JKSB Sri Lanka Market Strategy March 2011

ContentsCountry Fact Sheet 2

Executive Summary 3

Political Overview 4

Economic Overview 5

Market Overview and Strategy 11

Company ReviewsCommercial Bank of Ceylon PLC 17

Hatton National Bank PLC 23

Sampath Bank PLC 29

National Development Bank PLC 37

Tokyo Cement Company (Lanka) PLC 45

Royal Ceramics PLC 51

Colombo Dockyard PLC 57

Distilleries Company of Sri Lanka PLC 63

Aitken Spence Hotel Holdings PLC 69

Dialog Axiata PLC 75

Aitken Spence PLC 83

John Keells Holdings PLC 91

JKSB Contact Information 99

A JKSB Research Publication

Country Fact SheetGOVERNMENT

Unicameral Parliament: 225 seats; members elected by popular vote on the basis

of an open-list, proportional representation system by electoral district to serve six-year terms

General Elections: Last held in April 2010 (next - 2016)

Chief of state: President Mahinda Rajapaksa (since 19 November 2005); The President is both the chief of state and head of government

Presidential Elections: President elected by popular vote for a six-year term (eligible for multiple terms); election last held on 26th January 2010 (next to be held in 2017)

Cabinet: Cabinet appointed by the President in consultation with the Prime Minister.

PHYSICAL FEATURES AND CLIMATE Total area : 65,610 sq. km Land area : 62,705 sq.km Inland waters : 2,905 sq.km Highest elevation : 2,524m/8,281ft Low country (min/max) : 24.4oC – 31.7oC Hill country (min/max) : 17.1oC – 26.3oC Avg. Annual Rainfall : 2397mm

POPULATION AND VITAL STATISTICS Mid year population 2010 : 20.65mn Age distribution (‘000) – 2009 0 - 14 yrs : 5,205 (25.1%) 15 - 59 yrs : 12,991 (62.9%) 60 years and over : 2,457(11.9%) Population density (per sq km) : 318 persons Crude birth rate (2009) : 18.4 per ‘000 Crude death rate (2009) : 5.9 per ‘000 Rate of natural inc. (2009) : 12.6 per ‘000 Infant mortality (2006) : 10.0 per ‘000 Dependency ratio (2006) : 48.35% Average household size (2009) : 4.0 Life Expectancy (2007) Male : 70.3 years Female : 77.9 years

Literacy rate (2008) Overall : 91.3% Male : 92.8% Female : 90.0%

Income distribution Gini coefficient of household income (2009) : 0.47 Mean household Income (‘09) : Rs. 35,495 (US$ 320) Median household Income (‘09) : Rs. 24,106 (US$ 217)

Poverty Poverty Head Count Ratio (2009/10) : 7.6% Population below US $ 1 a day (1990-2005) : 5.6% Population below US $ 2 a day (1990-2005) : 41.6%

Human Development Index (2010) - Rank among 169 countries : 91

Employment Unemployment rate (3Q 2010) : 4.9% (Excluding Northern Province) Employed Persons Agriculture : 31.2% Industry : 25.1% Services : 44.3%

Water Supply Access to safe drinking water : 84.8% Access to pipe borne water : 35.5% Electricity Households with Electricity : 86% Per capita Electricity Consumption (kWh) : 412.8

Communication Fixed lines per 100 persons : 17 Mobile Subscriber penetration (SIMs) : 79% Internet & Email (Fixed) penetration : 1.26% Mobile Broadband penetration : 0.58%

Public Health Public Hospital Beds per 1000 persons : 3.4 Persons per Doctor : 1500 Gov. Expenditure on Health- % of GDP : 1.5%

Education School Density (Area per school – sq km) : 6.5 Primary/Secondary education (5-19yrs) : 96.1% Pupil/teacher ratio (Public Schools-2009) : 18 Eligibility for public universities : 62.5% Admission to university as a % of eligible : 16% Gov. Expenditure on Education - % of GDP : 2.1%

Banking Density Commercial Bank Branches (per 100k persons) :10.8 Area (sq km) per commercial bank branch : 29.41 ATM’s per 100,000 persons : 9.6 Credit Cards per 100 persons : 3.77

2 | John Keells Stock Brokers (Pvt) Limited | Market Strategy

Source : CBSL, Department of Census and Statistics

John Keells Stock Brokers (Pvt) Limited | Market Strategy | 3

Executive Summary>> With the peace dividend filtering in, the economy is expected to have grown at 8% in CY2010 having gathered healthy momentum with 5 consecutive quarters of accelerating growth from 2Q2009 to 2Q2010.

>> The economy has witnessed a significant improvement in business sentiment and business activity stemming from a benign interest rate regime and fiscal reforms resulting in a lower and simplified taxation and tariff structure. Furthermore overall macro level stability and an increased infrastructure spend together with an upturn in domestic demand have collectively underpinned a strengthened economy.

>> The resurgence of intra provincial trade with the reintegration of the North and East provinces to the main stream economy and the significant infrastructure spend across the island in road, power, port and rural infrastructure development together with the consequent multiplier effects feeding into increased domestic consumption underlie our medium term expectations of 8%+ GDP expansion. Sustaining this growth momentum beyond will however require a significant increase in FDI across a number of sectors to drive scale and productivity enhancements in the economy.

>> We anticipate the fiscal deficit would decline to 7% of GDP for 2011 stemming from lower interest expense on domestic financing, higher tax revenues and lower defense expenditure relative to GDP.

>> The loss of crop production due to the floods earlier this year will add further supply side pressure on food prices which we expect would push the CCPI up to 8.8% by end 2011. The property market is still relatively subdued and non-food and non-fuel inflation still remains under check although demand driven inflationary effects may begin to be evident towards the latter half of the year. The immediate concerns for this year on inflation remain on supply side shocks from food and more significantly the impact on oil prices from the recent events in North Africa and the Middle East. With inflation trending higher we believe that interest rates have bottomed out and prime lending rates may rise by 50bps by year end with prospects of strong credit growth remaining intact.

>> The ASPI has risen by 16.2% for the year to date on the back of a 96% increase in CY10 and a 280% increase since the end of the war. The recent upward movement in the ASPI is largely a result of strong retail and local HNI participation which has seen significant price movements in second tier and illiquid stocks not necessarily reflective of broad based healthy buying interest.

>> Sustained local retail buying interest in the market has pushed near term market multiples to 15.2x FY12E earnings, with aggressive buying on selected mid cap and speculative trading on illiquid counters having pushed the indices higher at an excessive pace thus far this year warranting a modest correction.

>> Businesses will benefit from increased domestic demand in the medium but will also be required to invest in building scale and enhancing productivity in anticipation of new competition that is inevitably ushered in by an improved operating environment

>> We remain bullish on the medium to long term earnings growth prospects of construction related Manufacturing, Banking and Leisure group stocks. A medium term outlook of sustainable normalized earnings of approximately 25% should see the index trend higher over the medium to long term


Political Overview>> With the removal of the constitutional bar on the president having a two term limit on the 8th September 2010, Sri Lanka started a new chapter in its political history. With the ruling United Peoples Front Alliance (UPFA) having only 144 seats the amendment had a smooth passage with 161 members voting in favour, and only 17 voting against.

Current administration firms up hold on power>> President Rajapaksa has astutely levered his post war popularity into what appears will be a long stay in the seat of power. The dominance of the Rajapakse administration is also partially due to the weakness of Sri Lanka’s second major political party the United National Party (UNP). Wracked by internal dissension the party has seen members defect once again to the ruling party while the remaining MPs have publically come out against Ranil Wickremasinghe’s party leadership.

>> The executive president enjoys enormous powers under the 1978 constitution. He can dissolve the parliament and declare emergency. He also appoints judges, heads of armed forces and police, election commissioners and secretaries to the government. In a state of emergency, the president can even promulgate regulations to override laws enacted by the parliament. The state of emergency continues to be in force even now though the war ended in May 2009.

Consolidation of power should deliver stability>> Sri Lanka has long suffered under political uncertainty with wafer thin majorities in Parliament exacerbating the effects of the turmoil of the nearly three decade long ethnic war. This focus on political uncertainty due to the possibility of a change in regime means many investment decisions were postponed. It is hoped that this current consolidation of political power will give an environment of stability in which faster economic growth can occur. The budget delivered in November 2010 underlined the importance the government places on catching up on the economic development that the country forfeited during its period of turmoil.

>> Much of the success of the war effort can attributed to the Rajapakse administration’s foreign policy which prioritized improving relations with regional powers like India and China as well the Middle East. These relationships are also important from an economic standpoint. India and China are committing substantial amounts to investment in infrastructure in post-war Sri Lanka. China is now Sri Lanka’s largest donor of developmental assistance after Japan. India is also one of Sri Lanka’s most important trade partners and is one of the largest sources of tourists into the country. Sri Lanka’s increasing links to the Asian region should prove important in continuing export led economic growth in the coming years.


Economic OverviewGDP Growth>> With the peace dividend filtering in, the economy is expected to have grown at 8% in CY2010 having gathered healthy momentum with 5 consecutive quarters of accelerating growth from 2Q2009 to 2Q2010. The last 8 months have seen a sharp improvement in business activity after a rebound in the wider economy lagged initial expectations as businesses adjusted to an abrupt end in hostilities in mid 2009 and then held back till the conclusion of parliamentary and legislative elections in early 2010. The economy has witnessed a significant improvement in business sentiment and business activity stemming from a benign interest rate regime and fiscal reforms resulting in a lower and simplified taxation and tariff structure. Furthermore overall macro level stability and an increased infrastructure spend together with an upturn in domestic demand have collectively underpinned a strengthened economy.

>> Credit growth which was marginal for much of 2008 and marginally negative for 2009 picked up sharply in the 2H of 2010 to end the year up an estimated 22.6% for CY2010. The resurgence of intra provincial trade with the reintegration of the North and East provinces to the main stream economy, the significant and simultaneous infrastructure spend across the island in road, power, port and rural infrastructure development and the consequent multiplier effects feeding into increased domestic consumption underlie our medium term expectations of 8%+ GDP expansion. Sustaining this growth momentum beyond will however require a significant increase in FDI across a number of sectors to drive scale and productivity enhancements in the economy.

>> Severe floods earlier this year in the North Central and Eastern provinces will result in a significant reduction in agricultural production in the first half of the year as a result of lost cultivation and damage caused to irrigation infrastructure.

>> The agriculture forestry and fisheries sector recorded a 6.2% growth for the 3Q stemming from the highest ever recorded paddy production during the 2009/2010 ‘Maha Season’; which accounts for approximately 65% of total paddy production in the country. The ‘Yala Season’ also witnessed a 21.4% increase in the area harvested over the previous year while yields also improved. The total gross area harvested during the ‘Maha’ and ‘Yala’ season in 2009 amounted to 943,000Ha which could increase by as much as 10%-15% in 2011/2012 should weather conditions be favourable, with increased land in the North and East being cultivated. The revised production figure following the floods for the ‘Maha Season’ is 2.3mn MT which is marginally lower than the 2009 output and a 24.5% decline for this years expected crop levels. Other field crops have seen a similar effect in loss of cultivated area. The fisheries sector grew by 14.4% in the 3Q 2010 with marine fishing growing by 15.3% with some of the most fertile fishing grounds of the North and East coast representing two thirds of the country’s coast line seeing increased production. Output of the country’s traditional exports witnessed sound growth with record prices for tea and rubber benefiting from strong external demand for commodities.

>> The commercial construction sector is gathering pace with loan disbursements for construction related activity increasing by 25.2% in the 3Q 2010 while cement production was up 20.6% yoy for the first 11 months of 2010.

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A strong pipeline of large scale infrastructure projects relating to expressways, increased power generation capacity, sea ports and airports as well as rural infrastructure development initiatives across the island will sustain this growth momentum over the medium term. The manufacturing segment which accounts for nearly 75% of industrial output in the country recorded steady growth of 6.8% in the 3Q with the garment sector remaining resilient following the suspension of the EU GSP + facility whilst other sub sectors will see increased capacity utilization.

>> Expansion of the import trade sector as well as a pick up in domestic trade into the North and East provinces and increased consumer spending across the island is expected to drive growth in the services sector. Import trade increased by 11.8% in the 3Q 2010 benefiting from a reduction in import tariffs in July for motor vehicles and a whole range of consumer products. Credit penetration has also increased sharply with the Banking, Insurance and Real Estate sector expanding by 8.5% in the 3Q, with private sector credit growth which was moderate for the 1H 2010 increasing sharply up 25% upto November last year. We anticipate credit growth to the private sector to average at 25% over the next two years. The Hotel and Restaurant sector benefited from an anticipated 46% increase

GDP Growth (%) Sector 2004 2005 2006 2007 2008 2009 2010E 2011E

Agriculture 0.0 1.8 6.3 3.4 7.5 3.2 6.1 5.6

Agriculture, Livestock and Forestry -0.1 6.9 3.5 2.3 7.3 2.8 5.2 4.8

Fishing 0.5 -43.0 53.5 15.6 9.9 6.9 14.0 12.0

Industry 5.4 8.0 8.1 7.6 5.9 4.2 8.0 8.6

Mining and Quarrying 5.5 17.8 24.2 19.2 12.8 8.2 11.0 10.0

Manufacturing 5.2 6.2 5.5 6.4 4.9 3.3 6.4 6.6

Electricity, Gas and Water 6.0 14.0 14.8 4.6 2.7 3.7 8.2 8.3

Construction 5.9 9.0 9.2 9.0 7.8 5.6 11.0 13.0

Services 6.7 6.4 7.7 7.1 5.6 3.3 8.3 8.3

Wholesale and Retail Trade 7.4 6.4 7.1 6.1 4.7 -0.3 7.7 8.2

Hotels and Restaurants 21.5 -14.1 2.5 -2.3 -5.0 13.3 32.5 25.0

Transport and Communication 9.7 9.5 12.6 10.5 8.1 6.6 11.2 9.8

Banking, Insurance and Real Estate etc. 5.8 7.0 8.5 8.7 6.6 5.7 9.0 9.0

Total GDP Growth 5.4 6.2 7.7 6.8 6.0 3.5 8.0 8.1

% Share of Total GDP (Sectors / key sub sectors) 2004 2005 2006 2007 2008 2009 2010E 2011E

Agriculture 13.0 12.5 12.3 11.9 12.1 12.0 11.8 11.6

Agriculture, Livestock and Forestry 11.7 11.7 11.3 10.8 10.9 10.9 10.6 10.3

Fishing 1.3 0.7 1.0 1.1 1.1 1.2 1.2 1.3

Industry 27.7 28.1 28.2 28.5 28.4 28.6 28.6 28.8

Mining and Quarrying 1.3 1.5 1.7 1.9 2.0 2.1 2.2 2.2

Manufacturing 18.1 18.1 17.7 17.7 17.5 17.4 17.2 17.0

Electricity, Gas and Water 0.7 0.7 0.7 0.6 0.6 0.6 0.6 0.6

Construction 6.0 6.2 6.3 6.4 6.5 6.6 6.8 7.1

Services 59.3 59.4 59.5 59.6 59.5 59.3 59.5 59.7

Wholesale and Retail Trade 24.7 24.7 24.6 24.5 24.2 23.3 23.2 23.3

Hotels and Restaurants 0.6 0.5 0.5 0.4 0.4 0.4 0.5 0.6

Transport and Communication 11.5 11.9 12.4 12.8 13.1 13.5 13.9 14.1

Banking, Insurance and Real Estate etc. 8.4 8.4 8.5 8.7 8.7 8.9 9.0 9.1

Other 14.1 13.9 13.5 13.3 13.1 13.3 12.9 12.7


in tourist arrivals with the sector growing by 32.2% for the 3Q in 2010 which followed a 20.6% expansion in the sub sector in the 3Q 2009. The transportation sector is also expected to expand sharply over the medium term driven by growth in cargo throughput and container handling at the port which was up by 18.9% and 12.9% respectively in the 3Q. Increased air travel as well as passenger and goods transportation within the country will further augment growth in the sector.

Fiscal Deficit>> Government revenue from taxes and grants increased by 14.4% for the first 11 months of CY10 whilst recurrent expenditure recorded a modest growth of just 3.7% in the same period, and as such we believe that approved estimates for CY10 of revenue to GDP of 14.8% and a budget deficit of 8% will be met. The budget proposals announced for 2011 express an intention to bring down the fiscal deficit to 6.8% in 2011 and 5% in 2012, with the initial MEFP attached to the LOI signed for the IMF Standby facility being to bring down the fiscal deficit to 5% by 2011. We anticipate the fiscal deficit would decline to 7% for 2011 stemming from lower interest expense on domestic financing, higher tax revenues and lower defense expenditure relative to GDP.

>> The taxation reforms spelt out at budget proposals for 2011 announced on the 22nd of November were well received and marked significant changes with the state boldly reducing and simplifying taxation structures for corporates and individuals in a bid to improve revenues by facilitating growth as opposed to the imposition of a host of adhoc taxes as was seen in the past. We do not anticipate a significant curtailment of recurrent expenditure in 2011 except for a moderate reduction in defense expenditure to GDP.

Inflation >> The CCPI has been trending higher from an annual average of 3.1% in February 2010 to 6.0% in January 2011 driven primarily by higher food prices which account for approximately 47% of the CCPI index. The loss of crop production due to the floods earlier this year will add further supply side pressure on food prices which we expect would push the CCPI up to 8.8% by end 2011, which is subject to revision depending on movements in oil prices.

>> Increased food production in the North and East provinces and improved yields should cushion the country’s exposure to imported inflation on food items in the medium to long term although the country’s exposure to supply side shocks still remains significant with its sensitivity to global commodity prices such as petroleum imports. The property market is still relatively subdued and non-food

Government Finance (% of GDP) 2004 2005 2006 2007 2008 2009 2010E 2011E

Revenue and Grants 15.3% 16.8% 17.3% 16.6% 15.6% 15.1% 14.7% 14.8%

Tax revenue 13.5% 13.7% 14.6% 14.2% 13.3% 12.8% 12.8% 12.6%

Non tax revenue excl. Grants 1.4% 1.7% 1.7% 1.6% 1.6% 1.7% 1.6% 1.9%

Total expenditure 22.8% 23.8% 24.3% 23.5% 22.6% 24.9% 22.7% 21.8%

Current expenditure 18.6% 18.1% 18.6% 17.4% 16.9% 18.2% 17.1% 16.9%

Budget deficit -7.5% -7.0% -7.0% -6.9% -7.0% -9.9% -8.0% -7.0%

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and non-fuel inflation still remains under check reflecting unutilized capacity in the system although demand driven inflationary effects may begin to be evident towards the latter half of the year. The immediate concerns for this year however remain on supply side shocks from food as mentioned earlier and more significantly the impact on oil prices from recent events in the Middle East.

Interest Rates

>> Interest rates have continued to trend lower with the 1 yr T-bill and weighted average prime lending rate down to 7.33% and 9.12% from 9.47% and 10.83% respectively a year earlier. The Central Bank eased policy rates in January with the Central Banks’ repurchase rate brought down by 25bps to 7.00% and the reverse repo rate down by 50bps to 8.50%. With inflation trending higher we believe that interest rates have bottomed out and prime lending rates may rise by 50bps by year end with prospects of strong credit growth remaining intact.

External TradeExports>> Export earnings for the first 11 months of 2010 were up 15.4% stemming from industrial exports and agricultural exports. Industrial exports recorded a 13.6% growth on the back of exports of product categories such as boats and rubber products while garment exports increased by 3.7% in the same period. Much of the growth in the sector stemmed from agricultural exports which grew by 21.7% accounting for 25.2% of exports for the period. This was largely due to high tea and rubber prices.

>> The garment sector is expected to remain resilient despite the loss of the GSP + facility, aided by a modest recovery in key western markets and increasing labour costs in China and labour unrest in Bangladesh enhancing the local industries’ competitiveness. We expect exports to grow by 15.2% in CY10 and by 13.3% in CY11.

Imports>> Total imports for the first 11 months of 2010 were up 32.6% driven by a 45.2% increase in import of consumer goods and a 33.6% increase in intermediate goods. The increase in consumer goods was predominately a result of non-food consumer goods led by motor vehicles while the 33.6% increase in intermediate goods was a result of a value driven growth of 45.8% in petroleum imports. Continued import of non-food consumer goods such as consumer electronics and motor vehicles together with an increasing oil import bill and import of industrial input materials is expected to see imports grow by 18% in CY11.

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US$ M External Trade

Exports (US$ m) (LHS) Imports (US$ m) (LHS) Trade Balance (US$ m) (LHS) Exports (% of GDP) - (RHS) Imports (% of GDP) - (RHS) Trade Balance (% of GDP) - (RHS)

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364 day T Bill Yield (%) PLR (%)


Summary of External Trade In US$ m 2002 2003 2004 2005 2006 2007 2008 2009 2010E 2011E

Agricultural Exports 939 965 1,065 1,153 1,299 1,507 1,855 1,690 2,050 2,415

Industrial Exports 3,630 3,977 4,506 4,948 5,381 5,968 5,758 5,305 6,016 6,710

Mineral Exports 90 84 120 144 137 128 98 89 96 120

Other 41 108 66 102 70 38 - - - -

Total Exports 4,700 5,134 5,757 6,347 6,887 7,640 7,711 7,084 8,162 9,245

Consumer Good Imports 1,189 1,345 1,442 1,503 1,784 1,768 2,184 1,713 2,458 2,929

Intermediate Good Imports 3,522 3,949 4,828 5,458 6,161 6,751 8,719 5,928 7,965 8,815

Investment Good Imports 1,169 1,320 1,670 1,869 2,246 2,686 3,049 2,450 2,980 4,050

Other 125 60 61 33 65 92 139 115 160 170

Total Imports 6,005 6,674 8,001 8,863 10,256 11,297 14,091 10,206 13,563 15,964

Trade Balance (1,305) (1,540) (2,244) (2,516) (3,369) (3,657) (6,380) (3,122) (5,401) (6,719)

Trade Deficit>> The trade deficit is expected to have widened by 73% for CY10 as a result of a sharp rise in imports which contracted in 2009. Garment and textile exports which accounted for approximately 46% of total exports in 2010 is expected to grow at just 6% in 2011, with total exports expected to grow at 13.3%. Anticipated growth in imports of 18% driven by petroleum products and non food consumer goods is expected to result in the trade deficit expanding by 24% in 2011.

Remittances and External Reserves>> Net remittances have remained strong amounting to US$ 3.4bn for the first 11 months in 2010, a 24.6% increase over the previous year. Total net remittances are expected to amount to US$ 4.1bn CY11 substantially offsetting the trade deficit. Strong inflows to government securities in 2010 along with the sixth tranche of the IMF stand by facility have pushed gross official reserves to US$ 6.6bn, equivalent to 6 months of imports. Upto US$ 1.5bn has now been released by the IMF as part of a US$ 2.6bn stand by facility.

Exchange Rates>> The central bank has continued its stance of retaining a soft peg against the US$ which has prevented a sharper appreciation of the LKR against the US$. The local currency has appreciated by a marginal 0.03% against the US$ since the start of this year whilst depreciating by 2.67% and 1.99% against the Sterling and Euro respectively. Whilst we expect investment flows to remain strong in the current year the Central Bank is expected to continue to intervene to help exporters retain competitiveness and retain stability in the exchange rates

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7 Ju

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LKR/Unit of foreign Currency Exchange Rate Movement

US$ Sterling Euro


Summary of Economic Indicators 2003 2004 2005 2006 2007 2008 2009 2010E 2011E

GDP

GDP at current market Prices (Rs.b) 1,822 2,091 2,453 3,014 3,565 4,394 4,825 5,564 6,535

Per Capita GDP at current prices (US$) 981 1,059 1,237 1,450 1,655 1,949 2,063 2,424 2,833

GDP Growth (%) 6.0 5.5 6.2 7.7 6.8 6.0 3.5 8.0 8.1

Population

Mid year Population (m) 19.3 19.4 19.7 19.9 20.0 20.2 20.5 20.7 20.9

Government Finance (% of GDP)

Revenue and Grants 15.2 14.9 15.5 16.3 16.6 15.6 15.1 14.7 14.8

Expenditure 22.9 22.8 23.8 24.3 23.5 22.6 24.9 22.7 21.8

Budget Deficit (7.7) (7.9) (8.4) (8.0) (7.7) (7.0) (9.9) (8.0) (7.0)

Government Debt (% of GDP)

Domestic Debt 57.9 54.7 51.6 50.3 47.9 48.5 49.8 47.2 45.8

Foreign Debt 47.9 47.6 39.0 37.6 37.1 32.8 36.5 36.8 35.4

Total Debt Stock 102.3 102.3 90.6 87.9 85.0 81.4 86.2 84.0 81.2

Interest Rates & Inflation (%)

364 day T-bill (Year end) 7.2 7.6 10.4 13.0 20.0 19.1 9.3 7.6 7.8

AWDR (Year end) 5.3 5.3 6.2 7.6 10.3 11.6 8.0 6.2 6.5

AWPR 9.3 10.2 12.2 15.2 18.0 18.5 10.9 9.8 10.3

CCPI ( Annual average) 6.3 8.8 11.0 10.0 15.8 22.6 3.4 5.9 8.8

External Trade (US $ m)

Exports 5,133 5,757 6,347 6,887 7,640 8,111 7,084 8,162 9,245

Imports 6,672 8,001 8,863 10,256 11,297 14,091 10,206 13,563 15,964

Trade Balance (1,539) (2,244) (2,516) (3,369) (3,657) (5,980) (3,122) (5,401) (6,719)

Trade Account (Deficit)/Surplus (% of GDP) (8.2) (11.1) (10.3) (11.9) (11.3) (14.7) (7.4) (10.8) (11.4)

Current Account (Deficit)/Surplus (% of GDP) (0.4) (3.1) (2.7) (5.3) (4.3) (9.5) (0.5) (3.4) (3.9)

External Reserves ( months of imports) 4.2 3.3 3.7 3.3 3.7 2.2 4.7* 4.8* 5*

Year-end Exchange Rate (LKR/$) 96.7 104.6 102.1 107.7 108.7 113.1 114.4 111.2 110.6

* Excluding IMF Stand-By Facility Draw down


Market Overview and Strategy>> The ASPI has risen by 16.2% for the year to date on the back of a 96% increase in 2010 and a 280% increase since the end of the war. The recent upward movement in the ASPI is largely a result of strong retail and local HNI participation which has seen significant price movements in second tier and illiquid stocks not necessarily reflective of broad based healthy buying interest. Furthermore the more liquid MPI index that contains most heavily traded large cap counters has increased by just 2% this year and is still 8.43% off its peak in early October 2010.

>> Average daily turnover levels in the market have increased from 2.4bn in 2010 to Rs. 3.64bn year to date. Expectations of 50 – 60 new listings in 2011/2012 will push turnover levels even higher with small to mid-sized listings conducted during the year so far attracting overwhelming local interest. These proposed listings include a host of finance companies whilst a few sizeable state run entities as well as firms in the retail, logistics and construction space are expected to attract significant institutional interest.

>> The market has witnessed a fresh influx of new funds stemming from investors shifting money from low yield fixed income securities into equities. In addition the market has also experienced a sharp rise in credit driven investments. Last year witnessed a doubling of active trading accounts in the system with market velocity increasing from 26.3% in 2009 to 32.8% in 2010 and market capitalistaion to GDP rising to 41%.

>> Foreign participation in the market which amounted to 30% of turnover in 2009 has declined to 19% in 2010. Foreign selling in the market has increased in recent months with near term valuations looking less favourble in comparison to regional peers although Sri Lanka ranks more favourably in terms of a sustainable medium term earnings outlook. Several mid to large cap counters such as those in the Manufacturing and Banking sectors still hold sound medium to long term value with low double digit multiples.

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Turnover ASPI MPI

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Turnover ASPI MPI

(400) (360) (320) (280) (240) (200) (160) (120) (80) (40)

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120 160

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Rs. (Mn) AVERAGE NET FOREIGN INVESTOR PARTICIPATION

Average Net Foreign Investor Participation (LHS)

CountryPER (x) EPS Growth (%)

PBV (x)FY10 FY11E FY12E FY10 FY11E FY12E

China 19.2 14.7 12.3 N/A 30.9 19.4 2.9

Hong Kong 14.7 12.6 11.0 21.5 16.1 15.1 2.1

India 16.3 17.1 14.4 18.1 -4.7 19.2 3.2

Indonesia 19.7 13.9 11.6 22.3 41.8 19.9 3.2

South Korea 15.0 10.1 9.0 17.1 48.9 11.9 1.3

Malaysia 17.1 14.9 13.4 15.8 15.0 10.9 2.4

Phillipines 12.4 12.4 11.0 N/A 0.2 12.4 2.3

Singapore 11.9 14.0 12.8 10.8 -15.0 10.0 1.7

Taiwan 15.4 13.1 11.7 8.6 17.6 11.8 2.0

Australia 17.3 14.0 12.1 16.6 23.7 15.3 2.1

New Zealand 50.8 15.4 13.0 48.7 230.0 18.8 1.5

Sri Lanka 39.6 19.0 15.2 -5.2 108.0 24.8 2.4

Source : Bloomberg, & JKSB Research


Sectoral earnings prospects>> Corporate earnings growth has also been strong with expectations for a 108% yoy growth in earnings for the current Dec/Mar financial year as businesses benefit from low finance expense and increased capacity utilization. The increase in volume driven growth across most sectors has resulted in several listed entities crossing breakeven thresholds and returning to profitability. Increased volumes are driving core earnings higher whether it is excess liquidity in the banks being mopped up by sharp growth in private sector credit, or increased capacity utilization at manufacturing plants, higher occupancy levels at hotels or even a modest rise in minutes of use among mobile phone subscribers. The current December 2010 quarterly results for 192 companies reported filings thus far in the earnings season amount to 84% yoy growth. Earnings are also driven by lower finance expense which has helped drive increased private investment with private sector credit growth expanding by over 25% in 2010. Downward revisions in taxation will enhance earnings prospects further in tandem with increased volumes. Businesses will benefit from increased domestic demand in the medium but will also be required to invest in building scale and enhancing productivity in anticipation of new competition that is inevitably ushered in by an improved operating environment.

