Carson Cumberbatch PLC (CARS.N0000) · 2016. 9. 29. · CARS’ main malt liquor (beer) producing companies, Lion Brewery (Ceylon) PLC (LION) and the recently acquired MBL, lead the

Sri Lanka | Diversified EQUITY RESEARCH

Initiation of coverage 24 April 2015

Carson Cumberbatch PLC (CARS.N0000)

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A capital market development initiative by the Colombo Stock Exchange in association with Copal Amba

A play on commodities and beverage Carson Cumberbatch PLC (CARS) is a diversified business conglomerate with operations in Sri Lanka, Indonesia and Malaysia, ranging from oil palm plantations, oils and fats, beverage to portfolio management, real estate and leisure. We expect a revenue CAGR of 13.0% during FY15E-FY17E, with the EBIT margin improving 195bps to 18.7% in FY17E. Strong volume growth supported by rising average selling prices (ASP), which are in line with excise duty increases, should drive the beverage segment to improve group revenue, while both oil palm plantations and oils and fats, driven by steady growth in volumes, should further boost the group’s top line. We expect a modest expansion in the EBIT margin owing to revenue growth and operational efficiencies in the oil palm plantations and beverage segments. Our DCF/SOTP valuation, along with our P/E-based relative valuation analysis, suggests a valuation range of LKR387-439, compared with the share price of LKR420 as of 23 April 2015.

CARS to post a 13.0% revenue CAGR over FY15E-FY17E. We expect the

beverage segment to record a 17.6% CAGR during FY15E-FY17E, driven mainly by strong volume growth as a result of rising consumerism, increased tourist arrivals, relatively inelastic demand for beer and a mix-shift towards soft liquor. Furthermore, the oil palm plantations segment should post a revenue CAGR of 12.6% during FY15E-FY17E, driven by modest volume growth on improving demand for edible and non-edible oils. We expect a stable recovery in crude palm oil (CPO) prices from 2016 owing to an uptick in demand and possible supply constraints. In addition, the oils and fats segment should achieve a revenue CAGR of 8.6% through FY15E-FY17E, driven by moderate volume growth due to potential demand for end products, as a result of rising consumerism – particularly in India and China.

EBIT margin expansion of 195bps through FY17E. We expect the oil palm

plantations segment’s EBIT margin to improve to 39.0% in FY17E owing to top-line growth and better operating cost management. The beverage segment’s EBIT margin should also improve modestly to reach 11.0% in FY17E on the back of revenue growth and improved cost efficiencies, which should offset cost increases owing to the exemption beer from the value added tax (VAT) and nation building tax (NBT). In addition, we believe the portfolio and asset management segments will maintain a conservative 92.0% EBIT margin, while we expect a 3.0% EBIT margin for the oils and fats segment in FY17E.

High debt levels may limit near-term major investment opportunities. CARS’

continuous investments in plantation developments and capacity enhancements in the oils and fats and beverage segments resulted in net debt increasing to LKR65.4bn in 3QFY15 (from LKR12.5bn in FY11) and gearing levels to 45.7% , thus capping the group’s ability to carry out any major investments. However, CARS has taken initial steps to refinance its debt in the current low-interest rate environment; we expect gearing levels to improve to 39.1% by FY17E. Furthermore, we expect fluctuating FCF to recover to positive territory starting FY16E, once the group reaches the tail end of its major capex cycle.

We establish a valuation range of LKR387-439. Our DCF/SOTP analysis implies a

valuation range of LKR387-430, considering positive and negative factors that impact our base-case assumptions, as explained on pages 18 and 19. Our P/E valuation suggests that CARS currently trades at a12-month forward P/E multiple of 14.1x – a 0.5% premium to its normalized two-year historical forward P/E average. Applying a 5% discount and a 5% premium to this normalized two-year average, we arrive at a P/E valuation range of LKR397-439.

Key statistics CSE/Bloomberg tickers

Share price (23 Apr 2015)

No. of issued shares (m)

Market cap (USDm)

Enterprise value (USDm)

Free float (%)

52-week range (H/L)

Avg. daily vol. (shares,1yr)

Avg. daily turnover (USD

‘000)

CARS.N0000/CARS

SL

LKR420

196

619

1,403

14.4%

LKR490/365

3,310

11

Source: CSE, Bloomberg Note: USD/LKR=131.2 (average for the one year ended 23 April 2015)

Share price movement

Source: CSE, Bloomberg

Share price performance

3m 6m 12m

CARS 5.1% -3.5% 8.6%

S&P SL 20 -1.3% 0.9% 19.3%

All Share Price Index -2.2% -1.0% 15.3%


Summary financials

LKRm (year end 31 March) 2014 2015E 2016E

Revenue 76,541 86,196 98,765

EBITDA 15,648 17,846 20,844

EBIT 12,800 14,962 17,524

Net profit 3,737 4,055 5,427

Recurrent EPS 19.0 20.6 27.6

ROE (%) 8.2 8.8 10.8

P/E (x) 19.2 17.7 15.2

Source: CARS , Copal Amba estimates

90%

100%

110%

120%

130%

Apr-14 Jul-14 Oct-14 Jan-15 Apr-15

CARS ASPI S&P SL 20

Carson Cumberbatch PLC

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Table of Contents

CARS to post a 13.0% revenue CAGR during FY15E-FY17E ............................................................................................ 3

Beverage segment to fuel CARS’ revenue growth ............................................................................................................................... 3 Oil palm plantations to support revenue growth at a 12.6% CAGR over FY15E-FY17E ...................................................................... 5 Oils and fats segment to support further revenue growth at a 8.6% CAGR during FY15E-FY17E ....................................................... 7 Other segments to moderately support revenue growth ....................................................................................................................... 8 Upside potential to top-line growth ..................................................................................................................................................... 10 Downside risks to revenue expectations ............................................................................................................................................ 10

EBIT margin expansion of 195bps through FY17E............................................................................................................ 11

Oil palm plantations segment’s EBIT margin to expand 194bps to 39.0% in FY17E .......................................................................... 12 The beverage segment’s EBIT margin to improve modestly by 173bps to 11.0% in FY17E .............................................................. 12 The portfolio and asset management segment to achieve EBIT margin of 92.0% in FY17E, an expansion of 38bps ........................ 13 The oils and fats segment continues to drag on profits; should return to profits in the medium to long term ...................................... 14 Downside risks to margin expansion .................................................................................................................................................. 14

Higher leverage and relatively low FCF generation on the back of recent capex could limit near-term investment opportunities ....................................................................................................................................................................... 15

We establish a valuation range of LKR387-439 for CARS’ shares.................................................................................... 18

DCF/SOTP analysis yields a valuation range of LKR387-430 per share ............................................................................................ 18 P/E analysis yields a valuation range of LKR397-439 per share ........................................................................................................ 19 Relative valuation data used as a measure of comparison ................................................................................................................ 20

Share price performance .................................................................................................................................................... 21

Earnings release focus areas ............................................................................................................................................. 22

Appendix 1: The Sri Lankan soft liquor industry ................................................................................................................ 23

Appendix 2: The global palm oil industry ........................................................................................................................... 28

Appendix 3: Company overview......................................................................................................................................... 36

Appendix 4: Key financial data ........................................................................................................................................... 41

Summary group financials (LKRm) ..................................................................................................................................................... 41 Key ratios............................................................................................................................................................................................ 42 Segmental summary ........................................................................................................................................................................... 43

Appendix 5: Diversified sector overview ............................................................................................................................ 45

Fact sheet ........................................................................................................................................................................... 48

Sri Lanka investment environment overview ...................................................................................................................................... 48


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CARS to post a 13.0% revenue CAGR during FY15E-FY17E

We expect CARS to record a 13.0% revenue CAGR over FY15E-FY17E (compared with a 7.6% CAGR over FY13-FY14), driven mainly by the beverage segment. This growth should be further supported by the oil palm plantations and oils and fats segments. The portfolio and asset management, real estate and leisure segments should also contribute positively towards this growth.

Figure 1: CARS’ revenue to grow at a 13.0% CAGR FY15E-FY17E, driven by the beverage segment

Source: CARS, Copal Amba estimates

Beverage segment to fuel CARS’ revenue growth

We expect the beverage segment to post a 17.6% CAGR over FY15E-FY17E (compared with a 19.4% CAGR over FY13-FY14), driven mainly by strong volume growth. We believe rising consumerism, increased tourist arrivals, along with the relatively inelastic nature of demand for malt liquor (beer) and the mix-shift towards soft liquor from hard liquor, should support volume growth at a 10.2% CAGR over FY15E-FY17E. We expect the recent acquisition of Millers Brewery Ltd (MBL) to further support the beverage segment’s volume growth. Further, we expect ASPs to move in line with the excise duty increases, which the company will directly pass on to the customer. However, we do not expect the company to increase ASPs for beer, in addition to the tax increase, as it had done previously. The beverage segment now accounts for 37.9% of the group’s revenue (as of 3QFY15), and we expect it to increase by 10bps to around 38.0% by FY17E.

Figure 2: Strong volume growth due to rising consumerism to mainly drive brewery revenue

Source: Department of Excise of Sri Lanka (DESL), Ceylon Beverage Holdings PLC (BREW), Copal Amba estimates

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FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E

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Oil palm plantations Oils & fats Beverage Portfolio & asset mgt. Other Revenue growth (RHS)

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Malt liquor production volume (LHS) Brewery revenue (RHS)

Beverage and oil palm segments to drive revenue growth

Beverage revenues to be driven by strong volume growth, coupled with ASP increase in-line with exercise duty increases


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We expect soft liquor volumes to be driven mainly by increasing per-capita income and disposable income, which has led to significant lifestyle changes. Urbanization also has supported this growth. This is evident in improving per-capita soft-liquor consumption, which improved from 2.64 liters in 2008 to 6.01 liters in 2013 (refer to Appendix 1, Figure 45). Increasing tourist arrivals have also contributed towards this growth, and we expect increasing tourist spending on soft liquor consumption to continue.

Malt liquor production recorded a 15.9% CAGR during 2009-2013, while hard liquor production came in at a negative 0.7% CAGR. Growth in malt liquor was driven mainly by beverages with an alcohol percentage above 5.0% (strong beer) posting a 21.4% CAGR over 2009-2013 and those with an alcohol percentage below 5.0% (mild beer) recording a negative 5.2% CAGR. We believe consumers have shifted more towards soft liquor and illicit hard liquor during this period, as a result of higher selling prices of hard liquor, with alternatives providing consumers a higher ‘kick-per-buck’.

CARS’ main malt liquor (beer) producing companies, Lion Brewery (Ceylon) PLC (LION) and the recently acquired MBL, lead the domestic beer industry, with a cumulative 86.3% market share as of 2013.

Figure 3: LION and MBL lead the domestic beer industry, with a cumulative share of 86.3% (as of 2013)

Source: DESL

Having benefited from the mix-shift towards soft liquor from hard liquor, we believe that LION and MBL will be able to capitalize on industry growth, given its marker leadership, strong brand presence and LION’s leadership in the strong beer sub-segment. LION currently holds the popular brand names ‘Lion’ and ‘Carlsberg’.

LION recently acquired MBL from Cargills (Ceylon) PLC (CARG) for a purchase consideration of LKR5.15bn. Along with the acquisition, LION acquired trademark ownership of ‘Three Coins’, ‘Sando’ and ‘Sando Power’ from CARG.

The segment holding company, Ceylon Beverage Holdings PLC (BREW), has controlling interests in four other subsidiaries involved in importing, selling and distributing alcohol. Retail Spaces (Pvt) Ltd operates eight retail outlets, while Pubs N’ Places (Pvt) Ltd operates three popular restaurant brands; ‘Machang’, ‘O!’ and ‘8.8’. Under Luxury Brands (Pvt) Ltd, the group imports ‘Diageo’ and ‘Moët Hennessy’ branded liquor. The latest addition to the beverage segment, Pearl Springs (Pvt) Ltd, was incorporated for the purpose of acquiring MBL and its trademarks.

