Economic Rewind
GDP growth gathers momentum
The year 2010 showed signs of improvement in the Sri Lankan economic outlook as the year witnessed the highest ever recorded GDP growth since 2002 in the 2Q, 2010 of 8.5 % amounting to Rs.634.9 bn. All three sectors of the economy registered significant growth in 2010 over the same period of previous year. The agriculture sector growth was backed by the improved global market prices and the upward trend in prices of natural rubber. The agriculture sector growth was further fuelled by increase in paddy and fishing production with the addition of North and East to the rest of the economy. res
Services sector witnessed a sound performance stimulating economic growth. Food & beverages industry fared better in the light of hotel & leisure sector expansion. Commendable performance recorded especially in banking & finance, agriculture and transportation sector backed by positive market sentiment and overall global economic recovery. Industry sector performance was affected by the removal of GSP+ tariff concessions coupled with the rising production cost however it was assisted by the increase in demand for semi precious stones, improvement in construction sector and electricity gas and water. The sector contribution of Agriculture,Industry, and Services to the total GDP in 3Q2010 was 12.0 %, 28.5 % and 59.5 % respectively. The Q3 GDP growth figure was well above expectations of the central bank and appeared optimistic that the momentum would continue well in to next year.
The fiscal position amidst significant fiscal reforms
2009 witnessed a staggering fiscal deficit of 9.9% of GDP well above the target deficit rate of 7% of GDP for the year. In 2010 the government deficit for the period January to October 2010 stood at Rs 376.8bn. The total revenue recorded an increase of 12.6% amounting to Rs. 671.9 bn from Rs. 596.7 bn recorded for the same period in 2009. Tax revenue grew by 14.66%percent to Rs. 580.3 bn from Rs. 506.1 bn accounted for in the same period of 2009. This was largely due to the increase in imports fuelled by reduction in imports duties especially on motor vehicle importation.
The total expenditure for the period grew by 6.87% amounting to Rs. 1,048.7 bn compared to Rs. 981.2 bn recorded for the same period in 2009. Recurrent expenditure during the ten month period increased by 3.07 % to Rs. 787.4 bn from Rs. 763.9 bn a year while capital expenditure increased by 20.24% to Rs. 261.3 bn from Rs. 217.3 bn. The expected approximate figure for year 2010 will reach 8.67% of GDP exceeding the IMF’s recommended target deficit rate of 8% of GDP. However government has made significant fiscal reforms in its 2011 budget proposal and the expected reduction in budget deficit from 9.9 % recorded in 2009 to 8.67% signals that the government is stepping in the right direction. Addressing the fiscal imbalance is however a complex and sensitive issue which ought to be dealt with extra diligence. While adhering to IMF requirements any comprehensive measure which aims at altering the distribution of resources should render special attention to the socio-economic and political impacts.
A gradual rise in inflation
Inflation has witnessed a gradual increase in year 2010. The year started with an annual average of 3.1 % which gradually climbed to 5.8 % in November 2010. The low inflation levels experienced at the beginning of the year was due to the contraction in demand backed by the global economic downturn .However with the gradual recovery of global economy inflation in Sri Lanka increased gradually and the point to point inflation for the month of November increased to 7% from the 6.6% accounted in the previous month. Further the 12 month moving average inflation was reported at 5.8 %, the highest reported since reaching 3. 1% in January 2010. The increase was largely due to supply side constraints which led to the increase of most food prices such as rice, vegetables, sea food and sugar.
Food imports account to circa 14% of the total import cost of the country therefore; the increase in the import cost of staple food items will continue to enforce upward pressure on inflation. The supply constraints are worsened by the rise in oil prices towards the latter part of 2010 which increases production costs. However the gloomy economic outlook which hovers over the western centric economies will keep global demand pressures intact for 2011, in this connection the Central Bank anticipates the inflation to remain within single digits in the coming year.
A widening trade balance
Sri Lanka experienced a trade pattern of continuous increase in the growth rate of imports not matched by a similar increase in the growth rate of exports throughout 2010.
The period January - October 2010 witnessed a trade deficit of USD 4,357.1 mn. There was a 32.8% YoY increase in import expenditure for the period in concern which amounted to USD 10,862.6 mn unmatched by the value of exports that reached USD 6,505.5 mn, an increase of 13.2% YoY.
