Monday, 3 November 2003  
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HNB Stockbrokers Weekly Market Review

The market lost momentum during the week, where the ASPI ended the week at 1416.4 points (down by 0.5% WoW). However, the more receptive MPI upped by 0.6% to close the index higher at 2583.4 points. The market was due some sort of a correction, which was expected.

Investors were rather buoyant about the banking sector and considered it to be undervalued in the present context of high market optimism and due to the expectation of strong September-quarter corporate results, thereby improving the demand and hence pushing most of the prices of the banking stocks higher.

NTB was at the forefront moving to a high of Rs.47 and closing at Rs. 43.75, with over 4 million shares traded. During the week the Colombo Stock Exchange recorded a turnover of Rs.2.58 billion with a daily average of Rs.515 million. The foreign participation picked up from the last week and contributed 25% of the total turnover. The retailers mainly kept the turnover at healthy levels, while cashing out on gains after the recent appreciation of share prices.

A highlight of the week was the sale of 1 million block of shares of HNB at Rs.110, the seller being Browns & Co. and the buyer NSB, which has increased its stake in HNB to 4.1%. Other active stocks during the week were SLT, Asian Hotels, Seylan Bank Non Voting, Distilleries, Asia Capital and Nations Trust Bank.

Point of View

LTTE submits interim Administration proposals

The much awaited draft proposals for an Interim Administration (IA) was submitted by the LTTE to the Norwegian negotiators on Friday after a series of meetings with the other Tamil Political parties. Both parties briefed the media on their initial reactions but the co-issues would be discussed only at a negotiation table. As expected by us the proposals demanded autonomous powers to rule the North and East, which are outside the present constitutional framework.

The LTTE stressed the need to look beyond the constitution to find a genuine solution to the ethnic conflict. Meanwhile the government responded by saying that the proposals outline the LTTE's vision regarding the framework for a political solution to the conflict but it differs in fundamental respects from the proposals submitted by them.

We believe that the wider gap between the two proposals should be narrowed through discussion, thus providing a platform to set up an Interim Administrative body, as the working solution for the conflict. While other political parties expressed immediate opposition to the proposals, Sri Lanka Muslim Congress stressed that it did not reflect the aspirations of the Muslim community. We believe that the sharing of power in the Eastern Province must be duly addressed in the IA body, through further negotiations.

The stalled peace talks are expected to re-commence in January to discuss the contentious issues pertaining to the establishment of the IA body. While the public in all parts of the country expecting a peaceful solution, and the whole process being strongly watched by the international community, we believe that the negotiations would lead towards setting up an IA body. However we maintain our view that it would be an extensive process with its own ups and downs.

Strong corporate results already evident

Most of the corporate results released last week showed strong growth, and held the market from hefty profit taking. As we had expected, the market remained mixed as investors took a cautious outlook in an already heated market.

However we expect the strong corporate earnings and signs of recommencement of peace talks to maintain the mixed momentum, with a shift to positive outlook in the coming weeks, overshadowing some modest profit taking.

Hemas Holdings results for 1H of 2003

Hemas Holdings Ltd. (HHL) released 2Q 2003 results. Since the company has not released the comparatives for the corresponding period last year, our analysis above shows the movement from Q1to Q2 of FY 03/04 as a basis of comparison.

Turnover meets the half yearly targets

HHL saw a turnover increase of 28.5 % over the preceding quarter to end at 3191.8 million for the full 1st half of the year. The main contribution to the revenue came from Personal Care (1412m or 44% of total revenue), Healthcare (832 million or 26%of total revenue) and Strategic investments (519m or 16% of total revenue). We spoke to the company, who revealed that turnover growth between 1H 2003 and 1H 2002 was approximately 30%.

The main growth sectors were Healthcare and Personal care sectors that have outperformed the company's own half yearly targets. The Personal Care sector which is mainly driven by the Baby Cheramy product range (as well as Clogard) saw a volume increase due to a general market growth as well as a marginal increase of market share away from the competitors. The Healthcare sector was driven by sales volumes in the manufacture and distribution of pharmaceuticals.

