Colombo Fort Land & Building Company PLC (CFLB) the fully diversified conglomerate

COMPANY PROFILE
The Colombo Fort Land & Building Company PLC is a public limited liability company incorporated and domiciled in Sri Lanka and listed on the Colombo Stock Exchange.

The Company was incorporated on 30th April, 1895 for the purpose of acquiring the premises known as Leyden Bastian located in Fort of Colombo then, occupied by the Wharf & Warehousing Company Limited, and to develop this site to meet burgeoning demand for high quality office accommodation in the city.

Over the years, the Company has expanded by organic growth as well as strategic acquisitions and has evolved from a passive property owning company into a dynamic conglomerate with diverse interest in real estates, chemicals and paints, consumer products, distribution, manufacturing, construction, leisure management, plantations and investments.

GROUP HOLDINGS STRUCTURE

ASSET VALUE

REAL ESTATE AND PROPERTY MANAGEMENT
The freehold land and building located at the Sir Baron Jayathilaka Mawatha is owned by the Colombo Fort Land & Building Company PLC and the Company has rented out the building to tenants at market rates.

York Arcade Holdings PLC, a subsidiary owns a building equipped with modern office facilities and has rented out the premises to tenants at market rates.

CHEMICALS
Lankem Ceylon PLC, a Group subsidiary started its agrochemical business in in 1973. hey represent companies such as Syngenta, Dupont, Kumiai, Nissan, Sumitomo, Mitsui and Algea.

The Company manufactures markets and distributes agricultural products, namely Weedicides, Insecticides,
Fungicides and Foliar Fertilizers.

Lankem Ceylon PLC holds a strong position in the chemical sector solvent market. The Company imports all its raw materials from reputed companies such as Exxon Mobil, Sasol, CKG Chemicals.

The Company is an island-wide distributor for Ceylon Petroleum Corporation and continues to be the largest private sector distributor making the entire range of bituminous products to the road constructions industry.

PAINTS
Lankem Paints has been in operation from 1984 and is the pioneer coatings manufacturer in the country. The Company currently owns the international brand name Robbialac and markets all the coatings under the same brand.

CONSUMER PRODUCTS
The Consumer Products Division of the Group subsidiary Lankem Ceylon PLC specialises in manufacturing and marketing of domestic detergents, household insecticides and general purpose cleaners. The Company also imports washing powder.

PLANTATION
Kotagala Plantations PLC is owned and managed by the Group.

LEISURE MANAGEMENT
The Group owns and manages three resort hotels. Hotel Club Palm Bay in Marawila is owned by Marawila
Resorts PLC and The Palms at Beruwala is owned by Beruwala Resorts Limited. Sigiriya Village Hotel, which is located in an ancient city is owned by Sigriya Village Hotels PLC.

CONSTRUCTION
The Group’s construction subsidiary, Lankem Developments PLC continues to focus on its core operating activities, namely water proofing and road construction.

DISTRIBUTION
E.B. Creasy & Company PLC, a subsidiary of the Group has an island-wide dealer network, which distributes hardware and automotive accessories, imported from well-known foreign principals as well as locally manufactured items. Darley Butler & Co. Limited has one of the most extensive distribution system in Sri Lanka has one of the largest team of professional Sales Representatives backed by a modern feet of vehicles and long establish network of financially sound goods.

Muller & Phipps (Ceylon) PLC and its subsidiary company Pettah Pharmacy Limited both are serving as agent representatives in Sri Lanka for foreign pharmaceutical companies and are engaged in importing, wholesaling and distribution of pharmaceuticals.

MANUFACTURING
Laxapana Batteries PLC quoted on the Colombo Stock Exchange is the pioneer manufacturer of dry cell batteries in Sri Lanka. The Company manufactures two types of dry cell batteries under the Laxapana brand name.

Creasy Foods Limited is the manufacturer of a range of medicated confectionery under licence from Cadbury Schwepps PLC of UK. The Company has diversified its activities and now produces falaovured sweets as well under the brand name of Candyman.

IMPORT AND MARKETING OF MOTOR VEHICLES & SPARE PARTS
Colonial Motors PLC is engaged in import and marketing of motor vehicles, spare parts and providing maintenance services. The business is highly competitive and continues to face severe competition.Carplan Limited, a subsidiary of Colonial Motors Limited, which holds the Agency rights for KIA Motors in Sri Lanka is engaged in import and marketing of motor vehicles and servicing of vehicles.

INVESTMENTS
Colombo Fort Investments PLC, Colombo Investment Trust PLC and Capital Investments Limited are associate companies in the Group engaged in holding and managing investment portfolios.

KEY SHAREHOLDERS

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Sri Lanka: AHUN records 20% top-line growth despite the off season in tourism

Aitken Spence Hotel Holdings' (AHUN) has recorded a net profit of LKR210.5 mn in 3QFY10 from a loss of LKR105.8 mn in 1HFY10, which is directly attributable to the reviving domestic tourism with higher occupancies and earnings from Maldivian hotels.

AHUN, a 71.7% owned subsidiary of local conglomerate Aitken Spence PLC (SPEN, LKR1379.00) currently operates 9 hotels in Sri Lanka, 7 in Maldives, 5 in Oman and another 5 in India. Company operates its resort portfolio under three brands; namely "Heritance", the premier brand with 5 star luxury properties, "Adaaran", the Maldivian resorts and "Aitken Spence Hotels", comprising of all managed properties. As a part of their asset light strategy, the company is continuously searching avenues to expand its presence regionally and globally using its expertise in hotel management with minimal capital participation .

Gross revenue up 20% YoY to LKR1,985.5 mn in 3QFY10. AHUN's top line has grown by a sharp 20% YoY in 3QFY10 and the result for cumulative 1-3QFY10 is also up by 8.8% YoY despite 6 months of the year falling into the off season of the tourism industry. The Sri Lankan sector recorded an improvement of 10.2% YoY whilst the South Asian sector has grown by a sharp 21.7% YoY during the quarter in concern,
mainly on the back of reviving domestic tourism and Maldivian contributions which were above expectations.

Operating costs have increased by 16.1%YoY in 3QFY10. The company's operating costs have increased by 16.1% YoY to LKR1,541.6 mn in 3QFY10 where as the cumulative growth for 1-3QFY10 was a slower 8.3% YoY. Staff costs and direct operating costs have risen by 7% and 33% YoY respectively during the quarter, on the back of increased activity in hotels whilst depreciation and amortization costs increased by 35% YoY owing to the increased asset base. Other indirect expenses has increased by a marginal 5% YoY in 3QFY10 resulting a dip of 0.8% YoY for the first nine months of the year as a result of the successful cost rationalization exercises implemented in its hotels .


Operating profit of LKR385 mn in 3QFY10. AHUN has converted its marginal profit of LKR69.8 mn in 1HFY10 into a profit of LKR385 mn just in three months due to the reviving local tourism which has shown signs of turnaround in the near future. This was further supported by the Maldivian sector earnings where the occupancy of AHUN's properties has gone up to 70% - 80% except a few resorts catering to niche up market segments.

