Lanka IOC: BUY - Acuity · Sampath Bank PLC/ Capital Trust Holders Pvt Ltd 0.42% EW Balasuriya & Co...

ACUITY STOCKBROKERS RESEARCH | SRI LANKA EQUITIES

Lanka IOC Power & Energy

Research Team Chethana Ellepola | (+94) 112 206 256 [email protected]

Anjula Nawarathna | (+94) 112 206 255 [email protected]

Anouk Weerasinghe | (+94) 112 206 254 [email protected]

Nilruk Soysa | (+94) 112 206 254 [email protected]

Lanka IOC: BUY

Source: Getty Images

mailto:[email protected]




May 2014



Investment Summary

Seven-Year Performance: LIOC vs. ASPI

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Top 10 Shareholders (as at 31st December 2013)

Indian Oil Corporation Limited 75.12%

Bank of Ceylon A/C Ceybank Unit Trust 3.65%

Employees Provident Fund 2.96%

National Savings Bank 2.89%

JB Cocoshell (Pvt) Ltd 1.56%

Mr Tarik Al Nakib 0.85%

Bank of Ceylon A/C Ceybank Century Growth Fund 0.60%

Deutsche Bank AG - National Equity Fund 0.45%

Sampath Bank PLC/ Capital Trust Holders Pvt Ltd 0.42%

EW Balasuriya & Co Pvt Ltd 0.39%

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LANKA IOC PLC Price Rs. 43.00

Bloomberg LIOC SL Equity

Market Capitalisation (Rs. Bn) 22.9

Issued Quantity (Mn) 532.5

Month to Date Turnover (Rs. Mn) 25.6

Year to Date Turnover (Rs. Mn) 1,144

Current Trading Range (Rs.) 42.70-43.00

Year to Date High (Rs.) 43.00

Adjusted All Time High1

43.00

Financial Year ended 31st March

Key Financials Period FY 2011/12 FY 2012/13 FY 2013/14E FY 2014/15E FY 2015/16E

(LKR millions except per share data)

Revenue 60,436 75,111 82,527 93,389 106,582

Rev. Growth (Y-o-Y) 17% 24% 10% 13% 14%

Operating Profit 1,956 2,862 6,301 6,487 7,482

Op. Profit Growth (Y-o-Y) 154% 46% 120% 3% 15%

Profit Before Tax (PBT) 931 2,991 6,360 6,574 7,557

PBT Growth (Y-o-Y) 4% 221% 113% 3% 15%

Net Profit 907 2,909 5,384 5,565 6,398

Net Profit Growth (Y-o-Y) 4% 221% 85% 3% 15%

EPS2 1.70 5.46 10.11 10.45 12.02

NAVPS2 19.00 24.47 32.73 41.09 50.70 Sources: Company Annual Reports, Acuity Estimates & Bloomberg

Note: 1. Adjusted for rights, splits, bonuses Price as at 02/05/14 2. Calculated on latest issued share capital

We believe declining global crude oil prices along with a stable LKR, robust economic growth and rapid outlet expansion will be reflected in LIOC’s auto-fuel segment margins. Near-term pressure on Bunkering volumes is also expected to ease, while the Bitumen and Lubricants segments are likely to continue growing in line with economic and organic expansion. We expect a forward EPS of LKR 10.11 (FY 13/14E), LKR 10.45 (FY 14/15E) and LKR 12.02 (FY 15/16E). Given LIOC’s 2013 record of trading at low multiples and its strong growth potential, we expect a forward PER of 4.0-5.0x. We thus believe the stock should trade in the range of LKR 48.0-LKR 52.0, implying a 12.0-21.0% up-side range. We recommend a medium-term BUY.

LIOC Expansion Buttressed by Global Commodity Price Trends & Domestic Macro-

Developments | Global oil prices have been trending

lower through Q4’13, and are expected to continue declining on the back of higher non-OPEC supplies. The IMF and EIA expect non-OPEC supplies to rise to 1.8 mbd in 2014 (cf. 1.4 mbd pace of demand), pushing Brent crude oil prices down to an average of $105/bbl (2014E) and $101/bbl (2015E). Despite this expected decline, a downward revision in domestic petroleum prices is unlikely given that CPC has yet to make a turn-around. In fact, most indications are for an upward price revision, implying strong potential for auto-fuel segment margins. Even excluding further upward revisions though, LIOC’s auto-fuel segment margins are likely to be strong, especially in light of LKR stability. Given the i) decline in global crude oil, ii) domestic petroleum industry developments and, iii) stable LKR, we expect strong growth from core-operations, particularly in the context of LIOC’s expected outlet expansion (to 200 from 167 by year-end).

