Sri Lankan tea prices marked a strong recovery from 2QFY10 onwards where it touched the highest ever prices in mid September which was recorded at LKR456 per kg (up 70% YTD). The upswing was mainly attributable to the global supply shortage created by the production deficit in Kenya, India and Sri Lanka due to unfavourable weather conditions.
Natural rubber prices which were at the lowest ever (LKR120 per Kg in December 2008) which fell due to the global recession has now started rising, where it has reached a NSA of LKR350 per kg at present.
Backed by the rising commodity prices, the sector is poised to mark strong earnings in FY10E. But the growth was hindered by the estate labour wage hike which increased the cost of production by 20% with effect from April 2009. This cost each company with a gratuity provision closer to LKR100 mn, creating a substantial impact in the bottom-line.
However we believe the +70% rise in tea and three-fold rise in rubber prices would be able to wither the negative effects of the cost of production to a certain extent, making the last quarter of the most of the companies recording exceptional profits.
Our key buys would be Malwatta (MAL), Kegalle (KGAL), Kotagala (KOTA) and Namunukula (NAMU) mainly on the back of strong earnings potential (where most of the companies have recorded results above expectations) coupled with strategies to strengthen the bottom line though aggressive cost management policies.
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