Diesel & Motor Engineering PLC

Overview of the company

Diesel & Motor Engineering PLC was established in 1939 as apartnership and probably the oldest sole distributor for Mercedes-Benz Passenger and Commercial Vehicles, in the Asian Region. InSri Lanka, DIMO is colloquially known as the “Benz Company”.

The Company has a record of 68 years experience in theautomobile and engineering industry and over the years has made a major contribution towards the development of thetransportation sector in Sri Lanka. DIMO represents many prestigious principals such as Daimler, TATA, Chrysler, MTU,Bosh, Komatsu, Siemens, Michelin, Osram, and Mahindra &Mahindra. Dimo group has diversified its business segments intothe areas of Power Engineering, Building Technologies, PowerSystems, Agricultural Machinery, Lighting Systems and WaterManagement Solutions.

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CHEMICAL INDUSTRIES: Impressive 58.7% YoY Growth in 3QFY11

Earnings Reach LKR759mn Posting an Impressive 58.7% YoY Growth

• Chemical industries (CIC.N.LKR154.70,CIC.X.LKR109.00), posted a net profit of LKR759.0mn for 1-3QFY11 (vs. a net profit of LKR485.3mn for 1-3QFY10), reflecting a growth of 56.4% YoY, where company achieved net earnings of LKR382.7mn for 3QFY11.
• Growth was supported primarily by strong growth in agricultural & livestock segment earnings ( 42.7% YoY growth). Further triggered by impressive performance from construction, consumer & pharmaceutical segments posting YoY growth rates of 46.8% and 37.6% respectively.
• With country’s agricultural sector showing significant growth with improved economic conditions (agricultural sector grew at an impressive 7.0% for the FY2010), where the growth is expected to continue(according to rice research & development institute, Sri Lankan Demand for rice for local consumption in 2020 expected to be 4.6mn tons. Production should increase by 50% in both dry & wet zone to meet this target), also with the improved performance of Poultry & Feed segments with the increasing consumption levels.
• Further with the boost in construction industry expected to continue with the rebuilding efforts and major undertakings in leisure industry, and with CIC’s plans expand overseas, counter is poised to benefit with the strong presence in Agricultural, Construction, consumer & pharmaceutical segments. Against this backdrop we expect CIC to record LKR935.2mn in FY11E (up by 56% YoY) and net earnings of LKR1, 143.4mn in FY12E (22% YoY growth).
• CIC (voting) currently trades at 15.7X forecasted FY11E net profit, 12.8X estimated FY12E net profit and 3.1X PBV. CIC non- voting currently trades at 11.4X forecasted FY11E net profit and 9.3X forecasted FY12E net profit, as opposed to a chemical & pharmaceutical sector PE of circa 17.7X and a current trailing market P/E of 18.7X. We believe counter holds strong upside.

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Lanka Walltile (LWL) - The Wall-Tile Giant

The wall-tile giant encompasses Lanka Tiles PLC (54.5% ownership) and Uni-Dil Packaging (52.9%) whilst having a controlling interest in Horana Plantations PLC with a 27% effective holdings (Through Ceytea Plantations). Furthermore, LWL has an associate interest of 34.6% on Parquet (Ceylon) PLC, which changed its core business to production of Grout and Mortar.

LWL recorded a 14% incline to LKR6,444.3 mn in the top line for the cumulative 3QFY11 on the back of the increased demand by the local market. 60% of the top line was contributed by the tile segment followed by packaging materials which contributed circa 18% of the counter‟s turnover.

Going forward, with the construction sector boom together with strong investment inflow and higher activity levels in the country the „tile giant‟ pertains value as a potential growth stock.

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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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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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Royal Ceramics' net profits up 189%YoY to LKR382.5 mn in 1QFY11

Royal Ceramic's (RCL) has reported net earnings of LKR382.5 mn (up 189%YoY ) in 1QFY11 whilst the top line grew by 58%YoY. This was mainly driven by strong home builders demand, improved sales mix in the sizes of tiles (Bigger tiles tend to have higher margins) and increase in demand from hotel refurbishment projects and apartment developments.

RCL, the market leader in floor tiles with circa 45% market share has two manufacturing plants for floor tiles in Horana & Ehaliyagoda and one for sanitary ware in Homagama. Currently the floor tile production lines operate closer to 100% capacity to produce circa 10,500-11,000 sqm/day whilst the bathware currently produces circa 12,000 pieces/month where the installed capacity is a near 20,000-24,000 pieces per month. In order to meet the excess demand the company is planning to increase the Horana plant's capacity by 3,500 sqm per day by Jan'2011.

