DISECTING 2010 - Sri Lanka Stock Market Perspective

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.

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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.

Features

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

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Sri Lanka Corporate Earnings - Analysis FY 2010

Market earnings have grown by an overwhelming 190% YoY in 4QFY10 and a sharp 44% YoY in FY10.
The conducive business environment subsequent to the end of the three decade old conflicts coupled with political stability and positive economic outlook has raised the business sentiments and the corporate earnings during 2HFY10 has been exceptional despite the slow global economic recovery.

The Corporate Earnings have gained in line with the market till 2007 and during the heightened war the corporate earnings have outstripped the prices. However with the complete end of the three decade long war and positive economic outlook the share prices have exceeded the growth in earnings.

SECTORAL CONTRIBUTION
Banks, Finance and Insurance sector has emerged as the major contributor to the corporate earnings contributing for circa 37% of the total corporate earnings in FY10. Diversified Sector has contributed for circa 24% whilst Food, Beverage and Tobacco sector has contributed to circa 17% of the corporate earnings in FY10.

TELECOMMUNICATIONS

Telecommunication sector has made a turnaround from the staid period by posing a +twofold YoY increase in profits to circa LKR1,309.1 mn in 4QFY10. However the FY10 saw a cumulative loss of circa

LKR9,223.6 mn mainly on the back of the massive asset impairments of Dialog Telekom which took place during the year. Further relatively high number of operators triggered stiff competition on tariffs which
reduced the profitability of the industry as a whole. Thereby the industry experienced a more turbulent period from 2008 to 2010 being a deflator to cumulative market earnings.

BANKS, FINANCE & INSURANCE

Banking and finance sector recoded a growth of 65% YoY during 1Q2010 which was driven by favourable macro economic conditions and political stability in the country. We witnessed banks such as Sampath Bank, Commercial Bank, DFCC Bank and Nations Trust Bank recoding impressive results during 1QFY10, which was backed by improved net interest incomes and reduction in provisions. Lanka Orix Leasing, LB Finance were in the forefront of the earnings drive of finance companies whilst HNB Assurance and Ceylinco Insurance spear headed the insurance sector earnings during the quarter. Further in terms of 4Q cumulative earnings the sector recoded a 50% YoY growth which was supported by banking sector counters such as HNB, SAMP, DFCC and NTB, finance companies such as LOLC, LFIN, First Capital Holdings and Asia Capital.

FOOD, BEVERAGE & TOBACCO

Food and Beverage sector earnings grew by a moderate 12% YoY in 4QFY10 whilst it improved by a decent 30% YoY in FY10. The growth was spearheaded by improved earnings in Ceylon Tobacco, Nestle
Lanka and Ceylon Tea Services, whilst poultry sub-sector counters together with Lanka Milk Foods & Lion Brewery ably shouldered the sector earnings growth.

CHEMICALS

The Chemicals and Pharmaceuticals sector grew by a impressive 370% during 4QFY10 whilst it grew by 55% YoY in FY10. The outstanding results of Haycarb that propelled the growth in the sector was at-
tributable to the organic growth and capital gains which incurred during the period. The exceptional growth of 930% YoY 4QFY10 achieved by chemical industries aided in spearheading the sectoral growth. Further the 200% YoY 4QFY10 improvement of Lankem Ceylon enhanced the sector growth even though Chemnex was holding the market down.

CONSTRUCTION & ENGINEERING

Earnings of the construction and engineering sector has increased by 5% YoY in FY10 to LKR1907.86 mn mainly on the back of the 10% YoY increase in earnings of Colombo Dockyard. DOCK contributed for
almost 99% of the sectoral earnings whilst Lankem Developments has made a turnaround by improving their earnings two folds YoY to LKR3.29 mn in FY10. Construction & Engineering sector has achieved a 5 year earnings CAGR of 57% which is recorded as the highest sectoral earnings growth in the Colombo Bourse.