Pre-tax losses year ago, converted into a profit in 3QFY10. AHUN's Sri Lankan resorts and hotels has posted a pre tax profit of LKR5.32 mn in 3QFY10 from a loss of LKR44.34 mn year ago, reducing the cumulative 9 months loss to LKR154.5 mn (vs a loss of LKR243.3 mn last year, down 36.5% YoY) mainly driven by the growing domestic tourism.

Furthermore, AHUN's associate earnings (Hotel Hill top and Browns Beach hotel) have also grown by stunning 106.5% YoY during the quarter in concern. However, the South Asian sector which comprises of Maldivian properties recorded a 39.3% YoY dip in its pre tax profits on the back of a slower recovery of the global economy (where the occupancy is still at 80%) and the downward pressure on the rates.

With the recovery of the global economy coupled with the company's world class hotel chain, we believe the sector will rebound and get back to its lucrative ways in the near future.

AHUN recorded a net profit of LKR210.5mn for 3QFY10. Backed by the local and Maldivian tourism which have already created signals of turnaround, AHUN has recorded a net profit of LKR210.5 mn (against the loss of LKR105.8 mn in 1HFY10) despite 6 months out of 9 months falling into the tourism off season.

However when comparing the bottom line with the same period in the previous year, AHUN has posted a significant dip of 41%. (Profit of LKR210.5 mn in 3QFY10 Vs profit of LKR357.8 mn in 3QFY09). It should be noted that the previous years net earnings includes the profit of LKR219 mn (included in Other operating income) which was gained from the disposal of Bathala Island Resort in FY09. Therefore, looking at the numbers excluding the capital gain, AHUN has posted a bottom line growth of a staggering 52% YoY for 3QFY10.

Future outlook
With the complete end to the 3 decade long terrorist conflict coupled with the positive macro economic outlook, tourism sector would be one of the first sectors to rebound. AHUN is positive on strong growth in local tourism, and as a part of their expansion strategy the company is planning to build one or more hotels in Trincomalee (where they have 100 acres) whilst seeking prospects in Jaffna and Kalpitiya. Also they are looking in to fill in its long lasting need for a City hotel in Colombo through acquisition or development of a new property.

Furthermore AHUN is refurbishing Neptune Hotel, one of its beach properties down south to be rebranded under its premier brand “Heritance”. Once refurbished, it will be a wellness resort and a spa specialising in ayurvedic treatments which will be opened in winter 2010.

According to their regional expansion strategies, plans have been finalised to add more properties in India (Under Heritance Brand) which would be operational in the coming years.

Forecast FY10 earnings revised down to LKR350 mn. Backed by the slower recovery of the South Asian sector which accounts to a plus 80% of the top line, we revised down our forecast net profit to LKR423.5 mn (down by 28.5% YOY) in FY10E and LKR851.8 mn (up by 101% YoY) in FY11E.

Share is fairly valued on 37.7X forecast FY10E earnings. The share has gained three fold (246%) since the end of war on 18th May 2009 whilst we believe further upside possible with growing earnings materialising in the coming quarters. Furthermore AHUN would be one of the prime beneficiaries of the revival of local tourism (with the complete end to the 3 decade long terrorist conflict and opening of the eastern coast which is rich of tourist hotspots such as Arugam bay, Nilaveli beach etc) which has 09 properties in all strategic locations in the island which are upgraded and ready for the boom (It would need 2-3 years to develop a new hotel).

AHUN is fairly valued on 37.7X forecast FY10E net profit and 18.7X projected FY11E earnings whilst it is trading on a PBV of 3.2X, we maintain – BUY

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Sri Lanka: Lanka Tiles (TILE) has recorded a staggering 71% YoY growth

Lanka Tiles (TILE: LKR71.75) has recorded a staggering 71% YoY growth in its 3QFY10 net earnings, resulting in an increase in the cumulative 1-3QFY10 net profits by a sharp 27% YoY. This is mainly attributable to the increase in the level of revenue due to the high demand triggered by the international market resulting in an increase of 97% in export sales for the 3QFY10.

TILE, the pioneer floor tile producer in Sri Lanka was incorporated in 1984 to manufacture Ceramic Glazed Floor Tiles as its core business. At present this is the second largest floor tile producer of the country with an approximate market share of 35%.

TILE is operating with a per day production capacity of approximately 9,500 square meters. Approximately 90% of the output is sold locally while the remaining 10% of the output is exported to countries such as Canada, USA, Middle East, Maldives, Australia, New Zealand, Japan and Singapore.

With the favourable economic conditions prevailing in Sri Lanka especially with the downward trend in interest rates coupled with the reconstruction boom in the North and East resulting in an overall improvement in the economy, we project earnings for the FY10E to reach LKR320 mn (up by 11.5%YoY).

Net sales up by a sharp 23% YoY in 3QFY10. TILE's gross revenue has increased by 20% YoY to LKR875.3 mn in 3QFY10 where the export sales (8% of total sales) recorded a growth of 97% whilst the local sales increased by a moderate 16% YoY. The top line increased by a marginal 2% YoY to LKR2,240.5 mn during the first 3 quarters of FY10 mainly on the back of low sales volumes experienced in the first 5 months which resulted a dip of 6% YoY in 1-2QFY10. After deducting a tax of nearly 10%, the

net sales of the company increased by 23% YoY during the quarter in concern to LKR787.1 mn, resulting a moderate growth of 5% YoY in cumulative 1-3QFY10.

37% increase in 3QFY10 gross profits. Cost of sales of the company has increased by 17% during 3QFY10 whilst the cumulative figure has recorded a dip of 1% owing to cost rationalization exercises coupled with the lower operating levels in the first two quarters of the year. Therefore TILE has marked 37% YoY increase in gross profits in 3QFY10 resulting an 18% YoY growth for cumulative 1-3QFY10 reaching LKR612.4mn.

3QFY10 Operating profit up by 49% YOY. The company has recorded an operating profit of LKR179.7 mn in 3QFY10, up by 49% YoY whilst the cumulative 1-3QFY10 profit has also increased by 23% YoY to LKR386.5 mn. This is directly attributable to the strong contribution from improved gross profits margins coupled with the threefold growth in other operating income as a result of charging interest for delayed payments from dealers and distributors. Even though the total expenses of TILE has increased by 26% YoY during 3QFY10, going forward we believe this would come down significantly owing to the merging of front office operations of TILE and its parent Lanka Walltiles (LWL).


Net earnings of 3QFY10 up by a stunning 71% YoY. Backed by the strong top-line growth, the company has posted a net profit of LKR107.9 mn in 3QFY10 (up 71% YoY) whilst the cumulative 1-3QFY10 net earnings are also up by 27% to LKR227.8 mn despite the lower earnings recorded in 1-2QFY10.

