector coupled with improving cargo logistics business and project FY2012E net profit rise by 13.6% YoY to LKR 2,795 mn.

Fairly valued on 21.0X forecast FY2011E net profit. Share is fairly valued on 19.8X projected FY2011E earnings and 17.4X forecast FY2012E net profit whilst trading on 2.3X PBV. With the finalisation of Colombo Port project which would strengthen the company’s bottom line in another 2-3 years time coupled with SPEN’s strong management and diversified operations we rate SPEN a Long term BUY

Sri Lanka - Sampath Bank (SAMP) 2Q2010 Net profit up 66%

noreply@blogger.com (Sri Lanka Equity Analytics) — Tue, 10 Aug 2010 02:43:00 +0000

SAMP's net profit increased 66% YoY during 2Q2010 mainly backed by improving core business activities (NII grew by 9.4% YoY) and capital gains realized from the sale of Lanka Bangla shares enabled the 1H2010 net profit to increase by 58.8% YoY to LKR1,344.5 mn.

With interest rates stabilizing (3 month treasury bill rate near 8%) and the private sector credit showing signs of growth (grew 2.2% YoY in May) which is expected to gather momentum during 2H2010 to record circa 10-12% growth by end 2010E, thus banking sector outlook remains positive. SAMP's net interest margins is expected to be intact at around 5%, whilst continuing to benefit from the wider reach facilitated by the current 149 branches coupled with its retail focus (nearly 60% retail exposure).

We are revising up our 2010E forecast by 2.6% to LKR2,457.0 mn (up 19% YoY) whilst maintaining our 2011E forecast at LKR2,698.4 mn (up 10% YoY). Thus the share offers good value on 11.2x forecasted 2010E earnings and 10.2x forecasted 2011E earnings whilst trading on 1.7x PBV. Maintain BUY

Interest income has reduced 17% YoY during 2Q2010 to LKR4,588.8. Interest income dropped 16.6% YoY during 2Q2010 due to a 13.1% YoY decrease in interest income from loans and advances to LKR 3,523.3mn and 26.2% YoY dip in interest income on other interest earning assets to LKR1,065.5 mn.

Interest income on loans and advances dipped despite a 2.5% growth in performing loans on the back of low interest rates. Government securities portfolio (held to maturity) dipped 56.3% during 2Q2010which was reflected in the reduction in interest income on other interest earning assets.

Interest expenses have dropped 30% YoY to LKR2,498.2 mn in 2Q2010. Interest expenses dropped 30.4% YoY in 2Q2010 mainly due to 27.1% YoY drop in interest expenses on deposits to LKR2,235.9 mn while interest expenses on other interest bearing liabilities also dropped 49.5% YoY to LKR262.3 mn. Total deposits increased 5.2% during the quarter to LKR 139.7 bn where low cost CASA deposits accounted for circa 46% (grew from near 44% during 1Q2010) of total deposits.

Net interest income has increased 9% YoY to LKR 2,090.6 mn. During 2Q2010, despite interest income dropping 16.6% YoY, interest costs dropped at a sharper pace of 30.4% YoY which resulted in the 9.4% YoY increase in net interest income.

Non interest income grew 71%YoY to LKR1,361.5 during 2Q2010. Non interest income grew 71.2% YoY mainly on the back of capital gain realized from selling off 1.2 mn shares (Due to this, Bank’s holding of 13.55% as at 31.12.2009 was reduced to 11.29% as at 30.06.2010) in Lanka Bangla Finance Ltd which boosted other income by 85.9% YoY.

Non interest expenses increased 15.7%YoY in 2Q2010 to LKR1,593.3 mn. Non interest expenses increased 15.7% YoY mainly due to 10.6% YoY increase in personnel cost to LKR673.2 mn and 13.5% YoY rise in overheads to LKR535.9. The increase in operating costs can be attributable to the expansions undertaken by the bank where it opened 6 new branches during 2Q2010. Further cost to income ratio stood at near 46% end of 2Q2010.

Provisions have increased 296% YoY in 2Q2010. Provisions have increased 296% YoY in 2Q2010 to LKR 322.4 mn largely owning to LKR255.0 mn specific provision on account of investment in Union Bank shares which increased total specific provisions to LKR669.5 mn. However recoveries have increased drastically during 2Q2010 by 239.1% YoY to LKR377.0 mn.

Operating profit has risen 27% YoY to LKR1,415.0 mn in 2Q2010. Operating profit rose 27.4% YoY during 2Q2010 to LKR1,415.0 mn backed by 9.4% YoY increase in net interest income and 71.2% increase in other income.

Total tax bill reduced 7% YoY to LKR 653.9mn. Total tax bill has reduced 6.9% in 2Q2010 due to 28.5% YoY decrease in corporate tax. However the VAT on Financial services has increased by 18.5%. The effective tax rate as at 30th June 2010 stood at 46%.

Net profit up 66% YoY to LKR746.1mn. SAMP’s net profit increased 66.1% during 2Q2010 mainly backed by improving core business activities (NII grew by 9.4% YoY) and capital gains realized from the sale of Lanka Bangla shares enabling the 1H2010 net profit to increase by 58.8% YoY to LKR1,344.5 mn.

Improved NPL ratios during 2Q2010. SAMP’s gross NPL ratio improved to 6.8% in 2Q2010 from 7.6% as at 31st December 2010 whilst net NPL ratio improved to 1.7% from 2.8%.

SAMP remains well capitalized. Tier I CAR stood at 11.1% (Tier I – Min 5%) whilst Tier II CAR was at 14.2% (Tier II – Min 10%) during 2Q2010.

Forecast 2010 net profit revised up by 2.6% to LKR2,457.0 mn (up 19% YoY). With interest rates stabilizing (3 month treasury bill rate near 8%) and the private sector credit showing signs of growth (grew 2.2% YoY in May) which is expected to gather momentum during 2H2010 to record circa 10-12% growth by end 2010E, thus banking sector outlook remains positive. SAMP’s net interest margin is expected to be intact at around 5%, whilst continuing to benefit from the wider reach facilitated by the current 149 branches coupled with its retail focus (nearly 60% retail focus).

Therefore we forecast 2010E net profit to grow by 19% YoY to LKR2,457.0 (revised up by 2.6%) and 2011E net profit to grow by 10% YoY to LKR2,698.4 mn. Share offers good value on 11.2x forecasted 2010E net profit. The share offers good value trading on 11.2x forecasted 2010E net profit and 10.2x forecasted 2011E net profit whilst trading on 1.7x PBV. Maintain BUY.