With the economic conditions improving and demand from both home builders and hotels and apartment towers picking up considerably and with the interest rates on the downward trend we revise our projected FY11E earnings upwards by 12.9% to reach LKR1,579.4 mn (up by 63%YoY). On top of the demand picking up in the country, the expected reconstruction boom in the North and East from drumming up the overall economic growth, the construction industry is expected to witness a turnaround. RCL is one of the prime beneficiaries as a leading player in the Western province and a dominant player in the country. With the company's short term plans to increase capacity in the existing production facilities we revise up our FY12E forecast also by 31% to LKR2,068.3 mn (up 31% YoY).

Yearly & Quarterly Performance
Net revenue grew 58% YoY to LKR1,152.4 mn in 1QFY11. RCL's net turnover has grown 58% YoY to LKR1,152.4 mn during 1QFY11 on the back of increased demand from home builders, hotel and apartment building projects. During 1QFY11 the sales volume grew by near 50%YoY whilst there has been no increase sales price.

Gross profit has risen by 51% YoY to LKR516.2 mn in 1QFY11. RCL's cost of sales has increased by 64.3% YoY to LKR636.2 mn in 1QFY11 where the company has posted gross profit of LKR516.2 mn in 1QFY11 (up 51% YoY). The gross profit margin has dropped marginally to 44.8%.

EBIT has increased by 73% YoY to LKR255.2 mn in 1QFY11. The company's administrative expenditure has increased to LKR82.3 mn (up 28.4% YoY) in 1QFY11 whilst distribution expenses have risen by 37.2% YoY to LKR178.7 mn on the back of increased expenses on the sales network of 41 showrooms. Consequently, RCL has recorded an EBIT of LKR255.2 mn in 1QFY11 (up 73% YoY) whilst the EBIT
margin has grown to 22.1% during the quarter from 20.2% in 1QFY10.

Other income has risen 68.3%YoY to LKR182.9 mn in 1QFY11. RCL's other operating income has increased by 68.3%YoY to LKR182.9 mn during the quarter mainly owing to profit on sale of shares amounting to LKR164.7 mn.

Net profit has increased by 188.9% YoY to LKR382.5 mn in 1QFY11. RCL's finance cost has dipped by 55.2%YoY to LKR55.8 mn in 1QFY11 owing to circa 26%YoY reduction in borrowings totalling to LKR790.7 mn and low interest rates. Consequently, the net profit during 1QFY11 grew by 188.9%YoY to LKR382.5 mn.

Slow and steady growth in bath-ware. The new Bathware manufacturing plant that commenced commercial operations in FY09 (built at a cost of LKR1.2 bn) with an installed plant capacity of around 250,000 pieces per annum has contributed LKR101.5 mn in revenue during 1QFY11 vs LKR26.4 mn in 1QFY10. The sanitaryware has also reduced its losses to record a loss LKR5.8 mn vs a loss of LKR38.5 mn in the corresponding previous quarter. Further, we believe that with the management's efforts on entering into new contracts this manufacturing facility would breakeven in another 10 - 12 months whilst the company is also focusing on increasing exports of sanitaryware.

Further, the company plans to open around 4 to 5 new showrooms during this year mainly in the recently liberated North and East. Further, due to the increased demand the company is planning to increase the capacity of the Horana plant by circa 3,500 pieces by January 2010. Moreover, the company owns a 33 acres land in Kiriwaththuduwa (owned by its newly incorporated subsidiary, Rocell Ceramics Limited) and has an option to commission a brand new floor tile facility there if there is a need for further expansion.

Forecast net profit to grow by 63.8% YoY to LKR1,579.4 mn in FY11E. With the economic conditions improving and demand from both home builders and hotels and apartment towers picking up considerably and with the interest rates on the downward trend we revise our projected FY11E earnings upwards by 12.9% to reach LKR1,579.4 mn (up by 63%YoY). On top of the demand picking up in the country, the expected reconstruction boom in the North and East from drumming up the overall economic growth, the construction industry is expected to witness a turnaround. RCL is one of the prime beneficiaries as a leading player in the Western province and a dominant player in the country. With the company's short term plans to increase capacity in the existing production facilities (increase production by 3,500sqm at Horana by Jan'2011) we revise up our FY12E forecast also by 31% to LKR2,068.3 mn (up 31% YoY).

Share offers good value on 4.5X forecast FY12E earnings. Despite the share appreciating sharply since we initiated "BUY" recommendation on the counter, the share is still trading at steep discount to market and remains very attractive on just 5.9X FY11E net profit and 4.5X forecast FY12E net profit whilst trading at 1.4XPBV. Maintain - BUY

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Dipped Products PLC (DIPD) : Escalating rubber prices remains a major concern

Dipped Products PLC (DIPD) is the fully integrated and globally acknowledged rubber glove manufacturing arm of the local conglomerate Hayleys PLC (HAYL: LKR301.00). Currently DIPD exports its products to +68 countries and enjoys a 5% global market share for natural and synthetic latex based domestic and industrial gloves.

