Sri Lanka: Equity Strategy 2019 · 1/14/2019 · ASPI to reach 6,200 by year end, with...

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Sri Lanka: Equity Strategy 2019Value thesis more pronounced; Specific drivers to the fore

SRI LANKA EQUITY

OUTLOOK

STRATEGY

14 JANUARY 2019

Current valuations indicate that investors are still pricing in residual political risk and uncertainty

1

▪ The ASPI trades at 8.5x trailing EPS (27% below 5-Yr average) and 7.3x on our FY19 estimates, both

indicating significant valuation upside

▪ In addition, ASPI trades at a 20% discount to MSCI EM, the lowest seen in the last 5 years

▪ We believe this discount reflects the high risk premia attached to SL equities; i.e. some residual

political risk with a possible spill over to macro

▪ Along with broader EMs, this risk-off sentiment exacerbated foreign fund outflow in CY18

▪ However, while the improved outlook for EMs would lead to more fund flow towards EMs, SL will miss

the catch-up rally due to a slew of reasons;

– Delayed budget reading, large debt maturities and uneasy political alliance between the

President and the PM will keep investors on the sidelines, in our view

▪ Furthermore, upward pressure on market interest rates with less room for the CBSL to afford

loosening of policy will see retail investors shifting more to fixed income

▪ However, 1H CY19 would provide several catalysts to indicate a reversal of some of the risks;

– Re-engaging with funding partners such as IMF, and managing the USD1.5bn sov. debt repayment

– Staying on track with the structural economic reforms, with no fiscal slippage in the budget

– An indication of an early election which can lead to a stable government that will continue the

reforms agenda

Equity outlook;

2019 to be challenging year.

Low valuation indicates a strong

case for equities, but policy

stability remains the key factor

for the return of fund flows

ASPI to reach 6,200 by year end, with back-loaded, asymmetric returns

2

▪ We forecast ASPI earnings to grow at 15.1% vs. consensus estimate of 17.4%

– Index-heavy Banks should see a pick up in earnings after muted CY18 due to heavy impairments

– Consumer (FMCG and retail) would see earnings upside in 2H CY19

– After a weak 2018, Construction sector would to see earnings stabilise in 2H CY19

▪ ASPI trades at 7.3x P/E CY19E, and we expect only a marginal expansion to 7.6x leading to our ASPI

target of 6,200

▪ Upside risks: 1) Pullback of tight fiscal conditions in the 2019 budget, 2) Early general elections

leading to a stable government and streamlined policy-making 3) Upgrade in sovereign credit ratings

▪ Downside risks: 1) Fiscal slippage in a year of elections, 2) Uneasy political alliance between

President and PM delaying key policy decisions/reforms, 3) Rising interest rates weighing down

investment-led growth

Equity outlook;

We expect the ASPI to trade up

to 6,200 by the end of CY19,

largely driven by earnings upside

▪ Our recommended portfolio for 2H CY18 outperformed with a 0.8% return vs. ASPI (-2.2%) and S&P SL

20 (-7.0%)

▪ We continue to take a bottom-up approach in picking stocks for 2019, focusing on the specific value

drivers

▪ In the current environment, we prefer companies with low-leverage and positive FX exposure, and

believe that its still early to position in cyclical stocks such as Retail and FMCG

▪ We include seven stocks in our portfolio 1) TJL, 2) ASIR, 3) EXPO, 4) SAMP, 5) HNB, 6) COMB and 7)

DIAL

– In addition, we recommend three long-term picks with an upside potential of >30% over a 3-year

horizon; 1) LGL, 2) HEMS and 3) AHUN

We rebalance our recommended

portfolio at this stage

We are cautiously optimistic about the macro outlook

3

▪ Political events have brought in fresh challenges to the economy which was on a stabilising path

▪ The two most profound after-effects are; 1) higher refinancing costs due to credit rating downgrade,

and 2) capital flight due to low investor confidence adding pressure on reserves

▪ However, we believe the fundamental growth story is intact, and 2019 should see a recovery in GDP

growth, albeit slow, supported by normalising Agri output, improving hydro power generation and

lower oil prices (reducing oil import bill)

▪ Furthermore, we forecast LKR to record a slower depreciation of 5.0% in CY19 on the back of;

– potential pullback of fed rake hikes in 2019 and 2020, reducing pressure on fund outflows

– the impact of tight monetary policy implemented in 2018

– regained investor confidence to some extent with the renegotiation of funding arrangements

[Click here to access the detailed macro outlook]

Macro outlook:

Debt repayments take center

stage; we are cautiously

optimistic

http://asiasecurities.net/content_management/macro-outlook-2019-cautious-optimism-amidst-external-headwinds/

Table of Contents

4

▪ Key Picks – Recommended Portfolio

▪ Long-term Picks

▪ Stock Screen Indicates a Second Layer of Investment Opportunities

▪ Asia Securities Sector Views

▪ Equity Strategy

▪ Sri Lanka: Macro Outlook 2019

▪ Asia Securities Research Sector Outlook

▪ Banking

▪ Telecommunications

▪ Alcoholic Beverages

▪ FMCG/R

▪ Conglomerates

▪ Logistics

▪ Construction

▪ Key Picks – Investment Thesis

▪ Coverage universe

………………………………………………………………………………………………………………………………………………………………… 05

……………………………………………………………………………………………………………………………………………………………………………………………… 11

………………………………………………………………………………………………………………15

…………………………………………………………………………………………………………………………………………………………………………… 18

………………………………………………………………………………………………………………………………………………………………………………………………… 23

………………………………………………………………………………………………………………………………………………………… 44

………………………………………………………………………………………………………………………………………………………………………… 40

▪ Manufacturing

▪ Healthcare

▪ Leisure

▪ Insurance

▪ Non-Bank Financial Institutions

▪ Energy

…………………………………………………………………………………………………………………………………………………………………………105

………………………………………………………………………………………………………………………………………………………………………………………… 113


JANUARY 2019

Asia Securities Recommended Portfolio

Key picks

Return to TOC

Key picks – ASEC recommended portfolio comprised of seven stocks

6

▪ Our key picks for 2019 are comprised of our bottom-up view of each stock, and the conviction we hold in each of its value story.

Accordingly, our picks include names which;

– have a strong business model

– were discounted heavily in CY18, but are well-positioned to post a turnaround when market conditions pick up, and

– exposed to the growth sectors of the economy with positive catalysts

▪ As such, our key picks for 2019 are as follows;

▪ Expolanka Holdings [TSR +45.0%]

▪ Asiri Hospitals [TSR +39.1%]

▪ Dialog Axiata [TSR +32.6%]

▪ Sampath Bank [TSR +31.1%]

▪ Hatton National Bank [TSR +26.1%]

▪ Teejay Lanka [TSR +23.9%]

▪ Commercial Bank of Sri Lanka [TSR +18.2%]

7Source: Asia Securities | Note: *ND/E – Net Debt/Equity, Priced as at end 11 Jan 2019 | **CY18E for December Y/E companies; FY19E for March Y/E companies

BBG

Ticker

Market capADV

(USD k)

CMP

(LKR)

12m TP

(LKR)TSR (%)

CY18E / FY19E**

Investment thesis

LKR bn USD mn P/E (x) P/B (x) DY (%) ROE (%) ND/E* (%)

EXPO SL 8 43 10 4.00 5.80 +48.8 7.1 0.6 3.8 8.3 6

EXPO has made investments in key

trade lanes to reap benefits in the

long-run, with significant investments

in the transpacific trade lane. Also,

focus on yield management will result

in more stable margins, while Leisure

and commodity exports to remain

focused on core operations. Our DCF

valuation indicates a TP of LKR

5.80/share resulting in a TSR of

+48.8%. BUY.

ASIR SL 25 138 11 22.00 30.00 +39.1 16.3 3.4 2.7 19.9 114.9

Currently the largest private sector

hospital operator in the country.

Promotional investments at Asiri

Surgical in new surgical packages are

now reaping benefits while completion

of key projects leads to debt

repayment and lower interest costs

from FY20E onwards. Our DCF

valuation indicates a TP of LKR

30.00/share resulting in a TSR of

+39.1%. BUY.


BBG

Ticker

Market capADV

(USD k)

CMP

(LKR)

12m TP

(LKR)TSR (%)

CY18E / FY19E**

Investment thesis


DIAL SL 82 452 68 10.10 13.00 +32.2 5.9 1.2 5.9 19.5 37.5

Data continues to drive growth. 4G

roll-out is almost complete, and the

new equipment is easily upgradable to

5G, leading to low additional capex

once the new technology is rolled out.

Reduction in voice telco levy would

help negate the falling MOUs. Share

has dropped 22.3% in 2018, and trades

at 2.9x CY19E EBITDA, which we

believe was largely due to forex

concerns (translation losses + DTV

margins impacted) given the large

depreciation seen in 4Q CY18. We

value DIAL at LKR 13.00/share (+30.0%

upside; +32.6% TSR); BUY

SAMP SL 61 337 342 218.10 270.00 +31.1 4.4 0.6 8.7 14.9 na

The fifth largest bank in SL, SAMP has

a strong foothold in retail and SME

business. While we see moderating

loan growth in CY19, we believe it is a

positive given it allows SAMP to focus

on quality credit growth. We believe

the NPL cycle will run its course and

SAMP will see further a increase until

1H CY19. We see upside when the this

valuation overhang clears. We value

SAMP at LKR 270.00/share (+23.8%



BBG

Ticker

Market capADV

(USD k)

CMP

(LKR)

12m TP

(LKR)TSR (%)

CY18E / FY19E**

Investment thesis


HNB SL 97 535 286 205.00 250.00 +26.1 4.7 0.7 4.1 15.1 na

HNB has a well-balanced customer

exposure across corporate, retail and

SME segments that support its growth

profile. We believe HNB will continue

to have one of the best NIMs in the

sector given its strong focus on NIM

management coupled with robust

corporate business, driving CASA. The

bank also seems to be ahead of the

peers in terms of the NPL cycle and

could see recovery before 1H CY18

ends. We value the stock at LKR

250.0/share (+22.0% upside; +26.1%

TSR); BUY

TJL SL 24 131 48 33.90 40.00 +23.9 10.5 1.9 5.9 18.5 -22.1

With the new capacity fully

operational, we believe TJL is poised

for a strong FY19E with the

incremental capacity helping top line

and bottom line growth. While no

capacity expansions are planned in the

next 12-15-month period, TJL’s next

phase of expansion will come with its

move into Asia (targeting 20.0% of

revenue by 2020), which it looks to do

by collaborating with Uniqlo. We

maintain that cotton prices remain the

key threat. We value the stock at a TP

of LKR 40.00/share (+18.0% upside;

+23.9% TSR). BUY.


BBG

Ticker

Market capADV

(USD k)

CMP

(LKR)

12m TP

(LKR)TSR (%)

CY18E / FY19E**

Investment thesis


COMB SL 114 627 300 114.00 128.00 +18.2 5.4 0.9 7.0 16.8 na

We expect its dominant position in SME

and corporate segments to drive loan

growth in the next few years (we

forecast 16.5% in CY19E). Strong

liquidity position allows the bank to

weather through the market liquidity

concerns without a major impact on

NIMs. Capitalisation remains strong,

and we believe this further strengthens

the bank’s ability to grow. We value

COMB at LKR 128.00/share (+12.3%



JANUARY 2019

Mid-term growth stories with attractive valuations

Long-term picks

Return to TOC


BBG

Ticker

Market capADV

(USD k)

CMP

(LKR)

12m TP

(LKR)TSR (%)

CY18E / FY19E**

Investment thesis


CFIN SL 19 105 6 87.00 97.00 +16.1 3.4 0.5 4.6 15.2 na

With one of the highest NIMs in the

industry, combined with a CAR of 29.60%

in FY18, CFIN will stand resilient to the

current headwinds in the industry. With

its dominant exposure to secondhand

leasing and its conservative business

strategy, we perceive CFIN to gather

momentum in net advances as the

regulatory implications in the overall

industry taper down. We forecast net

advances to grow at a CAGR of 8.9%

from FY18-FY21E. The stock is currently

trading at 0.5x P/B, below its 5-year

historical average of 0.8x.

Long-term picks

▪ In addition to our core stock picks, we include a list of long-term picks which could provide at least 30% return over a 3-year horizon

▪ Our criteria for selection is stocks that are exposed to a mid-term growth story based largely on our top-down sector analysis

▪ Accordingly, we expect these counters to unlock value over a two-to-three-year horizon once the current economic cycle improves and

believe these stocks provide an attractive entry point at current levels

13

BBG

Ticker

Market capADV

(USD k)

CMP

(LKR)

12m TP

(LKR)TSR (%)

CY18E / FY19E**

Investment thesis


AHUN SL 9 48 1 26.00 30.00 +19.2 7.1 0.4 3.8 6.1 0.7

AHUN’s solid international segment

should see two new Maldives properties

enter operations by FY21. This should

increase segment EBIT contribution to

~80.0% by FY21 (~71.0% in FY18). While

short-term earnings remains under

pressure on heaving finance costs, we

expect topline momentum to sustain and

forecast net profit to grow at a CAGR of

36.0% over FY18-FY21E

PLC SL 24 130 10 15.00 15.00 +8.3 4.8 0.8 8.3 16.9 na

As one of the only companies to have

significant exposure to commercial

leasing which includes 80.0% of busses in

the country, we expect PLC to stand at

an advantage in the long term as the

construction sector picks up. With strong

CAR expectation over 20.00% from FY19E

FY21E, we perceive PLC to withstand the

upcoming higher capital requirements.

We forecast net advances to grow at a

CAGR of 9.9% from FY18-FY21E. The

stock is currently trading at 0.8x, below

its 5-year historical avg. of 1.2x P/B

Source: Asia Securities | Note: *ND/E – Net Debt/Equity, Priced as at end 11 Jan 2019 | **CY18E for December Y/E companies; FY19E for March Y/E companies

14

BBG

Ticker

Market capADV

(USD k)

CMP

(LKR)

12m TP

(LKR)TSR (%)

CY18E / FY19E**

Investment thesis


LGL SL 6 33 2 17.90 20.10 +12.3 nm 2.8 - nm 78.7

LGL’s restructure of the group and its

aggressive move into adjacent niche

markets has opened new growth

verticals that will pay dividends in the

medium to long-term. It is our view that

LGL is in the early stages of a transition

from being a peripheral local play to a

vertically integrated regional play with

the terminal coming in. We believe

tangible returns from this segment will

start to accrue in FY20E once operations

stabilize post commencement in 4Q

FY19E. The key challenge to LGL lies in

managing its finance costs, until some of

its investments start paying dividends.

HEMS SL 49 269 72 85.00 130.00 +55.3 14.0 1.8 2.4 13.4 -5.8

Given the earnings outlook and the

cheaper valuation, we recommend

exposure to HHL for the long-term.

While there are short-term headwinds in

some of the key businesses, we believe

the underlying themes in Healthcare,

FMCG and Transportation are still

intact..