Forecast net profit to grow by 11% YoY to LKR320 mn in FY10E. Backed by the improved economic conditions coupled with the construction boom in the North and East, we project FY10E earnings to reach LKR320 mn (up by 11%YoY). This significant growth in earnings would be mainly from the sale of stocks that were built-up in the FY09 due to adverse economics conditions. Further with the commencement of the developments in the previously war torn North and East and with the revival of the construction industry together with the downward trend in the interest rates, we believe that the earnings of TILE would increase significantly.

Furthermore, with the actions initiated by government to increase the tariff on imported tiles would enable the local producers to gradually acquire market share from the imported tile companies, where TILE would be one of the prime beneficiaries.

In FY11E the earnings of TILE would continue to increase over earnings of FY09 however we project it to be lower than FY10E level. We expect earnings in FY10E to be significantly high as a result of the sale of stocks which were piled up in FY09 due to adverse economic conditions. Therefore, in FY11E the earnings of TILE is projected to reach LKR302 mn (down by 5.9%YoY compared to significant profits
generated in FY10 as a result of the sale of built-up stock).

Future Plans. The Company is considering to expand its current production capacity of 9,500 square meters per day to 11,500 square meters per day, where its factory is operating at 100% capacity at present. This expansion is not expected to be initiated in short-term but will be considered to be implemented in the FY12E
once the economy would be politically stabilized.

Share offers good value on 9.5x forecast FY10E earnings. The share remains attractive on 9.5x forecast FY10E net profit and 10.09x projected FY11E earnings whilst trading at 1.6xPBV. Maintain - BUY

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Sri Lanka: Ceylon Tobacco's (CTC) net profit has increased by a stunning 60% YoY

CTC's 2009 net earnings grow by a staggering 49% YoY Ceylon Tobacco's (CTC) net profit has increased by a stunning 60% YoY to LKR2,020.6 mn in 4Q2009 whilst total earnings for 2009 are also up by a strong 49% YoY to LKR4,114.6 mn. Despite a marginal decline in volumes, earnings have been boosted by a high margin brand mix coupled with aggressive cost management initiatives.

CTC enjoys a monopoly market for manufacturing, marketing and importing cigarettes in Sri Lanka. The company segregates the market based on income levels and markets Dunhill and Bensons for high income category along with Gold leaf for the middle income category, followed by Four Aces, Three Roses and Capstan for the low income category and Pall Mall as a value for money product.

Faced with slowing revenue growth CTC has focused more on its cost structure in order to improve the profitability. Thus the company has reduced its operating expenses by 52.4% YoY during 2009 resulting with the total expenses decline by 17.6% YoY despite a 47.6% increase in raw material cost and managed to grow its bottom-line by 49% YoY to LKR4,114.6 mn.

Net revenue up by a sharp 10.5% YoY to LKR12,353.9 mn in 2009. Gross revenue has increased by 9.5% YoY to LKR15,238.5 mn in 4Q2009 resulting a total of LKR58,079.5 mn for the year (up 6.1% YoY). This is mainly attributable for the improved sales mix, grabbing market share from illegal distributors and excise led price increases despite a moderate drop in volumes, which was a result of the ban on smoking in public areas coupled with change in smoking habits amongst the general public. However, the government’s continuous efforts in curbing the presence of smuggled and counterfeit cigarettes provide some optimism for volume growth in future.

Government levies accounted to 76% of gross revenue, which grew 5.3% YoY to LKR11,529.6 mn during 4Q2009. Consequently, net revenue has grown by a sharp 25.2% YoY to LKR3,708.9 mn in the quarter in concern and resulted an increase of 10.5% YoY to LKR12,353.9 mn for the year ended 31st December 2009.

Total operating costs have declined by 17.6% YoY in 2009. Operating costs have dipped 52.4%YoY to LKR2,002.8 mn during 2009 mainly on the back of aggressive cost rationalization initiatives implemented in all areas of the organization which was sufficient to weather the rising cost of tobacco leaf. During the first half of the year, company faced a shortage in the supply of tobacco leaf and had to source it at a higher cost which increased the raw material cost by 47.6% YoY.

With sales volumes on the gradual decline, the company will continue to focus on productivity enhancement and cost saving techniques as the key means of boosting earnings.

Net profit has risen by a staggering 49% YoY to LKR4,114.6 mn in 2009. Net interest income has fallen by 52% YoY to LKR73 mn in 4Q2009 owing to the falling interest rates. Nevertheless backed by the strong performance coupled with cost rationalization techniques, the company has recorded a net profit of  LKR2,021 mn for 4Q2009 (up by 59.9% YoY) whilst recording a net profit of LKR4,114.6 mn for

the year 2009 (up by 49% YoY).

Forecast 2010E net profit to reach LKR4,367 mn. We are forecast 2010E net profit to grow by a conservative 6.1% to LKR4,367 mn whilst projecting 2011E net profit up by 5.3% to LKR4,600 mn on the back of the company's continued focus on improving its brand mix coupled with successful cost rationalization exercises.

Good value on 9.3X forecast 2010E net profit. The share is attractive on 9.3X forecast 2010E net profit and 8.8X projected 2011E net earnings. Further given the historical dividend payout ratio of a near 95%, we believe the share would continue to be a dividend play - Maintain BUY

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Sri Lanka: Chemical Industries Colombo (CIC) record an impressive growth

Originally set-up as a Trading House for ICI - UK, Chemical Industries Colombo (CIC) has pursued a policy of planned growth which has resulted in its diversification into a number of fields over the years. The company grew into agriculture, paints, pharmaceuticals, industrial raw material and packaging dwarfing the chemical business.

CIC Agri Businesses, the biggest contributor in terms of revenue and earnings to the group (a near 70%), comprises of companies that provide inputs to the agricultural sector. The construction sector is effectively CIC's paints and surface coatings business (includes the flagship brand Dulux) which is under the group's associate Akzo Nobel Paints Lanka. CIC's quoted subsidiary Chemanex is a manufacturer and marketer of chemicals and industrial intermediates. The pharmaceutical business markets products from principals like Johnson & Johnson, Hilton Pharma and Solvay Pharmaceuticals and sells products from prescription drugs to diagnostic equipment to hospitals.

CIC reported a 1,635.2% YoY growth in net earnings to LKR327.2 mn during 3QFY10
whilst the 9 months too has grown 20.9% YoY to LKR478.3 mn. CIC's 3QFY10 profits
have been driven predominantly by the key agriculture and livestock sector (EBIT up
242%YoY) coupled with 658.9%YoY increase in other income and improved contribution from the construction sector (EBIT up 180% YoY). The consumer and pharmaceutical sector along with packaging segment has weathered a challenging period where the EBIT contribution from these segments dipped 37% and 5% respectively whilstthat of the industrial raw material sector grew by 57% YoY.

