Financial analysts firmly endorsed Sri Lanka post-conflict economic progress saying Sri Lanka is now enjoying the benefits of peace and getting accustomed to the fresh environment adding that dawn of peace has brought many tangible positives to the island nation’s economy. TKS Securities in a recent analytical report said the US$47 billion economy would soon achieve sustainable real growth rates of around 10 percent given its growth in domestic consumption and the external growth forces of tourism, trade and port services. The analysis re-iterated a previous foreign fund manager’s endorsement - "there needs to be supernormal negative powers and efforts to holdback Sri Lanka’s growth from this moment onwards and that also may not be possible given the huge positive change in sentiment of the 20 million population".
TKS Securities’ corporate earnings review 2010:
Corporate Coffers & the Bourse
The prolonged three decade long war having ended in mid 2009, Sri Lanka is now enjoying the benefits of peace and getting accustomed to the fresh environment. The island nation’s economy has been growing at a real growth rate of 5.9 percent during the past 20 years whilst weathering adverse shocks of interest rates at higher teens, inflation topping 12 percent, weakening reserve positions and double digit fiscal deficits.
During the period of war one third of the land and two thirds of the coastal belt was not integrated to the mainstream economy whilst the state was dependent on domestic borrowings to finance the war (amounting to near 6 percent of GDP), maintaining tourist arrivals was a stiff challenge, war risk premiums placed upon the country and its ports and airports was a drag on Sri Lanka’s competitiveness and the sentiment amongst the masses was rather weak given the fear of suicide bombings even in the capital Colombo.
So letting aside the positive change in sentiment, end of war has brought many tangible positives the state being able to raise cheaper debt from overseas markets (with the risk profile improving), reducing dependence on local borrowings which has resulted with market interest rates to nosedive by circa 800 bps, inflation also falling sharply from plus 20 percent levels to 6.5 percent levels (whilst we believe inflation around 6 percent to be sustainable in the long run though the prevailing oil price shock may push up inflation to around 8.5 percent levels), foreign exchange reserves has grown to highest ever levels (now at US$6.6 billion sufficient to finance plus 5 months worth of imports), foreign worker remittances has grown 15 percent YoY to top US$4 billion in 2010, tourist arrivals are up 46 percent YoY and the fiscal position is improving with the deficit expected to have narrowed to 8 percent in 2010 whilst forecast to edge lower to circa 7.2 percent in 2011.
Given this positive backdrop and if we are to quote a statement by a foreign fund manager "there needs to be supernormal negative powers and efforts to holdback Sri Lanka’s growth from this moment onwards and that also may not be possible given the huge positive change in sentiment of the 20 million population". Therefore it is not rocket science to fathom that the US$47 billion economy would soon achieve sustainable real growth rates of around 10 percent given its growth in domestic consumption and the external growth forces of tourism, trade and port services.
Hence now the focus is on economic performance and the challenge is to judge whether corporate Sri Lanka has lived up to its expectations. Taking a sample of 221 companies out of 247 listed in the Colombo bourse corporate earnings have soared 126 percent year-on-year (YoY) to LKR121.1 billion in 2010 and net profit has increased 81 percent YoY to LKR39.4 billion in 4Q2010. Banking, Finance and Insurance sector contributed circa 27 percent to overall corporate profits whilst the Conglomerates contributed 18 percent and the highest net profit growth rates were witnessed amongst the Hotel, Motors and Plantation sectors. Further since the end of war quarterly corporate earnings have grown at 28 percent CAGR which was mainly driven from domestic consumption ahead of any benefits from the recently commenced investments. In hindsight the market has edged down to 18.6x current earnings by end 2010 down from the 20x plane which we believe is the sustainable multiple for the re-rated market since the end of war. Nevertheless the mid cap retail drive had swiftly taken up the market multiple to 20.2x in 2011 whilst the market experienced a circa 3 percent correction during the three consecutive days starting 7 March 2011. During the correction positives such as corporate earnings growth, real GDP growth, improving reserves, monetary stability, deficit contraction etc. was sidelined and retail debt recovery from brokering houses, foreign portfolio sales (following near 100 percent index gains over the past 12 months and though not direct relevance the Middle Eastern and Indian sub continent troubles) and monies locked up in recent IPO issues became the main driving forces.
The positive implication for stocks, in our opinion, is that once investors refocus on fundamentals, above data will provide a solid floor to the market. Further a tangible market correction which we are undergoing at the moment (Market slid 3.4 percent during the current week) urges investors to watch market action ever so closely and take cues from the broader marketplace and not from a handful of grim predictions and speculations.
Thereby we believe the strong earnings performance, improving ROEs and strengthening financial position whilst the broader economic picture continuing to show improvement, Colombo bourse would regain its sanguinity.
Telecommunications: Telecommunications sector which weathered a major headwind during 2008 and 2009 on the backdrop of intense price competition and laidback approach of the regulator made a swift turnaround during 2010 posting flamboyant profits, which soared 179 percent YoY in 2010. The prudent directives of the regulator and the collective efforts of the industry acted as the catalysts in turning around the industry. Dialog Axiata (DIAL: LKR10.90) contributed for circa 56 percent of the year’s earnings, whilst Sri Lanka Telecom (SLTL: LKR57.40) contributed 44 percent.
Beverages, food and tobacco: BFT sector contributed for circa 13 percent of 2010 corporate earnings whilst seeing a YoY growth of 38 percent for December Quarter and 36 percent for 2010. Ceylon Tobacco (CTC: LKR360.00) and Distilleries Company of Sri Lanka (DIST: LKR178.00) were the major contributors to the sectoral turnover accounting for circa 55 percent in 2010. Further the formerly beleaguered poultry sector saw a strong spurt of growth during the year where Bairaha (BFL : LKR398.00), Ceylon Grain Elevators (GRAN : LKR183.90) and Three Acre Farms (TAFL : LKR165.00) saw +5 folds, 3 folds and 2 fold surge in earnings during 2010.