83% 83% 84% 80% 75% 75%

2% 3% 1% 3% 9% 11%

15% 14% 15% 17% 15% 14%

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100%

2008 2009 2010 2011 2012 2013

%

Lion Brewery Millers Brewery Asia Pacific Brewery

Increasing consumerism, increasing tourist arrivals and mix-shift away from hard liquor has resulted in higher soft liquor sales volume

Market leadership and strong brand presence enable LION and MBL to capitalize on industry growth


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Oil palm plantations to support revenue growth at a 12.6% CAGR

over FY15E-FY17E

We expect the oil palm plantations segment (upstream operations) to post a revenue CAGR of 12.6% over FY15E-FY17E, driven by modest volume growth. We expect CPO volumes to come in at a 14.6% CAGR over FY15E-FY17E on improving demand for both edible and non-edible oils. Further, we expect a stable recovery in CPO prices from 2016 onwards on account of possible supply constraints due to fluctuating weather patterns and steady demand from end markets. In addition, we believe that sales of palm kernel (PK) and fresh fruit bunches (FFBs) will favorably support the segment’s revenue growth, in line with the increase in the company’s CPO production.

Figure 4: Demand for end consumer markets and supply constraints to drive modest volume growth


We expect increasing per-capita income and global population growth to drive demand for edible oils and fats, with a sharp recovery in India contributing the most to volume growth (India is the largest palm oil importer in the world). Further, strong demand for biodiesel could drive demand for non-edible oils and fats. The Malaysian government has started selling B7 palm oil biodiesel from January 2015 in East Malaysia. The Malaysian Palm Oil Board (MPOB) is currently evaluating the compatibility of B10 palm oil biodiesel, which has a palm oil content of 10%. Also, the Indonesian government plans to increase biodiesel subsidies from IDR1,500 to IDR4,000 per liter with an intension to protect the domestic biodiesel industry amid the current low crude oil prices.

We believe CARS is well positioned to meet future demand for palm oil, given the increase in its mature acreage. Over the next three years, the company expects over 15,000 hectares (Ha) of its immature acreage to mature. This could lead to increased production of FFBs and production of CPO. CARS’ oil palm plantations are relatively young (Figure 5) and have a substantial land bank available for future development compared with its regional peers (Figure 6). Currently, only 34% of its planted area is at peak (7-12 years of age) production levels, and 24% is young (4-6 years of age) and at an early stage of production but expected to reach peak production levels in the next three years.

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LKRbn '000 MT

CPO production (LHS) Oil palm plantation revenue (RHS)

Moderate volume growth to drive revenue growth, while CPO prices remain a wildcard

Demand for edible and non-edible oils and fats to drive volume growth

Improving mature acreage enables CARS to capture industry growth


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Figure 5: CARS’ oil palm plantations are relatively young compared with its regional peers

Figure 6: CARS has more land available for future development compared with its regional peers

Source: CARS, Company reports, Copal Amba estimates

Note: Data as of latest available financials.

Immature (0-3 years), Young (4-6,7 years), Peak (7,8-17 years), Old (more than 18 years).

Astra Agro Lestari Tbk PT (AALI IJ), Indofood Agri Resources Ltd (IFAR SP), First Resources Ltd (FR SP), Bumitama Agri Ltd (BAL SP), London Sumatra Indonesia Tbk PT (LSIP IJ), Eagle High Plantations Tbk PT (BWPT IJ), Kencana Agri Ltd (KAGR SP)



At peak production levels, fresh fruit production per bunch and oil extraction rate per FFB tends to increase. Therefore, we expect CARS’ FFB production yield and CPO production yield to improve, returning to FY13 levels during our forecast period, resulting in high CPO production.

Figure 7: CARS’ yields are relatively better, however, low CPO extraction rate compared with its regional peers

Figure 8: Production is relatively low compared with its regional peers


Note: Data are for full year ended 31 December 2013 except for CARS.


Note: Data are for full year ended 31 December 2013 except for CARS.

12% 24% 30%

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BAL SP BWPT IJ KAGR SP CARS

% of land bank

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Figure 9: Yields and CPO extraction rate to improve with young acreage reaching peak levels….

Figure 10: ….resulting in higher production

Source: CARS, Copal Amba estimates Source: CARS, Copal Amba estimates

We believe improving demand for edible and non-edible oils and fats will limit downside pressure on CPO prices by mid-2015, in turn helping CPO prices recover by 2016. Further, we expect supply to slow down owing to expected El Niño weather conditions, high tree stress and mature acreage in Malaysia and Indonesia. This could lead to low FFB yields and lower CPO production.

At present, CPO prices are trending down, mainly due to an oversupply of global oilseed and edible oil. However, we remain watchful over any upside to CPO prices in the short term in the face of severe flooding in Malaysia since mid-December 2014, which has resulted in lower output and lower end stocks and declining global crude oil prices, which could impact the attractiveness of CPO as biodiesel (refer to Appendix 2).

Oils and fats segment to support further revenue growth at a 8.6%

CAGR during FY15E-FY17E

We expect the oils and fats segment (downstream operations) to achieve a revenue CAGR of 8.6% through FY15E-FY17E due to moderate growth in volume. CARS entered into downstream operations in FY12 as a strategic investment. CARS’ oils and fats segment operates under the Premium group, with three subsidiaries in Malaysia and one subsidiary in India (three operating subsidiaries and one management company). It produces mainly edible oils and fats such as confectionary fats, ice cream fats, dairy fat substitutes, bakery fats and frying fats. Its product range also comprises animal feed and non-edible hard fats.

We expect oils and fats volume to post a 5.0% CAGR during FY15E-FY17E owing to a potential increase in demand for end products. We believe rising consumerism, particularly in India and China, will drive demand for chocolate and confectionary, ice cream, bakery and biscuit products. CARS exports its products to more than 50 countries, while enjoying sizable market share in Russia and CIS, the Middle East, ANZ, China and India; the company caters to world-renowned consumer brands and leading companies in those regions. In order to meet potential demand for oils and fats, CARS improved its operating capacity in its Malaysian plant in 4QFY14; as a result, the segment’s total operating capacity rose to 321,404 metric tonnes (MT), a 9.8% YoY increase.

We expect CARS’ downstream segment to benefit with higher ASPs registering a 3.3% CAGR over FY15E-FY17E. We further expect downstream operations to absorb any volatility in CPO prices. We believe downstream operations are more stable compared to upstream operations, due to the nature of demand for end-consumer products. We expect CARS’ continuous efforts to improve its product mix towards value-added products through innovations and developments to further support ASP growth.

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Improving demand and limited supply to recover CPO prices

Moderate volume growth to drive revenue growth

Rising consumerism in India and China to drive the demand for end products


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Figure 11: Oils and fats production increased over FY12-FY14…

Figure 12: …while CARS improved operating capacity in FY14 to meet increased demand

Source: CARS Source: CARS

Other segments to moderately support revenue growth

Ceylon Guardian Investment Trust PLC (GUAR), CARS’ portfolio and asset management segment, focuses on CSE-listed equity, private equity, and third-party (client) funds – including managing unit trust operations through a joint venture company. We expect revenue from this segment to grow at an 11.5% CAGR over FY15E-FY17E. However, this is largely dependent on the performance of the Sri Lankan capital market over the forecast period. Sri Lanka’s main equity index, the All Share Price Index (ASPI), improved 4.1% in FY14, with a turnover of LKR229bn, and the segment reported revenue growth of 9.3% YoY. We believe the prevailing low-interest-rate scenario is likely to attract more investors and funds to the local stock market, which, in turn, should improve the index’s performance and the segment’s fund-management activities.

Figure 13: GUAR's portfolio outperformed the ASPI Figure 14: GUAR’s revenue grew in line with fund performance

Source: Ceylon Guardian Investment Trust PLC (GUAR), Copal Amba estimates

Note: Discretionary portfolio excludes investment in Bukit Darah PLC (BUKI).

Source: GUAR, Copal Amba estimates

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Operating capacity

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Capital market performance to determine fund performance and revenue growth


9


Figure 15: GUAR's AUM stands at LKR34bn Figure 16: Real estate segment’s rentable space rose in FY14

Source: GUAR

Note: Data as of 31 December 2014

Source: CARS

We further expect the real estate segment to support the group’s top line, with a revenue CAGR of 11.5% during FY15E-FY17E on the back of improved revenue per square feet (sq ft). Currently, the entire rentable space, located in Colombo, is lent for commercial purposes. We believe this could help improve revenue per sq ft alongside rising rent in Colombo. CARS improved its total rentable space to 192,000 sq ft from 148,000 sq ft in FY14 by renovating and refurbishing a previously vacant property. We expect overall occupancy to remain over 90.0% during our explicit forecast period, given the favorable outlook for the country’s real estate sector due to ongoing infrastructure developments.

We believe CARS’ leisure segment’s revenue growth would improve notably to a 13.5% CAGR for FY15E-FY17E due to the improvement in average revenue per available room (RevPAR). The group’s leisure sector comprises Pegasus Reef Hotel (PEG) and Giritale Hotel, which are located 10km and 220km from Colombo, respectively. We further expect the segment’s overall occupancy to improve to 50-60% during our forecast period, as a result of increasing tourist arrivals and a favorable environment for the tourism industry. Tourist arrivals surpassed the 1.5m mark in 2014, with tourism industry earnings of USD2.2bn. In addition, we expect food, beverage and other (MICE: meetings, incentives, conferencing, and exhibitions) revenue to improve at a favorable pace, as PEG underwent major refurbishment and banquet-hall renovation in FY14.

Figure 17: Occupancy in the leisure segment to recover during FY15E-FY17E

Figure 18: Tourist arrivals on an uptrend

Source: CARS Source: Sri Lanka Tourism Development Authority (SLTDA), Central Bank of Sri Lanka (CBSL)

Discretionary portfolio

41%

Strategic portfolio

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Clients 11%

Unit trusts 6%

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Real estate revenue to grow with improving rent per sq ft and high occupancy

Increasing tourist arrivals to boost occupancy levels and leisure revenues


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Upside potential to top-line growth

Adverse weather conditions for oil palm plantations. An increase in the probability of an El

Niño weather pattern could hamper global palm oil production and put upward pressure on CPO prices.

Speedier implementation of palm oil biodiesel mandate in Indonesia and Malaysia. The

proper implementation of biodiesel mandates in Indonesia and Malaysia could increase demand. Commencing from January 2015, East Malaysia has implemented its B7 biodiesel mandate and is evaluating the compatibility of B10 biodiesel with a palm oil content of 10%.

Capacity enhancements. Capacity enhancements in the oils and fats and beverage

segments should allow the company to capture potential growth in demand.

Downside risks to revenue expectations

Slowdown in end markets and excess supply of palm oil. A potential slowdown in end

markets in India, China and the European Union could hamper demand, while excess production and higher closing stocks could drag down CPO prices.

Further decline in crude oil prices. Falling crude oil prices could limit the attractiveness of

using palm oil for biodiesel production.

Tax hikes. In an attempt to increase tax revenues, the GoSL regularly increases the excise

duty on alcohol consumption (often by way of an overnight gazette). With beer sales being exempt from VAT and NBT, beer manufactures can no longer claim input VAT and increase ASPs beyond excise duty increases.


11


EBIT margin expansion of 195bps through FY17E

We forecast CARS’ EBIT margin to improve to 18.7% in FY17E, a 195bps increase from FY14 levels, led by the oil palm plantations, beverage and portfolio and asset management segments. However, we are cautious on the margin outlook for the group’s oils and fats segment due to the high cost of raw materials driven by volatility in CPO prices.

Figure 19: Oil palm plantations the biggest contributor to group EBIT


CARS enjoyed relatively high EBIT margins of 30-35% until FY12, during which time it entered into downstream operations. Since then, its oils and fats segment has weighed down the group’s operating profitability to 14-16%, as a result of the oils and fats segment’s high cost of raw materials. Downstream operations is a relatively low-margin business compared with upstream operations. Currently, CARS is not enjoying the synergic benefits of having upstream and downstream operations of the palm oil value chain, as the oils and fats segment meets its palm oil requirements through external buyers (due to geographical constraints). CARS’ upstream operations are located in Indonesia and its downstream operations are in Malaysia and India. However, we expect a gradual improvement in the group’s downstream operations through FY17E and beyond, which should aid the group’s bottom line. Our discussions with management revealed that making the oils and fats segment profitable over the coming years is a main priority for CARS.

Figure 20: Profit-margin analysis for CARS


Note: We have removed all fair-value gains and losses from EBIT and included in EBT as other income (expenses).