Sri Lanka Seylan Bank (SEYB) - Regaining Confidence...

noreply@blogger.com (Sri Lanka Equity Analytics) — Tue, 27 Jul 2010 04:06:00 +0000

Sri Lanka’s banking and financial services sector has been a steady contributor to the economy (10.3% to the GDP in 2009) and been one of the most sought after sectors in the Colombo bourse (that gained nearly 110% in terms of market capitalization and sector index gained near 124% during the year 2009). Going forward with the favorable economic outlook, growth potential of banks due to healthy capitalization levels and improving asset quality in the banking sector we see the sector performing above expectations in the coming years.

SEYB which was a one of the major player in the retail banking industry in the past is now showing signs of recovery after its set back in 2008 due to a run on the bank as a result of depositors losing confidence in the bank.

Deposits recoded a marginal 1.5% growth in 1H2010. Bank showing signs of recovering its lost deposits during 1H2010 where it recorded marginal growth after its steep decline in 2008. Further it is also encouraging to see a shift in the deposit mix more towards low cost current and savings (CASA) products. We believe SEYB would return to normalcy during the next 2 years recovering its deposits which would help them to grow from there onwards.

Improvement in non performing loans (NPLs) during 1H2010. NPL’s in 2009 peaked up to near LKR30.0 bn whilst the gross NPL ratio for 2009 stood at 29.3% (which was the highest in the industry). However with the emphasis on recovering the bad loans under new management we saw a reduction in NPL’s in 1H2010 which stood at LKR27.5 bn with the gross NPL ratio still being the highest in the industry at 25.6% (industry NPL ratio is circa 8%).

Healthy interest margins and capitalization levels. SEYB has always maintained its interest margins par with the sector due to its retail focus and differentiated service levels where the banks current interest margins stands at 5.5%. Further bank is also comfortably capitalized with in regulatory limits where the bank does not need to raise capital for its expansions in the near future.

Forecast 2010E earnings to rise by 78% YoY to LKR1,010.9 mn. With banks promising recovery process as stated above coupled with necessary measures to curtail cost and improve its core business activities we also believe SEYB would be in a position to benefit from the expected industry wide upside with strong macro economic position of the country. Based on these assumptions we are expecting a 78% YoY increase in projected 2010E earnings to LKR1,010.9 mn and projected 2011E earnings to rise by 30% to LKR1,316.3 mn.

Non voting share offers good value on 10.9x forecasted 2010E earnings. The non voting share which is trading at a near 44% discount to the voting share offers good value on 10.9x (compared to the sector PE of 13.8x) forecasted 2010E earnings and is attractive at 8.4x forecasted 2011E earnings whilst trading on 1.0x PBV. Given the above assumptions on recovery and industry wide upside we rate SEYB (Non Voting) a BUY.

The voting share is trading near 50% premium to the financial sector, However we believe given SEYB’s branch network and reach and the recovery in its core business coupled with the reviving macro economy and growth potential in the banking sector SEYB has further upside, hence we rate SEYB (Voting share) a HOLD.

Overview
Banking sector overview
Sri Lanka’s banking and financial services sector has been a steady contributor to the economy (10.3% to the GDP in 2009) and been one of the most sought after sectors in the Colombo bourse (that gained nearly 110% in terms of market capitalization and sector index gained near 124% during the year 2009). We saw the asset quality in the banking sector deteriorating in the recent past due to high interest rates and inflationary environment coupled with the weakening macro environment both globally and locally, despite the healthy capital adequacy levels that the banks maintained throughout.

Nevertheless, with the improving macro economic outlook for Sri Lanka and easing interest rates and inflation we expect the banking sector to be a prime beneficiary of this positive momentum. Further we expect that with the end of the 3 decade long seperatist conflict which has opened up a vast cash rich area will provide ample opportunities for banks to grow in the coming years.

Lower lending rates coupled with vast development projects which are underway in the island will enable the banks to grow their loan portfolios. Further with North and East integrated into the economy we foresee branch network of the banks expanding (near 35 new branches were opened after May 2009) and we can expect a growth in their deposit portfolios. In addition, the local banking industry is highly regulated and the issuance of new banking licenses in virtually a non-sorter as Central Bank of Sri Lanka (CBSL) discourages new entrants where we already have circa 23 players (both local and foreign). This provides the existing operators to enjoy the benefits of this upside. Going forward with the favorable economic outlook, growth potential of banks due to healthy capitalization levels and improving asset quality in the banking sector we see the sector performing above expectations in the coming years.

Company overview
Seylan Bank was incorporated in 1987 and obtained a listing for its ordinary shares on the Colombo bourse in 1989. Today the bank stands as the 4th largest private commercial bank in Sri Lanka with an asset base of LKR142.9 bn whilst operating an island wide branch network of 94.

From the inception the bank was more focus on the retail sector offering differentiated (5% bonus on interest reinvested in fixed deposits, 1% bonus interest on minimum balances of savings accounts) and customer oriented services (extended weekday banking hours as well as Saturday banking). SEYB enjoyed immediate success reporting an after tax profit of LKR11.3 mn in 1988 where the profitability has grown at a 19 year CAGR of 26% from 1988-2007. In 2008 bank faced a confidence crisis where customers were demanding for withdrawals due banks associates with Ceylinco group (held near 24%) and the SEYB recorded a loss of LKR143.0 in 2008. Today the bank is recovering from the crisis situation under the new management and the bank has potential for upside (along with the expected industry upside) given the bank will return to its normal operating levels by end of 2010.

The chain of events that happened in year 2008 led to the historic run on SEYB in late 2008 due to failure of financial institutions and loss public confidence in September 2008 an unlisted finance company “Sakvithi Investments” defrauded a near LKR900 mn worth of deposits (individual responsible for the fraud fled the country) after luring exceptionally high rates of returns.

With the instability and fear created by these unregistered finance companies made depositors demand back their funds at Golden Key (which was offering higher rates of 24-30% p.a.) a Ceylinco owned company. Finally all these incidents led to collapse of Golden Key and directors were sued for management malfunction.

Subsequent to the Golden Key crisis there was a run on SEYB where, by then the Ceylinco group (was the holding company of Golden Key) held 24% of the bank and Dr. Lalith Kotelawala who was the chairman of Ceylinco group was also the chairman/managing director of SEYB by that time.

Further bank also had reckless related party lending to most of the Ceylinco group companies which brought about huge NPL’s (peaked up to LKR30 bn in 2008) from Ceylinco group companies after most of them collapsed.

