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Market edging close to previous high

The market remained buoyant and moved higher to close at 1,051.1 on ASPI and 2,038.0 on MPI in the vicinity of the previous high of 1060.0 levels, despite short-term profit taking on Thursday. Week-on-week the market gained 10.6 points on ASPI and 25.5 points on MPI.

The market lost 5.3 points on ASPI and 7.8 points on MPI on Thursday after gaining 11.6 points on ASPI and 22.0 points on MPI during the first half of the week. The indices kept to relatively tighter ranges on Friday gaining 4.3 points on ASPI and 11.3 points on MPI. Meanwhile this week saw an improvement in foreign activity, which resulted in a net foreign inflow of Rs. 177.9 million. Amongst the key foreign transactions, on Tuesday Commercial Bank sold 15.4 million shares of Sri Lanka Telecom amounting to approximately Rs. 231.0 million to a foreign investor. This transaction accounted for 43% of the day's turnover. Total turnover for the week stood at Rs. 1,162.2 million with a daily average of Rs. 232.4 million. Nations Trust Bank, Sri Lanka Telecom, JKH, Distilleries and Grain Elevators remained amongst the heavily traded stocks.

Point of view:

The LTTE last week stated that they were still studying the government's latest proposals on an interim administrative body, and would submit fresh suggestions during the next few weeks.

The LTTE's political wing leader S.P. Thamilchelvam once again committed towards a peaceful solution to the ethnic conflict, but, stressed the need for more power to be vested with the administrative body.

Meanwhile the government expressed their confidence towards a resumption of the peace talks within the next few weeks. However the Southern political parties are still arguing on the proposed structure.

We feel that the establishment of an interim administration would take a minimum of 3 - 4 months, as the discussions should be two fold: both the LTTE, and the Southern political parties, should be consulted before finalization.

However we maintain our view that a resumption of the talks could take place sooner than later, as the government and the LTTE would have to sit at the table to discuss the co-issues of establishing such a body. This we believe could add further momentum to the market, which has already shown an upward trend.

This coupled with strong corporate earnings expected during the next few weeks, would be the key driving forces during the short run. Lanka Tiles witnesses a drop in earnings According to the unaudited accounts of Lanka Tile Ltd. (TILE) the 1Q2003 gross sales increased by 9.7% to Rs. 248.1 million due to increased volumes in the domestic market. However gross margins declined to 28% (35% for the same period last year) due to pressure on prices. This resulted in a 22.4% decline in profit from operations to Rs.38.3 million. However, reduction in finance cost and taxation helped the company record net earnings of Rs. 28.0 million, a decline of 13% over the same period last year.

Second tile factory to commence commercial operations in November 2003 TILE's second tile factory is expected to commence commercial operation in November increasing existing capacity by 35%. TILE currently produces 1.5 million sq.ft of tiles annually accounting for 30% of total floor tiles market share.

Profits to come lower in FY 2003/04

Higher start up cost at the second factory and increase in finance cost (estimated finance cost for FY 2003/04 is Rs. 20.0 million) coupled with tightening of margins in the domestic market will result in lower earnings for the company in FY 2003/04. Estimated earnings for TILE for FY 2003/04 is Rs. 110.0 million, a decline of 11% over the previous FY. Based on 1Q earnings annualized EPS of the stock is Rs. 5.56. Based on Friday's closing price of Rs. 48.25 the share is trading at a PE multiple of 8.6x. Net assets per share as at 30th June stand at Rs. 32.22.

DFCC results for 1Q FY2003/04 Earnings up 12%

DFCC Bank posted a 14% growth in net profits during the 1st quarter of FY2003/04, compared to the 1st quarter of FY2002/03. The Bank recorded a 4% growth in interest income, supported by an 11% growth in net loans and advances. Interest expense declined by 12% due to the low deposit rates and this resulted in a 40% surge in net interest income. This we believe is encouraging, since DFCC's core activities have returned to positive territory after recording a 4% decline in net interest income during FY2002/03.

Other income up by 13%

Non-interest income recorded a 13% growth compared to the corresponding period of FY2002/03, with the revenue form lending improving 46%. However the gains from the sale of securities declined from Rs.50 million to Rs.41 million during the period under review. Rs.112 million of DFCC's other income last year was the fee earned as financial advisor to the privatization of Sri Lanka Telecom and therefore, we do not expect DFCC to maintain a similar growth in other income during the current year.

The provision charged to income for the current period was Rs.66 million, five times the amount provided during the first quarter of last year. Like most other banks, DFCC too increased its provisions during the latter part of the FY2002/03 as it provided Rs.401 million for the full year. We expect the same level of provisioning during the current financial year, as we forecast a total provision of Rs.400 million for FY2003/04. Investment in Commercial Bank more of a strategic tool.

The bank recorded a 14% growth in profit after provisioning but before any share of profits from associates to Rs.292 million. DFCC's associate, Commercial Bank, continued to contribute immensely towards DFCC's profitability, as the share of profits from associates and subsidiaries accounted for 42% of net profits. The 29.91% stake in Commercial Bank is mainly a strategic asset to DFCC, but its contribution towards DFCC's profitability via its associate status is certainly significant.

Acquires MERC: Looking for commercial banking opportunities DFCC recently acquired MERC Bank with the objective of diversifying into commercial banking. The acquisition of 90% cost Rs.65 million, with a payment of Rs.2.65 per share. Despite already commencing commercial banking activities in a limited capacity, we are of the opinion that the real success will be seen in the medium to long term, as the strategic establishment still looks uncertain. MERC bank is still a young enterprise among the commercial banks, thus real growth could be expected after the current financial year. Strategic interests push the stock price

During the recent bull run at the Colombo Stock Exchange (CSE) DFCC's stock price appreciated and reached a peak, mainly due to strategic accumulation by selected investors. Further, investors became bullish towards the development banks after the Tokyo donor conference as they expected a major proportion of these funds to be channeled through the leading development banks.

However we feel that it is still premature to expect such a scenario, since the projects and development plans are yet to be identified. Our earnings estimates stand at Rs.1.09 billion for FY 2003/04, with forward multiples of 10.8x. We project a 3% growth in earnings for FY2004/05, with a PER of 10.5x. The counter is currently trading above the Banking sector forward PE of 8.9x (stocks covered in our universe) and further it trades at a 39% premium to its forward book value. This coupled with the uncertainty associated with DFCC's success in generating revenue through commercial banking activities we recommend a Hold.

Tea market round up

Earnings from tea exports for the 6-month period ending June 2003 are estimated to have dropped Rs.0.65 billion (2.1%) compared to the same period in 2002. However export earnings in June 2003 showed an increase of Rs. 0.88 billion to Rs. 5.78 billion when compared to June 2002, in line with the recovery in prices which has been witnessed already. The largest earnings decline for the 6 month period is from tea in bulk which showed an 8.4% decrease. Earnings from packeted teas have shown substantial growth in the six month period due to larger quantities of packeted teas being exported to Libya.

Impact of Middle Eastern crisis and floods

The drop in export revenues in the first half of 2003 can be attributed to the crisis in the Middle East and the floods in the Southern and Sabaragamuwa regions. Both these factors significantly affected the low grown sector, which has historically been the higher revenue earner for Sri Lanka tea. The Middle Eastern crisis affected export volumes and prices, while the flood situation affected production levels dealing a double blow to the low grown sector.

The recovery in low grown and overall tea prices witnessed since June 2003 is encouraging for the sector. We feel the tea sector will recover in the long term due to better prices, emphasis on quality and improved marketing in a global sense.

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