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Market retreats in the back of profit taking

The market went through an inevitable correction as the ASPI opened 82 points higher during the first 3 days of trading but swung narrowly in negative territory towards the latter part of the week, to close at 1275.8 points, up by 63.8 points or 5.22% from last Fridays close. Meanwhile the Milanka Price Index (MPI) grew by 114.2 points or 5% during the week and ended on 2398.9 points on Friday.

Large shares suffered a bout towards the end of the week, after a continuous upward momentum over the last 3 weeks. ASPI advanced 203 points or 18.6% month to date in a bullish market, as both foreign and domestic investors actively picked up the fundamentally strong stocks.

Activity high; outnumbers previous records.

The turnover surpassed Rs.1 billion mark during the each of the first 3 trading days of the week, as the 5 day turnover totaled to Rs.4.8 billion at a daily average of Rs.962.9 million. However the foreigners ended net sellers with a net foreign outflow of Rs.416 million during the week. (Refer Figure-1) Foreign purchases amounted to Rs.480.7 million, while the sales were at Rs.896.7 million. Foreign participation was at a low 14.3% of weekly turnover compared to 35%, 18.5%, and 49% respectively during the previous 3 weeks.

SLT, JKH, Asian Hotels and Apollo Hospitals continued to be among the heavily traded stocks, while the hotel counters were also in heavy demand. Point of View

During the 19 trading days of this month the bourse recorded a turnover of Rs.15.7 billion, the highest recorded in a single month in the history of the CSE. The previous high of Rs.10.5 billion was during the recent Bull Run in June 2003. Before June 2003 the highest ever turnover recorded during a month was Rs.5.5 billion in February 1994 Can the market sustain the momentum?

Since June 2, 2003 the ASPI has appreciated by 52%, with continued strong activity. The turnover has amounted to Rs.36.2 billion during the last 4 months, which is more than the highest ever recorded in a calendar year previously.

(1994 - Rs.34.5 billion) The low interest rate scenario, successful donor conference in Tokyo, the tax amnesty and the continued support from the international community towards a peaceful solution to the ethnic conflict were among the key factors, which drove the indices to these levels.

However we maintain our view that the sustainability at 1300 levels is strongly co-related to the peace process and the political situation in the country. In our view the investors have acted fast, foreseeing the developments in such areas, thus the indices have shown considerable growth, even without material facts.

Talks still in a deadlock

LTTE is yet to submit its proposals for an Interim Administrative (IA) body, as a counter proposal to government's suggestions. It is rumored that the proposals are to suggest the vacation of the government troops from the North, which in fact could lead to a further deadlock. At the LTTE's recent campaign (Pongu Thamil) event held in Vavuniya, they emphasized the establishment of an interim administration (IA) with adequate powers such as powers to deal with Land, Finance, Police and Judicial services.

We believe that political campaigns such as "Pongu Thamil", shows LTTE's interest towards a political solution to the ethnic conflict. Its political wing leader S.P. Thamilchelvan in a recent television interview reaffirmed LTTE's commitment towards a peaceful solution and dumped the chances of getting back to war.

PA - JVP alliance no more

Meanwhile the presidential spokesman, in a recent media conference highlighted that the President is firmly committed to the devolution of power, and was of the view that the ethnic conflict should be solved througha negotiations.

This in fact is among the main reasons for the breakdown ina proposed alliance between Peoples Alliance (PA) and Janatha Vimukthi Peramuna (JVP). We believe that the breakdown in the alliance would further reduce the chances of toppling the present UNF government, thus improving the political stability.

Fundamentals improving; market re-rated but presently at fair value....

These developments should improve the fundamental outlook of the Colombo bourse considerably, thus increasing investor confidence. Further JKH's recent acquisition of Asian Hotels, added more value to the market as it opened the eye for other investors to look for strategic opportunities through the stock market. Therefore we feel that the market deserves a marginal re-rating, thus the prospective market Price Earnings Ratio (PER) is upgraded to 10.3x from the present level of 9.9x. Based on a 30% YoY growth in corporate earnings, the target ASPI for 2003 now stands at 1149.6 points. However the ASPI has already reached 1274.2 points, outperforming our target by 11%.

This we feel is mainly due to the JKH's acquisition of AHOT, which increased the market capitalization by approximately Rs.9.1 billion within two days. Increase in the stock price of SLT by Rs.8.00 and rumors on bonus issues are among the other reasons for the indices to shoot up within a short period of time.

Therefore we are of the opinion that the market has presently reached or fractionally surpassed a level that's supported by the fundamentals.

In fact the index to be supported at 1274 points, the earnings should grow by 45% during FY2003. This is 15% above our expectations. Meanwhile based on the latest re-rating, a 25% growth in earnings during FY2004, would place ASPI target at 1381.8 points, an upside of 8% from Thursdays closing of 1274.2 points. However we feel that, establishment of an interim administrative body and the government consolidating its position through securing more stability in the parliament, another re-rating would be on the cards. We would further revise our prospective PER based on the material facts, whenever we foresee fundamental developments of the Colombo bourse.

JKH to raise new funds; improve liquidity by 26%

Countries largest conglomerate John Keels Holdings (JKH) is to raise new funds through a private placement of shares and a rights issue. The company is expecting to raise a total consideration of approximately Rs.6.1 billion from the new issues, enabling them to finance the recent acquisition of Asian Hotels Ltd (AHOT).

Last Friday JKH acquired the controlling interest of AHOT by purchasing 134 million shares or 60.5% stake, at Rs.30.00 per share.

The latest fundraiser would be mainly for the purpose of financing this acquisition, which amounted to Rs.4 billion. Further JKH is bound to make a mandatory offer to the minority shareholders of AHOT, thus the new funds could also be used to finance the mandatory offer.

Private placement at market price

According to regulations the private placement should be approved through a special resolution for which 75% of the shareholders should vote for, at an Extra Ordinary General Meeting (EGM). JKH has already conducted a foreign road show to sell 24 million shares through a private placement, at the prevailing market price on the day of placement.

We believe that the stock price should hover in the range of Rs.130.00 - Rs.140.00 until such time, thus enabling JKH to raise a maximum of Rs.3.24 billion. (assuming a closing price of Rs.135.00 on the day of placement) According to the company sources, they have witnessed considerable amount of interest for these shares from foreign investors.

Rights issue is at a relative discount

The private placement is to be followed by a 1 for 7 Rights Issue, at an issue price of Rs.75.00 per share, raising a further Rs.2.76 billion.

Considering the Current market price of Rs.134.00, the theoretical ex-rights price is Rs.126.60.

However after the private placement the share price is likely to dilute due to increase in the number of shares.

Contribution from AHOT may not improve the PER

We expect AHOT to contribute Rs.0.9 per share to JKH's EPS (minority interest is assumed to be 39.5%) during FY2004 and improve this to Rs.1.49 per share during FY2005. (Refer Figure-2) Based on the theoretical ex -rights price of Rs.132.75 and a projected fully diluted EPS of Rs.7.96 the PER is 16.7x.

The contribution from AHOT towards JKH's earnings growth is not expected to improve the PER for FY2005 since the fully diluted EPS does not show a strong improvement, due to the heavy dilution of the share.

Liquidity to improve by 26%

After the new issues, JKH's total shares in issue would reach a mammoth 295 million, an increase of 26% from the present levels. Assuming the 65% free float is to continue, the free float market capitalization is to increase to Rs.25.5 billion (US$270 million) based on the theoretical ex-rights price of Rs.132.75. This would make the stock more attractive on the hands of foreign investors.

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