Procurement Plan Changes & Port Expansion to

Offset Near-Term Pressure on Bunker Volumes | LIOC’s re-strategized procurement plan is expected to

ease some pressure off bunkering segment margins and restore some of the lost market share. Industry-wide bunkering volumes have been pressurized due to increased price competition from both domestic and regional sources. But, margin pressure is likely to be short-lived. Phase II of the South Harbor is due for completion by December and the Colombo port’s TEU capacity is expected to increase to 6.9Mn by year-end. The positive spillovers from this expanded capacity are likely to impact LIOC’s bunkering

segment volumes in the medium-long term.

Economic & Organic Expansion Support

Emerging Bitumen & Lubricant Segments |

LIOC’s Bitumen & Lubricant segments have mirrored the positive developments in the domestic economy and motors industry. Given the GoSL’s commitment to infrastructure development, we remain bullish on the Bitumen segment’s revenue contribution. Improved medium-term GDP prospects meanwhile, are likely to fuel lubricant sales as demand for vehicles is likely to be stronger on the back of GDP growth.

May 2014



LIOC Investment Overview Segment Review

Strong Short-Medium Term Prospects for Core Auto-Fuel

Silver-Lining for Bunkering Volumes

Bitumen & Lubricants Gain Increasing Prominence

Valuation

Buoyant Fundamentals Support Forward Multiples

Summary Financials

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May 2014



Investment Overview| Lanka IOC (LIOC) is a subsidiary (75.12%) of Indian Oil Corporation Ltd. (IOC), the highest ranked Indian company in the Fortune 500 listings. The company is engaged primarily in the auto-fuel sales but has significant exposure to the bunkering, bitumen and lubricant markets. With a 20% market share, LIOC currently functions as the 2nd largest player in the Sri Lankan auto-fuel industry.

LIOC’s Average Segmental Revenue Contribution

Auto-Fuel, 81%

Bunkering, 0.4%

Bitumen, 3.8%

Lubricants, 2.2%

We believe prospects for LIOC’s core auto-fuel business remain sound both on the basis of external and domestic factors. Auto-fuel margins are highly receptive to global crude oil price volatility, domestic petroleum price revisions and LKR fluctuations; but, in our view, developments in these global and domestic determinants are likely to support LIOC going forward. Global crude oil prices have edged consistently lower through Q4 2013, with the EIA and IMF estimating a 4.1% decline in 2014 as increased oil supply from non-OPEC sources outstrips tepid global demand. From a domestic perspective too, developments in the petroleum industry and overall macro-economy are likely to support LIOC’s auto-fuel revenue. Downward revisions in local fuel prices are unlikely in the immediate short-term despite the decline in global oil prices. Although the CPC has been successful in trimming a large quotient of its losses, a turn-around is pending and recent GoSL indications of further price-hikes imply the possibility of upward revisions. While this is indubitably positive for LIOC, we have refrained from pricing this in our estimates and assume, instead, that no downward price revision is likely. LKR stability is also likely to support LIOC margins going forward. Both due to improved demand conditions and a stronger B-o-P position, we view near-term LKR depreciation as unlikely. The stabler LKR in turn should support LIOC’s FX-sensitive auto-fuel margins. We thus believe that the confluence of these three factors – i) lower global oil prices, ii) developments in the domestic petroleum industry and, iii) a stable LKR – is likely to support LIOC, particularly in light of the company’s expansion plan to increase its outlets to 200 (from 167) by year-end. Prospects for LIOC’s bunkering segment are also, in our view, positive. Recent margin pressure has been on account of increased domestic and regional competition. Domestically, the entrance of a new player to the bunkering industry has led to near-term price pressure; improved cost synergies at the ports of Cochin and Chennai meanwhile, have led to the Colombo port losing some of its market share. The Cochin and Chennai ports’ initiatives to provide direct bunkering services, bypass

the services of bunker fuel traders (such as IOC and BPC), creating cost synergies and thus enabling more competitively priced bunker fuel. This in turn has implied that Colombo (which has just a single oil refinery capable of refining only specific types of crude oil) has lost some shipping traffic to these neighboring Indian ports. But, we believe these pressures to be largely short-term. Higher shipping traffic due to port expansion implies greater volume and positive spillovers to the domestic bunkering industry, helping offset some of the lost market share. With Phase II of South Harbor due for completion in December, the Colombo port’s annual TEU capacity is set to increase to 6.9Mn (cf. 4.5Mn currently). We thus expect the positive spillovers from this expanded capacity to impact LIOC’s bunkering volumes particularly given