Recovery process under new management
In December 2008 Ceylinco group divested its interest in SEYB where two state institutions (Sri Lanka Insurance Corporation and Bank of Ceylon) bought 25% of SEYB becoming the largest shareholder as at 31st December 2009. Following the take over, CBSL handed over the management of SEYB to Bank of Ceylon and was asked to appoint a new board in the meantime. Decisive action by CBSL to restore SEYB from its crisis was commendable and it also protected the entire financial services sector from further crisis. Under the new management the main priority was to restore public confidence and adopt appropriate risk management strategies.

Future outlook
During latter part of 2009 and 1Q2010 SEYB showed signs of recovery where they were able to bring down the NPL's (from a high of LKR31 bn in 2009 to near LKR27 bn by 1Q2010), curtail costs (near 20% YoY reduction in 2009), improve capital adequacy, strengthen liquidity position (stood at 29% end of 2009 compared to regulatory limit of 20%), improve net interest income and increase foreign remittances.

The bank drew up a 3 year strategic plan from 2009-2011 emphasizing to improve seven key performance indicators such as ROE, NPL ratio, cost to income ratio, profit after tax etc. Further the bank also has taken necessary steps to attract deposits, improve recoveries and managing its business risks. It is also noteworthy that with all these healing processes the bank is also looking at expansion plans for growth mainly in North and East.

Deposits
SEYB’s deposits recorded a steady growth during 2002-2004 where it saw a sizeable leap in 2005 but from 2005 onwards growth in customer deposits slowed down. Banks deposit base dropped considerably in 2008 mainly on the back of global financial turmoil and high inflationary situation in the country. However after 2008 the banking sector deposit growth recovered with declining inflation and recovery in the global crisis (9% YoY growth) in contrast SEYB recorded negative growth mainly because of the internal crisis (Ceylinco group crisis) the bank under went during 2H2008 and early 2009. With the new management in place and sound credit policies adopted the bank has been able build up the confidence of the customer where it has helped to attract the lost deposits to the bank (deposits recoded a marginal 1.5% growth in 1H2010).

Therefore going forward with the improving macro economic conditions and the upside in the banking sector we believe SEYB would be able to recover its lost deposits and will return to normalcy during the next 2 years which would help them to grow from there onwards.

Another positive sign we are seeing the banking sector is the shift in the deposit mix towards low cost CASA products. This is evident in SEYB as well where they have been able to grow its savings products whilst reducing the dependence on high cost time deposits. In 2008, 64% of SEYB’s total deposits came from time deposits where as the contribution from CASA was 36% which was mainly due to high interest rates prevailed at that time. But during 1H2010 saw a 42% contribution from CASA which has helped the bank to reduce their interest cost.

From the total deposits Western province contributes to near 65% where the bank operates 46 branches with average deposit base of LKR1.5 bn per branch. 8 branches in the North & East contributes 5% of to the total where the average deposit base per branch stands near LKR0.8 bn. Going forward with the newly liberated North & East integrated into the main stream economy we expect the contributions from the North & East branches to increase.

Loans
SEYB’s loan growth surged from 2001-2005 at a CAGR of 20.4% mainly backed by the industry wide growth momentum. However we see a notable dip in banks loan growth from 2006-2008 due to contractionary monetary policies adopted by CBSL to curtail inflation coupled with the heightened conflict situation which discouraged new investments.

We saw the industry loan growth slowly recovering from 2008 onwards where as SEYB recorded a 23% dip in its loan book in 2009 which was the largest contraction compared to its peers. This was mainly due to the high proportion of the loans being categorized as non performing loans. (2009 SEYB had the highest NPL ratio of 29.3%) During 1H2010 we saw a marginal dip of 1% in banks net loans due to growth slower private sector credit growth during 1H2010 but we saw an improvement in the NPL position of SEYB in 1H2010. (NPL ratio during 1H2010 stood at 25.6%).

In terms of the sector wise break down we see majority of the loans granted to the housing sector where it contributed for circa 17% of the total loan book whilst consumption sector contributed for 10%. However it is also note worthy that housing and consumption sectors are the sectors that will mostly affect the asset quality.

SEYB is concentrated more on short term loans where it is circa 51% of the total portfolio where as medium term loans contribute 25% and contribution from long term loans stands at 24%. Further SEYB from the inception had more focus on the retail segment (which yield higher margins) and currently operate at a retail : corporate mix of near 70:30. Bank also has seen increasing demand in its pawning business (which is a highly profitable business with low risk) specially from Northern province, where currently pawning contributes for circa 6-7% of the total advances.

Interest Margin
SEYB has been able to enjoy above 5% interest margins during the last five years (even in times of crisis) due to its retail focus and differentiated service. Banks interest margin of 5.5% was in line with the industry average of circa 5%.

Asset Quality
SEYB’s non performing loans (NPL) were at manageable levels (gross NPL ratio near 8%) during 2005-2008 but with reckless lending patterns which resulted in NPL’s to peak up to near LKR30 bn in 2009 whilst the gross NPL ratio for 2009 stood at 29.3% (which was the highest in the industry). However with the emphasis on recovering the bad loans under new management we saw a reduction in NPL’s in 1H2010 which stood at LKR27.5 bn however the gross NPL ratio is still the highest in the industry at 25.6% (industry NPL ratio is circa 8%).

Capital Adequacy
Bank has improved its capital position after it fell below regulatory limits in 2008 where the Tier II CAR stood at 9.4% vs 10% regulatory limit. Bank is comfortable with its current capitalization level (Tier I at 10.6% and Tier II at 12.8% compared to regulatory limits of 5% & 10%). Further Fitch Ratings Lanka Ltd’s rating on SEYB is BBB+ and the outlook is stable.

Financial Performance
SEYB was growing gradually during 2005-2007 where the major set back occurred in 2008 where the group recorded a loss of LKR143.0 mn. It is also noteworthy in 2008 banks operating cost increased exceptionally than its NII largely owing to high provisioning costs. However we saw the bank improving its performance during 2009 under the new management where the bank recorded a profit of LKR569.2 mn (up 498% YoY). Main reason behind improvement in operations was reducing operating costs and provisions despite business volumes were contracted. Further it is also encouraging to see SEYB recording a profit of LKR507.3 mn in 1H2010.