>> Sustained local retail buying interest in the market has pushed near term market multiples to 15.2x FY12E earnings, with aggressive buying on selected mid cap and speculative trading on illiquid counters having pushed the indices higher at an excessive pace thus far this year, warranting a modest correction. A medium term outlook of sustainable normalized earnings of approximately 25% should see the index trend higher over the medium to long term.

>> We remain bullish on the medium to long term earnings growth prospects of Manufacturing, Banking and Leisure stocks. The sharp earnings growth in the Telco and Energy sector is due to a recent return to profitability, while earnings growth in plantation stocks have been driven by steep appreciation in rubber prices caused by a significant drop in global supply.

>> The banking sector witnessed a sharp increase in credit growth over the 2H of 2010 with loan book expansion estimated to be 22.6% for 2010. The sharp loan growth helped push earnings higher for the sector in comparison to the previous year where bond trading gains augmented earnings. The outlook for credit expansion over the next three years is approximately 20-25% yoy given increased private investment and consumer spending. Net interest margins will moderate on account of competitive pressures and therefore would require more robust management of the asset/liability mix. Asset quality has improved significantly reflective of the lower credit default risk in the present environment. Increased recoveries has seen gross NPLs in the industry declining from 8.49% in 2009 to 5.33% as at end 2010 while provision cover the industry is estimated to have increased to 44.9%. A 15.6% growth in deposits has seen a steady shift towards low cost savings deposits on account of the narrow rate differential against term deposits. The reduction in corporate tax and financial VAT has resulted in effective tax rates for the banking sector declining from 60% to 45%. As a result average ROE at banks which ranged from 13% to 16% has increased to a range of 16% to 20% across the listed banks. This permits greater capital accumulation to fund aggressive loan book expansion. Scope for a further sharp improvement in ROE could potentially stem from consolidation in the sector in the medium to long term. Banks have also recently started to issue scrip dividends in favour of cash dividends in a bid to retain further Tier 1 capital. The collective result of these measures as well as the fact that most banks still exhibit a statutory liquidity ratio in excess of 25% means that banks are unlikely to require fresh capital infusions over the next 18mths. Government plans of a doubling of per capita GDP in the country by 2015 would effectively warrant a doubling of credit into


the economy and Commercial banks continue to be the dominant financial intermediary in the country. The country has a commercial bank branch per 29.4sq km, and a population to bank branch ratio of 4200 persons, including district co-operative rural bank branches. Whilst access to banking services is widely available actual credit penetration is still modest particularly in the personal and SME lending segment. Total licensed commercial bank advances amount to just over 25% of GDP.

>> The listed manufacturing sector entities are mostly oriented towards domestic market needs. With borrowing costs having sharply gone down over the last two years and improving revenues we have seen companies starting to improve utilization of their capacity. Thanks to belt tightening during the 2008/2009 period, reduced finance costs as well as scale economies from improved utilization has resulted in better margins on higher revenues leading to faster earnings growth. Construction in particular has boosted volumes sold of the cement and floor tiles companies, and both major floor tiles players have indicated higher capex for expansion.

>> The leisure sector recorded a 46% growth in arrivals last year, with the increase in arrivals pushing average occupancy to 67% in CY10 compared to 47% recorded in CY09. The 4QCY10 alone recorded over 200,000 tourists and an average occupancy of 74%. The South of Colombo is estimated to have enjoyed an occupancy of 92.8% in December 2010 while the North of Colombo recorded 86% in occupancy. Sri Lanka has a current capacity of 14,593 rooms, and requires a further 15,000 graded hotel rooms to achieve the industry’s 2016 target of 2.5mn visitors. The unlikelihood of sufficient room capacity coming on stream continues to be a key driver of medium term earnings prospects for the sector. Equally challenging for the sector apart from expanding the physical room capacity would be the ability to source and train the required skilled staff that would deliver service levels that can consistently demand increased rates. Most incumbents have already undertaken refurbishments of their existing properties while also commencing construction of newer properties. With increased demand for tourism coupled with stagnant room supply at least for another 1 – 2 years, we expect the local hoteliers to enjoy higher room rates along with greater occupancies. However, their ability to charge higher rates will very much depend on the quality of the product offered. More recently, the recent budget proposals have indicated an increase in the minimum room rate to US $ 125 for all 5 star properties across the country from April 2011. 5 star operators failing to charge the minimum rate will be charged a bed tax of US $ 20 per bed per night. This would collectively yield to consistently higher earnings growth rates for the sector in the medium term till such time significant additional room supply comes on stream.

Sector Price/Book Value (x)

ROE (%)

FY11E

PER (x) EPS Growth (%)

FY09 FY10 FY11E FY12E FY09 FY10 FY11E FY12E

Banking Finance & Insurance 2.85 16.24 29.8 22.4 17.6 14.0 (10.1) 33.2 27.6 25.2

Food & Beverage 4.98 33.24 22.1 20.6 15.0 12.5 9.8 6.9 37.6 19.8

Engineering 2.67 31.71 12.8 8.7 8.4 7.3 53.0 48.1 2.7 15.2

Conglomerates 3.05 11.82 38.6 30.5 25.8 18.2 (5.7) 26.5 18.2 41.7

Leisure 3.23 8.63 196.4 97.1 37.4 26.4 (49.6) 102.3 159.7 41.8

Manufacturing 3.21 20.02 35.9 23.8 16.0 12.9 (23.4) 50.9 48.4 24.1

Telecommunications 2.48 10.68 53.5 N/A 23.2 21.1 (74.1) (423.9) 171.1 9.9

Energy 1.79 14.06 N/A N/A 12.7 11.1 (152.9) 110.5 1972.9 14.9

Plantations 2.40 18.89 34.7 29.5 12.7 12.0 (61.9) 17.8 131.6 6.4

Trading and Others 3.07 20.94 101.9 36.2 14.7 11.6 (52.9) 181.9 146.2 26.0

Market 3.01 15.83 37.5 39.6 19.0 15.2 (30.8) (5.2) 108.0 24.8

* FY10 - Based on actuals; FY11E / FY12E excludes exceptional items (Prices as of 24th Feb. 2011)



Company Reviews


This document is published by John Keells Stock Brokers (Pvt.) Limited for the exclusive use of their clients. All information has been compiled from available documentation and JKSB’s own research material. Whilst all reasonable care has been taken to ensure the accuracy of the contents of this issue, neither JKSB nor its employees can accept responsibility for any decisions made by investors based on information contained herein.

>> Commercial Bank of Ceylon PLC (COMB) remains Sri Lanka’s leading private sector bank accounting for an estimated share of 13.8% of the country’s LCB assets and 13.1% of deposits. The bank has earned the reputation of being one of the best managed banks in the country and has grown aggressively since the 1980’s, after deciding to launch out as a nationwide bank from its early operations as a predominately corporate lender. Approximately 44% of the bank’s lending portfolio in Sri Lanka arises from the corporate sector while the growing retail and SME segment now accounts for 56% of advances. The bank operates 204 branches in Sri Lanka along with 333 ATM machines across the island with total assets of the bank currently amounting to Rs. 370bn.

>> COMB has also successfully ventured into Bangladesh where it has established a strong presence following the acquisition of the Bangladesh branch of Credit Agricole Indosuez in 2003. The bank has now expanded to 8 branches and a further 9 banking centres as dedicated SME and card centers and off shore banking units.

>> The operations in Bangladesh still carry a predominant corporate lending portfolio with assets accounting for over 10% of the bank’s total assets and approximately 13% of gross income in the group. The quality of its loan book in Bangladesh is reflected in the fact that it recorded zero NPL’s in the first 5 years of operations, and even at present NPL’s at its Bangladesh operations are close to nil. COMB’s investment in Bangladesh holds significant long term value given the difficulty in acquiring banking licenses in the country as well as extremely sound fundamentals displayed over the last 8 years.

Financial Performance>> The bank has recorded a 31.4% growth in earnings for FY10 benefiting from sound growth in advances of 26.3% particularly in the 2H. The bank is recovering strongly from a challenging period over 2008 and 2009 where the bank and the sector was buffeted by a high interest rate environment, high inflation and weakening economic conditions as the war intensified resulting in a reduction

Sri Lanka EquitiesCORPORATE UPDATEMarch 2011

John Keells Stock Brokers (Pvt) Ltd. A JKSB Research Publication

Yolan Seimon [email protected]

Commercial Bank of Ceylon PLCRs 273.00 BUYCOMB

Reuters Code COMB.CM

Bloomberg Code COMB.SL

Share Price LKR 273.00

Issued Share Capital (Shares)

*Voting 352,242,689

*Non Voting 24,181,195

12 mth High/Low (Rs.) - Voting 295 / 125.3

Average Daily Volume (Voting Shares) 499,948

Market Capitalisation (Voting) Rs. mn 96,162

Price Performance (%) - Voting

1 mth 6 mth 12 mth

ASPI 8.70 18.82 105.54

COMB (0.91) 10.08 117.88

* Adjusted for splits, bonus and rights issues

Valuation Metrics Dec 06A Dec 07A Dec 08A Dec 09A Dec 10A Dec 11E Dec 12E Dec 13E

Net Income (Rs. mn) 11,473 16,273 19,642 18,812 22,063 25,118 29,380 34,493

Pre-Provision Profit (Rs. Mn) 5,693 8,543 9,685 7,340 9,374 10,984 13,762 16,600

NPAT (Rs. mn) 2,718 4,037 4,119 4,192 5,508 6,930 8,684 10,569

EPS (Rs.) 7.2 10.7 10.9 11.1 14.6 18.4 23.1 28.1

EPS Growth % 27.7 48.5 2.0 1.8 31.4 25.8 25.3 21.7

PER (x) 37.8 25.5 24.9 24.5 18.7 14.8 11.8 9.7

P/BV 6.4 4.2 3.9 3.6 3.1 2.5 2.1 1.7

Dividend Yield % 1.8 2.6 2.6 2.6 2.6 2.6 2.6 2.6

DPS Rs. 5.0 7.0 7.0 7.0 7.0 7.0 7.0 7.0

NAV/Share 42.5 64.7 69.7 76.3 89.0 107.4 130.5 158.6

ROE 17.0 16.6 15.7 14.6 16.4 17.1 17.7 17.7

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COMB ADJUSTED PRICE - VOLUME GRAPH

Volume Price Rs.


in new business volumes and a contraction of its lending portfolio as seen across the sector. The bank nevertheless posted group earnings of Rs. 4.19bn in FY09 marginally up from Rs. 4.12bn in FY08 which included a capital gain of Rs. 405.5mn on its sale of a 30% stake it had in Commercial Leasing CO. PLC as well as a charge of Rs. 692.16mn to its income statement on account of oil hedging contracts for which it is yet to receive payment. The group ROAA stood at 1.6% for FY10 while ROAE for the group was 17.7%. We do anticipate at least a part reversal on the provisions made against the oil hedging contracts once arbitration proceedings are concluded.

>> High effective tax rates which were between 55% to 60% (35% Corporate Tax + 20% Financial VAT - on operating profit + personnel costs + economic depreciation) have been reduced with the 2011 budget proposals giving an immediate boost to ROE from FY11 onwards for the sector. Corporate tax rates of 35% have been reduced to 28% while the Financial VAT was reduced from 20% to 12%.

>> Gross NPL’s at the bank have declined to 4.22% as at end FY10 from a peak of 8.85% in June ’09 while provision cover is improving. Net interest margins have been sound at 4.74% rising over the last few quarters as the bank witnesses a steady shift from term deposits to low cost savings deposits. NIMs will however be under pressure given the relatively lower interest rate environment at present while the bank still displays excess liquidity with its domestic banking unit having a statutory liquid asset ratio of 29.9% as at end FY10 compared to a minimum regulatory requirement of 20%.

Loan Growth and Asset Quality>> Asset growth in the bank has recorded a 20.07% CAGR over the last five years prior to FY09 while its loan book has grown at a CAGR of 22.10% over the same period marginally above a 21.35% CAGR witnessed in the Sri Lankan banking sector in the same period. Asset growth in FY09 was 14.6% while the bank registered negative loan growth of 4.70% for FY09 with much of the deposits invested in government securities in the last year as demand for credit dried up. We expect the bank to post loan growth of 24% in FY11 onwards over medium having expanded by 26.6% in FY10. The bank’s personal banking division now accounts for 56% of total advances with the bank evolving from being an almost exclusive corporate lender in the 1980’s. The banks retail lending portfolio consists mainly of consumption and housing loans while the banks corporate loan portfolio is spread across key growth sectors of the economy without any significant over exposure in any segment.

2008 2009 2010

COMB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4Net Loans and Advances 177,815 177,136 177,831 171,727 173,591 165,999 166,329 171,727 172,220 174,793 192,916 216,815 QoQ Loan Growth -0.38% 0.39% -3.43% 1.09% -4.37% 0.20% 3.25% 0.29% 1.49% 10.37% 12.39%

Total Assets 278,931 276,183 282,246 281,567 287,879 300,787 311,157 322,546 334,563 338,172 364,614 370,258

Loan/Assets 64% 64% 63% 61% 60% 55% 53% 53% 51% 52% 53% 59%

Loan/Deposit 96% 92% 91% 86% 85% 77% 75% 73% 71% 72% 76% 83%

Net Provision and Recoveries Rs. 'mn 285 511 377 406 410 322 130 (275) (29) 105 196 (188)

QoQ Provision Expense Growth 80% -26% 8% 1% -21% -60% -312% 89% 456% 88% -195%

Gross NPL % 3.44 5.23 5.14 5.19 7.41 8.85 8.19 6.84 6.89 6.96 5.02 4.22

Net NPL % 1.88 3.53 3.35 3.35 4.94 6.65 5.92 4.89 4.97 5.05 3.36 2.78


>> The bank anticipates giving greater focus toward the high yield SME and micro enterprise sector in the medium term while also commencing activities in the pawning business in 2008 which is zero rated for capital adequacy purposes. We expect the bank’s NPL ratio to range from 4.2% to 4.3% in the medium term having declined to 4.22% by end FY10 from 8.85% in 2Q FY10. The 17.57% reduction in absolute NPLs over FY10 is reflective of lower credit default risk in the system in the present environment.

Funding and Capital>> Deposit growth for the bank has grown at a CAGR of 21.63% over the last 5 years and by 10.7% in FY10. The bank however continues to have a superior low cost deposit to total deposit ratio of 55% in comparison to other private commercial banks. A healthy surplus of low cost retail deposits over retail lending continues to help fund the banks corporate lending portfolio having a positive impact on cumulative interest margins. We expect COMB to grow its deposit base by 20% and 19.8% in FY11 and FY12 respectively.

>> The bank has a portfolio of longstanding branded savings products targeted at children, teens, seniors as well as working professionals which have helped the bank to cultivate its strong retail deposit base. The bank does have 8 branches in the North and East provinces and is expected to increase its presence in these regions giving a further boost to its savings deposit base.

>> The bank Tier 1 and Total capital adequacy ratios currently stands at 10.87% and 12.27% respectively. The bank has always successfully attracted funds via attractively priced rights issues over the years during periods when asset growth consistently exceeded ROE of the bank. Furthermore the bank has regularly raised finds via subordinated debt for Tier 2 capital. The bank’s capital adequacy is presently well above minimum requirements of 5% and 10% for Tier 1 and Total capital respectively.

Net Interest Income>> The sharp decline in yields on government securities have enabled banks to re-price its liabilities enabling banks to offset the negative impact on net interest margins caused by the adverse volume variance in the sector. One year treasury bills have fallen from 19.12% in early FY08 to a current rate of 7.33% which has spurred a downward revision on deposit rates. Commercial lending rates have also declined with prime lending rates to 9.59%. We expect net interest margins to moderate over the medium term to 4.5% while the resilience of the banks margins should

2008 2009 2010

COMB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4CASA Rs. 'mn 89,632 89,527 87,954 87,886 89,787 95,567 102,027 112,681 122,625 127,745 136,858 142,823 Total Deposits Rs. 'mn 186,099 191,498 195,797 199,865 204,281 215,714 223,190 234,731 241,340 242,241 252,562 259,745

CASA 48% 47% 45% 44% 44% 44% 46% 48% 51% 53% 54% 55%

QoQ CASA Growth 0% -2% 0% 2% 6% 7% 10% 9% 4% 7% 4%

QoQ Deposit Growth 3% 2% 2% 2% 6% 3% 5% 3% 0% 4% 3%

Deposits/Liabilities 73% 76% 76% 68% 78% 79% 79% 80% 79% 79% 76% 77%

Tier 1 CAR % 9.5 9.8 9.6 10.6 10.5 10.8 10.9 11.9 11.7 11.6 10.8 11%

Total CAR % 12.4 12.5 12.4 13.1 13.1 13.4 13.5 13.9 13.7 13.4 12.5 12%

SLR Domestic Banking Unit 22% 23% 23% 25% 28% 33% 37% 39% 39% 39% 36% 30%

SLR Off Shore Banking Unit 29% 27% 23% 22% 26% 37% 26% 28% 35% 30% 28% 31%


continue given its active promotion of its low cost savings deposits as well as its increased exposure to retail lending.

Non-Interest Income>> Non-interest income has consistently accounted for around 30% of total net income of the bank over the last 5 years. A stable exchange rate has however meant lower foreign exchange income while fee income from trade finance as becoming increasingly competitive. ATM fees however still remain strong accounting for nearly a fifth of total fee based income. The bank has aggressively pursued channeling the flow of worker remittances into the country and it has increased its share of formal inward remittances to a current 13% from 9% in 2007. Remittance houses established in Europe and the Far East as well as expansion of activities in the Middle East under the brand ‘Commex’ is expected to contribute to gains on foreign exchange income although at resent adversely affected by an appreciation of the LKR against the US$.

Operating Expenses>> COMB continues to record one of the lowest cost to income ratios among the local banks. Scale benefits from its size as well as constant re-engineering and rationalization of internal processes with the increased adoption of technology in its processes is expected to continue to register an incremental decline in costs going forward.

Valuations>> Earnings growth forecasts of 25.8% in FY11E and 25.3% in FY12E following the tax revisions correspond to a PER of 14.8x and 11.8x respectively at Rs. 273. The counter trades at a P/BV 3.07x, based on the NAV as of 30th December 2010. The counter trades at a slight premium to the sector. Given that the bank has consistently exhibited sound fundamentals and is well positioned to further consolidate its market position in Sri Lanka while having strong medium to long term prospects in the region, it is our view that the counter ought to continue to trade at a premium to the sector. We recommend BUY.

2008 2009 2010

COMB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4Fee Income / Operating Income 30% 35% 31% 32% 37% 40% 32% 29% 27% 26% 25% 26%

2008 2009 2010

COMB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4Operating Expenses (Excl VAT) 1,713 1,762 1,949 2,409 2,081 2,075 2,170 2,501 2,351 2,298 2,376 2,940 Cost / Income (Excl VAT) 40% 37% 41% 46% 45% 44% 49% 49% 48% 45% 41% 47%

Branches 174 174 176 181 181 183 184 184 190 196 201 204

Employees 3807 3960 3983 4041 4099 4075 4088 4074 4119 4148 4233 4291

Employees per branch 22 23 23 22 23 22 22 22 22 21 21 21

2008 2009 2010

COMB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4NIM 4.39 4.47 4.53 4.68 4.18 4.00 3.98 4.11 4.43 4.53 4.57 4.74Net Interest Income Rs. 'mn 2,992 3,078 3,283 3,531 2,942 2,846 3,047 3,590 3,574 3,819 4,322 4,668


Ratio Analysis 2005 2006 2007 2008 2009 2010E 2011E 2012E

Price / Book Value 6.4 4.2 3.9 3.6 3.1 2.5 2.1 1.7 EPS 7.2 10.7 10.9 11.1 14.6 18.4 23.1 28.1 PER 37.8 25.5 24.9 24.5 18.7 14.8 11.8 9.7 EPS Growth 27.7% 48.5% 2.0% 1.8% 31.4% 25.8% 25.3% 21.7%DVD YLD 2.2% 2.2% 2.2% 2.2% 2.2% 2.2% 2.2% 2.2%ROE 17.0% 16.6% 15.7% 14.6% 16.4% 17.1% 17.7% 17.7%ROAE 17.0% 20.0% 16.3% 15.3% 17.7% 18.7% 19.4% 19.4%ROAA 1.3% 1.6% 1.5% 1.4% 1.6% 1.7% 1.8% 1.9%NIM 3.7% 4.6% 5.0% 4.3% 4.7% 4.7% 4.6% 4.5%Fee Income / Operating Income 36% 29% 34% 34% 26% 27% 29% 29%Cost / Income 50.4% 47.5% 50.7% 61.0% 57.5% 56.3% 53.2% 51.9%Cost / Income (Excl VAT) 41.9% 38.0% 40.0% 48.9% 46.0% 45.0% 42.5% 41.5%Cost / Average Assets 2.86% 3.14% 3.62% 3.80% 3.66% 3.51% 3.29% 3.18%Tier 1 7.62% 10.00% 10.55% 11.92Loan Growth 26.8% 15.8% 3.5% -7.0% 26.4% 24.0% 24.1% 24.2%Asset Growth 24.4% 19.8% 4.9% 14.6% 14.8% 17.5% 18.4% 18.6%RWA Growth 33% 21% 5% 15% 15% 18% 18% 19%Loan/ Deposits 95.5% 95.1% 90.2% 71.4% 81.5% 84.3% 87.3% 90.5%Loan / Assets 67.1% 64.9% 64.0% 52.0% 57.2% 60.4% 63.3% 66.3%Deposit / Liabilities 75.7% 75.0% 78.3% 79.9% 77.1% 79.0% 80.1% 81.2%Equity / Assets 7.1% 9.1% 9.3% 8.9% 9.1% 9.3% 9.5% 9.8%NPL Ratio 2.79% 3.02% 5.33% 6.84% 4.22% 4.30% 4.25% 4.20%NPL Coverage 60.4% 67.5% 51.5% 44.0% 32.8% 53.0% 53.0% 52.0%

Income Statement 2006 2007 2008 2009 2010E 2011E 2012E 2013E

For the Year Ended 31st December Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mnIncome 23,418 35,207 43,960 42,305 40,379 47,244 59,871 70,752 Interest Income 19,302 30,521 37,213 35,914 34,689 40,401 51,491 60,897 Less: Interest Expense 11,945 18,934 24,318 23,493 18,316 22,125 30,491 36,259 Net Interest Income 7,357 11,587 12,896 12,421 16,374 18,276 21,000 24,638 Foreign exchange profit 1,439 1,545 2,633 2,962 1,741 1,828 2,011 2,212 Fee and commisison income 2,011 2,382 2,715 2,228 2,533 3,217 4,085 4,902

Other Income 665 760 1,398 1,200 1,416 1,798 2,283 2,740 Net Income 11,473 16,273 19,642 18,812 22,063 25,118 29,380 34,493 Less Operating ExpensesPersonnel Costs 2,566 3,284 3,665 4,664 5,270 6,008 6,643 7,640 Premises and Equipment expenses 1,384 1,600 1,996 2,176 2,472 2,780 3,086 3,549 Provision for staff retirement benefits - 269 293 450 359 402 451 505 Loan losses and Provisions 655 1,777 2,278 214 84 1,086 1,358 1,503 Total Expenses (6,435) (9,507) (12,235) (11,686) (12,773) (15,221) (16,976) (19,395)Profit from Operations 5,038 6,766 7,407 7,126 9,290 9,898 12,404 15,098 Add: Share of PBT of Assoc. 62 25 9 4 11 12 14 16 Profit before Tax 5,101 6,791 7,416 7,130 9,301 9,910 12,418 15,114 Less: Provision for Taxation 2,150 2,638 3,296 2,937 3,791 2,973 3,725 4,534 Profit after taxation 2,951 4,152 4,120 4,193 5,510 6,937 8,693 10,580 Less: Minority Interest 3 3 2 1 3 7 9 11

Net profit for the year 2,948 4,149 4,119 4,192 5,508 6,930 8,684 10,569 Cum. Red. Pref. Shares 13% 117.78

Cum. Red. Pref. Shares 11.25% 112.50 112.50

NPAT, MI & Pref. Dividend 2,718 4,037 4,119 4,192 5,508 6,930 8,684 10,569


Balance Sheet 2006 2007 2008 2009 2010E 2011E 2012E 2013E

As at 31st December Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mnASSETSCash and short-term funds 13,731 16,208 24,115 29,260 10,673 11,740 12,914 14,205 Balances with Central Banks 12,574 11,576 10,322 11,795 12,189 17,176 27,286 36,003 Government Treasury Bills and Bonds 12,222 41,266 35,598 70,518 99,744 104,731 106,826 110,030 Commercial paper 423 - - - - - - - Sec. purchased under re-sale agreements 4,593 3,804 3,400 8,523 14,797 15,537 16,313 17,129

Dealing Securities 145 207 58 81 283 312 343 377 Investment securities 1,795 1,756 1,197 1,025 2,366 2,720 3,129 3,598 Treasury Bonds Maturing after one year 20,025 8,795 16,270 17,630 - - - - Bills of Exchange 3,288 3,195 3,059 2,964 5,396 5,503 5,613 5,726 Loans and Advances 137,720 160,177 167,795 158,036 195,619 244,523 305,654 382,068 Lease rec. within one year 3,007 3,562 3,009 2,653 3,184 3,725 4,359 5,100 Lease rec. from one to five years 6,415 7,238 6,335 3,980 7,617 8,912 10,427 12,200 Investment in Assoc. 41 63 71 73 80 96 96 96 Interest and Fees receivables 1,639 2,120 2,341 4,093 4,353 4,875 5,460 6,115 Other Assets 3,006 4,041 3,654 6,802 7,370 7,959 8,596 9,283 Property, Plant and Equipment 3,438 3,997 4,343 5,113 6,589 7,380 8,265 9,257

TOTAL ASSETS 224,061 268,385 281,567 322,546 370,258 435,191 515,282 611,189 Financed By : - - - - - - - - Deposits form customers 157,532 183,088 199,865 234,731 259,745 311,694 373,453 447,529

Dividends Payable 113 113 - - - - - -

Borrowings 18,944 18,752 13,620 11,639 14,371 17,533 21,039 25,247

Sec. sold under repurchase agreements 14,317 23,238 24,960 29,773 45,659 50,681 56,256 62,445

Other Liabilties 8,402 9,741 10,094 12,242 11,370 11,711 12,062 12,424

Tax Payable 1,420 1,679 1,663 1,211 2,455 3 3 -

Deferred Taxation 625 712 676 767 993 1,390 1,946 2,724

Debentures 6,680 6,680 4,436 3,436 2,127 1,702 1,361 1,089 208,033 244,004 255,314 293,799 336,719 394,712 466,120 551,457

Minority Interest 11 24 27 26 27 36 36 36

SHAREHOLDERS FUNDSShare Capital 2,428 3,491 2,524 2,524 2,524 2,524 2,524 2,524

Statutory Reserve Fund 1,429 1,634 1,848 2,062 2,339 2,477 2,651 2,862

Reserves 12,159 19,233 21,854 24,135 28,650 35,442 43,952 54,310

Shareholders Funds 16,016 24,358 26,226 28,721 33,513 40,443 49,127 59,696 TOTAL LIABILITIES AND SHAREHOLDERS FUNDS 224,061 268,385 281,567 322,546 370,258 435,191 515,282 611,189

John Keells Stock Brokers (Pvt) Ltd. 130 Glennie Street Colombo 2 Sri Lanka T. 9411 2306 250, 9411 2342 066-7 F. 9411 2342 068 www.jksb.com Company No. PV 89

Voting Rs 400.00; Non-Voting Rs 216.00 Long Term Buy

>> Hatton National Bank PLC (HNB) is the second largest private bank in the country with an estimated 11.5% share of LCB assets, ranked closely to its peer Commercial Bank of Ceylon PLC in terms of banking assets and branch network. The bank has 196 banking centres across the island providing corporate and retail banking, along with trade and project finance services. The banks subsidiaries include Insurance, a Joint Venture investment in a Stock broking and Investment Banking firm while also functioning as a Primary Dealer for Government Securities. Contributions from these entities are relatively small. HNB is also the third largest issuer of credit cards in the country behind the two foreign banks HSBC and Standard Chartered Bank.

>> HNB has consistently exhibited a strong retail presence in the country while fundamentals have improved considerably over the last five years. The bank’s retail presence is well entrenched with a widely recognized portfolio of branded low cost savings deposit products as well as a strong

remittance business apart from being a leading player in corporate and project lending by virtue of its size.

Financial Performance>> The bank recorded a 10% yoy cumulative earnings growth for the 3Q FY10 on the back of moderate growth in net interest income that stemmed from a slow pick up in loan disbursements at the bank last year. Loan book growth for the 9month period was just 9% although it is expected to pick up significantly in 4Q FY10 and in FY11. Fee based income continued to drive non-interest income higher while foreign exchange income was flat for the period on account of a stable exchange rate. Operating expenses increased by 14% yoy while a sharp rise in recoveries as seen across the sector together with lower provision expense resulted in an 11% increase in operating profits. Non performing loans at the bank increased by a modest 5% in absolute terms while the gross and net NPL ratio declined marginally to 5.94% and 2.06% respectively. The bank which consistently benefited from tax losses over the last few years has





Hatton National Bank PLC

HNBReuters Code HNB.CM

Bloomberg Code HNB.SL

Share Price LKR (Voting) 400.00


*Voting 191,253,773

*Non Voting 46,692,433

12 mth High/Low (Rs.) - Voting 417 / 175.00

Average Daily Volume (Shares)- Voting 402,430

Market Capitalisation (Voting) Rs. mn 76,502

Price Performance (%)

1 mth 6 mth 12 mth

ASPI 8.70 18.82 105.54

HNB 0.00 20.48 128.57 * Adjusted for splits, bonus and rights issues

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Volume Price HNB ADJUSTED PRICE - VOLUME GRAPH

Volume Price Rs.