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YoY growth LKRbn

Oil palm plantations Oils & fats Beverage Portfolio & asset mgt. Other EBIT growth (RHS)

0%

10%

20%

30%

40%

50%

60%

FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E

%

GP margin EBIT margin EBT margin Net income margin

Oil palm plantations, beverage and portfolio and asset management segments to contribute to EBIT growth

Oils and fats segment has weighed down group’s profitability


12


Oil palm plantations segment’s EBIT margin to expand 194bps to

39.0% in FY17E

We expect the oil palm plantations segment’s EBIT margin to improve 194bps to 39.0% in FY17E from its current 37.1% on top-line growth and better operating cost management.

CARS carried out stringent cost-management activities in FY14, reducing operating expenses per MT of CPO produced to USD472 in FY14 from USD515 in FY13 (as per our calculations). We expect CARS to further reduce per-MT operating expenses over the next one to three years, through cost efficiencies relating to operations and logistics resulting from the maturing of 15,000 Ha of immature plantations. We expect lower planting-related costs during this period.

Figure 21: Harvesting and upkeep accounts for 40% of costs Figure 22: EBIT margin to expand with declining operating

costs

Source: CARS, Copal Amba estimates Source: CARS, Copal Amba estimates

However, we remain cautious about any significant upside to our margin forecast due to minimum-wage laws and tax policies in the plantation industry in Indonesia and Malaysia. For example, planters in Malaysia were affected severely by the introduction of the Minimum Wages Order 2012 (a 20% increase in minimum wages to MYR800-900, or USD227-256). Malaysia meets around 80-90% of its labour requirement from Indonesia. Planters usually face higher production costs due to high foreign-worker recruitment fees, higher fuel costs and electricity and water costs. Further, planters face labour shortages, as many young and capable workers are now reluctant to work in the plantation industry due to social issues, leading to a 5-10% reduction in production per annum for planters.

The beverage segment’s EBIT margin to improve modestly by

173bps to 11.0% in FY17E

With the acquisition of MBL, we expect volume increases to improve economies of scale in the beverage segment (given its leadership position in the local beer market), thereby reducing fixed-cost utilization. However, any meaningful margin upside should be offset by the cost increase arising from the exemption of beer sales from VAT and NBT.

At present, LION has sufficient brewing capacity to meet increasing industry volumes (1.2m hectoliters per annum), while CARS has the ability to improve its capacity to 2m hectoliters per annum over next three years, given the further increase in demand.

The segment stopped importing canned beer in 3QFY14, thereby favorably impacting margins – imported canned beer was relatively expensive compared with locally produced beer and was sold at less than the import cost. The company initially imported canned beer in order to meet market requirements, as it faced capacity constraints. However, since the improvement of local production capacities in FY14, it stopped importing canned beer. As a result, the segment’s gross profit margin expanded 80bps to 23.2% in FY14.

0

5

10

15

20

FY12 FY13 FY14

LKRbn

Harvesting and upkeep Processing costs Other operating costs

30.0%

35.0%

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45.0%

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USD/MT

Average CPO price Average operating cost

EBIT margin (RHS)

EBIT margin to improve on the back of revenue growth and better cost management

Economies of scale due to rising volumes to drive EBIT growth


13


Malt liquor manufacturers enjoyed better margins historically by increasing beers prices slightly higher than the excise duty price increases. However, as per the 2015 government budget proposals, beer sales are exempt from VAT and NBT, and excise duties have been increased substantially to bridge the resulting gap in government tax revenue. As a result, companies can no longer claim input VAT, leading to a significant cost increase. As a result, management expects an annual cost increase of LKR600m (around 3% of total operating costs, as per our calculations) during our explicit forecast period.

Although we do not expect the company to enjoy the high margins it enjoyed prior to FY12, we expect margins to improve modestly to 11.0% from the current 9.3% owing to operational efficiencies.

Figure 23: EBIT margin expansion through operating efficiencies


The portfolio and asset management segment to achieve EBIT

margin of 92.0% in FY17E, an expansion of 38bps

We expect the portfolio and asset management segment to record an EBIT margin of 92.0% in FY17E on the back of improving revenue, spurred by the CSE’s performance. We maintain a conservative 92.0% margin assumption through our explicit forecast period, a slight increase from its current level. We expect administrative and other operating expenses to remain at 8.0% as a percentage of revenue through FY17E.

Figure 24: Conservative 92% EBIT margin through FY17E


0.0%

5.0%

10.0%

15.0%

0

100

200

300

400


EBIT margin LKR/Liter

Average selling price Average operating cost EBIT margin (RHS)

90.0%

92.0%

94.0%

96.0%

0.0

0.5

1.0

1.5

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2.5

FY12 FY13 FY14 FY15E FY16E FY17E

EBIT margin LKRbn

EBIT (LHS) EBIT margin (RHS)

Expansion in EBIT margins in line with revenue growth


14


The oils and fats segment continues to drag on profits; should return

to profits in the medium to long term

We expect the oils and fats segment to achieve an EBIT margin of 3.0% in FY17E, expanding 157bps from the current level on better cost-management initiatives coupled with value-adding products driven through its newly built innovation center. We believe a positive shift towards higher-priced products should enable CARS to achieve better margins in the segment.

We expect the oils and fats segment to return to profitability in 2HFY15E due to higher sales volumes on account of the peak season. The segment has incurred losses since its introduction to the group in FY12, and it first recorded a profit in FY14. However, as a result of low sales volumes, it recorded an operating loss in 1HFY15.

Currently, the Malaysia-based downstream business purchases its feedstock requirements (raw material, which accounts for 80-90% of its total operating expenses) from local suppliers and the company’s unit in India imports its feedstock requirements (rather than from CARS’ upstream business in Indonesia). This is mainly due to geographical constraints and the relatively low CPO requirement for its oils and fats business. Indonesia is in the process of investing and improving its refining capacity to meet potential global demand for oils and fats. We believe integrating upstream and downstream businesses would enable CARS to improve margins in the oils and fats segment in the long term. Therefore, we expect CARS to explore opportunities in Indonesia to set up or acquire refining capacity for oils and fats.

Downside risks to margin expansion

Increase in harvesting, upkeep and other operating costs in oil palm plantations. An

increase in operating costs could affect profitability severely amid declining CPO prices.

Increase in feedstock cost in oils and fats segment. An increase in input costs in the oils

and fats segment could impact demand and, as a result, could significantly hamper the group’s profitability.

Drop in beverage volumes. Demand for illicit hard liquor from cost-conscious consumers is

rising owing to increasing taxes and ASPs in the liquor industry.

Shift towards value added products and better cost management should bring EBIT to positive territory


15


Higher leverage and relatively low FCF generation on the

back of recent capex could limit near-term investment

opportunities

CARS’ current debt levels remain high compared with those of its regional peers (a gearing level of 45% for CARS as of FY14 compared with 27-58% for its regional peers for the same period); this coupled with its fluctuating FCF generation limits near-term investment opportunities, in our opinion. Higher-than-peer debt levels have resulted in high finance expenses and high exchange losses on loan revaluation, thus impacting the group’s bottom line (CARS’ finance expenses increased to LKR2.8bn in FY14 from LKR836m in FY08).

During FY11, CARS made a strategic decision to invest in the downstream segment of palm oil operations. As a result, in FY12, CARS acquired three operating subsidiaries of Premium Nutrients Sdn Bhd, an oils and fats manufacturing company operating in Malaysia and India. CARS used external debt sources to fund its continuous investments in the plantation sector (both upstream and downstream). In addition, capacity expansions in the beverage segment resulted in a further increase in debt levels in FY13 and FY14. During 9MFY15, the beverage segment acquired MBL for a purchase consideration of LKR5.15bn. CARS incurred a cumulative capital expenditure (capex) of LKR57.5bn over FY11-FY14 owing to continuous investments in the oil palm plantations, oils and fats and beverage segments.

Figure 25: CARS incurred cumulative capex of LKR57.5bn over FY11-FY14

Source: CARS

Accordingly, at group level, CARS’ net debt rose to LKR47.8bn in FY14 from LKR4.2bn in FY08, and by 3QFY15 increased further to LKR65.4bn. The group’s gearing stands at 45.7% in 3QFY15, compared with 23.7% in FY08.

Figure 26: CARS’ net debt levels increased more than 15x during FY08-3QFY15

0%

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30%

-5

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20

25

FY08 FY09 FY10 FY11 FY12 FY13 FY14 9MFY15

As a % of revenue LKRbn

Operating cash flow Capex Incremental debt Capex as a % of revenue (RHS)

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(80)

(60)

(40)

(20)

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FY08 FY09 FY10 FY11 FY12 FY13 FY14 3QFY15

Gearing LKRbn

Oil palm plantations Oils & fats Beverage

Portfolio & asset mgt. Investment holding Real estate

Leisure Management services Gearing (RHS)

CARS’ continuous capex in the oil palm and beverage segments resulted in higher debt levels


16



Note: Positive values indicate net cash positions and negative values indicate net debt positions of each segment. 3QFY15 net debt is apportioned as per FY14 numbers.

Figure 27: Regional palm oil producers’ gearing ranges from 27% to 58%

Source: Bloomberg


CARS’ external borrowings are exposed to foreign-exchange fluctuations, as 78.5% of its borrowings as of FY14 are denominated in foreign currencies. CARS incurred LKR2.9bn of exchange losses on the revaluation of foreign-currency loans (translating foreign-currency loans to the reporting currency, which is LKR) in FY14, thereby eroding the oil palm plantations segment’s profits. However, these foreign-currency loans are mainly obtained for CARS’ foreign operations (oil palm plantations and oils and fats segments) where earnings are generated in the same currency, which should provide a natural hedge. Around 40.0% of the group’s borrowings (primarily used to finance day-to-day operations on a revolving basis) are maturing within one year.

CARS’ net finance cost also increased during this period, as a result of high net debt. The group’s net finance cost was LKR2.1bn in FY14 versus LKR803m in FY08. The continuous rise of finance expenses has impacted the group’s profitability over the past few years.

Figure 28: 79% of loans denominated in foreign currencies Figure 29: 40% of debt maturing in one year


0%

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30%

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(200)

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BW

PT

IJ

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L S

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Gearing USDm

Net debt (LHS) Gearing (RHS)

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USD IDR MYR LKR

LKRbn

0

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Less than 1year

1-2 years 2-3 years 3-4 years 4-5 years

LKRbn

Increased debt levels has impacted the group’s profitability


17


However, CARS has taken steps to refinance its debt in the prevailing low-interest-rate environment. In 3QFY15, LION, CARS’ brewing arm, raised LKR2bn at a 7.85% rate through listed unsecured redeemable debentures, with an intention to refinance short-term borrowings (obtained previously for capacity enhancements). LION raised LKR3bn in FY13 for the capacity enhancement programme at a higher average interest rate of 11.84%. We believe the repricing of debt will help CARS to reduce its finance expenses and thereby improve its bottom line.

As a result, we expect this situation to improve over the next two-three years given CARS’ intention to restructure its debt and refinance this with relatively less-expensive loans, thus reducing its gearing levels to 39.1% by FY17E and positively impacting its bottom line.

Figure 30: Decreasing finance expenses along with declining debt over next three years


Additionally, CARS’ free-cash-flow generation has also been volatile, ranging from negative LKR1.8bn to positive LKR3.0bn during FY08-FY14, except in FY13. In FY13, the group recorded a negative LKR13.5bn FCF as a result of low operating profit and high investment in capex. With much of the capex cycle complete, we expect the three major segments to incur relatively lower capex, which should support FCF to recover back to positive territory during our explicit forecast period.

Figure 31: FCF to recover to positive territory during FY15E-FY17E


(3.5)

(3.0)

(2.5)

(2.0)

(1.5)

(1.0)

(0.5)

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LKRbn

Interest income Interest expense

(15)

(10)

(5)

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5


LKRbn

Free cash flow

Debt refinancing to limit high finance expenses and improve profitability

FCF to recover over the forecast period on the back of low capex and better operating profits


18


We establish a valuation range of LKR387-439 for CARS’

shares

We establish a 12-month valuation range of LKR387-439 per share, based on our current earnings outlook for CARS shares, compared with the current share price of LKR420 as of 23 April 2015. We arrive at our valuation range by applying scenario analysis to a DCF/SOTP valuation, and using a P/E-based relative valuation approach. For comparison, we also assess CARS’ valuation levels relative to a group of peers.

