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The market activity this week remained very volatile but ended higher week-on-week. The ASPI gained 27.4 points to end at 1,014.9 while the MPI closed 68.5 points higher at 1,962.9.

The market started off with dip in indices on Monday. However, recovered on Tuesday and Wednesday gaining 35.8 points on ASPI and 86.2 points on MPI.

Nevertheless emergence of profit taking resulted in a marginal drop in indices during the latter part of the week. The market gained 30.3 points on ASPI and 69.8 points on MPI to close at 988.9 on ASPI and 1901.5 on MPI.

Foreigners play an active role

The foreign participation was noteworthy, as the total foreign activity for the week accounted for 38.0% of the total turnover.

However foreigners ended as net sellers with an outflow of Rs.28.9 million. Among the stocks, which were in foreign interest, were John Keels Holdings, Distilleries, Hayleys and Commercial Bank.

Total turnover for the week stood at Rs. 1,070.7 million with a daily average of Rs. 214.1 million. NDB, NDB Bank, Distilleries, JKH, HNB, Grain Elevators, Nations Trust remained amongst the heavily traded stocks.

Point of view:

World Bank launches country assistance strategy

The World Bank (WB) increased the funds allocated for the Country Assistance Strategy (CAS) from Rs.800 million to Rs.1 billion, expressing its confidence on the developments in peace progress and economic environment. (See separate story) The move, we believe would add more confidence to the investors who are looking for more certainty than uncertainty.

LTTE studying government's latest proposals

Meanwhile the government sent a skeleton of the draft interim administration to the LTTE through the Norwegian facilitators, keeping room for them to express their requirements. This we believe is a more effective way of addressing the issue, compared to previous attempts of the government, as it enable to identify the requirement of the LTTE.

Further it will pave the way for the resumption of the talks, which has been in a deadlock for almost three months. In our opinion, the two parties should discuss each other's requirements in detail before finalising, the temporary working solution through the interim administrative body.

Therefore a resumption of negotiations seems a must, even to work out the working solution.

Market to remain volatile

Since we pointed out last week, of the PER's returning to attractive levels, almost all these stocks have picked up in price with in a short period of time. However we feel that the stocks still have value at these prices, given the fundamental out look.

We feel that the recent interest shown by the foreigner's could add further momentum to the market, thus leading up to an important passage of time. However we maintain our view that the indices would fluctuate in a wide range in the short term creating buying opportunities at attractive price levels.

Rs. 11.0 billion excess liquidity in the money market

The Central Bank mop up part of the liquidity surplus in the money market by absorbing Rs. 1.0 billion via a Treasury bill auction in the secondary market. The market is widely expecting another rate cut in the near future due to excess liquidity in the market, stable market conditions, declining inflation and expectations of lower government borrowing.

Currently repo and reverse repo rates stands at 8.25% and 10.25% respectively. However, higher prevailing higher inflationary situation would thwart possibilities of another immediate rate cut. Although inflation saw a rapid decline during the month of June it still remains high at 9.0%. Meanwhile the Central Bank's year-end inflation target as measured by CCPI stands at 7.5%. Thus, for another rate cut to come into effect there has to be a further decline in inflation.

JKH First Quarter results; Rs.687 million VRS written off during the quarter Sri Lanka's largest conglomerate, John Keells Holdings (JKH) recorded a 82% decline in net profits during the first quarter of FY2003/04, largely due to Rs.687 million Voluntary Retirement Scheme (VRS) in Ceylon Cold Stores.

While recording significant growth in almost all sectors, JKH maintained a 60% growth in profit before tax and extra ordinary items, compared to the corresponding period of FY2002/03.

Turnover up 26%; boosted by Transportation and Leisure sectors

All six sectors recorded a growth in the top line, dominated by the transportation and leisure sectors. A full year consolidation of Lanka Marine Services (LMS), made a major difference to the transportation sector, as the sector turnover grew by 139%, compared to the first quarter of FY2002/03, to Rs.1.34 billion. We believe that the transportation sector would be the main income driver for the group in the coming years.

Increased tourist arrivals due to the on going peace process, resulted in a 39% growth in Leisure sector turnover to Rs.528.5 million. The SARS fears reduced the arrivals from East Asia, but the impact was minimum as the average occupancy rates improved compared to the corresponding period of FY2002/03.

Food & beverages, Financial Services and Information Technology sectors all recorded improvement in turnover, while the plantation sector affected by the war in the Middle East, showed signs of recovery with a 4% increase in the turnover.

Operating margins can be further improved.