Valuation Metrics Dec 06A Dec 07A Dec 08A Dec 09A Dec 10E Dec 11E Dec 12E Dec 13E

Net Income (Rs. mn) 12,425 15,946 18,438 21,036 22,388 26,181 31,061 36,677

Pre-Provision Profit (Rs. Mn) 3,482 5,008 5,287 6,983 7,318 9,278 11,255 13,743

NPAT (Rs. mn) 2,239 3,150 2,831 4,483 4,306 5,916 7,275 8,902

EPS (Rs.) 9.4 13.2 11.9 18.8 18.1 24.9 30.6 37.4

EPS Growth % 26.5 40.7 -10.2 58.4 -4.0 37.4 23.0 22.4

PER (x) 42.5 30.2 33.6 21.2 22.1 16.1 13.1 10.7

P/BV 7.4 4.5 4.2 3.6 3.3 2.8 2.4 2.1

Dividend Yield % 1.3 1.3 1.0 1.6 1.6 1.6 1.6 1.6

DPS Rs. 5.0 5.0 4.0 6.5 6.5 6.5 6.5 6.5

NAV/Share 54.3 89.5 96.3 110.8 122.8 141.4 164.7 194.7

ROE % 17.3 14.8 12.3 17.0 14.7 17.6 18.6 19.2


begun to witness a moderate increase in effective tax rates gradually nearing parity with the industry. NIMs still remain strong at 5.28% largely a result of its retail exposure in lending and low cost deposits.

Loan Book and Asset Quality>> HNB witnessed a 4% contraction in the bank’s loan portfolio stemming from high interest rates and depressed economic conditions in early FY09. We anticipate a loan growth of 17.9% in FY10 increasing incrementally to 22% post FY12 for HNB. The bank added 9 branches in FY09 and a further 12 branches in FY10, a bulk of which were added to boost its network in the North and East provinces which already has 21 branches.

>> Investments made in integrating its systems across its network of banking centres has strengthened follow up and credit risk monitoring over the past two years. In addition, more resources and greater proficiency has been brought into credit risk management over the last 4 years which has contributed to a healthier loan book. HNB also has a strong presence in SME and Micro Finance lending although neither segments are particularly well developed in the country yet. Micro-finance lending accounts for a little over 1% of the bank’s lending portfolio at present. Emphasis on recoveries, follow up and rescheduling of bad debts has resulted in a decline in the NPL ratio and a subsequent decline in provisioning expense. The banks gross NPL ratio declined to 5.94% in Sept. FY10 from 8.73% in Jun FY09 and is likely to improve further to 5.25% in FY10 and 4.5% in FY11 along with incremental improvements in provision cover.

Funding and capital>> Customer deposits are principally HNB’s core source of funding with approximately 89.7% of interest bearing liabilities being customer deposits as of Sept. FY10. Low cost demand and savings deposits account for 8.2% and 42.9% of total deposits as at Sept. FY10. Customer deposits grew 13% in FY09 and are expected to grow by 5.9% in FY10 and 14.6% in FY11. We do not foresee a significant change in the banks deposit mix over the medium term. The bank’s Tier 1 and Total capital stood at 10.49% and 12.25% respectively as at 30th September 2010, well above minimum statutory requirements of 5% and 10% respectively.

2008 2009 2010

HNB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3Net Loans and Advances Rs. ‘mn 154,724 155,270 159,526 173,145 166,497 162,949 168,459 167,095 164,399 170,103 181,515 QoQ Loan Growth 0.35% 2.74% 8.54% -3.84% -2.13% 3.38% -0.81% -1.61% 3.47% 6.71%

Total Assets Rs. ‘mn 241,414 247,748 256,585 261,990 267,714 274,101 276,152 287,511 289,396 295,179 304,594

Loan/Assets 64% 63% 62% 66% 62% 59% 61% 58% 57% 58% 60%

Loan/Deposit 88% 87% 87% 92% 86% 81% 83% 78% 77% 79% 82%

Net Provision and Recoveries Rs. 'mn 177 247 156 276 71 166 66 (339) 49 10 37

QoQ Provision Expense Growth 39% -37% 77% -74% 135% -60% -613% 115% -80% 264%

Gross NPL % 6.74 7.62 7.13 6.72 8.17 8.73 8.44 6.15 7.4 6.48 5.94

Net NPL % 2.18 2.89 2.53 2.27 3.48 3.86 3.67 2.9 4.11 3.3 3.09


Net Interest Income>> The bank maintained healthy net interest margins of 5.28% as of 3Q FY10 largely due to its significant exposure to low cost deposits as well as a sound maturity match of assets and liabilities. We expect net interest margins to decline marginally given the comparatively lower interest rate regime the country is entering into. The bank will however continue to enjoy above average NIMs given the banks strong low cost retail deposit base and its exposure to retail lending.

Non-Interest Income>> Non-interest income has consistently contributed nearly 1/3 of total income over the past few years, arising primarily out of fees and commissions for trade finance activities. The bank witnessed a moderate growth of just 9% in non-interest income in FY09. Increase in exposure to consumer lending as well as an upturn in general economic activity is expected to boost external trade which would filter down to increased fees and commissions. The bank is also expected to record an increase in foreign exchange income via it’s inward remittance business following the opening of exchange houses in Canada and the Middle East. The bank is estimated to have a 17% market share in the formal remittance market in the country, the highest among private commercial banks.

Operating Expenses>> HNB’s Cost to Income ratio declined moderately over the last 4 years. The bank has added nearly 50 branches over the last 4-5 years whilst retaining if not marginally reducing its staff cadre. The bank’s branch expansion going forward will have an average of just 7 personnel. The operational efficiencies have been complemented by the launch of a core banking software solution, from Finnacle, which has integrated the bank’s entire network facilitating the roll out of new branches and improving credit monitoring and follow up.

2008 2009 2010

HNB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3CASA Rs. 'mn 82,752 81,587 81,886 82,929 82,208 85,271 88,996 97,021 102,711 107,756 113,084 Total Deposits Rs. 'mn 175,462 177,788 182,707 188,178 193,190 201,225 203,812 213,819 214,473 216,369 221,258

CASA 47% 46% 45% 44% 43% 42% 44% 45% 48% 50% 51%

QoQ CASA Growth -1% 0% 1% -1% 4% 4% 9% 6% 5% 5%

QoQ Deposit Growth 1% 3% 3% 3% 4% 1% 5% 0% 1% 2%

Deposits/Liabilities 80% 79% 78% 79% 79% 81% 81% 82% 82% 81% 80%

Tier 1 CAR % 7.9 8.9 8.3 8.9 8.6 8.5 9.5 10.9 10.2 10.1 10.3

Total CAR % 10.3 11.4 10.4 11.1 10.7 10.6 11.6 12.9 12.2 12.0 12.2

SLR Domestic Banking Unit 21% 21% 22% 22% 24% 26% 25% 29% 30% 29% 27%

SLR Off Shore Banking Unit 23% 26% 21% 22% 22% 23% 24% 24% 24% 21% 26%

2008 2009 2010

HNB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3NIM 5.19 5.1 5.08 5.24 5.28 5.39 5.44 5.45 5.16 5.27 5.28Net Interest Income Rs. 'mn 2,967 2,953 3,042 3,580 3,402 3,606 3,702 3,822 3,661 3,863 3,933

2008 2009 2010

HNB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3Fee Income / Operating Income 30% 35% 33% 26% 26% 31% 30% 26% 28% 34% 34%

2008 2009 2010

HNB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3Operating Expenses (Excl VAT) Rs.’mn 2486 2671 2669 2944 2891 2969 3240 2874 3306 3400 3689Cost / Income (Excl VAT) 59% 59% 59% 61% 63% 57% 61% 56% 65% 58% 62%

Branches 169 171 173 177 178 178 180 186 187 189 196

Employees 4269 4310 4341 4395 4367 4334 4334 4302 4270 4280 4281

Employees per branch 25 25 25 25 25 24 24 23 23 23 22


Valuations>> HNB has exhibited strong fundamentals over the last three years with a healthier loan book, improved provision cover and enhanced profitability. Earnings growth expectations of -4.0% in FY10 over the previous year which included several exceptional items and 37.4% in FY11 correspond to a forecast PER of 22.1x and 16.1x FY10 and FY11 earnings respectively at a market price of Rs. 400.00. Earnings expectations for FY11 include a reduction in effective tax rates. The counter currently trades at a P/BV of 3.34x as at end September 2010. We recommend the counter as a Long Term BUY.

Income Statement 2007 2008 2009 2010E 2011E 2012E 2013E

For the Year Ended 31st December Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mnIncome 32,076 38,725 41,317 41,144 47,966 55,911 65,883 Interest Income 27,127 32,830 34,836 33,058 37,800 43,251 50,558 Less: Interest Expense 16,130 20,287 20,281 18,757 21,785 24,850 29,206 Net Interest Income 10,996 12,542 14,555 14,301 16,015 18,401 21,352 Foreign exchange profit 1,115 1,169 920 1,058 1,186 1,364 1,568 Fee and commisison income 2,122 2,435 2,355 2,874 3,592 4,311 5,086

Other Income 1,712 2,292 3,206 4,155 5,388 6,986 8,670 Net Income 15,946 18,438 21,036 22,388 26,181 31,061 36,677 Less Operating ExpensesPersonnel Costs 3,430 3,831 4,446 4,980 5,627 6,584 7,703 Premises and Equipment expenses 1,859 2,184 2,649 2,940 3,323 3,755 4,318 Provision for staff retirement benefits 4,740 5,717 6,243 6,992 7,784 9,001 10,404 Loan losses and Provisions 457 795 823 865 908 953 1,144 Other Overhead expenses 908 1,159 709 142 153 451 493 Total Expenses (11,396) (13,947) (14,877) (15,934) (17,811) (20,759) (24,078)Profit from Operations 4,550 4,492 6,159 6,453 8,370 10,302 12,599 Add: Share of PBT of Assoc. 14 (6) 8 24 27 34 42 Profit before Tax 4,565 4,485 6,167 6,477 8,397 10,336 12,641 Less: Provision for Taxation 1,365 1,599 1,613 2,073 2,351 2,894 3,540

Profit after taxation 3,200 2,886 4,553 4,405 6,046 7,442 9,102 Less: Minority Interest 49 55 70 99 130 167 200

Net profit for the year 3,150 2,831 4,483 4,306 5,916 7,275 8,902

Ratio Analysis 2007 2008 2009 2010E 2011E 2012E 2013E

Price / Book Value 4.5 4.2 3.6 3.3 2.8 2.4 2.1

EPS 13.2 11.9 18.8 18.1 24.9 30.6 37.4

PER 30.2 33.6 21.2 22.1 16.1 13.1 10.7

EPS Growth 40.7% -10.2% 58.4% -4.0% 37.4% 23.0% 22.4%

DVD YLD 1.3% 1.3% 1.3% 1.3% 1.3% 1.3% 1.3%

ROE 14.8% 12.3% 17.0% 14.7% 17.6% 18.6% 19.2%

ROAE 18.4% 12.8% 18.2% 15.5% 18.8% 20.0% 20.8%

ROAA 1.4% 1.1% 1.6% 1.4% 1.8% 1.9% 2.0%

NIM 5.18% 5.51% 5.94% 5.32% 5.18% 5.15% 5.09%

Fee Income / Operating Income 31% 32% 31% 36% 39% 41% 42%

Cost / Income 65.8% 69.4% 67.4% 70.5% 67.4% 65.4% 64.3%

Cost / Income (Excl VAT) 57.8% 61.4% 56.0% 61.9% 58.9% 55.9% 55.0%

Cost / Average Assets 4.69% 5.08% 5.16% 5.31% 5.39% 5.43% 5.43%

Tier 1 10.32 8.93 10.85Loan Growth 24.6% 8.9% -3.5% 13.9% 17.9% 19.9% 21.9%

Asset Growth 16.6% 8.7% 9.7% 7.0% 13.0% 15.3% 16.8%

RWA Growth 23% 14% 10% 7% 13% 15% 17%

Loan/ Deposits 90.4% 92.7% 79.3% 85.2% 88.7% 91.5% 94.6%

Loan / Assets 65.9% 66.0% 58.0% 61.7% 64.4% 67.0% 69.9%

Deposist / Liabilities 80.0% 78.2% 80.7% 80.2% 80.5% 81.2% 82.1%

Equity / Assets 8.8% 8.7% 9.2% 9.5% 9.7% 9.8% 9.9%

NPL Ratio 6.11% 7.12% 6.47% 5.25% 4.50% 4.00% 3.50%

NPL Coverage 67.4% 59.7% 45.8% 51.0% 52.0% 53.0% 54.0%


Balance Sheet 2007 2008 2009 2010E 2011E 2012E 2013E

As at 31st December Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mnASSETSCash and short-term funds 19,275 23,560 27,489 22,266 26,719 32,063 36,872 Balances with Central Banks 13,406 11,862 11,079 10,843 11,927 13,120 14,432 Government Treasury Bills and Bonds 1,156 759 306 352 404 465 535 Commercial paper 236 236 283 325 374 430 495 Sec. purchased under re-sale agreements 5,859 2,539 951 1,093 1,257 1,446 1,663

Dealing Securities 712 81 688 770 863 966 1,082 Investment securities 20,978 26,971 55,848 58,082 55,758 55,201 54,649 Bills of Exchange 2,069 1,959 1,476 1,506 1,536 1,566 1,598 Loans and Advances 143,415 159,462 156,392 178,287 210,378 252,454 307,994 Lease receivable within one year 4,396 4,392 3,931 4,481 5,288 6,346 7,742 Lease receiveable from one to five years 8,894 7,097 5,013 5,715 6,744 8,092 9,873 Investment in Assoc. 165 144 226 271 326 391 469 Other Assets 7,048 8,274 8,788 8,048 9,744 11,153 13,043 Property, Plant and Equipment 13,182 13,901 14,333 15,050 15,802 16,592 17,422 TOTAL ASSETS 241,003 261,990 287,511 307,727 347,695 400,802 468,332 Financed By :Deposits form customers 175,567 186,615 210,363 222,970 252,614 293,401 346,056 Dividends Payable 30 127 216 - - - -

Borrowings 18,257 25,050 17,998 20,158 22,576 25,286 28,320 Non Life Ins. reserves & Long Term Ins. Funds 1,221 1,831 2,453 2,747 3,077 3,446 3,860

Other Liabilties 16,606 18,074 23,139 25,916 29,026 32,509 36,410 Tax Payable 1,605 2,416 2,977 3,335 3,735 4,183 4,685 Deferred Taxation 608 873 938 1,051 1,177 1,318 1,477 Debentures 5,589 3,735 2,653 1,990 1,492 1,119 839

219,483 238,721 260,738 278,166 313,697 361,262 421,646 Minority Interest 220 348 400 348 348 348 348 SHAREHOLDERS FUNDSStated Capital 2,355 5,059 5,084 5,084 5,084 5,084 5,084 Statutory Reserve Fund 822 983 1,260 1,556 1,920 2,098 2,333 Reserves 18,123 16,879 20,030 22,573 26,647 32,011 38,921 Shareholders Funds 21,300 22,921 26,374 29,213 33,650 39,193 46,338 TOTAL LIABILITIES AND SHAREHOLDERS FUNDS 241,003 261,990 287,511 307,727 347,695 400,802 468,332



Rs 293.00 BUY


>> SAMP is the fastest growing bank among the larger private banks in the country with an estimated 7.11% share of LCB assets as at end 2010. SAMP has a 100% stake in both Sampath Surakum Ltd, a Primary Dealer in Government Securities, and Sampath Leasing and Factoring Ltd. In addition the bank has a 51% stake in S.C Securities (Pvt) Ltd, a mid-sized share broking company.

>> New senior management at the bank since late 2008 has set out an explicit objective of becoming the largest private bank in the country. The bank has since witnessed a significant improvement in core fundamentals, size and growth rates. SAMP has grown from just 122 branches as at end 2008 to 180 branches as at end 2010, including 40 branches opened in FY10. The largest branch expansion undertaken by an entity in the history of the local banking industry. SAMP now has the largest footprint among local private banks in the North and East with 12 and 14 branches respectively after entering the region following the

end of the civil conflict. The branches in these areas are a net lender account for advances of approximately Rs. 5bn or 4% of the bank’s loan book and approximately Rs. 4bn in deposits. SAMP expects to add a further 20 branches across the island this year bringing it in line with the two larger local private banks.

>> The fact that SAMP is a fairly new bank with just a 24 year history meant it was quick to adopt new technology being the first local private bank to use a core banking software solution, ATM’s etc. and therefore did not carry with it legacy processes and as a result has grown its branch network with an employee to branch ratio for the group of just 15.8 compared to an average of 21.2 among the two larger local private banks.

>> A centralized credit model initiated under the new management has proved a success. Under this model disbursements are approved by 20 regional centres that house senior staff with specialized expertise in credit evaluation, while responsibility for




Sampath Bank PLC

SAMP

Reuters Code SAMP.CM

Bloomberg Code SAMP.SL


Voting 152,807,972

12 mth High/Low (Rs.) 303.00 / 101.00

Market Capitalisation (Rs.mn) 44,773

Average Daily Volume (Shares) 322,114


1 mth 6 mth 12 mth

ASPI 8.70 18.82 105.54

SAMP 1.03 35.84 186.41


Valuation Metrics Dec 05A Dec 06A Dec 07A Dec 08A *Dec 09A **Dec 10A ***Dec 11E Dec 12E Dec 13E

Net Income (Rs. mn) 4,932 6,632 7,554 9,567 12,088 13,549 14,866 17,609 21,065

Pre-Provision Profit (Rs. Mn) 2,043 2,849 3,216 3,453 4,234 5,455 6,121 7,487 9,312

NPAT (Rs. mn) 854 1,072 1,145 1,495 2,072 3,484 3,901 4,695 5,663

EPS (Rs.) 5.6 7.0 7.5 9.8 13.6 22.8 25.5 30.7 37.1

EPS Growth % 25.5 6.8 30.6 38.6 68.1 12.0 20.3 20.6

PER (x) 52.4 41.8 39.1 30.0 21.6 12.8 11.5 9.5 7.9

P/BV 7.5 6.4 4.7 4.1 3.6 2.7 2.2 1.8 1.4

Dividend Yield % 0.7 0.9 1.0 1.4 2.0 3.3 3.3 3.3 3.3

DPS Rs. (Cash & Scrip) 2.0 2.5 3.0 4.0 6.0 9.6 9.6 9.6 9.6 NAV/Share 39 45 62 71 83 110 135 166 203 ROE % 14.3 15.4 12.0 13.8 16.4 20.8 18.9 18.5 18.3

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Volume Rs.

SAMP ADJUSTED PRICE - VOLUME GRAPH

Volume Price Rs.

* Earnings including exceptional items (Exceptional gains from a 9.3% sale in associate LankaBangla Finance Ltd and one off write off on a decline in investments, deferred tax provision and increased contribuition toward staff retitrement benefits following a change in accounting policy) ** Forecast earnings include exceptional items pertaining to Rs. 654.8mn in capital gains from a sale of shares in LankaBangla Finance Ltd, a Rs. 1.33bn recovery against a prior impairment provision, a Rs. 275mn write off of a stake in Union Bank and a Rs. 1.33bn excess specific provision taken as a prudent measure by management *** Forecast earnings FY11E onwards include preliminary estimates following reduction in corporate tax from 35% to 28% and Financial VAT from 20% to 12%.


collection and recoveries is delegated to branch managers. This has improved asset quality at the bank without compromising on growth. In addition the bank has significantly improved provision cover Aggressive penetration into new high yield segments such as gold loans (pawning of jewelley)and innovative deposit products aimed at narrowing a maturity mismatch have helped the bank consistently post NIMs above the industry over the last two years.

>> The bank also holds an 11.29% stake in LankaBangla Finance Ltd, a listed finance company in Bangladesh also engaged in merchant banking, credit cards as well as owning a highly profitable stock broking subsidiary which has been the market leader for the last three consecutive years. The bank disposed part of its stake given the high prices commanded by the share at the Dhaka Stock Exchange in FY09 and an additional 1.2mn shares in the 1H of FY10. The unrealized capital gain for SAMP on its present holding of 11.29% of this investment at current market prices is Rs. 3.7bn.

Financial Performance FY10>> The bank posted healthy earnings of Rs. 3.48bn and growth of 68.1% for FY10 on the back of strong growth in loans and advances and the retention of healthy net interest margins in a lower interest rate environment. Earnings for the year included several exceptional items including Rs. 654.8mn in capital gains from a sale of shares in LankaBangla Finance, a Rs. 1.33bn recovery against a prior impairment provision, a Rs. 275mn write off of a stake in Union Bank and Rs. 1.33bn in excess specific provisions taken as a prudent measure by management. The bank is likely to cash in on significant capital gains in FY11 as well should it divest its stake in Union Bank which is to list in 1H FY11 as well as a potential further sale of shares in LankaBangla Finance.

>> Net interest margins at the bank were healthy at 5.00% with loans and advances growing by 30.29% compared to an industry average of 22.6%. Deposit growth for the year was a healthy 19.4% against an industry average of 15.6% with lower cost current and savings deposits accounting for a bulk of the growth. The CASA ratio. Net interest income grew by 10.3% for the year while non-interest income increased by 15.4% despite a reduction in foreign exchange income as a result of the modest appreciation in the LKR against the US$. Operating expenses increased by 17% for the year despite the aggressive roll out of 40 new branches while provision expense increased by 66% as management prudently made specific provisions well in excess of regulatory requirements. The gross NPL ratio declined to just 3.95% against an industry average of 5.3% with absolute NPLs at SAMP declining by 31.2%. The net NPL ratio was -0.20% reflective of the significant increase in provision cover last year. The significant growth in earnings for the bank in FY10 was also a result of a significantly lower effective tax rate due to the exceptional tax free gains mentioned earlier.

Loan Growth and Asset Quality>> The bank has consistently reflected sound asset quality, while recording steady loan growth in line with the sector. Much of the recent growth in advances over recent years has arisen from personal retail loans, pawning, leasing and housing loans, in line with the trend seen in the sector. Corporate loans account for approximately 40% of its loan book with consumer and SME loans accounting for approximately 50% and 10% respectively.


>> The banks loan book witnessed some stress in FY09 with NPLs rising to 9.84% in 2Q FY09, as was seen across the sector. Specific provision has however increased to 88.89% in FY10 compared 44.93% for the industry as a result of SAMP’s management prudently deciding to increase provision cover in excess of requirements. A 1% general provision requirement on the total performing book is being phased out over the next 4 quarters but the resultant saving is compensated for by a commitment to a depositor’s insurance scheme linked to the health of the bank’s capital adequacy ratio. A centralized credit disbursement model initiated under the new management described earlier has been successful with incremental advances disbursed since implementation of this new model being under 2% as a result of strengthened pre-sanctioning credit quality evaluation and post sanctioning monitoring.

>> Gross NPLs for the bank were down to 3.95% as of the 4Q FY10, indicative of the lower credit/default risk in the market. Growth in the bank’s loan book was just 3.2% in FY09 as expected given the high interest rate environment and weak economic conditions stemming from sustained high inflation which has since fallen sharply over the last nine months. We anticipate loan growth of 23.9% in FY11 and 24% in 2012 as the bank pursues aggressive expansion and the wider economy begins to reap the benefits of a post war era. The bank is expected to open a further 20 branches in FY11 as it seeks to be on par with the larger two private banks Hatton National Bank (HNB.SL) and Commercial Bank of Ceylon (COMB.SL).

>> The bank has successfully grown its loan book whilst improving asset quality. Approximately 23% of the bank’s loan book is in Gold loans (pawning of jewellery) at rates of approximately 14% at present giving a healthy spread over retail deposits currently at approximately 5%. The current loan to value ratio for these loans is approximately 80%. The bank aggressively penetrated into the pawning segment which has a zero weighting for capital adequacy purposes, assisted by a decline in interest rates and higher Gold prices. The stronger weighting of the consumer segment continues to contribute toward a superior net interest margin compared to peers. The bank is also aggressively promoting credit cards, actively competing in the upper end of the market with the foreign banks (HSBC and Standard Chartered) that dominate market share in the credit card space.

Funding and Capital>> Low cost saving and current deposits account for 48% of the bank’s deposit base, with total customer deposits growing at a CAGR of 20.1% over the last five years assisted by steady branch expansion from 63 branches in 2003 to 180 at present. The bank has also successfully rolled out a series of innovative low cost deposit products which have resulted in an increase in savings deposits in the

2008 2009 2010

SAMP.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4Net Loans and Advances Rs. ‘mn 92,114 94,674 94,231 94,004 88,903 89,230 92,519 94,004 97,376 99,543 112,506 123,194 QoQ Loan Growth 2.78% -0.47% -0.24% -5.43% 0.37% 3.69% 1.60% 3.59% 2.23% 13.02% 9.50%

Total Assets Rs. ‘mn 138,599 143,220 143,643 158,002 141,995 145,566 153,731 158,002 164,374 171,940 178,131 187,886

Loan/Assets 66% 66% 66% 59% 63% 61% 60% 59% 59% 58% 63% 66%

Loan/Deposit 93% 92% 91% 88% 82% 78% 77% 75% 73% 71% 79% 82%

Net Provision and Recoveries Rs. 'mn 238 247 227 69 291 (165) 193 69 304 322 (343) 378

QoQ Provision Expense Growth 4% -8% -69% 319% -157% -217% -64% 338% 6% -206% 210%

Gross NPL % 7.36 6.83 7.43 7.47 8.86 9.84 8.86 7.63 6.89 6.8 5.47 3.95

Net NPL % 2.88 2.21 2.55 2.37 3.31 4.81 3.87 2.79 1.95 1.68 1.23 -0.2


bank’s deposit mix. Deposit growth for FY09 was 17% and 19.4% in FY10 and is expected to grow at approximately 22% over the next two years assisted by branch expansion. The group’s Tier 1 and Total Capital Adequacy Ratio stood at 11.0% and 13.3% respectively as at end 2010, above statutory requirements of 5% and 10% respectively. The bank does have real estate and quoted investments with significant unrealized gains that are expected to shore up its capital base as the bank pursues loan book expansion outpacing the sector average. Given the significant unrealized gains the bank can access, it is our view that the bank is currently not in any urgent requirement of a capital infusion. Furthermore the bank has initiated the issue of scrip dividends in the banking sector which ensures that Tier 1 capital is retained in the bank to fund loan growth.

Net Interest Income>> Net interest margins increased marginally to 5.6% in 1QFY10 as liabilities were revised downwards ahead of a downward revision in lending rates sparked by a sharp decline in treasury yields earlier in the year. Competitive pressures and the present lower interest rate regime has seen net interest margins contract marginally in FY10 and is likely to decline further over the next two years. The bank continues to show improvements in its management of net interest margins with a narrower maturity mismatch and effective management of its asset and deposit mix. We expect the favourable volume variance will result in healthy net interest income growth in FY11 and FY12. Net interest margins for the bank are expected to average at around 4.6% - 4.8% over the next few years.

Non-Interest Income>> SAMP has consistently pioneered the adoption of technology into banking services among local banks since its inception in 1987. These value added services along with other non-interest income revenue streams such as foreign exchange and trade finance income should see non-interest income continue to account for approximately a third of the bank’s net income. We expect recurring non-interest income to grow at approximately 20% year on year on despite lower foreign exchange income on expectations of a stable currency in the near term.

2008 2009 2010

SAMP.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4CASA Rs. 'mn 40,672 41,361 40,759 41,082 40,330 42,208 45,138 51,444 59,702 64,646 69,972 72,916 Total Deposits Rs. 'mn 99,522 102,508 103,557 107,341 107,785 114,859 120,319 125,974 132,759 139,689 143,072 150,375

CASA 41% 40% 39% 38% 37% 37% 38% 41% 45% 46% 49% 48%

QoQ CASA Growth 2% -1% 1% -2% 5% 7% 14% 16% 8% 8% 4%

QoQ Deposit Growth 3% 1% 4% 0% 7% 5% 5% 5% 5% 2% 5%


Tier 1 CAR % 7.7 7.0 6.8 8.5 8.7 8.5 8.4 10.6 10.3 11.1 10.0 11.0

Total CAR % 12.3 11.5 11.2 12.4 12.8 12.1 11.6 13.9 13.4 14.2 12.6 13.3



2008 2009 2010

SAMP.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4NIM 4.15 4.44 4.68 4.89 5.07 5.16 5.17 5.00 5.59 5.27 5.08 5.00Net Interest Income Rs. 'mn 1,371 1,595 1,757 1,878 1,732 1,910 2,027 2,204 2,241 2,091 2,113 2,241

2008 2009 2010

SAMP.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4Fee Income / Operating Income 32% 29% 28% 34% 32% 29% 35% 49% 23% 39% 25% 49%


Operating Expenses>> The bank’s cost to income ratio was significantly lower this year given the high exceptional gains on share sales; however the cost to income ratio on recurring net income and expenses still remains in line with the sector average but higher than other established peers such as COMB and NDB. The decline in cost to income is however commendable given the fact that the bank opened 19 new branches in 2009, more than any other bank in the country, without adding significant numbers to its staff cadre and a further 40 new branches in 2010. With a an additional 20 new branches to be opened in 2011 we anticipate a sharper rise in personnel and establishment expenses. The bank has also undertaken to renovate selected branches as part of its efforts to improve its offering to customers. The branch expansion drive will place SAMP on par with the two larger private commercial banks in terms of its branch network, whilst having a significantly lower staff cadre. The company will also migrate to a performance based remuneration of staff from FY11. Cost to income ratios over the last couple of years are lower due to cost control in the midst of expansion but declines are pronounced due to significant non-recurring gains recorded over the last two years.

Tax Revisions>> Tax revisions announced in the Budget Proposals for 2011 including a decline in corporate tax from 35% to 28% and a reduction in financial VAT from 20% to 12% means effective tax rates for the banking sector have declined from approximately 60% to 45%. Banks will however have to allocate 13% of PBT for a period of 3 years for development oriented projects against which the bank can lend at concessionary rates for development projects with a longer tenor of around 7 to 10 years. Interest income arising from this would be free of income tax. The resulting effect is a significant boost to ROE and ROA, in the sector and will permit greater capital accumulation at the bank to fund loan growth going forward.

Valuations>> At a market price of Rs. 293.00 the counter currently trades at a PER of 11.5x FY11E and 9.5x FY12E core earnings and a P/BV of 2.7x based on the NAV per share as at 30th December 2010 at a market price of Rs. 293.00. The counter trades at a 16% discount to the sector. Given the banks aggressive growth plans, and its strengthened senior management; we believe the counter should trade at a premium to the sector. We recommend BUY.