In terms of profitability ratios we saw SEYB maintained the interest margins at circa 5% levels. However average return on equity and average return on assets fell drastically below industry average in 2008 due to poor utilization of shareholder funds and mismanagement of resources. But bank recovered during 2009 which was reflected in its profitability ratios where the bank recorded improved ROAE of 9.4% and ROAA of 1.2% (Still below industry averages) end of 1H2010.

With higher interest rates we see major contribution (89%) from interest income to total income in 2009. However with rates reducing interest income contribution will decline marginally in the coming years. But we see a notable contribution coming from fee based income in 1H2010 where majority of this is through foreign worker remittances (where total remittances grew by near 14% YoY during 2009). Therefore going forward with the expected circa 15% YoY growth in remittances we believe SEYB will also grow their fee based income part through its partnerships with MoneyGram International, XPRESS MONEY and EzRemit.

SEYB’s cost to income ratio has been the highest in the industry where it peaked to 117% in 2008 largely owing to higher staff cost. In 2008 bank employed 4,354 employees as compared to 4,041 employed by the largest private commercial bank in the country. Therefore it emphasizes the over staffing problem the bank had over the past hiking up the operating costs. The new management has adopted measures to curtail costs and address the over staffing problem where the bank was able to bring down the cost to income ratio to 66% by 1H2010 (but still was the highest in the industry).

Areas to improve in the future

SEYB’s cost to income ratio of 66% is the highest in the industry (where industry average is around 55%) and bank also has an overstaffing issue to address (nearly half the size of countries largest private commercial bank in terms of assets but it employees virtually the same number of employees). Going forward tha bank need to address this issue where we have witnessed the bank’s new management have adopted few cost rationalization strategies to reduce cost.

SEYB’s NPL ratio, ranging from just over 11% to more than 25% since reporting began in 1998. Bank has the highest NPL ratio among its peers and exceedingly high compared with the industry average of 8%. Bank adopted various measures to bring down its NPL’s (execute legal action, stop lending to Ceylinco group etc.) where we saw banks gross NPL ratio improving to circa 25% from a high of 29%.

Profitability measures such as ROE and ROA fell significantly below the industry norms during the past two years. Therefore the company has to take the challenge of improving the profitability measures in the coming years through its wider reach and improving core business.

Valuation
Forecast 2010E earnings to rise by 78% YoY to LKR1,010.9 mn. With banks promising recovery process where we believe the bank would be able to reduce its NPLs from its current LKR27 bn, adopt necessary measures to curtail cost and improve its core business activities. We also believe SEYB would be in a position to benefit from the expected industry wide upside with strong macro economic position of the country. Based on these assumptions we are expecting a 78% YoY increase in projected 2010E earnings to LKR1,010.9 mn and projected 2011E earnings to rise by 30% to LKR1,316.3 mn.

Non voting share offers good value on 10.9x forecasted 2010E earnings. share has good value on 10.9x (compared to the sector PE of 13.8x) forecasted 2010E earnings and is attractive at 8.1x forecasted 2011E earnings whilst trading on 1.0x PBV. The non voting share which is trading at a near 44% discount to the voting share where the normal discount between the voting and non voting share in the banking sector is 25- 30%. Therefore we believe the gap between SEYB.N and SEYB.X should narrow in the future and given recovery in its core business that we have seen during 1H2010 coupled with the reviving macro economy and growth potential in the banking sector we rate Given the above assumptions on recovery and industry wide upside we rate SEYB (Non Voting) a BUY.

The voting share currently trades at 19.6x projected 2010E earnings and 15.0x on projected 2011E earnings whilst trading on 1.8x PBV. The voting share is trading near 50% premium to the financial sector, However we believe given SEYB’s branch network and reach and the recovery in its core business that we have seen in 1H2010 coupled with the reviving macro economy and growth potential in the banking sector SEYB has further upside, hence we rate SEYB (Voting share) a HOLD.

Seylan Bank’s (SEYB) net profit up 66% YoY during -2Q2010

noreply@blogger.com (Sri Lanka Equity Analytics) — Tue, 27 Jul 2010 01:38:00 +0000

Overview
Seylan Bank (SEYB) was incorporated in 1987 and obtained a listing for its ordinary shares on the Colombo bourse in 1989. Today the bank stands as the 4th largest private commercial bank in Sri Lanka with an asset base of LKR142.9 bn whilst operating an island wide branch network of 94. Today the bank is recovering from the crisis situation under the new management and the bank has potential for upside (along with the expected industry upside) given the bank will return to its normal operating levels by end of 2010.

SEYB’s net profit has grown by 66% YoY to LKR311.8 mn in 2Q2010 enabling cumulative 1H2010 earnings to grow by 169.8% YoY to LKR507.3 mn. Net profit growth during the quarter was mainly on the back of 37% YoY increase in net interest income and 29% YoY reduction in provisioning cost. With the expected economic growth the loan growth expected to gather momentum from 2H2010 onwards coupled with improving asset quality and healthy capitalization levels banking sector outlook remains positive. SEYB’s net interest margins are expected to be intact at around 5%, whilst continuing to benefit from an island wide branch network. We are revising up our forecast 2010E net profit at LKR1,010.9 mn (up 78% YoY) and projected 2011E net earnings to LKR1,316.3 mn (up 30% YoY). Thus the voting share is trading on
19.6x forecasted 2010E net profit and 15.0x projected 2011E net earnings, 1.8X PBV. The non voting share is attractive on 10.9x forecast 2010E net profit, 8.4x projected 2011E net earnings and 1.0x PBV .

SEYB’s interest income has dropped by 20.9% YoY to LKR4,204.1 mn largely due to the high non performing loans and low interest rates but on the contrary SEYB’s interest expenses have dipped by 43.2% YoY to LKR2,183.0 mn which has weathered the negative impact on interest income enabling the bank to improve their NII.

Bank’s OPEX has increased by 4.3% YoY mainly on the back of a 8.1% YoY increase in personnel expenses whilst all other expenses have been kept in check. Further it is also encouraging to see during 1H2010 banks OPEX has reduced by 1.8% YoY which has helped the cost/income ratio to come down to 66%.

Improved NII levels and marginal increase in OPEX have helped the bank to record a growth of 112.8% YoY to LKR893.9 mn in 2Q2010.

Provisioning cost has reduced by 29.2% YoY to LKR167.7 mn in 2Q2010 mainly due to 10.8% YoY reduction in specific to LKR360.9 mn and 90.8% YoY improvement in recoveries to LKR202.0 mn.
Value added tax on financial services has increased by 158.1% YoY to LKR189.0 mn and corporate tax has increased by 106.7% YoY to LKR193.4 mn which in turn has increased the total tax bill. Effective tax rate as at 30th June stood at 56%.

