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Sri Lanka Strategy Report – June 2019

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GDP growth is forecast at an average of +4.0% p.a. for 2019E – 2020E – below its potential levels of ~6-7%, given Sri Lanka’s Investment to GDP ratio of ~37%

The current political situation in Sri Lanka remains highly unpredictable, with post-Easter Sunday incidents contributing towards further instability

The next Presidential election is expected to be held by 07 December 2019, with General/ Parliamentary elections to follow by March 2020E – an anticipated improvement in political stability arising from these elections is likely to be viewed favourably by investors over the medium term

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

The LKR is expected to be under pressure in the near term, at levels above the average annual depreciation rate of the past decade (though at a lower level than witnessed during the latter part of 2018)

The Sri Lankan stock market has witnessed a decline in 2019YTD, with the ASPI declining -12% to 5,311 points, whilst the more liquid S&P SL20 has fallen -21% to 2,470 points (vs. declines of -5% and -15% respectively in 2018)

Forward market valuation of 9.2X for 2019E is at a discount to a majority of regional peers, on the back of an expected earnings growth of +7% YoY

Select key stocks, particularly in banking, consumer and export-related sectors offer relatively attractive valuations

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


John Keells Holdings (JKH) – Impact from Easter Sunday Attack – 25 April 2019

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Cinnamon Grand, a luxury hotel operated by JKH subsidiary, Asian Hotels and Properties (AHPL) was one of the targets of Easter Sunday Attacks in Sri Lanka

Leisure sector will be largely impacted in the near term whilst Property and Financial services sectors would also see a slight impact

JKH FY20E provisional Net Profit forecasts revised down by -5%; SOTP estimates at Rs.164 (at a 17% discount)

Whilst the share appears to be trading at a discount, degree of the recovery in the near term would be limited. We expect the share price to recover over time, however extent and timing will depend on the confidence instilled by authorities


Sampath Bank (SAMP) – Refuelling for Growth – 29 March 2019

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Growing industry facing higher capital needs

The banking industry can be viewed as an indirect play on the Sri Lankan economy, which has grown swiftly over the years. Local LCBs are also placed attractively amongst regional peers. However, the industry is facing increased capital requirements whilst 2018 saw higher impairment provisions and increased taxes

SAMP gained a significant presence within three decades

SAMP has gained a sizable market share since its incorporation in 1986. The bank has aggressively increased its position, reaching a 9% deposit and advance market share by end of 2018. SAMP also has improved physical and electronic infrastructure in par with its larger peers

Short term dip in ROE with capital raising

SAMP has consistently delivered above industry average returns. However, overall returns are expected to be under pressure in the near term with the recently proposed Rs.12.1bn rights issue. Returns are subsequently expected to improve over the medium term with continuous income growth and higher efficiencies

Buying opportunity with share overreaction

We value SAMP using blended PBV and residual income methodologies at Rs.216.0 (+18% upside potential). We view the recent drop in share price as too steep and recommend to accumulate the share. Near term weakness is however expected until the conclusion of proposed rights issue

Sector Report

Paradise In-sight (Sri Lanka Tourism Sector Report) – 29 March 2019

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Since the conclusion of the civil conflict in May 2009, tourist arrivals to Sri Lanka have increased at a CAGR of 18% during the past ten years to 2.3mn visitors in 2018

Revenue from tourism increased at a CAGR of 39% during 2008-2018 to an estimated US$4.4bn in 2018, i.e. 4.9% of GDP

The tourism industry boom though has not extended to the listed Hotels and Travels (HT) sector on the Colombo Stock Exchange (CSE). After an initial rally, the HT sector has tumbled -54% from its 2010 highs amid poor liquidity

HT sector returns have disappointed with overall profits falling sharply in recent years, with the sector generating ROEs of under 2% and still trading on premium TTM PERs of over 25X

Following steep share price declines, pockets of value appear to exist among a few of the smaller HT sectors, but the sector in general suffers from poor share liquidity