Source: Asia Securities | Note: *ND/E – Net Debt/Equity, Priced as at end 11 Jan 2019 | **CY18E for December Y/E companies; FY19E for March Y/E companies


JANUARY 2019

A second layer of opportunities

Stock Screen

Return to TOC

Stock screen indicates a second layer of investment opportunities

16

▪ With the dip in the market in 2018, we notice that stocks in addition to our key picks look attractive on the grounds of valuation. We have,

therefore carried out a stock screen based on;

– high liquidity: ADV 6months > USD40k

– depressed valuations: discount to last three-year P/E > 10%

– We then plotted this against the 3-year forward EPS CAGR (see chart)

▪ Based on the results, we note that our top picks rank high in the screening matrix (Indicated by the blue bubbles)

▪ In addition to our key picks, we also note that the stocks denoted by the grey bubbles present a second tier of investment opportunities

based on our screening criteria

▪ However, we believe the green highlighted stocks - while fitting our screening criteria - represent a number of investments risks, which

warrants the current valuation discount.

– NDB – failed discussion with the strategic shareholder leaves a capital gap when the asset base crosses LKR 500bn

– LION – due to potential risk of changes to the tax structure through the 2019 budget

– MELS – due to muted earning impact from DIST and SPEN

Any indication of these specific overhangs clearing would present a good investment opportunity at current valuations

Stock screen indicates a second layer of investment opportunities

17

Source: Company data, Asia Securities

Notes: Bubble size = Liquidity, Blue – Indicates companies already in top picks, Grey – Indicates companies stocks that are not included in our top picks, Green – Stocks with high investment risks

NDB SL DIAL SL

HNB SL

SAMP SL

COMB SL

LION SL

MELS SL

NEST SL

CTC SL

0

10

20

30

-70 -60 -50 -40 -30 -20 -10 0

Discount to 5-year average PE (%)

3-year EPS CAGR (%)


JANUARY 2019

ASIA SECURITIES SECTOR VIEWS

Return to TOC

19

Banks – maintain positive view

CBSL has maintained its neutral policy stance in November (SRR cut + policy rates raised), but based on the low market liquidity, we see further

upside to bank deposit rates, which would impact the growth of mid-sized banks with low liquidity more than the large banks. The current NPL

cycle will run its course until end 1H CY19, but we remain cautious given the recent headwinds faced by the tourism industry and prolonged

recovery of the construction sector. We maintain our view that credit growth will trend lower in CY19E with the banks taking a more cautious

view on extending credit. Profitability would see an uptick with the low impairment charges compared to CY18E, but the debt repayment levy

would remain an overhang on profitability.

Insurance – maintain neutral view

We maintain our neutral stance on the insurance industry over the next 12-months. The General insurance industry would see earnings soften

with new vehicle registrations slowing due to increased restrictions on vehicle imports and LKR depreciation. Life insurers would face also face

some headwinds in generating new business given our view of the impact on consumer spending. However, rising interest rates and associated

pick up in fixed income returns should drive up investment revenues, supporting earnings. Overall, we maintain our neutral view.

Telecommunications – maintain positive view

Data continues to drive growth, but we note that the rate seems to be stabilizing. CY18 saw several positive developments in the telco sector

regulations which would drive earnings in CY19E. Replacing the fixed floor rate with a cost-plus floor for each player is a positive for the larger

players with scale benefits, in our view. This, coupled with the reduction of the telco levy on voice would result in some support for the waning

voice business. The sector would see the telco levy being implemented in CY19E and we expect a 0.5% - 1.0% reduction on operating margins

from this.

Conglomerates – downgrade to neutral

Conglomerates provides exposure to multiple sectors in a more liquid manner when compared to buying individual stocks. However, most of

these companies are heavily exposed to consumer and leisure, which will continue to dampen earnings through 2019. However, we believe there

are opportunities on a long-term basis.

20

FMCGR - maintain neutral view

2019 continued to show further slowdown with consumers still seeking ‘value-for-money’ deals, particularly compelling FMCG and food retailers

to offer deals to move volumes. At consumer durables, consumers are taking a wait and see approach, while we expect the 100% cash margin

imposed for imports on particular products to impact cashflows, and the resulting FX impact on imports to also impact margins. We expect the

2019 budget to introduce a number of consumer friendly proposals, however, do not expect them to be as substantial compared to 2015/2016,

given ongoing fiscal consolidation. However, with the budget reading now expected to be in March 2019, we believe any positive impact will

come though in 2H CY19.

Construction – maintain neutral view

We expect the construction sector slowdown to draw out into 2019. On the demand side, we expect the sector to continue to be impacted by

slow government expenditure while sustained, relatively higher interest rates will impact demand in the residential sector. While ASP-led

revenue growth was seen in 1H FY19, global commodity prices that peaked since 2014 saw the margins in the construction sector take hit.

Furthermore, with expanded capacities across the sector remaining underutilized, low fixed absorption also played a part in bringing down

margins in 1H FY19. As global commodity prices ease out slightly in 2H CY18 and is expected to remain stable at current levels, we believe the

increased ASPs will provide some respite to margins in 2H FY19E.

Manufacturing – maintain neutral view

We remain bullish on the textile industry with Sri Lanka standing to benefit from US and EU markets as Consumer Confidence peaked in 1H CY18

since the 2007 global recession. This, coupled with GSP+ benefits which has seen an increased shift in sales volumes towards the EU markets

cements our bullish view on the sector. However, a recent dip in US and EU Consumer Confidence index remains a concern to us heading into

2019. Furthermore, we also take a positive view on the export names within the manufacturing space, for which we expect to see tailwinds from

the depreciating LKR positively impact earnings. However, we expect manufacturing companies such as GLAS SL, who are exposed primarily to

the local market, to continue to be impacted by a slowdown in the domestic segment due to a slowdown in the consumer spending.

Alcoholic Beverages – downgrade to neutral

We expect LION earnings to normalize from the +50-60% YoY growth over the past year, with the company now being fully operational. LION will

continue to benefit from lower prices for beer compared to hard liquor throughout 2019, provided that there are no significant changes to taxes

when the full budget for 2019 is presented. On the other hand, we expect DIST’s benefit from recommencing local ethanol sourcing will

normalize by 4Q FY19E and with the slow demand for hard liquor due to the pricing difference with beer, and general consumer slowdown, we

expect earnings to be muted. As such, we expect steady earnings from LION to be somewhat offset by lower earnings from DIST.

21

Healthcare – maintain positive view

With our coverage focus on the Hospital sector, we continue to expect stable industry earnings with the impact from dengue and VAT wearing off.

We also believe the impact from increase in corporate taxes is already priced in. Apart from this, we also believe counters exposed to pharma

manufacturing will continue to benefit from government buyback programs. However, the largest business in the industry, pharmaceutical

distribution, continues to remain under pressure from price controls and currency depreciation.

Leisure – maintain neutral view

We maintain a neutral view on the Sri Lankan leisure industry over 2019E, underpinned by the room inventory oversupply which we expect will

draw out in CY19E as well. While the launch of a comprehensive promotional campaign “So Sri Lanka”, along with the Lonely Planet

endorsement should boost Sri Lanka’s exposure to source markets, we expect travel warnings in October 2018 and possible elections in

2019/2020 to delay the pick up in arrivals momentum. However, we believe that most of the challenges have already been priced in.

Energy – maintain neutral view

We maintain a neutral view on the local energy sector for 2019 following the implementation of a fuel pricing formula in May 2018. While this

will benefit companies such as LIOC in the Energy space, delays in implementing a pricing formula in the local LPG market leads our negative

view on this subsector. Furthermore, we also take a neutral view on the Lubricant Market as stiff competition within the sector with six

additional players likely to enter the market (currently 13) will cause volumes to further dilute, impacting the growth of players such as LLUB

which operate in an already saturated market.

Non-Bank Financial Institutions – maintain neutral view

We maintain a neutral view on the Sri Lankan NBFI sector. The sector experienced a number of headwinds in the past 2 years including higher

import duties and restrictions, a depreciating currency, lower loan to value ratios across a number of vehicle categories and higher cash margin

for importers. The Central Bank has taken steps to tighten regulation on the sector, starting with increasing the core capital requirement by 5x

to LKR 2.0bn by 2020, and to LKR 2.5bn by 2021. While this will strengthen the sector in the long term by enforcing consolidation, there will be

profitability pressure in the short term due to restricting loan growth specially on smaller NBFIs.

Sector overview

22

Sector Period P/E (x)EV/EBITDA

(x)P/B (x) Div Yld (%) ROE (%) ROA (%) ND/E* (%) Outlook

Banks CY19E 5.3 na 0.6 10.4 13.8 1.4 nm Positive

Telecommunications CY19E 7.3 0.8 0.8 5.2 13.2 6.6 35.0 Positive

Alcoholic Beverages CY19E 14.8 8.1 6.5 3.3 45.9 15.6 53.7 Neutral

FMCGR CY19E 19.8 11.5 11.6 4.5 56.7 19.5 (26.7) Neutral

Conglomerates CY19E 13.9 6.6 1.0 2.9 7.5 4.5 (8.7) Neutral

Construction CY19E 10.0 4.4 0.6 5.1 7.7 5.6 16.7 Neutral

Manufacturing CY19E 12.0 6.1 1.5 5.4 13.0 8.3 13.9 Neutral

Healthcare CY19E 18.2 8.1 2.4 3.3 15.7 9.3 51.2 Positive

Leisure CY19E 10.1 5.6 0.5 3.7 5.3 3.9 13.6 Neutral

Insurance CY19E 5.2 na 1.1 25.9 22.7 6.3 nm Neutral

NBFI CY19E 4.2 na 0.7 4.3 18.9 3.5 nm Neutral

Energy CY19E 17.3 5.8 1.4 6.8 10.2 5.4 (9.1) Neutral



JANUARY 2019

Equity Strategy

Prominent value thesis amidst polarised risks

Return to TOC

ASPI closed CY18, down 5.0% YoY, while S&P SL 20 was down 14.6% YoY

Equity market faced multiple storms in 2018, but political uncertainty dominated the weak momentum

24

From a political standpoint, the immediate crisis is resolved, but the key concern for investors in 2019 is policy stability

Source: Bloomberg, Asia Securities

▪ The year of political uncertainty started in February 2018

– Local Government elections in February 2018 saw the ruling

coalition suffering a disconcerting loss, and upsetting a fragile

power balance that existed between the UNP and SLFP

– A no-confidence motion against PM Ranil Wickramasinghe

which was the first eruption of cracks within the coalition

▪ 2H CY18 saw the political crises reach unprecedented levels that

accelerated capital flight from both bond and equity markets

– In October 2018 the President controversially replaced the

sitting PM, Wickramasinghe and appointed Rajapakse

– Markets saw a short-lived positive reaction, but collapsed

after the legitimacy of the move was questioned

– Snap elections were called, the legality of which was

challenged by a collective of political parties

– in December, the judiciary decided against the President’s

decision to dissolve parliament which resolved the immediate

crisis

ASPI ended the year at 6,057, 3.8% below our expectations

2,800

3,000

3,200

3,400

3,600

3,800

4,000

5,700

5,800

5,900

6,000

6,100

6,200

6,300

6,400

6,500

6,600

6,700

Jan-18 Mar-18 May-18 Jul-18 Oct-18 Dec-18

IndexIndex

ASPI (LHS) S&P SL 20 (RHS)

Trailing-12-month (TTM) fund outflow from SL equities (USD 50mn) in

2018 was steeper than the TTM outflow from overall EM equity

Capital outflow in CY18 contributed to the overall market weakness and low valuation. Recovery depends

on visibility into streamlined policy-making

25

We believe that investors will take a wait-and-see approach in 1H CY19 until credible evidence of streamlined government policy-

making is seen

▪ Foreign fund outflows from the Sri Lankan market continued

throughout the year, but intensified in 2H CY18, due to;

– Idiosyncratic risks linked to political and policy uncertainty

– External pressure from trade tensions between US & China

– Pickup in oil prices to above USD 80.00/bbl in October raising

inflation concerns

▪ However, we believe the investment case for Emerging Market (EM)

equities has become stronger in 2019, with;

– US-China trade tensions easing

– Oil prices dropping to below USD 60.00/bbl levels

– Moderating US growth outlook, and potential pullback of fed

rake hikes in 2019 and 2020, consequently easing pressure on

EM currencies

▪ However, we do not believe that SL will benefit from this shift, in

the short-run, as other EMs offer a better risk-reward profile

-20

-10

0

10

20

30

40

-200

-100

0

100

200

300

400

Sep-12 Dec-13 Mar-15 Jun-16 Sep-17 Dec-18

USD bnUSD mn

SL - TTM (LHS) EM - TTM (RHS)

Source: Bloomberg, CSE, Asia Securities

Investment case for EMs appear strong, but SL will miss the catchup rally in 1H CY19

26

▪ SL equities have historically attracted ~0.75% of funds that come into EMs (2017 was an exception with 1.45%)

▪ EM performance in CY18 was dampened largely by strong growth in the US, trade tensions, and depreciating currency

▪ However, the equity outlook for EMs have improved, (China is the exception) which would turn the tide on fund flows into EMs

Positive earnings growth differential between EMs and Developed

markets expected to drive more fund flow into EMs

EM valuations are picking up, with underlying earnings continuing to

grow

70

80

90

100

110

120

130

0.65

0.67

0.69

0.71

0.73

0.75

0.77

0.79

0.81

Dec-16 Apr-17 Aug-17 Dec-17 Apr-18 Aug-18 Dec-18

T-12m EPSRelative PE

MSCI EM PE vs. MSCI world (LHS) MSCI EM T12-M earnings (RHS)

- 2.00 4.00 6.00 8.00 10.00

FTSE 100

DAX

Dow Jones

MSCI world

S&P 500

MSCI EM

Earnings growth CY 19E


Foreign funds continue to exit despite ASPI trading at a discount to MSCI

EM indexOutflow from equities intensified after October 2018

Market cost of political instability: Foreign fund outflows from SL market despite attractive valuations

27

-100

-50

0

50

100

150

200

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

USD mn

Fund flow 2018 Fund flow 2017

▪ USD 50mn outflow in 2018 vs. USD 190mn inflow in 2017

▪ 2017 included the one-off inflow due to Pakistan being

reclassified into EMs that brought in additional funds to other

Frontier Markets due to portfolio rebalancing

▪ Despite a low relative valuation gap (i.e. ASPI is trading at a

20% discount to MSCI EM index), throughout 2018, fund outflows

continued

(150)

(100)

(50)

-

50

100

150

200

250

300

350

0.6

0.8

1.0

1.2

1.4

1.6

1.8

Jan-14 Oct-14 Aug-15 Jun-16 Apr-17 Feb-18 Dec-18

USD mn(x)

ASPI premium/discount to EM (LHS) TTM fundflow (RHS)

