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Volatility to continue amid political drama

Shares closed mixed in moderate trading as both ASPI and MPI lost 23.9 points (2.05%) and 41.2 points (1.95%) to close for the week at 1140.9 points and 2070.9 points.

The market started on a negative note on Monday but the indices picked up during the next two days with ASPI and MPI gaining 17 points and 41.3 points. However investors greeted the news of signing the PA-JVP alliance negatively, as the market dipped 37 points on Friday.

The four day week recorded a turnover of Rs.822.7 million at a daily average of Rs.206 million, marginally below previous week's daily average of Rs.246 million. The week recorded a net foreign inflow of Rs.9.2 million. SLT, JKH, Asian Hotels and Blue Diamonds were among the actively traded stocks.

Point of View:

Alliance to be finalized but chances of a general election still below 50%

The People's Alliance (PA) and the Janatha Vimukthi Peramuna (JVP) announced their plans to finalize and sign the SLFP - JVP Alliance, but ruled out the chances of a general election in the near future.

We still believe that an election at this point of time would be disadvantageous towards both UNF and PA and we envisage a weaker government coming into power in the event of an election.

Therefore we place the chances of a snap poll below 50% probability levels. However market is expected to remain volatile during the coming few weeks, while being highly sensitive towards the political news.

If the alliance is greeted with growing internal resistance, we feel that the market would move towards positive territory, while strong support for the alliance may affect negatively towards the indices.

We advise investors to closely monitor the developments in the political front, before accumulating the fundamentally strong counters.

NDB: Political crisis delaying the merger

National Development Bank (NDB) is still awaiting parliamentary approval to merge with its commercial banking arm NDB Bank (NBL).

During early September 2003, the monetary board and other regulatory approval was granted for the two banks to merge with each other, but the present political climate has delayed the process of parliamentary approval, thus continuing the uncertainty on the time frame for the merger.

In our last Banking Sector report (Good Times For Banks), dated 28th January 2003, we highlighted the importance of the merger, and stressed the fact that the project lending model cannot stand alone in the future.

Results were evident throughout 2003, as NDB's loan book recorded negative growth of 21% during the first 9 months of the year and the total interest income dipped by 14% during the same period.

However Bank recorded only a 6% dip in both interest income and net advances, as the declines in-group figures were mainly due to the discontinuation of operations in Mercantile Leasing Ltd.

(NDB disposed its stake in MLL during FY2003).

Despite the drop in total interest income, the group managed to post a strong growth in the bottom line largely to the widening interest spreads and consolidation of the profits from Eagle Insurance (after increasing the effective control to 66.5%). Acquisition of Eagle; more of a strategic move

During mid 2003, NDB took Eagle Insurance Company Ltd under its wing by increasing its stake to 66.5%. (effective control) We believe that the benefits of the acquisition is more of a long term nature, as Eagle would provide the necessary diversification to NDB group, which is repositioning to areas such as commercial banking, Bancassurance etc.

The merged entity to focus on a quality service to the customers NDB has invested heavily on recruitment, training its staff and team building with the objective of providing a high quality service to their customers.

The management expects that although the merged entity would be in an expansionary mode, prominence would be given towards providing a quality service to its customers.

Close monitoring of the loan book

A recent company visit indicates that the management has concentrated on clearing up its loan portfolio and continuously assessing the Non Performing Loans (NPL).

Presently NPL ratio (NPL : advances) is hovering around 13% but the management believes that the merged entity would in the medium-term target an NPL ratio of 6%. In our opinion NDB would be in a position to reduce the ratio to such levels in the short run, but would maintain a medium term average of 8% - 9%, given the uncertain economic environment in the country.

No revisions to our profit forecasts

We maintain our profit forecasts for NDB as per the last revision with earnings for FY2003 is projected to be Rs.1.12 billion, up 20.6%, resulting in forward multiples of 7.3x. We forecast a 6.4% growth in the bottom line to Rs. 1.2 billion during FY2004.

Forward earnings multiples are expected to decline from 7.3x to 6.9x over the next year. The counter is trading 1.0x of its forward book value of Rs.157.89 for FY2004.

Despite the future of the merger and its outcome being yet uncertain, we feel that NDB has already taken steps to strategically position itself as a diversified financial institution. We therefore maintain our recommendation on NDB, a Long Term Buy.

Hayleys: Looking for opportunities overseas

Sri Lanka's largest export-oriented conglomerate, Hayleys Group is further affirming its global exposure to the areas of rubber, coir and environment.

During the last couple of years, the company has ventured into a number of overseas business operations, the most recent investments being the medical glove manufacturing plant in Thailand and the ICO Guanti marketing company in Italy.

Growth through overseas ventures

Hayley's subsidiary, Dipped Products Limited (DPL) has diversified its glove manufacturing, to produce medical gloves by setting up a medical glove manufacturing plant in Thailand.