Takeover options in the HT sector likely to pick up in the medium term amid sharp discounts to book and new entrants into sector nursing large losses, albeit with liquidity caveat

More liquid conglomerates such as John Keells Holdings (JKH) and Aitken Spence (SPEN) also provide exposure to tourism sector through their hotel investments (also extending to Maldives and other Asian markets), and may be the preferred option for investors looking to ride the Sri Lanka tourism wave

Event Update

Ceylon Tobacco Company (CTC) Excise Duty Led Price Increases – 18 March 2019

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In the 2019 National Budget, it was proposed to increase Excise Duty (excluding 15% VAT and NBT) for the 60mm and above stick length categories by +12% w.e.f 06 March 2019. Consequently, CTC increased its product prices for 60mm and above stick length categories

Net revenue : gross revenue forecast revised up to 23.4% for 2019E (vs. 23.1% previously and 22.7% in 2018), given that the price increase was higher than the excise duty increase

CTC’s net profit forecast revised up by +3% to Rs.17,921mn for 2019E (+5% YoY – off a high base). Meanwhile 2020E net profit forecast at Rs.19,433mn (+8% YoY)

The defensive share has outperformed the market, rising +35% over the past 12 months (vs. ASI’s decline of -13% during the same period) – reaching an all time high of Rs.1,500 on 18 Dec 2018, although down -10% subsequently

On our  revised estimates CTC trades at PER multiples of 14.1X for 2019E and 13.1X for 2020E – a partial valuation discount however remains warranted given that it is susceptible for government policies

Although further near term material share price gains are likely limited, given recent share price increases and possible short term sales volume dips, we believe that the share may continue to be favoured by investors at current valuations given CTC’s track record of high value creation, especially amid the current challenging economic and political environment

Event Update

Sri Lanka National Budget 2019 – Impact Analysis – 08 March 2019

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The National Budget 2019 Proposals focus on driving growth via consumption and investments – providing financial aids to government workers and lower income families, whilst fast tracking the national infrastructure drive

The GoSL is expecting a fiscal deficit of 4.4% for 2019E, with a key shift in deficit financing to local sources

The GoSL is expected to continue its fiscal consolidation program, with no major changes being proposed to tax policies implemented in 2018

We are of the view that there may be some shortfall in GoSL revenue generation and an overshoot of expenditure. However, we expect some scaling back in public expenditure in such a scenario. Accordingly, we forecast a 2019E fiscal deficit of 4.9% of GDP

The final reading of and the approval of the Budget is expected on 05 Apr 2019

We have highlighted the key proposals of the Budget, including the potential impact on key sectors and selected listed companies

Event Update

Sri Lanka National Budget 2019 Highlights – 05 March 2019

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The Minister of Finance and Mass Media of Sri Lanka, Mr. Mangala Samaraweera, presented Sri Lanka’s National Budget for 2019 in Parliament on 05 March 2019

The Government of Sri Lanka (GoSL) expects to reach a fiscal deficit of 4.4% to GDP for 2019E (lowest since 1977, vs. 5.3% provisional in 2018E)

The GoSL expects to increase Total Revenue and Grants to 15.8% of GDP in 2019E (vs. 14.1% in 2018E), whilst GoSL estimates total expenditure at 20.2% of GDP for 2019E (vs. 19.4% in 2018E)

The GoSL expects GDP to increase at 3.5% in 2019E

2019E deficit is expected to be financed largely via domestic sources, which is also aiming at reducing the total outflows

The report has highlighted the main proposals of the Budget 2019, including the key affected listed companies. A detailed review analysing the implications of Budget 2019 will be released soon

Event Update

Sampath Bank (SAMP) – Event Update – Rights Issue – 01 March 2019

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Sampath Bank announced that it is going for an Rs.12.1bn Rights Issue to boost its Tier 1 Capital to comply with Basel III requirements

Expect to issue 89mn ordinary voting shares in the ratio of 07 new ordinary voting share for 23 shares held at an issue price of Rs.136.0 per share (discount of 41% to share price as at 28 Feb 2019)