its strong market share (40.0%). Moreover, LIOC’s re-strategized procurement plan is likely to result in a more competitive pricing structure which in turn should support overall segment margins. LIOC’s Bitumen and Lubricant segments are also likely to grow in line with organic expansion plans and domestic GDP growth. Bitumen and Lubricant revenue has grown strongly in the recent past, largely reflecting the country’s ongoing economic developments. Bitumen revenue has grown in line with the country’s post-war infrastructure development projects; Lubricant demand meanwhile, has mirrored the Motors industry’s developments. Given the GoSL’s continued committment to infrastructure development, we believe prospects for the Bitumen segment are robust. Domestic GDP growth meanwhile, is likely to support LIOC’s lubricant sales; the Sri Lankan lubricant market is primarily automotive demand-driven and we expect strong vehicle demand (on the back of robust medium-term GDP) to support lubricant sales.

LIOC’s Average Segmental Revenue Contribution

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Some Near-TermPressure

Supported by GDP Growth &

Continued Public Investment

Positive External &Domestic Developments

Based on our estimated EPS range of LKR 10.11-LKR 12.02 and a forward PER of 4.0-5.0x, we believe there is strong upside potential for LIOC. We expect the stock to trade at a 12.0-21.0% premium in the medium term as we expect the price to range between LKR 48.0-52.0. We recommend a short to medium-term BUY on the stock, particularly in light of i) improving crude oil prices, ii) a stable LKR and robust domestic economic growth, iii) improved prospects for bunkering services and, iv) continued progress in the emerging segments Bitumen and Lubricants.

Positive Global & Domestic Trends Drive LIOC’s Medium Term Value

Investment Overview

Source: Company Annual Reports

Source: Company Annual Reports & Acuity Research Estimates

May 2014



LIOC’s Expansion Strategy Buttressed by Global

Commodity Prices & Domestic Macro- Developments | Performance in LIOC’s core business, auto fuel, is driven by three main factors, i) global crude oil prices ii) domestic exchange rate fluctuations and, iii) price revisions in the local fuel market. Historically therefore, LIOC’s bottom-line has been impacted by the volatility in global crude oil prices, the frequency of local petroleum price revisions, and LKR depreciation. Developments in the global crude oil and domestic petroleum industry are thus crucial elements in determining LIOC’s prospects.

Crude Oil Prices, FX Rates & Domestic Price Revisions Impact LIOC Profits

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As the underlying commodity through which all petroleum products are derived, the price of crude oil is the primary determinant of petroleum product prices such as auto-fuel. Like most other commodities though, price volatility is a defining characteristic of global crude oil prices. But, crude oil prices are particularly sensitive to geopolitical and economic events and are thus, arguably, more volatile than certain other commodities. During the 2008 global financial crisis for instance, oil prices hit an all-time high of $143.68 despite sluggish demand from economic power-houses India and

China both due to i) supply shortages in Nigeria & Iraq, and ii) strong capital-flight away from risky financial assets and towards commodities such as oil. While prices have since slackened due to the easing of US/Iran tensions, a stronger USD and the continued weakness in the Euro-Area, the fundamental fact remains that crude oil prices are essentially dependent on both physical factors (such as energy consumption, production, inventories, spare production capacity, and geopolitical risks) and other influences (futures market trading activity, commodity investment, exchange rates, and equity markets).

Crude Oil Prices React to Range of Geopolitical & Economic Events

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Crude oil prices through Q4 2013 have edged lower, mainly due to the continued supply surge from North America. Non-OPEC supplies, particularly from North America have increased to 1.3 million barrels a day (mbd), faster than the 1.2mbd growth in demand. Although there is increasing supply pressure from OPEC - particularly from disruptions in Libya, Syria, Nigeria and Yemen and from sanctions against Iran- the IMF and EIA estimate that oil prices will decline given the expanding non-OPEC oil supply and continued tepidity in demand. The IMF estimates that growth in non-OPEC supply will rise to 1.8 mbd in 2014, well above the 1.4 mbd pace of demand. Based on EIA estimates, Brent crude oil prices are likely to weaken to an average of $105/bbl and $101/bbl in 2014 and 2015, respectively.