2008 2009 2010

SAMP.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4Operating Expenses (Excl VAT) Rs.’mn 1042 1107 1242 1345 1273 1377 1389 1511 1491 1593 1712 1700Cost / Income (Excl VAT) 52% 50% 51% 47% 50% 51% 45% 35% 51% 46% 61% 39%

Branches 119 121 121 122 124 125 131 139 143 149 167 180

Employees 2433 2548 2535 2513 2491 2475 2480 2518 2554 2670 2759 2837



Income Statement 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E

For the Year Ended 31st December Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn

Income 9,135 12,934 18,081 23,069 25,560 23,586 28,194 34,818 41,630 Interest Income 7,575 10,505 15,526 20,103 21,345 18,722 23,403 29,028 34,405

Less: Interest Expense 4,203 6,302 10,527 13,502 13,472 10,036 13,328 17,208 20,566

Net Interest Income 3,372 4,202 4,999 6,601 7,873 8,686 10,075 11,819 13,839 Foreign exchange profit 192 646 505 647 774 498 612 735 919 Fee and commisison income 829 1,107 1,211 1,355 1,515 1,818 2,327 2,792 3,491

Other Income 538 677 839 963 1,926 2,548 1,851 2,263 2,816

Net Income 4,932 6,632 7,554 9,567 12,088 13,549 14,866 17,609 21,065 Less Operating ExpensesPersonnel Costs 1,037 1,286 1,472 2,018 2,255 2,649 3,126 3,594 4,170

Premises and Equipment expenses 907 1,101 1,328 1,666 1,773 2,062 2,474 2,870 3,329

Provision for staff retirement benefits 120 144 171 188 469 358 394 453 521

Loan losses and Provisions 622 493 960 846 389 661 286 656 1,076

Total Expenses (3,511) (4,276) (5,298) (6,961) (8,243) (8,755) (9,030) (10,779) (12,828)Profit from Operations 1,421 2,357 2,256 2,607 3,845 4,794 5,836 6,831 8,236 Add: Share of PBT of Assoc. 18 38 128 181 160 - - - -

Profit before Tax 1,432 2,395 2,384 2,787 4,005 4,794 5,836 6,831 8,236 Less: Provision for Taxation 503 1,261 1,182 1,262 1,921 1,274 1,913 2,110 2,542

Profit after taxation 929 1,134 1,202 1,525 2,084 3,520 3,923 4,721 5,694 Less: Minority Interest 74 62 57 30 11 36 21 26 31

Net Profit for the year 854 1,072 1,145 1,495 2,072 3,484 3,901 4,695 5,663

Ratio Analysis 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E

Price / Book Value 7.47 6.45 4.69 4.14 3.55 2.67 2.17 1.77 1.44

EPS 5.6 7.0 7.5 9.8 13.6 22.8 25.5 30.7 37.1

PER 52.4 41.8 39.1 30.0 21.6 12.8 11.5 9.5 7.9

EPS Growth 24.5% 25.5% 6.8% 30.6% 38.6% 68.1% 12.0% 20.3% 20.6%

DVD YLD 0.7% 0.9% 0.9% 0.9% 0.9% 0.9% 0.9% 0.9% 0.9%ROE 14.3% 15.4% 12.0% 13.8% 16.4% 20.8% 18.9% 18.5% 18.3%

ROAE 16.7% 16.6% 13.9% 14.7% 17.7% 23.7% 20.8% 20.4% 20.1%

ROAA 1.1% 1.1% 1.0% 1.1% 1.5% 2.1% 2.0% 2.0% 2.0%

NIM 4.6% 4.5% 4.5% 5.1% 5.6% 5.0% 4.7% 4.6% 4.6%

Fee Income / Operating Income 32% 37% 34% 31% 35% 36% 32% 33% 34%

Cost / Income 71.2% 64.5% 70.1% 72.7% 68.2% 64.6% 60.7% 61.2% 60.9%

Cost / Income (Excl VAT) 65.0% 55.3% 61.9% 62.6% 45.9% 47.6% 52.0% 50.6% 49.0%

Cost / Average Assets 4.69% 4.45% 4.44% 5.29% 5.82% 5.35% 4.56% 4.52% 4.53%

Tier 1 10.14% 8.38% 7.58% 8.10% 10.40%Total Capital Adequacy 13.53% 10.82% 11.58% 11.95% 13.45%Loan Growth 28.4% 29.7% 23.4% 1.6% 2.4% 31.1% 23.9% 24.0% 22.0%

Asset Growth 25.4% 30.1% 21.2% 3.1% 11.1% 18.9% 22.3% 18.5% 18.6%

RWA Growth 30% 45% 23% 7% 11% 19% 22% 18% 19%

Loan/ Deposits 88.5% 90.6% 91.4% 85.9% 74.9% 81.9% 81.8% 85.2% 87.1%

Loan / Assets 64.5% 64.3% 65.5% 64.5% 59.5% 65.6% 66.4% 69.5% 71.5%

Deposit / Liabilities 78.7% 75.8% 77.2% 81.4% 86.4% 88.0% 89.3% 90.0% 90.9%

Equity / Assets 6.9% 6.1% 6.9% 7.6% 8.0% 8.9% 9.0% 9.3% 9.6%

NPL Ratio 6.19% 5.52% 7.03% 8.00% 7.63% 3.95% 4.00% 4.15% 4.15%

NPL Coverage 82.4% 82.3% 63.6% 66.5% 63.4% 104.9% 105.0% 90.0% 85.0%



Balance Sheet 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

As at 31st December Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn

ASSETSCash and short-term funds 5,848 8,820 9,108 6,924 3,403 3,729 3,543 3,897 4,676

Balances with Central Banks 5,671 6,719 7,698 6,879 7,398 10,545 9,912 10,756 13,123

Government Treasury Bills and Bonds 229 12,172 13,658 20,741 34,730 28,243 38,081 41,127 43,595

Sec.purchased under re-sale agreements 356 301 14 3 2,677 2,944 3,239 3,563 3,919 Dealing Securities 4,671 4,165 4,275 1,224 276 304 334 368 404

Investment securities 9,612 2,888 4,410 5,397 7,451 8,614 10,768 9,906 10,402

Bills of Exchange 2,557 2,390 2,772 2,658 2,875 2,285 2,833 3,513 4,286

Loans and Advances 50,092 63,446 78,467 81,429 86,102 116,539 144,508 179,190 218,612

Lease receivable within one year 1,559 2,368 3,020 3,173 2,402 2,268 2,812 3,487 4,254

Lease receiveable from one to five years 2,253 5,025 6,093 4,556 2,625 2,103 2,523 3,053 3,725

Investment in Assoc. 407 445 300 364 - - - - -

Interest and Fees receivables 1,291 1,442 1,750 2,325 1,854 2,145 2,274 2,683 3,166

Other Assets 760 995 1,712 1,834 1,395 1,636 2,185 2,747 3,255

Property, Plant and Equipment 2,194 2,695 4,445 4,646 4,732 6,437 6,823 8,051 9,500

TOTAL ASSETS 87,511 113,884 137,984 142,279 158,002 187,886 229,847 272,354 322,930 Financed By :Deposits form customers 63,786 80,787 98,864 106,892 125,573 150,375 186,571 222,145 265,118

Dividends Payable 44 18 23 32 30 - 69 69 69

Borrowings 4,184 10,248 15,573 10,743 6,362 5,887 6,181 6,490 6,815

Sec. sold under repurchase agreements 6,335 7,004 2,687 2,440 2,887 4,361 4,579 4,808 5,049

Other Liabilties 3,743 4,656 5,365 5,782 6,278 6,012 6,553 7,143 7,786

Tax Payable 235 733 632 669 584 951 1,274 1,913 2,110

Deferred Taxation 210 384 444 269 479 184 193 203 213

Debentures 2,491 2,734 4,433 4,514 3,102 3,199 3,615 4,085 4,616

81,028 106,565 128,022 131,339 145,295 170,969 209,035 246,855 291,774 Minority Interest 488 373 413 120 95 152 144 137 130

SHARE CAPITAL 689 1,582 1,582 1,582 1,582 1,786 1,786 1,786 1,786

Statutory Reserve Fund 286 338 391 422 471 654 849 1,084 1,367

Reserves 5,020 5,027 7,577 8,816 10,559 14,326 18,032 22,492 27,872

Shareholders Funds 5,995 6,947 9,549 10,820 12,612 16,766 20,667 25,362 31,025 TOTAL LIABILITIES AND SHAREHOLDERS FUNDS 87,511 113,884 137,984 142,279 158,002 187,886 229,847 272,354 322,930


Rs 361.00 BUY

>> The National Development Bank was established through an Act of Parliament in 1979 as one of two state owned Development Finance Institutions to provide project funding to the private sector and distribute credit lines received from multilateral agencies.

>> The bank was privatized in 1993 with the bank recording impressive growth in the mid to late ‘90s with total assets growing at a CAGR of 20.25% from 1995 to 2000 when it moved into commercial banking.

>> The bank’s main source of funding in the nineties was the concessionary credit lines obtained from multilateral agencies. However realizing that credit lines from such sources are likely to reduce with the country achieving certain benchmarks of development, the bank sought to enter the commercial banking arena via the merger with NDB Bank (formerly ABN AMRO, Sri Lanka) giving it access to low cost retail deposits. NDB Bank was incorporated in 2001 as a separate commercial banking entity and

was consequently merged with NDB to form NDB Bank in mid-2005 under the Companys Act.

>> NDB has over the last 10 years transformed its operations from a one-product project lending operation to a more diversified ‘Universal Bank’ offering retail banking, corporate banking, leasing, investment banking, stock broking and insurance in addition to its project finance division.

>> The bank is still an entity in transition into commercial banking with a mid-sized branch network of just 47 branches with a recent footprint established in the North and East. NDB has resisted a rapid expansion of its branch network, choosing rather to leverage on technology and feet on street strategies in going its deposit base. The efforts have had mixed results with the bank having to be competitive in the market in order to diversify its fund base which now accounts for 68% of liabilities. The higher CASA ratios in comparison to more established commercial banking entities have meant consistently





National Development Bank PLC

NDBReuters Code NDB.CM

Bloomberg Code NDB.SL



Voting 82,100,951

12 mth High/Low (Rs.) 410.00 / 179.00


Market Capitalisation Rs. mn 29,638


1 mth 6 mth 12 mth

ASPI 8.70 18.82 105.54

NDB 0.56 13.44 65.68 * Adjusted for splits, bonus and rights issues

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NDB ADJUSTED PRICE - VOLUME GRAPH

Volume Price Rs.

Valuation Metrics Dec 07A Dec 08A Dec 09A Dec 10A Dec 11E Dec 12E Dec 13E

Net Income (Rs. mn) 4,746 5,449 6,793 7,052 8,391 9,901 11,798

Pre-Provision Profit (Rs. Mn) 2,218 2,503 3,189 3,164 4,157 4,997 6,068

NPAT (Rs. mn) 1,272 1,605 2,085 2,150 2,847 3,513 4,352

EPS (Rs.) 15.5 19.5 25.4 26.2 34.7 42.8 53.0

EPS Growth % (37.4) 26.2 29.9 3.1 32.4 23.4 23.9

PER (x) 23.3 18.5 14.2 13.8 10.4 8.4 6.8

P/BV 2.5 2.3 2.1 2.0 1.6 1.4 1.1

Dividend Yield % 1.7 1.7 1.7 1.7 1.7 1.7 1.7

DPS Rs. 6.0 6.0 6.0 6.0 6.0 6.0 6.0

NAV/Share 142 154 173 176 220 263 316

ROE % 10.9 12.7 14.7 14.9 15.7 16.3 16.8


narrower net interest margins. NIMs are however expected to increase moderately as we expect NDB to witness a sharper shift toward low cost deposits from term deposits as the rate differential narrows in a low interest rate environment.

>> The bank continues to display superior asset quality and strong provision cover in comparison to peers stemming from prudent management practices as well as specialized credit evaluation expertise it has retained from its period as a development bank. Furthermore aggressive credit growth at the bank was intentionally eased from 2008 until last year given the poor macro-economic conditions. The healthier balance sheet that resulted when the civil conflict ended has given NDB a strong platform to launch out on a more aggressive growth trajectory.

>> Management has been very explicit over the last few years of its intention to grow inorganically as well. The bank displays very strong Tier 1 and Total capital adequacy ratios in addition to a low cost to income ratio, high provision cover and the best asset quality in the industry. Furthermore, it’s smaller branch network makes NDB all the more likely to attract M&A activity.

Financial Performance>> NDB recorded marginal earnings growth of just 3% in FY10 largely as result of earnings for FY09 of Rs. 2.1bn assisted by a 54% increase in other income which included capital gains on bond trading amounting to Rs. 733mn as well as capital gains on the sale of quoted and non-quoted equities. The bank recorded flat net interest income growth and net interest margins declined amid competitive pressures in a lower interest rate environment. Non-interest income increased by 9% largely as a result of gains on disposal of quoted and non-quoted securities during the year, which it acquired as a part of its project financing business.

>> Operating expenses grew by 15% yoy while strong recoveries as seen across the sector last year resulted in healthy write backs over and above provisioning requirements for the year. Associate income via its stake in AVIVA NDB were lower at the insurance business due to increased marketing spend on a rebranding initiative and lower profitability of the general insurance segment.

Loan Growth and Asset Quality>> Loan growth at the bank for FY10 was a healthy 30%, well above an estimated 22.6% in credit growth for the industry. Much of the loan growth stemmed from the bank’s strong pipeline of project lending as well as an increase in retail consumption loans. The bank has diversified its loan book over the years from being a 100% long term project lender in 2001 to having a corporate lending portfolio accounting for 47% of its loan book with project finance and retail banking now accounting for approximately 30% and 23% respectively. Despite the contraction of the loan book in FY09, the bank’s retail lending portfolio notably increased by 12%.

>> An anticipated increase in domestic and external trade already evident should see steady credit demand for its commercial lending portfolio with new branches in the Norther and Eastern provinces being set up by the bank in the 2H FY09. The bank is expected to benefit from credit demand from infrastructure projects for


which it leverages on a comprehensive array of project financing skills that the bank has consciously sought to retain and develop over the last 30 years.

>> Loan growth in the bank for the full year in FY11 is expected at 22.8% and 20.1% in FY12. The bank also rolled out credit cards in FY09 which should benefit from an anticipated upturn in retail consumer credit demand. Retail lending however will continue to be driven by focused segments of housing loans, leasing, and personal loans including mortgage backed education loans and personal consumption loans.

>> The bank’s asset quality continues to remain the best among local private commercial banks with a reported gross and net NPL ratio of 1.87% and 0.46 % respectively as at end December 2010 compared to an industry gross NPL ratio of 5.3%.

Funding and Capital>> Customer deposits now account for over 68% of total funding as at end December FY10 from being almost entirely funded by government and multilateral sources in 2001. The bank has been competitive in its deposit rates which have enabled the bank to outpace peers in its deposit growth in recent years. The bank’s cost of funds are however higher than most peers such as COMB, HNB and SAMP which enjoy a larger proportion of low cost savings deposits to total deposits. Time deposits at NDB account for 71% of total customer deposits with demand and low cost savings deposits accounting for 12.3% and 17.01% respectively.

>> Deposit growth for FY09 was 61% with the commercial banking sector benefiting from a loss of consumer confidence over the safety of deposits in non-banking financial institutions since mid-2008. Deposit growth for FY10 was a sound 19% against a sector average estimated at 15.6%. New branches opened in the North and East as well as the roll out of competitively priced savings products will attract an increasing amount of low cost savings deposits. In addition a lower interest rate differential between term and savings deposits has resulted in a steady shift in the deposit mix in favour of savings deposits.

>> The bank’s Tier 1 and Total capital stood at 17.8% and 20.3% respectively as at 30th December 2010, well above minimum statutory requirements of 5% and 10% respectively.

2008 2009 2010

NDB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4Net Loans and Advances Rs. ‘mn 51,451 55,586 57,230 54,589 52,981 50,429 50,305 54,106 55,772 58,668 63,010 70,519 QoQ Loan Growth 8.04% 2.96% -4.61% -2.95% -4.82% -0.25% 7.56% 3.08% 5.19% 7.40% 11.92%

Total Assets Rs. ‘mn 78,841 82,936 83,412 83,280 86,748 90,310 89,966 99,286 95,894 97,539 103,038 108,712

Loan/Assets 65% 67% 69% 66% 61% 56% 56% 54% 58% 60% 61% 65%

Loan/Deposit 191% 194% 200% 176% 154% 131% 115% 108% 112% 121% 121% 119%

Net Provision and Recoveries Rs. 'mn 13 8 45 106 107 46 37 96 70 (14) (15) (212)

QoQ Provision Expense Growth -40% 459% 138% 1% -57% -20% 162% -27% -120% -10% -1280%

Gross NPL % 2.61 2.45 2.24 2.29 2.6 3.09 3.02 2.58 2.43 2.34 2.08 1.87

Net NPL % 1.17 0.98 0.76 0.58 0.76 1.07 0.88 0.62 0.53 0.46 0.3 0.46


Net Interest Income >> Widening net interest margins will be challenging given competitive pressures in lending and attracting of deposits. Much of the scope in enhancing margins would depend on the extent to which NDB can grow its retail loan book while concurrently improving its CASA ratio. We expect net interest margins to rise to around 4.3% by year end FY11 on account of a continued steady shift toward lower cost deposits.

Non-Interest Income>> Other income on the back of gains from a sale of quoted and non-quoted securities will augment net income. Trade finance activities are expected to increase with a reduction in lending rates and the withdrawal of additional credit margin requirements for import of goods as well as the likely reduction in import duties. A stable SLR to the US$ is expected to result in muted foreign exchange income while active treasury operations and fee based commissions should see non-interest income continuing to account for approximately 35% of total net income.

Operating Expenses>> NDB continues to record a relatively low cost to income ratio in comparison to peers. Centralisation of processes and increased use of technology across all operations has enabled the bank to steadily curtail operating expenditure. Further centralization of support functions in the bank is expected to result in further modest improvements in the cost to income ratio.

2008 2009 2010

NDB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4CASA Rs. 'mn 8,735 8,423 8,355 7,988 7,920 8,441 9,511 11,308 12,446 12,327 13,783 17,396 Total Deposits Rs. 'mn 26,924 28,673 28,612 31,091 34,315 38,520 43,594 49,948 49,907 48,309 52,120 59,364

CASA 32% 29% 29% 26% 23% 22% 22% 23% 25% 26% 26% 29%

QoQ CASA Growth -4% -1% -4% -1% 7% 13% 19% 10% -1% 12% 26%

QoQ Deposit Growth 6% 0% 9% 10% 12% 13% 15% 0% -3% 8% 14%


Tier 1 CAR % 22.3 18.9 18.4 20.0 19.2 19.1 19.3 20.6 19.2 18.5 18.1 17.8

Total CAR % 25.2 22.6 22.1 23.6 22.9 22.7 23.0 23.8 22.4 21.5 21.1 20.3



2008 2009 2010

NDB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4Operating Expenses (Excl VAT) Rs.’mn 559 545 585 699 608 657 655 750 727 787 747 803Cost / Income (Excl VAT) 41% 41% 43% 51% 37% 35% 36% 51% 45% 44% 35% 53%

Branches 40 40 40 40 40 40 40 44 45 45 45 47

Employees 874 889 915 946 942 964 987 991 1029 1067 1081 1126


2008 2009 2010

NDB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4NIM 4.00 3.92 3.93 4.06 4.77 4.41 4.46 4.15 4.04 4.03 4.03 3.86Net Interest Income Rs. 'mn 900 913 942 1,033 1,156 997 1,095 986 1,057 1,055 1,129 1,025

2008 2009 2010

NDB.SL Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4Fee Income / Operating Income 35% 32% 31% 25% 30% 46% 40% 33% 34% 40% 48% 32%


Outlook>> Insurance Business: The bank holds 41.14% of AVIVA NDB Insurance PLC, with Aviva PLC having controlling interest of the entity. AVIVA NDB insurance PLC is the 3rd and 5th largest insurance company in the Life and Non-Life insurance business in Sri Lanka respectively with a market share of 19.49% in Life and 7.48% in Non-Life. The company contributed a weak Rs. 295mn in associate company earnings in FY10 and we conservatively estimate the entity to contribute Rs. 360m in FY11.

>> Consolidation: The bank has repeatedly voiced the need for consolidation in the banking sector; a position that we also subscribe to along with most players in the banking sector. Rationalisation of costs as a result of a merger or acquisition will be substantial thus improving ROE levels from the present muted 14% - 15% levels at the bank. In addition NDB being a well managed highly capitalized bank with a modest branch network of about 47 branches makes it an attractive entity to partner with. NDB Bank has been actively looking for M & A opportunities in the sector and has repeatedly voiced its desire for inorganic growth While we feel consolidation in the banking sector is inevitable given the value that can be unlocked from an ROE perspective; issues pertaining to ownership restrictions on banks and strong employee trade unions have among others issues discouraged consolidation thus far.

Valuations>> Earnings growth forecasts of 32.4% in FY11 and 23.4% in FY12 correspond to a PER of 10.4x and 8.4x respectively at a market price of Rs. 361.00 and a corresponding P/BV of 2.10x based on the NAV as of 30th December 2010. The bank recently announced a 1 for 1 share split, while NDB has a recent track record of a 40%+ dividend payout ratio, the highest among listed banks. The counter currently trades at a 24% discount to the sector. We recommend BUY.

Ratio Analysis 2007 2008 2009 2010 2011E 2012E 2013E

Price / Book Value 2.5 2.3 2.1 2.0 1.6 1.4 1.1 EPS 15.5 19.6 25.5 26.3 34.8 42.9 53.2 PER 23.2 18.4 14.2 13.7 10.4 8.4 6.8 EPS Growth 25.4% 26.2% 29.9% 3.1% 32.4% 23.4% 23.9%DVD YLD 1.4% 1.4% 1.4% 1.4% 1.4% 1.4% 1.4%ROE 10.9% 12.7% 14.68% 14.9% 15.7% 16.3% 16.8%

ROAE 11.4% 13.2% 15.5% 15.0% 17.5% 17.7% 18.3%ROAA 1.8% 2.0% 2.3% 2.1% 2.4% 2.6% 2.8%NIM 4.4% 4.1% 4.2% 3.9% 4.3% 4.3% 4.3%Fee Income / Operating Income 26% 30% 38% 39% 40% 41% 41%Cost / Income 53.3% 54.1% 53.1% 55.1% 50.5% 49.5% 48.6%Cost / Income (Excl VAT) 43.8% 44.6% 43.6% 45.6% 41.0% 40.0% 39.1%Cost / Average Assets 3.58% 3.70% 3.95% 3.74% 3.64% 3.67% 3.68%Loan Growth 17.4% 10.7% -2.5% 32.5% 22.8% 20.1% 20.0%

Asset Growth 17.2% 9.4% 19.2% 9.5% 13.9% 15.7% 17.5%

RWA Growth 20.4% 8.1% 19.2% 9.5% 13.9% 15.7% 17.5%Loan/ Deposits 192.5% 175.6% 106.5% 118.8% 130.2% 135.3% 137.6%Loan / Assets 64.8% 65.5% 53.6% 64.9% 69.9% 72.5% 74.1%Deposit / Liabilities 48.3% 49.3% 71.3% 70.3% 71.8% 73.0% 74.9%

Equity / Assets 15.3% 15.2% 14.3% 13.3% 14.6% 15.1% 15.4%

NPL Ratio 1.67% 2.34% 2.58% 1.92% 2.00% 2.10% 2.20%

NPL Coverage 213.1% 146.7% 137.8% 138.0% 135.0% 125.0% 110.0%

NPL Ratio 6.19% 5.52% 7.03% 8.00% 7.63% 3.95% 4.00%

NPL Coverage 82.4% 82.3% 63.6% 66.5% 63.4% 104.9% 105.0%


Income Statement 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

For the Year Ended 31st December Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn

Income 9,822 12,522 14,167 12,738 15,302 18,817 22,249 26,526 Interest Income 8,599 10,860 11,607 9,953 11,960 14,807 17,437 20,751

Less: Interest Expense 5,076 7,073 7,374 5,686 6,912 8,916 10,451 11,452

Net Interest Income 3,522 3,787 4,233 4,267 5,049 5,891 6,986 9,299 Other Income 1,224 1,662 2,560 2,785 3,342 4,011 4,813 5,775

Net Income 4,746 5,449 6,793 7,052 8,391 9,901 11,798 15,074 Less Operating ExpensesPersonnel Costs 932 1,129 1,281 1,530 1,744 2,006 2,307 2,653

Provision for staff retirement benefits 17 22 19 37 48 62 81 105

VAT on Financial Services 476 558 847 825 766 927 1,128 1,452

Loan losses and Provisions 65 116 286 (172) 282 206 105 255

Other Overhead expenses 1,102 1,237 1,457 1,496 1,676 1,910 2,216 2,615

Total Expenses 2,593 3,062 3,891 3,717 4,516 5,111 5,836 7,079 Profit from Operations 2,153 2,388 2,903 3,335 3,875 4,790 5,962 7,995 Add: Share of PBT of Assoc. 179 172 526 295 360 432 509 596

Profit before Tax 2,333 2,560 3,428 3,630 4,234 5,222 6,471 8,591 Less: Provision for Taxation 945 852 1,307 1,407 1,299 1,601 1,985 2,645

Profit after taxation 1,387 1,708 2,121 2,223 2,935 3,621 4,486 5,946 Less: Minority Interest 115 103 37 73 88 109 135 178

Net profit for the year 1,272 1,605 2,085 2,150 2,847 3,513 4,352 5,767


Balance Sheet 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

As at 31st December Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn

ASSETSCash and short-term funds 7,758 5,900 8,243 5,553 6,441 5,797 6,377 7,015

Government Securities 4,843 9,476 11,429 10,381 4,983 4,335 4,162 4,370

Commercial paper 414 - - - - - - -

Investment and Dealing Securities 9,848 9,016 20,699 17,284 20,396 23,251 26,506 30,482 Bills of Exchange 2,121 2,247 2,689 3,363 3,968 4,761 5,618 6,630

Loans and Advances 45,373 50,431 48,579 64,747 79,638 95,566 114,679 137,615

Lease Rentals Receivable 1,820 1,910 1,949 2,409 2,964 3,616 4,447 5,470

Investment in Assoc. 1,210 1,393 1,724 1,763 1,763 1,763 1,763 1,763

Interest and Fees receivables 504 - 889 - - - - -

Other Assets 1,165 925 2,033 1,300 1,529 1,692 1,901 2,631

Property, Plant and Equipment 2,004 1,981 1,937 1,908 2,194 2,523 2,901 3,337

TOTAL ASSETS 76,143 83,280 99,286 108,712 123,875 143,303 168,355 199,312 Financed By :Deposits form customers 25,624 31,091 49,948 59,364 66,495 76,840 90,678 107,902

Dividends Payable 170 250 344 451 181 181 181 181

Borrowings 34,147 34,993 29,591 28,236 32,753 37,994 44,073 51,125

Other Liabilties 3,102 3,716 4,550 4,577 5,784 6,114 6,897 7,811

Tax Payable 522 352 560 539 1,407 1,299 1,601 1,985

TOTAL LIABILITIES 63,043 70,050 84,433 92,628 105,214 121,129 141,829 167,019 Minority Interest 1,415 568 687 717 568 568 568 568

SHAREHOLDERS FUNDSStated Capital 1,033 1,033 1,033 193 1,033 1,033 1,033 1,033

Statutory Reserve Fund 819 819 819 879 819 819 819 819

Reserves 9,833 10,811 12,345 13,395 16,242 19,754 24,106 29,873

Shareholders Funds 11,685 12,662 14,197 14,467 18,093 21,606 25,957 31,725

TOTAL LIABILITIES & CAPITAL 76,143 83,280 99,316 107,812 123,875 143,303 168,355 199,312



Voting Rs 63.00; Non-Voting Rs 44.00 BUY

>> The hoped for upturn in construction activity after the conclusion of the war took longer than expected to materialize, with real signs of the sector picking up only apparent in the last half of 2010. Despite this we feel that Tokyo Cement’s increased capacity will prove timely over the next few years. We expect exceptional earnings in the coming years thanks to the anticipated boom driven by reconstruction in the North and East as well as by the massive infrastructure undertakings all over the island.

>> Post war rebuilding in the war torn North and East will now be compounded by the damage done by the floods that happened over the last quarter of 2010. The resurgence of the construction sector can be found in figures for 3Q:CY2010 which showed that GDP growth of 8.0% was exceeded by the Construction sub-sector which grew at 11.3% for the period. The end of the North-East conflict and the rebuilding effort through housing and

infrastructure projects is expected to fast track the growth momentum in the industry indicating a 10% plus growth rate through CY12.

>> TKYO’s main production facility is located in the Eastern sea port of Trincomalee, ideally located for the rebuilding boom. A doubling of grinding capacity in FY09 to 1.8m MT boosted total installed capacity to 2.4m MT per annum. Tokyo Cement also completed its long delayed 10MW Bio Mass power plant in FY09 which will provide its total electricity requirement while the excess is sold to the national grid.

>> The cement industry imports half of its requirement providing domestic producers ample ground for expansion. With the construction industry expected to boom, cement growth is expected to increase by 15% in FY11.