With the announcement of rights issue, SAMP share came down below the theoretical ex-rights price of Rs.209.6 (-17% to Rs.193 from previous close at the time of the report)

Despite the expected recovery in earnings and decent fundamentals, the proposed capital raising would act as an overhang for the share. Further, the discount for the rights issue price of Rs.136.0 is viewed too steep and share is expected to remain weak in the near term until the rights issue is finalized

Event Update

Tokyo Cement Company (Lanka) – Cement Price Revision -18 February 2019

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Cement prices for 50kg bags have been increased by Rs.100 (+10%) to Rs.1,095 w.e.f 17 February 2019. The price revision was approved by the Consumer Affairs Authority following the successful lobbying efforts of local cement players. Total price increase within the last 12 months amounts to Rs.165 per 50kg bag (+18%)

We broadly maintain our FY19E revenue forecast at Rs.36,880mn (+4% YoY), and revise up our FY20E revenue forecast by +2% to Rs.41,010 (+11% YoY), amid the price increase in February 2019. Though prices have increased +10%, we have revised up our FY20E revenue forecast by +2% given lower volume expectations

The voting share underperformed the broader market declining -12% and -63% over the past 3M and 12M respectively (vs. ASI’s performance of -1% and -10% over the last 3M and 12M respectively). The non-voting share declined -12% and -59% during the last 3M and 12M respectively

Whilst an increase in the share price in the short-term is expected, medium to long term prospects of the share will continue to be affected by competition from imported cement, subdued demand by the retail segment, and the expected entrance of a Chinese cement manufacturer in 2020E. A re-rating of the share will depend on a meaningful recovery in local cement consumption – a possible catalyst being the conclusion of Provincial Council elections in 2019E and a revival of GoSL-led construction projects

Event Update

Chevron Lubricants Lanka – Wins three state lubricant tenders – 08 February 2019

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Chevron Lubricants Lanka (LLUB) has won three tenders to supply lubricants to state-owned power stations and transport services

We have revised up our 2019E volume forecast by +5% to 29.3 litres (+9% YoY), amid LLUB regaining the previously lost contracts. Meanwhile, 2020E local sales volume forecast at 30.5mn litres (+3% YoY)

LLUB’s net profit forecast revised up by +1% to Rs.2,434mn for 2019E (+9% YoY – off a low base) and 2020E net profit forecast at Rs.2,485mn (+2% YoY)

The LLUB share has declined -34% over the past 12 months (vs. the ASI’s decline of -9%). However, we expect LLUB’s gross dividend yield of 12% to limit any further near term material share price decline. On our current estimates, LLUB trades at PER of and 7.4X for 2019E and 7.2X for 2020E

Near term pressure on earnings to remain due to currency depreciation coupled with the volatility in crude oil prices, together with stiff industry competition

Whilst we view LLUB gaining the three state lubricant tenders as positive, a potential re-rating of the share would likely depend upon LLUB regaining volumes in a more higher margin retail segment

Event Update

Distilleries Co. of Sri Lanka – Product Price Revisions – 28 January 2019

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Distilleries Co. of Sri Lanka (DIST), Sri Lanka’s market leader in the (legal) hard alcohol segment, issued a statement indicating that it has revised alcohol prices w.e.f 28 January 2019, in response to escalating costs of production

Upward price revisions (especially in the higher margin quarter bottle segment) are expected to somewhat offset near term margin pressure due to higher imported raw material costs, stemming from continued currency depreciation

Full and Quarter bottle sales are however likely to face further volume pressure from the soft alcohol segment, consequent to excise-duty led price reductions of “strong” beer in Nov 2017