Figure 32: Valuation range analysis provides a range of LKR387-439 per share (current share price: LKR420)

Source: CARS, Bloomberg, Copal Amba estimates

DCF/SOTP analysis yields a valuation range of LKR387-430 per share

In valuing CARS shares, we applied a combined DCF/SOTP approach. Key elements of this approach include the following:

We have valued the oil palm plantations, oils and fats, beverage, leisure and management services segments using a standard DCF approach, applying a risk-free rate of 8.0% and a market risk premium of 6.0%. CARS’ current capital structure is 45% debt and 55% equity. We have assumed a 45/55 target capital structure, along with a terminal growth rate of 3.0%, and a 28% corporate tax rate. We have estimated FCF figures throughout the explicit and fade periods. Our terminal value for FY24E is calculated by applying the terminal growth rate to unleveraged FCF as of FY24E. Finally, we arrived at our segment equity value by discounting the unleveraged FCF values over the explicit and fade periods at the segmental WACC.

We have valued the investment holding and portfolio and asset management segments based on current market value.

We have valued the real state segment using the fair value of investment property as of 31 December 2014.

Based on the above assumptions, our bull-case scenario considers CARS’ intrinsic value without a holding company discount.

Further, we arrive at our bear-case equity valuation after assigning a 10% holding company discount. We have assigned the holding company discount in order to account for CARS’ investments in the oils and fats segment. We believe any potential loss arising from the segment could reduce the company’s valuation.

365

397

387

490

439

430

420

300 400 500

52-week range

P/E analysis

DCF-SOTP

Our base-case assumptions for the beverage segment include a risk-free rate of 8.0% and a market risk premium of 6.0%


19


Figure 33: DCF/SOTP assumptions schedule

Segment Equity value (LKRm) LKR per share

Oil palm plantations 117,022 595.87

Oils & fats 3,981 20.27

Beverage 38,264 194.84

Investment holding and portfolio & asset management 24,792 126.24

Real estate 2,112 10.75

Leisure 2,519 12.83

Management services 148 0.76

Total enterprise value 188,838 961.56

Less: Net debt / Add: Net cash (65,436) (333.20)

Less: Minority interest (39,049) (198.84)

Add: Investment in associates 16 0.08

Equity value of CARS (bull case) 84,370 429.61

Equity value of CARS post 10% holding company discount (bear case) 75,933 386.65

Source: Copal Amba estimates

P/E analysis yields a valuation range of LKR397-439 per share

CARS’ 12-month forward P/E has ranged from 10.0x to 27.0x since April 2010. The share’s normalized two-year average historical forward P/E multiple stands at 14.0x. The stock currently trades at a 12-month forward multiple of 14.1x (based on our forecasts) – a 0.5% premium to its normalized two-year historical average.

Figure 34: CARS has traded at a P/E of between 10.0x and 27.0x over the past five years

Source: CARS, Bloomberg

In determining a P/E valuation range, we apply two scenarios:

Optimistic scenario: Under this scenario, we assumed a better-than-expected recovery in CPO prices, an improvement in beverage volumes and higher margins in the oils and fats segment. Accordingly, we have applied a 5% premium to the normalized two-year historical P/E average and arrived at a forward multiple of 14.7x. Applied to our 12-month forward EPS estimate of LKR29.87, this leads to a share price of LKR439 per share.

Pessimistic scenario: Here, we assume a 5% discount to the normalized two-year historical average, implying that CARS will trade at a forward multiple of 13.3x. This is driven mainly by a lower-than-expected recovery in CPO price, less demand for biodiesel, less volume growth in beverages, higher excise duty increases and continuing losses in the oils and fats segment. Applying this multiple to our 12-month forward EPS estimate, we arrive at a fair value of LKR397 per share.

0

200

400

600

800

Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15

LKR

10.0x 14.3x 18.5x 22.8x 27.0x MPS

Scenario analysis driven by CPO prices, beverage volumes and the profitability of the oils and fats segment


20


Relative valuation data used as a measure of comparison

Selecting an adequate peer group for a conglomerate is challenging, as no potential peer has an identical slate of business segments. Since oil palm operations account for over 63% of CARS’ operations (based on revenue in FY14), we have selected other domestic conglomerates and regional oil palm operators (mainly Indonesian) to provide some measure of comparison with other local and regional players.

Figure 35: CARS’ P/E relative to regional peers

Company name P/E EPS CAGR FCF yield

FY13 FY14 FY15E FY16E FY15E-FY17E FY13 FY14

Carson Cumberbatch PLC 18.8x 19.2x 17.7x 15.2x 20.2% -15.6% -0.6%

Local peers

Bukit Darah PLC 17.0x 18.7x 15.2x na nm -11.1% 6.0%

Sunshine Holdings PLC 5.8x 6.4x 11.4x 9.9x nm 14.0% 12.1%

Distilleries Company of Sri Lanka PLC 9.7x 10.0x 10.7x 9.7x nm 4.9% 0.0%

Regional peers

Astra Agro Lestari Tbk PT 21.9x 15.3x 13.2x 11.8x 1.9% 0.6% -1.7%

Indofood Agri Resources Ltd 23.3x 12.7x 10.9x 8.7x 6.3% -0.5% 6.4%

First Resources Ltd 11.2x 12.9x 10.8x 9.2x 14.6% 0.7% 0.8%

Bumitama Agri Ltd 18.6x 15.0x 12.0x 9.9x nm 1.4% 6.1%

London Sumatra Indonesia Tbk PT 17.1x 14.1x 10.1x 9.0x 8.3% 1.2% 4.3%

Eagle High Plantations Tbk PT 30.0x 15.0x 7.0x 5.4x nm -16.9% -21.6%

Kencana Agri Ltd na 24.0x 9.4x 7.1x 86.6% 2.7% -8.3%

Mean 17.2x 14.4x 11.1x 9.0x 23.6% -0.3% 0.4%

Median 17.1x 14.5x 10.8x 9.2x 8.3% 1.0% 2.5%

High 30.0x 24.0x 15.2x 11.8x 86.6% 14.0% 12.1%

Low 5.8x 6.4x 7.0x 5.4x 1.9% -16.9% -21.6%

Source: CARS , Bloomberg, Copal Amba estimates


21


Share price performance

CARS shares closed at LKR420 on 23 April 2015, LKR33 higher than 12 months earlier, an increase of 8.6%, compared to a 19.3% increase in the S&P SL 20 and a 15.3% increase in the All Share Price Index (ASPI).

Figure 36: CARS has underperformed the market over the past 12 months


As shown in Figure 37, CARS has underperformed the CSE’s two main indices over the past three years.

Figure 37: CARS vs. key indices

3m 6m 1 year 2 years 3 years

CARS 5.1% -3.5% 8.6% -5.6% -9.4%

S&P SL 20 -1.3% 0.9% 19.3% 20.4% 31.1%

ASPI -2.2% -1.0% 15.3% 20.9% 30.4%


60%

80%

100%

120%

140%

Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15

CARS ASPI S&P SL 20


22


Earnings release focus areas

Here is a checklist of items that investors should track in the next – and subsequent – quarterly earnings release. We will closely track CARS’ performance across these key areas, and will revise our forecasts and update our valuation range in future earnings update notes.

1. Have there been any changes to supply and demand factors for palm oil?

2. Have there been any changes to CPO prices?

3. Have there been any revisions to the excise duty? Has LION and MBL been able to pass these on to consumers through higher ASPs?

4. Has the Department of Excise published the latest volume data?

5. How has the industry consumption mix-shift changed towards soft liquor?

6. Have there been any new retail brewery operators (distributors) that have entered the market?

7. Has the group carried out any major capital investments?

8. Has there been any change to the group’s capital structure?

9. Has the government issued guidelines on the implementation of the “Super Gain Tax”?


23


Appendix 1: The Sri Lankan soft liquor industry

The country’s domestic soft liquor market mainly consists of malt liquor, commonly known as beer. Beer is an alcoholic beverage made from malted cereal grains, such as barley and wheat, through a brewing process. Beer is also flavored with hops to add bitterness, while certain herbs, fruits and caramels are used to add a variety of sweetened flavors.

Figure 38: Snapshot of the domestic soft liquor market

Soft liquor Growth drivers Key players

Malt liquor (beer) with alcohol % above 5%

High demand: Growth underpinned by shift to high-alcohol soft liquor from hard liquor due to increasing tax hikes

Lion Brewery, Asia Pacific Brewery

Malt liquor (beer) with alcohol % below 5%

Moderate demand: We believe the spillover effect from the shift in volumes to soft liquor benefits this category of producers as well

Lion Brewery, Millers Brewery

Source: Copal Amba

The domestic soft liquor market can be broken up based on its key product types, malt liquor with an alcohol percentage above 5.0% (strong beer) and malt liquor with an alcohol percentage below 5.0% (mild beer), as shown in Figure 39. Strong beer accounted for approximately 89% (up from 71% in 2008) of the country’s soft liquor market. In 2013, the total volume of malt liquor produced amounted to approximately 120m liters. Production of malt liquor grew at a 15.9% CAGR during 2009-2013, while production of hard liquor recorded a negative CAGR of 0.7% during the same period.

Figure 39: Strong beer continues to dominate the soft liquor market

Source: DESL

The domestic malt liquor market comprises three main players. LION is the market leader in both sub-segments, and is the overall market leader in the domestic soft liquor market, with a market share of approximately 75.1% as of 2013.

29% 23% 21% 16% 13% 11%

71% 77% 79%

84% 87% 89%

0

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40

60

80

100

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2008 2009 2010 2011 2012 2013

Volume (m liters)

Mild beer Strong beer


24


As of 2013, soft liquor dominated the domestic alcohol industry, with a 54% market share, while hard liquor has gradually lost its share to 46% (from around 62% in 2008) (Figure 42). We believe the recent trend toward soft liquor is owing to rising consumerism, increasing tourist arrivals and the mix-shift towards soft liquor from hard liquor due to the increasing prices of hard liquor as a result of excise tax increases.

Figure 42: Soft liquor continues gain share in the local liquor consumption market

Source: DESL

Government influence on the domestic alcohol industry

The main impact that the government has on the industry is by way of excise duty policies, with taxes being payable every 15 days on production volumes. The domestic alcohol industry has always been a major tax revenue source for the GoSL – generating LKR66.0bn in revenue in 2013. Tax revenue from liquor accounted for roughly 9% of total tax revenue earned on production and expenditure in 2013 – 7% from hard liquor and 2% from malt liquor.

38% 37% 41% 43% 53% 54%

62% 63% 59% 57% 47% 46%

0%

20%

40%

60%

80%

100%

2008 2009 2010 2011 2012 2013

%

Soft liqour Hard liqour

Figure 40: LION led the strong beer sub-segment in 2013…. Figure 41: ….as well as the mild beer sub-segment

Source: DESL Source: DESL

Lion Brewery

73%

Asia Pacific Brewery

15%

Millers Brewery

12%

Lion Brewery

89%

Millers Brewery

8%

Asia Pacific Brewery

3%


25


Figure 43: Tax revenue from liquor increased to 9% of taxes earned on production and expenditure in 2013

Source: CBSL, DESL, Copal Amba estimates

We note that one impact of the tax increases in recent times has been the gradual mix-shift to soft liquor (such as beer), with malt liquor making up 54% of total consumption in 2013 (surpassing the 50% mark in 2012 after several years, when compared to the recent past) as reflected in Figure 42. Furthermore, according to industry experts, these constant upward tax revisions have also led to increased consumption of illicit (moonshine) and illegal (imitations produced by licensed manufacturers or those liters produced not declared for tax purposes) hard liquor products among consumers, who are looking for greater value for money, measured by the ‘kick-per-buck’. In addition, illicit and illegal brewers make up approximately 50% of the domestic alcohol industry in Sri Lanka, with around 200,000 illicit brew retailers, compared to approximately 3,300 licensed liquor stores, based on statistics from the Institute of Policy Studies of Sri Lanka.

Since these illicit players remain untaxed and unregulated, illicit alcoholic products are significantly less expensive (roughly 30-40% lower, according to industry experts), which makes them a suitable substitute to the price-sensitive consumer, despite the inferior quality and poor hygiene standards.

On 10 October 2014, taxes on mild beer and strong beer were raised by LKR10 and LKR15, respectively. Beer manufacturers were able to pass the cost increase to end consumers through price increases. Along with the 2015 budget proposal, the GoSL decided to exempt the sale of beer from the VAT and NBT. To recover the resulting loss in government revenue, on 25 October 2014, the GoSL increased taxes on mild beer and strong beer for the second time in the month by LKR30 and LKR40, respectively. As a result, the beer industry can no longer claim the VAT, resulting in a notable cost increase for the players.