However in the month of October Sri Lanka’s trade deficit rose by 79.2 % YoY to USD 4,375.1 mn despite export earnings (+27.6% YoY) managing to outpace the flow of imports (+8.4% YoY). Therefore, the export gains recorded during the month of October were partially offset by the overall activity recorded during the year. Crude oil accounts for 25% of the total import costs while food imports accounts for 14% of total imports. The major exports on the other hand mainly comprises of primary commodities making Sri Lanka highly vulnerable to price volatilities of the global market. Trade deficit for the first ten month period of 2010 contracted by 20.9% to USD 328.6 mn compared to the same period of 2009.
The sharp increase in all segments of imports are expected to continue well in to the next year fuelled by the increase in consumption. Western countries continue to be the major destination for Sri Lanka’s exports. Europe and U.S.A together account for 60% of country’s exports. Hence the recent unfavourable economic conditions prevailing in the US coupled with the sovereign debt crisis of Euro zone would have a negative impact on the export earnings given the western economies would continue in experiencing a sluggish economic recovery over the coming year.
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Key Events that had a bearing on the market
2010 In Retrospective
The forward march from a stunning year 2009 persisted as the Colombo bourse continued it ‘climb up’ during 2010 to record a YTD return of 96.0%. After being recognized as the second best performing market by Reuters in 2009, CSE sustained the momentum to touch 7,000 levels in October 2010 and overtook Mongolia to emerge as the top performer in the world for 2010.
However, CSE performance lost grounds thereafter shedding nearly 600 basis points till December. The more liquid Milanka Price Index (MPI) also gained in line with the broader market index by 83% during 2010 and surpassed its 7,000 milestone in September 2010. Despite the dip in the CSE since October 2010, MPI regained its 7,000 levels with the revival that was seen in the bourse over the past couple of weeks.
Turnover levels were concurrent with the market performance taking the YTD average daily turnover to LKR2.4 bn.
The YTD foreign interest recorded an outflow of LKR32.6 bn. Having overcome few of the bottlenecks for investment in Sri Lanka; inclusive of political instability monetary and fiscal disciplines last year, we believe foreigners would revert their attention to Sri Lanka’s equity market.
2010 New Listings
Entities continue to show interest for listing especially from the finance sector due to regulatory obligations. All the Initial Public Offers (IPOs) during 2010, were over-subscribed reflecting the positive investor appetite.
*To Initiate trading in January 2011
Source : Colombo Stock Exchange
Quick Look at Sectoral Performance during 2010
The top five sectors during 2010 are as below :
Trading Stores & Supply Motors Services Banks, Finance & Insurance
Among the weak performers during 2010 were :
Investment Trust Construction & Engineering Healthcare Telecommunication Power & Energy Land & Property
Earnings Snapshot
Banks, finance and insurance, one of the heavy weight sector, exhibited strong performance in terms of earnings during the year, majorly due to accelerated economic activities in the country. The same momentum can be expected going forward which would be backed by significant investment in branch expansion and investor friendly policies imposed by the government. The major contributors to this growth are Hatton National Bank, Commercial Bank & LOLC.
The Hotel & Travels sector saw a great revival during the latter part of 2010 as many hotels plunged into operations after their refurbishments in mid 2009. Colombo city hotels such as Galadari, Cinnamon Lakeside and Cinnamon Grand highly benefited with the corporate activity level grabbing in many foreign visitors. Resort hotels were also able to improve their bottom line with the seasonal foreign tourist arrivals. Going ahead, with Sri Lanka having already catered 600,000 tourists mid December, is targeting 2.5 mn tourists by 2016. The hotel and the leisure sector as a whole will be a direct beneficiary of these expectations.
The food & beverage, one of the key sectors listed in CSE, posted positive earnings during the year. Poultry sector players (Bairaha Farms and Three Acre Farms) sustained their growth story benefiting from the increased chicken consumption in the country. Cargills (Ceylon) also contributed to the sector growth with the addition of the North and East markets to its customer base whilst momentum continued in liquor oriented businesses (Distilleries, Lion Brewery and Ceylon Brewery).
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The sector would sustain its growth as most of the counters that contributed to the sector’s performance to continue to capitalize on the post war scenario. However, certain counters such the Distilleries, Lion Brewery and Ceylon Brewery; despite increase in their top line the sector would find their net earnings being squeezed with the increment of corporate taxes to 40% from 35% and the upward revision in the excise duty structure.
Throughout the past, earnings of the Manufacturing sector had been highly volatile, which was mainly due to seasonal impacts and unfavorable macroeconomic outcomes in the global economy. Chevron Lubricants, Royal Ceramics and Tokyo Cement further strengthened the sector earnings during 2010.
