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Unchanged policy rates boost investor confidence

The market steadily advanced into positive territory throughout the week supported by the Central Bank's decision to maintain the policy rates at the current levels. This coupled with strong corporate earnings released by companies, showed signs of improved investor enthusiasm, resulting in renewed buying interest. The ASPI and MPI edged higher by 14.8 points (1.14%) and 36.2 points (1.88%) to close for the week at 1,312.9 points and 1,962.7 points respectively.

The weekly turnover was an encouraging Rs.1.2 billion, the average daily turnover improved from Rs.157 million in the previous week to Rs. 239 million. A highlight during the week was the Eagle's 15% acquisition (3.5 million shares) of Union Assurance from International Finance Corporation.

The transaction was executed at Rs. 58.00 and the total investment was Rs. 217.5 million.

A net foreign outflow of Rs. 110 million was recorded during the week. The actively traded stocks during the week included Vanik Incorporation, Colombo Land, Union Assurance, SLT and Distilleries.

Point of View:

Central bank maintains policy rates

Central Bank made no changes to its policy rates, recognizing the need for maintaining the growth momentum unabated. However the inflation remained static at 3.7% (CCPI), indicating a halting of the declining trend observed since February 2003. We feel that the increasing global fuel prices and the depreciation in the rupee would pressurize the low inflationary scenario in the coming months. However the overnight Repo rates are currently at 7%, still leaving room for the inflation to increase without a major impact on the interest rates.

The Central Bank's commitment towards maintaining and working towards a low interest rate regime, is an encouraging sign from the investors perspective, thus we believe that it has ironed out some uncertainty at least in the short term.

Market PER drops to attractive levels, backed by strong corporate earnings

Healthy corporate profits released during the last two months have pushed down the historical market PER to 10.4x from 11.5x three weeks ago. This is just marginally above our prospective market PER of 10.3x, thus showing strong signs of market fundamentals. While we do not envisage a robust growth in corporate earnings during calendar year 2004 due to the macro economic uncertainty (a resultant of prevailing political and peace issues), it should be clearly noted that the market fundamentals still remain positive based on our moderate growth projection of 14%.

However we expect the developments in the peace and the political front to influence the short-term market behaviour, creating volatility in the indices. While we advice the investors to take trading positions in fundamentally strong small and mid caps, the longer term investors should look at gradual accumulation of big caps that trade below their intrinsic value.

Hayleys results for FY2004

Hayleys Ltd recorded a 24% improvement in revenue to Rs. 15.5 billion, in comparison to the previous year, mainly contributed by notable growth in rubber sector and inland marketing. Although the gross profit rose by 11% in line with the revenue growth, to Rs. 4.3 billion, the operating profit saw a marginal dip owing to the 24% and 16% increase in distribution costs and administrative costs respectively. These rises in distribution and administrative expenses can be attributable to the acquisition of ICO Guanti in Italy in FY2002/03, which became fully operational during the period under review.

The revenue growth spurred by rubber and inland marketing sectors Transportation, inland marketing, environment and the coir sector contributed to the growth in the revenue, with 27%, 28%, 23% and 12% improvements respectively, while the rubber sector, which is represented by its subsidiary Dipped Product Ltd (DPL), has shown a remarkable 46% growth during the FY2004.

The revenue from the rubber perked up considerably to Rs. 4.6 billion particularly on account of the higher revenue generated by DPL's 55% owned subsidiary ICO Guanti with the full year results being consolidated to the accounts. This new subsidiary has generated a revenue of around Rs. 1.5 billion.

Operating profit flat despite improvements in rubber and inland marketing The operating profit of HAYL slipped by a fractional 0.6% to Rs. 1.44 billion, although operating profits of two biggest revenue generators of HAYL, namely the rubber sector and inland marketing depicted improvements of 25% and 17% respectively.

To the rubber sector growth in operating profits, the new subsidiary ICO Guanti also contributed around Rs. 100 million. It should also be stated that the plantation sector, which contributed 7% to the operating profit performed well to register a creditable 57% growth to Rs. 163 million. We forecast the operating profit from the rubber sector to rise by 16% to Rs. 366 million in FY2005.

The only sectors that recorded a negative growth in operating profit were environment and agriculture sector. Despite a 23% revenue growth in the environment sector, the operating profit from the environment segment declined considerably by 62% to Rs. 93 million. The draught experienced during the year 2002 limited the production of coconut in the country to 2,800 million nuts, which resulted in a heavy shortage of coconut shell charcoals. Therefore, Haycarb had to import around 25% of its charcoal requirements by paying very high freight, with imports costing around Rs. 22,000 a MT.

Due to the shortage, the local prices too increased over 25% to Rs. 19,000 a MT. Nevertheless, the charcoal prices have now reduced to around Rs. 16,000 per MT with the modest improvements in coconut production in the year 2004.

HAYL exceeds our earnings projections due to significant boost in income from associate companies.

