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BANKING SECTOR UPDATE

SLFR and SDFR reduced by a further 25bps to assist economic activity
04 April 2020

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  • CBSL held an emergency meeting to take policy action again on the eve of 03 Apr 2020
  • SDFR and SLFR reduced by 25 bps each resulting in 100bps each cumulative 2020YTD cuts for both windows
  • We revise down our LKR forecast to depreciate -10.5% to Rs.200.7 as at 31 December 2020 whilst the 12-month Treasury yield forecast is revised down by -50bps to 6.5% as at 31 Dec 2020 (12m T yield stood at 7.4% as at 04 Apr 2020).

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BANKING SECTOR UPDATE

Banking sector Capital, NPA requirements and other timelines relaxed
30 March 2020

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The Monetary Board of the Central Bank of Sri Lanka (CBSL) has decided to introduce several regulatory measures to provide flexibility to Licensed Commercial Banks (LCBs) and Licensed Specialized Banks (LSBs) to provide certain relief to businesses and individuals affected by the COVID-19 crisis. Accordingly, the Monetary Board introduced the following measures to provide further space for banks.

  1. Allow Domestic Systemically Important Banks (D-SIBs) and non-D-SIBs to draw-down their capital conservation buffers by 100bps and 50bps, respectively, to facilitate smooth credit flows to the economy and COVID-19 affected borrowers to sustain their businesses in the immediate future.
  2. Withdraw the requirement to classify all credit facilities extended to a borrower as non-performing when the aggregate amount of all outstanding non-performing loans granted to such borrower exceed 30% of total credit facilities.
  3. Allow banks to recover loans in Rupees, as the last resort, in circumstances where recovery of loans in foreign currency is remote, subject to banks ensuring certain conditions are met.
  4. Permit banks to give an extension of 60 days, to borrowers who are not entitled to any other concessions, to settle loans and advances which are becoming past due during March 2020 and not to consider such facilities as past due until the end of this 60 day period.
  5. Allow banks to consider all changes made to payment terms and loan contracts from 16 March 2020 to 30 June 2020, due to challenges faced by customers amidst the COVID-19 outbreak as ‘modifications’ instead of ‘restructuring’ for the purpose of classification of loans & advances and computing impairment.
  6. Defer the requirement to enhance capital by banks which are yet to meet the requirement by end 2020, till end 2022.
  7. Reset the timelines for addressing supervisory concerns, if necessary, by prioritizing on the severity/importance of the concerns raised. Banks which are required to meet timelines to address supervisory concerns/findings during the period up to 30 May 2020, are granted a further period of 3 months for addressing such supervisory concerns.
  8. Extend the deadline for submission of statutory returns to the Bank Supervision Department by two weeks and the publication of quarterly financial statements by one month, until further notice.

In addition to the capital buffer draw down proposal, other proposals are likely to contain the expected sudden increase of NPAs to a significant extent whilst deferring of capital enhancements (up to Rs.20bn) for banks by two years will likely to benefit PABC (Rs.13.3bn*), UBC (Rs.17.5bn*), ABL (Rs.11.9bn*) and CargB (Rs.10.6bn^) as the revised timeline allows further natural retention for these LCBs.

Given that the above revisions are likely to create some space for banks and not likely to improve bottom-line owing to an anticipated local recession, we do not revise up our LCB NP forecasts for 2020E.

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MARKET UPDATE

Colombo Stock Exchange
11 March 2020

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CT CLSA – Market Update – Twin Impact from COVID-19 & Low Crude Oil Prices – 11 March 2020

  • The CSE All Share Index (ASPI) is now at 5,205, down -15% in 2020YTD mainly on the back of an avalanche of negative news flow including fears of the coronavirus and falling oil prices. Unlike some select regional markets, all is not lost for Sri Lanka though, given strong fundamentals and a number of tax cuts announced recently to revive the economy
  • The ASPI is currently at an oversold position on the back of nearly US$28mn in net foreign selling.
  • The continued sell-off has been triggered by nagging fears of the COVID-19 spreading worldwide as well as recent sell-off in the global oil market. However, Sri Lanka remains an outlier within its regional peers, given that still the spread of COVID-19 within Sri Lanka is largely under control with only two reported COVID-19 cases thus far
  • The market is now trading at PE multiples of 9X – 10X on 2020E -2021E earnings and is below the mean of past decade PEs

Sri Lanka remains a winner within the region!

  • Sri Lanka has only 2 confirmed cases of COVID-19. Tourist arrivals are expected to decline however with its key markets such as China and Europe being impacted by the epidemic
  • Continued fears on COVID-19 should not really affect Telcos and energy-based manufacturing companies given the anticipated cost savings amid falling commodity and oil prices
  • Falling oil prices and softer commodity prices are positive for Sri Lanka given it imports nearly all of its oil requirement and lower import costs are likely to help its BOP in the near term. Note that there is a +0.6 correlation between the Commodity Research Beureau’s CRB Index and Sri Lanka’s headline inflation

Policy Space already created!