Navin Ratnayake [email protected]

Tokyo Cement Company (Lanka) PLC

TKYOReuters Code TKYO.CMBloomberg Code TKYO.SLShare Price LKR Voting 63.00 Non-Voting 44.00Issued Share Capital (Shares) Voting 202,500,000

Non-Voting 101,250,000

12 mth High/Low- Voting (Rs.) 69.00 / 28.00

12 mth High/Low- Non-Voting (Rs.) 46.40 / 17.75 Market Capitalisation (Rs.mn) 17,213

Average Daily Volume (Shares) Voting 180,630

Average Daily Volume (Shares) Non Voting 590,133

Price Performance (%)1 mth 6 mth 12 mth

ASPI 8.70 18.82 105.54

TKYO.N 5.18 61.54 113.56

TKYO.X 0.23 57.35 125.13

Valuation Metrics Mar 08A Mar 09A Mar 10A Mar 11E Mar 12E Mar 13E

Revenue (Rs. 'mn) 14,029 17,652 14,634 17,984 20,498 24,475

EBITDA (Rs. 'mn) 1,524 2,444 2,179 2,561 2,884 3,359

EBIT (Rs. 'mn) 927 1,438 1,138 1,512 1,915 2,463

PAT (Rs. 'mn) 554 347 291 959 1,512 2,149

EPS 1.8 1.1 1.0 3.2 5.0 7.1

EPS Growth (31.9) (37.4) (16.0) 229.1 57.6 42.1

P/E (x) Voting 34.5 55.1 65.7 19.9 12.7 8.9

P/E (x) Non Voting 24.1 38.5 45.9 13.9 8.8 6.2

EV/EBITDA 12.1 7.3 8.6 6.8 5.4 3.9

Dividend Yield (Voting) 0.6 0.5 2.6 2.6 2.6 2.6

Dividend Yield (Non Voting) 0.9 0.7 3.8 3.8 3.8 3.8

P/B (x) 3.4 3.3 3.2 2.8 2.3 1.8

ROE % 11.1 6.6 5.3 15.6 19.9 22.2

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>> Tokyo Cement is one of the largest grinders of Portland and Pozzollana cement in Sri Lanka on a joint venture between local conglomerate St. Antony’s Consolidated and Nippon Coke & Engineering Company of Japan. The group structure consists of 3 subsidiaries out of which Fuji Cement Company (Lanka) Ltd. (FCCL) and Tokyo Super Cement Company Lanka (Pvt) Ltd. (TSCCL) are fully owned while Tokyo Cement Colombo Terminal (Pvt) Ltd. (TCCT) is a 56.85% subsidiary. Tokyo Cement operates a cement grinding plant with a capacity of 600,000 MT while FCCL cement grinding plant capacity is 300,000 MT. Both plants are situated in Trincomalee where the company owns a private 100 metre jetty, which can berth 25,000 tonnage ships. TCCT operates a bagging plant within the Port of Colombo consisting of 600,000 MT.

>> The newly constructed grinding plant of 900,000MT capacity in Trincomalee is fully owned by TSCCL and has doubled the grinding capacity of the Group to 1.8m MT while the total capacity extends to 2.4m MT with the bagging plant in Colombo.

>> The group currently owns 3 ships with capacities of 17,500 MT, 20,000 MT & 22,000 MT respectively to ensure an uninterrupted supply of raw materials, predominantly clinker.

Construction Industry>> The construction industry boomed in 2006 & 2007 as growth rates picked up by 9.2% and 9% respectively on the back of rapid escalation of housing and condominium projects. But with inflation and interest rates skyrocketing as the civil war came to its conclusion, the sector lost its momentum. However the latter half of 2010 saw the sector finally recover after a longer than expected lag after the end of the war. With lower interest rates and the commencement of large scale infrastructure development with the ports and road networks we feel that the sector should surpass the growth rates of 2006-2007.

>> In addition to the reconstruction demanded by the war torn provinces of the North and East, the floods that hit the Eastern and North Central Provinces in the last quarter have also caused substantial damage to infrastructure like irrigation networks, roads and houses and buildings. Economic damage from this has been estimated at 1% of GDP. While this will have a short term impact on TKYO’s final March 2011 quarter we feel that demand for cement will be spurred by the needs for rebuilding over FY12.

>> Sri Lanka also suffers from an estimated shortage of 400,000 housing units countrywide with the gap estimated to increase to 650,000 over the next few years by the Central Bank. Some estimates of the housing market in the Western Province put annual demand at 40,000 units. The majority of cement sales in the country are predominantly retail driven, but with increasing economic development we expect the proportion of commercial usage to correspondingly increase.

Cement Industry>> The current total cement consumption is approximately 5-6m MT per annum with domestic production at almost 4m MT and the rest imported from countries such as India, China, Thailand and Indonesia.

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>> The domestic production of cement is dominated by Tokyo Cement and Holcim Lanka each having approximately a 30% market share (inclusive of imported cement). Both companies are looking to expand production capacity with only 47% of the demand met by domestic production and grinding. Tokyo Cement already doubled its grinding capacity in CY08 while Holcim has obtained approval to expand to Trinco. Tokyo Cement has capacity of 2.4m MT per annum while Holcim has 1.4m MT per annum.

>> While imported cement from firms like Ultratech and Lafarge (which are both believed to have 30% of share collectively) are present in the market, Tokyo continues to enjoy both location and cost benefits as well as having a reputation for quality in a market which has gotten wary of lower quality imports.

Clinker>> Clinker is the largest cost for the Group amounting to approximately 85% of production cost (including freight). Tokyo Cement imports clinker mainly from Thailand, Indonesia and Malaysia while powder for the bagging plant of TCCTL is imported from Indonesia. The Group purchased 3 vessels with the intention of saving on freight charges which amounts to almost 40% of production cost. The company makes a considerable saving on freight by maintaining its own fleet of ships.

10MW Bio Mass Power Plant>> Tokyo uses approximately 40kWh of energy annually. The company satisfies its energy requirement through its own 3.5MW thermal power plant and partly by the national grid. The energy costs account for 6% of the group production costs. Tokyo Cement commissioned a 10MW Bio Mass power plant which would meet the entire energy requirement of the Group with the excess power being sold to the National Grid. The power plant uses paddy husks available especially in the North Central and the Eastern Provinces, where rice mills are in abundance. Fuel wood is to be obtained from Gliricidia plantations.

>> The success of the venture into power has made the company Incorporate a fully owned subsidiary called “Tokyo Cement Power (Lanka) Ltd” for the purpose setting up and operating power generation with the focus on dendro (bio mass) generation.

>> Apart from the considerable cost savings with the Bio Mass power plant, the company now qualifies for carbon credits worth of Rs.20m-30m. Tokyo Cement is also testing ‘green cement’ products, made using clean energy for electricity and admixtures like fly ash and burnt rice husk ash, which have good binding properties, as a component of cement.

Earnings>> Clinker prices appear set to recover from the dips in 2010, while prices for a 50kg cement bag have recovered from about Rs.700 to the Rs.730-740 levels. Volumes and revenues should pick up by the middle of this calendar year with construction already having picked up and the reconstruction from the floods commences.


>> Borrowings have decreased by 11% over the twelve months to December 2010. We expect finance costs to sharply fall over the next few years as the company pays off debt thanks to its cash generation as well as due to lower debt financing. The debt was incurred for the installation of the new vertical roller mill which doubled grinding capacity as well as the bio mass power plant.

Outlook>> We expect Tokyo Cement revenue to reach almost Rs.18bn for FY11 in spite of the previous year’s drop in sales prices with the decline in raw material prices. TKYO volumes are expected to pick up as the construction sector is likely to improve with favourable macro economic conditions. In addition to the declining interest rates, reconstruction efforts should pave the way for rapid development in the cleared provinces.

>> Given the number of infrastructure projects in the pipeline, the rebuilding of the North and East with houses, schools, hospitals, roads and bridges would indicate considerable growth, signaling a significant boost in demand for cement. We expect TKYO to post earnings of Rs.959m and Rs.1,512m for FY11E and FY12E respectively

>> At Rs. 63.00, the voting share trades at a PER of 19.9x FY11 earnings and 12.7x FY12 earnings. At Rs. 44.00, the non-voting share trades at a PER of 13.9x FY11 earnings and 8.8x FY12 earnings. With the stock being one of the better exposures to the expected boom in North East infrastructure building, we recommend BUY.

Ratios and Valuation Mar 08A Mar 09A Mar 10A Mar 11E Mar 12E Mar 13E

Growth (%)Sales 26.26 25.83 (17.09) 22.89 13.98 19.40EBIT (22.57) 55.12 (20.84) 32.80 26.70 28.59Net Profit (31.94) (37.36) (16.00) 229.13 57.57 42.13EPS (31.94) (37.36) (16.00) 229.13 57.57 42.13Margins (%)EBITDA 10.86 13.85 14.89 14.24 14.07 13.73

EBIT 6.61 8.15 7.78 8.40 9.34 10.06Pre-Tax margin 3.86 3.67 1.85 5.58 7.72 9.19Net Margin 3.95 1.97 1.99 5.33 7.37 8.78Valuation Metrics (x)P/E 34.54 55.15 65.65 19.95 12.66 8.91P/B 3.44 3.28 3.16 2.80 2.27 1.78EV/EBITDA 12.11 7.33 8.58 6.78 5.38 3.90EV/EBIT 19.90 12.46 16.42 11.48 8.10 5.31ROE % 11.07 6.62 5.34 15.59 19.92 22.22


Income Statement 2008 2009 2010 2011E 2012E 2013E

For the Year Ended 31st March Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn

Revenue 14,029 17,652 14,634 17,984 20,498 24,475 Cost of sales (11,977) (14,952) (12,353) (14,998) (16,757) (19,651)Gross profit 2,052 2,700 2,281 2,987 3,742 4,823 Other operating income 101 204 175 101 101 101 Selling and distribution (1,036) (1,095) (1,029) (1,209) (1,451) (1,814)Admin expenses (184) (328) (289) (355) (461) (623)

Other expenses - - - (15) (25) (25)Profit from operations 933 1,481 1,138 1,509 1,905 2,463 Finance Cost (392) (834) (868) (504) (323) (214)PBT 541 647 270 1,004 1,583 2,249 Taxation 31 (289) 12 (15) (24) (34)Profit after tax 572 358 283 989 1,559 2,215 Minority Interest (18) (11) 9 (30) (47) (66)Profit attributable to Equity Holders 554 347 291 959 1,512 2,149

Balance Sheet 2008 2009 2010 2011E 2012E 2013E

As at 31 March Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn

AssetsNon current assetsProperty plant and equipment 4,687 9,359 8,587 8,710 8,065 7,445

Capital WIP 3,698 397 518 197 97 (3)

Goodwill 13 13 13 13 13 13 Non current receivables 83 77 73 83 83 83

8,481 9,846 9,191 9,003 8,258 7,538 Current AssetsInventories 1,212 1,388 535 1,529 1,742 2,020

Receivables and prepayment 1,468 1,882 1,689 2,170 2,460 2,876

Cash and cash equivalents 181 311 462 747 2,529 4,871

2,861 3,581 2,686 4,446 6,731 9,767 Total Assets 11,342 13,427 11,877 13,449 14,989 17,305 Capital and ReservesStated Capital 1,793 1,793 1,793 1,793 1,793 1,793

Retained Earnings 3,212 3,450 3,661 4,361 5,795 7,875

5,005 5,243 5,454 6,154 7,588 9,668 Minority Interest 147 158 149 188 235 301

5,152 5,401 5,603 6,342 7,823 9,969 Non - Current liabiltiesLong term borrowings 1,273 864 1,792 700 591 445

Retirement benefit obligation 23 23 28 28 28 28

Others 67 372 302 132 131 131

1,363 1,259 2,123 860 750 604 Current LiabilitiesTrade and other payables 2,269 3,823 2,194 3,895 4,439 5,422

Loan Repayable 2,009 2,574 1,576 2,100 1,772 1,152

Current tax liabilities (36) (71) - (57) (10) 7

Borrowings 585 441 380 309 216 151

4,827 6,767 4,151 6,247 6,417 6,732 Total Liabilities 6,190 8,026 6,274 7,107 7,167 7,336 Total Equity & Liabilties 11,342 13,427 11,877 13,449 14,989 17,305


Cashflow Statement 2008 2009 2010 2011E 2012E 2013E

As at 31st March Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn

Net profit before tax 541.0 647.0 270.3 1,007.2 1,592.6 2,248.7 Adjustments 990.0 1,822.0 1,862.2 1,571.5 1,299.6 1,079.9

Changes in Working Capital 201.0 939.0 (625.9) (344.8) 29.1 46.0

Interest paid (386.0) (791.0) (868.0) (504.4) (322.6) (214.1)

Tax Paid (51.0) (93.0) - (1.0) 23.1 (16.7)Defined Benefit Obligations paid (1.0) - - (5.0) - -

Net cashflow from operating activities 1,294.0 2,524.0 638.7 1,723.5 2,621.8 3,143.8 Investing ActivitiesFixed Assets (611.0) (1,917.0) (290.6) (400.0) (300.0) (300.0)

Interest received 4.0 - - 6.9 16.5 55.9

Expenditure on capital WIP (1,309.0) (328.0) - (200.0) (200.0) (200.0)

Other 2.0 - (66.8) - - -

Net cashflow from investing activities (1,914.0) (2,245.0) (357.4) (593.1) (483.5) (444.1)Financing ActivitiesProceeds from issued capital - - - - - -

Receipt / (Repayment) of term loans 300.0 (75.0) (68.7) (150.0) (200.0) (200.0)

Dividends (33.0) (108.0) - (81.0) (135.0) (135.0)

Other (22.0) (54.0) - (22.0) (22.0) (22.0)

Net Cashflow from financing activities 245.0 (237.0) (68.7) (253.0) (357.0) (357.0)Net cash and cash equivalents (375.0) 42.0 212.6 877.4 1,781.3 2,342.7 Cash and cash equivalentsAt start of the year 203.0 (172.0) (130.8) (130.0) 747.4 2,528.7

Increase / (Decrease) (375.0) 42.0 212.6 877.4 1,781.3 2,342.7

At end of period (172.0) (130.0) 81.8 747.4 2,528.7 4,871.4


Rs 159.00 BUY


>> Sri Lanka’s floor tiles market displayed unusual resilience in the face of difficult economic conditions in 2007-2008 and continues to display robust revenue growth. Royal Ceramics is the largest domestic manufacturer of the product with a market share that we estimate at approximately 40%.

>> Royal Ceramics has two production facilities at Eheliyagoda and Horana which have a capacity of 11,000 square meters a day. Of the two facilities, Eheliyagoda produces only porcelain tiles with a capacity of 3,500 square meters.

Industry >> Support for the tile market came from the Government during 2007-2008 which doubled the minimum tariff applicable to ceramic tile imports to Rs. 200 per square meter from the previous Rs. 100 per square meter which we believe would have dropped the share of mostly Chinese imports for the total market by as much as 50%.

>> Floor tiles are an aspirational product for upwardly mobile Sri Lankans with both rural and urban

demand. With expectations of doubling per capita income to US$4,000 by 2014 we feel the resulting higher living standards should boost overall housing unit growth and remodeling along with the broader construction sector.

>> Royal Ceramics should also greatly benefit from the development of the North and East markets as well as from large scale hotel and BOI projects. We expect this demand to kick in only after FY2011 as tiling and bathware stages for retail construction would happen after a significant time lag.

>> Tile industry growth is estimated to be at 15-20% for floor tiles with the total market estimated at 12.5mm square meters per annum or Rs.13.5bn. Growth rates in the past five years averaged 6-7%. The economically dominant Western and Southern provinces account for much of this volume, with a demand of at least 60-70%. With an imminent construction boom expected in the North and East (which traditionally accounted for at least 15% of the country’s GDP) we expect RCL to benefit from not only state sponsored rebuilding projects but also retail construction.




Royal Ceramics PLC

RCLReuters Code RCL.CM

Bloomberg Code RCL.SL



Voting 110,789,384

12 mth High/Low (Rs.) 167.5 / 47.5



Price Performance (%) - Voting

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ASPI 8.70 18.82 105.54

RCL 6.00 70.05 234.74 * Adjusted for splits, bonus and rights issues

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RCL ADJUSTED PRICE / VOLUME GRAPH


Revenue (Rs. 'mn) 3,475 3,741 4,451 5,872 7,164 8,597

EBITDA (Rs. 'mn) 1,195 1,194 1,722 2,106 2,334 2,828

EBIT (Rs. 'mn) 992 959 1,382 1,828 2,042 2,521

PAT (Rs. ‘mn) 611 518 963 1,488 1,737 2,249

EPS 5.51 4.67 8.69 13.43 15.68 20.30

EPS Growth 85.63 -15.21 85.92 54.53 16.73 29.50

P/E (x) 28.84 34.01 18.30 11.84 10.14 7.83

EV/EBITDA 15.84 15.54 10.75 8.76 7.74 6.08

Dividend Yield (%) 0.63 1.26 3.14 3.14 3.14 3.14

P/B (x) 6.64 5.76 4.64 3.48 2.68 2.05

ROE % 23.02 16.92 25.37 29.43 26.46 26.20


>> The average tile consumption of 0.7 square meters per person demonstrates the potential of the market when taking into account other averages like China (2 square meters per person), Europe (5 to 6 square meters per person) or Brazil (2.5 square meters per person). Averages tend to be boosted by larger scale construction of projects like condominiums, hotels and malls which would follow with higher income levels.

Bathware >> Royal Ceramics venture into bathware has proved more successful than anticipated with the operation achieving break even an year before expected in FY10. The facility which is located in Panagoda currently has a rated annual capacity of 250,000 pieces per annum and has a 90 cubic metre kiln, automated driers and glazing lines. Investment in the facility came to Rs.1.8bn.

>> Rocell competes with brands such as Kohler, American Standard and Toto. The market had previously been dominated by imports and market shares were fragmented with no single dominant supplier. The size of the bathware market is estimated at around 600,000 pieces a year, including the market for squatting pans which is around 175,000 pieces a year.

>> Production technology and bathware designs are from Italy. Products start at a price of around Rs.20,000 and go up to Rs.80,000 targeting the middle and upper end of the market- the strategy being not to compete with cheaper Chinese and Indian products. The Rocell branding strategy of marketing tiles as lifestyle trappings instead of generic building materials has been extended to bathware as well.

>> However we feel margins are possibly lower than the tile business with raw materials like clay for sanitaryware imported from locations like Britain. The facility is currently operating at 65% capacity and as of December made an EBIT of Rs.35.0m. Management states that many of the expected overheads are absorbed by the existing sales infrastructure and believes they have already captured 25% of the domestic market.

Tiles >> Royal Ceramics produces around 11,000-12,000 square meters of tiles. Along with the 3,500-4,000 porcelain capacity of Eheliyagoda another 15% of the Horana production is also glazed porcelain. Both factories are currently operating at close to full capacity. Royal Ceramics is the main local producer of porcelain tiles which are higher value added products and provide higher margins. Porcelain tiles are prepared from a clay mixture that provides a very dense body tile. It is impervious to moisture with low absorption rates of less than 3% to 0.5% depending on the quality of the tile. The company is reputed for the quality of their product and reaps higher margins that its competition because of this.

>> Royal Ceramics has benefited from using a direct network of company owned showrooms as their main distribution channel. This has proven to be a key advantage in their competitive positioning since they are better able to control buyer perceptions for their higher quality offerings. The company plans to open around 3 to 4 new showrooms during this year mainly in the recently liberated North and East and it would increase the total number of showrooms to 44.


Expansion Plans>> The capacity at the Horana factory that manufactures ceramic tiles will be expanded by 3,500 square meters a day, while capacity at the Eheliyagoda factory that manufactures porcelain tiles will be expanded by 1,500 square meters a day. The investment for these expansions are expected to come to Rs.300m.

>> The company had initially delayed planned investments in their 33 acre property in Kiriwaththuduwa for a new porcelain tile factory with a capacity of 10,000 sq meters as well as subsidiary involved in roofing material manufacturing that were deferred due to the economic downturn. We expect work on the tile facility to commence in late FY11. Additionally the planned eventual capacity for the bathware production facility is 500,000 pieces. A substantial proportion of this will be earmarked for export.

3QFY11 Performance>> RCL’s 3Q earnings were up 12.7% on the back of a 36% growth in net revenue. GP margins were down to 46.8% from 48.4% last year while also sequentially up from 2Q’s GP margin of 46.0%. Net margins were also down slightly to 24.6% for the quarter from last year’s 26.3%.

>> Distribution and admin expenses were up 55% and 19% respectively. Finance expenses were down 50% from the year before. Inventories were down 13.0% from last year as well as being 5.6% lower sequentially. Long-term debt has reduced by 3.2% YoY while short term debt has reduced by 5.7% YoY.

Outlook>> We expect RCL to make Rs.1,488m in earnings for the current FY11 year which would be a growth of 54.5%. We subsequently expect earnings to grow over the next two years at a 22.9% CAGR on the back of a 21.0% two year revenue growth CAGR. Admin and distribution expenses are expected to grow at an average of 13.2% and net margins are expected to stay essentially flat over the period.

>> With more people moving into the middle and upper classes over the next few years as well as the planned increases in capacity we feel Royal Ceramics is well positioned to maintain its current share of the domestic tile market. Increasing economic growth should also see an increase in larger construction projects in addition to the improving retail demand

>> Despite the share outperforming the broader market in the last year we feel that valuations are still cheap when looking at market earnings multiples and believe that the company should trade at a premium to the market after taking into account the potential for sustained earnings growth . RCL’s forward multiples stand at 10.1x FY12E earnings (compared to a market earnings multiple of 15x FY12).



Year ending 31st Mar Rs. mn Rs. mn Rs. mn Rs. mn Rs. mn Rs. mnRevenue 3,475 3,741 4,451 5,872 7,164 8,597 Cost of Services (2,002) (2,098) (2,332) (3,171) (4,012) (4,814)Gross Profit 1,472 1,643 2,119 2,701 3,152 3,783 Other operating income 56 75 157 138 35 35 Selling/Distribution expenses (402) (477) (538) (603) (675) (756)Administrative expenses (137) (179) (355) (409) (470) (540)

Provision for dimunution of investment - (122)Operating Profit 989 940 1,382 1,828 2,042 2,521 Net finance cost (346) (403) (382) (212) (148) (89)PBT 643 538 1,000 1,616 1,894 2,432 Tax (33) (20) (37) (128) (157) (183)Net Earnings 611 518 963 1,488 1,737 2,249


Growth (%)Sales 33.9 7.7 19.0 31.9 22.0 20.0EBIT 72.2 -3.4 44.1 32.3 11.7 23.5Net Profit 85.6 -15.2 85.9 54.5 16.7 29.5EPS 85.6 -15.2 85.9 54.5 16.7 29.5Margins (%)EBITDA 34.4 31.9 38.7 35.9 32.6 32.9

EBIT 28.6 25.6 31.0 31.1 28.5 29.3

Pre-Tax margin 18.5 14.4 22.5 27.5 26.4 28.3Net Margin 17.6 13.8 21.6 25.3 24.2 26.2Valuation Metrics (x)P/E 28.8 34.0 18.3 11.8 10.1 7.8P/B 6.6 5.8 4.6 3.5 2.7 2.1EV/EBITDA 15.8 15.5 10.8 8.8 7.7 6.1

EV/EBIT 19.1 19.3 13.4 10.1 8.8 6.8

ROE % 23.0 16.9 25.4 29.4 26.5 26.2

Cash flow statement 2008 2009 2010 2011E 2012E 2013E

Year ending 31st Mar Rs. mn Rs. mn Rs. mn Rs. mn Rs. mn Rs. mnPBT 643 538 1,000 1,616 1,894 2,432 Depreciation / Amortization 203 235 340 278 292 306 Net finance costs 349 421 382 212 148 89 Other (32) 39 Change in working capital (153) (443) (62) (497) (581) (645)

Cash from Operations 1,009 789 1,660 1,609 1,753 2,183 Finance costs paid (349) (421) (382) (212) (148) (89)Income tax paid (49) (26) (37) (128) (157) (183)Other (3) (3)Net Cash from Operations 608 340 1,240 1,269 1,447 1,911 Net PPE (1,236) (611) (536) (689) (699) (701)

Net Investments (34) 314

Other 14 25

Net Cash from Financing (1,256) (273) (536) (689) (699) (701)Net Borrowings 601 (63) (301) 36 (575) (514)

Dividends paid (65) (114) (228) (228) (228) (228)

Other (7) (8)

Net Cash from Financing 529 (185) (529) (192) (803) (742)Net increase in Cash (118) (119) 175 387 (54) 468



As at 31st Mar Rs. mn Rs. mn Rs. mn Rs. mn Rs. mn Rs. mn

Fixed AssetsPP&E 3,541 3,918 4,114 4,525 4,932 5,327

Intangible assets 1 Other investments 13 13 13 13 13 13 Other receivables 138 173 173 173 173 173

3,693 4,104 4,300 4,711 5,118 5,513 Current AssetsInventories 1,064 1,497 1,558 2,055 2,507 3,009

Trade and other receivables 330 377 445 587 716 860 Other investments 542 169 169 169 169 169 Income tax recoverable 1 6 6 6 6 6 Cash and equivalents 49 46 221 609 554 1,022

1,987 2,095 2,399 3,425 3,952 5,065 Current LiabilitiesTrade and other payables 307 379 445 587 716 860

Dividend payable 11 8 8 8 8 8

Income tax payable 4

Borrowings 1,206 1,633 1,190 907 635 381

1,527 2,020 1,643 1,502 1,359 1,248 Non current LiabilitiesBorrowings 1,361 978 1,120 1,439 1,007 604

Deferred tax liabilities 86 86 86 86 86 86


1,499 1,118 1,260 1,579 1,147 744 Net Assets 2,653 3,061 3,795 5,055 6,564 8,585 Stated Capital 815 815 815 815 815 815

Reserves 468 468 468 468 468 468


Shareholder's Funds 2,653 3,061 3,795 5,055 6,564 8,585



Rs 280.00 BUY


>> Colombo Dockyard has had a muted FY2010 compared to their previous year which had a greater proportion of ship repair revenue. The company continues to have a strong outlook for shipbuilding having an order book worth US$240m to build ships with the 78m Greatship Rohini being the most recent vessel delivered. Increased shipbuilding activities continue to be supported by ship repair which has declined in significance over the last two years.

>> The company is the sole shipbuilding and repair company in Sri Lanka, and was initially incorporated to deal with repair business from vessels coming into Colombo Port with the company being predominantly state owned. The majority stake was bought by Onomichi Dockyard Co Ltd of Japan in the 1980s. The company has a well established reputation for being a timely solutions provider in the repair business while expanding its involvement in the new building portion of the business.

Ship repair>> The company has four drydocks with capacities ranging from 9,000 to 125,000 DWT with two or more of these continuously occupied with repair work while the remaining capacity is used for new building. The company uses a variety of techniques to increase throughput and reduce time spent in the drydock using semi-tandem building techniques, efficient management of inventory and raw materials which free up space in the area and so on. While originally the company used to carry out hull repairs and steel renewals they are now also focussed on procuring more profitable, higher value orders which help revenue and profitabiliy. During the course of the building process, fluctuations in variable costs such as raw material prices, forex levels, scheduled labour input, etc, determine where the project’s actual profitability will end up once the project is completed.

>> The company is able to cater to a range of vessels from dredgers to tankers and bulk carriers. The dominance of this portion of the business has ebbed after the company successfully weathered the 2008 global recession. However the improved global economic




Colombo Dockyard PLC

DOCKReuters Code DOCK.CM

Bloomberg Code DOCK.SL



Voting 68,437,071

12 mth High/Low (Rs.) 317.00 / 246.00




1 mth 6 mth 12 mth

ASPI 8.70 18.82 105.54

DOCK 3.70 11.55 9.68

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Revenue (Rs. 'mn) 11,155 13,498 14,867 18,584 21,371 24,577

EBITDA (Rs. 'mn) 1,772 2,560 2,468 3,064 3,501 4,234

EBIT (Rs. 'mn) 1,563 2,189 2,177 2,786 3,209 3,927

PAT (Rs. 'mn) 1,453 2,152 1,938 2,211 2,547 3,118

EPS 21.24 31.45 28.32 32.31 37.21 45.56

EPS Growth 31.99 48.07 (9.95) 14.08 15.18 22.43

P/E (x) 13.18 8.90 9.89 8.67 7.52 6.15

EV/EBITDA 8.76 6.00 4.94 3.86 1.59 0.65

Dividend Yield 1.07 2.50 2.86 2.86 2.86 2.86

P/B (x) 4.25 3.10 2.50 2.04 1.67 1.36

ROE % 32.2 34.8 25.3 23.5 22.2 22.1


environment and increased freight rates should see the demand for ship repair increase in comparison to FY2010.

Ship building>> Due to its docks’ size, Colombo Dockyards specializes in smaller sized niche vessels and, thus, does not present an intensive threat to major regional shipyards.

>> Shipbuilding started in the 1980’s with the company initially specializing in tug boat and speed boat manufacturing mostly for the Sri Lanka Navy. Consequently however the company has developed the capability to build a range of vessels and now regularly delivers two to three vessels every year.

>> The bulk of shipbuilding business comes from India with the company’s largest customer being the Greatship Group of Companies with an orderbook of 11 vessels to be delivered in total. Other significant markets include Singapore, the Middle East and the Maldives.

>> Colombo Dockyard is currently building two 130 Ton Bollard Pull Anchor Handling Tug Supply Vessels for another Singaporean owner with deliveries scheduled for second and third quarter of 2011.

>> In addition to the above two Anchor Handlers, Colombo Dockyard is nearing completion of the fourth 78 m Multipurpose Platform Supply Vessels being built to comply with Indian flag state requirements, which is scheduled to be delivered in the first quarter of 2011.

>> Apart from these, there is one 100 Passenger Launch being built for the Road Development Authority to be operated in the Jaffna Peninsula. Because of safety issues, passenger vessels can be higher value orders.

>> These new additions to the order book including the two MPSVs from the main contract and this order from the optional contract, will take the company through the year 2011 and 2012. The three MPSVs are scheduled for delivery in first, second and third quarter of 2012.

Heavy engineering and offshore engineering>> Dockyards also has a subsidiary, Dockyard General Engineering Services (DGES) which concentrates on heavy engineering, services and maintenance. Its services range from designing to commissioning for petrochemical, infrastructure development, power, and irrigation projects. Incorporated in 2009, the subsidiary has successfully obtained orders in Sri Lanka for projects like steel fabrication for the Upper Kotmale hydropower plant as well providing services in the Maldives for its Petrochemical and Power sector infrastructure development.

>> The new Kelani River Yard managed by DGES already has started its operations and is expected to meet Sri Lanka’s requirement of small boats and barge building and will service tourism development and transport infrastructure expansion needs.

>> The large number of infrastructure development projects in the North and East coupled with power station installations means that this business has significant potential for growth


>> Dockyards also has involvements in offshore engineering providing higher-end repair and maintenance services such as repairing offshore drilling units. Thanks to a tieup the company is able to cater to Middle East offshore oil drillers and has also won business from India and the Maldives.

Outlook>> With a lower proportion of ship repair revenue seen in the interim results of 2010, about 64% of total revenue for the nine months upto September 2010 has come from new buildings. The company has explained that the higher repair revenue in FY2009 was mostly non-recurring since it tied into the cyclical cohort of vessels coming for regular survey and maintenance.

>> We expect Dockyards to make Rs.1,938m in earnings for FY10, and Rs.2,211m in earnings for the current FY11 which would be a growth of 14.1%. We expect earnings to grow at a three year CAGR of 17% upto FY2013 on the back of revenue growth of 18% per annum with net margins improving.