Quarterly performance at a glance
CIC's turnover grew by 45.1% YoY to post LKR4,816.02 mn in 3QFY10, boosted by higher turnover in the key agriculture and livestock segment(up 62% YoY) mainly due to improved performance in the seed and livestock business. The paints segment (inputs to Akzo Nobel Paints Lanka) (up 41% YoY) witnessed a substantial improvement with previously cash strapped consumers now gradually willing to spend on non-essentials. Revenue from consumer and pharmaceutical segment has grown by 21% YoY whilst that of industrial raw material dipped by 21% YoY due to the global economic downturn where demand for paints related raw materials, rubber and textile binder related materials was still sluggish. The packaging sector dipped (1% YoY) marginally signalling the improvement in the previously deteriorating market conditions.

Cost of sales (up 30.9% YoY to LKR3,827.9 mn) have also increased inline with the rise in turnover levels whilst Gross Profit increased by an impressive 150.1% YoY to LKR988.1 mn. Further, the gross margins have improved to 20.5% in 3QFY10 (vs 11.9% in 3QFY09) due to the group's efforts on retooling the value chain.

Consequently, despite a rise in administration expenses by 38.9% YoY to LKR361.5 mn and distribution costs by 15.2% YoY to LKR235.8 mn, operating profit grew to an impressive LKR391.6 mn (vs a loss of LKR131.5 mn in 3QFY09). CIC's main operational counters witnessed a significant growth in operating earnings. Accordingly, operating profit from the Agriculture segment grew 242% YoY to LKR275.6
mn whilst the construction sector posted LKR24.9 mn (vs a loss of LKR31.3 in 3QFY09).

The Other income has grown to LKR292.5 mn vs LKR38.5 mn posted in 3QFY09 mainly due to LKR250 mn released by the government as subsidy payments for Fertilizer sales during November'08 - March'09.
On the back of a flat macroeconomic milieu the Packaging sector too dipped 5% YoY to LKR20.7 mn. Meanwhile operating margins grew to 8.1% during 3QFY10 compared to -3.9% during the corresponding previous quarter.

CIC's share of profit from associates has dipped 16% YoY to LKR56.5 mn in 3QFY10 on the back of the dip in profitability of construction sector (Akzo Nobel Paints Lanka).

Overall, CIC's EBIT has witnessed an unprecedented growth to reach LKR740.5 mn in 3QFY10 (vs LKR(21.2) mn in 3QFY09).

Finance cost during the quarter dipped by 20.4%YoY to LKR139.2 mn mainly on the back of dip in interest rates. Subsequently, the Profit Before Tax has rocketed to LKR601.3 mn in 3QFY10 vs a loss of LKR196.1 mn in 3QFY09.

3QFY10 net earnings have reported a sharp increase to reach LKR327.2 mn (vs a net loss of LKR21.3 mn in 3QFY09) where net margins are at 6.8% in 3QFY10 compared to -0.6% in 3QFY09.

Agri business to propel growth?
CIC Agri Businesses, the biggest contributor in terms of revenue and earnings to the group (circa 70%), weathered a challenging period where the off take in crops was slow. Looking ahead, revival in agriculture is expected to propel earnings growth in the future. Whilst agribusiness remains the company's key sector, CIC has acted to diverse its agri-revenue streams thereby reducing exposure to weather shocks. CIC
is positioned to successfully reap benefits from the changing macro environment of the country where we believe the company is to benefit significantly from an anticipated revival in the agribusiness sector specially stemming from the previously war torn North. CIC has already ventured into the recently liberated Eastern province with two large dairy farms. The expansion projects in the sector (banana export project
in the Eastern Province, 2,200 acre large scale dairy complex at Mutuwalla in East, Rice exports, etc) would be an added bonus, once the benefits materialize.

With the much anticipated economic integration of the previously war torn North & East and the untapped potential in these areas along with an extension to its out grower network we believe CIC agri business is prime to benefit in future.

The Construction business is effectively CIC's paints and surface coatings business which comes under the group's associate company Akzo Nobel Paints. CIC is into decorative, vehicle refinishing and industrial paints segments where 80% of the revenue comes from the decorative sector. CIC has a near 40% market share with paints under the brand names such as Dulux and Glidden targeting different income levels.The paints and coatings business had a turbulent period with circa 5% to 10% volume dip due to harsh market conditions. However, once fresh investments, rehabilitation activities and infrastructure developments commence in the North and East there would be enormous scope for growth.

The Consumer & Pharmaceutical and Industrial Raw Material businesses are also expected to witness a turnaround in FY11 with improved global economic environment.

Positive Outlook
Forecast FY 10E net profit to rise 42.9% YoY to LKR583.0 mn. On the back of improving economic conditions and anticipated payoffs from the new projects we revise the FY10 (which had a poor 1HFY10- net earnings LKR151 mn)) forecast upwards by 11.3% to LKR583 mn (up 42.9% YoY). With the group’s plans for growth, retooling of value chain and diversified risk we expect CIC to enjoy a 32.5%growth in earnings to reach LKR772.5 mn in FY11E.

The voting counter trades at 10.4x FY10E earnings (7.9x FY11E) and the non-voting counter trades at 6.5x FY10E earnings (4.9x FY11E) whilst trading at discount to market. Despite the current economic turmoil domestic growth would be observed from the vast potential in the North & East especially in the agriculture and paints sectors.On the back of prospects of steady growth along with growth stemming from agriculture in the long term and untapped potential in the North & East, we maintain- BUY.

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SRI LANKA - PLANTATION SHARES MOSTLY UNDERVALUED

SECTOR           -     PLANTATIONS

SECTOR P.E.    -    12.50

MARKET P.E.   -    17.75

Plantation companies in the Colombo Stock Exchange are mostly undervalued at present. Specially if you take past couple of months, Plantation companies as a Sector substantially  under performed to the Overall market.

WHY PLANTATION SECTOR IS NOT ATTRACTIVE ?

• High Cost of Sales [ Labour cost,Fertilizer cost. etc]
• Volatility in Commodity prices in the market.
• Unpredictable weather conditions.

 WHY PLANTATIONS ARE ATTRACTIVE NOW?

• Increasing Oil prices in the world market paved the way to increase the demand for Natural Rubber Products & Palm Oil products.
• Commodity prices are on the rebound presently.
• Most of Plantation companies are diversified.
• Sector which is substantially under performed to the market.
• Most of other sectors in the Colombo Stock Market are over heated now.
• Best strategy is to move away from heated speculative counters & to invest in plantations.
• Most of the share prices of other companies in the Colombo Stock Market are @ their highest levels reported for the past 5 to 7 years. But not the Plantations.

There are 18 plantation companies listed in Colombo Stock Market up to now.

Main income generating crops are

• Tea
• Rubber
• 0il palm

Apart from these core income generating sectors, many of listed plantation companies have diversified their business interest to the following areas as well.
 * Hydro power   * Tourism   * Forestry   *Investments   *Other cultivations  [Coconut, Perennial crops etc.]