Figure 44: Excise duty on malt liquor continued to increase

Source: Ministry of Finance and Planning

6.0% 5.9% 6.2%

8.4% 8.9% 9.2%

0%

2%

4%

6%

8%

10%

0

20,000

40,000

60,000

80,000

2008 2009 2010 2011 2012 2013

% LKRm

Taxes on malt liqour Taxes on hard liqour Taxes on liquor as a % of taxes on production and expenditure (RHS)

0

50

100

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25-O

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6-O

ct-

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31-J

ul-13

10-O

ct-

14

25-O

ct-

14

LKR/Liter

Mild beer Strong beer


26


Industry demand drivers for the soft liquor market

The fundamental growth drivers for the overall local soft liquor market in Sri Lanka continue to remain healthy, in our view. As shown below, soft liquor consumption trends in Sri Lanka have seen a steady increase since 2010, with an 18.2% CAGR during 2009-2013. We believe the favorable impact through rising consumerism, increasing tourist arrivals and the mix-shift towards soft liquor from hard liquor due to the increasing prices of hard liquor as a result of excise tax increases to be the main drivers.

Figure 45: Total consumption of soft liquor continues to grow with increasing income levels

Source: DESL

We believe this demand would be driven by rising consumerism in Sri Lanka spurred by a growing middle class with increasing per capita income, allowing for greater disposable income levels. Sri Lanka’s GDP per capita stood at USD3,280 in 2013, with the GoSL anticipating this to reach USD4,677 by 2016E at a 12.6% CAGR. As shown in Figure 46, the ‘dependence’ on alcoholic beverages has made demand for liquor increase along with per capita income growth. Therefore, we believe the industry will benefit from stable volumes, despite increasing selling prices.

The product’s inelastic nature of demand means that volumes should continue their upward trajectories, despite price increases (primarily due to higher excise duties) each year. For example, 2012-2014 saw excise duty revisions (upwards) on five occasions; this was in addition to the two increases during 2011. However, based on data provided by the Department of Excise of Sri Lanka (DESL) and our calculations, we estimate 2013 per capita beer consumption to have grown to 6.01 liters versus 2.57 liters in 2009, at a 17.8% CAGR, clearly indicating the price inelasticity of alcohol.

Figure 46: Per capita beer consumption improved with increased per capita income

Source: CBSL, DESL, Copal Amba estimates

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In addition, we expect increasing tourist arrivals into Sri Lanka to also drive demand growth. Tourism is a burgeoning industry in Sri Lanka, and it has taken off post war (since May 2009). Tourist arrivals grew 27.8% per annum from 2009 to reach 1.53m in 2014. The GoSL expects tourist arrivals to increase to 2.5m by 2016E and 4.5m by 2020E, and we believe this would contribute to growth in soft liquor consumption (see Figure 47).

Figure 47: Rising tourist arrivals should increase the demand potential for beer

Source: SLTDA, DESL

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28


Appendix 2: The global palm oil industry

Overview

Palm oil is widely used as an edible oil around the world. It is also utilized in an extensive range of non-edible products. CPO is derived from the reddish pulp, known as the mesocarp, of the fruit of oil palm trees, while palm kernel oil (PKO) is derived from the seed inside the palm fruit.

Oil palm trees grow in tropical environments, mostly 10 degrees within the equator. Typically, lands are developed for cultivation within 1.5-2 years, which could vary depending on the nature of the terrain and environmental and social constraints. The development cost is usually capitalized as part of biological assets. In general, an oil palm tree has an economic lifetime of 20-25 years, and the first 2-3 years are considered as immature. Oil palm trees produce 8-12 average FFBs annually, each containing 1,500-2,000 fruits weighing 20-30kg. The weight of a FFB increases as the oil palm tree reaches its maturity, resulting in high amounts of oil extraction. CPO and PK are extracted from FFBs through a mechanical process in mills located inside plantations. A processing mill commonly handles 2-10 MT of FFBs per hour, depending on its production scale. PKO is extracted in separate kernel-crushing plants, where some are integrated with CPO processing mills.

A FFB usually extracts 20-25% of CPO depending on the quality of fresh fruits, number of loose fruits (contains only 40-48% of oil), delivery time to the mill from the after harvesting, quality of the processing machines, and the harvesting time. The extraction rate of PK from FFBs usually comes to about 4-6%. Palm oil is considered as the highest-yielding crop among vegetable oil crops, with a yield of 3.5-5 MT CPO per Ha – thus has the ability to meet increasing demand in the absence of adequate land for cultivation. However, higher yields are hardly achieved due to climatic conditions, where oil palm trees could suffer heavily from water-related stress, thus producing a low number of FFBs. Furthermore, management of costly inputs such as labour, fertilizer, pesticides and harvesting machinery could weaken the yield. The highest cost involved in the CPO production is harvesting and plantation maintenance costs (around 40% of the total operating costs), whereas processing/milling cost comes to about 5-6% of total operating costs.

Production has grown more than 4x during the past two decades

Indonesia is the world’s largest palm oil producer in the world, with a 50.9% market share, followed by Malaysia with 34.4% and Nigeria with 1.7% as of 2013.

Over the past two decades, palm oil production has grown significantly and is now the largest globally produced edible oil. From 1991 to 2013, the global production of palm oil grew from 11.9m MT to 55.8m MT, which is equivalent to an average annual growth rate of 7.1%.

Figure 48: World production of palm oil over 1991-2013

Source: Food and Agriculture Organisation of the United Nations (FAO)

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29


Currently, it is the most globally traded vegetable oil and is used as an input for a wide range of industries ranging from cosmetics to pharmaceuticals. Within the food industry, it caters to many segments in the value chain such as bakery, chocolates and confectionary. It is also considered to be the most productive crop in comparison to other oil seeds as it yields 6.3x (as of 2013) more than its closest competitor soybean (Figures 49 and 50). It is also characterized as having relatively low production costs as it uses less inputs and relatively less land. However, the production process is comparatively more labour intensive.

Figure 49: Palm fruit yield vs. others Figure 50: Palm oil yield vs. others

Source: FAO Source: FAO, Copal Amba estimates

Much of the palm oil production growth has come from Indonesia and Malaysia, with these two countries accounting for 90.0% of total exports in palm oil in 2013. Malaysia was at the forefront of the development of the palm oil industry with Indonesia following. They should continue to be the main producers, but we can expect production growth in Malaysia to stagnate in the future owing to limited land availability (Figure 51). As a result, many investors are now looking at West Africa to secure land.

Figure 51: Regional exports of palm oil during 1990-2014E

Source: United States Department of Agriculture (USDA)

While the boom in the palm oil industry has created widespread economic benefits for the countries involved, it has been widely criticized for the environmental impact. The effect of large-scale deforestation, which palm oil production is associated with, has resulted in increased greenhouse gas emissions and biodiversity losses, making palm oil among the products with the highest ecological damage. Therefore, much emphasis is currently given to sustainable palm oil production and increasingly, firms in the industry are expected to gain certification to uphold these initiatives (such as the Roundtable on Sustainable Palm Oil – RSPO, established in 2004 to develop best practices in the industry).

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30


Key drivers of demand for palm oil

Strong global demand for palm oil is expected to continue in the near to medium term, a view underpinned by (1) a rebound in economic growth from the largest import markets and reduced inventory stocks, (2) uptake from the biodiesel industry and (3) reduced support for the soybean sector and increased demand for genetically modified (GM) free and trans-fat free food. There has been a steady increase in the global palm oil per capita consumption level, increasing at an average growth rate of 5.5% per annum over the past decade. Currently, it stands at around 8.4kg and is expected to rise further in the years to come.

Figure 52: Global per capita consumption of palm oil

Source: USDA, United Nations Population Fund (UNFPA), Copal Amba estimates

The largest import markets for palm oil are India and China (Figure 53). As such, upbeat economic growth in these developing nations should be supportive of robust demand for palm oil. Furthermore, low domestic inventory stocks in China and India will result in re-stocking activities in the short run, which should further boost demand (Figure 54).

Figure 53: Palm oil imports by region (as of 2013) Figure 54: End stocks for palm oil

Source: USDA Source: USDA

In addition, much of the palm oil boom has been directed to the biodiesel surge that began in the West. Increasingly, other countries that are large producers of vegetable oils have joined in this biodiesel take off in an effort to cut gasoil imports and save on foreign exchange. This can have a significant impact on demand for palm oil in Malaysia and Indonesia, which are the largest exporters of palm oil, take policy moves to implement stronger biodiesel mandates. According to the Organisation for Economic Co-operation and Development (OECD)-FAO agricultural outlook 2014-2023, demand for biodiesel will continue to increase steadily, growing at an average rate of 4.4% per annum during 2014E-2023E.

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3%

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The introduction of the ambitious biodiesel mandate in Indonesia, which came into effect in August 2013, was aimed at boosting the country’s domestic demand for palm oil. The government has issued a directive that 10% of biodiesel must be blended into gasoil for the transportation sector, while power plants would be asked to use 20%. Meanwhile, Malaysia, the largest palm oil producer after Indonesia, which implemented a biodiesel mandate at the end of 2013, has set higher biodiesel blending rates nationwide beginning from July 2014.

Figure 55: Biodiesel production, growth and outlook

Source: OECD-FAO Agricultural Outlook 2014-2023

Given that biodiesel is a substitute for crude oil, a spike/decline in crude oil prices should have a notable impact on demand for biodiesel and hence palm oil.

Figure 56: Prices of crude oil vs. global biodiesel production

Source: OECD-FAO Agricultural Outlook 2014-2023, World Bank Global Economic Monitor Commodities (WBGEM)

In the past, palm oil was a major competitor for soybean oil, with the two directly competing for market share based on prices. However, over the past decade, there has been a greater shift toward palm oil, which is now dominating the markets (Figure 57). Industry experts believe one possible driver for this is reduced support given from both developed and developing nations for GM-free food. Initially, this resulted in a shift from GM soybean sources to GM-free soybean sources. However, the increasing adoption of GM soybeans lowered the availability of GM-free soybeans. Increasingly, this resulted in a shift toward palm oil as it was also a much cheaper alternative than soybean oil (Figure 58). Over the years, while both their prices have increased, palm oil has been trading at a much larger discount in recent years, which has also been a factor for increased global demand.

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32


Figure 57: Palm oil imports vs. other vegetable oil imports Figure 58: Palm oil traded at a larger discount to soybean oil

Source: USDA Source: WBGEM

Slower production growth with uncertain supply responses

Growth in production of palm oil is expected to slow down driven by 1) adverse weather conditions such as the expectation of a potential El Niño; 2) tree stress (tree stress is mostly caused by low moisture leading to higher proportion of flowers becoming non-fruit producing male flowers and fewer flowers and ineffective pollination resulting in small FFBs, which could carry on for few production cycles) following higher crop performance during the previous years, which tends to even out the yield as most palm trees are reaching peak production cycles; and 3) mature hectarage in Malaysia and slowdown in growth of mature hectarage in Indonesia.

There is also an increasing risk of land restrictions and environmental restraints, which constrain production growth. In Indonesia, as of October 2013, a foreign company is only allowed to own a maximum of 100,000 Ha of land for new oil palm plantations. As the palm oil industry is highly labour intensive, it is crucial to attract and retain skilled labour. However, it’s been noted to be quite challenging to attract locals for this work, as there is an increasing shift in employment from plantations to manufacturing in both Malaysia and Indonesia. These labour shortages add pressure on wages and hence the cost of production.

CPO prices dropped during 2014

At present, CPO prices are experiencing a downward trend due mainly to an oversupply of global oilseed and edible oil output. The leading producers in the world, Indonesia and Malaysia, increased their plantation acreage aggressively during early 2014, increasing palm oil production. Higher commodity prices witnessed during 2013, which made oil palm plantations highly profitable, have encouraged producers to increase the planting land areas. This price decline in global vegetable oils was further supported by the estimated improvement in soybean supply owing to favorable weather conditions in the US. Furthermore, forecasts made during early 2014 for an El Niño weather pattern, which could affect supply, was reduced. In addition, demand from China weakened owing to tighter credit conditions faced by importers, and demand from India weakened following higher import tariffs on palm oil. This was clearly evident in increased inventory levels and reduced exports in Indonesia and Malaysia. In addition, slow progress in adopting biodiesel mandates in Indonesia and Malaysia and lower crude oil prices caused demand for CPO to reduce.