DIPD is globally ranked amongst the top three manufacturers of non-medical gloves whilst it ventured in to production of medical gloves in 2002 with a production facility in Thailand. At present DIPD operates seven production facilities in Sri Lanka and Thailand with marketing operations in Italy.

Despite the global recessionary pressures which hampered the demand for gloves, the company’s Thailand operation which is dedicated to produce medical gloves has posted a profit of LKR101 mn in FY2010 from a loss of LKR159 mn the previous year. At present all seven plants of DIPD are operating at near full capacity (which is at circa 85%). DIPD also manages the plantation arm of Hayleys group with two listed companies namely: Kelani Valley Plantations PLC (KVAL: LKR99) and Talawakelle Tea Estates PLC (TPL: LKR38.00). The company holds 71.67% in KVAL and 25% of TPL which produces around 5% of Sri Lankan tea and 4.5% of country’s rubber with +19,500 ha.

Further, KVAL sells 25% of its produce to its parent DIPD whilst selling the balance at auctions. Going forward, with the increasing rubber prices resulted by recovering global activity levels we believe KVAL will strengthen the bottom line of DIPD.

Therefore, we forecast KVAL to post a net profit of LKR245 mn in 2010E and to grow by a further 15% YoY in 2011E. Further during FY2010, DIPD acquired one third of Hayleys Plantation Services; the holding company of TPL for a consideration of LKR280 mn. Being one of the high quality tea manufacturers in the country, this venture would also result in a positive push for the group’s bottom line (through associate income).

Future outlook 
The glove industry is a steadily growing industry in the world where medical glove category being the main growth catalyst backed by the necessities in healthcare and ever evolving medical technology sectors. Going forward it is estimated that global demand for gloves to be at circa 150 bn pieces in 2010 and to grow by a steady 8%-10% thereafter. The company plans to add another 50% to the current capacity of the Thailand Operation which is the sole medical glove facility of the group in FY2011E for an estimated investment cost USD5.6 mn. This will increase the production of the plant to 855 mn medical gloves per annum by the end of FY2011, which is inline with the high growth potential of the medical glove segment. Out of the total investment 30% would be equity funded by DIPD whilst the rest would be financed from bank borrowings. Backed by the additional capacity coupled with reliable and long lasting customer base in 68 countries we believe DIPD would post sustainable earnings growth in the years to come.

Fluctuating rubber prices could affect the company’s margins considerably and current escalating rubber prices in the global commodity exchanges remains a concern to the company as a near 50% of the cost of production comprises of latex sourcing costs. However, DIPD could wither the negative effects to a certain extent as they can pass the price hike to its customers.

Furthermore, weakening Euro amidst the financial crisis in European Union would also have negative impact on company earnings. It should be noted that additional capacity would add value to the earnings only from FY2012 (as all three production lines would commence operations by the end of FY2011) whereas borrowing costs would impact the bottom line of the company in the short term (with 70% of USD5.6 mn being funded from debt).

The management of DIPD is positive about its future and plans to implement lean production systems to all its plants with the objective of improving productivity. To minimize the energy costs the company has already taken measures to reduce dependency on fossil fuels where a few plants have bio mass heaters in place. The management also stated that the loss of GSP+ for Sri Lankan exports would not have a material effect on DIPD’s sales, as only 3% of its total production would fall in to GSP+ benefited category. In addition, the company’s continuous focus on new product development aiming especially the niche markets in the glove industry would enhance the sustainability of the earnings growth.

Forecast FY2011E earnings to record LKR723.7 mn. With the company’s expansion strategies to be implemented in Thailand operations (which would add another 50% to its current capacity during FY2011), continuous focus on new product development coupled with the much anticipated recovery of the global activity from the current downturn and healthy earnings from plantation arm (backed by escalating rubber prices and higher tea prices), we forecast the company to post a net profit of LKR723.7 mn in FY2011E (up 50.5% YoY) and reach LKR814.3 mn in FY2012E (up 12.5% YoY). Share offers good value trading on 10.5X FY2011E earnings.

The share currently trades on 10.5X forecast FY2011E net profits whilst trading at 9.4X projected FY2012E net earnings. Hence, backed by the enhanced capacities with focus towards further expansion, development of value added products coupled with better returns from the subsidiary on the back of high tea and rubber prices would strengthen DIPD’s bottom line in the future. Therefore we rate DIPD a BUY

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