Bank’s bottom line has grown by 66.0% YoY to LKR311.8 mn mainly on the back of improved NII and reduction in provisioning costs despite increase in total tax bill and marginal increase in OPEX. Banks cumulative 1H2010 earnings have grown 169.8% to LKR507.3.

Bank managed to reduce its non performing loans by 2.5% YoY to LKR27.5 bn during the quarter. Thus gross NPL ratio has witnessed a considerable improvement to 25.6% in 2Q2010 from 29.3% in December 2009 and Net NPL ratio improved to 18.4% from 22.3%. However compared to the industry average of circa 8% SEYB’s NPL ratios are still at high levels.

SEYB’s loan book has recorded a 2.2% YoY growth in 2Q2010 to LKR64.1 bn where we saw the private sector credit growth (2.2% YoY growth in May)picking up during the 2Q2010.

Deposit base grew by 1.1% to LKR107.0 bn during 2Q2010 mainly due to growth in savings and demand deposits. Further we see a shift in the deposit mix towards low cost CASA deposits which will help SEYB to reduce it funding costs.

SEYB is showing signs of recovery from the financial turmoil which it underwent in 2008. Therefore on the back of the bank’s recovery, favourable macro economic environment coupled with expected credit growth in 2H2010 and growth potential for the banking sector we forecast 2010E net profit to rise by 78% YoY to LKR1,010.9 mn.

The voting share currently trades at 19.6x projected 2010E earnings and 15.0x on projected 2011E earnings whilst trading at 1.8x PBV. The voting share is trading at near 50% premium to the sector, however given SEYB’s branch network and reach and the recovery in its core business that we have seen during 1H2010 coupled with the reviving macro economy and growth potential in the banking sector SEYB.N. has further upside, hence we rate SEYB.N a HOLD

The non voting share is attractive at 10.9x projected 2010E earnings and 8.4x on projected 2011E earnings whilst trading at 1.0x PBV. The non voting share trades near 44% discount to the voting share where the normal discount between the voting and non voting share in the banking sector is 25-30%. Therefore we believe the gap between SEYB.N and SEYB.X should narrow in the future and given SEYB’s recovery in its core business that we have seen during 1H2010 coupled with the reviving macro economy and growth potential in the banking sector we rate SEYB.X a BUY

Royal Ceramics' net profits up 189%YoY to LKR382.5 mn in 1QFY11

noreply@blogger.com (Sri Lanka Equity Analytics) — Tue, 27 Jul 2010 01:18:00 +0000

Royal Ceramic's (RCL) has reported net earnings of LKR382.5 mn (up 189%YoY ) in 1QFY11 whilst the top line grew by 58%YoY. This was mainly driven by strong home builders demand, improved sales mix in the sizes of tiles (Bigger tiles tend to have higher margins) and increase in demand from hotel refurbishment projects and apartment developments.

RCL, the market leader in floor tiles with circa 45% market share has two manufacturing plants for floor tiles in Horana & Ehaliyagoda and one for sanitary ware in Homagama. Currently the floor tile production lines operate closer to 100% capacity to produce circa 10,500-11,000 sqm/day whilst the bathware currently produces circa 12,000 pieces/month where the installed capacity is a near 20,000-24,000 pieces per month. In order to meet the excess demand the company is planning to increase the Horana plant's capacity by 3,500 sqm per day by Jan'2011.

With the economic conditions improving and demand from both home builders and hotels and apartment towers picking up considerably and with the interest rates on the downward trend we revise our projected FY11E earnings upwards by 12.9% to reach LKR1,579.4 mn (up by 63%YoY). On top of the demand picking up in the country, the expected reconstruction boom in the North and East from drumming up the overall economic growth, the construction industry is expected to witness a turnaround. RCL is one of the prime beneficiaries as a leading player in the Western province and a dominant player in the country. With the company's short term plans to increase capacity in the existing production facilities we revise up our FY12E forecast also by 31% to LKR2,068.3 mn (up 31% YoY).

Yearly & Quarterly Performance
Net revenue grew 58% YoY to LKR1,152.4 mn in 1QFY11. RCL's net turnover has grown 58% YoY to LKR1,152.4 mn during 1QFY11 on the back of increased demand from home builders, hotel and apartment building projects. During 1QFY11 the sales volume grew by near 50%YoY whilst there has been no increase sales price.

Gross profit has risen by 51% YoY to LKR516.2 mn in 1QFY11. RCL's cost of sales has increased by 64.3% YoY to LKR636.2 mn in 1QFY11 where the company has posted gross profit of LKR516.2 mn in 1QFY11 (up 51% YoY). The gross profit margin has dropped marginally to 44.8%.

EBIT has increased by 73% YoY to LKR255.2 mn in 1QFY11. The company's administrative expenditure has increased to LKR82.3 mn (up 28.4% YoY) in 1QFY11 whilst distribution expenses have risen by 37.2% YoY to LKR178.7 mn on the back of increased expenses on the sales network of 41 showrooms. Consequently, RCL has recorded an EBIT of LKR255.2 mn in 1QFY11 (up 73% YoY) whilst the EBIT
margin has grown to 22.1% during the quarter from 20.2% in 1QFY10.

Other income has risen 68.3%YoY to LKR182.9 mn in 1QFY11. RCL's other operating income has increased by 68.3%YoY to LKR182.9 mn during the quarter mainly owing to profit on sale of shares amounting to LKR164.7 mn.

Net profit has increased by 188.9% YoY to LKR382.5 mn in 1QFY11. RCL's finance cost has dipped by 55.2%YoY to LKR55.8 mn in 1QFY11 owing to circa 26%YoY reduction in borrowings totalling to LKR790.7 mn and low interest rates. Consequently, the net profit during 1QFY11 grew by 188.9%YoY to LKR382.5 mn.

Slow and steady growth in bath-ware. The new Bathware manufacturing plant that commenced commercial operations in FY09 (built at a cost of LKR1.2 bn) with an installed plant capacity of around 250,000 pieces per annum has contributed LKR101.5 mn in revenue during 1QFY11 vs LKR26.4 mn in 1QFY10. The sanitaryware has also reduced its losses to record a loss LKR5.8 mn vs a loss of LKR38.5 mn in the corresponding previous quarter. Further, we believe that with the management's efforts on entering into new contracts this manufacturing facility would breakeven in another 10 - 12 months whilst the company is also focusing on increasing exports of sanitaryware.