DIVERSIFIED

The diversified sector earnings grew by an impressive 88% YoY during 4QFY10 whilst it grew by 54% YoY in FY10. This growth was spearheaded by outstanding results posted by Hayleys owing to the capital gains made from divesting a few hotels under Carbotels and increased contribution Hayleys MGT. Further, Carsons Cumberbatch reported an exceptional growth mainly due to better palm oil returns and profits from the beverage business. Colombo Fort Land reported impressive growth on all sectors especially in plantations
whilst the diversified segmental profit was further supported by John Keells Holdings where the hotel arm performed above expectation. Richard Pieris turned around strongly (276% YoY) during the year and shouldered the sectoral growth.

HOTELS & TRAVELS

The Hotel sector earnings grew by an impressive 319% YoY during 4QFY10 whilst it grew by 643% YoY in FY10. Hotels and Leisure sector is the prime beneficiary of the complete end of the three decade long war, whereby the sector propelled the earnings of the broad market in 2HFY10. 4QFY10 was a turnaround period for almost all the hotels and exhibited tremendous improvement in earnings on the back of circa 54% YoY increase in tourist arrivals during the quarter and improved ARRs and occupancy rates.

INVESTMENT TRUST

The investment trust sector earnings grew by 152% YoY during 4QFY10 whilst the FY10 earnings grew by 143% YoY in FY10. The growth was lead by growth in Ceylon Guardian, Touchwood, Sunshine holdings
and Ceylon investments. Apart from Renuka holdings and Watapota investments which saw sharp dip in earnings during FY10 all other companies in the sector have witnessed significant turnaround.

LAND & PROPERTY

A 172% YoY growth in 4QFY10 and a 42% YoY increment for FY10 was lead by the sector heavyweight Overseas Realty. Overseas Realty contributed over 75% of the total quarterly earnings of the sector whilst
showing an increase of 72% YoY for 4QFY10. Property Development shouldered the earnings during the year whilst East West turned around strongly (up 1791% YoY).

MANUFACTURING

The manufacturing sector earnings witnessed a 67% YoY growth during 4QFY10 whilst it saw 91% YoY growth during FY10. The growth was driven by Chevron Lubricants (up 97% YoY) on the back of bet-
ter margins whilst Royal Ceramic also lent support (up 86% YoY in FY10). Lanka Ceramic, Lanka Wall tiles and Grain Elevators saw im pressive growth in their bottom line mainly driven by increased consumer spending. However, Pelwatta Sugar weathered a challenging period (down 569% YoY in FY10) where it has been a drag on the sectoral performance whilst ACL cables too have negatively impacted the growth (down 101% YoY in FY10).

PLANTATIONS

The sector has grown two-fold in 2010/FY10 to LKR1,937.8 mn owing to high tea and rubber prices which prevailed since mid 2009 despite low output levels. During 1Q2010/4QFY10, the sector saw net earnings of LKR1,313.7 mn versus a loss of LKR391 mn in the corresponding period previous year which could be mainly attributable to the escalated rubber prices where companies with exposure to rubber benefited immensely.

OIL PALMS
The sector has recorded an impressive two fold growth in net earnings for 1Q2010/FY2010 which could be mainly attributable to the remarkable performance in Bukit Darah; the holding company of 4 oil palm companies which operate plantations in Malaysia along with holdings in the Carsons Cumberbatch group. Rising oil palm prices (which were at a drop in 2008 due to global recession) strengthen the performance in the four oil palm companies. Further, for the year FY2010 sector has recorded LKR3.2 bn from the LKR894 mn posted last year.

SERVICES
A fivefold increase was seen in services sector during 4QFY10 and +400% YoY increase in earnings for FY10 whilst Health care sector recorded 201% YoY increase during 4QFY10 and 148% YoY increase during FY10. Services sector growth was spearheaded by the impressive improvements in earnings of Asiri Group Hospitals and Nawaloka Hospitals

STORES & SUPPLIES
The stores & supply sector witnessed an over whelming 233% YoY growth during 4QFY10 whilst FY10 earnings grew by 245% YoY mainly on the back of strong growth seen in E B Creasy (up 579% YoY in FY10).