Though the telecommunication sector includes only 2 counters, it contributed approximately 5% to the total market. The sector witnessed healthy earnings posted by two participants during the year. Going forward the sector has potential in the local context with the technological advances together with the high penetration levels in the island. Further with government reducing the call charges we expect the revenue to grow due to the high elasticity of the product coupled with the growing per capita income.
The Diversified sector earnings approximately doubled during the year. The earnings growth was shouldered by the heavy weight John Keells Holdings with its capital gains through Asian Hotels & Property and Keells Hotels. Even though the sector earnings show high fluctuations on QoQ basis the earnings has usually outperformed the sector and the market. Going forwards we expect the diversified sector to report higher earnings on the back of the high geared local economy. Further the sector would benefit with the low interest rates persistent in the island together with the high investment rate as the sector is prone to diversification.
During June 2010 government reduced import duty for vehicles by 50%.This has immensely helped the stagnant industry to move ahead. With the new budget proposals government has reduced import tax on heavy vehicles. This would positively impact on the earnings of counters like Lanka Ashok Leyland, Dimo, Sathosa Motors and United Motors during the upcoming quarter.
Construction & Engineering sector perform relatively well comparison to the market during 2010. This was mainly backed by increasing income generated through post war developments and increasing demand for land & property in Colombo city limits. The growth was further facilitated by reduction in income tax for construction companies and reduction in custom duties for raw materials and capital equipments.
What’s up 2011? - A year of consolidation The Economy 2011
The inflation picked from a 3.1% annual average in Jan to 5.8% annual average in November 2010, mainly in the back of rising commodity prices and crude oil. Would the rise in the CCPI index lead to an increase in the policy rates during 2011? Sri Lanka just witnessed healthy private credit growth (during 2H of 2010), hence, would a possible increase in the policy rate create any impediment to the near witnessed private credit flows?
Most of the essential commodities are related with import tax and VAT, hence going forward if the country could aim to augmen t its revenues via valued added exports and tourism, the GoSL could look to relax import tax and VAT on essentials and invariably reduce the food price burden of the cosumer. During 2011 the private sector should take the initiative given from the budget to start structurally move up the value chain in terms of export products. Furthermore, Sri Lanka should reduce being western centric in terms of its exports (60% of all exports go to the western nation) and start penetrating the vibrant markets of the Asian powerhouses.
Albeit, certain encouraging tax reductions, the tax authority will have to better manage its tax collections and continue fiscal consolidation ( via cost reforms) to achieve improved fiscal outlook. During 2011 the GoSL would have to encourage more FDI’s and more private sector participation (Via Public Private Partnerships – PPP’s) to fast-track economic growth and capital formation within the economy.
Colombo Bourse 2011
The “Credit” debate
The latest directive issued on 30th December , reads “with effect from 1st January all broker firms shall be required to force-sell by T+5, securities of buyers who are in default of settlement by T+3 days, in order to recover the monies owing to them by such default clients.” T+3 have been an unnecessary fear psychosis, the majority of the market has fallen into. Ironically, the regional more developed markets also operate at T+3/ T+2. Hence, it should not be a huge deterrent on our market. In actual sense, it would prevent the market moving into more “Ponzi” levels, which actually brings more stability to the market during 2011 as well as stock brokering companies.
A flurry of IPO’s
It is very encouraging to hear that the Securities and Exchange Commission endeavors to augment the Colombo bourse market capitalization by 45% during the year 2011. What is more encouraging is that the envisaged increase is via new listings in the market. They foresee approx 75 IPO’s during the year 2011. Hence, it is a monthly average of circa 6 listings. Also it is planned to list gold and metal back ETF’s. Colombo bourse requires more IPO’s (fundamentally strong), liquidity and different options (ETF’s, Derivatives, Short Selling etc.) to give the investors more choice in terms of investing. Invariably making investors look at different stocks/ options to create healthy investing. As opposed to looking at the same counters and pushing them “up” and “selling”.
Sector “Hot-Picks” backed by healthy earnings
We advice the investors to especially watch the counters related to food & beverage consumption, consumer durables (based on expected hyped festive buying), tourism ( based on augmented tourist volumes) and banking counters ,especially the undervalued nonvoting counters (backed by improved credit growth during the past quarters) as short to medium term picks. Manufacturing, Construction and Land & Property would be medium to long term picks.
Courtesy- Asia Research
Vallibel One is likely to be listed under ‘Diversified Sector’ (DIV) or the ‘Investment Trust’ (INT). DIV sector is trading at a PE of 32.8x and at PBV of 3.6x, while the same for INT sector is 28.6x and 4.0x respectively. Thus Vallibel One shares are issued at a significant discount to its respective sectors.