HAYL's share of associate companies' profits increased significantly by 109% to Rs. 257 million. The Hayleys Mgt Knitting Mills has contributed around 38% to the above figure and the rest has been from the other associate companies such as Talawakelle Plantations and Carbotel. Further, a 50% plant expansion at the end of the year is also on the cards and we believe once the expansion is completed, Hayleys Mgt Knitting Mills contribution to operating profits will rise by around Rs. 40 million a year (41 % growth), thereby further boosting the income from associate companies from next year onwards.

Improved contribution is expected from the environment sector The performance of the environment sector is largely contingent upon the coconut production in the country as activated carbon is produced using charcoal. According to the Coconut Development Authority, for the first four months of the year 2004, the coconut production in the country has increased by 17% to 875 million nuts, which gives clear testimony to the improvement in the nut production during the ongoing year.

However, despite the increase in the nut production in Sri Lanka, the increasing demand for coconut following the higher requirement for coconut based products such as activated carbon, we are of the opinion that Haycab will yet need to import around 8% of its charcoal requirement. On account of the expected higher coconut production of the country, we expect environment sector to contribute around Rs. 152 million to the operating profits of HAYL for the FY2005.

Forecast revised taking the new developments into consideration We revised our financial forecast for the FY2005 and 2006 while taking in the new developments in rubber and inland marketing segments. We forecast a net profit of Rs. 846 million (15% growth) in FY2005 and then to go past billion-rupee milestone in FY2006 for the first time in its over 100 year history of business.

Based on the forecast EPS of Rs. 16.9 and the current market price of Rs. 123, the forward earnings multiples stand at 7.3x and we envisage the PE to come down to an attractive level of 5.8x. Higher overseas business exposure reduces the vulnerability to adverse local developments.

In comparison to the PEs of other conglomerates such as 10.9x of JKH and 7.2x of Aitken Spence based on the FY2006 earnings, HAYL' same of 5.8x offers attractive value to the investors in the long-term. Further, it should also be noted that HAYL is a less risky investment as opposed to the other two heavyweights, particularly considering its relatively lower exposure to leisure and transport sector, which are more or less pegged to the social and economic stability in the country. With regard to HAYL, the company is highly export oriented and it is also continuously looking at increasing the overseas investments, which will minimize the risks emanating from economic and social upheavals in the country. Therefore we reaffirm our recommendation, Long-term buy.

CIC results for the FY2004

Chemical Industries (Colombo) Ltd. observed a notable growth in revenue of 32% to Rs. 10 billion in comparison to the previous year. Although the profit before tax of CIC group fell by 1% to Rs. 619 million, the company did well to register a net profit of 7.9% to Rs. 315 million mainly on account of the reduction in tax liability.

Agricultural and construction sector fuel the top line growth

All five sectors of CIC group recorded improvements in the turnover, while agricultural, industrial raw material and construction sectors were among the notable gainers. Agricultural sector, which contributes around 30-40% of CIC's revenue, soared by a noteworthy 47% to Rs. 4.9 billion, while the construction sector also improved by 17% to Rs. 3.4 billion. The construction sector growth can be attributed to the decision by most of the hotels to refurbish their properties, which boosted the demand for its construction sector products such as paints and surface coatings.

The revenue growth in the agricultural sector was largely due to the full year consolidation of CIC Feed Mills's for the first time, where as the drop in operating profit can be directly attributed to the unfavorable weather that prevailed during the last year, escalation in the fertilizer prices in the world markets and the partial withdrawal of the fertilizer subsidy by the government. Nonetheless, we expect the improved weather conditions and the recent 44% increase in fertilizer subsidy to Rs. 650 per bag to help the company to improve upon the results in FY2005. A notable improvement can be seen in the industrial raw material sector, where the revenue and operating profit from this sector have surged by a significant 42% and 173% to Rs. 553 million and to Rs. 67 million.

Accordingly, the operating margins from this sector have improved to 12% in FY2004 from 6% in FY2003 on the back of cheap source of raw materials coupled with upward revisions in the prices of its products.

Tax reduction helped CIC to improve earnings

Although the operating profit of CIC group was up by 4% to Rs. 710 million, the profit before tax (PBT) declined by a marginal 1% to Rs. 619 million largely owing to the finance cost increasing by 42% to Rs. 136 million. The short-term debts grew by 40% to Rs. 997 million, where most of the debts have been used to fund working capital requirements and the 49.5% acquisition of CIC Feed Mills. Despite the slight dip in PBT, the company was able to post an 8% growth in the bottom line to Rs. 315 million solely supported by the decline in the tax liability.

The income tax expense reduced by 31% to Rs. 135 million as a result of the higher tax-free dividend income earned and effective tax planning pursued by the company. During the FY2004, the dividend income of CIC at the company level has surged by 82% to Rs. 104 million.

CIC Group posted a net profit of Rs. 315 million resulting in an EPS of Rs. 33.7. Based on these earnings the current price of Rs. 152.00, the PER stands at 4.5x, which compares well to the current market PE of 10.4x. Looking forward, we believe that the agricultural sector should show improved performance supported by improved weather conditions and higher fertilizer subsidy, thereby boosting the earnings of CIC during FY2005.

The views based herein are expressed with no malafied 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.

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