Source: Bloomberg, CSE, Asia Securities

Z-Spread on Sovereign bond (Apr 19 maturity) remains ~80bps above 26-

Oct levels

ASPI trading at a 33% discount to last 5-year average of 11.2x on a

forward PE basis

Risks are well priced in, with both equity and bond markets trading at a sizeable discount

28

-

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

-

100

200

300

400

500

600

01-Jan-18 02-Apr-18 02-Jul-18 01-Oct-18 31-Dec-18

YTM %bps

Z-Spread: Apr 19 (LHS) YTM Apr 2019 YTM Apr 2023

▪ ASPI valuations continue to remain under pressure with outflow of foreign capital

▪ Bond market has seen a similar trend; the Z-spreads, especially on sovereign bonds (Apr-19 maturity) are ~80bps above 26-Oct levels

– While the cut in sovereign credit rating is partially responsible for the higher yields, we note that the initial reaction to the

political crisis has not corrected yet. Bahrain and Kenya (also Moody’s B2 stable) trade at 222bps and 227bps vs. SL at 315bps

5.0

7.0

9.0

11.0

13.0

15.0

Jan-14 Oct-14 Aug-15 Jun-16 Apr-17 Feb-18 Dec-18

Fwd P/E (X)

ASPI 5-year mean -1 S.Dev -2 S.Dev

Source: Bloomberg, CBSL, Asia Securities

Valuation upside is further established compared to earnings growthSri Lanka equities trading at a higher risk premium compared to regional

peers and benchmarks

Sri Lanka value thesis is more prominent post the ASPI performance in 2018

29

While the valuation discount is well-understood by the market, we believe investors are assigning a higher risk premia due to the

political instability, high debt repayments and muted economic outlook in an election year

Sri Lanka

India

Pakistan

Vietnam

Philippines

Malaysia

Indonesia

Thailand

China

MSCI Frontier Mkt

MSCI Frontier Asia

MSCI Emerging Mkt

MSCI World

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

6.0 8.0 10.0 12.0 14.0 16.0 18.0 20.0 22.0

EPS growth CY19E

P/E CY19E

0

2

4

6

8

10

-

3.0

6.0

9.0

12.0

15.0

18.0

21.0

ASPI

S&

P S

L 2

0

Pakis

tan

Chin

a

Vie

tnam

Thailand

Indonesi

a

Mala

ysi

a

Philip

pin

es

India

Fro

nti

er

mkt

Em

erg

ing m

kt

Worl

d

Fro

nti

er

Asi

a

Sri Lanka Regional MSCI

%PE (X)

CY 19E CY 20E Implied risk Premia


Debt maturities is a key investor concern, and CBSL has highlighted the path to managing the repayments

30

▪ SL will see USD debt maturities of ~USD 5.9bn in CY19, and the Central bank (CBSL) has highlighted the available funding lines, and its plan

to fund the upcoming obligations. We believe this is a step in the right direction to build investor confidence

– China Development Bank loan – USD 1bn

– Final tranche of the Hambantota port sale – USD 645mn

– SAARC country funding facility via RBI – USD 400mn (tentatively agreed)

– Syndicated loans from Middle-east banks – USD 1.0bn (under negotiation)

– Upscaling of China Dev. Bank loan – USD 500mn (planned)

– Active Liability Management Act – ability to raise up to USD 1.7bn

– Potential ISB – USD 1.0bn or more

– Panda/Samurai Bonds issuance – amounts not disclosed (planned)

– Swaps from RBI and China – amount not disclosed (planned)

– IMF EFF remaining tranches - ~USD 450mn (2 tranches left)

▪ In our view, re-initiating talks on IMF EFF is a key positive to build investor confidence. This will further enhance fiscal discipline through

meeting IMF targets and maintaining policy implementation within IMF conditions

▪ Risks: 1) Higher refinancing cost due to lower sovereign credit rating (Moody’s: B2 Stable) exacerbated by higher global rates (IMF forecasts

the Fed rate to be at 3.25% by end 2019); 2) delays in funding negotiations if key policy decisions are pushed due to lack of political

coordination

Inflation to stabilize at 5.0%, below IMF’s upper limit of 6.0%, supported

by CB’s inflation-targeting mechanismReserves balances to reach 4.0 months of import in CY20E

Reserves position to remain above 3.8 months of imports, while inflation to stabilize at 5.0% by 2020

31

▪ US rate hike cycle expected to slow down in 2019, reducing pressure on fund outflows

▪ Pick-up in tourist arrivals (we expect 2.5mn; ~8.6% YoY growth in CY19E) to support inflows

▪ Risks: Political uncertainty adding pressure on LKR, leading to more CB intervention to support currency

5.05.1

4.6

3.7

4.0 4.03.9

4.0

4.2

CY13 CY14 CY15 CY16 CY17 CY18E CY19E CY20E CY21E

Months of imports

0.0

2.0

4.0

6.0

8.0

10.0

2011 2012 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E

(%)

Headline inflation (%) 12M moving average

Source: DoCS, MoF, Asia Securities

We expect GDP growth to pick up from CY19, and gradually move closer

to EM and developing Asia

GDP growth to normalize in 2019 after slow momentum 2018

32

Broad-based growth across agriculture, industries and services to drive

growth

0

1

2

3

4

5

6

7

8

CY14 CY15 CY16 CY17 CY18E CY19E CY20E

(%)

Sri Lanka EM and Developing Asia

▪ We expect the GDP growth momentum to be largely driven by;

– Normalising agriculture sector, leading to a pick up in HH

consumption

– Lower global fuel prices, leading to stable inflation

– Favorable external trade with local exports being more

competitive given the depreciation of the currency

▪ Downside risk: tight monetary policy and unpredictable policy

implementation will lead to lower investment led growth

(10)

(5)

-

5

10

15

(60)

(40)

(20)

-

20

40

60

80

Q1 15 Q3 15 Q1 16 Q3 16 Q1 17 Q3 17 Q1 18 Q3 18

%%

Share of GDP (LHS) HH consumption Growth (RHS)

Household (HH) consumption (65% of GDP) is marking a recovery in 2018

Source: DoCS, World Bank, Asia Securities

Broader EM currency weakness recovered post September, while LKR

further depreciated given political uncertaintyLKR/USD volatility remains high, indicating the impact of fund outflow

Currency volatility has intensified with the spike in political risks

33

-0.05

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

Jan-18 Mar-18 Jun-18 Aug-18 Nov-18

Volatility (pp)

LKR/USD 1-day avg volatility

0.75

0.80

0.85

0.90

0.95

1.00

1.05

1.10

1.15

Jan-16 Jun-16 Nov-16 Apr-17 Sep-17 Feb-18 Jul-18 Dec-18

Index

JP EM currency index LKR/USD


LKR currently undervalued, at 4% below REER target of 100All regional peers, except Pakistan have reduced currency depreciation

since September

Regional peers saw strengthening currency since September 2018; LKR remains undervalued

34

-30

-25

-20

-15

-10

-5

0

LKR PKR INR IDR PHP

YTD dep'n (%)

Sep-18 Dec-18

Jan-15 Jul-15 Feb-16 Aug-16 Mar-17 Sep-17 Apr-18 Nov-18

REER

REER = 100


Market interest rates have trended up with tight liquidity conditions

35

6.8

7.8

8.8

9.8

10.8

11.8

12.8

-150

-100

-50

0

50

100

150

Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 Jan-18 May-18 Sep-18 Jan-19

(%)LKR bn

Overnight Liquidity SLIBOR 3M (RHS) AWPLR (RHS)

▪ Prolonged overnight liquidity shortfall since September 2018 has pushed market rates up

▪ Looking ahead, we expect the rates to remain elevated, given;

– CBSL would turn more towards local borrowing, with international borrowing costs expected to rise

– The upward revision of FD ceiling rates (+176bps) for NBFIs, that would add further pressure on deposit rates


CY18 earnings soft with index-heavy banks and conglomerates remaining under pressure

36

▪ CY18 saw earnings headwinds for index-heavy Banks and Conglomerates leading to 9M CY18 market earnings recording a 1.4% YoY drop.

– Banks were impacted by elevated impairment charges on the back of weak asset quality

– Conglomerate earnings contracted largely due to soft consumer spending (e.g. CCS) as well as depreciating LKR (e.g. Pharma business

of HHL)

– In addition, companies with USD debt (e.g. DIAL) suffered with translation forex losses weighing down reported results

▪ We expect 4Q CY18 to show a similar trend given no material improvement in underlying conditions are seen

▪ However, looking ahead, we see several positives for corporate earnings in 1H CY19;

– Recovery of agriculture (27% of labor force) and low food-inflation would lead to a pick up in HH consumption, albeit we expect the

spending to be largely concentrated on essentials

– Low oil prices and more hydro-power generation should reduce the import burden leaving room for the government to relax fiscal

tightening

▪ We also view the following challenges;

– Import restrictions, especially on consumer durables would lead to high working capital requirements for importers and prolong a

recovery of consumer spending on non-discretionary items

– Market interest rates have an upward bias, which would increase the interest burden of levered corporates

– Banks/Finance companies would see a moderation of loan growth in CY19E, and the debt repayment levy would weigh down

profitability

ASPI to reach 6,200 by end of 2019, driven mainly by earnings growth

37

▪ For CY19, we expect market earnings to pick up 15.1% YoY.

– Our forecast is below the consensus estimate of 17.4% as we remain cautious on the earnings recovery, given;

o the additional burden for banks from the DRL as well as the tower levy for telco players which will be effective from 01st Jan

2019

o recovery of retail and FMCG businesses pushed to 3Q CY19

o construction sector, which would see its recovery pushed to 4Q CY19

▪ ASPI currently trades at 7.3x CY19E PE based on our estimates, and we expect the market CY19 PE multiple will expand modestly to 7.6x,

and ASPI to reach 6,200 by end CY19 (+3.9% YoY based on 11th January close)

▪ Upside risks:

– Pullback of tight fiscal conditions in the 2019 budget acting as a catalyst to boost investor sentiment

– Early general elections leading to a stable government and streamlined policy-making which can lead to increased USD fund flow

– Upgrade in sovereign credit ratings

▪ Downside risks:

– Fiscal slippage in a year of elections; Provincial council, Presidential and possibly general elections

– Uneasy political alliance between President and PM delaying key policy decisions and reforms agenda

– Rising interest rates weighing down investment-led growth

Key picks portfolio outperformed both ASPI and S&P SL20 in 2H CY18 on a total return basis

38

▪ Our key picks returned 0.8%, beating both ASPI TR (-2.1%) and S&P SL 20 (-7.0%)

▪ We maintain our dynamic portfolio allocation method, with a stop loss feature and assuming dividends are reinvested

▪ Following our research calls, JKH was the top performer in the portfolio, with a 7.8% price return, whilst further contributing to the

portfolio return carrying a higher weightage given our ADT-based allocation method

85

87

89

91

93

95

97

99

101

103

20-Jul-18 3-Aug-18 17-Aug-18 31-Aug-18 14-Sep-18 28-Sep-18 12-Oct-18 26-Oct-18 9-Nov-18 23-Nov-18 7-Dec-18 21-Dec-18

Index value

ASEC SP20 TR CSEALL TR

Key picks for 2019 with reduced exposure to Conglomerates

39

▪ Overall, we do not see any particular sector generating strong shareholder returns, but favour stocks that have low gearing, given our

expectations of a gradual pick up in market interest rates

▪ We rebalance our portfolio at this stage. Accordingly, our new core portfolio comprises TJL, ASIR, EXPO, SAMP, HNB, COMB and DIAL. We

have removed LION and JKH, and moved HEMS to our long-term recommendations. We have added HNB and EXPO as key picks

– We add HNB given our view that the bank will likely see a possible early recovery from the NPL cycle, coupled with its drive to push

growth in the high-margin SME segment while the industry is largely focused on the low-margin (and low-risk) corporate business

– HEMS has seen a heavy impact from currency weakness impacting its pharma business, while we expect the consumer business to see

only mild growth in 1H CY19. However, the first year impact of Atlas should support earnings momentum through 1Q CY19 (3Q FY19 for

HEMS)

– We see a higher possibility of an increase in taxes for the alcoholic beverages industry, which leads us to remove LION

– JKH was included initially in our portfolio given its attractive valuations, and has traded up to our target price in 2H CY18. With the

muted growth in consumer segment (via CCS) we do not see a major upside in a one-year horizon

– For DIAL, the main concern remains LKR depreciation, and the translation loss (non-cash) which is booked every quarter. With our

expectation of normalizing currency depreciation in CY19, this impact would subside. The tower-levy, which will be implemented from

CY19 is already included in our estimates, and will reduce maximum 1.5ppt from EBITDA margins.

▪ In addition, we recommend LGL, HEMS and AHUN in our long-term picks, as these counters will offer solid returns in a 3 to-5 year horizon

given the specific drivers in place


JANUARY 2019

Cautious Optimism Amidst External Headwinds

Macroeconomic Outlook

Return to TOC

Growth to pick up at a slow pace on higher consumer spending and

hydro recovery

Constitutional face-off dominated 2H CY18; impact on sentiment to

prevail


41

▪ We expect CY19E growth to remain muted although slightly

ahead of that of CY18E, at 4.2% YoY.

▪ We expect the recovery to be supported by

▪ continued growth in the agriculture sector in the

absence of adverse weather conditions

▪ higher government expenditure on subsidies and rural

development towards the run up to elections.

▪ Accordingly, we expect the consumer led growth to pick-up

in the second half of CY19E.

▪ On the external front, we expect stabilising global crude oil

prices (-22.1% from October 2018 highs as forecasted by the

World Bank) and lower dependency on thermal (due to a

pickup in hydro) to ease pressure on the trade balance.

▪ The constitutional crisis, although now resolved, did lead to

some considerable consequences with regards to 1) foreign

outflows, 2) exchange rate, 3) ratings and 4) the overall

sentiment of the country.

▪ While the reinstated government is taking steps to realign

policy, we believe sentiment for 2019 has taken a hit in

terms of political and policy uncertainty.

Fiscal consolidation likely to slow down on election pressuresMonetary policy to remain tight, reserve strengthening a priority


42

▪ We forecast the fiscal balance at -5.0% of GDP in CY19E and

-4.7% by CY20E, which we note is lower than the target set

by IMF and the government’s target of -3.5% by CY20E.

▪ We expect more efficient revenue collection through

▪ the new IRA

▪ improved non-tax revenue measures set in 2018

▪ Given the possibility of a general election in 2019, and

Presidential election 2020, we expect the government would

step up spending in areas of 1) subsidies, specially towards

the agri industry and 2) rural development.

▪ As such, we see limited room for improvement on curtailing

government expenditure.

▪ Following the rate hike in November, we don’t expect any

changes to key policy rates in 2019.

▪ We expect the CB to prioritise strengthening reserves , given

up-coming debt repayments of ~USD 4.0bn during the year.