Further, the company plans to open around 4 to 5 new showrooms during this year mainly in the recently liberated North and East. Further, due to the increased demand the company is planning to increase the capacity of the Horana plant by circa 3,500 pieces by January 2010. Moreover, the company owns a 33 acres land in Kiriwaththuduwa (owned by its newly incorporated subsidiary, Rocell Ceramics Limited) and has an option to commission a brand new floor tile facility there if there is a need for further expansion.

Forecast net profit to grow by 63.8% YoY to LKR1,579.4 mn in FY11E. With the economic conditions improving and demand from both home builders and hotels and apartment towers picking up considerably and with the interest rates on the downward trend we revise our projected FY11E earnings upwards by 12.9% to reach LKR1,579.4 mn (up by 63%YoY). On top of the demand picking up in the country, the expected reconstruction boom in the North and East from drumming up the overall economic growth, the construction industry is expected to witness a turnaround. RCL is one of the prime beneficiaries as a leading player in the Western province and a dominant player in the country. With the company's short term plans to increase capacity in the existing production facilities (increase production by 3,500sqm at Horana by Jan'2011) we revise up our FY12E forecast also by 31% to LKR2,068.3 mn (up 31% YoY).

Share offers good value on 4.5X forecast FY12E earnings. Despite the share appreciating sharply since we initiated "BUY" recommendation on the counter, the share is still trading at steep discount to market and remains very attractive on just 5.9X FY11E net profit and 4.5X forecast FY12E net profit whilst trading at 1.4XPBV. Maintain - BUY

Dipped Products PLC (DIPD) : Escalating rubber prices remains a major concern

noreply@blogger.com (Sri Lanka Equity Analytics) — Sat, 17 Jul 2010 08:40:00 +0000

Dipped Products PLC (DIPD) is the fully integrated and globally acknowledged rubber glove manufacturing arm of the local conglomerate Hayleys PLC (HAYL: LKR301.00). Currently DIPD exports its products to +68 countries and enjoys a 5% global market share for natural and synthetic latex based domestic and industrial gloves.

DIPD is globally ranked amongst the top three manufacturers of non-medical gloves whilst it ventured in to production of medical gloves in 2002 with a production facility in Thailand. At present DIPD operates seven production facilities in Sri Lanka and Thailand with marketing operations in Italy.

Despite the global recessionary pressures which hampered the demand for gloves, the company’s Thailand operation which is dedicated to produce medical gloves has posted a profit of LKR101 mn in FY2010 from a loss of LKR159 mn the previous year. At present all seven plants of DIPD are operating at near full capacity (which is at circa 85%). DIPD also manages the plantation arm of Hayleys group with two listed companies namely: Kelani Valley Plantations PLC (KVAL: LKR99) and Talawakelle Tea Estates PLC (TPL: LKR38.00). The company holds 71.67% in KVAL and 25% of TPL which produces around 5% of Sri Lankan tea and 4.5% of country’s rubber with +19,500 ha.

Further, KVAL sells 25% of its produce to its parent DIPD whilst selling the balance at auctions. Going forward, with the increasing rubber prices resulted by recovering global activity levels we believe KVAL will strengthen the bottom line of DIPD.

Therefore, we forecast KVAL to post a net profit of LKR245 mn in 2010E and to grow by a further 15% YoY in 2011E. Further during FY2010, DIPD acquired one third of Hayleys Plantation Services; the holding company of TPL for a consideration of LKR280 mn. Being one of the high quality tea manufacturers in the country, this venture would also result in a positive push for the group’s bottom line (through associate income).

Future outlook
The glove industry is a steadily growing industry in the world where medical glove category being the main growth catalyst backed by the necessities in healthcare and ever evolving medical technology sectors. Going forward it is estimated that global demand for gloves to be at circa 150 bn pieces in 2010 and to grow by a steady 8%-10% thereafter. The company plans to add another 50% to the current capacity of the Thailand Operation which is the sole medical glove facility of the group in FY2011E for an estimated investment cost USD5.6 mn. This will increase the production of the plant to 855 mn medical gloves per annum by the end of FY2011, which is inline with the high growth potential of the medical glove segment. Out of the total investment 30% would be equity funded by DIPD whilst the rest would be financed from bank borrowings. Backed by the additional capacity coupled with reliable and long lasting customer base in 68 countries we believe DIPD would post sustainable earnings growth in the years to come.

Fluctuating rubber prices could affect the company’s margins considerably and current escalating rubber prices in the global commodity exchanges remains a concern to the company as a near 50% of the cost of production comprises of latex sourcing costs. However, DIPD could wither the negative effects to a certain extent as they can pass the price hike to its customers.

Furthermore, weakening Euro amidst the financial crisis in European Union would also have negative impact on company earnings. It should be noted that additional capacity would add value to the earnings only from FY2012 (as all three production lines would commence operations by the end of FY2011) whereas borrowing costs would impact the bottom line of the company in the short term (with 70% of USD5.6 mn being funded from debt).

The management of DIPD is positive about its future and plans to implement lean production systems to all its plants with the objective of improving productivity. To minimize the energy costs the company has already taken measures to reduce dependency on fossil fuels where a few plants have bio mass heaters in place. The management also stated that the loss of GSP+ for Sri Lankan exports would not have a material effect on DIPD’s sales, as only 3% of its total production would fall in to GSP+ benefited category. In addition, the company’s continuous focus on new product development aiming especially the niche markets in the glove industry would enhance the sustainability of the earnings growth.

Forecast FY2011E earnings to record LKR723.7 mn. With the company’s expansion strategies to be implemented in Thailand operations (which would add another 50% to its current capacity during FY2011), continuous focus on new product development coupled with the much anticipated recovery of the global activity from the current downturn and healthy earnings from plantation arm (backed by escalating rubber prices and higher tea prices), we forecast the company to post a net profit of LKR723.7 mn in FY2011E (up 50.5% YoY) and reach LKR814.3 mn in FY2012E (up 12.5% YoY). Share offers good value trading on 10.5X FY2011E earnings.