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Figure 59: CPO prices dropped during 2014 Figure 60: Exports declined while stocks built up in Malaysia

Source: WBGEM Source: Malaysian Palm Oil Board (MPOB)

Higher-than-expected global palm oil production witnessed until November 2014 resulted in higher palm oil inventory, which could possibly lead to a drop in prices in the short-term. Furthermore, demand could have a negative impact from its main markets in the northern hemisphere due to the winter season, where usage of tropical oils declines in low temperatures. To encourage global palm oil demand and prices, the Indonesian and Malaysian governments imposed zero export tariffs on palm oil exports during September-October 2014 and expect to maintain these until the first quarter of 2015.

During December 2014, India raised import duties on crude edible oils and refined edible oils by 5% to 7.5% and 15%, respectively, as a government initiative to protect local planters against increasing imports from Indonesia and Malaysia. This could negatively affect the price competitiveness of imported edible oils against locally produced edible oils. Currently, 60-70% of India’s vegetable oil requirement is met through palm oil imports from Indonesia and Malaysia. India is the largest vegetable oil importer and its annual edible oil demand accounts for 18-19m MT (around 11% of global vegetable oil consumption). This may have weakened demand from India and thus suggesting a negative for palm oil price outlook.

However, we believe this has been partly offset by weakened supplies in Malaysia owing to floods. Malaysia experienced the worst flooding in 30 years in the country’s east coast (states which accounted for 29.3% of 2013’s CPO output and 13.5% of 2013’s oil palm planted area) since mid-December 2014, affecting around 184,000 Ha (3.5% of total oil palm planted area in Malaysia) of its oil palm cultivating areas. CPO production dropped 15.0% MoM to 1.16m MT during January 2015, resulting in lower inventory levels of 1.77m MT. The Malaysian government expects inventory levels to drop further due to the implementation of its biodiesel mandate (blending 7% of palm biodiesel with 93% of petroleum diesel) from January 2015 onwards. However, the impact of this move on CPO prices now remains uncertain due to prevailing lower crude oil prices. With the sharp fall in crude oil prices, CPO prices are now trading at a significant premium, thus making it uneconomical for producers to convert CPO into biodiesel. However, the current premium is relatively low compared to the historical premium.

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Figure 61: CPO prices are now trading at a significant premium; relatively low to the historical premium

Source: WBGEM

Note: CPO price conversion to USD/bbl from USD/MT is 1 MT = 7.87 bbl according to US Energy Information Administration.

We expect CPO prices to remain at current low levels in the near term due mainly to supply constraints. There will be limited availability for palm oil exports due to slow production growth stemming from limited palm oil production in Malaysia as result of recent floods and overall limited production due to increased probability of El Niño weather patterns. However, we expect the positives to outweigh the current negatives from 2016 onwards and create an upward pressure on CPO prices. We believe rising domestic consumption in both Malaysia and Indonesia, due to the biodiesel mandate, and rising consumerism in India and China, along with improving per capita income would drive demand for CPO in the mid to long term.

Global vegetable oils and fats industry

Oils and fats are derived from processed vegetable oils. Oils and fats are used in both edible and non-edible forms globally, where palm oil accounts for approximately 30-35% of world consumption of major oils and fats. CPO is widely used in the food industry as cooking oils, confectionary fats, ice cream fats, dairy fat substitutes, frying fats, shortenings and as substitutes for animal fat. Also PKO is used in different forms of animal feed. Furthermore, palm oil is used in manufacturing soap, detergent, greases, lubricants, candles, bactericides, cosmetics, pharmaceuticals, water-treatment products and in the biofuel industry.

Palm oil’s unique properties of high resistance to oxidation and long shelf life make it more suitable for use in tropical environments.

According to the OECD-FAO Agricultural Outlook 2014-2023, the global consumption of major oils and fats grew significantly over the past two decades, at a 5.5% CAGR during 1995-2004 and 4.0% during 2010-2014. We believe the average annual increase of 5.5 MT per annum during 1995-2007 is due mainly to growth in the food industry. The higher growth of 6.0 MT per annum during 2008-2014 is mainly attributable to increasing demand for oils and fats from the biofuels industry. As per the United States Department of Agriculture (USDA), of this growth in the world consumption of major oils and fats, CPO and PKO increased its share from 26.7% in 1994 to 39.3% in 2014.

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Figure 62: Global consumption of vegetable oil grew nearly 4x over the past two decades

Source: OECD-FAO Agricultural Outlook 2014-2023, USDA

Per capita consumption of vegetable oils and fats improved to 23.8kg in 2014 from 10.4kg in 1994, while per capita consumption of CPO and PKO improved to 9.3kg in 2014 from 2.8kg in 1994, gradually improving its share in the end-consumers market. Per capita consumption of vegetable oils and fats in high-income-earning countries, such as the US and some countries in Europe, is generally higher than the low-income-earning countries, such as India and China. In 2014, the per capita consumption of vegetable oils and fats in the US, European Union, China, and India amounted to 45kg, 42kg, 24kg and 15kg, respectively. At higher income levels, elasticity of demand tends to be low and at lower income levels elasticity tends to be high. Therefore, we expect higher increases in consumption to be seen in low-income-earning countries, supported by increasing per capita income and population growth. Moreover, growth in consumption in developed countries would be relatively low. We believe that palm oil is well positioned in these emerging markets to capitalize on this growth, and palm oil has been strong in these developing countries over the years.

Figure 63: Per capita vegetable oil consumption

Source: OECD-FAO Agricultural Outlook 2014-2023, Copal Amba estimates

In general, consumption in each country tends towards locally produced oils and fats. Palm oil and coconut oil based products are mostly used in tropical countries, while in North America, Europe and Russia, soybean oil-based products are used. Currently, around 70.0% of CPO and 24.0% of PKO produced globally is used for food production and the remainder is used for industrial non-food applications and as feed waste.

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36


Appendix 3: Company overview

Carson Cumberbatch PLC (CARS) is the seventh-largest company listed on the CSE by market cap – which stood at LKR83bn as of 23 April 2015. It was listed on the CSE in1967.

The company was originally incorporated as Carson and Company in Sri Lanka in 1913, with operations concentrated on rubber plantation. In 1947, it merged operations with Cumberbatch and Company, resulting in Carson Cumberbatch PLC. Subsequently, CARS shifted its main operations to oil palm cultivation in Malaysia from rubber plantation as a strategic move, following which the company diversified into the hotels, real estate and investment sectors, thus leading to the diversified conglomerate it is today. The group has a geographical presence in Sri Lanka, Malaysia, Indonesia, Singapore and India via 50 subsidiaries (of which, 12 are listed on the CSE), one investment holding company and one jointly controlled entity.

CARS posted revenue of LKR76.5bn for FY14. Oils and fats contributed 33.8%, beverage accounted for 33.8% and oil palm plantations made up 29.2%. The group recorded an EBIT of LKR12.8bn, with the oil palm plantations and beverage segments contributing 64.2% and 18.6%, respectively. CARS’ PBT grew at a 24.2% CAGR to reach LKR11.1bn during FY10-FY14.

Figure 64: The top line grew at a 35.4% CAGR in FY10-FY14; oil palm plantations being the largest contributor over the past three years

Figure 65: Oil palm plantations profits fell in FY14, negatively affected by droughts in Indonesia and unfavorable foreign exchange movements


CARS’ business segments

CARS’ core business activities are focused on oil palm plantations, production of oils and fats, beverage, and portfolio and asset management. CARS also conducts operations in the leisure, real estate, management services and investment holding segments.

Plantations segment

The plantation segment’s operations are managed primarily through the sector holding company – Goodhope Asia Holdings Ltd. This division focuses on both upstream and downstream production of palm oil.

Oil palm plantations. This segment engages in the production and sale of CPO, PK, PKO,

palm kernel expeller (PKE) and FFBs to both local and international customers. It operates with more than 15 companies located in Malaysia and Indonesia and it holds 77,575 Ha of gross planted land (as of FY14). In addition, it has five CPO mills operating in Indonesia, with a committed capacity of 2,673,000 MT per annum and a kernel crushing plant, with a capacity of 108,000 MT per annum.

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37


Oils and fats. This division’s downstream operations involve manufacturing and distributing

refined edible oils, specialty fats and cooking oil products to industries and end customers. The company entered the edible oils and fats market in 2011, after acquiring three operating subsidiaries in Malaysia and India. It currently has a combined refining and production capacity of 321,404 MT per annum.

Beverage segment

The beverage segment’s operations include manufacturing, marketing and exporting beers, and managing a chain of wine shops and pubs. Ceylon Beverage Holdings PLC and Lion Brewery (Ceylon) PLC are two of the major holdings in this segment.

Ceylon Beverage Holdings PLC (BREW). BREW owns a 52% stake in LION and operates a

chain of wine shops and pubs via its wholly owned subsidiaries, Pubs ‘N Places, Retail Spaces and Luxury Brands.

Lion Brewery (Ceylon) PLC (LION). LION currently has a production capacity of 1.2m

hectoliters per annum. LION brews and markets beers, including two of Sri Lanka’s leading beers, Lion and Carlsberg. The company exports Lion beers to several countries including the US, Canada, Australia, the UK, Japan, and the Maldives – which is the largest export market. In 2014, Pearl Spring (Pvt) Ltd was incorporated as a subsidiary of LION and has completed the acquisition of Miller Brewery Ltd, a subsidiary of Cargills (Ceylon) PLC.

Portfolio and asset management segment

This segment is involved in equity, asset, mutual funds and unit trust management. Ceylon Guardian Investment Trust PLC (GUAR), Ceylon Investments PLC (CINV), and Guardian Capital Partners PLC (WAPO) are some of the main holding companies reported under the segment.

Leisure segment

The leisure segment shows results of two star-class hotels owned and operated by CARS – Peagus Reef Hotel, a modern four-star hotel with 140 rooms, and Giritale Hotel, a three-star hotel with 40 rooms.

Real estate segment

This segment owns and manages four office premises and a warehouse in Colombo city, representing a total area of approximately 195,000 sq ft.

Investment holdings segment

This segment reflects CARS’ strategic investments in sector holding companies of the group, which, in turn, hold ownership of sector-level subsidiaries. A sector holding company usually controls one to twenty nine subsidiary companies under its portfolio.

Management services segment

This segment serves internal customers of the group based on their geographical set-up. It provides services such as corporate finance, company secretarial, legal, tax, IT, HR and group internal audits.


38


Shareholding structure

Institutional investors hold 96.0% of CARS’ ordinary shares, while domestic investors accounted for 82.6% of the company’s ownership. Bukit Darah PLC (BUKI) is the largest shareholder in CARS, accounting for a 45.7% ownership interest. CARS holds a 26.2% stake in BUKI as an investment holding (Under new Sri Lanka accounting standards, BUKI is no longer considered as an associate under equity method and has been reclassified as an available for sale financial asset from 1QFY15). The 20 major shareholders represent 96.5% of total shareholding. Only 14.4% of CARS’ shares are available as the free float.

Figure 66: Local investors own 83% of CARS’ shares Figure 67: Institutional investors account for 96% of CARS’

shareholder base

Source: CARS

Source: CARS

The top five shareholders as of 31 December 2014 are listed below.

Name of shareholder Stake

Bukit Darah PLC A/C No 2 45.68% Tower Investments (Pvt) Ltd 10.66% Fulcrum (Pvt) Ltd 9.79% Lake View Investments (Pvt) Ltd 8.79% Portelet Ltd 7.51%

Source: CARS

Board of directors

As of February 2015, CARS’ board comprised eleven directors. Their details are provided below.

Name of Director Description

Mr. Tilak de Zoysa Chairman/independent non-executive director (INED). He currently serves as chairman of the supervisory board and advisor to the Al-futtaim Group of Companies in Sri Lanka, Amaya Hotels and Resorts USA, AMW Capital Leasing and Finance PLC, Jetwing Zinc Journey Lanka (Pvt) Ltd and HelpAge Sri Lanka.

Mr. Hari Selvanathan Deputy chairman/executive director (ED). He is also the chairman of BUKI and deputy chairman of Goodhope Asia Holding Ltd. Currently, he serves as a director of several subsidiary companies in the group and he holds over 20 years of experience in commodity trading in international markets.

Mr. Mano Selvanathan ED. He holds directorship in several companies under the Carson Cumberbatch Group, while serving as the chairman of Sri Krishna Corporation (Pvt) Ltd, Ceylon Finance and Securities (Pvt) Ltd and Selinsing PLC.