▪ We forecast CY19E reserves to end at USD 7.2bn, covering

3.9 months of imports on the expectation that funding that

was delayed towards end 2018 will materialise in 2019. This

include, among others;

▪ The final two tranches of the IMF’s EFF of ~USD 460mn

▪ Syndicate loan of USD 1.0bn from Middle Eastern Banks

▪ Upscaling of the CDB loan for USD 500mn

▪ The issuance of panda and samurai bonds.

▪ However, we believe FDI inflows to remain subdued, at ~USD

1.5bn, as the policy uncertainty is like to have investors take

a wait-and-see approach.


43

Key indicators 2014 2015 2016 2017 2018E 2019E 2020E 2021E

Real GDP growth (%) 5.0 5.0 4.5 3.3 3.5 4.2 4.9 5.5

Headline inflation (%) 2.1 4.6 4.5 7.1 2.8* 4.3 5.0 5.0

12M moving average (%) 3.3 2.2 4.0 6.6 4.3* 4.7 5 4.8

Core inflation (%) 3.5 4.9 4.4 4.3 3.1* 5.0 4.7 5.0

LKR/USD (Monthly avg) 131.05 144.06 149.80 152.85 180.37* 189.00 195.00 198.00

Depreciation (%) 0.2 9.9 4.0 2.0 18.0* 4.8 3.2 1.5

Unemployment (%) 4.3 4.7 4.4 4.2 4.2* 4.3 4.2 4.3

12M government bond yield (%) 6.01 7.30 10.17 8.90 10.85* 10.60 10.30 9.00

12M moving average (%) 6.69 6.61 9.93 10.05 9.75* 10.41 10.5 9.7

Fiscal balance (% of GDP) (5.7) (7.6) (5.4) (5.5) -4.9 -5.0 -4.7 -4.5

Trade balance (% of GDP) (10.4) (10.4) (11.2) (11.9) -11.7 -11.6 -10.9 -10.7

Current balance (% of GDP) (2.5) (2.3) (2.1) (2.6) -2.4 -2.5 -2.3 -2.4

FX reserves (months of imports) 5.1 4.6 3.7 4.0 3.7* 3.9 4.0 4.2

Debt/GDP (%) 71.3 77.7 78.8 77.6 77.5 79.5 80.0 79.4

Foreign debt (% of total debt) 30.0 32.4 34.0 35.5 35.3 34.0 33.4 32.0

Source: CBSL, DoCS, MoF, Asia Securities | E: baseline estimate | *: Actuals


JANUARY 2019

ASIA SECURITIES RESEARCH SECTOR OUTLOOK

Return to TOC


JANUARY 2019

Weathering the cyclical storm; we favour the large banks

BANKING SECTOR

Return to TOC

Banking sector earnings to recover in CY19E once the high impairments normalise

46

▪ We take a cautiously positive view on the banking sector for 2019

▪ The CBSL has maintained a neutral monetary policy stance since signalling the end of policy tightening in April 2018.

▪ While we expect policy rates to remain stable in the short-run, market interest rates could edge up further given the current tight liquidity

in the market. We maintain our view that NIMs will see a modest contraction in CY19E

▪ Asset quality, which saw a major deterioration in CY18 would gradually peak by 2Q CY19E. Key risks to our view are;

– Impact of the political crisis on the tourism industry which was recovering from a slow 2017

– Payments to contractors exposed to government projects would see the recovery prolonged due to the political crisis

▪ Credit growth would ease further in CY19E, and we expect 16.0% YoY growth for the banks under our coverage

– We see large banks getting more selective with lending to reduce risk exposure, and...

– ... smaller banks will face tough competition and would need to balance out risk vs. growth

▪ We forecast sector earnings in CY19E to pick up from 2018 levels with overall industry net earnings growing by 17.0% YoY

– CY18 saw earnings being hit by high impairment charges on the back of asset quality deterioration, and cost of risk for the sector

picked up to 110bps (vs. 40bps in 2017)

– In addition, banks would adopt IFRS 9 with 4Q CY18E results, with the hit taken into equity. On average, this has a 4%-5% impact for

the banks under our coverage

– We expect the impairment costs to normalise in CY19E with asset quality improving, which should provide an upside to earnings.

However, we factor in the impact of the debt repayment levy (charged as a 7% VAT) that shaves off ~8.5% of our sector earnings

Recommend taking up positions in COMB, SAMP and HNB

47

BBG

TickerYear end

Market capADV

(USD k)

CMP

(LKR)TP (LKR) TP date TSR (%)

CY2019E


COMB SL Dec-18 114 627 300 114.00 128.00 16-Nov-18 +18.2 5.4 0.9 7.0 16.8 nm

SAMP SL Dec-18 61 337 342 218.10 270.00 15-Nov-18 +31.1 4.4 0.6 8.7 4.9 nm

HNB SL Dec-18 97 535 286 205.00 250.00 23-Nov-18 +26.1 4.7 0.7 4.1 15.1 nm

SEYB SL Dec-18 22 120 17 76.00 71.40 01-Nov-18 -1.4 5.8 0.7 4.6 12.1 nm

NDB SL Dec-18 22 121 219 104.80 110.00 05-Nov-18 +11.2 5.4 0.5 7.2 10.7 nm

NTB SL Dec-18 24 131 6 86.30 98.90 07-Nov-18 +17.5 5.2 0.8 2.9 15.2 nm

UBC SL Dec-18 12 65 8 10.90 11.20 30-Oct-18 +3.7 21.8 0.7 0.9 3.1 nm

SDB SL Dec-18 4 22 3 72.20 UR nm nm nm nm nm nm

DFCC SL Dec-18 24 132 4 90.30 100.00 07-Nov-18 +16.3 5.7 0.5 5.5 8.2 nm

Average 7.3 0.7 5.1 12.0

Source: Asia Securities | Note: *ND/E – Net Debt/Equity, Priced as at end 11 Jan 2019

▪ We further expect all banks to focus on enhancing its digital offering, which would lead to an overall improvement in operating efficiency

▪ Basel III new capital requirements will be in place from 01st Jan 2019. All banks are in compliance, but NDB would need to raise additional

capital (after the failed attempt at getting a strategic investor) once the asset base crosses LKR 500bn

Valuations at a ~40% discount to 5-year averageSector has outperformed the ASPI over the past five years

The Banking sector is trading at 0.8x BV, 40.2% below its five-year average of 1.3x

48

Source: Bloomberg, Asia Securities | Priced as at end 11 Jan 2019

▪ We expect the sector ROEs to moderate in CY19E given that the banks would move into a regime of higher capital requirements (under

Basel III)

▪ Accounting for this structural shift, we note that the current valuations offer an attractive entry point into the three large banks that are

well capitalised and has the necessary strength to withstand the industry headwinds such as high impairments and NPLs

0

20

40

60

80

100

120

140

160

180

Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19

Index value

Banks ASPI

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0


P/B (x)

Banks ASPI 5-yr Average


JANUARY 2019

Data drives growth; voice gets a boost

TELECOMMUNICATIONS SECTOR

Return to TOC

Boost to drive the voice business a key positive for CY19E; data to remain the mainstay of growth

50

▪ We hold a positive view on the telecommunications sector for 2019

▪ Following the reduction in the telco levy for data, CY18 saw a major boost in data driven growth for both DIAL and SLT, and we expect data

business to anchor the growth, especially for DIAL where mobile data revenue has overtaken voice in the overall revenue mix.

▪ However, we note that the growth seems to be stabilising, as the saturation point at current income levels is approached.

▪ On the voice side, we believe that several key changes which impact the tariffs structure will support growth in CY19E

– Implementation of a unit cost-plus model as a floor rate tariff instead of the fixed floor rate favors the large players who can take

advantage of the scale benefits

– While the exact rate is not disclosed by either player, our discussions with management indicate that the new cost for DIAL would be

lower than the previous fixed floor rate (LKR 1.50/minute)

– In addition, the reduction of the telco levy on voice to 15% from 25% previously would provide some additional impetus to improve the

declining MOUs in the voice business

▪ One of the major concerns, especially for DIAL, is the LKR depreciation. Given its exposure to USD-denominated debt, DIAL needs to book a

translation loss every quarter, which weighs on reported profitability

▪ The tower levy, which was watered down from its original form is also in effect from Jan 2019 and will reduce operating margins by ~1.5%,

based on our calculations

▪ Overall, we expect the sector earnings to see an 8.0% pickup in CY19E

Top pick from the sector is DIAL

51

BBG

TickerYear end

Market capADV

(USD k)

CMP


CY2019E


DIAL SL Dec-18 82 452 68 10.10 13.00 13-Nov-18 +32.2 5.9 1.2 5.9 19.5 37.5

SLT SL Dec-18 43 236 1 23.80 24.00 19-Nov-18 +4.6 7.8 0.5 3.7 7.2 59.4

Average 6.8 0.9 4.8 13.4 48.5


Valuations have trended down in CY18, and the sector now trades at

~40% discount to 5-year averageSector has generally traded above the ASPI historically

Telecommunications sector is trading at 7.8x PE, 40.1% below its five-year average of 13.1x

52


60

80

100

120

140

160

180

200


Index value

Telecom ASPI

4

8

12

16

20


P/E (x)

Telecom ASPI Average


JANUARY 2019

Possibility of a tax change looms ahead

ALCOHOLIC BEVERAGE SECTOR

Return to TOC

Alcoholic Beverage sector earnings to be up ~69.0% in FY19E

54

▪ We take a neutral view on the alcoholic beverage industry for 2019

▪ We expect LION earnings to normalize by 4Q19E, albeit growing at a steady low double digit pace

▪ DIST will see the benefit from lower COGS (due to recommencing local ethanol sourcing) normalize post 3Q19E

▪ LION will continue to benefit from lower prices for beer compared to hard liquor throughout 2019, provided that there are no significant

changes to taxes when the full budget for 2019 is presented

▪ As such, we expect steady earnings from LION to be somewhat offset by lower earnings from DIST

▪ We expect sector earnings to be up 68.9% YoY in FY19E and up 16.8% YoY in FY20E. FY19E growth is mainly due to earnings recovery at LION

▪ Main risk is possible changes to the tax structure through the 2019 budget reading in March 2019. Given the high probability of such

changes, we do not recommend any stock from the sector

BBG

TickerYear end

Market capADV

(USD k)

CMP


FY2019E


LION SL Mar-19 45 245 87 556.30 710.00 16-Nov-18 +28.3 18.0 3.9 0.7 23.5 71.9

DIST SL Mar-19 74 407 8 16.10 21.00 16-Nov-18 +35.4 13.4 10.1 5.0 79.8 73.8

Average 15.7 7.0 2.8 51.7 72.8


Valuations are relatively in line with the historical average Sector has underperformed the ASPI over the past year*

The Alcoholic Beverage sector is trading at 17.6x FY19E EPS, a 14.5% premium to the five-year trading

average

55Source: Bloomberg, Asia Securities | Priced as at end 11 Jan 2019 | * The dip in the index is mainly due to the relisting of DIST at a lower free float

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Alcoholic Beverages ASPI


JANUARY 2019

Demand remains subdued amidst a cautious consumer

FMCG/R SECTOR

Return to TOC

FMCG and Retail sector dampened by cautious consumer spending; sector earnings to be up 3.3% in FY19E

57

▪ We take a neutral view on the FMCG and retail sector in 2019E

▪ The December quarter has seen a very slow uptick, and based on our discussions with consumer companies, we do not see demand picking

up till 3Q CY19

▪ FMCG

– Consumers are still seeking ‘value-for-money’ deals, compelling FMCG companies to offer deals to move volumes

– Due to FX depreciation, we believe companies exposed to local sourcing will see less pressure on margins

▪ Retail

– At food retailing, consumers continue to focus mostly on essentials, resulting in smaller basket sizes and lower ticket sizes

– With lower food inflation in 2019E, there would be a positive impact on demand for essential food items. However, margins remain

thin on these products, which may not really help boost the basket value

– In the midst of the current environment, we believe addition of new store expenses will also be a strain on margins in the short run

– At consumer durables, consumers are taking a wait and see approach. More handset sales occurring resulting in lower margin at

consumer electronics/durables retailers

– Also, we expect the 100% cash margin imposed for imports on refrigerators, TVs, air-conditioners and phones to impact cashflows. In

addition, the resulting FX impact on imports will also impact margins, as retailers may have to maintain pricing in order to be

competitive in the market

– At clothing retailers, sales have been relatively more stronger, albeit at a slow pace compared to last year. However, post the festive

season in December, we expect a considerable slowdown in demand

FMCG and Retail sector dampened by cautious consumer spending; sector earnings to be up 3.3% in FY19E

(contd)

58

▪ At CTC (only listed tobacco company), volumes were impacted by price increases in August 2018. While we expect a slight pick up during

the previous quarter, we believe the full impact will normalize only by mid-2019.

▪ We expect the 2019 budget to introduce a number of consumer friendly proposals, however, do not expect them to be as substantial

compared to 2015/2016, given ongoing fiscal consolidation

▪ However, with the budget reading now expected to be in April 2019, we believe any positive impact will come though only towards the

latter part of 2019

▪ As such, we expect sector earnings to be up 3.3% YoY in FY19E and up 13.4% YoY in FY20E

BBG

TickerYear end

Market capADV

(USD k)

CMP


FY2019E


CARG SL Mar-19 51 279 19 198.00 175.00 19-Nov-18 -9.6 23.3 2.9 2.0 12.9 69.3

CCS SL Mar-19 71 392 2 750.00 700.00 02-Nov-18 -4.0 41.5 5.2 2.7 12.5 45.5

KFP SL Mar-19 4 21 0 147.00 135.00 02-Nov-18 -4.1 12.0 2.0 4.1 17.3 -2.0

NEST SL Dec-18 91 502 26 1,700.00 1,800.00 14-Nov-18 +9.9 24.2 18.8 4.1 78.0 51.1

CTC SL Dec-18 264 1,453 77 1,410.20 1,260.00 13-Nov-18 -4.8 16.7 54.8 5.9 336.4 -356.0

Average 23.6 16.7 3.7 91.4 -38.4


Valuations are below the historical rangeFMCG sector earnings are down 6.4% YoY while food retail sector earnings are down ~55.0% YoY in 1H FY19

Tightening consumer spending taking a toll on FMCG and food retailing players

59Source: Company data, Asia Securities | Data includes CCS, CARG, NEST, KFP, and Arpico revenues

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Slow same store sales offsetting

growth from new store sales

Low demand for beverage products

at CCS mainly drove down earnings

Sector has traded relatively in line with historical averageSector has outperformed the ASPI over the past two years

The FMCG/R sector is trading at 22.8x FY19E EPS, which is at a 14.0% discount to the five-year trading

average

60Source: Bloomberg, Asia Securities | Priced as at end 11 Jan 2019

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Sector trading at a discount due to lacklustre performance; no top pick for 2019

61

▪ The sector is currently trading at a discount to its historical five year average, mainly due to the lacklustre performance over the past two

years

▪ The sector has historically traded at a premium to the rest of the market given the high ROEs (53.6% average over the past five years).

