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Strategy Report 2014

Sri Lanka Strategy Report - August 2014

Market Outlook 

  • Increased local interest in equities in record low interest rate environment
  • Improving macro outlook and lower interest rates in particular to translate into stronger corporate earnings from 2H2014E
  • GDP growth strengthening to ~7.5%, inflation soft at ~5% and currency stabilizing with modest ~2% depreciation vs. US$
  • The upgrade of Qatar and UAE from frontier to emerging status in June 2014 has also increased the concentration of the flow of foreign cash into fewer countries
  • Amongst frontier markets, whilst Sri Lanka rates low in scale and liquidity, it also offers relatively superior stability, governance and strong and steady growth
  • Current market valuation of 14.3X 2014E appear fair in view of ~18% YoY earnings growth and record low interest 
  • Last Updated (Tuesday, 19 August 2014 16:01)


    Ceylon Tobacco Company

    CTC – Rs.1,135.00 - 2Q2014 RESULTS SUMMARY - 06 August 2014 

    1Q2014 EPS of Rs.10.8 (+39% YoY, but -20% QoQ), broadly in line with our expectations; sharp YoY rise is off a relatively low base, supported by revenue growth, despite the 3.6% YoY drop in volumes, and a decline in other opex. CTC’s first quarter earnings are generally its lowest, partly due its relatively conservative accounting approach of allotting other opex


    2Q2014 net profit of Rs.2,511mn (-11% YoY; off a relatively high base; 2Q2013 net profit hit a record high of Rs.2,823mn), below our expectations, largely due to higher than anticipated allotment of other operating expenses coupled with greater than expected decline in sales volumes. Consequently, 1H2014 net profit +6% YoY to Rs.4,537mn


    Outlook & Valuations:


    • CTC’s net profit forecasts revised down marginally to Rs.10,293mn for 2014E (+13% YoY) and Rs.11,643mn for 2015E (+13% YoY), on account of the downward revision of sales volumes though partly compensated by the upward revision in the net revenue : gross revenue ratio
    • On 11 July 2014, Sri Lanka's Supreme Court ordered CTC to include pictorial health warnings covering ~60% of the front and back panels of the cigarette packs released to the market w.e.f 01 January 2015. Whilst the move is not expected to have a significant negative impact on volumes as ~95% of sales are by individual sticks, it will however further reduce CTC’s promotional capabilities, especially for new brands
    • Amidst CTC’s sharp share price gains (+1,476% since 01 Jan 2009), the relatively illiquid share trades at premium PERs of 20.7X 2014E and 18.3X 2015E, though partly justified for a monopolistic inelastic demand play, offering ROEs of >100% and above market average gross dividend yields of 4.8% 2014E and 5.5% at a ~100% dividend payout
    • CTC’s volumes being in long term decline, with very limited market scope for growth vs. regional tobacco plays, remains an obvious concern. Nevertheless, CTC’s monopolistic position and superior business model are expected to reward long term investors with a steady mix of earnings and dividend growth
    • Whilst near term valuations remain relatively rich, we recommend accumulation of the share on any near term price weakness, especially by long term investors seeking a fundamentally strong defensive play on the Colombo Stock Exchange (CSE), although it may not materially outperform the market in the near term, as has been the case over the past six consecutive years


    National Development Bank

    NDB – Rs.215.80 - 2Q2014 Results Summary - 5 August 2014

    National Development Bank (NDB) reported a net profit (NP) of Rs.843mn in 2Q2014 (up 6% YoY, however down 29% QoQ), broadly in line with our expectations, for our FY2014E NP forecast of Rs.3,674mn (+39% YoY). Consequently, NDB’s 1H2014 NP rose 56% YoY to Rs.2,034mn


    §  NDB’s loan book grew 6% QoQ (2014YTD up 12%) to Rs.153bn while its deposit base grew 3% QoQ (2014YTD up 8%) to Rs.139bn as at 30 June 2014

    §  Non-Interest Income (Non II) fell 5% YoY (down 24% QoQ) to Rs.1,036mn in 2Q2014 largely due to a decline in net fees and commission income (down 10% YoY to Rs.570mn in 2Q2014). Consequently Non II: Net II ratio fell to 50.9% in 2Q2014 from 73.3% in 1Q2014 and 59.3% in 2Q2013. However, NDB’s 1H2014 Non II rose 19% YoY to Rs.2,402mn due to improved cross selling business volumes and to relatively higher money market related business volumes in 1Q2014

    • In June 2014, NDB raised USD 75mn debt via a syndication facilitated by the International Finance Corporation (IFC), thereby completing a total syndication of USD 200mn sanctioned in March 2014 (at an estimated interest cost of 3.3%, the Government of Sri Lanka is expected to absorb 75% of the  associated forex hedging risk). The Bank raised USD 125mn of this syndication in March 2014. Funds raised will be infused to the SME sector of the country and other eligible sectors that contribute towards national development


    Outlook & Valuations:


    • NDB’s net profits are broadly maintained at Rs.3,674mn and Rs.4,165mn for 2014E and 2015E amid higher NIS and lower Non II forecasts for 2014E
    • NDB share has outperformed the broader ASI, appreciating 32% YoY and 13% in past three months (vs. ASI’s 11% YoY and 9% three month increase). Following the recent outperformance in the share, NDB currently trades at sector par valuations on PBV multiples of 1.3X (PER – 9.7X) 2014E and 1.2X (PER – 8.6X) for 2015E. The company is forecast to deliver an ROE of 14.2% for 2014E and 14.4% for 2015E
    • With the group expected to actively participate in near term financial sector consolidation initiatives, we expect the share to find favour amongst value oriented medium term investors
    • However, in the absence of any confirmed details of its proposed merger initiative with DFCC, we believe that much of the likely good news is priced in at current valuations and we expect the NDB share to perform in line with the broader market in the near term.

    Chevron Lubricants

    LLUB – Rs.314.00 - 2Q2014 Results Summary - 30 July 2014 

    2Q2014 EPS of Rs.5.6 (+20% YoY off a low base however down -12% QoQ), slightly below our expectations, amidst ~6% YoY decline in 1H2014 sales volumes subsequent to the 12% upward product price revision implemented w.e.f. from 27 January 2014. Gross Profit margin reached a record high of 42.7% during 2Q2014


    Outlook & Valuations:


    • LLUB’s net profit forecast revised down marginally to Rs.2,782mn for 2014E (+10% YoY) and to Rs.3,080mn for 2015E (+11% YoY), due to higher than expected volume decline
    • PE multiples of 13.5X 2014E and 12.2X 2015E, are at a discount to the market and other listed MNCs, although approaching high end of recent range. Meanwhile, ROEs remain attractive at ~56%-59%
    • LLUB is in a comfortable position to meet its remaining plant relocation capex (~Rs.0.3bn), likely resulting in a dividend payout of 95% subsequent to completion of the capex cycle (vs. 71% in 2013) resulting in gross dividend yields of 7.0% 2014E and 7.8% 2015E
    • LLUB has gained renewed interest during the past three months, rising 17% (vs. the ASI’s gain of 9% during the same period), likely on expectations of higher dividends and increased favour for dividend plays, especially in the current declining interest rate context
    • Although LLUB’s long term growth potential appears modest given increased competition and declining market share, the defensive share may be favoured by medium to longer term investors seeking exposure to a relatively liquid MNC with a strong brand equity and to an attractive dividend play
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