  • With massive tax cuts announced during late November 2019 and January 2020, the Government of Sri Lanka (GoSL) has taken steps to increase disposable income of the general consumer in order to stimulate consumer growth thus far. If the GoSL is successful in containing the spread of COVID-19 (compared to its regional counterparts) as it has been thus far, a possible recovery in credit and consumption to materialize earnings expectations of the overall economic players in the near to medium term

Actionable plays!

  • We believe the market is oversold at current levels and the best way to play the market would be via relatively big cap high upside potential counters

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MARKET UPDATE

Colombo Stock Exchange
18 February 2020

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  • Despite steady earnings growth witnessed in the past few years, valuations have fallen to levels witnessed in the last stages of the civil conflict in 2009
  • Earnings have witnessed a steady growth, with TTM earnings recording a CAGR of ~3% during 2012 -2019. Exception being 2019, when earnings witnessed a slight decline following the Easter Sunday terror attacks, which had a direct impact on many sectors including Leisure and Construction
  • We believe that the decline in valuations is due to lack of investor confidence on political stability, which is anticipated to return post-Parliamentary elections in April 2020
  • Further, recent tax cuts on construction and consumer sectors are likely to assist in the revival of sector earnings. However, Leisure sector is likely to be impacted for a pro-longed period due to a decline in tourist arrivals from China, following the coronavirus (Covid-19) outbreak in December 2019

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EVENT UPDATE

IRDSL reverses Taxes on SLDBs
17 February 2020

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  • As per the announcement dated 12 February 2020 by the Inland Revenue Department of Sri Lanka, the interest income from SLDBs were exempted from taxes w.e.f. 01 Apr 2018. In line with the new ruling, already recognized liabilities to be reversed in 4Q2019.
  • URL: http://www.ird.gov.lk/en/Lists/Latest%20News%20%20Notices/Attachments/220/WHT12022020_E.pdf
  • Out of major listed investors in SLDBs, top three private Commercial Banks, i.e. COMB, HNB and SAMP remained significant. Given that SAMP has already reported a tax reversal amounting to Rs.500mn (as per media reports) for its 14 February 2020 released 4Q2019 results, this update focuses on the potential (likely) earnings increases of COMB and HNB only.
  • With SAMP reporting a SLDB holding of ~Rs.60bn as at 31 Dec 2019, we estimate COMB and HNB’s estimated SLDB holdings to be ~Rs.69.2bn and Rs.118.9bn as at 31 Dec 2019 respectively. Thus, the estimated tax reversal owing to the 12 February 2020 dated IRD announcement is estimated at Rs.577mn and Rs.991mn for COMB and HNB respectively.

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EVENT UPDATE

Changes in Corporate Taxes
21 January 2020

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  • The Cabinet of Ministers has granted approval for the proposal by Hon. Prime Minister Mahinda Rajapaksa as the Minister of Finance, Economic and Policy Development in order to restructure corporate tax rates w.e.f 01 Apr 2020
  • The changes to tax proposals are expected to reduce overall government revenue. However, the exact details on the reduction of revenue and ways to mitigate the impact is yet to be disclosed by the GoSL
  • Meanwhile, the potential increase in earnings from tax reduction is expected to result in higher economic activity, which would partially offset the revenue loss of the GoSL
  • The market impact on the new disclosure would be positive, with across the board earnings expected to increase

The document discusses potential earnings impact of companies under our coverage

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ECONOMIC UPDATE

Cabinet Approves Removal of the Debt Repayment Levy
20 January 2020

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  • On 20 January 2020, the Inland Revenue Department of Sri Lanka (IRDSL) announced the cabinet approval for the removal of the Debt Repayment Levy (DRL) with effect from 1 January 2020
  • IRDSL previously announced the removal of Nation Building Tax (NBT) with effect from 1 December 2019
  • However, with the announcement of details of the SME sector benefits from the Banking sector (please refer our update on SME sector benefits, dated 14 January 2020), during last week, the above benefits on the banking sector are expected to be neutralized
  • Thus we expect this announcement to be price neutral on the sector.