The operating profit grew by 81% to Rs.425 million, but operating margins were still at 10%, the same levels recorded during FY2002/03.

Retirement scheme proves costly in the short run

JKH wrote off aRs.687 million Voluntary Retirement Schemes (VRS) in Ceylon Cold Stores and John keells Ltd, thus producing a sharp decline in the bottom line. We expect a further Rs.200 VRS in Lanka Marine Services (LMS).

The move comes as no surprise as we have already highlighted this in our last results update on JKH. This could reflect as a short-term burden on the company but should be viewed as a positive indicator in the long run as it would attract cost savings in the future.

The net profits declined by 82% to Rs.45 million, with a diluted EPS of Rs.0.20 for the quarter. JKH due to its liquidity and the market cap has always been trading at high earnings multiples, thus the counter still trades at 15x of its projected forward earnings.

Still foresee a high potential for growth

JKH has just completed a restructuring study conducted by the Boston Consultancy Group (BCG) and we believe that the successful implementation of the suggestions would enable the group to exploit greater synergies, improving operating margins. The recent bonus issue has add more liquidity to the stock, which could be a major attraction for the foreign investors.

A detail analysis and forward forecasts will follow in our upcoming research report on John Keells Holdings.

World Bank Country Assistance Strategy

The World Bank (WB) launched its US$ 1.0 billion Country Assistance Strategy (CAS) for Sri Lanka on Wednesday.

The WB in the CAS document it released is of the opinion that the situation in Sri Lanka has been stabilising since late 2001 owing to the improvements made on the peace, political and economic fronts:

*The five successful peace discussions facilitated by Norway has resulted in an increased level of optimism that the long lasting ethnic conflict in the country can be resolved.

*The present private sector oriented government has moved forward decisively with implementing a comprehensive reform program

*Economy is experiencing a gradual recovery

*The current situation is very unlike the uncertain conditions under which a CAS was prepared for Sri Lanka in June 1996.

WB feels that the Government of Sri Lanka's economic and poverty reduction strategy, Regaining Sri Lanka (Vision and Strategy for Accelerated Development) is an ambitious proposal, which is aimed at eliminating factors which inhibit restraints on private sector activity and change the role of the state while addressing the key elements of poverty.

The CAS programme, which is results-focused and built around the themes of peace, growth and equity, supports the poverty reduction strategy. WB feels that the following three chosen themes are important.

(I) A return to peace and restoration of domestic security are critical to create a sustainable poverty reduction framework and ensure a tolerable fiscal burden

(ii) Economic growth is the main instrument for achieving prosperity and creating more resources for distribution

(iii) Ensuring a balance or equity within society is essential especially due to the deep pockets of poverty that exist in the South and Northeast.

Key outcomes under different themes

Under the peace theme, the CAS will support restoring infrastructure in health, irrigation and agriculture and building technical capacity to implement the reconstruction and poverty reduction efforts.

Under the growth theme, CAS outcomes include establishing legal frameworks to increase flexibility in labour and land markets, regulatory environment conducive to private sector participation, reducing and time and formal cost of business start-up and clearer land titles and more consistent price signals for agricultural producers. Improving quality of and access to public services in education, health and water supply and improving the degree of empowerment of communities to address their own development needs are supports under the equity theme.

Two lending scenarios developed

The CAS program is formulated under two scenarios - base case and high case. Under the Base case scenario, WB will lend US$ 800 million over a period of 4 years with US$ 205, 230, 195 and 170 million respectively in FY2003, 2004, 2005 and 2006. Specific triggers, which include maintaining satisfactory macroeconomic performance, successful implementation of the economic reform programme, progress in addressing equity concerns and satisfactory portfolio management has to be met.

The high case scenario will have a lending volume, which is approximately 25% higher than the base case but requires improvements in the areas of fiscal management, private participation in infrastructure, public sector management and decentralisation in addition to the base case triggers.

In addition the CAS describes two low case scenarios. One is in the event the peace process breaks down and there is a resumption of hostilities or the serious lagging behind of structural reforms and the worst case scenario which is an exit strategy from Sri Lanka for the CAS if the peace process were to break down entirely and hostilities break out on a national scale.

Even though the CAS is designed for US$ 800 million, the WB Board has approved an additional US$ 200 million since preparation of the strategy, increasing the total to US$ 1 billion.

Of this total, a sum of US$ 140 million will be in the form of an outright grant while the remaining US$ 860 million will be at zero percent interest repayable in 40 years commencing in 2013. Approximately one third of the entire CAS is likely to be used toward the conflict areas in the country.

A detailed analysis of the WB funds will be made available.

www.crescat.com

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