The share currently trades on 10.5X forecast FY2011E net profits whilst trading at 9.4X projected FY2012E net earnings. Hence, backed by the enhanced capacities with focus towards further expansion, development of value added products coupled with better returns from the subsidiary on the back of high tea and rubber prices would strengthen DIPD’s bottom line in the future. Therefore we rate DIPD a BUY

Sri Lanka Sierra Cables (SIRA): Signs of Recovery

noreply@blogger.com (Sri Lanka Equity Analytics) — Sun, 11 Jul 2010 02:49:00 +0000

Sierra Cables [SIRA : LKR3.70], together with its subsidiaries, is engaged in the manufacturing and sale of power and communication cables and various aluminum conductors for the domestic as well as international market (such as India, Australia, Dubai, Tanzania and Maldives). It is the parent company of the well reputed brand of ‘Alucop Cables’. SIRA holds around 20% share in the Sri Lankan electric cable market.

SIRA’s product range comprises of domestic cables as well as heavy cables. It is the heavy cable range which carries greater margins for SIRA with the main consumer being the Ceylon Electricity Board (CEB). CEB makes up around 40% of SIRA’s top line which varies according to the number of tenders awarded to them. Also, these heavy cables have little but strong competition with just 3 players in the market whilst competition for small domestic cables is more intense.

Of SIRA’s total cost structure, approximately 90% of the total cost encompasses the raw materials, copper and aluminium whilst PVC takes up around 2%-3%. Copper and aluminium is imported from India on a weekly basis and traded at London Metal Exchange (LME) spot prices whilst PVC is purchased from Singapore and Malaysia. The graph below shows the price movements of these materials over a year:

Sales dipped 31.5% YoY in FY2010, as a result of the management’s hesitation to deliver stocks on credit to customers whose purchasing power was crippled during the financial turmoil in 2009.

Also, SIRA has terminated its manufacture of enameled winding wires as the product did not perform to their expectations. Though the top line was eroded, the company has recorded a favorable move in gross profit margins from 15.2% to 21.2%, thus restoring SIRA’s financial stability in FY2010. This was a result of the management procurement policy in purchasing raw materials on a WoW basis and thus is prone to minute price fluctuations than other risky attempts.

The investment in energy efficient machinery last year also contributed to the company’s production efficiency strategies shrinking energy cost from LKR2.4 per kg to LKR1.65 per kg this year.

The overall administration costs fell by 15.1% YoY leading to an operating profit of LKR115.6 mn with a 3% YoY increment elevating the Operating profit margins by 3.7% YoY to 11.1%. Other income owed vastly to support SIRA record a healthy bottom line despite the dip in the top line.

Other income recorded a 34.8% YoY increase on the back of a gain of LKR34.6 mn made on the disposal of the 20.3% stake in their associate- Central Industries [CIND : LKR250]. SIRA now holds 16.8% in CIND as at 31.03.2010.

Future Potential Early 2010, SIRA took a diversified move to invest around LKR250 mn (of which LKR100 mn was funded through commercial loans) in hydro power stations in the Central Province of Sri Lanka through its 100% owned subsidiary, ‘ Sierra Power’, which holds 93% of this investment.

The intent of the strategy was to merge strongly with the energy industry of the nation. The management expects to add the output to the national grid in another two years time. Also, the company plans to produce value added products such as wire harnesses for auto mobile as they believe these value added products would yield better margins.

SIRA is in the process of negotiating with an European car manufacturer to supply their new product range of automobile wires which is being delayed as a result of the air financial crisis. Also, similar discussions continue on a tie up with a Norwegian cable manufacturer. As per the publication of Central Bank of Sri Lanka, the construction industry had grown by 8.5% YoY during 1Q2010 in comparison to equally high growth rates witnessed in 2006 and 2007 after recording a mere 3% YoY growth n 1Q2009.

According the 2010 mini budget, the Nation Building Tax of LKR16.9 bn would be invested in the rehabilitation and reconstruction programme in 2010. The budget also highlighted that around LKR13 bn was spent on the road network projects during January-April 2010 whilst power, port, irrigation, water, resumption of private sector initiatives on urban development projects also absorbed in heavy investments.

SIRA has shown signs of recovery after reporting an upturn of 31.05% YoY in FY2010.The company is taking optimistic moves in having their market penetration and product development strategies in play coupled with the footing in the hydro generation. With unconfirmed tenders from CEB and after taking into account the positive outlay by the construction industry at large with no drastic adverse moves in the global copper prices, we expect SIRA to exhibit a 63.7% YoY growth in earnings to LKR177.1 mn in FY2011E with a P/E of 11.2X whilst reporting LKR263.6 mn in FY2012E (up by 48.9%) and trading on a P/E of 7.5X FY2012E earnings.

Chemical Industries (CIC) : FY10 earnings driven by agriculture sector

noreply@blogger.com (Sri Lanka Equity Analytics) — Thu, 08 Jul 2010 11:04:00 +0000

Originally set-up as a Trading House for ICI - UK, Chemical Industries Colombo (CIC) has pursued a policy of planned growth which has resulted in its diversification into a number of fields over the years. The company grew into agriculture, paints, pharmaceuticals, industrial raw material and packaging dwarfing the chemical business.

CIC Agri Businesses, the biggest contributor in terms of revenue and earnings to the group (near 70%), comprises of companies that provide inputs to the agricultural sector. The construction sector is effectively CIC's paints and surface coatings business (includes the flagship brand Dulux) which is under the group's associate Akzo Nobel Paints Lanka. CIC's quoted subsidiary Chemanex is a manufacturer and marketer of chemicals and industrial intermediates. The pharmaceutical business markets products from principals like Johnson & Johnson, Hilton Pharma and Solvay Pharmaceuticals and sells products from prescription drugs to diagnostic equipment to hospitals.

CIC reported a 47.4% YoY growth in net earnings to LKR600.9 mn during FY10 (greatly inline with our forecast of LKR583 mn) driven by the strong performance in 2HFY10.

CIC's FY10 profits have been driven predominantly by the key agriculture and livestock sector (EBIT up 50%YoY) coupled with 17.8%YoY increase in other income and improved contribution from the industrial raw material sector (EBITT up 92.4% YoY).

The consumer and pharmaceutical sector has weathered a challenging period where the EBIT contribution dipped 10.5% YoY whilst construction sector and packaging segments recorded healthy results to post 7.6% YoY and 12.3%YoY growth respectively during the year.