>> We feel that the recovery in the global economy as well as booming regional trade will increase Dockyard’s ability to capitalize on higher value offerings in both the repair and newbuilding parts of the business more than offsetting the capacity constraints they have. The government’s focus on ramping up logistics infrastructure could also benefit Dockyard in the longer term in terms of increasing traffic as well as the possibility of obtaining new dockyard space in one of the newly built ports.

>> Dockyard’s forward multiples stand at 8.7x for FY11 which reduces to 6.1x in FY13 which we feel is undervalued when comparing the potential of the business. We recommend BUY.


Growth (%)Sales 25.92 21.00 10.14 25.00 15.00 15.00EBIT 17.59 40.01 -0.53 27.98 15.19 22.37Net Profit 31.99 48.07 -9.95 14.08 15.18 22.43Margins (%)EBITDA 15.89 18.96 16.60 16.49 16.38 17.23

EBIT 14.01 16.21 14.64 14.99 15.02 15.98

Pre-Tax margin 15.44 17.58 14.64 14.99 15.02 15.98Net Margin 13.03 15.94 13.04 11.90 11.92 12.69

Valuation Metrics (x)P/E 13.18 8.90 9.89 8.67 7.52 6.15

P/B 4.25 3.10 2.50 2.04 1.67 1.36EV/EBITDA 8.76 6.00 4.94 3.86 1.59 0.65

EV/EBIT 9.93 7.01 5.60 4.24 1.73 0.70

ROE % 32.21 34.79 25.33 23.55 22.22 22.10


Balance Sheet 2008 2009 2010E 2011E 2012E 2013E

As at 31st Dec Rs. mn Rs. mn Rs. mn Rs. mn Rs. mn Rs. mn

Fixed AssetsPP&E 2,147 2,061 2,091 2,175 2,262 2,352

Intangible assets 4 9 7 7 7 7 Invesment in associateLong term investments 57 57 57 57 57 57

Deferred Tax Assets 20 45 45 45 45 45 2,227 2,171 2,200 2,284 2,371 2,461

Current AssetsInventories 993 779 778 847 915 988

Trade and other receivables 5,768 7,073 7,051 7,805 4,274 4,915

Cash and equivalents 3,657 3,939 7,080 7,473 13,760 16,603

10,419 11,791 14,909 16,125 18,949 22,506 Current LiabilitiesTrade and other payables 5,515 6,128 6,767 6,318 7,266 8,356

Income tax payable 345 319 344 510 378 267

Dividends payable 7 13

Borrowings 1,399 399 1,388 1,388 1,388 1,388

7,267 6,859 8,499 8,216 9,032 10,011 Non Current LiabilitiesBorrowings 96 64 64 64 64

Deferred tax liabilities 0 0 0 0 0


842 887 914 740 740 740 Net Assets 4,537 6,216 7,697 9,453 11,547 14,216 Stated Capital 684 684 684 684 684 684

Reserves 3,827 5,501 6,966 8,704 10,778 13,423

Shareholder's Funds 4,512 6,186 7,651 9,389 11,462 14,107 Minority interest 25 30 46 64 85 109

Total Equity 4,537 6,216 7,697 9,453 11,547 14,216

Income Statement 2008 2009 2010E 2011E 2012E 2013E

For the Year Ending 31st Dec Rs. mn Rs. mn Rs. mn Rs. mn Rs. mn Rs. mnNet Revenue 11,155 13,498 14,867 18,584 21,371 24,577 Cost of Goods (8,561) (9,985) (11,421) (14,495) (16,606) (18,826)Gross profit 2,594 3,514 3,446 4,088 4,766 5,751 Other income 333 272 175 290 290 290 Distrib expenses (21) (16) (17) (25) (28) (31)Admin expenses (1,316) (1,512) (1,615) (1,752) (1,963) (2,198)

Other expenses (27) (68) 40 48 48 48

Operating profit 1,563 2,189 2,029 2,649 3,114 3,860

Net finance cost 159 184 148 137 96 67 AssociatePBT 1,722 2,373 2,177 2,786 3,209 3,927 Tax (267) (216) (223) (557) (642) (785)

Minority interest (2) (4) (16) (18) (21) (24)

Net earnings 1,453 2,152 1,938 2,211 2,547 3,118


Cash flow statement 2008 2009 2010E 2011E 2012E 2013E

For the Year Ending 31st Dec Rs. mn Rs. mn Rs. mn Rs. mn Rs. mn Rs. mnOperating Profit 1,563 2,189 2,177 2,786 3,209 3,927 Depreciation / Amortization 209 371 291 278 292 306

Net finance costs (148) (137) (96) (67)Other 363 501 Change in working capital 1,567 (571) 734 (1,280) 4,279 265

Cash from Operations 3,702 2,489 3,054 1,648 7,685 4,431 Finance costs paid (72) (70) 148 137 96 67

Income tax paid (335) (266) (223) (557) (642) (785)

Other (38) (56)Net Cash from Operations 3,257 2,098 2,979 1,227 7,139 3,713 Net PPE (516) (413) (322) (362) (379) (397)

Net Investments (63) (0)Other 231 254

Net Cash from Investing (348) (160) (322) (362) (379) (397)Net Borrowings (628) (1,110) 957 (0) (0) (0)

Dividends paid (194) (473) (473) (473) (473) (473)

Other (1) (1)

Net Cash from Financing (824) (1,585) 484 (473) (473) (473)Net increase in Cash 2,086 353 3,141 393 6,287 2,843



Rs 174.50 BUY


>> Privatized in 1992, Distilleries is the largest producer of arrack in Sri Lanka. Brand loyalties and economies of scale have enabled the company to retain an estimated 75% market share of the legal liquor market. Despite a low per capita GDP, Sri Lanka has one of the highest per capita consumption of spirits in the world but the majority of this market comprises of illicit alcohol.

>> The June 2009 reversal of the SLIC acquisition has now scaled back the conglomeratization of Distilleries. With the subsequent payback of their purchase price of Rs.5.7bn which was delayed by the Government until December 2010, the company although cash rich appears to have scaled back on their ambitions. The company is still due approximately Rs. 4bn from the Government as per the Supreme Court ruling in lieu of profits earned by SLIC during the period the insurer was under the control of DIST. Their troubled fixed line telco subsidiary Lanka Bell was put on sale while a 70% stake in the fund management company NAMAL has already been sold to Union Bank and Ennid Capital Pvt Ltd for Rs. 455mn. The company remains

a strongly cash generative beverage play however with the core business coming to over 80% of revenue and 88% of PBT.

>> The company has the largest market share of Sri Lanka’s hard liquor segment with 75% of the legitimate tax paying liquor segment. Sri Lanka’s non-taxpaying segment is estimated at 50-60% of volumes. Sri Lankan consumption of hard liquor mainly consists of coconut spirits (Coconut and Processed Arrack) and rectified spirits (Extra Special and Special Arrack) and Excise Department projections indicate that 46m proof litres of hard liquor are manufactured in the country per annum. Volumes in the beverage sector are expected to grow steadily between 7% - 9% per annum with margins remaining stable on account of incremental increases in prices to match increases in excise, and increased volumes from sales in supermarkets.

>> DIST has two plants to distil spirits from coconut toddy - one in Seeduwa which accepts toddy from the northern segment of the tapping belt in Sri Lanka, and Beruwala Distillery




Distilleries Company of Sri Lanka PLC

DIST

Reuters Code DIST.CM

Bloomberg Code DIST.SL



Voting 300,000,000

12 mth High/Low (Rs.) 186.00 / 112.50




1 mth 6 mth 12 mth

ASPI 8.70 18.82 105.54

DIST (2.74) 21.25 51.30


Revenue (Rs. 'mn) 38,942 21,872 20,048 22,554 25,260 27,787

EBITDA (Rs. 'mn) 7,368 5,965 5,429 6,840 7,789 8,315

EBIT (Rs. 'mn) 5,967 4,794 3,723 6,562 7,497 8,009

PAT (Rs. 'mn) 4,101 3,387 2,136 4,130 4,809 5,227

EPS 13.67 11.29 7.12 13.77 16.03 17.42

EPS Growth 13.71 (17.40) (36.95) 93.40 16.42 8.71

P/E (x) 12.77 15.46 24.51 12.67 10.89 10.01

EV/EBITDA 7.76 9.60 10.00 7.45 6.11 5.28

Dividend Yield 1.00 1.29 1.43 1.43 1.43 1.43

P/B (x) 2.78 2.33 2.58 2.16 1.82 1.55

ROE % 21.74 15.10 10.51 17.06 16.70 15.47

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which accepts toddy from the south. The liquor is then matured at warehouses in Seeduwa and Kalutara for periods ranging from three months to seven years. The company has five plants for blending and bottling - two in Kalutara, and the others in Seeduwa, Badulla and Kandy.

>> Distilleries’ Periceyl subsidiary also manufactures a range of higher value-added products such as Whiskeys, Brandys, Vodka, Rums and Gin which falls into the ‘Country made foreign liquor’ excise category. Periceyl also distributes wines and other products manufactured by the global Pernod Ricard. However, contribution to the sector turnover is less than 5%.

>> The last few years have seen a continuous increase in excise tax with current tax rates coming to Rs.600 to Rs.800 per proof litre. The current regime has also strengthened legislation against alcohol and tobacco leading to an effective ban against advertising of any form. Despite also being a constraint on new products being introduced this however also constitutes a barrier to new entrants. Despite regulatory constraints we feel that over the longer term higher personal income levels will enable marginal volume growth with potential upside from a possible reduction in the illicit market.

Plantations>> Earnings from the plantation sector come via the firm’s 43% stake in Balangoda Plantations and a 31% stake in Madulsima Plantations (accounted for as an associate) which are expected to record a significant improvement particularly in Balangoda Plantations despite a wage hike with higher revenue stemming from record high tea prices. Rubber profitability has been greater than that of tea largely leading to the profitability in Balangoda while Madulsima has been operating with losses.

Telco >> The floor price established in 2010 and interconnection regime has helped fixed line telco Lanka Bell recover from the Rs.788m loss made in FY10 to a Rs.92m profit for 1H:FY11. However the lack of a mobile licence despite their CDMA network means their business model has clearly suffered especially when taking into account previous earnings of Rs.1.03bn in FY07 and Rs.0.90bn in FY08 and efforts have been made to divest the company which was bought in 2005. In addition to their CDMA network in Sri Lanka, Lanka Bell also owns and operates the sole landing station of Reliance Telecom’s undersea FLAG optical fibre network in Sri Lanka.

Insurance >> The company obtained a licence to start an insurance operation making an investment of Rs.500m to start an exclusively general insurance business titled “Continental Insurance”. The company has aggressively targeted motor vehicle insurance segment by introducing a policy that lets a vehicle owner/driver who maintains an accident free period of one year to enjoy an additional year for free.


Aitken Spence PLC >> Distilleries upped their associate stake in Aitken Spence from 22.5% to 28% by November 2010. Thanks to SPENs’ presence in tourism (they own or manage over 2,000 rooms in multiple countries) and logistics (they will have a 30% stake in the Colombo South port terminal with a capacity of 2.4m TEUs to be completed in 2014) the company has potential to make over Rs.3.5bn in earnings in FY12.

Outlook>> Distilleries had sharply higher quarterly earnings for the three months to December 2010 growing by 45% YoY. While net revenues and GP increased in tandem at a healthy 15%, distribution and administrative costs fell sharply by 32% and 26% respectively. The combined savings added Rs.424m to the bottom line which comes to 35% of Distilleries’ quarterly earnings to equity of Rs.1,219m.

>> While the company generally has stronger liquor sales in the bottom half of the year, the improvement in earnings is better than expected. Added impetus was provided by the continuing turnaround of Lanka Bell which made earnings of approximately Rs.109m for the quarter, while plantations have also reverted into profits.

>> The company’s franchise over the Sri Lankan hard liquor segment is unlikely to be reversed for many years to come. With the cash generated by this business it remains to be seen if Distilleries plans to repeat its strategy of diversification in the future.

>> At Rs.174 the stock trades at 10.9x FY12 earnings which is a discount to the market multiple of 15.5x. The loss of SLIC has led to the company regaining focus as the dominant liquor producer in the country and it still remains a cash rich and asset rich entity with the potential for further acquisitions. We recommend BUY.


Growth (%)Sales 31.46 (43.83) (8.34) 12.50 12.00 10.00 EBIT 24.10 (19.66) (22.34) 76.26 14.24 6.83

Net Profit 13.71 (17.40) (36.95) 93.40 16.42 8.71 EPS 13.71 (17.40) (36.95) 93.40 16.42 8.71 Margins (%)EBITDA 18.92 27.27 27.08 30.33 30.83 29.92

EBIT 15.32 21.92 18.57 29.09 29.68 28.82

Pre-Tax margin 15.25 20.04 17.27 30.04 31.25 30.89

Net Margin 10.53 15.49 10.65 18.31 19.04 18.81

Valuation Metrics (x)P/E 12.77 15.46 24.51 12.67 10.89 10.01 P/B 2.78 2.33 2.58 2.16 1.82 1.55

EV/EBITDA 7.14 9.14 9.65 7.16 5.90 5.03

EV/EBIT 8.82 11.37 14.07 7.47 6.13 5.23

ROE % 21.74 15.10 10.51 17.06 16.70 15.47



Year ending 31st Mar Rs. mn Rs. mn Rs. mn Rs. mn Rs. mn Rs. mnNet Revenue 38,942 21,872 20,048 22,554 25,260 27,787Cost of Goods (27,255) (12,176) (11,694) (11,614) (12,892) (14,310)Gross Profit 11,687 9,697 8,354 10,940 12,369 13,477Investment and Other operating income 6,022 687 520 240 280 280Distrib expenses (2,783) (2,571) (2,007) (1,992) (2,211) (2,454)

Admin expenses (5,468) (3,019) (3,184) (2,626) (2,941) (3,294)Increase in Life Fund (3,528)

Other operating gain 37 40

Operating Profit 5,967 4,794 3,723 6,562 7,497 8,009

Negative goodwill on acquisition 62

Net finance cost (637) (748) (566) (376) (263) (184)

Associate 547 337 305 590 661 760

PBT 5,939 4,383 3,462 6,776 7,894 8,584

Tax (1,764) (1,683) (1,311) (2,575) (3,000) (3,262)

Profit attributable to SLIC 730

Minority interest (74) (43) (16) (71) (86) (95)

Net Earnings 4,101 3,387 2,136 4,130 4,809 5,227



As at 31st Mar Rs. mn Rs. mn Rs. mn Rs. mn Rs. mn Rs. mnFixed AssetsPP&E 15,145 8,106 7,898 8,214 8,542 8,884

Leasehold properties 408 390 372 372 372 372Intangible assets 130 2,787 2,584 2,584 2,584 2,584Invesment in associate 3,134 3,368 3,545 4,135 4,796 5,556

Long term investments 25,625 46 1,505 7,221 7,221 7,221Goodwill on Acquisition 2,371 255 255 255 255 255Policyholders Loans 2,544

Deferred Tax Assets 13 110 110 110 110

Advance Lease Premuim 85 4 3 3 3 3

49,443 14,970 16,271 22,893 23,882 24,984

Current AssetsShort term Investments 20,743 1,927 1,845 1,845 1,845 1,845

Inventories 4,677 4,272 3,746 3,834 4,294 4,724

Trade and other receivables 7,110 4,245 4,031 4,511 5,052 5,557

Amount due from associate 931 479 75 75 75 75

Cash and equivalents 3,309 1,220 2,190 5,685 9,112 13,189

36,769 12,144 11,886 15,950 20,378 25,389Net Assets in SLIC 10,542

Receivable from Treasury (SLIC) 6,716 1,000 1,000 1,000

Current LiabilitiesTrade and other payables 9,193 5,994 6,767 7,668 8,589 9,447

Amount due to Related Companies 120 95 1,078 1,078 1,078 1,078

Income tax payable 1,243 926 510 510 8 8

Borrowings 5,772 3,958 2,941 3,012 3,012 3,285

16,328 10,972 11,295 12,268 12,686 13,818

Non Current LiabilitiesInsurance Provision - Life 35,654

Insurance Provision - Non Life 9,888

Borrowings 1,193 1,220 1,025 1,049 1,354 1,241

Deferred tax liabilities 538 98 113 113 140 140

Retirement benefit obligation 1,102 571 677 677 677 677

Deferred Income 284 205 239 239 239 239

48,658 2,093 2,055 2,078 2,410 2,297

Net Assets 21,225 24,590 21,523 25,496 30,163 35,257Stated Capital 300 300 300 300 300 300

Reserves 18,559 22,133 20,013 23,916 28,496 33,495

Shareholder's Funds 18,859 22,433 20,313 24,216 28,796 33,795Minority interest 2,366 2,158 1,210 1,281 1,367 1,462

Total Equity 21,225 24,590 21,523 25,496 30,163 35,257


Cash flow statement 2008 2009 2010 2011E 2012E 2013E

Year ending 31st Mar Rs. mn Rs. mn Rs. mn Rs. mn Rs. mn Rs. mnPBT 5,939 4,383 3,462 6,776 7,894 8,584Depreciation / Amortization 1,402 1,171 1,706 278 292 306Net finance costs (3,787) 478 304 376 263 184Associate (547) (337) (305) (590) (661) (760)

Other 5,568 105 (199)

Change in working capital (1,801) (226) 2,060 334 (1,503) (935)Cash from Operations 6,773 5,573 7,028 7,174 6,286 7,380

Finance costs paid (701) (735) (566) (376) (263) (184)

Income tax paid (2,138) (2,453) (1,808) (2,575) (3,000) (3,262)

Other (103) (65) (62)

Net Cash from Operations 3,831 2,320 4,593 4,223 3,023 3,934

Net PPE (3,725) (921) (1,471) (594) (620) (648)

Net Investments (5,649) (2,282) (678)

Other 5,146 459 428

Net Cash from Investing (4,229) (2,744) (1,721) (594) (620) (648)

Net Borrowings (369) 2,121 (125) 95 1,252 1,019

Dividends paid (531) (562) (691) (228) (228) (228)

Net Cash from Financing (901) 1,559 (817) (133) 1,024 791

Net increase in Cash (1,298) 1,136 2,055 3,496 3,427 4,077


Rs 101.00 Long Term Buy


>> Aitken Spence Hotel Holdings PLC (AHUN) - backed by one of the top conglomerates in Sri Lanka, Aitken Spence PLC (SPEN), is a leading hotelier in the country with its operations spanning across the Asian as well as the Middle Eastern regions. The company presently owns or manages 27 hotels and resorts under the brands “Heritance”, “Adaaran” and “Aitken Spence Hotels & Resorts” in Sri Lanka, the Maldives, India and Oman with a total room capacity of 2,300.

>> AHUN currently owns and operates 6 hotels (of which 2 hotels with 64 rooms are currently closed for extensive refurbishment) with 565 rooms in Sri Lanka along with 2 other properties with collectively 216 rooms held as associates. The company also manages 3 hotels in the upcountry. In the Maldives, the group owns and operates 7 hotels with 591 rooms under its premier foreign brand “Adaaran” while managing a total of 10 hotels in India and Oman.

>> Strong rebound in the local tourism industry post war has widened prospects for large hotel chain operators

such as AHUN who have already seen sharp improvements in both room rates as well as occupancies. The most recently released results show a fourfold increase in PAT for the 1-3QFY11 over the comparative period in FY10. AHUN, having made plans to expand its footprint in Sri Lanka, undertook a rights issue to raise approximately US $ 23 million in FY10.

Sri Lanka>> Tourist arrivals in to the country rose 22% yoy in FY10 to 501,597 thanks to the end of the war, while growth in FY11 - 10 months up to January 2011 has been stronger with 568,264 tourists, representing a yoy growth of around 45% for the comparative period. Sri Lanka achieved the highest ever tourist arrivals in CY10 with a total of 654,476.

>> With the anticipation of greater arrivals to Sri Lanka in the medium term, AHUN embarked on several new projects in order to increase its capacity. Of its existing portfolio of hotels in the country, Hotel Neptune in Beruwala is currently undergoing extensive



Jeewanthi Malagala [email protected]

Aitken Spence Hotel Holdings PLC

AHUN

Reuters Code AHUN.CM

Bloomberg Code AHUN.SL



Voting 336,290,010

12 mth High/Low (Rs.) - Adjusted 124.29 / 51.68




1 mth 6 mth 12 mth

ASPI 8.18 46.55 104.65

AHUN (7.34) 40.01 92.09


Revenue (Rs. 'mn) 6,091 6,311 7,001 9,436 11,028 12,090

EBITDA (Rs. 'mn) 1,683 1,803 1,899 2,748 3,365 3,854

EBIT (Rs. 'mn) 1,146 1,204 1,157 1,815 2,294 2,698

PAT (Rs. 'mn) 790 824 775 1,450 1,955 2,393

Earnings to Equity (Rs. 'mn) 513 593 524 958 1,300 1,705

EPS* 1.48 1.72 1.51 2.81 3.82 5.02

EPS Growth (%) (69.67) 16.06 (11.91) 85.40 36.21 31.48

P/E (x) 68.23 58.79 66.74 36.00 26.43 20.10

EV/EBITDA (x) 23.12 21.58 20.49 14.16 11.56 10.10

Dividend Yield (%) 0.11 0.06 0.21 0.21 0.21 0.21

P/B (x) 9.04 7.19 6.55 3.97 3.48 2.98

ROE % 13.25 12.23 9.81 11.02 13.15 14.84

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refurbishment and is expected to reopen as “Heritance Maha-gedera” by mid-2011 as an Ayurveda wellness resort. Neptune Ayurvedha Village which comprises 20 rooms will be amalgamated in to this property which will consist of 64 rooms upon completion.

>> Ramada Resorts – a 100 roomed property located on a 5 acre land in Kalutara was acquired by AHUN in FY10 for Rs. 350 million, prior to which the hotel was only managed by AHUN. The hotel is due to be closed from April 2011 to make way for expansion and major refurbishment and is scheduled for reopening by winter 2011. Browns Beach Hotel PLC (BRWN), in which AHUN has an associate stake of 29.46%, will also be closed from April 2011 for an extensive transformation.

>> AHUN’s Sri Lankan operations in FY10 saw a remarkable improvement despite the closure of Hotel Neptune and Neptune Ayurveda with a yoy revenue growth of around 15%. Consequent to increased arrivals, the segment returned to profitability with a PBT of Rs. 78.5 million for FY10 including associate earnings, from a loss of Rs. 54 million in FY09 with the 4QFY10 alone generating over Rs. 110 million. AHUN’s local resorts enjoyed an average occupancy of around 55% in 2009 compared to a Sri Lankan average of around 50%. The Sri Lankan segment accounted for around 20% of group turnover in FY10 compared to 17% in FY09 while being a positive contributor to group PBT.

>> More recently, AHUN inked an agreement with Six Senses Resorts & Spas to commence construction of the first Six Senses property in the country through a joint venture worth US $ 35 - 40 million. The project will comprise a Six Senses resort and spa as well as beach front residential villas on a 10.5 acre plot, adjoining Heritance Ahungalla on the Southern coast and on a 27 acre island nearby. The hotel is expected to be operational in 2012 with an average room rate of around US $ 400 – 450. The project will comprise a total of 40 one - bedroom villa suites and 14 two – bedroom beach front residential villas in Ahungalla as well as 15 island villas.

>> In June 2010, Heritance Kandalama was rated as the best 5 star resort in the island for the 3rd consecutive year.

Maldives, India and Oman>> AHUN’s foreign operations took a beating in FY10 with the global economic meltdown that curtailed the flow of tourists in to more expensive destinations such as the Maldives and Oman. Maldives, where AHUN owns and operates over 600 rooms, saw only a 5% growth in arrivals in FY10 largely due to a 20% increase in 4QFY10 alone. Stagnant tourist arrivals coupled with an increase in room supply led to a decline in occupancy to 70% in FY10 compared to 76% in FY09. Average Room Rates (ARRs) too fell consequent to higher competition.

>> Despite a slow recovery, the sector remained profitable with its 2 upmarket properties of HuduRan fushi and Vadoo enjoying higher yields. In FY10, AHUN launched Adaaran Prestige Vadoo – its 5th addition to the Adaaran Resorts which was well received by the public. The hotel, having commenced operations in April 2009, gained recognition at the international travel industry’s Oscar as the “Indian Ocean’s Leading Water Villa Group” in November 2009.


>> However, arrivals from April – December 2010 have seen a sharp improvement with arrivals growing around 21% over the same period in 2009. Although occupancies have improved along with arrivals, room rates continue to be slightly under pressure consequent to increased capacity.

>> AHUN’s operations in India and Oman are only in the form of management contracts where the group manages 5 hotels in each country. Its latest addition in India was the Grand Palace Hotel and Spa, a hill resort in Tamil Nadu. Falling occupancies in these upmarket properties have adversely affected its management fee income which is a function of the topline as well as gross profit.

>> Oman, being heavily dependent on regional tourism, too witnessed declining yields and earnings during FY10 due to a decline in arrivals from UAE. Revenue from management fees accounted for 1.22% of group revenue in FY10 compared to around 2% in FY09.

>> The South Asian segment posted a PBT of Rs. 679 million compared to Rs. 907 million in FY09 which included a profit of Rs. 219 million from the sale of its first island resort, Adaaran Club Bathala.

Earnings Outlook>> With a solid recovery in the local tourism industry along with an increase in AHUN’s room capacity, the company stands to enjoy strong returns in the medium term. AHUN continues to place strategic importance on delivering a niche, high quality product to the high yielding travellers, thus volumes will not be of great concern. However, the local segment is likely to see the closure of around 300 rooms during the off season period in 2011 (April – September) which should have only a marginal impact for earnings in FY12E. However, with most of its properties expected to be operational by the beginning of the winter season, we expect AHUN to recover its lost earnings through higher room rates and occupancies.

>> The group’s parent company SPEN, owns 100 acres of prime beach land in Nilaweli where AHUN is expected to commence the development of a resort in the medium term. This includes a 500 room property offering luxury villas, standard rooms and apartments.

>> AHUN places greater emphasis on expanding its footprint in Sri Lanka given high potential exhibited by the industry. The Government aims to attract an ambitious target of 2.5 million tourists by 2016 which would require at least another 15,000 graded rooms to cater to this demand. Although local as well as foreign operators have shown interest in expanding the room supply, we expect a time lag of at least 2 years for these projects to become operational, until which time, the current properties would enjoy high yields.

>> Despite its investments in Sri Lanka, we expect the South Asian segment to be the largest contributor to group earnings, albeit a reduction in its share due to increased contribution from the local segment. For forecasting purposes, we have factored in an average occupancy of 75% in FY12E for the local segment on an ARR of US $ 120 while for the Maldivian segment, we have included an occupancy of 85% with an ARR of around US $ 293.


>> The group’s interest bearing borrowings stood at Rs. 3,815 million in FY10 with approximately 81% of it being dollar denominated carrying low rates of interest. However, by the end of December 2010, its total long term borrowings amounted to Rs. 3,935 million with short term deposits of Rs. 2,786 million from funds raised via the rights issue.

>> Given the above, we expect AHUN to post Rs. 1,450 million in PAT for FY11E, growing at a CAGR of around 28% during the next 2 years with the local segment accounting for over 50% of operating profit. Adjusted for the minority holdings, we expect earnings to equity to reach Rs. 958 million for FY11E, growing at a CAGR of 33% during the next 2 years. On a forecasted EPS of Rs. 2.81 and Rs. 3.82 for FY11E and FY12E respectively, the share is trading at a PE multiple of 36x and 26x FY11E and FY12E earnings respectively, at a price of Rs. 100.10. The share is therefore, trading at a slight premium to the sector which we believe is warranted due to its high exposure to the Sri Lankan as well as the Maldivian tourism industries compared to most other standalone properties. We recommend Long Term Buy.


