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Trading during the first two days of the week were rather docile but the market picked up in the latter part of the week (Wednesday and Friday). The ASPI gained 11.1 points to close at 791.5 while the MPI gained 20.4 points to close at 1331.0 by Friday, with retail investors picking up shares at relatively low prices. However, the gains in indices were not accompanied by healthy turnover levels and total turnover for the week stood at Rs. 103.8 million with an average of 25.9 million.

Foreigners too remained detached from the market resulting in a net outflow of Rs. 3.4 million. During the week, big blocks of The Finance (Rs. 10.2 Mn), NDB Bank (Rs. 23.5 Mn) were traded, accounting for 33%of the total turnover.

HNB expected to record exceptional profit growth for FY2002 Hatton National Bank (HNB) has recovered from a slip in its earnings in FY 2001 and is heading towards exceptional growth in profitability during the current financial year. Bank and group profits declined by 62% and 97% respectively during the financial year 2001, but a recent company visit indicates that the bank is getting back to the days where they enjoyed strong profitability. According to our forecast HNB Group should record a profit growth of 28 times to Rs. 651 million during the current financial year, albeit from a low base - during FY2001 HNB Group recorded a marginal net profit of Rs.23 million due to country's economic crisis and the poor performance of its subsidiaries.

HNB has recorded an average net loan growth of 20% during the first nine months of 2002. We believe that this rate would be maintained during the last quarter, if not improved. The deposit growth for the first nine months has been 10% and our discussions with the management indicates that a further improvement in the growth rate can be expected too. Net fee income has grown at an average rate of 18% over the past nine months, and HNB is currently evaluating a proposal to restructure its fee based income.

The proposed structure will enable the Bank to increase its fee income by an additional Rs.60 million, simply by adopting practices similar to other banks. The foreign exchange profits have declined, due to the lower depreciation in the Rupee but the bank expects at least a 5% growth over the next two years.

Rental payments to attract tax benefits to the group

The shift into the new head office building has increased the operating costs significantly, mainly due to an annual rental payment of Rs.360 million. However the Bank pays the rent to its 100% owned subsidiary Sithma Development, which is a BOI approved company. From a group point of view, the arrangement is expected to generate tax benefits.

HNB is currently looking for tenants to let out approximately 50,000 sq. ft. of the building, out of its total area of 300,000 sq. ft. HNB has invested Rs.600 million in information technology over the last 3 years and estimates another Rs.300- Rs.400 in IT expenses per annum for the next two years. This will enable all 140 branches to have full network interconnectivity and common platform for better use of information, while also providing customers better access with features such as internet banking.

Most of the proceeds raised (Rs.2 billion) from the debenture issue in September 2002 have already been utilised for various lending requirements. One of them is to fund its housing finance business, which has shown significant growth over the last few months. HNB's Rs.1 billion subordinate debentures will also be redeemed during FY2003 and this, coupled with additional fund requirements, may lead the way for HNB to issue another block of debentures. However, our estimate of HNB's funding requirements of about Rs.2 billion may be partially met by the sale of its stake in Sampath Bank (see below).

The Bank currently has 10 branches in the North and East and these branches have recorded strong performance, with the branch in Jaffna leading the way. HNB is recognised as one of the banks that have established themselves early in these regions. We believe that HNB would expand further to the North East, based on the developments of the peace process, which should yield an attractive earnings growth during the coming years.

Like other banks, HNB will also face an additional tax burden due to the VAT surcharge, especially since its personnel costs are as high as Rs.1.8 billion. We believe that HNB's additional tax burden will be around Rs.250 million as a result of the new VAT charge. However this figure may further reduce if the ongoing negotiations between the Bankers and the treasury end up favouring the Banking sector.

HNB is looking to sell its stake in Sampath Bank and according to our forecasts the gain on disposal of the stake should to be around Rs.200 million.

It is possible that the transaction will materialise before year end, and this could lead to HNB making an annual profit of around Rs.850 million for the FY2002.

