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Strong Corporate results during the last quarter of 2002

The market failed to respond to the strong corporate earnings, as both indices continued its slump for the third consecutive week. The situation in the Gulf and the political instability dominated the market as the investors overlooked the low earnings multiples and tremendous growth in Companies. ASPI fell 17.75 points and the Milanka slipped 20.21 points to close the week at 730.48 points and 1225.23 points respectively. Activity was low at Rs.145.35 million at a daily average of Rs.29.07 million. More importantly, a net foreign inflow of Rs. 42.93 million was recorded with foreign buying amounting to Rs. 52.46 million.

Central Bank implements active market-based open market operations

The new bidding system was launched during the week where a market oriented system for daily bidding for its overnight borrowing and lending facilities was established. Under the new system an interest rate corridor is announced in terms of the Repo and Reverse Repo, which forms the lower and the upper limit of the interest rate corridor. (Currently the corridor stands at 9.0% for the lower limit and 11.0% for the upper limit, which remained unchanged from last revised Repo and Reverse Repo rates of 9.0% and 11.0%). The open market operation would be basically conducted to maintain the inter bank rate stable thus in the event of a shortage of liquidity the inter bank rate tends to move towards the upper limit of the corridor, at which point the Central Bank would inject liquidity through reverse repo auctions to cover the deficit. Similarly if excess exists, the Central Bank would absorb the surplus through repo auction. Under the new system the interest rate is decided by the market while the volumes would be decided by the Central Bank.

The main objective of the system is to regulate the volume of money in the economy in order to achieve the final objective of economic and price stability.

Less volatile interest spreads for the banking sector

The new system is expected to reduce the volatility in banks borrowing and lending rates, thus creating more static interest spreads compared to 2002. Volatile interest spreads were part of the reason for most Banks recording a significant growth in net interest income last year.

However we believe the same level of interest spreads cannot be expected in 2003 as in 2002, and the current level of spreads will vary in a narrow range, but still contributing towards the profitability of the banking sector. We have already factored this into our forecasts, and in our opinion the new system will not make a significant impact on our expectations.

Commercial Bank Earnings up 17.8%

Commercial Bank outperformed 2001 results and recorded a profit growth of 17.04% (before tax) and 25.39% (after tax) for FY2002, compared to FY2001.

The banking giant recorded YoY growth in almost all areas, but failed to maintain its 48% growth in profits as for the first nine months results.

Total revenue up; despite static growth in total interest income

The total revenue grew by 23% (net interest income + other income), despite a static growth in total interest income. The total interest income grew by only 1.3% compared to FY2001, as declining interest rates hampered the growth. Commercial Bank's corporate client base were only willing to borrow at lower rates.

However due to the declining borrowing rates the interest expense reduced by 11.46% to Rs. 4.4 billion. Growth in the loan book and deposits coupled with better interest margins contributed towards a 27.5% growth in net interest income to Rs. 3.108 billion.

For non-interest income, foreign exchange profit recorded a significant drop (18%) due to the rate of depreciation of the Sri Lanka Rupee against the US Dollar being only 3% during 2002 as against the higher rate of depreciation of 9.3% during the corresponding period in 2001. Despite this drop in exchange profit, the Bank recorded a growth in other income mainly due to a 30% growth in fee based income.

Provisions high, for prudence

Commercial's provisions grew significantly by 70% to Rs.402 million, and according to the management, this is a policy of prudence, as some of the non performing advances have been fully written off despite confidence of recovering at least some of them.

Declining interest rates a concern

Commercial's total interest income has not shown growth in the last quarter due to the prevailing stabilising interest rates. We expect the interest rates to further decline, thus creating a concern towards the Banks' interest based income.

We have incorporated these changes to our earnings model and the revised net profit attributable to ordinary shareholders for FY2003 is Rs.1.356 billion, with earnings multiples of 5.5x. This is a growth of 13.7% from the current earnings. Despite the reduction in earnings forecast, the fundamentals still look positive.