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EVENT UPDATE

Banking Sector – Concessions on SME Sector Loan Repayments
14 January 2020

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– Details of the moratoriums / benefits announced
– Only part of benefits gained from recent tax reductions will be utilized
– Investors overselling the sector upon announcement of details

  • From the benefits granted, Capital moratoriums for the performing advances in the SME sector are likely to only result in a cash flow impact (with a minimal interest income impact) for the banking sector
  • Write off of NPL penal interest and eventual write-off of 50% of NPL interest may on the other hand result in incremental revenue as these result in interest in suspense translating to partial income. Even though this exercise may result in a reduction of overall system NPLs for the banking sector, the overall process should be closely monitored in order to pass the benefits to the honest economic agents as opposed to the other.
  • With the announcement of details (upon discussion of same during the second week of January 2020) on the SME sector relief package, the listed licensed banks were sold by most of the investors resulting in their prices falling below the pre- tax concession prices.’
  • Given that the 20 December 2019 initial SME relief announcement stated that “the SME benefits will not exceed the tax benefits gained by the individual banks from their 2020E earnings”, we expect the maximum benefit of the proposed SME relief package to not exceed the tax benefits gained from the recent tax revisions for the sector.

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EVENT UPDATE

John Keells Holdings – Khazanah sells 11% stake in JKH
09 January 2020

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  • On 09 January 2020 Broga Hill Investments Ltd (a special purpose vehicle of Malaysia’s sovereign wealth fund Khazanah Nasional Berhad and second largest shareholder in JKH) divested its 11% stake in JKH (141mn shares). The divestment was carried out at Rs.160 per share totaling Rs.22.7bn
  • The purchase was done by Citigroup Global markets Ltd. on behalf of a global institutional client.
  • The transactions marks the seconds largest in the history of CSE and can be viewed as a vote of confidence in Sri Lanka by foreign investors
  • The JKH share trades at forward PER multiples of 18.7X for FY20E, 10.4X for FY21E and 9.0X for FY22E and trades broadly in line with our break-up estimated Sum of the Parts (SOTP) valuation of Rs.163 per share
  • We do not expect material share price gains in the near term due to recent weak earnings of JKH. Whilst group earnings expected to be boosted post the completion of ‘Cinnamon Life’ project in FY21E, a major catalyst to re-rate the share in the medium term would hinge upon new developments on the Cinnamon Life Project, especially the casino aspect

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SRI LANKA

Outlook 2020
09 January 2020

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  • The stock market is expected to be boosted in the near term owing to the downward movement in interest rates, on the back of the Central Bank of Sri Lanka (CBSL) adopting a loose monetary policy in order to stimulate economic activity
  • Forward market valuation of 10.6X for 2020E is at a discount to a majority of regional peers, on the back of an expected earnings growth of +25% YoY – off a low base. Select key stocks, particularly in banking and consumer sectors offer relatively attractive valuations
  • A relative improvement in political stability following the general elections in early 2020E is anticipated to result in a clearer economic outlook over the medium term. Such political stability may act as a catalyst for attracting investments, and thereby help re-rate market valuations

The report discuss Economic and key sector outlook for 2020E along with few stocks to focus

*** All valuations and market data in this report are as at 31 December 2019***

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EVENT UPDATE

Distilleries Co. of Sri Lanka –  Government of Sri Lanka (GoSL) Ban on the Legal Importation of Ethanol
02 January 2020

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  • The Ministry of Finance and Planning has issued a statement suspending the importation of ethanol for liquor production w.e.f 01 January 2020 on the directives of Prime Minister Mahinda Rajapaksa as the Minister of Finance. Ethanol is the key raw material required for the production of hard alcohol
  • Distilleries Co. of Sri Lanka (DIST), the market leader in Sri Lanka’s (legal) hard alcohol market with a ~65% market share in the core arrack segment, is believed to import ~50% of its total ethanol requirement, with ethanol comprising ~80% of cost of sales
  • Whilst Prime Minister Rajapaksa indicated that the ban on imported ethanol was ordered given that there is sufficient ethanol being produced within the country, DIST has previously mentioned that it is unable to fully procure its ethanol requirements locally, given supply side constraints and quality issues
  • Prices of locally procured ethanol are estimated to be at least one third cheaper compared to imported ethanol. Owing to this, DIST may see a margin benefit if local ethanol is available in sufficient quantities and no upward price revisions are made by the GoSL to local ethanol in the near term
  • Given the current lack of clarity on the legal implementation of the ban on imported ethanol (via an official gazette) and the potential for an upward revision to locally produced ethanol prices in the near term, we have maintained DIST’s net profit forecast at Rs.6,883mn for FY20E (EPS Rs.1.5, +30% YoY) and at Rs.7,816mn for FY21E (EPS Rs.1.7, +14% YoY) at this point in time
  • In the event that the ban on imported ethanol is passed and supply side constraints relating to locally produced ethanol remain, there is potential for volume pressure for DIST going forward
  • The DIST share has outperformed the broader market over the past 3 months and 12 months, rising +13% and +11% respectively (vs. the ASI’s rise of +7% and +1%), and trades at PER multiples of 12.0X for FY20E and 10.6X for FY21E

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