The same trend is expected in the second half for these two sectors, which have very little seasonality if at all. On the other hand the Leisure sector and Transportation can be expected to show better numbers in the second half (which is the seasonal trend) and a total revenue growth of around 40% year is foreseen by the company, which is also in line with our outlook.

Profits looking comfortable

The operating profit growth for the six months was due the increased turnover, improved product margins (Clogard - due to change in product formulations), dividend income from subsidiaries and capital gains from divestments (30m). The total net profit of 260.6m for the 1st half was in line with our forecast for the full year of Rs. 531 million (especially considering the fact that 2 H numbers are seasonally higher than 1H due to the cyclical tourism sector).

Based on a market price of Rs. 91.75 and an EPS (fully diluted) of 6.68, forward PER stands at 13.5x. The Net Assets per share was at 29.2 yielding PBV 3.14 Our long-term fundamental outlook remains unchanged.

FY 2004 EPER of 13.5x makes it in line relative to forward market PER of approximately 13x. However, the multiples decline to 8.2x in FY 2006 E, due specifically to the strong upsurge in earnings contribution expected from the power segment. While it has already surpassed our target price in its recent run-up, we maintain the stock as a Long-Term Buy due to its prospects in the power segment. The company's return on assets and equity still remain the best among the conglomerates.

Seylan Bank: 9 months results to Sep 2003 -Earnings up 105%

Total revenue up, supported by healthy profits from treasury operations

Seylan recorded a 46.5% growth in total revenue (net interest income + other income) to Rs.5.1 billion during the first 9 months of FY2003 as opposed to the same period in FY2002. The loan book grew by 14% during the period, but total interest income remained almost flat, at Rs.6.3 billion. This is largely due to the continuous decline in lending rates during the period. However the interest expense declined by 11.5% due to the declining deposit rates, thus net interest income grew by 17% to Rs.2.7 billion.

The gains from the fixed income transactions together with other treasury operations jumped up 197% to Rs.1.35 million during the period under review.

This is the main cause for the 92% surge in other income to Rs.2.35 billion. Other income continued to represent bulk of the total revenue, as it amounted to 46% of the total revenue.

Cost to income ratio on the decline

The personnel costs increased by 15% to Rs.1.19 billion. The 10% VAT surcharge is applicable on Profit Before Tax and personnel cost and the new tax has resulted in an additional burden of Rs.139 million, during the first 9 months of FY2003. Other overhead expenses grew by 23% to Rs.808 million largely due to the increase in overheads, such as electricity, telephone, rental etc. However the cost to income ratio based on the nine months results stands at 57%, well below last year's (YE Dec 2002) ratio of 65%.

Provisions a concern

During the period Seylan provisioned 126% more than what it provisioned in the corresponding period of 2002. Total provisions for the period amounted to Rs.844 million, almost in line with our full year forecast of Rs. 965 million. However, we have not factored in any provisions with relation to the loans provided to Vanik Inc. This may add an additional provision during the year, which we feel would increase total provisioning by a further 12% - 15%.

Strong growth in bottom line

The healthy growth in income resulted in a 105% growth in profit after tax and minority interest to Rs.1.19 billion, and once the 14.51% preference dividend was apportioned to the first 9 months, Seylan's ordinary shareholders were left with a profit of Rs.1.187 billion. Seylan's earnings multiples stand at an attractive 3.4x, (based on annualized EPS) the lowest among the listed banks.

We expect Seylan's profits to grow by 48% to Rs.1.45 billion during FY2003, resulting in an EPS of Rs.17.40. Profits are projected to further improve by 10.5% during FY2004 and reach Rs.1.6 billion, with an EPS Rs.19.20. Forward earnings multiples are declining from 3.7x to 3.1x over the next two years.