A recent company visit affirms that this plant is expected to be commercially operational by September 2004 and HAYL is hoping to bring in modest profits as early as the FY2005/06.

During FY2002, DPL acquired 55% stake in ICO Guanti (the company's largest distributor of gloves in Europe) signalling clear signs of strategically positioning to build up a value chain in the distribution of its products.

Consistent and prudent investment to continue

The management emphasized that they would maintain its new investments irrespective of the political climate of the country. HAYL has been investing approximately Rs.600 million per annum over the last decade. For the next financial year, the company expects to commit its capital expenditure on the rubber sector and textile business.

In summary we feel that HAYL will continue to focus on export-oriented business. The company will not only search for selling opportunities in overseas markets, but also seek production opportunities globally, where the relatively cheap production costs are available.

Spence: Outlook positive on the tourism sector

During a recent company visit to Aitken Spence's Hotel and Tourism sector, we learnt that their outlook on 2004 remains positive amidst the present political uncertainty and the stalled peace talks.

The 4th quarter of 2003 bringing a record number of visitors in to the country enabling Sri Lanka to achieve the half a million milestone helped most of the hotel and tourism sector players to record sizable revenues for the period.

Political uncertainty not a deterrent but peace is the key

The management agrees to the view that the present political uncertainty alone is not going to slow down the tourist arrivals in to the country.

As long as the ceasefire prevails, the political power struggle and who's in power may not be the key factors considered by the tourists in deciding to visit the country. The cancellations during the last two months of 2003, in which the present crisis began have been quite insignificant.

Company actively considering growth

The company is seeking to expand its hotel properties to increase its capacity to service the higher tourist clientele expected. On the calendar are plans to refurbish existing hotels during the off-season with minimum disruption to operations.

Funding for these growth and expansion initiatives is not specified but the company is expected to utilize one of the many options available, including parent company funding, borrowing from bank, using internal cash or may be even raising from the market depending on the conditions prevailing at the time of raising funds.

Our forward view

In conclusion we feel that FY2004 would be quite positive for the company if the ceasefire continues without any major setback. We expect the Spence hotels to record sizable growth in their toplines with continued growth in earnings. An in depth analysis on Spence Hotels (AHUN) would be made available in our up coming research report on Sri Lanka Hotel Sector.

LMF plans to move into liquid milk sector

Sri Lanka's second largest player in the milk food sector Lanka Milk Foods Ltd (LMF) has plans to extend its current liquid milk production by a large proportion in the coming 2-3 years.

Currently the group is heavily dependent on the powered milk product, "Lakspray", but with increased competition due to the entry of 19 new brands to the market LMF hopes to shift to the liquid milk sector to compensate the decline in volumes.

In addition to fierce competition the recent government policy to promote liquid milk as opposed to powdered milk, has encouraged LMF to enter the liquid milk sector with more aggression.

New project to contribute heavily

"Danida mixed credit scheme" of the foreign ministry of Denmark has agreed to sponsor a major project at one of LMF's subsidiaries in Ambewela. This project is expected to cost Rs. 700 million and this would be borne by the Danish organization.

The management expressed that they envisage the completion of this project by the end of 2005, at a recent company visit. This project is expected to increase the company's daily liquid milk production from 7,000 liters to 26,000 liters, which would in turn contribute to approximately 20-25% of the group turnover.

It is expected to improve the quality of grass and to import cattle of better quality. This in tern would contribute towards a significant increase in the production of liquid milk and improve the quality.

Future outlook

LMF's earnings for FY 2004 is expected to be around Rs.100 million, which is a 23.8% decline, compared to Rs.131.2 million in FY2003. Accordingly group EPS stands at Rs.3.34, and based on market price of Rs.27.25 the share is trading at PE multiples of 8.16x.

Although earnings are expected to decline we feel that the company would maintain its dividend rates, which are in the range of 10%-15%.

We feel that LMF would be in a position to maintain its current market share over the next couple of years despite fierce competition as they have an advantage over its competitors in its pricing policy.

LMF's strong bargaining power would enable them to purchase the milk powder at lucrative prices, in the overseas markets. Further the entrance to the liquid milk market would improve its margins, which would come into effect from FY2006. Despite the immediate shortcomings, we feel that the long-term fundamentals still remain positive.

The views based herein are expressed with no mala fide intension to any party whatsoever based on already published data and from the information obtained by the research team. No matter published as above creates any liability of any kind whatsoever on HNB Stock Brokers Pvt Ltd or its associates.

The views cannot be reproduced in any form without the explicit (written or otherwise and photocopied) permission from HNB Stock Brokers (Pvt) Ltd.

(Courtesy HNB Stockbrokers)

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