BEST BETS IN THE MARKET

• Balangoda Plantation                                                                             
• Malwatte Plantation 
• Watawala Plantation
• Kotagala Plantation
• Namunukula
• Kegalle
• Kelani Valley
• Agalawatte
• Hapugastanne
• Maskeliya

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Sri Lanka CW Mackie bought by Lankem group

Sri Lanka's Lankem group gained control of C.W.Mackie PLC one of the oldest companies in Sri Lanka through the purchase of 56.4% shareholdings on Friday. Lankem and its group company Kotagala Plantations purchased 20.89 mn shares from Aarhus United A/S and its local subsidiary Ceylon Trading Company at a sale price of Rs 35 per share. The transaction was valued at 712 million rupees.

The above purchase is likely to trigger the mandatory offer required under the Takeover and Merger Code of Sri Lanka and purchasers/its partners are expected make an announcement shortly with regard to their manadtory obligation to purchase balance shareholdings of C.W.Mackie PLC at a price of Rs 35/= share.

Mr Anushman Rajaratnam the Managing Director of Lankem PLC, Mr Tom Ellawala Managing Director Ceylon Trading Company and Mr Johnny Andersson Partner Mannheimer Swartling representing Aarhus United A/S executed the agreement between companies which followed the trade of 20.89 mn shares on the Colombo Stock Exchange (CSE).

This transaction was facilitated by Mr Nishan Sumanadeera well known investment banker and a founder director of Sri Lanka Equity Analytics (www.srilankaequity.com) a company specialized in equity research and cutting edge investment banking solutions together with Sahan Kulatunga of Incapita Investments. Trade was executed by the Taprobane Securities (pvt) Limited one of the premier stock brokering company in Sri Lanka

The CW Mackie was founded in 1900 by the late Mr C.W.Mackie a Scotsman, who carried on the enterprise as Merchants and Commissions Agents under the name of ‘CW Mackie & Company’. In 1922, the business was incorporated as a private limited company. In 1946, a consortium of Ceylonese and Indian Businessman bought over the shares of the company and converted it to a public company.

The year 1971 marked a significant change when Ceylon Trading Company Limited, the Sri Lanka based subsidiary of Aarhus United A/S of Denmark, bought a part of the Indian shareholding and took over the management of the company. In late 1994, shares equivalent to 25% of the total shares in the company were issued to the public so as to broad-base the ownership of and give the Company greater access to the capital market of Sri Lanka to raise capital funds for the future diversifications and expansions.

The Group consist of CW Mackie PLC and three subsidiary companies engaged in a diversity of activities such as export of primary and manufactured products, ranging from all types of natural rubber and coconut products to rubber based products; import, manufacture and distribution of sugar; import and resale of branded marine paints and protective coatings, welding equipment and consumables, refrigeration and air-conditioning and light engineering products.

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Lion Brewery : Set to roar again

Investment Summary

Lion Brewery (Ceylon) PLC (LION) is the leader in the soft alcohol market in Sri Lanka. LION has held market leadership since inception of its brand, “Lion Beer” by its parent, the Ceylon Brewery PLC (BREW) in 1881. Currently, LION commands 86% of the soft alcohol market in Sri Lanka, which despite difficult economic and security conditions has grown reasonably strongly by a CAGR of 3.6% over the past three years. LION’s beers are also exported to over 50 countries.

Strong links to Carlsberg. LION also brews, bottles and markets “Carlsberg” beer under license from the Danish brewer and is also 25% owned by that multinational. The links to Carlsberg has also enabled LION to acquire world class brewing technology, thus enhancing its operating efficiency.

Soft alcohol/beer market poised to grow. With the end of the military conflict,we expect strong revival in demand for beer, underpinned by opening up of new markets in the northern and eastern provinces, the likely sharp increase in tourist arrivals, improved security conditions which will prompt increased demand for recreation activity and of course rising disposable incomes underpinned by economic expansion.

Low per capita consumption of beer points to upside potential. Per capita consumption of soft alcohol/beer in Sri Lanka at 2.45 litres per annum is low by regional standards and thus offers tremendous opportunity for improvement as disposable incomes rise and inflation is maintained at sustainably low levels.

LION ventures into India with Carlsberg. LION has also begun to invest in a number of new breweries in India together with Carlsberg in order to exploit the vast untapped market in the sub-continent. LION has effective ownership of 22.5% of South Asian Breweries Limited, which has already constructed five breweries in India.

Earnings to grow by a near eight fold in FY10E. Underpinned by lower raw material costs and improved market conditions, LION’s net profit has grown by nearly a ten fold YoY in 1H10 to LKR 237.1 mn. We are projecting LION’s full FY10E earnings to grow by a further eight fold YoY to LKR 437.0 mn. As demand improves, we are projecting LION’s net profit to grow strongly by 30.1% YoY to LKR568.6 mn in FY11E.

Share attractive on 11.4X forecast FY11E net profit. Having hit a low of LKR42.75 in 7th January 2009, LION’s share price has risen strongly by 75.4%. Following this gain, LION trades on a relatively heady 13.7X projected FY10E net profit.

But given our expectation of a sharp increase in FY11E earnings to LKR568.6 mn, LION is attractive on a PER of 10.6X, given the expected strong growth in demand for soft alcohol/beer, the company’s near monopoly status, likely gains from the foray into India and high ROE. We rate LION a BUY


The LION's story

Lion Brewery (Ceylon) PLC (LION) is by far Sri Lanka's dominant manufacturer and marketer of soft alcohol. The company produces the highly popular "Lion" brand of beers and stouts and also "Carlsberg" beer (under licence from Carlsberg International of Denmark). LION commands a near monopoly share of the soft alcohol market in Sri Lanka and also exports its Lion brand of beers and stouts to Maldives, UK,Japan, Australia, France, Canada and West Africa, although export volumes are still small.

Owned by the Carsons Group. LION is 50.4% owned by Ceylon Brewery PLC [BREW:LKR112.00], which in turn is 66.63% owned by the diversified investment group Carson Cumberbatch [CARS: LKR90.00). CARS is owned and managed by the Selvanathan family, one of the oldest business families in Sri Lanka. The other major shareholders of LION are Carlsberg Brewery Malaysia Berhad (24.6%), HSBC Intl.Nom. Limited - BBH Genesis Smaller Companies (9.86%), HSBC Intl. Nom. Limited - SNFE-Arisaig India Fund Limited (5.95%) and Ceylon Guardian Investment Trust PLC (2.68%).

Pedigree of over a century. The Lion brand is owned by BREW and has a history of over 100 years. BREW was established in 1881 by British entrepreneur Sir Samuel Baker with the brewery being set up in the hill country town of Nuwara-Eliya (175 kilometres east of Colombo). The location of the brewery had apparently been influenced by a water fall that produced crystal clear water which gave Lion beer a unique flavour and hence its legendary popularity.