With future prospects looking attractive, we are of the view that HNB will have a good year in 2003. A detailed study on HNB (including forward forecasts) will feature in our upcoming report of the Sri Lankan banking sector.

IFC interested in SLIC's 20% stake in Commercial Bank

The World Bank's private sector investment arm, the International Finance Corporation (IFC) has shown interest in the 20% stake of Commercial Bank (COMM) that SLIC owns, which would be up for grabs prior to the privatisation of the insurance giant.

It is not yet known whether this transaction is to go through the market or it would take the form of a book building process/placement.

However we are of the view that instead of a single party owning 20% stake of COMM, spreading ownership into the general market would boost the liquidity of the stock. At present DFCC holds a 29.8% stake in the bank (through special approval from the Central Bank) and in the event of another single party holding on to a 20% stake, this would continue to affect the liquidity of the share. Even at present liquidity is considered a strain on the share where almost 54.4% of the issued capital is held by the Sri Lanka Insurance Corporation and DFCC. Furthermore divestment also provides an opportunity to fetch a higher price in the market for the share.

The average daily volume of COMM is approximately 42,345 over the past 12 months, while average daily volume as a percentage of issued (voting) share capital is 0.11%. On the other hand the average daily volume of NDB is 154,326 (almost 4 fold in comparison to COMM) while average daily volume as a percentage of issued share capital stands at 0.29% amply demonstrates the lack of liquidity of COMM at current levels.

At a price of Rs. 195.0 the stock is trading at PE multiples of 5.5 x compared to sector PE of 9.1 x. Royal Dutch Shell to buy the remaining shares of Shell Lanka? After several rounds of postponements of the sale of the Government 49% stake in Shell Gas and possible listing of the energy company on the Colombo Stock Exchange it looks like its 51% major shareholder Royal Dutch Shell Company is looking at taking total control over the company.

It was learnt that the reason for the postponement of the listing of Shell was due to ongoing negotiation between PERC (Private Enterprise Reform Committee) on the sale price.

According to earlier plan, the Government was to issue a 10% stake in Shell Gas to the market at a price around Rs. 30.0 per share. Managers to the IPO, Peoples Merchant Bank is meeting with PERC on the future progress of the sale and further information would be available afterwards.

Private sales starving stock market of much needed liquidity Meanwhile the market will be disappointed with the news, as an IPO of Shell would have added to the market capitalisation and perhaps provide a further catalyst for the Colombo stock market to attract more foreign investments. The liquidity of the Colombo market seems to be a major constraint, keeping foreign investors away despite its attractiveness in terms of earnings and growth potential.

The stock market is starved for liquidity and would benefit from the listing of high-capitalised companies, of which Shell, SLT, CPC and Sri Lankan Airlines would fit those criteria perfectly. Meanwhile although the recently concluded SLT IPO would add a further 3.3 billion in to the market making it the highest capitalised company on the stock market, overall liquidity will remain languid.

Although the Government appears to have a capital market friendly policy, deals such as this (and the private sale of SLIC's stake in Commercial Bank highlighted above) would only hamper any initiatives taken to improve capital markets while minimising the its contribution to overall GDP (Gross Domestic Production). Point of View:

As the market has fallen considerably throughout the month, strong opportunities exist in banking, diversified and the tourism sectors. All three sectors are highly correlated to the economic environment in the country, and are expected to show healthy profits for the year 2002/03. The overall economy is turning around from negative growth last year, with our forecast for GDP growth in FY2002 at 2%.

Our outlook remains one of vigilant and confident expectation of the market improving in the near to medium term.

However this expectation is preclusive of any sudden calamity in the domestic political situation. With falling and low interest rates, a stable rupee, economic reforms, improving economic activity and (most importantly) peace and tranquillity prevailing we expect the Sri Lankan economy to make healthy gains in the coming year.

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Copyright 2001 The Associated Newspapers of Ceylon Ltd.
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