Oil Prices to Decline as Non-OPEC Supplies Increase & Global Economic Recovery Remains Slow

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Lower Global Crude Prices to Support Bottom-line…

Strong Short-Medium Term Prospects for Core Auto-Fuel Business

Source: IMF & EIA

Source: EIA & Thomson Reuters

Source: EIA & Thomson Reuters

May 2014



The implications of these expected developments on LIOC’s profit margins are evident. Profit margins in LIOC’s core business are likely to be impacted positively by the expected decline in global crude prices, particularly in the context of its expansion strategy. But, LIOC’s margins are also impacted by two other significant factors: i) Local fuel price adjustments and ii) LKR depreciation. When global crude oil prices fluctuate rapidly, local fuel prices are largely determined by the Government of Sri Lanka, which through its state-owned entity Ceylon Petroleum Corporation (CPC) functions as the largest player in the domestic auto-fuel industry. Additionally, domestic FX rate fluctuations have a notable impact on LIOC’s margins. The convergence of these three elements - global

crude oil prices, domestic fuel prices and LKR fluctuations - are thus a significant determinant of LIOC’s profits. In FY 2008/09 for instance, profits fell 153.0% Y-o-Y to a loss of LKR 1.2Bn both on account of a 35.0% increase in crude oil prices and a >LKR497.0Mn exchange loss. By contrast, LIOC’s profits for the 9M to December 2013 rose 95.0% Y-o-Y, as lower global oil prices coupled with the stable LKR and the GoSL’s decision to keep local fuel prices unchanged boosted margins. In our view, medium-term prospects for the domestic macro-economy and local petroleum industry are sound. Sri Lanka’s medium-term GDP growth is likely to be in the 7.5%-8.0% range on the back of capital deepening and higher total factor productivity (TFP). Indeed, IMF estimates place Sri Lanka’s longer-term potential output at 8.0% (cf. 4.5%-6.5% over the last decade) with the contribution from TFP increasing 3.5 percentage points and capital deepening increasing its contribution by 3.0 percentage points. The LKR meanwhile, is likely to remain stable as the B-o-P remains in surplus both in the short and medium-term. In our view, the trade deficit will continue to improve on the back of the weaker LKR while healthy services and financial/capital inflows are likely to buoy the B-o-P position further. The stronger GDP growth, coupled with the low-but-stable LKR should thus support LIOC’s core earnings. LKR Depreciation Eases from High in Early 2013

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Prospects for the domestic petroleum industry are also, in our view, positive. Sri Lanka’s auto-fuel industry consists of two players - state-owned CPC and LIOC - with CPC, as the dominant player, generally determining price-revisions. Given the CPC’s recent history of operational losses, we believe any downward revision in domestic fuel prices is unlikely. CPC’s losses are attributable to global crude oil price volatility, LKR weakness, operational inefficiencies, and exacerbated by drought conditions. The result has been a slew of domestic energy price revisions, with the latest (in February 2013) amounting to an increase of LKR 3.00 per liter (petrol) and LKR 6.00 per liter (diesel). CPC’s History of Fuel-Price Revisions

Year Number of Revisions (Times per Year)

2007 4

2008 5

2009 1

2010 1

2011 2

2012 2

2013 1 While the energy price revisions, coupled with lower global oil prices, a stabler LKR and improved weather conditions have helped trim some of the CPC’s losses, the CPC is yet to make a turnaround. This, together with GoSL’s indication of further energy-price revisions in 2014, implies the possibility of additional upward revisions in domestic fuel prices. In the

context of lower global crude oil prices, the possibility of an upward revision in domestic fuel prices implies strong potential for higher margins at LIOC. Although we have refrained from pricing in an upward price revision in our revenue estimates for LIOC, we believe the upside potential for LIOC is significant if such an upward adjustment in domestic fuel prices materializes.

…Aided by Stable Exchange Rate & Domestic Petroleum Industry Developments

Strong Short-Medium Term Prospects for Core Auto-Fuel Business

Source: Central Bank of Sri Lanka

Source: Ceylon Petroleum Corporation

Source: Central Bank of Sri Lanka & Acuity Estimates

May 2014



CPC Losses Ease Amid Price Revisions

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LKR 5.2 Bn (Est)

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We estimate LIOC’s revenue in FY 2013/14E from core operations to be LKR 61.5Bn and reach LKR 76.8Bn by FY 2015/16E both as a result of global commodity price trends and domestic macro-economic & industry developments. We believe core operations are likely to continue accounting for approx. 70% of the total revenue despite the increase in total group turnover. In our view, LIOC’s expansion strategy and procurement plan are targeted at capitalizing on the existing global and domestic industry trends. LIOC currently operates 167 outlets and plans to increase this to 200 by FY 2014/15E. Given that distribution channel is one of the key determinants of the success for auto-fuel industry players, we expect a substantial impact on LIOC’s top line once these outlets are fully operational. LIOC’s expected cost per outlet is estimated to be LKR 25.0-30.0Mn and LKR 800.0Mn is planned to be disbursed on refurbishments every year. Moreover, given that the company plans to utilize its cash reserves to fund the expansion, we believe the impact of its capex costs on its income statement will be minimal. Number of Outlets to Increase to 200 by FY 2014/15E