However, with expanding demand and age, the Nuwara-Eliya brewery had clearly reached the end of its life span by the late 1980s, as capacity and efficiency constraints (and of course high government taxes) began to be a drag on the financial performance of BREW. Consequently, a major re-organisation of the company was undertaken in the mid 1990s with LION being established to construct a brand new brewery and takeover the manufacturing and marketing of Lion beer.

However, the Lion brand continues to be owned by BREW and hence, it is recorded to have paid a royalty of LKR53.98mn in FY09 to BREW for its use.

State-of-the-art brewery. LION's brewery was constructed in Biyagama (25 kilometres east of Colombo) and began commercial production in early 1998. The modern brewery with an initial capacity of 300,000 hectolitres p.a. cost LKR 1.8 bn to complete in 1997 and was funded by equity of LKR 1 bn and bank borrowings of LKR 0.5 bn.

BREW took up 50.4% of the initial equity and Carlsberg Brewery Malaysia invested 24.6%. The balance 25% of the equity was raised via an IPO, which listed LION on the Colombo Stock Exchange in 1997. Capacity of the brewery has subsequently been increased to 500,000 hectolitres p.a. funded largely by retained earnings.

Links to Carlsberg of Denmark. LION also brews, bottles and markets beers under the world renowned "Carlsberg" brand with licensing from Carlsberg International of Denmark. Its strong relationship with Carlsberg gained evidence with its tie up to float South Asian Breweries in 2006, and now its present foray into India.

Background

Strong Management. Being part of Carson Cumberbatch group has enabled LION to assemble a highly competent management team in addition to being able to draw on the expertise of the parent. CARS is a diversified group with investments in oil palm plantations (in Indonesia and Malaysia), property, insurance underwriting (Union Assurance), listed equities, hotels and beverages. LION's Chief Executive, Suresh Kumar Shah has been with the Company for about 18 years and was instrumental in setting up the new brewery. Further, the senior management of the company have extensive experience in the retailing industry.


BEER MARKET POISED FOR GROWTH

Demand for soft alcohol/beer has been dampened by inflationary pressure and hence lower disposable incomes, relatively high government taxes (which also deflected demand towards illegal and illicit hard liquor), negligible levels of tourist arrivals, security conditions that have curtailed recreational activity and the ban on media advertising. Despite the tough market conditions, demand for soft alcohol/beer has grown over the past two years with sales/production volumes reaching 57.3mn litres, as per the Administrative Report of the Commissioner General of Excise for the year 2008, up by 15% YoY. We also estimate that sales/production volume to remain stagnant at 57.3mn litres in 2009.

However, with the end of the military conflict, we expect strong revival in demand for beer, underpinned by opening up of new markets in the northern and eastern provinces, the likely sharp increase in tourist arrivals, improved security conditions which will prompt increased demand for recreation activity and of course rising disposable incomes underpinned by economic expansion.

Further, per capita consumption of soft alcohol/beer in Sri Lanka at 2.45 litres per annum is low by regional standards and thus offers tremendous opportunity for improvement as disposable incomes rise and inflation is maintained at sustainably low levels.

Against the above backdrop, we are projecting demand for soft alcohol/beer to grow by 18% YoY to 67.6mn litres in 2010 and further by 19% YoY to 80.5mn litres in 2011.

Lower relative prices likely as inflation eases
The biggest deterrent to the growth of the soft alcohol/beer market in Sri Lanka is the high incidence of Government Taxes. The final retail price of a typical 625 millilitre bottle of beer has risen from Rs. 60.00 in 2004 to Rs. 110.00 in 2009, roughly at a CAGR of 10.8% p.a. And the major part of this increase has been due to Government Taxes. Currently, 40% of the retail price of a bottle of beer is accounted for by Government Taxes. The high incidence of Government Taxes coupled with the historically high level of general price inflation in the country has put the relative price of soft alcohol/beer beyond the reach of the average consumer. This has compelled consumers to shift to consumption of hard liquor and more so to illegal and illicit hard liquor (with high content of alcohol), which are perceived as providing a “greater kick per rupee spent”.

However, we believe that as general price inflation in the country falls to sustainably low levels, the relative price of soft alcohol/beer will decline vis-a-vis hard liquor. This will also provide greater space for soft alcohol/beer producers to negotiate tax increases with the Government that could be absorbed by the market/consumer, making the products more affordable. A further step by the Government to ease its policies on the soft alcohol segment, would contract the vast illicit portion constituting approximately 60%-90% of the alcohol market. Thus giving room for LION to further utillize its potential outlay.

Lion is king of the market
LION is the undisputed leader of the soft alcohol/beer market in Sri Lanka and commands a composite 86% share of the market. The second largest producer, Asia Pacific Brewery, has only a 15% share, whilst McCallum Brewery holds approximately 2%. Imports account for a very minute portion of the market but locally manufactured soft alcohols are protected by lower Government Taxes and hence imports are unlikely to be a significant threat.

One of LION’s key competitive advantages is also its extensive distribution network.LION distributes its products across the length and breadth of the country via a network of 2,500 retail distributors. This strong retail chain has enabled LION to overcome the Government’s ban on advertising its products in public media and continue to dominate the market.

LION also exports its Lion brand to Maldives, UK, Japan, Australia, France, Canada and West Africa, with Maldives being the largest destination. LION expects export sales volumes to continue to grow at around 50% per annum over the next three years as global economic recovery takes hold.

We are also projecting LION’s export sales revenue to grow on the underpinned by global economic recovery.

The brand strength of a lion
LION’s key strength is its legendary product brand “LION BEER”. The Lion brand has been nurtured for over a hundred years and is one of Sri Lanka’s oldest and most recognised brands. Lion beer’s legendary popularity is apparently derived from the location of the original brewery in the salubrious climes of Nuwara-Eliya. The story is that the brewery was constructed adjacent to a water fall that yielded pristine clear water, which when used in the brewing process gave Lion beer an apparently distinct flavour. Over the years, Lion beer has also won many international accolades further augmenting its brand image/equity.

Strong brands are a significant asset in Sri Lanka’s consumer market place as customer loyalty once earned is not easily swayed by competitors, not even by multinationals. The prevailing restrictive market in the country also deters competition allowing LION to continue its roar as the king of the leading brand.

Lion lager leads the way
LION brews, bottles and markets three beers under the Lion brand – Lion Lager, Lion Strong Beer and Lion Special Brew, a stout also under the Lion logo – Lion Stout and Carlsberg beer under licence from its original Danish brewer.

The most popular product by far is “Lion Lager” accounts for majority of LION’s sales volume. The second largest seller is Carlsberg, accounting for the next largest.

A bulk of LION’s products are packed in 625 millilitre bottles. LION also sells beers in smaller 300 millilitre bottle aimed at the impulse market and now even in cans. Further, in FY2009, the company set up a brand new canning plant in order to pack it products in aluminium cans. The canned beers are an important addition to LION’s product line in the light of revival of the tourism industry, likely growth of the impulse and convenience segments of the market and also the company’s export ambitions.