Growth (%)Net Revenue 49.70 3.62 10.93 34.78 16.88 9.62

EBIT 74.30 5.04 (3.88) 56.81 26.37 17.61

PAT 107.54 4.41 (6.01) 87.17 34.83 22.37

EPS 145.72 16.06 (11.91) 85.40 36.21 31.48

Margins (%)EBITDA 27.63 28.56 27.12 29.12 30.52 31.87

EBIT 18.82 19.08 16.53 19.24 20.80 22.31

Pre-Tax margin 13.31 13.39 11.32 15.70 18.04 20.09

Net Margin 12.96 13.06 11.07 15.37 17.73 19.79


P/B 9.04 7.19 6.55 3.97 3.48 2.98

EV/EBITDA 23.12 21.58 20.49 14.16 11.56 10.10

EV/EBIT 33.94 32.31 33.61 21.44 16.96 14.42

ROE and Credit RatiosROE % 13.25 12.23 9.81 11.02 13.15 14.84

Net Debt/Equity (%) 77.73 83.90 64.54 4.11 N/A N/A

Net Debt/EBITDA (x) 1.74 2.20 1.76 0.13 N/A N/A

Profit and Loss Account 2008 2009 2010 2011E 2012E 2013E

For the year end 31st March Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn

Revenue (Net of bed tax) 6,091 6,311 7,001 9,436 11,028 12,090

Other Operating Income 45 323 89 102 117 135

Operating costs (4,995) (5,427) (5,937) (7,773) (8,932) (9,633)

Operating Profit 1,140 1,207 1,153 1,765 2,214 2,592 Share of Associate Earnings 6 (3) 5 50 80 106

Finance Income 27 10 13 18 21 24

Finance Expenses (362) (369) (378) (351) (325) (293)

Profit Before Tax 811 845 793 1,482 1,989 2,429

Taxation (21) (21) (18) (32) (34) (36)

Profit After Tax 790 824 775 1,450 1,955 2,393 Minority Interest (277) (232) (251) (492) (655) (688)

Profit Attributable to shareholders 513 593 524 958 1,300 1,705



As at 31st March (Rs. Mn) Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn

ASSETSNon - Current Assets

Property Plant & Equipment 6,665 8,687 8,756 8,824 8,753 8,597

Leasehold Property 1,408 1,555 1,516 1,566 1,616 1,666

Others 278 405 407 461 541 647 8,351 10,646 10,680 10,852 10,910 10,911

Current AssetsTrade & Other Receivables 1,093 983 773 1,460 1,707 1,871

Short term deposits 389 342 375 450 518 596

Cash and cash equivalents 119 117 90 2,941 4,258 6,183

Others 616 624 636 737 826 885

2,218 2,065 1,874 5,588 7,309 9,535 TOTAL ASSETS 10,568 12,711 12,554 16,440 18,219 20,445 EQUITY AND LIABILITIESEquityStated capital 1,056 1,056 1,056 3,555 3,555 3,555

Reserves 1,035 1,463 1,199 1,199 1,199 1,199


Minority Interest 1,220 1,346 1,589 2,066 2,706 3,379

4,977 6,070 6,778 10,625 12,478 14,769 Non - Current Liabilities

Interest - Bearing borrowings 2,930 3,746 2,962 3,181 2,874 2,613

Others 117 114 163 122 134 147

3,048 3,861 3,125 3,303 3,008 2,760 Current Liabilities

Other Provisions and Payables 872 799 791 777 893 963

Amounts due to Ultimate Holding company 527 779 646 743 855 983

Interest - Bearing borrowings 498 676 853 561 507 461

Short term Bank borrowings 333 217 35 28 25 28

Others 314 310 326 403 452 481

2,544 2,781 2,651 2,512 2,732 2,916 TOTAL EQUITY & LIABILITIES 10,568 12,711 12,554 16,440 18,219 20,445


Cashflow Statement 2008 2009 2010 2011E 2012E 2013E

For the year ended 31st March (Rs. Mn) Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn

Profit before Tax 811 845 793 1,482 1,989 2,429 Net Cashflow from Operating Activities 777 1,503 1,485 1,659 2,901 3,460

Cashflow from Investing ActivitiesPurchase of Property, Plant & Equipment (731) (2,166) (675) (1,000) (1,000) (1,000)Others (1,470) 140 13 (50) (50) (50)

Net cash used in Investing Activities (2,201) (2,026) (662) (1,050) (1,050) (1,050)Cashflow from Financing Activities

Issue of shares - - - 2,498 - -

Net borrowings 1,417 844 (569) (72) (361) (307)

Others (39) (238) (69) (102) (102) (102)

Net cash used in Financing Activities 1,377 606 (638) 2,324 (463) (409)Net increase in cash & cash equivalents (47) 83 184 2,932 1,387 2,001

Balance at the beginning of the year 205 158 242 426 3,358 4,745

Balance at the end of the year 158 242 426 3,358 4,745 6,746




>> Dialog Axiata PLC (DIAL), an 83% owned subsidiary of Axiata Investments (Axiata Group Berhad) is the largest telecommunication provider in the island offering fixed line, mobile, broadband and media services through its fully owned subsidiaries with a market capitalization of over US $ 880 million. In addition to Axiata’s investment in Sri Lanka, the parent also operates in several other Asian countries including Malaysia, Indonesia, Bangladesh, India and Singapore.

>> Having survived the most difficult years of its operations in FY08 and FY09, DIAL rebounded sharply in FY10 with significant improvements through its cost rescaling strategies supported by healthy revenue growth thanks to price stability in the industry and the economy to record a PAT of Rs. 5 billion for FY10.

>> DIAL currently boasts an active mobile subscriber base of 6.83 million, which accounts for around 41% of the total market, thereby making it the largest mobile operator in the country.

Industry Overview & Regulatory Developments>> As per the statistics available, Sri Lanka’s mobile subscriber base witnessed exponential growth over the last 10 years with a CAGR of 49% to reach 16.3 million by the end of 3QCY10 thanks to aggressive customer acquisition strategies by all operators in the industry. This, including the dual SIM effect represents a mobile penetration of 79%. However, we believe that excluding the dual SIM effect, Sri Lanka’s mobile penetration should hover around 50% - 55%. The current regulations allow an individual to hold up to a maximum of 5 SIMs per operator.

>> The local mobile industry comprises 5 operators with the final entrant being Bharti Airtel in early 2009. In anticipation of lower than the then market prices being offered by the new entrant, the incumbents undertook aggressive price reductions which saw the entire industry in red as volumes failed to grow in tandem with price reductions.



Jeewanthi Malagala [email protected]

Dialog Axiata PLC

DIAL

Reuters Code DIAL.CM

Bloomberg Code DIAL.SL



Voting 8,143,778,405

12 mth High/Low (Rs.) 13.50 / 6.75


Average Daily Volume (Shares) 3,989,537


1 mth 6 mth 12 mth

ASPI 8.18 46.55 106.12

DIAL (0.84) 19.19 68.57

Valuation Metrics Dec 07A Dec 08A Dec 09A Dec 10A Dec 11E Dec 12E

Revenue (Rs. 'mn) 32,516 36,167 35,779 41,422 43,378 46,303

EBITDA (Rs. 'mn) 13,431 5,067 7,149 14,425 15,117 16,922

EBIT (Rs. 'mn) 8,884 (1,591) (4,817) 5,145 5,227 5,990

PAT (Rs. 'mn) * 8,908 (3,593) (13,291) 4,754 4,829 5,618

EPS (Rs.) 1.09 (0.44) (1.58) 0.56 0.59 0.69

EPS Growth (%) (11.96) (140.34) (257.64) 135.57 5.63 16.33

P/E (x) 10.79 (26.74) (7.48) 21.02 19.90 17.11

EV/EBITDA (x) 8.65 22.93 16.25 8.05 7.68 6.86

Dividend Yield (%) 4.66 N/A N/A 1.69 4.66 4.66

P/B (x) 1.89 2.24 3.42 3.07 2.92 2.74

ROE % 17.50 (8.37) (45.72) 14.58 14.66 15.99

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* Adjusted for rights issues


>> Consequent to the price war, the regulator imposed a price floor of Rs. 2 and Rs. 1.00 per minute on an off net and on net call respectively from July 2010 along with a “calling party pay” regime at a cost of Rs. 0.50 per minute from June 2010. More recently, it was proposed to reduce the off net floor rate to Rs. 1.50 per minute from July 2011.

>> With price competition having subdued on the local voice calls, operators have now moved to compete on price of international calls by piggybacking on other networks owned and operated by their parent company. With increasing volumes on this segment, the regulator has introduced a levy of Rs. 2 per minute on all outgoing international calls.

>> Although the regulator has shown interest on implementing Mobile Number Portability (MNP) in Sri Lanka, it is expected to take at least 2 years prior to implementation.

>> Despite such high penetration levels in Sri Lanka, there exists room for growth in Minutes of Use (MoU) which currently hovers around 140 to 150 minutes per user per month. This, compared to our regional peers, ranks well below that of countries such as India where the MoUs average over 200 minutes.

Operational Review of DIAL

Mobile

>> DIAL remains the market leader in the local mobile industry with an active subscriber base of 6.83 million accounting for 41% of the total market and 55% of revenue share. The company, historically, enjoyed above industry growth in subscribers thanks to its island wide coverage which covers approximately 76% in land mass and 95% of population, but increased competition over the years has slowed down its growth. DIAL currently operates 1,942 2G base stations along with 932 3G base stations.

>> With increasing competition, DIAL saw its market share steadily declining from a high of 63% in 2005 to its current level – a trend which is likely to continue until such time the regulator further restricts the number of SIMs an individual may own. Of its subscriber base, approximately 89% are pre paid who contribute towards around 40% of company turnover.

>> The company was the first mobile provider to begin operations in the war torn areas of North and East – home to around 2.5 million people with high propensities to consume, where it has secured at least 80% of market share.

2002 2003 2004 2005 2006 2007 2008 2009 Sep-10

Mobile Subs 931,403 1,393,403 2,211,158 3,361,775 5,412,496 7,983,489 11,082,071 14,095,346 16,305,417

Growth in Mobile 50% 59% 52% 61% 48% 39% 27% 16%

Dialog Market share 52% 60% 61% 63% 57% 53% 50% 45% 41%

Dialog's share of incremental subs. 75% 65% 66% 48% 45% 40% 29% 16%

Total Line Population (Mobile & Fixed) 1,814,511 2,332,416 3,202,397 4,605,769 7,296,572 10,725,548 14,528,482 17,531,304 19,854,338Growth in Line 29% 37% 44% 58% 47% 35% 21% 13%

Fixed Line Penetration 5% 5% 5% 6% 9% 14% 17% 17% 17%

Mobile Penetration 5% 7% 11% 17% 27% 40% 55% 69% 79%

Line Penetration 10% 12% 16% 23% 37% 53% 72% 86% 96%

Source : TRC & Company data


>> In FY09, having partially recovered from double digit inflation experienced in FY08, DIAL saw its blended MoUs grow by around 29% over FY08 to 129 minutes in FY09 at the expense of a 29% reduction in blended ARPU to Rs. 324. Performance in FY10 has been even more encouraging with a blended MoU growth of 12% to 145 minutes while blended ARPUs dropped only by 5%, indicating improving elasticity levels.

>> The existence of a high tax environment has historically been a constraint to MoU growth with as much as 31% been charged out as effective taxes from the subscriber. From January 2011, the regulator implemented a new Telecommunication levy of 20% (effective tax of 22.4%) replacing all other taxes, which we believe would boost MoU in addition to improving economic conditions in the country.

>> DIAL’s global business including the international voice termination segment has been a significant contributor to company revenue with increased tourist arrivals and economic activity. The segment witnessed a 27% growth in revenue on the back of increased traffic to account for around 25% of company revenue in FY10 compared to 23% in FY09.

>> With voice telephony exhibiting limited growth potential, the company has moved its focus towards mobile broadband which has seen significant growth over the last 2 years. Sri Lanka’s internet and broadband penetration stood at less than 2% in FY10 indicating heavy under penetration. The mobile broadband subscriber base at DIAL reached 118,000 by the end of 2010. Mobile broadband along with other value added services account for about 10% of company turnover.

>> In FY09, as a part of its cost rescaling strategy, the company expensed a one off charge of Rs. 6 billion of its current GSM network to facilitate the move to a 100% NGN infrastructure while a further Rs. 2,069 million was written off as a non recurring charge to align capital inventory with international best practices. The company also implemented a two phase VRS with a total provisioning of Rs. 881 million. Through the above, the company saved approximately Rs. 2 billion in FY09 over FY08 while a further Rs. 805 million was saved in FY10.

Pay TV>> Since inception, the Pay TV business struggled heavily in attracting sufficient number of subscribers to breakeven partly due to the adverse economic conditions experienced coupled with the social attitudes with regard to Pay TV. For a short while, the company offered cheaper packages in order to attract more subscribers but later on revised its packages upwards in a bid to increase the ARPU levels in order to breakeven. The subscriber based touched a high of 160,000 by the end of 1QFY10 but the numbers declined to 152,000 by 3QFY10 due to an aggressive credit control policy imposed on customers who have defaulted. However, by the end of FY10, the subscriber base increased to 168,291.

>> Thanks to a revision of prices on its packages, the unit has seen a steady increase in its ARPU which stood below Rs. 700 in 2009 to around Rs. 826 by 2010. Of the company’s revenue, around 78% is accounted for by the monthly subscription fees while the remainder being the income from the sale of the unit as well as other income. The Pay TV segment was initially expected to breakeven with around 200,000 subscribers but the unit has managed to become EBITDA positive

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in 2010 with an EBITDA of Rs. 343 million for FY10 improving 243% yoy thanks to a 23% growth in revenue. NPAT too improved 80% yoy to a cumulative loss of Rs. 154 million with the 4QFY10 recording a profit of Rs. 74 million due to a one off reversal.

CDMA & Broadband>> CDMA and broadband services at DIAL are provided through its fully owned subsidiary, Dialog Broadband Networks (Pvt) Ltd. (DBN) while also managing the group’s telecommunication infrastructure along with the mobile arm. The fixed line industry in Sri Lanka has reached its saturating point with a subscriber base of around 3.44 million. However, the industry may witness marginal growth with increased subscription for ADSL services offered by the incumbent, Sri Lanka Telecom PLC (SLTL).

>> DIAL’s CDMA subscriber base stood at 189,000 by the end of FY10 growing marginally by 6.8% over 2009. The broadband and voice bundled product offered by the subsidiary has seen significant growth in 2010 compared to broadband only subscribers.

>> Over the years, the unit has remained dilutive to group performance both at EBITDA and PAT level due to its business model but increased focus on cost rescaling strategies helped DBN in becoming EBITDA positive since April 2010 while also seeing a reduction in its loss margins. The unit has undertaken accelerated depreciation of its network which should reduce the depreciation strain on DBN beyond FY12. The WiMAX network will be fully depreciated in FY11 while the CDMA network will be fully depreciated by FY12.

Earnings Outlook & Valuations>> The intervention by the regulator in the form of a price floor has virtually ended severe price competition among operators. With stability in prices and increase in affordability due to slowing down inflation and reduction of taxes, we expect the mobile segment to enjoy a growth in MoUs and thereby revenue, driven mainly by the prepaid segment. We have conservatively factored in a CAGR of 5% in revenue for the pre and postpaid segments. Further, DIAL has been a net receiver with the imposition of the interconnection charge but we expect the gap to narrow in the medium term given the current policy of issuing SIMs.

>> Increased computer literacy and need for information sharing among the society coupled with declining prices of PCs has increased demand for broadband services in the country. With broadband penetration being at low levels compared to most other developing nations, we expect DIAL’s mobile broadband unit to be a key revenue generator in the medium term.

>> Global revenue driven by increased international traffic will also be a significant contributor to DIAL’s revenue given the increase in tourist arrivals in the country along with a sharp reduction in IDD rates. With increased volumes, the regulator has placed a levy of Rs. 2 per minute on international calls which has been passed on to consumers in the case of DIAL.

>> On the media unit, we expect the segment to become PAT positive within the 1HFY11E given that the company achieves stronger subscriber growth.


However, the CDMA and broadband segment is likely to remain dilutive to group PAT due to its accelerated depreciation policy although it will continue to be EBITDA positive with improved performance.

>> In terms of capex, the group intends to allocate a sum equivalent to 15% - 20% of group revenue. DIAL, as an approved investment under the Board of Investment in Sri Lanka was granted a 15 year tax holiday which commenced from 1998 and due to expire in 2012. Post its expiry, the company has the option of selecting a corporate tax of 28% or a 2% tax on its topline.

>> The group had obtained an advance of US $ 47.5 million and Rs. 3,724 million from its parent company along with another term loan to the amount of US $ 135 million from OCBC which is at a preferential rate through a corporate guarantee from the parent company. During 4QFY10, DIAL repaid US $ 10 million of the advance. However, DIAL is not under obligation to immediately repay the advance but has opted to do so in order to remove the insecurity of a possible dilution of minority holdings.

>> DIAL, having recovered from the biggest loss ever of Rs. 12.2 billion, posted a PAT of Rs. 5 billion for FY10 while at company level (the mobile arm) recorded a PAT of Rs. 6,552 million. PAT at group level included a forex gain of Rs. 680 million. The group recorded an EBITDA margin of around 36% during FY10 while at company level, EBITDA margin was around 38%.

>> With improved performance from the subsidiaries, we expect DIAL to post Rs. 4,829 million in earnings after preference dividends for FY11E while at company level, we expect a PAT of Rs. 6,775 million. Excluding the forex gain of Rs. 680 million in FY10, this represents a yoy growth of 18.5% in group PAT. The Preference shares will be fully repaid by 1HFY12E. Given its current cost structure we anticipate an EBITDA margin of around 35% - 37% to be sustained in next couple of years.

>> At a price of Rs. 11.80, the counter is trading at a PE multiple of 20 times FY11E earnings and 17 times FY12E earnings. We recommend Long Term Buy.

Ratios and Valuation Dec 07A Dec 08A Dec 09A Dec 10A Dec 11E Dec 12E

Growth (%)Sales 26.62 11.23 (1.07) 15.77 4.72 6.74 EBIT (16.22) (117.91) (202.75) 206.81 1.60 14.60

Net Profit (11.35) (132.10) (324.03) 141.34 (1.96) 14.85 EPS (11.96) (140.34) (257.64) 135.57 5.63 16.33 Margins (%)EBITDA 41.30 14.01 19.98 34.82 34.85 36.55

EBIT 27.32 (4.40) (13.46) 12.42 12.05 12.94

Pre-Tax margin 27.72 (6.56) (32.92) 13.37 12.53 13.49

Net Margin 27.58 (7.96) (34.12) 12.18 11.41 12.27

Valuation Metrics (x)P/E 10.79 N/A N/A 21.02 19.90 17.11 P/B 1.89 2.24 3.42 3.07 2.92 2.74

EV/EBITDA 8.65 22.93 16.25 8.05 7.68 6.86

EV/EBIT 13.08 (73.02) (24.12) 22.58 22.22 19.39

ROE and Credit RatiosROE % 17.50 N/A N/A 14.58 14.66 15.99

Net Debt/Equity (%) 6.44 62.41 98.91 64.02 59.12 39.96

Net Debt/EBITDA (x) 0.24 5.29 3.89 1.39 1.29 0.83


Profit & Loss Statement 2005 2006 2007 2008 2009 2010 2011E 2012E

Year Ended 31 December Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mnRevenuePost paid 7,282 9,306 10,439 9,852 8,228 9,544 10,141 10,624 Pre-paid 6,593 10,816 14,811 15,976 14,667 14,984 15,062 16,490 International Termination Revenue 1,364 2,221 3,270 4,064 5,839 7,221 7,605 7,889 Other Revenue 1,178 1,788 3,063 5,192 5,853 8,125 8,712 9,071

International Roaming Revenue 1,616 1,548 933 1,083 1,191 1,548 1,858 2,230 Total Revenue 18,033 25,679 32,516 36,167 35,779 41,422 43,378 46,303 Direct Costs 6,214 8,821 13,402 19,989 22,301 23,600 24,439 25,678

Gross Profit 11,819 16,858 19,114 16,178 13,478 17,822 18,940 20,625 Other income 53 123 380 611 704 134 148 144

Administration costs 2,222 3,064 6,076 10,468 18,055 7,112 7,995 8,542

Selling and distribution costs 2,335 3,067 3,774 6,690 6,159 5,432 5,570 5,949

EBITDA 9,162 13,339 13,431 5,067 7,149 14,425 15,117 16,922 Finance Costs 263 657 629 2,003 1,748 (124) 85 34

PBT 7,052 10,193 9,015 (2,372) (11,780) 5,537 5,437 6,244 Tax (42) (75) (45) (507) (428) (490) (489) (562)

PAT 7,010 10,118 8,969 (2,879) (12,208) 5,047 4,948 5,682

Balance Sheet 2005 2006 2007 2008 2009 2010 2011E 2012E

As at 31 December Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mnFixed Assets 22,430 33,633 54,337 69,827 59,856 56,802 56,292 53,536 Current AssetsInventories 350 580 954 656 211 271 256 274 Recievables 3,726 6,910 10,090 10,743 9,647 9,629 11,699 12,487 Cash and equivalents 6,690 2,302 6,856 1,146 5,295 5,434 5,411 7,380

10,766 9,793 17,899 12,544 15,153 15,334 17,366 20,141 Total Assets 33,197 43,426 72,236 82,371 75,009 72,136 73,658 73,677 Ordinary share capital 7,403 7,403 8,144 8,144 8,144 8,144 8,144 8,144

ESOS Trust Shares (2,385) (1,925) (2,000) (2,000) (1,731) (1,991) (1,731) (1,731)

Preference Shares - - 5,000 4,500 3,750 2,500 1,250 -

Share Premium 5,277 5,277 20,653 20,653 19,912 19,912 19,912 19,912

Retained earnings 6,901 14,206 19,096 11,618 (2,102) 2,656 5,333 8,789

Revaluation reserve 5 21 20 21 136 132 22 22

Shareholders Funds 17,201 24,982 50,912 42,935 28,109 31,353 32,930 35,136

Non Current LiabilitiesBorrowings 9,049 8,185 9,256 9,139 25,862 20,123 18,104 15,077

Retirement benefit obligations & Others 82 112 355 394 1,130 3,169 407 644

9,131 8,298 9,611 9,533 26,993 23,292 18,511 15,721

Current LiabilitiesPayables 5,214 8,866 10,811 11,025 12,668 12,094 15,363 16,399

Current tax liability 36 63 24 78 3 14 79 78

Borrowings 1,615 1,216 877 18,800 7,237 5,383 6,774 6,343

6,865 10,145 11,713 29,903 19,907 17,491 22,216 22,820

Total Liabilities 33,197 43,426 72,236 82,371 75,009 72,135 73,657 73,677


Cashflow Statement 2005 2006 2007 2008 2009 2010 2011E 2012E

Year Ended 31 December Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mnPBIT 7,054 10,193 9,015 (2,372) (12,220) 5,537 5,437 6,244 Depreciation 1,954 2,736 4,547 6,658 18,590 9,281 9,890 10,932

Other non cash items 156 (959) 220 1,082 2,192 (979) 595 592 Net change in working capital (152) 238 (1,608) (141) 3,184 444 (232) (132)Net cash generated from operations 9,011 12,207 12,173 5,227 11,746 14,282 15,690 17,636 Investing activitiesPlant property and equipment (8,205) (11,878) (24,815) (22,993) (9,738) (6,689) (7,808) (8,335)Intangibles (463) (503) (187) (33) (15) - - -

Acquistition of subsidiary, net of cash reqd. (1,441) (849) (40) - - - - -

Others 36 19 20 - 28 (60) - -

Net cash used in investing activities (10,073) (13,212) (25,022) (23,026) (9,725) (6,748) (7,808) (8,335)

Financing ActivitiesShare premium on issue of shares 491 15,376 - - - - -

Proceeds from ESOS 460 129 9

Option Scheme ESOS Shares 1

Preference Share Issue 5,000 (500) (750) (1,250) (1,250) (1,250)

Proceeds from issue of shares 5,402 740 - - - - -

IPO cost set off (113)

Repayment of subscription in advance (2,460)

Payment to ESOST (2,399) (205)

Finance lease repayment (22) (23) (44) (48) (47) (26) (26) (26)

Loan repayment (521) (1,151) (12,198) (11,931) (20,638) (7,899) (4,000) (4,000)

Borrowings 7,061 143 12,736 26,671 25,039 3,492 500 500

Dividends (2,859) (2,813) (4,132) (5,106) (755) (343) (2,227) (2,557)

Net cash used in financing 4,581 (3,383) 17,403 9,095 2,849 (6,025) (7,002) (7,333)Inc./dec. in cash and equivalents 3,519 (4,388) 4,554 (8,704) 4,870 1,509 879 1,969

Cash at beginning 3,170 6,690 2,303 6,857 (1,848) 3,022 4,531 5,411

Cash and equivalents at end 6,690 2,303 6,857 (1,848) 3,022 4,531 5,411 7,380





>> Aitken Spence has continued to expand its presence in the leisure sector in the region while upgrading its properties in Sri Lanka and is now well positioned to take advantage of the anticipated renaissance in the Sri Lankan tourism sector following the end to the war.

>> In addition a consortium made up of Aitken Spence and China Merchants Holdings that bid for the new container terminal at the Colombo Port have been granted approval to proceed to design and build a 2.4mn TEU facility. Aitken Spence will have a 30% stake in the entity while China Merchant Holdings will have a 55% stake and the Sri Lanka Ports Authority a 15% stake.

>> Construction on the above US$ 500mn project is expected to commence in 2Q CY11 and is expected to be funded on a 70:30 debt equity mix. Details on royalty payments have not been made public and overall returns on the project are still unclear, however given the anticipated levels of transshipment and domestic throughput expected at the Colombo Port, it is likely that capacity utilisation would be

high once completed in CY14. The two terminals at the Colombo Port have a current capacity of 4.1mn TEU’s. Under the terms of the agreement with authorities no new terminal would be operated at the Colombo port for a period of 7 years after completion. We expect the company to raise to capital from the market to fund part of this investment.

Leisure>> The leisure sector experienced a significant boost in arrivals which were up 46% from a year ago. With the opportunities peace in Sri Lanka has presented to the group and an increasing trend of tourists from India, China and the Middle East, the leisure sector is well positioned to spearhead earnings growth over the medium term.

Leisure - Sri Lanka>> Low occupancy levels and drop down room rates which were a common feature in the tourism industry over the last 3 decades has reversed with the industry experiencing unprecedented growth.




Aitken Spence PLC

SPEN

Reuters Code SPEN.CM

Bloomberg Code SPEN.SL



Voting 405,996,045

12 mth High/Low (Rs.) 220.00 / 58.00




1 mth 6 mth 12 mth

ASPI 8.70 18.82 105.54

SPEN (8.02) (16.91) 107.23

Valuation Metrics Mar 08A Mar 09A Mar 10A Mar 11E Mar 12E

Revenue (Rs. 'mn) 27,194 29,000 24,349 27,262 31,777

EBITDA (Rs. 'mn) 4,857 5,374 5,499 5,693 6,636

EBIT (Rs. 'mn) 3,744 4,103 4,051 4,173 5,040

PAT (Rs. 'mn) 1,841 2,040 2,077 2,406 3,366

EPS 4.53 5.03 5.12 5.93 8.29

EPS Growth 20.3% 10.8% 1.8% 15.9% 39.9%

P/E (x) 37.9 34.2 33.6 29.0 20.7

EV/EBITDA 16.5 14.9 14.5 14.0 12.1

Dividend Yield 0.27% 0.37% 0.37% 0.37% 0.37%

NAV/Share 29.3 42.1 46.7 46.7 54.0

P/B (x) 5.9 4.1 3.7 3.7 3.2

ROE % 15.5% 11.9% 11.0% 12.7% 15.3%

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>> Aitken Spence operates 7 resort hotels in the country with a total of 781 rooms, a bulk of which are upper range rooms. This includes the newly acquired 100 room Ramada Resort which was previously under company management. The company boasts some of the best resort properties in the country with premier Sri Lankan properties in the southern coast, the cultural triangle and the hill country being re-furbished and re-branded under the (Heritance) brand. The revival of the North and East also offers the company to capitalize on the group’s prime block of beach front land in Nilaveli, Trincomalee.

>> The end of the war and the dawn of peace in the country has resulted in resurgence in tourist arrivals in FY10 with occupancy levels averaging out at 56% in FY10 as a result of a poor 1H, increasing to a conservative 65% in FY11. ARR’s are forecast of US$96 in FY11 and US$ 114 in FY12, from US$81 in FY10. Sri Lankan resort operations are expected to post an EBIT of Rs. 1,160mn in FY11 and Rs. 1,897 in FY12 as a result of an expected increase in occupancy and an increase in room rates.

>> The likely requirement of additional hotel rooms in the country over the next 5 years and beyond should see the group investing in developing further properties like the 100 acre prime beach front land in Nilaveli, Trincomalee, in addition to refurbishments of the Neptune property. In addition, the company plans to build a 4 start city Hotel in Jaffna in the north of the country as well as develop the 10.8 acres of freehold land adjacent to Heritance Ahungalla in the South.

Leisure - Maldives >> The Group’s operations in the Maldives have consistently propped up the company’s tourism sector in the midst of a volatile Sri Lankan market. The groups 7 Maldivian properties were repositioned under the “Adaaran” brand in 2008 with the group operating 591 rooms with a total bed strength of approximately 1,600 in the archipelago. The group has successfully pioneered the resort within a resort concept in the country catering to a cross section of travelers in the 4 star, wellness, and 5 star boutique holiday maker categories. The addition of the high end 5 star boutique holiday resorts in particular have increased yields.

>> The group divested its first island resort Adaaran Club Bathala in the last financial year but also saw the completion of Adaaran Prestige Vadoo consisting of 50 high end water villas as well as 37 water bungalows on the HudhuRan Fushi Island under Adaaran Prestige Ocean Villas. In addition 16 water bungalows were added to Adaaran Club Rannalhi.

>> Average occupancy has consistently been in excess of 80% with ARRs’ conservatively expected to remain flat for FY12. Average blended room rates for the group’s Maldivian operations are estimated at approximately US$ 257 compared to a current average of US$ 81 in Sri Lanka. Maldives is at present displaying a degree of excess capacity which has forced lower room rates. Occupancy levels in the Maldives were 69.5% in 2010 despite a 20.7% increase in arrivals.

Leisure - Management of Indian and Oman hotel properties>> The company has signed an agreement to manage 5 hotels of the Oman Hotels and Tourism Company including a luxury desert camp added in 2008 two


hours away from the capital Muscat with 30 luxury Bedouin style tents. The other 4 hotels also include the 4 star 143 room Al Falaj hotel and the 3 star 105 room Ruwi Hotel located in Muscat. The two other resorts include the 54 room 3 star Al Wadi Hotel located 210km from Muscat and the 108 room Sur Plaza Hotel located in the city of Sur along the country’s northern coast and in close proximity to Turtle Beach.

>> Tourist arrivals in Oman are expected to rise from 1.8mn in 2007 to 6mn by 2012 with the World Travel and Tourism council estimating that Oman’s tourism sector would grow to US$ 8bn in 2018 from US$ 2.5bn in 2008.

>> Aitken Spence currently has 5 hotels under management in India, these include, ‘Barefoot at Havelock’ a resort in the Andaman Islands, the 78 room Poovar Island resort in Kerala which also houses a 20 Deluxe Cottage Ayurveda Village, and a 60 room 4 star property named Atithi in the southern coast off Chennai.

>> The terms of the management agreements for the properties managed in India and Oman have not been disclosed by the company and as such, potential contribution to earnings is difficult to ascertain. However earnings contributions from managed properties are not significant to the group, at present.

Strategic Investments>> SPEN owns and operates 3 thermal power plants, the largest of which, the 100MW Ace Power Embilipitiya power plant which was built in partnership with Caterpillar and commenced commercial operations in early FY06. The company has recently discontinued an external management agreement of the plant and is now internally managed resulting in savings on operation and maintenance. The Power Purchase Agreement with the state utility CEB is expected to expire in FY16. The company also operates two 20MW Power Plants in Matara and Horana with a 10 year Power Purchase Agreement expected to expire in April and December 2012 respectively.

>> The state utility are the sole purchasers of power and the purchase agreements are for the generation and sale of energy for 10 years, which is guaranteed by an Implementation Agreement with the Government of Sri Lanka. The agreements allow for the full pass-through of fuel costs and are structured so that all three projects receive separately calculated payments for the capacity and the energy provided. The capacity payment formula accounts for the fixed operating costs and interest costs and is paid irrespective of the amount of energy purchased.