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.....And Supported by LIOC’s Organic Expansion

Strong Short-Medium Term Prospects for Core Auto-Fuel

Source: CBSL Annual Report 2013 & Fiscal Management Report_2014


May 2014



LIOC Procurement Plan & Colombo Port Expansion to Boost Bunkering Volumes | LIOC’s bunkering business contributes approx. 20.0% (on average) to group revenue, and accounts for about 40.0% of the domestic bunkering industry. But, margins in LIOC’s bunkering business have come under pressure in FY2013/14 both due to domestic and external headwinds. In the first nine months of 2013/14, LIOC’s revenue contribution from bunkering operations fell to 15.0% relative to 24.0% and 23.0% for FY2012/13 & FY 2011/12. Pressure has stemmed from both domestic and external sources. Domestically, increased price competition by a new entrant to the bunkering industry has pressurized bunkering sector margins. Externally

meanwhile, regional competition from the ports of Cochin and Chennai has increased due to cost synergies that these regional ports possess. The ports of Cochin and Chennai have taken steps to provide direct bunkering services to ships (instead of through bunker fuel traders such as IOC and BPC) thus creating cost synergies between its oil refineries and bunkering service provision. This in turn implies that relative to Colombo, which possesses a single oil refinery capable of refining only specific types of crude oil, these neighboring Indian ports provide more competitively priced bunkering fuel. Bunkering volumes for traders such as LIOC have consequently been impacted, with estimated bunkering revenue for FY 2013/14E declining 31.0% Y-o-Y. In our view though, the external headwinds to the domestic bunkering industry are largely near-term. Higher shipping traffic due to port expansion implies greater volume and positive spillovers to the domestic bunkering industry, helping offset some of the lost market share to the Indian ports. The Colombo Port Expansion Project adds three new container terminals, with the view to transition the Colombo Port to a maritime and logistic hub. Once all three terminals are completed, the Colombo Port is estimated to have a capacity of 7.2Mn TEU/year (cf. 4.5Mn Twenty Foot Equivalent Units currently). Each terminal has an estimated throughput of 2.4Mn TEU/year and can cater to the new, larger mega container vessels. The recently concluded 1st phase of the new South Terminal has added a further 0.8Mn TEU/year to current capacity (4.5Mn TEU’s/year) and is expected to increase the port’s annual TEU capacity to 6.9Mn by end-2014 (est. completion of the South Terminal). We thus expect the positive spillovers from the Colombo Port’s expanded capacity to impact LIOC’s bunkering segment positively, particularly given LIOC’s strong (40.0%) market share. Port Expansion Adds Three Terminals to Existing Two

SAGT JCT South East West

Depth (ie: Draft) 14.5m 14m 18m 18m 18m

Quay Wall (Length) 940m 1642m 1200m 1200m 1200m

TEU Capacity (Mn) 2 2.5 2.4 2.4 2.4

Quay Cranes (Number) 10 17 21 21 21

Date of Completion (est.) 2014 2016 N/A

New TerminalsExisting TerminalsFeature

South & East Terminals to Add 4.8Mn TEUs by 2020E

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LIOC’s strategic realignment of its procurement plan is also likely to impact bunkering margins. We believe LIOC’s profit margins are likely to benefit from more competitive pricing once its procurement processes are re-structured. We thus view both i) LIOC’s re-strategized procurement plan and, ii) the potentially higher trade volumes from the Colombo Port expansion project as strong positive drivers for the bunkering segment in the medium-term. We concede however,that bunkering revenue in the immediate short-term is likely to be pressurized. Given the decline in 9M FY2013/14 bunkering revenue, we expect LIOC’s full year revenue from its bunkering business to decline by 31.0% Y-o-Y (cf. FY 2012/13 increase of 24.0% Y-o-Y). Beyond FY 2014/15E however, we expect segmental revenue to strengthen both on the back of i) increased shipping traffic post the completion of South Harbour Phase II and the consequent enhancement in the Colombo Port’s capacity and, ii) as a result of LIOC’s re-strategised procurement plan which is likely to subdue costs. The absence of large fluctuations in global oil prices meanwhile, is also likely to provide additional support to LIOC’s medium-term bunker margins. Near-Term Pressure on Bunkering Business to Mitigate

