JKH's FY10 earnings have been spearheaded by strong growth in the core Transportation sector (Net Profit up 38.9%YoY) and the much anticipated revival in the Leisure sector (NP up six folds YoY). Further, the financial services sector (NP up 43.5%YoY) also performed strongly. However, the other core sectors such as Property (NP down 28.8%YoY), Consumer foods & Retail (NP down 45.2%YoY) and Information Technology (NP up 110.5%YoY) have under performed due to lower activity levels, squeezed margins and costs associated with capacity building.
Quarterly performance at a glance
JKH’s FY10 Consolidated revenue has increased 17% YoY to LKR47,980.0 mn whilst that of 4QFY10 has grown by an impressive 40.7%YoY to LKR13,924.6 mn. This is mainly due to the consolidation impact of Union assurance (which is now a subsidiary) and during the year the top line contribution from the Leisure, Consumer food & retail and Financial services sectors have grown strongly whilst Property sector has shown improvement in revenue. Though revenue from Transportation sector dipped 17%YoY during FY10 it has shown impressive performance during 2HFY10.
Cost of Sales have also increased (+18% YoY to LKR36,914.0 mn) in line with the rise in turnover levels whilst Gross profit has grown 12.8% YoY to LKR11,066.0 mn during FY10.
Meanwhile JKH's total operating expenses have increased by a sharp 19.5% YoY to LKR10,778.8 mn in FY10 mainly due to the consolidation impact of Union Assurance, Capacity building (at Keells super markets) and increased marketing and distribution costs in John Keells foods India and in local Consumer Food business. Further, escalating costs in the Transportation sector subsequent to the altered operating model in the bunkering unit and increased costs in the hotel sector also have contributed to the increase in costs.
Further, JKH's other operating income in FY10 has shot up by 34.4% YoY to LKR5,020.7 mn, attributable mainly to the finance income of Union assurance (which is now a subsidiary) and the circa LKR751.0 mn capital gain on disposal of KHL rights (JKH divested 150 mn of its rights in KHL in Mar'10 and subscribed for the entirety of its remaining rights and an additional rights of 7 mn shares. Subsequently, JKH currently holds 82.9% of KHL where it previously held 92.7%). These have supported to weather the impact from reduced interest income earned on the investment portfolio mainly due to dip in interest rates. Subsequently, operating profit rose by 16.9%YoY to LKR5,351.8 mn during the year.
JKH's share of profit from associates have increased by 9.2% YoY to LKR2,555.9 mn in FY10 mainly due to the improved performance of Transportation sector associate South Asia Gateway Terminals and financial services associate Nations Trust Bank (NTB: LKR 37.5) having performed well. Further, the IT segment has witnessed a turnaround to make LKR17.6mn Vs a loss of LKR167.2 mn. Subsequently, EBIT grew by 14.3% YoY to LKR7,907.7 mn during the year.
Finance cost has dipped by 19.2% YoY to LKR1,370.2 mn on the back of low interest rates and reduced borrowings. The Profit before Tax has increased by 3.9% YoY to LKR6,537.6 mn during FY10 despite the capital gain on AMW (LKR1,025 mn) in the previous year.
Tax expenses during FY10 dipped 25.7%YoY (due to last year's one-off tax expenses of LMS) and subsequently JKH's Net Profit has grown 9.9% YoY to LKR5,201.5 mn.
Sectoral Snapshot
Transportation sector net profit up 38.9% YoY to LKR2,258.8 mn in FY10
JKH’s key Transportation sector which is mainly represented by the fully owned subsidiary Lanka Marine Services [LMS] and 42.2% owned associate South Asia Gateway Terminals (SAGT) reported a 38.9%YoY increase in bottom line to LKR2,258.8 mn whilst the top line declined by 17%YoY to LKR9,494.7 mn. The top line dipped mainly due to the reduced contribution from LMS on the back of low oil prices and high competition. Despite this setback LMS retains the market leadership and has managed to post positive earnings (4QFY10 EBIT of LKR60 mn Vs LKR64 mn in the previous period though FY10 EBIT fell by 40%YoY to LKR175 mn).