However, we do note that, this is mainly due to CTC and NEST which produces significantly high ROEs

▪ Despite the slow growth, we expect an FY19E ROE of 56.7% and a FY20E ROE of 60.5%

▪ However, we currently do not recommend any stock from this sector, given that we do not see any opportunity for rerating

▪ We expect companies with exposure to low-mid income earners and local supply, and with a strong brand presence to continue to perform

relatively better during this period (NEST and CARG)

Valuations are below the historical rangeSector ROE third highest in our coverage; however, mostly driven by NEST

FMCGR sector generates high ROEs

62Source: Company data, Asia Securities

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ROE (%)


JANUARY 2019

Exposure to Leisure and Consumer dampens outlook

CONGLOMERATES

Return to TOC

Adverse impact from consumer and leisure businesses a recurring theme across the Conglomerates

64

▪ Conglomerates accounted for >13.0% of the CSEs market capitalization and more than >10.0% of trade volumes in 2018

▪ The counters provide exposure to multiple sectors and is generally more liquid than a collection of individual counters which would provide

exposure to similar sectors

▪ Within our coverage we have five options; JKH, HHL, SHL, MELS and SPEN

– JKH to be impacted by the consumer business in 2019; offset to some extent by Transportation and Finance

o The Consumer business which accounts for ~52.0% of Group top line and ~42.0% of Group EBIT, is down ~59.0% in 1H FY19,

mainly due to low beverage volumes, low basket values at Retail, and new store expenses

o With our subdued expectations for the FMCG/R space for 2019, we believe the segment will continue to create a drag on

earnings for the remainder of FY19E and 1H FY20E

o Also, refurbishments in the Leisure segment will also impact earnings in 2019

o These will to some extent be offset from Transportation and Finance

– HEMS to benefit from Maritime and addition of Atlas; however offset by pharma distribution and consumer business in

Bangladesh

o Consumer business to benefit from Atlas, however some of the gains will be offset by operations in Bangladesh which are still

ramping up post restructuring

o The pharma distribution business which accounts for ~30.0% group top line and EBIT continues to be impacted by price controls

and adverse FX impact

o Maritime continues to perform well with the new logistics park expected to contribute positively from 2H FY19E onwards

o At Leisure, soft renovations continue to create a drag on earnings

Adverse impact from consumer and leisure businesses a recurring theme across the Conglomerates (contd..)

65

– SHL to benefit from the Healthcare and Finance business; offset by losses in Auto and Leisure

o Healthcare, which accounts for ~18.0% of top line and ~34.0% of group EBIT is driven by steady performance at ASIR (see

Healthcare sector for further details)

o The Finance segment continues to be driven by strong performance at AAIC (refer Insurance sector for further details)

o However, Retail to be affected by slow spending, adverse FX impact on imports, and 100% cash margin required on an array of

consumer electronics/durables imports which will affect cashflow management

o In addition, earnings losses from Auto and Leisure will continue to crate a drag on earnings

– SPEN affected by higher interest costs in Leisure and discontinuation of the Ambilipitiya Power Plant

o The Leisure segment, which accounts for ~50.0% group top line and EBIT continues to be affected by the adverse FX impact on

its USD borrowings, resulting in higher interest expenses

o At Strategic Investments, we believe SPEN has halted the operations of the Ambilipitiya Power Plant due to non-payment of fees

by the Ceylon Electricity Board

o We expect some of this impact to be offset by Maritime & Logistics and the Services segment, albeit at a minimal level

– MELS adversely affected by SPEN earnings, while benefit from lower COGS at DIST to end in 4Q FY19E

o With MELS owning 50.1% of SPEN, we expect the above mentioned concerns for SPEN to create a drag on MELS earnings in 2019

o While DIST has been performing well over the past two quarters, this was mainly due to the COGS benefit from reverting to local

supply of ethanol

o However, we expect this impact to anniversary in 4Q FY19E and due to the pricing disadvantage compared to beer, we expect

demand to remain relatively subdued for the remainder of the year (See Alcohol Sector review for further details)

Conglomerate earnings to be down 7.6% in FY19E; no top pick for 2019

66

▪ As such, we expect the sector to be down 7.6% in FY19E, driven mainly by JKH and SPEN

▪ With most of the conglomerates exposed to consumer related businesses, key risk to sector performance is consumer spending

▪ The sector is currently trading in line with its historical five year average, mainly due to the lacklustre performance over the past two years

▪ With exposure to consumer and leisure, we do not expect to see a notable pick up in earnings till late 2019

▪ As a result, we currently do not recommend any stock from this sector, given that we do not see any opportunity for rerating

▪ However, we have included HEMS as a long term pick


BBG

TickerYear end

Market capADV

(USD k)

CMP


FY2019E


HEMS SL Mar-19 49 269 72 85.00 130.00 19-Nov-18 +55.3 14.0 1.8 2.4 13.4 -5.8

JKH SL Mar-19 212 1,167 1,995 153.00 166.00 12-Nov-18 +12.4 14.4 1.0 3.9 7.1 -1.6

SHL SL Mar-19 23 128 40 19.50 22.10 27-Nov-18 +15.9 27.5 1.3 2.6 5.9 176.4

MELS SL Mar-19 55 301 115 47.00 47.80 19-Nov-18 +3.8 8.2 0.6 2.1 8.1 32.4

SPEN SL Mar-19 18 100 6 45.00 49.60 16-Nov-18 +13.6 7.2 0.4 3.3 5.6 43.8

Average 14.2 1.0 2.9 8.0 49.0

Sector has traded below the historical rangeSector has tracked the broader market over the past two years

The sector is trading at 13.4x FY19E EPS, trading at a ~15.8% discount to its five year trading average


60

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Conglomerates ASPI

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P/E (x)

Conglomerates ASPI Average


JANUARY 2019

Trade tensions key overhang in 2019

LOGISTICS SECTOR

Return to TOC

Logistics sector earnings to be up ~55.0% in FY19E

69

▪ We take a positive view on the Logistics sector

– Maritime

o Terminal and bunkering operations will perform well due to demand created through the operations at the deep-water terminal

o However, terminal operations will face constraints by end next year due to lack of capacity

– Integrated logistics

o Companies exposed to both local and regional operations will benefit, in particular, larger players who control strong volumes in

different sectors (EXPO and HAYL)

▪ Our coverage includes EXPO and we expect sector earnings to be up 54.8% YoY in FY19E and up 27.7% YoY in FY20E

▪ There is also indirect exposure to the sector through JKH, HHL, SPEN and HAYL

– JKH – bunkering, terminal operations, integrated logistics

– HEMS – integrated logistics, shipping agency

– SPEN – port management, integrated logistics

– HAYL – integrated logistics

US/China trade tensions remain the key risk in 2019 to the sector

70

▪ Main risks are;

– Slowdown in global trade. Trade tensions between the US and China is expected to be the main risk to global trade currently. Should

there be no amicable agreement between the governments, the impact from the slowdown will be seen through 2019

o There has already been a front-loading of exports in 2018, which could result in slow orders in 2019 despite no escalation of the

trade war

o In late September 2018, WTO cut its forecast for world merchandise trade volume growth to +3.9% in 2018 from the previous

forecast if +4.4% and +3.7% for 2019E from its previous forecast of +4.0%.

o Currently new discussions have begun between the two governments to renegotiate terms. Deadline for negotiations are set for

March 2019

– Competition from regional players (ports and integrated logistics players)

– Continuous consolidation of shipping lines resulting in higher bargaining power for the alliances


BBG

TickerYear end

Market capADV

(USD k)

CMP


FY2019E


EXPO SL Mar-19 8 43 10 4.00 5.80 14-Nov-18 +48.8 7.1 0.6 3.8 8.3 6.0

Average 7.1 0.6 3.8 8.3 6.0

Valuations are below the historical rangeSector has outperformed the ASPI over the past year

EXPO is trading at 7.1x FY19E EPS, which is at a ~48.0% discount to the five-year trading average


70

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130

140


Index value

Logistics ASPI

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P/E (x)

Logistics ASPI Average


JANUARY 2019

Slowdown to draw out into 2019

CONSTRUCTION SECTOR

Return to TOC

Slowdown to prolong; margins to see some respite in CY19E

73

▪ We take a neutral view on the construction sector for 2019

▪ On the demand side, we expect the sector to continue to be impacted by slow government expenditure in the light of rising debt

commitments in 2019 while sustained, relatively higher interest rates will impact demand in the residential sector.

▪ While ASP-led revenue growth was seen in 1H FY19, global commodity prices that peaked since 2014 saw the margins in the construction

sector being hit. However as global commodity prices ease out slightly in 2H CY18 and is expected to remain stable at current levels, we

believe the increased ASPs will provide some respite to margins heading into FY20E.

▪ We expect sector earnings to be fall 26.7% YoY in FY19E and expect the sector to see recovery in FY20E to grow 32.7% YoY in FY20E.

▪ With expanded industry capacities remain underutilised given tepid volume growth, the key concern in the sector is a working capital

crunch. With the GoSL and its agencies remaining the largest buyer of construction services, delays in LG elections has resulted in non-

payment of the existing Local Government (LG) contracts, in turn having a ripple effect where unpaid contractors extended credit or

default payments from retailers, resulting in attempts to extend credit with material manufacturers.

▪ In our view, some of the factors that would lead to a pick up in the construction sector include

– Holding of elections without further delay,

– A fall in interest rates to drive residential growth and…

– A sharp fall in global commodity prices which would lead to companies cutting ASPs, which in turn would drive higher volumes while

maintaining margins

Slowdown to prolong; margins to see some respite in CY19E

74

BBG

Ticker Year end

Market capADV

(USD k)

CMP


FY2019E


TKYO SL Mar-19 9 51 42 24.00 25.00 21-Nov-18 +6.3 27.0 0.6 2.1 2.3 97.4

ACL SL Mar-19 4 24 2 36.00 46.00 19-Nov-18 +31.9 6.0 0.4 4.2 6.7 13.4

AEL SL Mar-19 14 75 81 13.70 20.20 12-Nov-18 +54.7 6.3 0.6 7.3 10.1 31.9

TILE SL Mar-19 4 22 0 77.00 77.00 15-Nov-18 +5.2 7.8 0.6 5.2 7.4 6.0

RCL SL Mar-19 8 45 2 73.40 75.00 21-Nov-18 +9.0 4.2 0.4 6.8 9.2 56.1

PARQ SL Mar-19 1 6 1 38.70 38.00 15-Nov-18 -0.5 22.0 0.5 1.3 2.4 103.5

ALUM SL Mar-19 4 22 1 13.10 15.50 05-Nov-18 +26.0 10.0 1.7 7.6 17.1 161.5

Average 11.9 0.7 4.9 7.9 67.1


Valuations are below the historical rangeThe Ministry of Finance expects infrastructure expenditure to pickup 54.2% YoY growth in 2019E. However, we believe the GoSL will be forced to cut

their expenses on the public investment front to meet debt obligations in 2019 and 2020.

Infrastructure Expenditure

75

The overall slowdown is mainly driven by cuts in expenditure on expressway, highways, roads, bridges and flyovers, which on

average have accounted for ~70.0% of total infrastructure expenditure in the past.

Source: Ministry of Finance, Asia Securities

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2013 2014 2015 2016 2017E 2018E 2019E 2020E

(%)LKR bn

Exp. Way (LHS) Highways (LHS) Roads (LHS) Bridges & F/O (LHS) Irrigation (LHS) Water supply (LHS) As a % of GDP (RHS)

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Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2011 2012 2013 2014 2015 2016 2017

1995 = 100

Greater Colombo housing index 2M Moving Avg

Valuations are below the historical rangeHousing approvals have been on declining trend following interest rate hikes; a 100bps policy rate hike in combination with a 150bps increase in the

reserve ratio in 2016 and a further 25bps policy rate hike in early 2017 saw lending rates picking up

Residential Demand

76

Given our view that there won’t be any further rate cuts 2019, we believe the slowdown in residential demand will continue

throughout 2019

Source: Central Bank of Sri Lanka, Asia Securities

…while valuations have been below the ASPISector has outperformed the ASPI in the past…

The sector is currently trading at 6.1x FY19E EPS, which is at a 32.3% discount to the five-year average


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Index value

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JANUARY 2019

Textiles to continue steady trajectory

MANUFACTURING

Return to TOC

Textile sector remains resilient; non-textile names continue to see pressure

79

▪ We remain bullish on the textile industry with Sri Lanka standing to benefit from US and EU markets as Consumer Confidence peaked in 1H

CY18 since the 2007 global recession. This, coupled with GSP+ benefits which has seen an increased shift in sales volumes towards the EU

markets cements our bullish view on the textile sector.

▪ However, a recent dip in US and EU Consumer Confidence index remains a concern to us heading into 2019.

▪ We also take a positive view on the export names within the manufacturing space, for which we expect to see tailwinds from the

depreciating LKR positively impact the financial statements.

▪ We expect companies, such as GLAS SL, who are exposed primarily to the local market, to be impacted by the slowdown in the domestic

segment due to heavy taxes imposed on liquor and sugar taxes on the F&B segment, which we believe will be sustained in 2019.

▪ We expect sector earnings to grow 35.1% YoY mainly driven by the textile names, TJL SL and MGT SL. Of this, we expect TJL to contribute

the highest growth given its expanded capacity, coupled with strong demand from the US and EU markets.


BBG

TickerYear end

Market capADV

(USD k)

CMP


FY2019E


MGT Mar-19 2 11 10 9.20 14.00 05-Nov-18 +52.2 7.5 0.7 - 9.0 140.9

TJL Mar-19 24 131 48 33.90 40.00 02-Nov-18 +23.9 10.5 1.9 5.9 18.5 -22.1

GLAS Mar-19 4 19 3 3.70 4.30 05-Nov-18 +20.3 16.8 0.8 4.1 4.9 10.0

Average 11.6 1.1 3.3 10.8 42.9

Valuations are above the ASPI Sector index has fallen since the consumer slowdown

The sector is trading at 13.1x FY19E EPS, which is at a 12.6% discount to the three-year average of 15.0x

80

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Manufacturing ASPI


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P/E (x)

Manufacturing ASPI Average


JANUARY 2019

A mixed dose for 2019; hospitals to see steady growth

HEALTHCARE SECTOR

Return to TOC

Healthcare sector earnings to be up ~31.0% in FY19E

82

▪ We take a positive view on the Healthcare sector (hospitals)

– Hospital earnings have now normalized with the impact from dengue and VAT wearing off, and seeing steady growth from NCD related

surgeries and OPD business

– Due to price controls and FX devaluation, the largest segment in the industry, pharmaceutical distribution, will continue to see

earnings headwinds and margin pressure. Currently there are no pure play Pharmaceutical distributors which are listed and could only

be accessed by investing in HHL

– Pharma manufacturing business to benefit from government buyback programs. There are limited options in which to play this story,

with the only player listed (JL Morison) being 98.0% owned by HHL.