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Positive Spillovers from Colombo Port Expansion

Silver-Lining for Bunkering Volumes

Source: SLPA

Source: Company Annual Reports & Acuity Estimates

Source: SLPA

May 2014



Bitumen & Lubricant Segments Expand in Line

with Economic & Organic Expansion | LIOC’s Bitumen and Lubricants businesses account for approx. 10.0% and 2.0% respectively of total revenue and have been gaining increasing prominence over the last two years. Revenue from Bitumen has grown at a 3-year average of 57.0%, while Lubricant sales have grown at an annual average of 17.0% over 3-years. These increases largely reflect the ongoing developments in the Sri Lankan economy. Bitumen revenue has grown in line with the country’s post-war infrastructure development projects, while Lubricant demand has mirrored the Motors industry’s developments. Sri Lanka’s post-war emphasis on infrastructure development has unequivocally had a strong positive impact on LIOC’s Bitumen sales. The GoSL’s focus on public sector investments, particularly infrastructure development projects, has been evident in the number of new roads, highways and bridges constructed over the last three years. Indeed, public investments in road development has risen exponentially post-war, with spending increasing from LKR 9.7Bn in 2000 to LKR 100.0Bn in 2009 and LKR 128.0Bn in 2011. Demand for Bitumen -which is a by-product of crude oil - has consequently increased, and this growth is clearly mirrored in LIOC’s Bitumen sector revenue. Revenue from the segment has grown at an annual average of 57.0% since 2010/11, the highest annual average growth in any of LIOC’s segments. LIOC’s Bitumen Sales Reflect Country’s Rapid

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Given the GoSL’s ongoing emphasis on road development and rehabilitation (an estimated LKR 175-200Bn is to be spent annually over the next 2-3 years1), we forecast LIOC’s Bitumen sector revenue to grow 8.0% Y-o-Y in FY2013/14E and increase to between 15.0-20.0% Y-o-Y between FY2014/15E-FY2015/16E. We expect revenue from the sector to continue hovering around the 10.0% range, as the group’s total revenue base increases.

Prospects for LIOC’s Lubricants segment are also, in our view, sound. Sri Lanka’s Lubricant market has grown at a 3-year

CAGR of 7.8% since 2009, indicating steady demand within the segment.The domestic Lubricant market consists of 13 entities, with 66.0% of the market being manufactured by market leaders Chevron Ceylon (market share: 55.0%) and LIOC (market share: 11.0%).

LIOC Remains 2nd Largest Player in Lubricants Industry

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Total Sales Quantity (KL) Market Share (LIOC)

Given LIOC’s historical ability to sustain its market share at current levels (11.0-12.0% over the past 4 years), we believe Lubricant sales will grow on the back of both organic growth and economic expansion. LIOC’s domestic expansion strategy aims at increasing outlets to 200 by FY2014/15E (from 167) and is likely to provide the necessary volume growth for domestic Lubricant sales. Its regional expansion strategy meanwhile, is targeted at entering the Southeast Asian market and is likely to buffer LIOC’s current regional volumes from Maldives & Nepal (100.0% volume growth from these regions). Given that Lubricant sales are largely dependent on the company’s fuel distribution network, we believe prospects for

the segment are robust in light of LIOC’s domestic and regional expansion targets. Domestic GDP growth is also likely to support LIOC’s Lubricant sales. The Sri Lankan Lubricant market is largely dominated by automotive demand (approx. 69.0% in 2012) and is thus highly dependent on the motors industry. While frequent changes in vehicle import taxes have had a dampening effect on the overall motors industry and have consequently impacted Lubricant sales, we believe robust medium-term GDP growth is likely to fuel vehicle demand going forward. Indeed industry profit margins have been on an uptrend, with market leader Chevron recording a 500bps increase in its 9M FY 2013/14 GP margins. Moreover, LIOC remains one of the two industry players who can blend locally, eliminating the need to import the final product; in this context, we expect the decline in global oil prices to buttress LIOC’s Lubricant segment margins. We thus expect LIOC’s Lubricant sector to contribute 5.0% of the total revenue in FY 2013/14E (cf. 2.0% FY 2012/13) and increase to 6.0%-7.0% in FY 14/15E-15/16E.

