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

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.

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

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

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

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

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

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.

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

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

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

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.

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

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

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

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.

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