Banking, finance and insurance: Sectoral earnings were up 70 percent YoY in 4Q2010 and up 87 percent YoY during 2010 which was broadly backed by the favourable macro economic situation and positive monetary policy adopted by the Central Bank. During 4Q2010 Commercial Bank (COMB.N: LKR257.80, COMB.X: LKR158.00), Sampath Bank (SAMP: LKR279.70) and NDB Bank (NDB: LKR348.70) led the banking sector earnings backed by loan book expansion, improving asset quality and reducing funding costs. Insurance sector earnings was driven by Ceylinco Insurance (CINS.N: LKR636.80, CINS.X: LKR320.00), AVIVA NDB Insurance (CTCE: LKR282.20) and Janashakthi Insurance (JINS.N: LKR16.40) whilst Lanka Orix Leasing (LOLC: LKR120.60), LB Finance (LFIN: LKR142.20) and Central Finance (CFIN: LKR865.30) drove finance sector earnings mainly due to expansions in the leasing, hire purchase and advances portfolios. However it should be noted that DFCC Bank (DFCC: LKR175.80) and LOLC made one off non-recurring gains of LKR2.9 bn and LKR1.7 bn. Thus excluding the one off gains sectoral earnings grew 61 percent YoY during 2010.
Chemicals and pharmaceuticals: This sector recorded a net earnings growth of 38 percent YoY in 4Q2010 and 90 percent YoY in 2010. Lankem Ceylon (LCEY: LKR410.20) was the prime contributor during 4Q2010 backed by its plantation, consumer and chemicals segments. Net earnings growth of 90 percent during the financial year was driven by LCEY, Haycarb (HAYC: LKR155.00) and CIC Holdings (CIC.N: LKR160.00, CIC.X: LKR113.10).
Diversified holdings: The Diversified sector mainly consisting of the leading blue-chip companies in the bourse accounting for circa 20 percent of the market capitalization has contributed circa 18 percent to the corporate earnings during the year 2010 whilst seeing an impressive 69 percent YoY increase. This growth was spearheaded by outstanding results posted by heavy weight John Keells Holdings (JKH: LKR277.80) owing to the hefty capital gains made from divesting minor stakes in the two hotel chains. Further, Richard Peiris (RICH: LKR14.10) reported an exceptional growth mainly due to better plantation returns and profits from the retail chain. Colombo Fort Land (CFLB: LKR423.50) reported impressive growth on all sectors especially in plantations whilst the diversified segmental profit was further supported by Hayleys PLC (HAYL: LKR385.00) and Hemas Holdings (HHL: LKR46.40).
Hotels and travels: Hotels and Leisure sector plays the center stage in the post war Sri Lanka, luring laudable green field projects both local and foreign. The occupancies and ARRs grew at a rapid pace following the end of the war being a spell of rain to the long beleaguered sector. During 2010 the country occupancy levels stood at circa 70 percent being the highest in the history where certain months topped 90 percent levels underpinned by the static supply and the 46 percent YoY growth in tourist arrivals. Average spending per tourist per day stood at USD82 during the year, showing auguring great potential for growth. Against this backdrop the sector posted an exorbitant growth in earnings posting an increase of circa 4 folds in 2010. City hotels posted 465 percent YoY growth in Asian Hotels and Properties (AHPL: LKR191.30) and John Keells Hotels (KHL: LKR18.50) cumulatively have contributed for circa 40 percent of the sectoral earnings, whilst Aitken Spence Hotels (AHUN: LKR97.50) is the second major contributor with a contribution of circa 20 percent in 2010.
Manufacturing: Sectoral earnings were up 68 percent YoY due to sound macro outlook which saw a rise in consumer spending and construction activities. Tile sector companies such as Royal Ceramic (RCL: LKR155.10), Lanka Ceramic (CERA: LKR150.00), Lanka Walltiles (LWL: LKR170.30) and Lanka Tiles (TILE: LKR125.00) saw increased demand which boosted its profitability whilst construction drive in North and East saw helped earnings of Tokyo Cement (TKYO.N: LKR56.80, TKYO.X: LKR41.80) and ACL Cables (ACL: LKR89.90). However manufacturing sector recorded a 4 percent YoY dip in earnings in 2010.
Motors: New vehicle registrations showed an immediate improvement in 2010 with the economy gaining traction coupled with low interest rates and a favorable tax charge. The substantial reduction in excise duty and removal of duty surcharge has reduced the price of an imported brand new vehicle by an average of 30 percent. Thereby, new vehicle registrations soared by + 76 percent YOY in 2010 with a major contribution from motor cycles, motor tricycles, Buses and goods transport vehicles. The price sensitive small vehicle segment experienced an extraordinary volume growth due to increased affordability. Against this backdrop all the motor sector companies saw earnings increasing between 5 to 200 folds (Except for Autodrome) leading the sectoral earnings to surge by a humungous 100 folds.
Plantations: Against the backdrop of increased rubber prices coupled with higher tea prices seen 4Q2010, plantation sector earnings grow 95 percent YoY and a near nine fold YoY during 2010. Healthy rubber prices boosted earnings of Kegalle (KGAL: LKR209.80) and Horana (HOPL: LKR72.10) plantations during the quarter whilst Malwatte Valley (MAL.N: LKR105.00, MAL.X: LKR80.50) and Namunukula (NAMU: LKR120.00) benefited from higher tea prices.