Raw material costs can rise
LION’s gross margin has come under pressure over the past years falling from a 35% in FY07 to 32% in FY09. The decline in gross margin has been inline with the increase in global prices of raw materials. However, LION’s gross margin is on a recovery phase in FY10E, reaching 32.2% in 1H10 following lower commodity prices. The costs will be continue in the same phase with the falling prices of raw material in the year 2010 and will remain static afterward avoiding the prevailing inflationary impact. Successful research to back up the management’s thinking of using cheaper materials, with no impact on the quality or taste, has been largely accepted in the past years and would do so even in the future.

However, a gross margin of about 33%-34% has been maintained over time. EBITDA margins at 9.9% for FY09 is expected to reach 13.8% in FY10 and 15.2% in FY11 The main raw material used in the brewing process has been Malt, which is derived from Barley. Hops and Wheat (used in the brewing process), ox and Yeast (used in the fermenting process) are the other inputs.

We estimate that the raw material costs accounts for nearly 67% of LION’s production cost. However, in recent times LION has been substituting rice for malt given the fact that the commodity is abundantly available in the home country with no impact to taste or quality. This has been largely accepted by the consumers.

A major internal strength of LION would be its sophisticated manufacturing plants which is highly technical driven proving it to be a highly capital intensive manufacturer. This indicates its high reliance on electricity as a major source of energy, although gas plants have been set up within the premises as pilot experiments to cut down on the future reliance on Ceylon Electricity Board’s supply.

India, the new hunting ground
Having successfully marked its strong presence of the ‘Lion Brand’ in the First World regions such as UK, Canada, Australia, Japan, West Africa and Maldives, it has now successfully tapped the vast Indian Beer market. The Indian beer industry, with the third largest market in the world for alcoholic beverages, is savouring significant growth and is attracting large investments from brewing giants across the world. The Indian beer market is pegged at 13mn hectolitres, which is 26 times of Sri Lanka and is expected to double in the next few years. LION’s investment in Carlsberg India through South Asia Breweries (LION has an effective ownership of 22.5% of the joint venture brewery in India whilst the remainder is held by Carlsberg and Industrialization Fund for Developing Countries [IFU]). We see huge potential in that investment over the medium long term with the expansion into their fifth brewery at Andhra Pradesh.

This move had been identified as one of the fastest growing ventures exhibited by an international brewer. Carlsberg now operates 4 breweries in India. First one in Aurangabad Maharashthra, Kolkata, then in Himachal through the acquisition of small breweries in that region and a more recent one which began operation in 2008 in Alwar- Rajasthan. Each of these has a combined capacity of 825,000 hectolitre or nearly 10 million cases (of 7.8 litre each) annually. Carlsberg had also reported to have started off with its fifth brewery in Andra Pradesh. Sale of alcohol has been growing steadily at 6% and is estimated to grow at the rate of 8% per year.

Beer sales in India is forecasted to grow at a CAGR of 17.2% to 2011. So, with the Indian beer industry seeing steady growth, Carlsberg had proved to have been able to capture about 10 per cent market share in Delhi and Kolkata and about five per cent in Western India in just 6 months after initiation. Carlsberg’s claim of 450,000 hectolitre of domestic sales in 2009 has surprised industry watchers, who have tracked the global beer maker’s investments into manufacturing keenly. While the beer market is growing at a YoY rate of about eight to ten per cent, Carlsberg had also planned to capture about 15 per cent of the total market share in two years and increase its current capacity of 15 mn hectolitres p.a with the loosening of Quantity Restrictions.

All these ensure substantial capital gains in the future though this investment had proven to have a prolonged pay back period.

Profit Outlook
LION has a strong medium term profit outlook on the back of recovery in market conditions. Its established position in the market will enable it to maintain its share and is not likely to be seriously threatened.

Strong growth expected in the upcoming years
Revenues are expected to grow by over 28% YoY in FY10E with the opening up of the war zone areas and the economy at large recovering carrying forward higher levels of celebrations during the festive seasons, when compared to only a 17% YoY in FY09.

A close to eight fold YoY increase in net profit at LKR437.0 mn for the next FY10E is forecasted, having the festive and high peak seasons in mind, reporting a PBT of LKR470.7 mn with a YoY increase of close to four fold. A further increase in profits by 30.1% YoY to LKR586.8 mn with a PBT YoY increase of 31.6% at LKR619.3 mn is forecasted with the North and East markets gain momentum by FY11E.

However 2Q10 revenue had increased by 12.9% QoQ to a near LKR1,880.5 mn and a QoQ decrease of 23.4% finance cost to LKR77.1 mn relieves the gearing level of the Company and broadens the financing scope of the highly aggressive investment theme of the present management.

A huge portion of the FY09’s profits were offset by the finance costs which is expected to ease in the next year with decreasing interest rates and thus providing LION to extend its capacity more easily with its current safe gearing.

It is evident that LION would recover from its fluctuating profit levels and report a more stable and upward moving profit figures shooting up the reported half year earnings of LKR237.1 mn with an EPS of LKR4.30, assuming that the policies of the nation remains favourable.

Despite the unsatisfactory global conditions, LION had been able to remain strong and mark satisfactory contributions. With the recovery from the global economic slowdown coupled with the company’s continuous efforts in new product development (canning facility) and its market penetration strategies as we believe set opportunistic boundaries.

Valuation
LION is on the course of a sharp revival with earnings expected to grow by CAGR of 61.7 % over the next three years. Underpinned by lower raw material costs and improved market conditions, LION’s net profit has grown by nearly a ten fold YoY in 1H10 to LKR 237.1 mn. We project LION’s earnings to grow by a further eight fold YoY to LKR 437.0 mn in FY10E. As demand improves with the North and East markets gaining momentum, we project LION’s net profit to grow by a strongly 30.1% YoY to LKR568.6 mn in FY11E.

Share attractive on 10.6X forecast FY11E net profit. Having hit a low of LKR42.75 in 7th January 2009, LION’s share price has risen strongly by 75.4%. Following this gain, LION trades on a relatively heady 13.7X projected FY10E net profit. But given our expectation of a sharp increase in FY11E earnings to LKR568.6 mn, LION is attractive on a PER of 10.6X, given the expected strong growth in demand for soft alcohol/beer, the company’s near monopoly status, likely gains from the foray into India and high ROE. We rate LION a BUY.

Source - Asia Securities Research

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Sri Lanka Keeps Rates at Five-Year Low to Spur Growth

Sri Lanka’s central bank Governor Nivard Cabraal kept benchmark interest rates unchanged at a five-year low to spur investments and aid economic growth after the end of a 26-year civil war.The Central Bank of Sri Lanka left the reverse repurchase rate at 9.75 percent, the Colombo-based bank said. The repurchase rate was also maintained at 7.5 percent. The economy will expand more than 6 percent this year, Cabraal said in a Bloomberg Television interview today.