Market Leader Chevron’s GP Margins Improve

9M Dec 2013 9M Dec 2012

Revenue (LKR Bn) 11 12

Gross Profit (LKR Bn) 4 4

GP Margin (%) 37% 32%

Domestic GDP Growth Supports Demand

Bitumen & Lubricants Gain Increasing Prominence

Source: Ministry of Highways, Mahinda Chintana & Acuity Estimates

Source: Public Utilities Commission of Sri Lanka


May 2014



Valuation | Based on our earnings growth estimates and a forward PER of 4.0-5.0x, we believe LIOC is likely to trade at an upside range of 12.0-21.0%. LIOC’s medium-term EPS is likely to grow at a 3-year CAGR of 30.0% indicating the company’s strong earnings potential in the context of positive economic and industry developments. We thus believe LIOC’s price could range between LKR 48.0-52.0 and recommend a BUY with a medium term view. LIOC’s LKR 48-52 Price Range Provides 12-21% Upside

FY 13/14E FY 14/15E FY 15/16E

5.0 4.3

PER @ LKR 42 4.2 4.0 3.5

PER @ LKR 48

PER @ LKR 52

4.7 4.6 4.0

5.1

We estimate LIOC’s bottomline will reach LKR 5.38Bn in FY2013/14E, resulting in an EPS of LKR 10.11 per share. Beyond FY2013/14E, we estimate a forward EPS of LKR 10.45 (FY2014/15E) and LKR 12.02 (FY 2015/16E), backed by revenue growth of 13.0% Y-o-Y. At the current price levels, the forward P/E for the company would consequently range between 3.5-4.0x, between FY 2014/15E- 2015/16E.

LIOC’s Average PER Through 2013 Between 4-4.5x

2.0

3.0

4.0

5.0

6.0

Apr-13 Jul-13 Oct-13 Jan-14 Apr-14

Dai

ly P

ER

(x)

Average PER has been 4.1x through 2013

Although the Power & Energy sector PER of 8.6x and LGL’s (closest listed peer) trading multiple of 8.5x imply the potential for LIOC to trade at this range, we view 4-5.0x a more appropriate trading range. LIOC’s core business exposure is different to that of LGL (LGL’s auto-fuel business is marginal cf. LIOC’s approx. 70.0% exposure in the segment) and the rest of the Power & Energy sector players. More significantly though, LIOC’s PER has averaged between 4.0-5.0x throughout 2013, and given that this has been in the context of strong earnings, stable commodity prices and a steady LKR, we believe this to be a more appropriate target multiple. While we concede that upside to this range exists - particularly in light of improving market sentiment - we have opted to use the more conservative end of our target multiple range.

Thus, based on a forward PER between 4.0-5.0x, and a 3-year EPS CAGR of 30.0%, we believe there is strong upside potential for LIOC. We expect the stock to trade at a 12.0-21.0% premium in the medium term as we expect the price to range between LKR 48.0-52.0. We recommend a medium-term BUY on the stock, particularly in light of i) improving crude oil prices, ii) a stable LKR and robust domestic economic growth, iii) improved prospects for bunkering services and, iv) continued progress in emerging segments Bitumen and Lubricants.

Notes:

1. Department of National Planning and Ministry of Finance & Planning, Sri Lanka, The Emerging Wonder of Asia (Mahinda Chintana, Vision for the Future) _2010

Forward P/E Attractive For Strong BUY

Buoyant Fundamentals Support Forward Multiples

Source: Acuity Estimates

Source: Price Waterhouse Coopers, Global Gaming Outlook

Source: Bloomberg

May 2014

Company Financials ACUITY STOCKBROKERS RESEARCH | SRI LANKA EQUITIES


FY 2011/12 2012/13 2013/14E 2014/15E 2015/16E

LKR Mn (except per share data)

Revenue 60,436 75,111 82,527 93,389 106,582

Gross Profit 4,357 5,389 8,905 9,339 10,658

Other Operating Income 36 38 39 44 50

Selling & Distribution Expenses (1,425) (1,676) (1,801) (1,868) (2,132)

Administrative Expenses (1,011) (889) (841) (1,028) (1,094)