Quarterly performance at a glance
CIC's turnover grew by a modest 5.9% YoY to post LKR16,610.5 mn in FY10, driven by higher turnover in the key agriculture and livestock segment (up 7.5% YoY) mainly due to improved performance in the seed and livestock business. The paints segment (inputs to associate Akzo Nobel Paints Lanka) saw the top line dipping (down 21.4% YoY) due to the poor performance in 1HFY10 despite the previously cash strapped consumers gradually willing to spend on non essentials during 2HFY10. Revenue from consumer and pharmaceutical segment has grown by 11.4% YoY whilst that of industrial raw material grew by a mere 2.3% YoY due to the global economic downturn where demand for paints related raw materials, rubber and textile binder related materials was still sluggish. The packaging sector remained flat (up 0.5% YoY) signalling the improvement in the previously deteriorating market conditions.

Cost of sales (up 5.4% YoY to LKR13,247.1 mn) has also increased inline with the rise in turnover levels whilst Gross Profit increased by 8.0% YoY to LKR3,363.4 mn. Further, the gross margins have improved marginally to 20.2% in FY10 (vs 19.8% in FY09) due to the group’s efforts on retooling the value chain and efficient business model. With the turnaround seen in 3QFY10 after a poor first half the 4QFY10 too has shown improvement where the revenue has grown 6.2% YoY during the quarter whilst the gross profit has grown 12.4% to LKR893.2 mn

Consequently, despite a rise in administration expenses by 6.5% YoY to LKR1,301.4mn and distribution costs by 11.2% YoY to LKR997.8 mn, operating profit grew by an impressive 27% YoY to LKR1,060.9 mn mainly on the back of the foreign currency translation loss of LKR160 mn incurred in FY09. CIC’s main operational counters witnessed a significant growth in operating earnings where operating profit from the Agriculture segment grew 41.9% YoY to LKR740.6 mn whilst the Packaging sector posted LKR79.1 mn, up 12.3% YoY. The Industrial raw material sector grew by 92.4% YoY to LKR52.0 mn and Construction sector grew by 7.6% YoY to LKR58.3 mn whilst the Consumer and Pharmaceutical sector EBIT dipped 10.5% YoY to LKR215.6 mn despite the sector revenue growing by 11.4% YoY. This is mainly on the back of the pending commissions receivables in food trading.

The Other income has grown to LKR484.9 mn vs LKR411.5 mn posted in FY09 (includes the capital gains from the disposal of Commercial Leasing and Dev-Fern Ltd) mainly due to LKR250 mn released by the government as subsidy payments for Fertilizer sales during November’08 - March’09.

CIC’s share of profit from associates has dipped 19.6% YoY to LKR212.6 mn in FY10 on the back of the dip in profitability of paints sector (Akzo Nobel Paints Lanka). Overall, CIC’s EBIT has witnessed a growth of 16.4% YoY to reach LKR1,758.5 mn in FY10.

Finance cost during the year dipped by 8.6%YoY to LKR671.8 mn mainly on the back of dip in interest rates. Subsequently, the Profit Before Tax has increased by 39.9% YoY to LKR1,086.6 mn in FY10. FY10 net earnings have reported a sharp 47.4% YoY increase to reach LKR600.9 mn where net margins are at 3.6% in FY10 compared to 2.6% in FY09.

Agri business to propel growth?
CIC Agri Businesses, the biggest contributor in terms of revenue and earnings to the group (circa 70%), weathered a challenging first half where the off take in crops was slow however with improved sales and receipt of pending subsidy payments in 2HFY10 the sector contributed positively in FY10. Looking ahead, revival in agriculture is expected to propel earnings growth in the future. Whilst agribusiness remains the company’s key sector, CIC has acted to diverse its agri-revenue streams thereby reducing exposure to weather shocks. CIC is positioned to successfully reap benefits from the changing macro environment of the country where we believe the company is to benefit significantly from an anticipated revival in the agribusiness sector specially stemming from the previously war torn North. CIC has already made its business move into the Eastern province with two large dairy farms. However, venturing in the dry zone is taking more time to break even than expected. But we believe with CIC’s efforts to manufacture for leading brands or developing their own brands would take at least another two years to breakeven. The expansion projects in the sector (banana export project in the Eastern Province, 2,200 acre large scale dairy complex at Mutuwalla in East, Rice exports, etc) would be an added bonus, once the benefits materialize.

Further, forward integration into food retail is also on the cards for CIC however according to the company nothing concrete has been tabled. With the much anticipated economic integration of the previously war affected North & East and the untapped potential in these areas along with an extension to its out grower network we believe CIC agri business is prime to benefit in future.

The Construction business is effectively CIC’s paints and surface coatings business which comes under the group’s associate company Akzo Nobel Paints. CIC is into decorative, vehicle refinishing and industrial paints segments where 80% of the revenue comes from the decorative sector. CIC has a near 40% market share with paints under the brand names such as Dulux and Glidden targeting different income levels. The paints and coatings business had a turbulent period with circa 5% to 10% volume dip due to harsh market conditions. However, once fresh investments, rehabilitation activities and infrastructure developments commence in the North and East there would be an enormous scope for growth.

The Consumer & Pharmaceutical and Industrial Raw Material businesses are also expected to witness a turnaround in FY11 with improved global economic environment.

Forecast FY11E net profit to rise 26.5% YoY to LKR760.2 mn. On the back of improving economic conditions, benefits from the North& East and anticipated payoffs from the new projects especially in the food trading, industrial raw material and seed business we forecast CIC to post LKR760.2 mn (up 26.5% YoY) in FY11E and LKR947.9 mn (up 24.7% YoY) in FY12E.

The voting counter has gained 14.4% YTD whilst the non-voting counter has gained 17.3% YTD against a market gain of 25.2%. Following the end of the three decade old war (18th May 2009) the broader market gained an impressive 95.3% whilst CIC (voting) has gained 87% and CIC (non voting) has gained 74.3%.

The voting counter trades at 8.7x FY11E earnings (7.0x FY12E) and the non-voting counter trades at 5.8x FY12E earnings (4.7x FY12E) whilst trading at discount to market.

We believe domestic growth would be observed from the vast potential in the North & East especially in the agriculture and paints sectors where CIC is positioned to successfully reap benefits. On the back of prospects of steady growth (through company’s strategy of balancing the business portfolio between agriculture and non agriculture segments) along with growth stemming from agriculture in the long term and untapped potential in the North & East, we believe both the voting and non voting counters still offer substantial value.

However, CIC’s vast exposure to agriculture and especially fertilizer business makes the company’s quarterly performance unstable. We believe the heavy rains during the first two months of 1QFY11 (however according to the company there has not been a notable reduction in sales so far) and the still to recover paints business could have an impact on the first quarter performance. Despite the short term vulnerability in earnings due to the potential in the long term and attractive earnings multiples we rate CIC a Long Term BUY.