▪ As such, companies exposed to the Hospital sector and pharma production will benefit in 2019

▪ We believe the impact from increase in corporate taxes is already priced in

▪ Our coverage includes ASIR and LHCL, and we expect sector earnings to be up 31.4% YoY in FY19E and up 42.7% YoY in FY20E

▪ Main risks are improvement to public healthcare services and policy inconsistency


BBG

TickerYear end

Market capADV

(USD k)

CMP


FY2019E


ASIR SL Mar-19 25 138 11 22.00 30.00 16-Nov-18 +39.1 16.3 3.4 2.7 19.9 114.9

LHCL SL Dec-18 9 51 0 41.80 60.00 09-Nov-18 +48.3 14.7 1.5 4.8 10.4 -1.2

Average 15.5 2.5 3.8 15.2 56.9

Valuations are below the historical rangeSector has outperformed the ASPI over the past year

The Healthcare sector is trading at 16.3x FY19E EPS, which is at a 23.3% discount to the five-year trading

average


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Index value

Healthcare ASPI

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16

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31

36

41


P/E (x)

Healthcare ASPI Average


JANUARY 2019

Occupancies and ARRs remain under pressure

LEISURE SECTOR

Return to TOC

Leisure sector earnings to remain under pressure on over-supply

85

▪ We take a neutral view on the Leisure sector for 2019

▪ We continue to expect city hotel and resort sector earnings to remain under pressure in the medium term (2019-2021) as room inventory

growth continues to outpace that of arrivals, adding pressure to occupancies and room rates.

▪ On the supply side we see;

– Robust growth in both formal and informal sector inventory to continue, although occupancy split will remain stable at 50/50

– Star-graded city hotel occupancy dilution to be more acute in 2019 with four major hotel projects coming into operation in Colombo;

Next (164), Pearl Grand Tower Hotel (307), Park Inn by Radisson (199), Sheraton (306)

▪ Catalysts for a pick up in arrivals in the medium include;

– depreciation of the currency

– launch of a comprehensive promotional campaign “So Sri Lanka” along with,

– Lonely Planet endorsement

▪ However, we don’t expect this to materialise in CY19 given;

– political headwinds (general, provincial and presidential elections) that are likely to add drag on arrivals

– travel warnings and negative foreign press Sri Lanka received following political events in October 2018

– Not only did this have an impact on peak season bookings, but also over shadowed promotional traction that was gathering pace post

Lonely Planet thumbs up

Source: Asia Securities, SLTDA

Leisure sector earnings to remain under pressure on over-supply (cont.)

86

BBG

TickerYear end

Market capADV

(USD k)

CMP


FY2019E


AHUN Mar-19 9 48 1 26.00 30.00 12-Nov-18 +19.2 7.1 0.4 3.8 6.1 0.7

KHL Mar-19 11 58 1 7.30 8.40 21-Nov-18 +19.2 7.8 0.4 4.1 5.1 0.1

AHPL Mar-19 19 103 2 42.00 42.00 21-Nov-18 +2.4 11.5 0.6 3.5 5.1 0.0

Average +8.8 8.8 0.5 3.8 5.4 0.0


▪ Given the loss in promotional momentum and uncertain political environment that discourages tourists, we expect CY19E arrivals to

amount to 2.5mn, (+8.6% YoY). In absolute terms, we expect the increase to be ~200,000, below the historical average YoY increase of

250,000 p.a.

▪ Nevertheless, we look more favourably on operators with a noteworthy exposure to Maldives, as the market is expected to rebound in

2019 on the back of

▪ stabilising political environment

▪ airport capacity expansion which is expected to come into operation in 2019

Valuations are below the historical rangeWe expect arrivals to come in at 2.5mn CY19E and reach 3.0mn by CY21. The dip in momentum for CY19E is based on the expectation that travel

warnings issued in October 2018 and the upcoming election season to have an impact on overall arrivals

Tourist Arrivals

87

SLTDA targeted 2.5mn arrivals for 2018 and 4mn arrivals by 2020. We note that the annuals target have been missed on three

consecutive years due to travel advisories and lack of comprehensive promotional campaign for Sri Lanka

Source: SLTDA, Asia Securities

+201,499+149,630

+268,988

+252,560

+271,227

+252,452 +65,575+217,389

+200,706

+253,450

+253,704

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CY10 CY11 CY12 CY13 CY14 CY15 CY16 CY17 CY18 CY19E CY20E CY21E

Arrivals

Total Increase Growth YoY (%)

%

Valuations are below the historical rangeWe expect the capacity absorption to pick up in 2022 and beyond, gradually closing the gap between demand and supply.

Capacity Absorption

88

In the longer term, we expect room inventory growth to taper down as the government focuses on approving smaller, villa/boutique

style properties. Further, we expect Sri Lank to reach its arrivals target 4.0mn by 2025 based on a p.a. growth rate of 8.0%.

Source: SLTDA, Asia Securities

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4

6

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12

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 2019 2022

%mn

Available hotel nights (LHS) Occupied hotel nights (LHS) Hotel occupancy rate (RHS)

Forecast period

Valuations are below historical average Sector has underperformed the ASPI over the past year

The Leisure sector is trading at 11.6x FY19E EPS, a 7.9% discount to the five-year average


-

20

40

60

80

100

120

140


Index value

Leisure ASPI

6

8

10

12

14

16

18

20


P/E (x)

Leisure ASPI Average


JANUARY 2019

GI growth capped; LI finds new growth avenues

INSURANCE SECTOR

Return to TOC

GI to see a softening year, while LI recovery will depend on improved affordability

91

▪ We take a neutral view on the insurance sector for 2019

▪ The GI industry would see some softening in new business given the dual impact on new vehicle imports; 1) tightened import restrictions

which saw new registrations drop drastically since October 2018, and 2) LKR depreciation, which increases the overall acquisition cost and

maintenance costs.

▪ With no significant movement expected in the claims ratio (unless a major weather event occurs) and the expense ratio, we expect

earnings to be soft for GI business in CY19E

▪ While we expected the LI business to face headwinds in 2018, on the back of low household spending power, we note that the LI companies

under our coverage recorded ~10% growth in gross written premium (GWP) with most businesses turning into alternative channels for

growth (bancassurance, group life/health, etc.)

▪ Accordingly, we expect the LI businesses to report robust 4Q CY18E results and also expect a growth in LI surplus transfers in CY18E

▪ Looking ahead, we believe that a material pick up in LI business will largely driven by a recovery in consumer spending. Thus, we expect

this to take effect from 4Q CY19 vs. our initial expectation of 3Q CY19

▪ With the new IRA regulations, LI surplus transfers are now taxable, but all the companies have carry-forward tax losses which will be

utilised in the next 2-3 years which means that taxation will not be an immediate concern for the LI players.

▪ On the other hand, in line with our expectations of upward pressure on market rates, we expect the investment returns to show an

increase.

Our coverage of five stocks include two composites, two pure-play life insurers and one pure-play GI

92

BBG

TickerYear end

Market capADV

(USD k)

CMP


CY2019E


CINS SL Dec-18 46 252 148 1,995.00 2,000.00 28-Nov-18 +1.9 5.1 1.0 1.6 22.0 na

PINS SL Dec-18 4 21 2 19.00 21.00 19-Nov-18 +18.9 5.5 1.0 9.5 19.0 na

AAIC SL Dec-18 17 91 221 44.20 35.50 12-Nov-18 -17.4 9.0 2.9 2.3 37.1 na

HASU SL Dec-18 7 38 17 139.90 114.20 12-Nov-18 -13.1 5.2 1.3 7.8 27.1 na

JINS SL Dec-18 7 37 39 29.70 UR nm nm nm nm nm na

Average -6.8 6.2 1.6 5.3 26.3


Valuations are below the historical range, but the gap is narrowingSector saw a pick up in trading towards the end of CY18

The Insurance sector is trading at 1.5x BV, 10.6% below its five-year average of 1.6x

93

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50

100

150

200

250


Index value

Insurance ASPI

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4


P/B (x)

Insurance ASPI Average



JANUARY 2019

Regulations weigh down sector growth

NBFI SECTOR

Return to TOC

Growth subdued as a result of near-term headwinds

95

▪ We take a neutral view on the NBFI sector in the short-to-medium term

▪ Leasing sector is slowing down owing to import restrictions across most vehicle categories

▪ In addition, LKR depreciation will impact the acquisition and maintenance cost of vehicles (our house view is LKR to depreciate further by

5.0% YoY to LKR 189 during CY19)

▪ Furthermore, we believe that higher lending rates will lead subdued overall net advance growth

▪ The stronger NBFIs having the ability to diversify their product range will be resilient amidst the changes in the industry, with diversification

into different product categories is seen as a critical success factor

▪ Companies are seen moving to second hand leasing amidst slow demand for leases

– Risks: High competition from already established large players having significant market share

▪ Gold loans are another product which the NBFIs have diversified into

– LFIN has 20% exposure in terms of loan book; there is further potential to grow in this segment

– However, competition from banks is high

Valuations are below the historical rangeNIMs are to pick up slowly during FY20E mainly due to upward revision of the ceiling rate of 12 month fixed deposits offered by the NBFIs

Average net interest margins of the sector

96Source: Company data, Asia Securities | Data includes PLC, CFIN, LFIN, CDB, and COCR revenues

12.9

12.2

11.511.5

11.3 11.4

11.7

FY15 FY16 FY17 FY18 FY19E FY20E FY21E

NIM (%)

Valuations are below the historical rangeImpairments picked up across all stocks over the last 12M

TTM Impairment charge

97Source: Company data, Asia Securities | Data includes PLC, CFIN, LFIN, CDB, and COCR revenues

-4,500

-4,000

-3,500

-3,000

-2,500

-2,000

-1,500

-1,000

-500

0

LFIN CDB CFIN PLC COCR

LKR mn

TTM 2Q FY18 TTM 2Q FY19

NBFI earnings growth to remain subdued on the back of slowdown in leasing

98

▪ We forecast sector earnings to grow at 1.4% YoY in FY19E due to a 27.5% YoY drop in COCR’s earnings

▪ Net advances growth will come in at 7.7% YoY during FY19E, excluding CDB that has net advance growth of 18.0% YoY for FY19E

▪ We expect NIMs to average around 11.33% for the sector during FY19E

– Currently CDB has the lowest NIMs within the sector (CFIN – 16.99%, PLC – 9.51%, LFIN – 12.81%, COCR-15.57%, CDB -6.95%)


BBG

TickerYear end

Market capADV

(USD k)

CMP


FY2019E


PLC SL Mar-19 24 130 10 15.00 15.00 31-Oct +8.3 4.8 0.8 8.3 16.9 nm

CFIN SL Mar-19 19 105 6 87.00 97.00 14-Nov +16.1 3.4 0.5 4.6 15.2 nm

LFIN SL Mar-19 17 93 14 122.50 118.60 8-Nov +5.8 3.6 0.9 9.0 27.7 nm

CDB SL Dec-18 4 21 3 83.50 84.90 16-Nov +7.7 2.7 0.5 6.0 20.3 nm

COCR SL Dec-18 9 48 0 27.30 22.50 12-Dec -14.8 4.7 0.6 2.7 13.2 nm

Average 3.8 0.7 6.1 18.7 nm

Near term headwinds

99

▪ Import restrictions, a 200% deposit for LCs, higher import duties, depreciating LKR, and lower loan to value ratios across several vehicle

categories will curb new vehicle demand

▪ We believe these restrictions will prevail in the medium term

▪ Significant impairments due to IFRS 9 implementation combined with a slow growth environment

▪ 35% threshold rate imposed on interest rates on micro loans will restrict micro lenders

– COCR, having ~20% of loan portfolio concentrated in micro segment will be most impacted

▪ All NBFIs are required to increase the core capital requirement by 5x to LKR 2.0bn by 2020, and to LKR 2.5bn by 2021

– All companies within our coverage fulfill this requirement

– This is expected to drive consolidation during 2020 and 2021 as 10 out of the 28 listed companies currently do not meet this

requirement

▪ Upward revision of deposit rates triggering a pick up in cost of funds in CY20E to lead to narrowing NIMs

– The central bank revised the ceiling rate that finance companies offer on 12 month FDs to 14.22% from 12.46% with a further

provision to offer additional 1% to senior citizens from 1st Jan 2018.

– Lending rates of NBFIs are also expected to adjust upward , however, not significantly as it may affect loan demand. As a result, we

see NIMs narrowing in the short term.

– The impact is relatively low on large and established NBFIs such as PLC, CFIN and LFIN compared to small NBFIs having liquidity

concerns.

…while valuations have been below the ASPISector has outperformed the ASPI in the past…

The sector is currently trading at 0.7x FY19E BVPS, which is at a 36.3% discount to the five-year average


-

50

100

150

200

250

300


Index value

Financials ASPI

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2

Oct-13 Oct-14 Oct-15 Oct-16 Oct-17 Oct-18

P/B (x)

Financials ASPI Average

Sector trading at a discount which is warranted given the near-term headwinds; no top pick for 2019

101

▪ The sector is currently trading at 0.7x FY19E BV coming down significantly from the 1.1x recorded for the past five years

▪ Our forecasted sector ROE is 18.7% for FY19E and 17.3% for FY20E, coming down from the previously forecasted 19.4% for FY19E and 23.6%

for FY20E

▪ As a result of low growth expected for the sector stemming from both leasing and loans, we do not recommend a top pick for 2019

▪ Long-term picks: Based on expectations of a pick up in the overall sentiment of NBFI sector and relaxation of import levies, we recommend

PLC and CFIN as long-term picks

▪ PLC

– ~75% of leasing advances are concentrated in commercial leasing which has less impact from import restrictions. Largest NBFI having a

large branch network (103 branches compared with the coverage average of 91) with the backup of People’s bank.

– Strong core capital positioning (core capital recorded at LKR 26.5bn for FY18 which is well above the 2021 requirement of LKR 2.5bn)

▪ CFIN

– Strong positioning in the second hand leasing segment which has relatively positive impact from import restrictions and having a large

branch network (97 branches). Strong core capital position of LKR 25.7bn as at FY18, comfortably covering the 2021 requirement of

LKR 2.5bn

– Strong NIMs position (TTM 12M NIMs 16.99%, currently the highest within our coverage) providing better ability to absorb the pressure

from the rise in cost of funds and conservative strategy leading to lowest impairments within the coverage (TTM impairments at LKR

809mn)

– Poor dividend payer: CFIN needs to grow its dividend payout (4.6% DY compared to 6.1% DY for the sector for FY19E, PLC and LFIN

have DYs of 8.3% and 9.0% respectively for FY19E )


JANUARY 2019

Increasing vulnerabilities drive neutral outlook

Energy

Return to TOC

Implementation of pricing formula to drive recovery of sector earnings

103

▪ We maintain a neutral view on the local energy sector for 2019. Despite the absence of the pricing formula as of January ’19, we believe it

is imperative the GoSL re-introduces the pricing formula to meet the conditions for the IMF EFF.