Mr. Israel Paulraj INED. Currently serves as the chairman of Ceylon Guardian Investment Trust PLC, Ceylon Investment PLC, Guardian Capital Partners PLC and Rubber Investment Trust Ltd. In addition, he is on the board of several subsidiaries of CARS.

International 17%

Domestic 83% Institutions

96%

Individual 4%


39


Mr. Chandima Gunawardena Non-Executive Director (NED). He serves as a Director of BUKI and an advisor to the group’s strategic planning and management forums in Sri Lanka. He was appointed to the Carson Group Director Board in 1990 and has over 40 years of experience in various fields of business.

Mr. Suresh Shah ED. He is also the director and chief executive officer (CEO) of Ceylon Beverage Holdings PLC and Lion Brewery (Ceylon) PLC. He is the chairman of the Ceylon Chamber of Commerce and director of the Sri Lanka Business Development Centre.

Mr. Chandana Tissera ED. He is the CEO for the plantations, oils and fats segments. He also serves as a director in several companies in the group.

Mr. Vijaya Malalasekera INED. He is also the chairman of Bogala Graphite Lanka PLC, Axis Financial Services (Pvt) Ltd, Fairway Skyhomes (Pvt) Ltd and Boston Capital (Pvt) Ltd.

Mr. Faiz Mohideen INED. Prior to this appointment, he served as the deputy secretary to the Treasury and Director General, External Resources Department, Ministry of Finance and Planning.

Mr. Rajendra Theagarajah INED. He acts as the CEO and Director of NDB Group. He also serves on the board of several companies in the NDB group and holds over 30 years of experience in the banking sector.

Mr. Ravi Dias INED. He was appointed to the board in August 2014. Prior to this appointment, he served as the Managing Director/Chief Executive Officer of Commercial Bank of Ceylon PLC. He also serves as a director of Commercial Development Company PLC, Lanka Clear (Pvt) Ltd and Lanka Financial Services Bureau Ltd.

Mr. Krishna Selvanathan Alternate director to Mr. Mano Selvanathan. He is also a director of Carson Management Services (Pvt) Ltd, Lion Brewery (Ceylon) PLC and the investment sector companies of the Carson Group.

Source: CARS


40


Figure 68: Corporate holding structure

Source: CARS

Note: * denotes listed companies on CSE. Percentages indicate respective controlling interests in each company by CARS either directly or through subsidiary companies.


41


Appendix 4: Key financial data

Summary group financials (LKRm)

INCOME STATEMENT 2012 2013 2014 2015E 2016E 2017E

(For the year ended 31 March)

Revenue 66,079 76,162 76,541 86,196 98,765 110,487

EBITDA 17,224 13,550 15,648 17,846 20,844 24,280

EBIT 14,838 10,995 12,800 14,962 17,524 20,636

Interest expense (2,336) (1,496) (2,074) (2,552) (2,015) (2,087)

Associate/JV income/(expense) 151 (16) (11) (2) (2) (2)

Earnings before Tax (EBT) 15,533 13,637 11,136 11,711 15,507 18,546

Net profit 11,226 9,655 7,879 8,253 11,165 13,353

Net income 5,598 4,594 3,737 4,055 5,427 6,490

BALANCE SHEET 2012 2013 2014 2015E 2016E 2017E

(As at 31 March)

Current assets

Cash and cash equivalents 8,769 7,864 16,834 8,927 7,649 8,023

Short term investments - - - - - -

Accounts receivable 6,724 10,374 9,848 12,039 12,472 12,955

Inventories 6,609 7,260 7,941 7,695 7,945 8,111

Total current assets 23,000 26,556 35,925 30,851 30,255 31,279

Non-current assets

Property, plant and equipment 41,913 51,042 54,759 58,863 65,026 71,632

Biological assets 33,699 42,787 46,817 48,822 53,761 59,285

Intangible assets 7,263 8,061 8,177 12,950 13,297 13,712

Investments in associates/JVs 574 18 18 17 17 18

Total non-current assets 95,532 132,463 138,678 155,306 166,755 179,302

Total assets 118,532 159,020 174,604 186,157 197,010 210,581

Current liabilities

Short term debt 11,863 24,789 25,855 24,342 24,342 24,342

Accounts payable 9,688 10,769 16,342 13,611 13,692 14,302

Income tax payable 1,541 - 127 889 889 889

Total current liabilities 23,092 35,559 42,326 38,854 38,935 39,544

Non-current liabilities

Long term debt 25,802 27,445 38,733 47,718 47,718 47,718

Post-retirement benefit obligation 546 1,241 1,038 1,111 1,111 1,111

Total non-current liabilities 32,846 36,839 49,146 58,725 58,725 58,725

Equity

Common share capital 1,115 1,115 1,115 1,115 1,115 1,115

Retained profit 25,796 40,158 37,806 41,455 46,489 52,586

Minority interest 30,852 40,072 38,939 40,706 46,445 53,308

Total equity 62,594 86,622 83,132 88,578 99,351 112,311

Total liabilities and equity 118,532 159,020 174,604 186,157 197,010 210,581


42


CASH FLOW STATEMENT 2012 2013 2014 2015E 2016E 2017E

(For the year ended 31 March)

Operating activities

Net cash flow from operating activities 14,068 7,384 17,364 10,929 15,901 19,048

Investing activities

Purchase of PPE and intangible assets (11,864) (20,901) (17,788) (18,309) (14,768) (16,190)

Dividends received from associates/JVs - - - - - -

Net cash flow from investing activities (17,586) (19,257) (15,199) (21,099) (14,264) (15,758)

Financing activities

Debt issuance/(repayment) (2,852) 3,400 13,905 7,472 - -

Common share issuance/(repurchase) - - - - - -

Interest paid* (2,336) (1,496) (2,074) (2,552) (2,015) (2,087)

Dividends paid to common shareholders (1,439) (2,716) (3,767) (3,456) (2,522) (2,522)

Dividends paid to minority interests - - - - - -

Net cash flow from financing activities (5,420) (384) 9,038 3,529 (2,915) (2,915)

Net increase/(decrease) in cash and cash equivalents

(8,938) (12,257) 11,203 (6,641) (1,278) 375

Note: *In this case, interest paid in the cash flow statement is equal to the interest expense on the income statement.

Key ratios

KEY RATIOS 2012 2013 2014 2015E 2016E 2017E

Growth

Revenue growth (%) 90.8% 15.3% 0.5% 12.6% 14.6% 11.9%

EBITDA growth (%) 28.3% -21.3% 15.5% 14.0% 16.8% 16.5%

EBT growth (%) 23.7% -25.9% 16.4% 16.9% 17.1% 17.8%

Net profit growth (%) 17.6% -14.0% -18.4% 4.7% 35.3% 19.6%

Recurrent diluted EPS growth (%) 23.9% -17.9% -18.6% 8.5% 33.8% 19.6%

Margins

EBITDA margin (%) 26.1% 17.8% 20.4% 20.7% 21.1% 22.0%

EBIT margin (%) 22.5% 14.4% 16.7% 17.4% 17.7% 18.7%

EBT margin (%) 23.5% 17.9% 14.5% 13.6% 15.7% 16.8%

Net profit margin (%) 17.0% 12.7% 10.3% 9.6% 11.3% 12.1%

ROE (%) 19.2% 11.7% 8.2% 8.8% 10.8% 11.6%

Liquidity and Efficiency

Current Ratio (x) 1.0 0.7 0.8 0.8 0.8 0.8

Total Asset Turnover (x) 0.6 0.5 0.4 0.5 0.5 0.5

Gearing and Cash Flow

Debt/Capital (%) 37.6% 37.6% 43.7% 44.9% 42.0% 39.1%

Interest Cover (x) 6.4 7.3 6.2 5.9 8.7 9.9

Free cash flow (FCF) yield (%) 2.4% -15.6% -0.6% -10.3% 1.4% 3.5%

Net debt/FCF (x) 13.1 (3.3) (112.7) (8.6) 56.9 22.4

Valuation

P/E (x) 16.3 18.8 19.2 17.7 15.2 12.7

P/BV (x) 2.9 1.9 1.6 1.5 1.6 1.4

EV/Sales (x) 2.3 2.2 2.1 2.0 1.9 1.7

EV/EBITDA (x) 8.8 12.6 10.1 9.9 9.0 7.7

EV/EBIT (x) 10.2 15.5 12.4 11.8 10.7 9.1

EV/FCF (x) 68.5 (12.6) (373.7) (23.9) 165.2 65.4

Dividend yield (%) 0.4% 0.5% 0.5% 0.5% 0.5% 0.5%

Dividend cover (x) 28.6 24.6 20.1 21.0 28.4 34.0


43


PER SHARE DATA (LKR) 2012 2013 2014 2015E 2016E 2017E

Reported basic EPS 35.7 23.4 19.0 20.6 27.6 33.0

Recurrent diluted EPS 28.5 23.4 19.0 20.6 27.6 33.0

Common dividend per share 2.0 2.0 2.0 2.0 2.0 2.0

Book value per share (BVPS) 161.6 237.0 225.0 243.8 269.4 300.4

Net operating cash flow per share 71.6 37.6 88.4 55.6 81.0 97.0

Net cash flow per share (45.5) (62.4) 57.0 (33.8) (6.5) 1.9

Segmental summary

Oil palm plantations 2012 2013 2014 2015E 2016E 2017E

Revenue 25,876 25,797 22,347 23,828 26,756 31,879

EBIT 10,679 8,604 8,282 9,055 10,301 12,433

YoY Growth

Revenue 25.4% -0.3% -13.4% 6.6% 12.3% 19.1%

EBIT 24.4% -19.4% -3.7% 9.3% 13.8% 20.7%

Margins

EBIT 41.3% 33.4% 37.1% 38.0% 38.5% 39.0%

Oils & fats 2012 2013 2014 2015E 2016E 2017E

Revenue 19,416 25,059 25,893 28,276 30,623 33,119

EBIT (320) (889) 370 566 766 994

YoY Growth

Revenue nm 29.1% 3.3% 9.2% 8.3% 8.1%

EBIT nm 177.9% -141.6% 52.8% 35.4% 29.8%

Margins

EBIT -1.6% -3.5% 1.4% 2.0% 2.5% 3.0%

Beverage 2012 2013 2014 2015E 2016E 2017E

Revenue 18,134 23,002 25,846 31,161 38,138 42,021

EBIT 2,399 1,600 2,397 3,116 4,004 4,622

YoY Growth

Revenue 55.6% 26.8% 12.4% 20.6% 22.4% 10.2%

EBIT 45.4% -33.3% 49.8% 30.0% 28.5% 15.4%

Margins

EBIT 13.2% 7.0% 9.3% 10.0% 10.5% 11.0%

Portfolio & asset management 2012 2013 2014 2015E 2016E 2017E

Revenue 2,081 1,661 1,815 2,178 2,396 2,516

EBIT 1,983 1,543 1,663 2,004 2,205 2,315

YoY Growth

Revenue nm -20.2% 9.3% 20.0% 10.0% 5.0%

EBIT nm -22.2% 7.8% 20.5% 10.0% 5.0%

Margins

EBIT 95.3% 92.9% 91.6% 92.0% 92.0% 92.0%

Other 2012 2013 2014 2015E 2016E 2017E

Revenue 572 642 639 752 852 951

EBIT 96 138 87 222 249 272

YoY Growth

Revenue 13.3% 12.2% -0.4% 17.6% 13.2% 11.7%


44


EBIT 92.7% 43.2% -36.4% 153.4% 12.2% 9.5%

Margins

EBIT 16.8% 21.4% 13.7% 29.5% 29.2% 28.6%

Source: CARS , Copal Amba estimates


45


Appendix 5: Diversified sector overview

As of 23 April 2015, the diversified sector represented 19% of the CSE’s total market capitalization of USD22.7bn. It is the third-largest sector on the stock market, behind financial services and beverage, food and tobacco.

Figure 69: Top five sectors on the CSE by market capitalization

Sector name

Market cap

(USDbn)

% of total CSE

market cap Two largest companies

Banks, finance & insurance 5,691 27% Commercial Bank of Ceylon PLC

Hatton National Bank PLC

Beverage, food & tobacco 4,218 20% Ceylon Tobacco Company PLC

Nestle Lanka PLC

Diversified 3,925 19% John Keells Holdings PLC


Telecommunication 1,324 6% Dialog Axiata PLC

Sri Lanka Telecom PLC

Manufacturing 1,248 6% Chevron Lubricants Lanka PLC

Textured Jersey Lanka PLC

Source: CSE Note: Data as of 23 April 2015.