TRADING
The trading sector earnings grew by 32% YoY during 4QFY10 whilst it grew by an impressive 272% YoY in FY10. This growth was spearheaded by exceptional results posted by Browns where the FY10 earnings have grown by 113% YoY, however there was a downward trend in quarterly performance. With the latest tax and tariff reforms implemented in June 2010 there seem to be a favorable prospect for the trading sector in the near future.

MOTORS
Motor sector recoded an impressive +300% YoY increase during 4QFY10 and FY10. Sector growth was driven by Diesel and Motor Engineering Company, United Motors and Colonial Motors. Further the recent 50% import duty reduction on motor vehicles will also have a positive impact on its top line growth in the future.

FOOTWEAR & TEXTILES
The Footwear and Textile sector trended downwards 31% YoY during 4QFY10 whilst it grew by an impressive 97% YoY in FY10. Hayleys MGT spearheaded the entire sector with outstanding results whilst contributing over 100% of the total sectoral earnings in 4QFY10.Ceylon Leather is on the path of recovering from a loss making run whilst presenting profits for 4QFY10 as well as FY10. On the other hand Kuruwita Textiles added pressure on the Footwear and textile sector with a 177% YoY dip in 4QFY10 dragging
the earnings of the company into negative figures.

POWER
The sector has marked a turnaround in 1Q2010/4QFY10 recording a net profit of LKR744.8 mn whilst resulting a cumulative 4 quarter profit of LKR356.8 mn. This is mainly attributable to the improved performance in Lanka IOC, which contributed negatively to sector performance in 2008/FY2009. The three other companies which are mainly into hydro power generation have shown improved earnings from the corresponding period previous year. With the market re-rating to a new and higher valuation plane with the positive macro environment the market is currently trading on 4 quarter trading multiple of 19.8x. Given our expectation of near 30-35% YoY growth in corporate earnings in FY11 the market PER would fall to circa 15.0x.

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John Keells Holdings (JKH): FY10 records 10% YoY growth in net earnings

John Keells Holdings (JKH) the largest listed conglomerate on Colombo bourse with a market capitalization of LKR113.2 bn (USD994.6 mn) marks it’s strong presence in Leisure, Transportation, Food & Beverage, Property Development, IT and Financial Services Sectors. Conglomerate John Keells Holdings (JKH) has reported net profit of LKR5,201.5 mn in FY10, up by 9.9% YoY, slightly above our original expectation of LKR4.7 bn.

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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Tokyo Cement (TKYO) FY10 net profit down 16%YoY

The market leader, Tokyo Cement's (TKYO) recorded a net profit of LKR291.5 mn in FY10 (down 15.9% YoY) however the 4QFY10 exhibited 108.4% YoY growth to post a net earnings of LKR233.9 mn. Subsequent to the poor 9 months performance, TKYO's 4QFY10 turned around strongly as expected nevertheless the growth has been spearheaded by the sharp dip in depreciation and finance cost whilst the top line has slid 27.3%YoY during the quarter.

The resolution to the national conflict is expected to shape up developments in the North & East and thus TKYO would be able to fulfill the demand with its excess capacity. We expect TKYO to record LKR626.7 mn in FY10 (up 115%YoY). Further, we believe Tokyo cement is poised for demand driven growth especially in FY12 and we expect a conservative 65% YoY increase in net earnings to post LKR1,034.0 mn. 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, the fluctuating nature of the earnings exhibited in the past and lack of transparency associates a risk factor with the counter. Whilst advising caution due to the risk of fluctuating earnings exhibited, we 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.

Revenue has dipped by 17% YoY to LKR14,634.4 mn in FY10. TKYO’s revenue has dipped by 17.1% YoY to LKR14,634.4 mn in FY10 which is mainly due to a near 12% - 15% YoY dip in sales volume whilst the with marginal variances the price is maintained at circa LKR720/bag (maximum retail price is circa LKR750/50kg bag). During the year the cement imports contracted by 14.9% whilst domestic cement production fell by circa 7.4% mainly on the back of deceleration of private sector construction and home building activities.