▪ While this will benefit companies such as LIOC in the Energy space, a low likelihood of implementing a pricing formula in the local LPG

market lets us to have a negative view on this subsector.

▪ We continue to take a bearish view on the Lubricant Market as stiff competition within the sector with six additional players likely to enter

the market (currently 13) will cause volumes to further dilute.

▪ We expect energy sector earnings to recover in FY19E, mainly driven by LIOC coming back into profits following the pricing formula.

▪ We expect some respite to the energy segment from crude oil prices that have weakened since peaking in October 2018. We note that

crude oil prices have fallen 36.7% as of December 2018, since peaking at ~USD 81.00/bbl in October 2018

▪ Despite the fall in crude oil prices, we note that the depreciation of the LKR against the USD offsets these benefits partly. We note that the

LKR has depreciated 18.8% in 2018, while depreciating 7.8% between October to December alone.

BBG

TickerYear end

Market capADV

(USD k)

CMP


FY2019E


LLUB Mar-19 18 98 87 73.90 74.00 31-Oct-18 +11.0 8.1 4.2 10.8 52.7 -14.3

LGL Mar-19 6 33 2 17.90 20.10 19-Nov-18 +12.3 nm 2.8 - nm 78.7

LIOC Dec-18 12 67 6 23.00 UR 29-Oct-18 nm nm nm nm nm 214.6

Average 8.6 3.5 5.4 52.7 93.0

Valuations are below the historical rangeEnergy prices have been on a declining trend towards end 2018…

Crude oil prices

104

…while Bloomberg futures show prices to stabilise at current levels in 2019

Source: Bloomberg, Saudi Aramco, Asia Securities

0

10

20

30

40

50

60

70

80

90

0

100

200

300

400

500

600

700

Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18

USD/bblUSD/ton

Propane (LHS) Butane (LHS) WTI (RHS) Brent (RHS)


JANUARY 2019

Key Picks – Investment Thesis

Rerouted to deliver value

106

▪ Investments in key trade lanes to reap benefits in the long-run

– Significant investments in the transpacific trade lane

▪ Focus on yield management results in more stable margins

▪ Leisure and commodity exports to remain focused on core operations

▪ Our DCF valuation indicates a TP of LKR 5.80/share resulting in a TSR of +48.8%. BUY

Source: Company data, Asia Securities | Priced as at end 11 Jan 2019

Financial summary

In LKR mn FY16 FY17 FY18 FY19E FY20E FY21E

Revenue 56,015 63,492 77,533 97,118 112,653 125,654

EBITDA 1,902 2,060 1,760 2,508 3,093 3,751

Recurring net profit 1,113 955 711 1,100 1,405 1,754

Diluted recurring EPS (LKR) 0.57 0.49 0.36 0.56 0.72 0.90

ROE (%) 9.9 7.9 5.7 8.3 9.9 11.4

P/E (x) 7.0 8.2 11.0 7.1 5.6 4.5

EV/EBITDA (x) 4.6 4.2 4.8 3.5 2.9 2.4

P/B (x) 0.7 0.6 0.6 0.6 0.5 0.5

Regular business to drive growth

107

▪ Largest private sector hospital operator in the country; with Kandy 12.0% of private sector capacity

▪ Promotional investments at Asiri Surgical in new surgical packages, now reaping benefits

▪ Completion of key projects leads to debt repayment and lower interest costs from FY20E onwards

▪ Acquisition of Hemas Galle hospital; Long-term benefits to come through consolidation of bed-capacity

▪ Our DCF valuation indicates a TP of LKR 30.00/share resulting in a TSR of +39.1%. BUY


Financial summary

In LKR mn FY16 FY17 FY18 FY19E FY20E FY21E

Revenue 9,952 10,397 12,025 14,556 17,483 19,749

EBITDA 2,850 2,914 3,540 4,269 5,541 6,075

Recurring net profit 1,053 1,024 1,156 1,532 2,342 2,688

Diluted recurring EPS (LKR) 0.93 0.90 1.02 1.35 2.06 2.36

ROE (%) 1.94 0.95 0.60 0.60 0.60 0.60

P/E (x) 23.8 24.4 21.6 16.3 10.7 9.3

EV/EBITDA (x) 13.6 13.3 10.9 9.0 7.0 6.4

P/B (x) 4.6 4.3 3.6 3.4 2.8 2.3

Tuning in through the noise

108

▪ DIAL’s capex spend in the past few years was focused on expanding its 4G coverage, conversion of 3G equipment into 4G and taking a

further step by ensuring the equipment is easily upgradable to 5G

▪ We believe this cycle is already nearing completion, but DIAL would continue with expanding the coverage in CY19E and CY20E

▪ Data business has overtaken voice as the largest revenue generator, and we believe the added boost to the voice business will continue to

support MOUs and revenue

▪ The stock has seen a 22.3% price drop in 2018, and trades at 2.6x CY19E EBITDA, vs. the last 5-yr average of 4.8x, which we believe is

unwarranted

▪ Our latest TP for DIAL is LKR 13.00/share (+28.7% upside; +32.2% TSR)

▪ Key risks

– Increasing depreciation driven by the capex cycle and high interest cost on USD debt with a pick up in LIBOR

– Currency depreciation weighing on reported earnings, albeit this is a non-cash translation loss


Financial summary

In LKR mn CY15 CY16 CY17 CY18E CY19E CY20E

Revenue 73,930 86,745 94,196 106,633 119,207 134,017

EBITDA 23,969 29,136 33,636 41,523 45,699 51,059


Recurring diluted EPS (LKR) 0.94 1.21 1.35 1.60 1.72 1.96

TTM ROE 16.6 19.4 19.0 20.5 19.6 19.6

P/E (x) 10.7 8.3 7.4 6.3 5.9 5.2

EV/EBITDA (x) 5.0 4.1 3.5 2.9 2.6 2.3

P/B (x) 2.1 1.8 1.6 1.4 1.2 1.1

Steady fundamentals masked by short-term headwinds and weak momentum

109

▪ Sampath Bank (SAMP) is the fifth-largest bank in the country by gross loans, with a strong presence in the retail and SME segments

▪ With the current weak economic conditions, we expect SAMP to reduce exposure to SME, and focus largely on corporate and collateralised

retail lending

▪ We believe SAMP’s loan growth would moderate to ~17.0% levels in CY19E-21E, taking a break from its historic aggressive growth which

averaged 23.4% in CY14-17. We believe this allows the bank to focus more on quality loan growth, especially with SMEs

▪ Similar to the industry, we expect earnings to remain weak in CY18E mainly on the back of high impairments. Cost of risk for the bank

increased to 140bps in 9M CY18, but we expect this to trend down to 120bps by CY19E

▪ Given SAMP’s exposure to construction and tourism sectors, we see the NPLs picking up slightly higher in 1H CY19 before hitting the peak

▪ The stock has seen an 18.4% price drop in 2018 with a large part of the dip seen after July 2018 owing to non-fundamental factors. SAMP

trades at 0.6x CY19E BV, vs. 1.2x past 5-year average

▪ Our latest TP for SAMP is LKR 270.00/share (+23.8% upside; +31.1% TSR)


Financial summary


Net interest income 18,550 23,955 30,297 38,173 43,712 51,650

Pre-impairment income 12,780 17,691 24,453 32,598 37,122 44,423


Gross loans and advances 393,654 480,917 595,687 696,954 822,405 970,438


ROE (%) 18.0 21.4 21.4 15.6 14.9 17.5

P/E (x) 7.2 5.0 4.8 4.9 4.4 3.3

P/B (x) 1.2 1.0 0.7 0.7 0.6 0.5

Driving strong roots deep into the economy

110

▪ HNB has a well-balanced customer exposure across corporate, retail and SME segments that support its growth profile.

▪ It has one of the highest net interest margins (NIMs) within our coverage (Q3 CY18: 4.58%) buoyed by the strong SME and retail presence,

whilst the bank enjoys relatively low cost of funds supported by high CASA levels driven by robust corporate business

▪ Its wide branch network (252 island-wide), and mindshare provides a strong footing to grow into the high-margin SME and MSME business

profitably while managing the risks

▪ The bank has a strong focus on NIM management, and has shown its willingness to forego growth to maintain NIMs. We expect HNB would

record loan growth of 16.5% in CY19E

▪ The bank seems to be slightly ahead of the peers in terms of the credit cycle, given its early exposure to rising NPLs through the agriculture

sector which we view as a positive in the current environment

▪ The stock has dropped 13.4% in 2018 and currently trades at 0.7x CY19E BV, vs. 1.3x past 5-year average

▪ Our latest TP for HNB is LKR 250.00/share (+22.0% upside; +26.1% TSR)


Financial summary





Gross loans and advances 518,586 608,966 666,768 773,451 901,071 1,054,253


ROE (%) 14.7 17.7 15.2 14.2 15.1 16.4

P/E (x) 9.4 6.8 6.1 5.5 4.6 3.7

P/B (x) 1.3 1.1 0.8 0.8 0.7 0.6

Capacity additions to lead FY19E-20E growth

111

▪ Expanded capacity fully operational; will lead growth in FY19E-20E

▪ Rising cotton prices remain key threat; company takes measures to mitigate risk

▪ Move into Asia to lead next phase of growth

▪ More focus on synthetic line for next phase of growth

▪ We value the stock at a TP of LKR 40.00/share FY19E (+18.0% upside; +23.9% TSR).

Key ratios

FY16 FY17 FY18 FY19E FY20E FY21E

P/E (x) 10.9 12.0 14.8 10.5 9.5 7.9

EV/EBITDA (x) 7.4 7.7 8.1 6.2 5.6 4.8

P/B (x) 2.3 2.1 2.0 1.9 1.8 1.6

ROA (%) 18.6 12.7 9.2 11.9 12.0 13.1

ROE (%) 25.3 18.4 14.0 18.5 19.1 21.2

Dividend payout (%) 51.3 79.9 69.8 62.0 63.0 58.2

Dividend yield (%) 4.7 6.6 4.7 5.9 6.6 7.4


Attractive entry point to the industry leader

112

▪ COMB is the third largest bank in SL with a strong brand value, robust net interest margins (4.0%), and an efficient cost structure

(cost/income: ~34%)

▪ We expect its dominant position in SME and corporate segments to drive loan growth in the next few years (we forecast 16.5% in CY19E)

▪ With sufficient liquidity (loan-to-deposit ratios at ~90.0%), we expect the bank to see lower pressure from the market-wide rise in cost of

funds, which should support volume growth

▪ In addition, the bank boasts the lowest opex/branch in the sector, and its continuous focus on digitisation drives cost efficiency (C/I

reached ~34% by 3Q CY18)

▪ COMB’s solid provisioning policy provides downside protection in an environment of deteriorating asset quality

▪ The bank is sufficiently capitalised with a T1 CAR of 11.24% and total CAR of 15.69% as of CY18E, comfortably above even the increased

requirements of 10.00% and 14.00% that come into effect in 2019

▪ The stock has seen a 14.2% price drop in 2018 and trades at 0.9x CY19E BV, vs. 1.5x past 5-year average

▪ Our latest TP for COMB is LKR 128.00/share (+12.3% upside; +18.2% TSR)


Financial summary





Gross loans and advances 528,984 638,607 761,094 890,481 1,037,410 1,193,021


ROE (%) 16.7 19.4 17.8 16.1 16.8 16.6

P/E (x) 9.6 7.8 6.8 6.3 5.4 4.8

P/B (x) 1.6 1.5 1.1 1.0 0.9 0.8


JANUARY 2019

Coverage Universe

114Source: Asia Securities | Priced as at end 11 Jan 2019, *Recommendation could vary from analyst published one due to price movements

BBG

Ticker

Market cap ADV

(USD

k)

CMP

(LKR)

12m TP

(LKR)

TSR

(%)Rec

P/E (x)

PEG

P/B (x) D/Y (%) ROE (x) ROA (x)

LKR bnUSD

mn

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

Conglomerates

HHL 49 269 72 85.00 130.00 +55.3 BUY 14.0 9.9 0.4 1.8 1.6 2.4 2.4 13.4 16.8 6.9 8.7

JKH 212 1,167 1,995 153.00 166.00 +12.4 HOLD 14.4 11.5 2.1 1.0 1.0 3.9 3.9 7.1 8.7 5.0 5.8

SHL 23 128 40 19.50 22.10 +15.9 BUY 27.5 18.8 0.1 1.3 1.2 2.6 2.6 5.9 6.8 3.2 3.7

MELS 55 301 115 47.00 47.80 +3.8 HOLD 8.2 6.4 0.4 0.6 0.6 2.1 2.1 8.1 9.6 3.9 4.8

SPEN 18 100 6 45.00 49.60 +13.6 HOLD 7.2 6.1 1.5 0.4 0.4 3.3 3.3 5.6 6.2 3.5 4.1

Average 14.2 10.5 0.9 1.0 0.9 2.9 2.9 8.0 9.6 4.5 5.4

FMCG/R

CARG 51 279 19 198.00 175.00 -9.6 HOLD 23.3 18.1 1.2 2.9 2.7 2.0 2.5 12.9 15.3 5.7 6.7

CCS 71 392 2 750.00 700.00 -4.0 HOLD 41.5 28.6 3.3 5.2 4.7 2.7 2.7 12.5 17.2 6.0 7.6

KFP 4 21 0 147.00 135.00 -4.1 HOLD 12.0 10.9 0.8 2.0 1.8 4.1 4.1 17.3 17.7 12.6 13.1

NEST 91 502 26 1,700.00 1,800.00 +9.9 HOLD 24.2 21.0 1.9 18.8 18.4 4.1 4.6 78.0 88.4 24.8 27.0

CTC 264 1,453 77 1,410.20 1,260.00 -4.8 HOLD 16.7 15.5 1.6 54.8 51.3 5.9 6.3 336.4 340.9 64.9 70.6

Average 23.6 18.8 1.8 16.7 15.8 3.7 4.0 91.4 95.9 22.8 25.0

115

BBG

Ticker

Market cap ADV

(USD

k)

CMP

(LKR)

12m TP

(LKR)

TSR

(%)Rec

P/E (x)