Operating Profit 1,956 2,862 6,301 6,487 7,482

Profit Before Tax 931 2,991 6,360 6,574 7,557

Profit for the Year 907 2,909 5,384 5,565 6,398

EPS 1.70 5.46 10.11 10.45 12.02

DPS 0.00 1.00 1.85 2.09 2.40

FY 2011/12 2012/13 2013/14E 2014/15E 2015/16E

LKR Mn

Property Plant & Equipment 3,276 3,265 3,428 5,369 6,773

Total Non Current Assets 8,348 8,337 8,500 10,441 11,845

Inventories 8,813 10,240 11,277 12,761 14,564

Trade & Other receivables 2,951 2,570 3,033 3,432 3,917

Total Current Assets 13,774 16,363 21,359 25,122 30,263

Total Assets 22,122 24,700 29,859 35,563 42,108

Capital & Reserves 10,117 13,028 17,427 21,879 26,998

Total Non Current Liabilities 39 47 47 47 47

Trade & Other Payables 7,705 7,258 7,900 9,019 10,293

Borrowings 4,260 4,367 4,485 4,618 4,770

Total Current Liabilities 11,966 11,625 12,385 13,637 15,063

Total Liabilities 12,005 11,672 12,432 13,684 15,110

Total Equity & Liabilities 22,122 24,700 29,859 35,563 42,108

FY 2011/12 2012/13 2013/14E 2014/15E 2015/16E

Gross Profit Margin 7.2% 7.2% 10.8% 10.0% 10.0%

Net Profit Margin 1.5% 3.9% 6.5% 6.0% 6.0%

ROE 9.4% 25.1% 35.4% 28.3% 26.2%

ROA 4.2% 12.1% 21.3% 18.5% 17.9%

Dividend Payout 0.0% 18.3% 18.3% 20.0% 20.0%

Interest Cover (Times) 1.84 22.54 17.95 19.95 22.09

Net Asset Value/Share (Rs.) 19.00 24.47 32.73 41.09 50.70

Ra

tio

s P

rofi

t &

Lo

ss S

tate

me

nt

Ba

lan

ce S

he

et

Source: Company Annual Report & Acuity Estimates

Research Team Chethana Ellepola (+94) 112 206 256 [email protected] Anjula Nawarathna (+94) 112 206 255 [email protected] Anouk Weerasinghe (+94) 112 206 254 [email protected] Nilruk Soysa (+94) 112 206 255 [email protected]

Sales Team

Deva Ellepola (+94) 112 206 220/221 [email protected] Prashan Fernando (+94) 112 206 222 [email protected] Kapila Pathirage (+94) 112 206 227/228 [email protected] Naren Godamunne (+94) 112 206 225 [email protected] Roshan Noah (+94) 112 306 237/257 [email protected] Arjuna Dasanayake (+94) 112 206 235 [email protected] Amarasena Liyanage (+94) 112 206 231 [email protected] Susil Fernando (+94) 112 206 234 [email protected] Navin Dullewe (+94) 112 206 230 [email protected]

Disclaimer:

“Distributed in Sri Lanka and abroad by Acuity Stockbrokers (Private) Limited (ASB) and its authorized representatives. ASB is fully owned by Acuity Partners (Pvt) Ltd (APL) and APL is a joint venture of DFCC Bank and Hatton National Bank PLC. The Information contained herein has been compiled from sources that ASB (“The Research Institution”) believes to be reliable but none of the Research Institution holds itself responsible for its completeness or accuracy. It is not an offer to sell or a solicitation of an offer to buy any securities. The Research Institution and its affiliates and its officers and employees may or may not have a position in or with respect to the securities mentioned herein.

The Research Institution and its affiliates may from time to time have consulting relationship with any company, which is being reported upon. This may involve the Research Institution providing significant corporate finance services or acting as the company’s official or sponsoring broker.

All opinions and estimates included in this report constitute judgment as of this date of the Research Institution and are subject to change or amendment without notice. The Research Institution has the copyright for this report and the views herein cannot be reproduced and/or distributed in any form without the explicit (written or otherwise) permission from Research Institution.

Chathura Siyambalapitiya (+94) 112 206 232 [email protected]

S. Vasanthakumar (+94) 112 206 250/251 [email protected] Dhammika Wanniarachchi (+94) 112 206 229 [email protected] Shivane Wijayaratnam (+94) 112 206 236 [email protected] Sameera Rajawatte (+94) 112 206 279 [email protected] Dilanjan Perera (+94) 112 206 278 [email protected] Rukshan De Mel (+94) 112 206 268 [email protected] Kumar Dias Desinghe (+94) 814 474 443 [email protected] Prasanna Semasinghe (+94) 814 474 443 [email protected] Thehani Weerasinghe (+94) 112 206 224 [email protected]

ACUITY Stockbrokers (Pvt) Ltd., (Company Reg: No-P.V.3310) ‘ACUITY House’, No. 53, Dharmapala Mw,

Colombo 03, Sri Lanka.

TEL : (+94) 112 206 206 FAX : (+94) 112 206 298







Lanka IOC: BUY - Acuity · Sampath Bank PLC/ Capital Trust Holders Pvt Ltd 0.42% EW Balasuriya & Co...

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