Performance of Port operator SAGT has improved significantly during FY10 with container throughput increasing by circa 12% YoY to 1,882,220 TEUs (Apr’09 – Mar’10). The volumes have risen steadily from April’09 despite the sharp dip witnessed in the first four months of 2009. The increase in throughput volumes is mainly on the back of increased activity in low margin transshipment (circa 77% of the total volumes is from transshipment). The increase in total volume could be attributable to recovery in regional trade, competitive rates, efficiency and persuading existing shipping line customers to move containers through the Colombo port than direct calls at Indian ports. The sectoral share of associate company income (consisting of SAGT and Maersk Lanka) has increased by 10.7% YoY to LKR2,158.4 mn.
The transportation sector posted 38.9%YoY growth to reach LKR2,258.8 mn spearheaded by the impressive performance by SAGT however in absence of the one-off charges (circa LKR630 mn) of LMF in FY09.
Leisure sector net profit up by six folds to LKR893.0 mn in FY10
The Leisure sector has recorded a remarkable six fold increase during FY10 to reach LKR893.0 mn, mainly on account of the improved performance of the Sri Lankan City and resort hotels. Both city and resort hotels showed impressive performance during the 2HFY10 on the back of increased tourist influx into the country. All four Maldivian resorts are currently operational including the completion of the breakwater construction
at Cinnamon Island Alhidoo and according to the company despite the dip in tourist arrivals to Maldives all four resorts have performed satisfactorily especially in the 3rd and 4th quarters. The Sri Lankan resort hotels have shown improvement in occupancy, with occupancy levels averaging around 60% during the 2HFY10 whilst the city hotel occupancy rate has picked up to circa +90% where it was previously at a near 50%.
Consumer Foods & Retail sector net profit down 45.8% YoY to LKR45.8 mn in FY10
The Consumer Foods & Retail sector that includes listed subsidiaries Ceylon Cold Stores [CCS: LKR205.0] and Keells Food Products [KFP: LKR66.75] has recorded a profit of LKR45.8 mn in FY10 (Vs a profit of LKR83.6 mn in FY09). However, the top line grew by 12.1% YoY to LKR15,843.5 mn mainly due to growth in the retail sector (circa 18%YoY up) and a near 6%YoY increase in consumer food revenue driven by CCS. However, the net earnings were dragged down mainly by poor performance by the processed meat business in India and hampered convenience food segment in Sri Lanka. JKH is continuing its aggressive expansion drive with regard to the supermarket chain totaling 45 outlets, whilst the company plans to increase the total number of supermarkets to +50 by end FY11.
Property Development sector net profit down 28.8% YoY to LKR292.1 mn in FY10
The Property sector has recorded a dip in earnings to LKR292.1 mn in FY10 (down 28.8% YoY), on account of revenue recognition from the completion on "Monarch" in the corresponding previous period. With the third apartment tower 'The Emperor's" (163 apartments) construction underway, we believe recognition of earnings (a near 82% sold and circa 20% is already recognized) from this project would be: recognition
of 20% over FY10 and the rest to be spread through out FY11 and FY12.
Financial Services sector net profit up 43.5% YoY to LKR477.6 mn in FY10
The Financial Services sector has recorded 43.5% YoY growth in earnings to LKR477.6 mn inFY10 where the turnover has grown phenomenally to LKR5,262.3 mn (vs LKR499.3 mn) on account of the consolidation of subsidiary Union Assurance [UAL: LKR112.0] coupled with healthy performance of the stock broking arm on the back of increased trading in the stock market and better contribution from associate Nations Trust Bank [NTB:LKR38.75].
Information Technology sector net profit up 110.5% YoY to LKR 17.6 mn
The Information Technology sector has recorded a net profit of LKR17.6 mn in during FY10 (vs a net loss of LKR167.0 mn in FY09) driven by improved performance of the Indian BPO operations that has operated on a break even level. The Other businesses of JKH including Plantation Services, Strategic Investments and
the Corporate Centre recorded a net profit of LKR1,216.5 mn in FY10 (vs LKR2,323.5 mn in FY09). The impact of the capital gain from the disposal of AMW in FY09 was partially set off by the treatment of UAL and gains made on KHL rights.
Future Outlook
Looking ahead, we expect JKH’s key Transportation sector to record improved earnings mainly on the back of better performance by SAGT despite the reduced LMS market share. Further, with recovery in the regional trade, competitive rates and persuading existing shipping line customers to move containers through the Colombo port than direct calls at Indian ports, volumes at SAGT is expected to grow by a near 8%-10% YoY during FY11.