PEG


LKR bnUSD

mn

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

Banks

SAMP 61 337 342 218.10 270.00 +31.1 BUY 4.9 4.4 0.3 0.7 0.6 7.3 8.7 15.6 14.9 1.4 1.4

HNB 97 535 286 205.00 250.00 +26.1 BUY 5.5 4.7 0.3 0.8 0.7 4.1 4.1 14.2 15.1 1.7 1.8

COMB 114 627 300 114.00 128.00 +18.2 BUY 6.3 5.4 0.5 1.0 0.9 5.9 7.0 16.1 16.8 1.5 1.5

SEYB 22 120 17 76.00 71.40 -1.4 HOLD 6.0 5.8 1.2 0.7 0.7 4.6 4.6 12.4 12.1 1.1 1.0

NDB 22 121 219 104.80 110.00 +11.2 HOLD 6.0 5.4 0.6 0.6 0.5 6.2 7.2 11.5 10.7 1.0 1.0

NTB 24 131 6 86.30 98.90 +17.5 BUY 6.5 5.2 0.5 0.9 0.8 2.9 2.9 14.7 15.2 1.2 1.3

UBC 12 65 8 10.90 11.20 +3.7 HOLD 22.7 21.8 1.5 0.8 0.7 0.9 0.9 3.0 3.1 0.4 0.4

SDB4

22 3 72.20 UR nm UR nm nm nm nm nm nm nm nm nm nm nm

DFCC 24 132 4 90.30 100.00 +16.3 BUY 6.4 5.7 0.5 0.5 0.5 5.5 5.5 7.5 8.2 1.0 1.1

Average 8.1 7.3 0.7 0.7 0.7 4.7 5.1 11.9 12.0 1.2 1.2

Source: Asia Securities | Priced as at end 11 Jan 2019, *Recommendation could vary from analyst published one due to price movements

116

BBG

Ticker

Market cap ADV

(USD

k)

CMP

(LKR)

12m TP

(LKR)

TSR

(%)Rec

P/E (x)

PEG


LKR bnUSD

mn

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

Alcoholic Beverages

LION 45 245 87 556.30 710.00 +28.3 BUY 18.0 14.4 0.1 3.9 3.1 0.7 0.7 23.5 23.9 10.6 11.8

DIST 74 407 8 16.10 21.00 +35.4 BUY 13.4 11.9 0.7 10.1 7.9 5.0 5.6 79.8 74.4 21.7 24.4

Average 15.7 13.2 0.4 7.0 5.5 2.8 3.2 51.7 49.2 16.2 18.1

Construction

TKYO 9 51 42 24.00 25.00 +6.3 HOLD 27.0 9.5 (1.7) 0.6 0.6 2.1 2.5 2.3 6.4 4.5 5.9

ACL 4 24 2 36.00 46.00 +31.9 BUY 6.0 5.0 0.5 0.4 0.4 4.2 4.2 6.7 7.6 5.3 5.3

AEL 14 75 81 13.70 20.20 +54.7 BUY 6.3 5.5 (9.7) 0.6 0.6 7.3 8.8 10.1 11.0 5.7 6.4

TILE 4 22 0 77.00 77.00 +5.2 HOLD 7.8 6.0 (1.1) 0.6 0.5 5.2 6.5 7.4 9.1 5.9 7.0

RCL 8 45 2 73.40 75.00 +9.0 HOLD 4.2 3.5 (5.4) 0.4 0.3 6.8 8.2 9.2 10.3 5.9 6.4

PARQ 1 6 1 38.70 38.00 -0.5 HOLD 22.0 5.7 (2.9) 0.5 0.5 1.3 2.6 2.4 8.9 5.5 6.2

ALUM 4 22 1 13.10 15.50 +26.0 BUY 10.0 6.9 0.3 1.7 1.5 7.6 9.2 17.1 23.1 9.9 12.7

Average 11.9 6.0 (2.8) 0.7 0.6 4.9 6.0 7.9 10.9 6.1 7.1


117

BBG

Ticker

Market cap ADV

(USD

k)

CMP

(LKR)

12m TP

(LKR)

TSR

(%)Rec

P/E (x)

PEG


LKR bnUSD

mn

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

Energy

LLUB 18 98 87 73.90 74.00 +11.0 HOLD 8.1 7.8 (4.0) 4.2 4.1 10.8 12.2 52.7 52.5 38.1 38.4

LGL 6 33 2 17.90 20.10 +12.3 HOLD nm 162.7 nm 2.8 3.3 - 5.6 nm 1.9 0.4 3.3

LIOC 12 67 6 23.00 UR nm UR nm nm nm nm nm nm nm nm nm 4.7 6.5

Average 8.1 85.3 (4.0) 3.5 3.7 5.4 8.9 52.7 27.2 14.4 16.1

Telecommunications

DIAL 82 452 68 10.10 13.00 +32.6 BUY 6.3 5.9 0.5 1.4 1.2 3.9 5.9 20.5 19.5 9.9 9.7

SLTL 43 236 1 23.80 24.00 +4.6 HOLD 8.4 7.8 0.6 0.6 0.5 3.7 3.7 7.0 7.2 3.3 3.4

Average 7.4 6.8 0.6 1.0 0.9 3.8 4.8 13.8 13.4 6.6 6.6

Manufacturing

MGT 2 11 10 9.20 14.00 +52.2 BUY 7.5 6.9 (0.0) 0.7 0.6 - - 9.0 9.0 5.1 5.3

TJL 24 131 48 33.90 40.00 +23.9 BUY 10.5 9.5 0.5 1.9 1.8 5.9 6.6 18.5 19.1 11.9 12.0

GLAS 4 19 3 3.70 4.30 +20.3 BUY 16.8 7.7 0.9 0.8 0.8 4.1 8.1 4.9 10.3 4.6 6.9

Average 11.6 8.0 0.4 1.1 1.0 3.3 4.9 10.8 12.8 7.2 8.1


118Source: Asia Securities | Priced as at end 11 Jan 2019, *Recommendation could vary from analyst published one due to price movements

BBG

Ticker

Market cap ADV

(USD

k)

CMP

(LKR)

12m TP

(LKR)

TSR

(%)Rec

P/E (x)

PEG


LKR bnUSD

mn

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

Insurance

CINS 46 252 148 1,995.00 2,000.00 +1.9 HOLD 6.1 5.1 0.6 1.3 6.1 1.6 1.6 21.6 22.0 5.7 6.1

PINS 4 21 2 19.00 21.00 +18.9 BUY 5.4 5.5 (7.7) 1.1 5.4 8.4 9.5 21.9 19.0 8.7 7.7

AAIC 17 91 221 44.20 35.50 -17.4 SELL 11.6 9.0 0.4 3.9 11.6 2.3 2.3 38.9 37.1 9.7 11.0

HASU 7 38 17 139.90 114.20 -13.1 HOLD +6.8 +5.2 +0.3 +1.5 +6.8 +5.3 +7.8 +24.6 +27.1 5.1 5.7

JINS 7 37 39 29.70 UR nm UR nm nm nm nm nm nm nm nm nm 1.5 3.4

Average 7.5 6.2 (1.6) 2.0 7.5 4.4 5.3 26.7 26.3 6.1 6.8

Non-Bank Financial Institutions

PLC 24 130 10 15.00 15.00 +8.3 HOLD 4.8 4.3 0.5 0.8 0.7 8.3 8.3 16.9 17.3 2.8 2.9

LFIN 17 93 14 122.50 118.60 +5.8 HOLD 3.6 3.0 0.2 0.9 0.8 9.0 9.0 27.7 27.3 5.7 6.1

CFIN 19 105 6 87.00 97.00 +16.1 BUY 3.4 3.2 0.5 0.5 0.4 4.6 4.6 15.2 14.2 5.9 5.9

CDB 4 21 3 83.50 84.90 +7.7 HOLD 2.7 2.5 0.3 0.5 0.5 6.0 6.0 20.3 19.2 2.8 2.8

COCR 9 48 0 27.30 22.50 -14.8 HOLD 4.7 6.5 (0.2) 0.6 0.5 2.7 3.7 13.2 8.3 2.1 1.5

Average 3.8 3.9 0.3 0.7 0.6 6.1 6.3 18.7 17.3 3.9 3.8

119

BBG

Ticker

Market cap ADV

(USD

k)

CMP

(LKR)

12m TP

(LKR)

TSR

(%)Rec

P/E (x)

PEG


LKR bnUSD

mn

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

Healthcare

ASIR 25 138 11 22.00 30.0 +39.1 BUY 16.3 10.7 0.5 3.4 2.8 2.7 2.7 19.9 26.8 9.8 12.7

LHCL 9 51 0 41.80 60.00 +48.3 BUY 14.7 12.4 0.7 1.5 1.4 4.8 4.8 10.4 11.8 7.7 8.8

Average 15.5 11.6 0.6 2.5 2.1 3.8 3.8 15.2 19.3 8.8 10.8

Property

RIL 6 30 3 6.90 7.00 +2.9 HOLD 18.6 9.2 (0.1) 0.3 0.3 1.4 7.2 2.6 4.2 3.1 3.9

Average 18.6 9.2 (0.1) 0.3 0.3 1.4 7.2 2.6 4.2 3.1 3.9

Leisure

AHUN 9 48 1 26.00 30.00 +19.2 BUY 7.1 4.4 0.2 0.4 0.4 3.8 7.8 6.1 9.3 3.3 4.3

KHL 11 58 1 7.30 8.40 +19.2 BUY 7.8 5.1 0.3 0.4 0.4 4.1 5.5 5.1 7.4 4.6 6.6

AHPL 19 103 2 42.50 42.00 +2.4 HOLD 11.5 10.0 1.8 0.6 0.6 3.5 5.9 5.1 5.7 4.0 4.5

Average 8.8 6.5 0.8 0.5 0.4 3.8 6.4 5.4 7.5 4.0 5.1


120

BBG

Ticker

Market cap ADV

(USD

k)

CMP

(LKR)

12m TP

(LKR)

TSR

(%)Rec

P/E (x)

PEG


LKR bnUSD

mn

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

FY19

E

FY20

E

Logistics

EXPO 8 43 10 4.00 5.80 +48.8 BUY 7.1 5.6 0.2 0.6 0.5 3.8 3.8 8.3 9.9 4.4 5.2

Average 7.1 5.6 0.2 0.6 0.5 3.8 3.8 8.3 9.9 4.4 5.2


Disclaimer

121

Analyst Certification

I, Kavinda Perera, certify that the views expressed in this report accurately reflect my personal views about the company. I also certify that no part of my compensation was, is, or will be, indirectly or

directly, related to the specific view or recommendation expressed in this report.

I, Lakshini Fernando, certify that the views expressed in this report accurately reflect my personal views about the company. I also certify that no part of my compensation was, is, or will be,

indirectly or directly, related to the specific view or recommendation expressed in this report.

I, Mangalee Goonetilleke, certify that the views expressed in this report accurately reflect my personal views about the company. I also certify that no part of my compensation was, is, or will be,

indirectly or directly, related to the specific view or recommendation expressed in this report.

I, Naveed Majeed, certify that the views expressed in this report accurately reflect my personal views about the company. I also certify that no part of my compensation was, is, or will be, indirectly

or directly, related to the specific view or recommendation expressed in this report.

I, Isuri Munasinghe, certify that the views expressed in this report accurately reflect my personal views about the company. I also certify that no part of my compensation was, is, or will be, indirectly

or directly, related to the specific view or recommendation expressed in this report.

Company Certification

Asia Securities (Private) Limited has no direct affiliation with the company/companies covered in this report and does not receive any material benefit from the company for publishing this report.

Disclaimer

The report has been prepared by Asia Securities (Private) Limited. The information and opinions contained herein has been compiled or arrived at based upon information obtained from sources

believed to be reliable and in good faith. Such information has not been independently verified and no guaranty, representation or warranty, express or implied is made as to its accuracy,

completeness or correctness, reliability or suitability. All such information and opinions are subject to change without notice. This document is for information purposes only, descriptions of any

company or companies or their securities mentioned herein are not intended to be complete and this document is not, and should not be construed as, an offer, or solicitation of an offer, to buy or

sell any securities or other financial instruments. In no event will Asia Securities (Private) Limited be liable for any loss or damage including without limitation, indirect or consequential loss or

damage, or any loss or damage whatsoever arising out of, or in connection with the use of this report and any reliance you place on such information is therefore strictly at your own risk.

Asia Securities (Private) Limited may, to the extent permissible by applicable law or regulation, use the above material, conclusions, research or analysis in which they are based before the material is

disseminated to their customers. Not all customers will receive the material at the same time. Asia Securities (Private) Limited, their respective directors, officers, representatives, employees, related

persons and/or Asia Securities (Private) Limited, may have a long or short position in any of the securities or other financial instruments mentioned or issuers described herein at any time and may

make a purchase and/or sale, or offer to make a purchase and/or sale of any such securities or other financial instruments from time to time in the open market or otherwise, in each case either as

principal or agent. Asia Securities (Private) Limited may make markets in securities or other financial instruments described in this publication, in securities of issuers described herein or in securities

underlying or related to such securities. Asia Securities (Private) Limited may have recently underwritten the securities of an issuer mentioned herein. The information contained in this report is for

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Disclaimer

122

RESEARCH DISCLOSURES

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Kavinda Perera – Head of Research

Strategy | Banks | Insurance |

Telecommunications

[email protected]

+94 11 772 2044

Mangalee Goonetilleke

Conglomerates | Consumer |

Healthcare

[email protected]

+94 11 772 2042

Naveed Majeed

Manufacturing | Leisure |

Energy | Construction

[email protected]

+94 11 772 2043

Lakshini Fernando

Economics | Finance

[email protected]

+94 11 772 2045

Isuri Munasinghe

Economics | Leisure

[email protected]

+94 11 772 2036

CONTACT US

Research

Sabri Marikar

CEO

[email protected]

+94 11 772 2022

+94 77 357 6868

Shiyam Subaulla

Co-head, Broking

[email protected]

+94 11 772 2011

+94 77 350 2016

Ruwan Hettiarachchi

[email protected]

+94 11 772 2020

+94 77 741 0164

Anushan Kandasamy

[email protected]

+94 11 772 2019

+94 77 722 2519

Niroshan Wijekoon

[email protected]

+94 11 772 2007

+94 77 771 3645

Osadi Hettiarachchi

Finance

[email protected]

+94 11 772 2048

Thilini Amarasiri

[email protected]

+94 11 772 2047

Institutional Sales

Gagani Jayawardhana

[email protected]

+94 11 772 2014

+94 71 408 4953

Niroshan Ratnam

[email protected]

+94 11 772 2006

+94 77 371 7515

Miflal Farook

[email protected]

+94 11 772 2010

+94 77 225 3730

Charith Perera

[email protected]

+94 11 772 2015

+94 77 359 8937

Lahiru Ariyaratne

Co-head Broking

[email protected]

+94 11 772 2002

+94 77 3468103

Dinusha Gomes

Head of Foreign Sales

[email protected]

+94 11 772 2080

+94 77 300 2274

Foreign Sales

CONTACT US

Retail Sales

Subeeth Perera

[email protected]

+94 11 772 2035

+94 71 404 2683

Priyantha Hingurage

[email protected]

+94 11 772 2033

+94 77 350 2015

Ashan Silva

[email protected]

+94 11 772 2005

+94 77 045 8028

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+94 31 567 6881

+94 77 369 1685

Romesh Priyadarshana

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+94 11 772 2032

+94 77 254 8795

Kalana Hewawasam

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+94 77 395 9438

Nuwan Eranga Perera

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