Seylan has traditionally traded almost 60% below its peers, but we expect PER to come more in line with other banks, as the Bank is working towards filling up lapses in asset utilization and credit policy. This we believe would create an opportunity for an upward revision in price over the next three years. The counter is trading at 0.6x to its forward book value of Rs.101.94 as at 31st December 2005. We maintain our optimism on Seylan in the Long Term, thus a Long Term Buy.

Asian Hotels Corporation 2Q profit grows by 282%

Asian Hotel Corporation released its 2Q2004 numbers yesterday. Total group revenue at the half year point was up by 150 % to Rs 1.55 billion with Crescat Developments contributing a hefty Rs. 799 million (up 153 % from last year). 2Q alone brought in 1.1 billion revenue which was a remarkable 188 % over the Q1. The gross operating profits were up by 191 % to Rs. 562 million while the net profit attributable to shareholders of the group grew 282 % to Rs.368 million. The 6 month EPS was at Rs. 1.66.

Transasia earnings strengthen

Transasia revenues for the 1st half of the year has risen by 41 % to Rs. 399 million with the gross operating profits standing at Rs. 252 million (up by 28%). The earnings to the shareholders grew by 55 % to Rs. 108 million due to the increased turnover coupled with the low finance cost. The 6 month EPS was Rs 2.16.

Overall, we remain upbeat on the hotel sector in Sri Lanka due to increased tourist arrivals and increased patronage from local residents on the back of economic prosperity. A clear sign of this has been a sharp increase in room rates and occupancies across the board.

Another pledge on the implementation of Caller Party Pay (CPP) system;

Impact on SLT minimum

All mobile phone users are expected to enjoy free incoming calls from January 2004 as the authorities once more urged to implement the Calling Party Pays (CPP) system. Initially this was to be introduced in January 2003 and was put off to July 2003, due to objections from the fixed line operators. The implementation was further delayed due to the continued opposition from the 3 fixed line operators, Sri Lanka Telecom (SLT), Suntel and Lanka Bell.

As per the existing system, if a fixed line subscriber connects to a mobile phone, both the caller as well as the receiver will pay for the same call - currently, in per minute terms, it is approximately Rs.5.16 to the calling party and Rs.5.00 to the mobile customer.

Furthermore, the fixed line operator will have to pay a mobile termination charge to the mobile operator.

Reduction in volumes likely on fixed line operators in the short run According to the new system Rs.5.00 call incoming call charge on the mobile customer, will be abolished. Fixed line operators will then have to adjust their tariffs upwards to pass through this additional termination charge to fixed line customers. As a result of the increased tariffs on fixed line customers, for their calls to mobile phones, we feel that a reduction in volumes is likely on fixed line operators. Further SLT already increased tariffs by approximately 12% last month, thus another upward price revision could lead to shift in usage from fixed line to mobile, reducing the volumes of SLT.

Encourage the growth in mobile market

However, except for the initial adjustment period, we do not believe that this move will adversely affect traffic volumes significantly in the long run. On the contrary, we believe that this actually represents a much more progressive billing system and puts it in line with most major telecom operators' tariff structures worldwide. It would also encourage the further development of the mobile market and attract subscribers, thereby increasing overall usage, both mobile and fixed line.

Impact to be eased off in the long run

However, with Mobitel now being a fully owned subsidiary, SLT is in a position to leverage the adverse impact of the CPP system, as the shift in fixed line volumes can be compensated through increased volumes of its mobile operator. Mobitel is expected to launch is first phase of its GSM network during November, has already shown strong progress in increasing its subscriber base.

We remain positive on our investment view for SLT. We believe that there is tremendous scope for the development of the telecommunications market in Sri Lanka, with penetration rates still hovering around 10%.

A fairer tariff structure, as proposed above, will also help in the development of Mobitel, who are rolling out a new GSM network in order to pose a serious challenge to Dialog. Further we expect the PER to reduce from 19.9x to 11x over the next 3 years, thus justifying our recommendation, Long Term Buy.

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