We believe that Commercials clean loan book will grow at 18% during FY2003 and the debenture issue and preference share issues would provide additional funds for such growth. Therefore we maintain our Buy recommendation at the current price levels.

Apollo reduces loss during the quarter ended Dec 31, 2002

Apollo Hospitals released its results for the seven months ended December 31, 2002, with a 63.6% reduction in the loss incurred during the first four months operations.

Improvements were seen in almost all areas, and the foundation is laid to break even in FY2003/04. Currently the hospital has started making profits on a monthly basis, but we do not expect the three months profits (Jan 2003 - March 2003) to wipe out first seven months losses.

The turnover grew by a very strong 46.8% to Rs.461.5 million during the three months to December 31, 2002, compared to the first four months of operations. As expected, the income from surgery and laboratory tests were the main contributors to the turnover growth. Apollo recorded a gross profit of Rs.195.8 million during the period under review as oppose to the Rs.300.1 million during the first four months. The other income, which comprise of interest received from fixed deposits, declined by 67% to Rs.4.9 million as they eliminated the fixed deposit balances.

Despite only commencing operations in 2002, we expect Apollo Lanka Hospitals to break even in FY2003/04, and to show strong earnings growth over the next three years. With most of its fixed costs already expensed, future expansion costs are also low. A further analysis of Apollo's results would be made available towards the early part of next week after a company visit. We maintain our optimism on Apollo.

TKYO earnings marginally down

TKYO's consolidated turnover increased by a healthy 38% helped by the operations of its new subsidiary Samudra Cement. Samudra Cement was set up basically to meet the requirements of the Colombo and the suburbs where a major part of the country's construction work takes place. However, the Samudra terminal, which is based in the Colombo port, functions only as a cement bagging plant and imports its total cement requirement based on demand for the same.

TKYO has three brands under its umbrella namely Mitsui which is their superior brand and Atlas and Samudra. The company saw a shift in demand from Atlas to Mitsui. This was evident in the company's financials where net earnings from Tokyo has declined by 32% to Rs. 56.1 million while Fuji Cement (manufacturers of Mitsui cement) has increased et earnings by 22% to Rs. 135.6 million. However, Samudra posted a net loss of Rs. 23.1 million.

Import of cement for Samudra the main reason for increase in cost of sales According to the company, the cost of sales increased by 51%, mainly due to start up operations of the Samudra Cement terminal and the import of cement powder for Samudra Cement.

TKYO's cost of production was also affected due to high energy cost. Prices of raw materials (mainly clinker) too witnessed an increasing trend, which resulted in a decline in gross margins.

Although cost reduction methods resulted in a 12% increase in operating profit to Rs. 239.6 million the increase in finance cost due to consolidation of interest cost of Samudra Cement which led to a 7% decline in net earnings to Rs. 179.9 million.

Increase in market share with the inclusion of Samudra

The consumption of cement in the domestic market stands at approximately 2.7 million metric tonnes per annum out of which 1.5 million metric tonnes is manufactured locally by Holcim Lanka Cement and TKYO. According to our company source TKYO has increased its market share from 20% to around 25% with the inclusion of its subsidiary Samudra Cement.

Outlook for the FY 2003/04 looks positive

We might not see a major turnaround in company results during the final quarter as well due to higher initial expenses in Samudra Cement and a slower pick up in the construction sector. On the other hand, we will see healthy increase in profits in FY 2003/04 if major infrastructure projects take off the ground next year.

Furthermore if peace prevails rebuilding North-East would result in higher demand for Tokyo cement, where the company is the market leader in the region. Based on annualised earnings currently the share is trading at PE of multiples of 5.8x compared with the manufacturing sector PER of 9.7 x and market PER of 11.4 x.

However, as mentioned, we do not expect a major turnaround in the company in the final quarter. Thus we do not expect the share to outperform the ASPI in the immediate future.

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Copyright 2001 The Associated Newspapers of Ceylon Ltd.
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