46


There are 19 listed diversified companies trading on the CSE, 13 of which are listed on the main board, while 5 are listed on the Diri Savi board and 1 is listed on the default board. We have listed the top 10 companies in the diversified sector based on market capitalization as of 23 April 2015, along with a brief description of their main businesses.

Figure 70: Details of conglomerates listed on the main board of the CSE

Company name Bloomberg/CSE tickers

Market cap

(USDm)

Free float

(%) Top 3 businesses by revenue contribution

John Keells Holdings PLC JKH SL/ JKH.N0000 1,546 98.5% Consumer food (manufacturing) & retail

Tourism (hotels, destination management)

Transportation (oil bunkering, container handling)

Carson Cumberbatch PLC CARS SL/ CARS.N0000 619 14.4% Oils and fats (refined oils, cooking oil, specialty fats)

Beverage (breweries)

Oil palm plantations (palm oil, palm kernel, fresh fruit)

Aitken Spence PLC SPEN SL/ SPEN.N0000 304 38.7% Tourism (hotels, destination management)

Strategic investments (power generation, printing &

packaging, garment manufacturing, plantations)

Logistics (freight forwarding, courier services,

integrated logistics, maritime transport)

Hemas Holdings PLC HEMS SL/ HHL.N0000 293 28.2% Healthcare (pharmaceuticals, diagnostic and surgical

services, hospitals)

FMCG

Power generation

Vallibel One PLC VONE SL/ VONE.N0000 179 19.3% Tiles

Finance (banking)

Apparel

Hayleys PLC HAYL SL/ HAYL.N0000 179 40.0% Hand protection (rubber gloves)

Transportation & logistics (warehousing & distribution,

freight, chartering and port operations)

Purification products (carbon granular, fines, powders

and pellets)

CT Holdings PLC CTHR SL/ CTHR.N0000 179 39.3% Retail and wholesale distribution

Food processing (consumer foods)

Restaurants

Expolanka Holdings PLC EXPO SL/ EXPO.N0000 125 32.7% Freight & logistics (air and sea freight, logistics,

warehousing)

International trading and manufacturing (agricultural,

paper, plastic, metal pharmaceutical products)

Investments & services (airline general sales agent,

business process outsourcing, education,

investments, corporate services)

Richard Pieris & Co. PLC RICH SL/ RICH.N0000 122 42.9% Retail

Plantations (tea, rubber, palm oil)

Plastics (water tanks and pumps, foam mattresses,

bulbs, molded plastics)

Softlogic Holdings PLC SHL SL/ SHL.N0000 83 29.1% Healthcare services

Retailing

Financial and Insurance services

Source: CSE, Bloomberg, Company annual reports

Note: Market capitalization data as of 23 April 2015 and free float data as of 31 December 2014. Revenue contribution based on FY14 (31 March 2014) data.


47


The shareholding structures of these listed conglomerates are shown in the table below. Three companies have significant international shareholding, and management hold large stakes in five issuers.

Figure 71: Shareholding structures by investor type and geographical location

Investor type Geographical location

Management Other retail Institutional Management Other domestic International

John Keells Holdings PLC 4.8% 28.1% 67.1% 4.8% 27.9% 67.3%

Carson Cumberbatch PLC 0.3% 3.7% 96.0% 0.3% 82.3% 17.4%

Aitken Spence PLC 1.9% 7.4% 90.7% 1.9% 55.8% 42.3%

Hemas Holdings PLC 4.1% 5.2% 90.7% 4.1% 89.0% 6.9%

Vallibel One PLC 63.7% 6.2% 30.2% 63.7% 35.5% 0.8%

Hayleys PLC 48.5% 22.2% 29.4% 48.5% 47.9% 3.7%

CT Holdings PLC 19.1% 41.7% 39.2% 19.1% 64.7% 16.2%

Expolanka Holdings PLC 73.1% 9.9% 16.9% 73.1% 23.6% 3.3%

Richard Pieris & Co. PLC 2.6% 13.9% 83.5% 2.6% 37.1% 60.3%

Softlogic Holdings PLC 68.8% 9.1% 22.1% 68.8% 25.6% 5.6%

Source: Company annual reports Note: All data as of FY14.

Below are key financial statistics for these conglomerates.

Figure 72: Key financial data

Company Name Revenue EBIT Net income EBIT margin (%) Net income margin (%)

John Keells Holdings PLC 686 45 90 6.6% 13.1%

Carson Cumberbatch PLC 589 99 29 16.8% 4.9%

Aitken Spence PLC 278 44 28 15.8% 10.2%

Hemas Holdings PLC 252 19 19 7.6% 7.3%

Vallibel One PLC 372 48 12 12.8% 3.3%

Hayleys PLC 619 52 14 8.4% 2.2%

CT Holdings PLC 453 14 10 3.2% 2.2%

Expolanka Holdings PLC 418 16 11 3.7% 2.6%

Richard Pieris & Co. PLC 267 17 11 6.4% 4.1%

Softlogic Holdings PLC 225 22 1 9.6% 0.5%

Source: Bloomberg Note: All data as of FY14. All figures are in USDm, unless stated otherwise.


48


Fact sheet

Sri Lanka investment environment overview

Sri Lanka’s economy has been on an upward trajectory since the end of the three-decade civil war in May 2009. Sri Lanka currently boasts South Asia’s highest GDP growth, conducive fiscal and monetary policy, and favorable socio-economic conditions, which together create an attractive investment destination.

Figure 73: Sri Lanka's GDP projected to increase at a 4% CAGR 2014E-2016E

Figure 74: GDP per capita to increase 43% by 2016E

Source: CBSL, Road Map 2015 – CBSL

Source: CBSL, Road Map 2015 - CBSL

Figure 75: Annual core inflation post-war has averaged 5.8%, government targeting mid-single digit levels in the medium term

Figure 76: CBSL expects the rupee to stabilize in the medium term despite recent volatility

Source: Department of Census and Statistics, CBSL

Source: Bloomberg

Figure 77: Fiscal deficit target of 5.2% of GDP for 2014E

Figure 78: Debt-to-GDP to fall to 67% by 2016E

Source: CBSL, Road Map 2015 – CBSL Source: CBSL, Road Map 2015 – CBSL

6.8 6.0

3.5

8.0 8.2

6.3 7.2 7.4

8.0 8.0

0

2

4

6

8

10

2007

2008

2009

2010

2011

2012

2013

2014E

2015E

2016E

%

0

1,000

2,000

3,000

4,000

5,000

2007

2008

2009

2010

2011

2012

2013

2014E

2015E

2016E

USD

7.7

13.6

7.0 7.0 6.9 5.8

4.5 3.5

0

2

4

6

8

10

12

14

16

2007 2008 2009 2010 2011 2012 2013 2014

%

100

150

200

250

Jan-07 Aug-08 Apr-10 Dec-11 Aug-13 Apr-15

LKR

LKR/USD LKR/EUR LKR/GBP

0%

4%

8%

12%

0

200

400

600

2007 2008 2009 2010 2011 2012 2013 2014E

% of GDP LKRbn

Fiscal deficit As a % of GDP

102 102 91 88 85 81 86 82 79 79 78 75 71 67

0

20

40

60

80

100

120

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014E

2015E

2016E

%


49


The Sri Lankan equity market offers a rare and attractive alternative to investors in an investment era impacted by economic growth worries. Backed by the country’s robust economic growth, the Sri Lankan capital market is well set to offer attractive returns to investors who are keen to be a part of this emerging market success story. There are several strong incentives for entering the Sri Lankan capital market.

Figure 79: Post war, the ASPI has significantly outperformed global and developed market indices

Figure 80: Post war, the ASPI has also outperformed some of the best-performing regional indices

Source: Bloomberg

*Note: All figures re-based to 1 June 2009

Source: Bloomberg

*Note: All figures re-based to 1 June 2009

Figure 81: The CSE’s market capitalization has doubled since 2009

Figure 82: FDI inflows reached USD1.4bn in 2013, an 11% CAGR 2009-2013

Source: CSE, CBSL

Source: CBSL, Road Map 2015 – CBSL

Figure 83: Most sector P/Es are below market average and historical valuations

Figure 84: Trend is similar on a P/BV value

Source: CSE Source: CSE

0

80

160

240

320

400

Jun-09 May-10 May-11 May-12 May-13 Apr-14 Apr-15

%

ASPI Dow Jones FTSE 100

MSCI World DAX

0

100

200

300

400

Jun-09 May-10 May-11 May-12 May-13 Apr-14 Apr-15

%

ASPI Bombay (BSE 500)

Jakarta (JCI) Philippines (PASHR)

Thailand (SET) Vietnam (VNINDEX)

MSCI Emerging Market Index

1,092

2,211 2,214 2,168 2,418

3,105 3,021

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2009 2010 2011 2012 2013 2014 2015(Apr)

LKRbn

601 516

1,066

1,279 1,391

1,900

0

400

800

1,200

1,600

2,000

2009 2010 2011 2012 2013 2014E

USDm

0

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50


IMPORTANT DISCLAIMER

This document has been prepared on behalf of the Colombo Stock Exchange (“CSE”) by Amba Research Lanka Private Limited (“Amba”) and is sponsored by the CSE. The views expressed in this document are those of the authors based on available and accessible information from the public domain and do not represent those of the CSE. Please note, inter alia, that with the publication of this document on the CSE website, www.cse.lk, neither Amba , as author, nor CSE (as sponsor) intend to assume and are not assuming any responsibility or liability (including under contract, common law or tort) to any party arising out of or with respect to this document. This document is not intended to, and does not form part of any contract with anyone (including a contract between author and reader/recipient) and no one shall have any right (contractual or otherwise) to enforce any claim in relation to the document either directly or indirectly.

Except as otherwise indicated, you may only view and print one copy of the document for your own personal, non-commercial use. You may not copy, store [either in hardcopy or in an electronic retrieval system] transmit, transfer, broadcast, publish, reproduce, create a derivative work from, display, distribute, sell, license, rent, lease or otherwise transfer any of the contents to any third person (including, without limitation, to others in your company or organization) whether for direct or indirect commercial or monetary gain or otherwise without the prior written permission of Amba and CSE.

This document does not contain any investment advice nor does it constitute an offer to buy, sell or hold any of the investment product(s)/asset class (es) mentioned herein. Prospective investors are required to possess sufficient knowledge when evaluating the advantages and risks inherent to such investment product(s)/asset class(es) mentioned herein and to take into consideration their circumstances and financial position when assessing the suitability of such investments.. Prior to making an investment decision, prospective investors are strongly advised to obtain independent advice from competent legal, financial, tax, accounting and other professionals. Amba and CSE shall not be held liable in any manner for any direct, indirect or consequential loss that may arise as a result of investing in the investment product(s)/asset class (es) mentioned herein. Amba and CSE expressly disclaim any fiduciary responsibility or liability for any consequences, financial or otherwise from any reliance placed on the information in this document. The investment product(s)/asset class (es) described in this document may not be eligible for sale or subscription within a particular jurisdiction or to particular categories of investors. This document is not intended for distribution to a person or, within a jurisdiction where such distribution would be restricted or illegal. It is the responsibility of any person reading this document to observe all applicable laws and regulation of the relevant jurisdiction. Neither Amba, nor CSE, shall be responsible for any error which may have occurred at the time of printing of this document. The information set out in this document is subject to change without notice.

The information contained herein has been obtained from sources believed to be reliable and Amba and CSE make no warranty, expressed or implied, as to the accuracy, timeliness, completeness or correct sequencing of the information.

This document does not purport to list all of the terms and conditions, nor to identify or define all or any of the risks that would be associated with the purchase or sale of the investment product(s)/asset class (es) described herein. Please note that any price levels, rates, simulations, illustrations, terms or conditions contained herein are indicative only, and may vary in accordance with changes in market conditions. All the information included in this document is current at the time of preparing this document and subject to change at any time. Any forecast, projection or forward looking statement made in this document embodies assumptions and predictions about future events that by their nature cannot be verified as facts. They are not necessarily indicative of future or likely performance, of investment product(s)/asset class (es), countries, markets or companies. Any past market conditions or product performances may not be representative of future market conditions or product performances.

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