>> It is uncertain as to what the terms will be should these PPA’s be renewed since several large state owned plants currently under construction such as the 150 MW Hydro Upper Kotmale Power Plant and the 300 MW Norochcholai Coal Power Plant which are expected to be completed by end 2011. The country had an installed capacity of 2,684MW as of 2009 with 23.28% being attributed to Private Power Producers while Private Power Producers accounted from 44.85% of total gross generation in 2008. Currently 84% of the population has access to the national grid while demand for power grows at an estimated 8% per year, notwithstanding the likely accelerated demand over the next few years in the North and East and across the country in general.


>> The company is also evaluating potential to manage or invest in power generation in Pakistan and Bangladesh. Projects managed in South Africa which generated modest revenue for the company have been completed with more such outsourced projects being sourced in the continent.

>> The strategic investments sector which also has small investments in Garments and a Printing and Packing business is expected to collectively contribute an EBIT of Rs. 1.761bn in FY11 increasing to Rs. 2.093bn in FY12. Contribution from this sector beyond 2012 will depend on terms negotiated for new PPAs going forward.

Other Businesses>> The groups cargo and logistics sector include freight forwarding, courier, integrated logistics and maritime transport businesses and are expected to contribute an EBIT of Rs. 555mn in FY11.

>> SPEN also owns 50% of MMBL Money Transfer which gives the company exposure to the growing inward remittance market, with Sri Lankan expatriate workers accounting for US$ 2.6bn in 2008. The MMBL network has over 500 subagents and has a tie up with Western Union. Other businesses in the service sector include the operation and maintenance of its power plants, the OTIS Elevator Agency, Insurance Broking particularly related to and Marine Insurance as well as management of its commercial property. Contributions from these businesses are relatively small and would amount to an EBIT contribution of Rs. 376mn in FY11.

Outlook and Valuations>> The group has not raised capital from the public since FY 2000, with capital constraints limiting potential for further diversification or aggressive expansion in existing lines of business. However despite its capital constraints Aitken Spence has diversified its exposure in the leisure sector gaining a soft foot print in the potentially lucrative Indian and Middle Eastern markets while well positioned to benefit from a renaissance in the tourism sector expected in Sri Lanka following the end of the hostilities.

>> SPEN is one of just two large leisure groups in the island with the resources, expertise and land bank in key tourist hotspots; giving it the ability to consistently build fresh room capacity over the next 10 years.

>> A recent share split has removed the liquidity risk discount that clouded the counters performance for many years. With earnings expectations of Rs. 2.41bn and Rs. 3.37bn in FY11 and FY 12 the counter trades at a P/E of 29.02x and 20.75x respectively. With the company’s stake in the new Colombo Port terminal to be constructed and begin operation in FY14 and the pool of resort hotels and its land bank in key tourist hot spots offering healthy earnings prospects in the medium to long term, we recommend Long Term Buy.


Ratios and Valuation Mar 08A Mar 09A Mar 10A Mar 11E Mar 12E

Growth (%)Sales 37.6 6.6 (16.0) 12.0 16.6 EBIT 3.7 9.6 (1.3) 3.0 20.8

Net Profit 20.3 10.8 1.8 15.9 39.9 Margins (%)EBITDA 17.9 18.5 22.6 20.9 20.9 EBIT 13.8 14.1 16.6 15.3 15.9

Pre-Tax margin 11.3 11.7 13.8 12.9 14.2

Net Margin 6.8 7.0 8.5 8.8 10.6

Valuation Metrics (x)P/E 37.9 34.2 33.6 29.0 20.7

P/B 5.9 4.1 3.7 3.7 3.2 EV/EBITDA 16.5 14.9 14.5 14.0 12.1

EV/EBIT 21.4 19.5 19.7 19.2 15.9

ROE % 15.5% 11.9% 11.0% 12.7% 15.3%

INCOME STATEMENT 2008 2009 2010 2011E 2012E

FOR THE YEAR ENDED 31ST MARCH Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mnRevenueLeisure 6,995 7,398 7,320 10,718 11,971 Strategic Investments 16,158 16,977 12,037 10,208 12,751 Cargo and Logistics 3,282 3,235 3,438 4,626 5,089 Services 759 1,390 1,554 1,710 1,967

Total Revenue 27,194 29,000 24,349 27,262 31,777 Operating ProfitLeisure 1,258 1,264 1,173 1,425 1,789

Strategic Investments 1,712 1,869 1,656 1,761 2,093

Cargo and Logistics 351 529 623 555 611

Services 290 450 579 376 472

Total Profit from Operations 3,611 4,112 4,032 4,117 4,965

Net finance income / (expense) (679) (706) (698) (646) (525)

Share of assocaite companies profit / (loss) 132 (9) 19 57 75

Profit before tax 3,065 3,397 3,353 3,527 4,515

Income tax expense (235) (328) (349) (321) (323)

Net profit for the period 2,829 3,069 3,004 3,206 4,192

Minority Interest 989 1,029 927 800 826

Profit attributable to shareholders 1,841 2,040 2,077 2,406 3,366


BALANCE SHEET 2008 2009 2010 2011E 2012E

AS AT 31ST MARCH Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mnASSETSNon Current AssetsProperty Palnt and Equipment 16,982 22,636 23,328 23,063 22,767 Leasehold property 1,357 1,505 1,468 1,468 1,468 Intangible Assets 123 109 154 139 125

Investment Property 29 29 29 29 29 Investment In Associates 764 753 767 814 879

Long Term Investments 264 405 484 484 484

Deferred Tax assets 39 74 57 84 89

19,558 25,510 26,288 26,081 25,841

Current Assets

Inventories 1,305 1,284 1,394 1,363 2,860

Trade and Other Receivables 6,085 5,834 5,344 4,836 5,148

Amounts due from associates 116 161 125 125 105

Current Investments 5 5 5

Deposits and Pre-payments 482 533 490 409 636

Current Tax receivable 18 57 158

Short term deposits 2,597 2,020 2,752 1,636 2,224

Cash and cash equivalents 859 828 825 880 945

11,465 10,721 11,093 9,249 11,918

Assets classified as held for sale 162 149 162 - -

Total Assets 31,185 36,381 37,543 35,330 37,759

EQUITY AND LIABLITIES

Equity Attributable to Shareholders

Stated Capital 2,135 2,135 2,135 2,135 2,135

Reserves 3,505 7,228 9,317 7,228 7,228

Retained Earnings 6,264 7,715 7,497 9,615 12,577

11,904 17,078 18,950 18,977 21,940

Minority Interest 3,882 4,553 4,566 4,566 4,566

Total Equity 15,786 21,631 23,516 23,544 26,506

Non Current Liabilities

Interest bearing liabliities 6,508 6,241 5,157 5,104 4,864

Deferred Tax Liabilities 187 198 223 225 243

Employee benefits 209 238 295 328 361

6,904 6,677 5,675 5,657 5,468

Current Liablities

Trade and Other Payabels 3,782 3,909 4,191 2,726 2,542

Interest Bearing liabilities repayable within one year 2,106 1,866 1,541 1,276 1,216

Amounts due to associates 4 1 3 - -

Current tax payable 93 135 147 - -

Interim dividend declared 81 - - - -

Short term bank borrowings 2,429 2,162 2,470 2,127 2,027

8,496 8,072 8,352 6,129 5,785

Total Liabilities 15,399 14,749 14,027 11,786 11,253

Total Equity and Liabilities 31,185 36,381 37,543 35,330 37,759


CASHFLOW STATEMENT 2008 2009 2010 2011E 2012E

FOR THE YEAR ENDED 31ST MARCH Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mn Rs. 'mnNet cash generated from / (used in) operating activities 1,627 3,916 4,731 4,667 2,431

Cash Flow from Investing ActivitiesInvestments made during the year (104) (141) (102) - - Purchase of property plant and equipment (1,654) (3,799) (459) (1,200) (1,300)

Disposal of Subsidiaries (20)Purchase of leasehold rights (1,402) (64) (51) - -

Proceeds from sale of property plant and equipment 307 362 (1,938) - -

Proceeds from sale of investments 48 247 15 - -

Proceeds on retirement of assets held for sale - 13 343 162 -

Dividends by subsidiary companies to outside shareholders (421) (524) (929) (929) (929)

Dividends received from associate companies 19 3 7 10 10

Net cash used in investing activities (3,208) (3,923) (3,114) (1,957) (2,219)

Cash flow from financing activities

Interest received from deposits 417 419 289 204 286

Proceeds from interest bearing liabilities 2,348 1,273 616 700 700

Repayments of interest bearing liabilities (1,935) (2,026) (1,979) (1,100) (1,100)

Issue of shares by subsidiaries - 25 - - -

Dividends Paid (176) (189) (257) (289) (404)

Net cash used from / (used in) financing activities 654 (498) (1,330) (484) (518)

Net inc./(dec.) in cash & cash equivalents at beginning (927) (505) 287 2,226 (306)

Cash and cash equivalents at the beginning of the period 2,119 1,325 820 1,106 3,332

Cash and cash equivalents at the end of the period 1,192 820 1,106 3,332 3,026



Rs 296.00


>> JKH remains the largest listed company on the Colombo Stock Exchange with a market capitalization of US$ 1.66bn and technically a 100% free float. Whilst organically growing its business interests in a diverse range of sectors offering a proxy to the post war growth prospects of the country; the company with a history of successful inorganic growth still retains strong cash reserves and a pipeline of projects and assets set for development including 25.61 and 10.9 acres of freehold and leasehold land respectively in Colombo.

LeisureThe group’s leisure business has a portfolio of 796 resort rooms located in key tourist hot spots across the island accounting for nearly 9% of the country’s graded room capacity. The group also owns land in prime tourist locations including 10 acres in the central hill capital of Kandy, 44.37acres of freehold land in the east coast city of Trincomalee, 22.15 acres of freehold land South of the country in Weerawila as well as the location of the Tsunami destroyed Beach Hotel Bayroo which

is being reconstructed under the groups “Chaaya” brand.

>> The company also has in its possession upto 40% of the city 5-star room capacity through the 501-room Cinnamon Grand and the 340 room Cinnamon Lakeside property, which are also at present the most recently refurbished properties in the city. Fresh city 5-Star room supply is not expected to come on stream for at least another 2.5 years.

>> The group now has 3 properties in the Maldives including the recently refurbished Chaaya Lagoon, after acquiring the head lease of Dhonveli Island (Chaaya Island) for a period of 18 years as consideration for divesting the headlease of the loss making Cinnamon Island, in Alidhoo. Maldives attracted 791,917 tourists in 2010, a 20.7% increase compared to 2009 with a year round occupancy of 69.5% compared to 70.2% in the previous year with tourists from China and the UK accounting for nearly 30% of total arrivals. ARRs however did come under pressure in a bid to lure visitors given the protracted recovery in the west.




John Keells Holdings PLC

JKHReuters Code JKH.CMBloomberg Code JKH.SLShare Price LKR 296.00 Issued Share Capital (Shares)

Voting (In Millions) 623.4

12mth High / Low (Rs.) 358 / 137

Average Daily Volume (Shares) 1,156,436

Market Capitalisation Rs. Mn 184,533


1 mth 6 mth 12 mth

ASPI 8.70 18.82 105.54

JKH 1.37 1.72 74.63

Valuation Metrics Mar 07A Mar 08A Mar 09A Mar 10A Mar 11E Mar 12E

Revenue (Rs. 'mn) 32,818 41,641 40,972 48,663 53,903 60,899

EBITDA (Rs. 'mn) 7,344 9,791 10,023 10,150 14,702 16,153

EBIT (Rs. 'mn) 6,087 8,169 7,985 7,876 12,148 13,277

* PAT (Rs. 'mn) 3,532 5,111 4,732 5,201 8,966 10,042

EPS 5.7 8.2 7.6 8.3 14.39 16.1

EPS Growth 15.8% 44.7% -7.4% 9.9% 72.4% 12.0%

P/E (x) 52.2 36.1 39.0 35.5 20.6 18.4

EV/EBITDA 23.8 17.8 17.4 17.2 11.9 10.8

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* Net earnings excluding exceptional items - FY10 - Rs. 4,450mn* Net earnings excluding exceptional items - FY11 - Rs. 7,054mn


>> Tourist arrivals in Sri Lanka increased by 46% in 2010 with the peak winter season in November and December recording occupancies of 86.1% and 83% respectively. Much of the earnings growth from the leisure sector at JKH will stem from its Sri Lankan operations. The country offers compelling potential as a prime diverse tourist destination with significant upside from current arrivals of just 654,476 tourists that visited the island last year at an average ARR of US$50 – 60 in 2010. An ambitious target of the authorities to grow tourist arrivals to 2.5mn in five years is limited only by the pace at which adequate room, skilled staff and tourist related infrastructure capacity can be added to cater to the steep rise in demand. In the short term, leisure groups like JKH would benefit significantly from the lack of adequate room supply. Furthermore the imposition of a minimum room rate of US$ 125/- for 5- star properties from 1st April 2011 from its current US$ 100/- will further boost earnings in the medium term.

>> While the more favourable operating environment will attract fresh competition locally as well as from international leisure groups, large local leisure groups like JKH have the distinct advantage of already having a significant portfolio of 841 city and 796 resort rooms. With properties in prime locations in addition to a large land bank of prime tourist locations the group can incrementally add capacity over the years, outpacing new entrants in securing increased occupancy and commanding higher rates in the medium term.

>> The 154 room Coral Gardens property is currently under extensive refurbishment at a cost of Rs. 1.1bn and is expected to open in mid to late FY12 in addition to the 190 room ‘Chaaya Bey’ expected to be completed by FY13 at a cost of Rs. 2.3bn. Further addition to room capacity in the city and in new resort locations are likely going forward given the land the group already owns in key locations.

Property Development>> The group recently launched a 475 unit apartment complex that would begin construction in mid-2011, having impressively acquired bookings for over 70% of the units within the first few weeks of launch, given the fact that the property market still remains subdued with several competing large scale apartment complexes still yet to sellout units despite completion of construction. The construction of the 164 residential apartment complex, Emperor at the Asian Hotels property complex is expected to be completed in the current year having sold all units off plan. The Asian Hotel property has space for a fourth high rise as well as further potential for development at the 7.2acre leased property at Cinnamon Lakeside. In addition JKH has 25.61 and 10.69 acres of prime freehold and lease hold land including 8 cleared acres bordering the Beira Lake.

Transportation>> JKH currently owns an associate stake in South Asian Gateway Terminals, which operates the 2m TEU capacity Queen Elizabeth Quay at the Colombo Port on a 30 year BOT arrangement commencing September 1999. The Company upped its stake in SAGT by 4.2% to 37.9% in September 2008 and a further 4.2% in March 09, when the ADB and IFC exercised their put options, for a total consideration of US$23m.0

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>> SAGT throughput which recorded a growth of 12% for FY10 recording the highest ever throughput of 1,882,195 TEUs handled in a fiscal year is approaching full capacity having increased by 9% yoy for the first 7 months of the fiscal year. The sector’s earnings are further augmented by strong growth in the airline and logistics businesses.

Financial Services>> The group associate companies include a 29.9% stake in Nations Trust Bank (NTB). NTB is a mid-tier bank which focuses on high end corporate and retail lending, which has recently embarked on expanding its reach nationwide. The bank has grown assets at an average of 28% over the last five years and currently has a loan book of Rs.45.67 billion whilst posting earnings of Rs. 1.08bn in FY10 from Rs. 0.69bn in FY09. Central Bank guidelines on ownership in banks with a cap of 15% by a single investor would mean that promoters JKH and Central Finance will have to reduce their holding in NTB to a maximum of 15% by April 2012.

>> UAL remains one of the leading insurance providers in Sri Lanka with a market share of 11.3% and 9.6% in Life and Non-Life segments, respectively. During the last 5 years, UAL witnessed a CAGR of 20.5% in Gross Written Premium (GWP) being in line with industry growth. The country still exhibits low penetration levels that are expected to rise exponentially as per capita GDP levels approach upper middle income levels. The company recorded earnings growth of 28% yoy to post earnings of Rs.512mn in FY10. Earnings growth in the sector has also been further augmented by contributions from the Stock Broking unit that has benefited from increased trading volumes at the Colombo Stock Exchange.

F & B and Retail>> Increased consumer spending and the opening up of the North and East provinces have collectively contributed to an increase in volumes. The company is expected to continue to consolidate its position across its meat, ice cream and soft drink segments with new product lines while expanding its retail footprint.

>FY11E>> Leisure & Property development: Average ARRs of US$60 for local resorts and occupancies of 63% for FY11E, stemming from a 46% growth in tourist arrivals along with increased contributions from the city hotels is expected to propel earnings from the sector by 175%.

>> With a full compliment of 841 city five star rooms available for a full year, city hotel earnings similarly are expected to grow 138% on estimates of 75% occupancy for Cinnamon Grand and Cinnamon Lakeside properties on a blended average room rate of US$ 93.

>> Maldives sector earnings contribution for the full year will be sound following the divestment of the loss making Alidhoo property as well as with Chaaya Lagoon reopened in time for the prime winter season in Q3 FY11 following refurbishment.

>> The recognition of a further 25% of Emperor revenues on a percentage of completion basis of the apartments already sold, will see property income register healthy earnings growth.


>> Capital gains amounting to approximately Rs. 2bn in the 2Q FY11E from a divestment of a 5% and 2.57% stake on AHPL and KHL respectively as part of group strategy in being asset light, has added a significant earnings boost freeing up further cash for expansion in the leisure sector.

>> Associates: Earnings from Associate companies are expected to grow by 42.4% with an expectation of 1.9mn+ TEU’s handled at SAGT, marginally higher than the previous year but a marginally more favourable mix weighted toward high yielding domestic shipments. Our models indicate upside of over 30% to every 10% positive change in the transhipment to domestic shipment mix. Earnings growth from associate Nations Trust Bank PLC was up by 58% for the current financial year.

>> F & B and Retail: The losses at meat processing operations in India have been contained while volume growth on core soft drinks, ice cream and retail businesses is expected to result in a significant boost to the sectors contribution to group earnings.

>> FY11 earnings are expected to record a normalized yoy growth of 58.5% (72.4% growth including exceptional gains from the sale of stakes in KHL and AHPL). The growth would primarily arise from the Leisure sector earnings bounce back and improved associate company contribution.

>FY12E>> Leisure & Property development: Industry estimates of a 25% yoy growth in arrivals is expected to boost occupancy levels at local resorts to 67% with ARRs of US$72 pushing earnings up 58% over FY11E levels for local resorts. Minimum room rates for 5 Star properties of US$ 125 from 1st April 2011 will boost city hotel earnings with occupancy levels expected to hit 80% for FY12E.

>> The recognition of remaining Emperor revenues and a modest rise in rental income will see property income record marginal gains over FY11E earnings. Earnings from the new ‘On320’ property will be recognized on completion in FY14.

>> Associates: Earnings from associate companies are expected to record modest growth in FY12E on improved contributions from NTB and with SAGT expected to hit full capacity. The listing of Central Hospitals in FY12E would potentially yield further capital gains that have not been factored into our forecasts.

>> F & B and Retail: Expected increase in consumer spending will result in sustained volume driven earnings growth for the sector.

>> FY12 earnings are expected to record a yoy growth of 43.5% spurred on predominantly by leisure sector earnings along with a sound increase in earnings contribution across all core group businesses as well as a reduced effective tax rate for the group following corporate tax revisions announced in November last year.


Growth Prospects>> Land Bank: The group land bank includes 25.61 and 10.9 acres of prime freehold and leasehold land respectively in Colombo. This includes over 8 acres of cleared lake front land at the former Cold Stores Premises and a further 3 acres in Union Place where plans are drawn up for a combined development.

>> Leisure Properties: Real estate assets in key tourist destinations in the South and East of the island which include 44.63 acres in Trincomalee and 25.15 acres in Weerawila are in the pipeline for development.

>> Cash: The group has over US$ 166m in available liquid cash as at end 3QFY11.

>> Food & Beverage: Successive years of high inflation and the constraints of war have kept the retail sector earnings in check. However, there can be significant upside for the sector on increases in per capital consumption on ice creams, soft drinks and meat items post war as well as margin gains on high volume supermarket sales on an upward shift in basket mix from staples to higher end items.

Valuations>> At 18.3 FY12E earnings, the counter is at a 17.7% premium to the market. However, the premium may be justified in terms of the organic growth potential of its in situ infrastructure and the acquisition/expansion capacity via its strong cash reserves. FY12E normalised earnings of Rs. 10.04bn after adjustments for tax revisions post FY11, are a 42.4% increase from FY11E normalised earnings of Rs. 7.054bn notwithstanding potential for further capital gains in FY12E.

Ratios and Valuation Mar 07A Mar 08A Mar 09A Mar 10A Mar 11E Mar 12E

Sales 11.3 26.9 (1.6) 18.8 10.8 13.0 EBIT 25.8 34.2 (2.3) (1.4) 54.2 9.3

Net Profit 15.8 44.7 (7.4) 9.9 72.4 12.0

Margins (%)EBITDA 22.4 23.5 24.5 20.9 27.3 26.5

EBIT 18.5 19.6 19.5 16.2 22.5 21.8 Pre-Tax margin 14.5 15.7 15.4 13.4 20.3 20.1

Net Margin 10.8 12.3 11.5 10.7 16.6 16.5


P/B 4.7 4.2 4.1 3.7 3.2 2.8

EV/EBITDA 23.8 17.8 17.4 17.2 11.9 10.8

EV/EBIT 28.7 21.4 21.9 22.2 14.4 13.2

ROE % 9.00 11.76 10.40 10.44 15.76 15.44

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Profit and Loss Statement 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E

Financial year ended 31st March Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn

Turnover 16,827 22,285 22,851 29,492 32,818 41,641 40,972 48,663 53,903 60,899 Operating Profit by Sector

Consumer Food & Retail 246 (402) 245 390 630 569 487 399 532 644

Tea, Stock Broking & Warehousing 108 369 325 229 182 429 353 547 606 710

Leisure & Real Estate 384 1,186 652 1,611 1,742 1,825 1,138 1,171 3,225 5,082 Transportation 631 595 1,056 1,507 1,447 1,089 508 358 386 398

Information Technology 42 51 (4) 115 131 65 (2) 14 64 70

Insurance and Others 163 172 51 (450) (375) (390) (503) (43) 371 472

Total 1,574 1,971 2,326 3,402 3,757 3,587 1,980 2,446 5,183 7,377 Other income 268 159 - 481 630 2,341 3,665 2,873 3,829 2,243

Finance costs 329 457 404 525 1,315 1,618 1,695 1,370 1,212 1,038

Share of Associate company profits 451 703 833 956 1,700 2,242 2,340 2,557 3,136 3,657

Profit before taxation 1,964 2,375 2,754 4,314 4,772 6,551 6,291 6,506 10,937 12,240 Taxation 316 285 645 822 831 1,029 1,327 955 1,348 1,261

Profit after taxation 1,648 2,090 2,109 3,491 3,940 5,522 4,964 5,551 9,589 10,979 Minority Interest 169 201 413 441 408 411 232 350 622 936

Profit attributable to shareholders 1,479 1,889 1,696 3,050 3,532 5,111 4,732 5,201 8,966 10,042 Profit attributable to shareholders excluding exceptional items 4,450 7,054 10,042

Balance Sheet 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E

As at 31st March Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn

Fixed Assets 13,968 22,544 26,113 27,978 38,187 47,506 63,420 64,092 64,178 66,738 Current AssetsInventories 1,285 1,473 1,642 2,083 3,400 3,985 2,254 2,295 2,542 2,872

Receivables 3,293 4,537 6,428 5,263 6,593 6,770 9,063 9,957 11,029 12,460

Short term investments 598 1,601 3,030 2,537 16,138 10,455 15,347 19,301 19,301 19,301 Cash 951 2,161 2,090 1,329 1,626 2,191 2,053 3,013 6,329 11,182

6,127 9,772 13,190 11,212 27,757 23,401 28,717 34,566 39,201 45,816 Current LiabilitiesShort term loans & OD 2,642 2,429 6,303 3,268 8,880 4,836 6,836 6,895 4,850 4,850

Other 2,450 3,731 5,636 5,372 6,019 8,230 7,070 9,989 10,385 11,662

5,092 6,160 11,939 8,640 14,899 13,066 13,906 16,884 15,235 16,512 Long term LiabilitiesTerm Debt 1,476 1,601 2,786 2,058 6,504 7,809 14,760 10,557 9,557 8,558

Other 1,698 2,387 2,477 2,332 1,643 1,855 13,039 14,990 14,953 15,054

3,174 3,988 5,263 4,390 8,147 9,664 27,799 25,547 24,510 23,612 Net Assets 11,829 22,169 22,100 26,158 42,898 48,177 50,432 56,227 63,633 72,431 Issued Capital 1,876 3,001 3,316 4,000 5,529 6,360 6,106 6,196 6,196 6,196

Capital Reserves 2,855 7,896 7,894 8,201 19,853 22,170 23,857 24,700 24,700 24,700

Revenue Reserves 5,082 6,331 7,209 10,328 13,851 14,913 15,545 18,936 26,009 34,159

Shareholders Funds 9,813 17,228 18,419 22,529 39,233 43,443 45,507 49,832 56,905 65,054 Minority Interest 2,016 4,941 3,681 3,629 3,665 4,734 4,925 6,395 6,728 7,375

Capital Employed 11,829 22,169 22,100 26,158 42,898 48,177 50,432 56,227 63,633 72,431


Cashflow Statement 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E

For the year ended 31st March Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn Rs. ‘mn

Profit After Tax 1,808 2,375 2,754 4,314 4,772 6,551 6,291 6,506 10,937 12,240 Depreciation 738 862 1,074 1,083 1,257 1,622 2,038 2,274 2,554 2,875

Other Non Cash Items (785) (342) (617) (1,162) (1,486) (1,974) (4,074) (1,893) (2,474) (2,695)

Net Working Capital Changes 109 283 2,226 (1,426) (256) 713 174 3,405 (363) (485)

Cashflow from Operations 1,870 3,179 5,438 2,809 4,287 6,913 4,429 10,292 10,653 11,935 Acquisition Of Fixed Assets (2,023) (6,633) (4,263) (4,081) (5,499) (3,476) (2,517) (650) (2,110) (3,900)

Investments & Associate Stakes 20 (111) 404 1,228 (4,587) (879) 1,232 - - -

Net Cashflow From Investing (2,003) (6,744) (3,859) (2,853) (10,086) (4,355) (1,285) (650) (2,110) (3,900)Dividends (467) (688) (1,364) (1,431) (1,695) (3,294) (2,116) (2,182) (2,182) (2,182)

Issue Of Shares 103 6,210 90 110 13,040 218 (2,355) - - -

Term Loans 640 354 685 1,617 5,900 1,139 8,380 200 200 201

Loan Repayments (307) (505) (713) (1,322) (545) (2,011) (1,428) (1,817) (4,169) (1,200)

Other 163

Net Cashflow From Financing (31) 5,371 (1,139) (1,026) 16,700 (3,948) 2,481 (3,799) (6,151) (3,181)Net Cash In/Outflow (164) 1,806 440 (1,070) 10,901 (1,390) 5,625 5,843 2,392 4,854

Cash & Equivalents b/f 136 855 2,661 3,100 2,030 12,931 11,541 17,166 23,009 25,401

Cash & Equivalents c/f (28) 2,661 3,100 2,030 12,931 11,541 17,166 23,009 25,401 30,255



JKSB Contact Information

GeneralAddress : 130, Glennie Street, Colombo 02, Sri LankaTelephone : (+94 11) 230 6250, (+94 11) 233 8066-7Fax : (+94 11) 234 2068, (+94 11) 232 6863Email : [email protected] : www.jksb.com

Tivanka RatnayakeVice President – JKHChief Executive OfficerMobile: (+94 77) 742 0537, Direct: (+94 11) 471 0725e-mail: [email protected]

Suran WijesingheExecutive Vice President – JKHChief Financial Officer–Financial Services GroupDirect: (+94 11) 230 6275email: [email protected]

Ms. Chryshanthi ManuelManager – Back OfficeDirect: (+94 11) 230 6276email: [email protected]

SalesAkmal MashoorAssistant Vice President – JKHHead of SalesMobile: (+94 77) 748 9468, Direct: (+94 11) 471 0728e-mail: [email protected]

Susira Ranasinghe Assistant ManagerMobile: (+94 77) 773 0846, Direct: (+94 11) 471 0727email: [email protected]

Dinesh RahimAssistant ManagerMobile: (+94 77) 734 7798, Direct: (+94 11) 230 6259e-mail: [email protected]

Asmath Iqbal Assistant ManagerMobile: (+94 77) 734 7833, Direct: (+94 11) 471 0730 e-mail: [email protected]

Nithila TalgaswatteAssistant ManagerMobile: (+94 77) 340 4386, Direct: (+94 11) 230 6260e-mail: [email protected]

Rakesh Daryanani Investment AdvisorMobile: (+94 77) 383 1808, Direct: (+94 11) 230 6261e-mail: [email protected]

Kapila GunawardenaInvestment AdvisorMobile: (+94 77) 326 1595, Direct: (+94 11) 230 6265e-mail: [email protected]

Nadeem ShumsInvestment AdvisorMobile: (+94 77) 206 7517, Direct: (+94 11) 230 6255e-mail: [email protected]

Lasitha MendisInvestment AdvisorMobile: (+94 77) 206 7519, Direct: (+94 11) 230 6256e-mail: [email protected]

Liara IbrahimInvestment AdvisorMobile: (+94 77) 730 0182, Direct: (+94 11) 230 6255 e-mail: [email protected]

Ashan SenathirajahInvestment AdvisorMobile: (+94 77) 730 0180, Direct: (+94 11) 230 6256e-mail: [email protected]

Vishnu VethodyInvestment AdvisorDirect: (+94 11) 230 6255e-mail: [email protected]

ResearchYolan SeimonHead of ResearchDirect: (+94 11) 230 6273Mobile: (+94 77) 206 7512email: [email protected]

Navin RatnayakeAssistant ManagerDirect: (+94 11) 230 6272e-mail: [email protected]

Jeewanthi MalagalaFinancial AnalystDirect: (+94 11) 230 6274email: [email protected]

Punyamali SaparamaduFinancial AnalystDirect: (+94 11) 230 6283email: [email protected]



Notes

Documents

JKSB Sri Lanka Market Strategy March 2011