With the signs of recovery witnessed during 2HFY10 we expect the profitability of SAGT to improve not only due to the increase in transshipment volume but also on the back of the expected change in mix between domestic container volumes (which gives three times the revenue of the transshipment containers) and the transshipment containers (the current mix between domestic volumes to transshipment is 77% to 23%). This change in mix is expected to materialize with increased activity in the local economy and construction sector reviving coupled with increase in the regional trade. However, the transportation sector remains vulnerable to sudden changes in the global economic climate.
With changing macro environment in Sri Lanka the local tourism industry is poised for strong growth and we expect significant improvement in both the local city and resort hotels. The number of arrivals to the country is already up 50% YoY during Jan-Apr’ 10. However, the Maldivian segment is expected to weather a challenging period on account of depressed international tourism on the back of the slow recovery from
global recession. The Sri Lankan sector would revive strongly given increased economic and business activity subsequent to the ending of war and infrastructure developments in the previously war torn areas. JKH with its portfolio of 2,000 rooms comprising of 860 city rooms and 775 resort rooms is well positioned to reap the
benefits. Further, JKH is currently investing heavily in upgrading the existing hotel properties and in new hotel ventures where it re-launched the 80 room Clun Oceanic in Trincomalee as “Chaaya Blue” in May 2010 at a cost of LKR450 mn. Further, JKH acquired 4.6 acres of land which give them a contiguous block of 10 acres on the prime Beruwela beach front on which the group has planned to build a 190 room hotel at an investment of LKR2 bn. In addition, the 254 rooms in the South wing of Cinnamon Grand hotel is currently being re-furbished at a cost of LKR300 mn. The key plans in the leisure arm includes refurbishment of Cinnamon Lodge Habarana (LKR300 mn), Coral Gardens Hikkaduwa (LKR1.1 bn), Chaaya Laoon Hakuraa Huraa (USD2.6 mn) and Bentotal beach hotel (LKR200 mn). In view of the substantial plans for expansion John Keells Hotels went for a rights issue of 1:3 to raise approximately LKR3.6 bn.
Going forward, we believe a significant proportion of the earnings arising from the property development (164 apartments Emperor) would be recognized in FY11 and FY12 and there by contributing to sectoral growth. With a real estate portfolio of more than 33 acres of land in Colombo (where contiguous large blocks of land are available) and 133 acres outside Colombo the sector is primed to benefit. Further, we believe the sector would benefit significantly from the declining interest rates and the anticipated demand from expatriate Sri Lankans.
The Financial services sector is expected to record consistent performance on the back of improved performance of associate NTB and continued growth of UAL (the 4th largest insurer by asset). However, on account of the local Banking Act, JKH will have to reduce its stake in NTB to 15% by 2012.
Despite the start up costs, the Information Technology sector would benefit from the BPO venture and post moderate earnings growth, albeit off a low base.
The Consumer Food & Retail sector is expected to rebound from FY11 onwards on the back of increase in demand from the North and East whilst we believe the sector has potential to post attractive earnings through cost rationalization and further consolidation of its renowned brands.
Trading on 13.6X forecast FY12E earnings. We continue to maintain our forecast net profit of LKR6,553.5 mn (up 26% YoY) in FY11E and project net earnings to rise by a further 26.8% YoY to LKR8,312.5 mn in FY12E. The main attraction of the stock is the fast EPS growth, a CAGR of 20.3% over 2005/2012E. JKH is currently trading on 17.3X forecast FY11E earnings, 13.6X projected FY12E earnings and 2.1X PBV (2011) where the counter has always been trading on premium to market. However, the premium may be justified with investments already in place in the domestic leisure sector and its large real estate portfolio, the company is primed to reap strong benefits from the macro upside. Further, JKH continues to be cash rich, subsequent to the rights issue in 2007 coupled with the drawing of USD75 mn loan facility from the International Finance Corporation (IFC) and in a strong position to launch fresh acquisitions/investments (Further, JKH is capable of raising substantial capital both in debt and equity market if needed). Healthy balance sheet along with investments in place we believe the share has marked upside, whilst being a proxy to the macro upside - Maintain BUY
JKH Annual Report http://www.keells.com/pdf/annual_reports/jkh_ar_2009_10/john_keells_annual_report_2009_10.pdf
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