Operating at a near 60-65% production capacity (1.8 mn metric tones where a 900,000 metric tones vertical roller mill was commissioned during the year) 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 14.8% YoY to LKR3,099.9 mn in FY10. The cost of sales has dipped at a faster rate of 22.8% YoY mainly on the back of relatively lower price of clinker and low vessel charter cost due to oil price dip (the total dip in cost is circa $4/ton), hence the gross profit has grown by 14.8% YoY during the year to post LKR3,099.9 mn. TKYO's gross margins have strengthened from 15.3% in FY09 to 21.2% in FY10 backed by the dip in cost of sales.

EBITDA has fallen by 12.4% YoY to LKR2,179.4 mn in FY10. Subsequent to a three fold increase operating cost has risen to LKR920.5 mn, leading to a 12.4% YoY fall in EBITDA. The main driver of cost increases have been the Nation Building Tax (3% of the top line) being charged here coupled with higher sales commissions and staff salaries.

PBT has dipped by 58.2% YoY to LKR270.3 mn in FY10. The dip in EBITDA coupled with the marginal increases in depreciation (up 3.4%YoY to LKR1,041.1) and finance cost (up 4.0% YoY to LKR867.9 mn) has led the PBT to fall by a staggering 58.2% YoY to LKR270.3 mn during FY10. However, during 4QFY10 the depreciation cost dipped by 48.5%YoY to LKR228.1 mn whilst the finance cost has reduced by 47.3%YoY to LKR161.1 mn due to the dip in interest rates (to a near 11.5% from circa 20% an year ago) whilst the borrowing costs have shot up to LKR1,792.3 mn vs LKR863.7 mn in FY09.

Net profit has dipped by 15.9% YoY to LKR291.5 mn in FY10. Despite a significant fall in PBT the reversal of provision for deferred tax liabilities charged has reduced the taxation and thus the net earnings have dipped by 15.9%YoY to LKR291.5 mn.

Expected Growth and developments in the North & East. Following the entirely resolved terrorist conflict, demand is expected to grow 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 TKYO is in a strong footing to serve the anticipated increase in demand.

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 operations is circa 7.5MW whilst the company supplies the surplus to the national grid. This facility is expected to generate cost savings of around LKR250 mn during FY11. Further, the company announced today that it has incorporated a wholly owned subsidiary "Tokyo Cement Power (Lanka) Ltd” for setting up and operating of power generation, giving an indication that the company would look for more power projects in the future.

Capitalization of Reserves. The company announced the capitalization of reserves where both the voting and non voting shares would be capitalized in the proportion of 1:8 for a consideration of LKR17 per share. However this is subject to the in principle CSE approval and shareholder approval at an AGM.

FY10E net profit to reach LKR626.7 mn, up 115% YoY. The resolution to the national conflict is expected to shape up developments in the North & East and thus TKYO would be able to fulfill the demand with its excess capacity. Accordingly, we believe revenue growth of circa 35% would be achieved via a conservative 15%- 20% volume growth and a 3%-5% price growth. A marked reduction in the cost base is expected through the synergies of the bio mass plant (LKR250 mn savings) and low interest cost. We expect TKYO to record LKR626.7 mn in FY10 (up 115%YoY).

Further, we believe Tokyo cement is poised for demand driven growth especially in FY12 and we expect a conservative 65% YoY increase in net earnings to post LKR1,034.0 mn.

Share is attractive on 8.7XFY12E net earnings. TKYO (voting) currently trades on 14.4X forecast FY11E net profit, 8.7X projected FY12E net profit and 0.4XPBV. TKYO non-voting currently trades on 9.3X forecast FY10E net profit, 5.6X projected FY12E net profit and 0.4XPBV. 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, the fluctuating nature of the earnings exhibited in the past and lack of transparency associates a risk factor with the counter. Whilst advising caution due to the risk of fluctuating earnings exhibited, we 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.

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