DIST’s current net profit forecast stands at Rs.4,946mn for FY19E (EPS Rs.1.1, +14% YoY) and at Rs.5,751mn for FY20E (EPS Rs.1.3, +16% YoY), primarily driven by GP margin expansion, stemming from a higher local spirit mix. Given the significant difference in price revisions on different product categories, and the lack of visibility with respect to the sales volume breakdown between ‘Extra Special’ full, half and quarter bottles, we will need to seek further clarification from DIST management prior to revising our volume and price per proof litre assumptions

The DIST share has underperformed the broader market since its re-listing on 03 Apr 2018, declining -36% (vs. the ASI’s decline of -7%), and trades at PER multiples of 14.9X for FY19E and 12.8X for FY20E

Any medium term re-rating of valuations is likely to depend upon measures taken by the Government of Sri Lanka (GoSL) to increase points of access of licit alcohol, especially in rural areas, and an improvement in current share liquidity levels – current estimated public float of DIST stands at ~3.3%, and the company has been provided a 20-month grace period (w.e.f July 2018) by the CSE to meet minimum public holding listing requirements of 7.5%

Event Update

Chevron Lubricants Lanka (LLUB – Rs.73.4) Market share falls to 37% in 3Q2018 – 23 January 2019

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As per the Public Utilities Commission of Sri Lanka (PUCSL), the shadow regulator for Sri Lanka’s lubricant industry, overall lubricant market volumes declined -3% YoY in 3Q2018. Consequently 1-3Q2018 market volumes grew +5% YoY to 50mn litres

LLUB’s volumes declined -6% YoY in 3Q2018, resulting in its 1-3Q2018 volumes growing +1% YoY. Meanwhile, LLUB’s market share declined to ~37% in 3Q2018 (vs. ~38% in 3Q2017), amid intense industry competition on the back of price pressure by competitors. Consequently, LLUB’s market share declined to ~39% in 1-3Q2018 (vs. ~40% in 1-3Q2017), with ExxonMobil’s market share increasing to ~8% in 1-3Q2018 (vs ~6% in 1-3Q2017)

LLUB’s local market share forecasts remain broadly unchanged at ~39-40% for both 2019E and 2020E

Our current 2019E and 2020E net profit forecasts for LLUB are Rs.2,407mn (+8% YoY growth – off a low base) and Rs.2,432mn (+1% YoY) respectively

The LLUB share has risen +13% subsequent to falling to a nine-year low of Rs.65.0 on 28 September 2018 (vs. the ASI’s gain of +2% over the same period). However, the share price to be supported by a high gross dividend yield of 12%

Given the recent share price increase, we believe that benefits stemming from ongoing commodity price fluctuations have partly been factored in. Meanwhile, more sustainable growth in core earnings is likely to depend upon any strategies taken by LLUB’s management to regain a material portion of its previously lost market share

Outlook 2019

Sri Lanka Outlook 2019 – 10 January 2019

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The stock market is expected to face near term pressure from the anticipated upward movement in interest rates

Forward market valuation of 9.5X for 2019E is at a discount to a majority of regional peers, on the back of an expected earnings growth of +12% YoY. Select key stocks, particularly in banking, consumer and export-related sectors offer relatively attractive valuations, backed by strong earnings growth prospects

Given the current uneasy co-existence between political leaders and the major political parties, political risk continues to remain at elevated levels

Whilst the overall market performance is likely to remain subdued in 1H2019E, opportunities for possible M & A plays cannot be ruled out in the near term

A relative improvement in political stability in 2H2019E or 1H2020E would result in a clearer economic outlook over the medium term acting as a catalyst for attracting investments, and thereby would help re-rate market valuations

Event Update

DIAL becomes first in South Asia to launch 5G – 02 January 2019

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DIAL launches its fully-functional pre-commercial 5G transmission

Over 20% of DIAL’s base stations upgraded to “5G Ready Status”

Event Update

Hutch and Etisalat Merger – 04 December 2018

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Hutch Lanka to survive whilst Etisalat Lanka ceases to exist post-merger

Emirates Telecommunications Group to own 15% of Hutch Lanka

CK Hutchison’s Holdings Ltd Group to own 85% stake of Hutch Lanka