“The rate is sufficient to stimulate growth as well as ensure that any risk of inflation is also curtailed,” Cabraal said. “We need not have any fear” of inflation now, he said.

The island’s biggest companies including John Keells Holdings Plc and Aitken Spence & Co. are expanding their hotel and shipping businesses to take advantage of a rebound in the $41 billion economy. President Mahinda Rajapaksa is holding an election two years before his mandate expires after the defeat of the Liberation Tigers of Tamil Eelam rebels in May helped push growth above 4 percent in the third quarter.

“The central bank wants loan books to grow and money to flow into the economy,” Saminda Weerasinghe, research manager at Acuity Stockbrokers Pvt. in Colombo, said before the report. “Inflation pressures aren’t that great.”

Inflation Forecast

Sri Lanka’s inflation rate was 4.8 percent in December, less than half that in January 2009. Today’s rate decision took into consideration a potential pickup in inflation, Cabraal said in the interview before the central bank policy statement.

“Projections of inflation for 2010 indicate benign inflationary pressures, enabling inflation to be in single digits by year end,” the central bank said in the statement.

The economy may grow 7 percent in 2010, the fastest pace in four years, spurred by company investments and construction of new roads, ports and power plants, Cabraal said Jan. 4.

John Keells, Sri Lanka’s biggest diversified company, said in November it will invest about $100 million to build new resorts to benefit from a tourism revival after the war.

Aitken Spence, Sri Lanka’s biggest operator of resorts, plans to expand its hotel and shipping businesses while Commercial Bank of Ceylon Plc, the nation’s biggest private lender by assets, aims to extend more loans in the northern and eastern regions, which were recaptured from the Tamil Tigers.

Presidential Polls

Rajapaksa scheduled presidential elections to be held on Jan. 26, betting the economy’s recovery will boost his popularity.

Cabraal has kept interest rates unchanged for two straight months. He lowered the central bank’s reverse repurchase rate by 75 basis points and the repurchase rate by 50 basis points in November. A basis point is 0.01 of a percentage point.

“We have seen a sharp increase in lending during the past month which indicates to us there is stimulation taking place,” Cabraal said. “If we find there is a bubble being formed or too much liquidity being created, then we would think it’s time for us to increase the rates. But we haven’t seen any such danger right now.”

Sri Lanka’s benchmark stock index, the Colombo All-Share Index, jumped 125 percent last year, outperforming the rest of Asia and trailing only Russia worldwide, on prospects of an economic rebound in the Indian Ocean island.

The International Monetary Fund, which granted Sri Lanka a $2.6 billion aid package in July, expects the island’s economic growth and credit demand to pick up.

By Anusha Ondaatjie and Susan Li - Bloomberg

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Behind The Numbers…Beneath The Surface !

• Recovers from BOP crisis but economy slowing due to imports contracting
• Though LTTE was defeated peace building yet to take off
• Private sector corruption gets exposed
• Stock market buoyant but corporate health in question
• Inflation reported low but brand penetration declines

Being responsible for different facets of the Sri Lankan economic agenda in the last couple of years and having travelled to Jaffna a number of times on military flights together with the soldiers going for war, gave me a very good sense of the ground reality. There are two themes that emerge in my mind that captures Sri Lanka in 2009 — the first being the words of the former World Bank economist Ejaz Gharni who said God is a Sri Lankan.

When I initially heard this I laughed, but when I analysed the economic reality that unfolded in 2009 and the response that Sri Lanka has thrown back to the world, I now agree with the sentiments that God is a Sri Lankan! The second theme that captures my attention is from the Indian Foreign Minister Pranab Mukherjee. He commented that in a country, economics, the corporate sector and politics are interlinked. He went on to say that If people do not understand this reality and want these three areas to work in isolation then, a country’s growth trajectory will be stunted. I fully endorse this when I look back at 2009. Let me now highlight the key events that shook Sri Lanka last year.

Sri Lanka – The new Miracle of Asia

Private sector corruption
After having worked for almost 15 years in a multinational culture where honesty and integrity are required traits, when I decided to work for the government during the time I was pursuing a doctoral study programme the one question that I got bombarded with from my private sector friends was how do I work in a system that is so corrupt. My answer was easy – it is the private sector that corrupts the public sector.

I did not have to explain more as the Golden Key saga unfolded later on where corruption was in excess of Rs. 30 billion. This was the first shock for Sri Lanka in 2009. It was the first time in the history of the country that private sector corruption surfaced with over 10,000 witnesses that ultimately led to the biggest philanthropist in the country being remanded for almost nine months. I strongly believe that this is only the tip of the iceberg.

The sad fact is that the public sector is tainted with a peanut butter approach of being corrupt when the reality is that ninety five percent of the public sector consists of honorable and committed people who have come from the university system after topping their batch. The best case in point is the ‘Upahara’ scheme of Mobitel targeting the public sector which has zero bad debts. Hence the challenge in 2010 is strong reforms in the public sector and ensuring that corruption is curbed.

However, the reverse is currently happening in Sri Lanka with the public sector getting bloated with more recruitment and also consuming over 50% of the tax revenue for salaries and pensions which needs to be corrected in 2010. Public Sector reforms have to come in and curbing of corruption at all levels must take place if we are to drive Sri Lanka to a strong growth. However, a point to note is that this begins with me. Each of us needs to ensure corruption is not resorted to, to get things done in Sri Lanka.

Stock Market Reflection
Post May 18, Sri Lanka’s stock exchange was the golden light that kept Sri Lanka shining in the world stage. In fact when it was ranked as the fourth best performing stock exchange of the world, it did shake little Sri Lanka with this news as we as a nation were yearning for some good news post war. But the key question that needs to be asked is if this is an indicator of strong corporate health based on fundamentals or is it more to do with market sentiment?

Another point that needs our focus in 2010 is that, market capitalisation in Sri Lanka is lower than 30 percent hence the stock market indicator in Sri Lanka is not a real indicator of an upward movement of the economy. Hence in 2010 this needs to be corrected with the big boys in the private sector like Dilmah, Brandix and MAS attracted and listed in the Colombo Stock Exchange. It is only then that we can say the Sri Lanka stock exchange is a reflection of the Sri Lankan economy. If not, we are living in a make believe world that will not get us very far.

The reality of Inflation
Sri Lanka is currently showcasing to the world that inflation is at a low ebb of 3.4%. It may be the reality but when we analyse the panel data either by the trusted consumer panel from LMRB or the Retail Panel data of AC Nielsen we see that in many key consumer categories brand penetration has declined considerably. In fact the only reason that some categories are kept alive is due to the small packs that have been launched.
This fact is shaking Sri Lanka’s private sector as a typical brand health index throws off the brand momentum index declining not only of the brand but in the total industry. The best case in point is Sri Lanka’s banking industry in 2009.

I feel we need to get a grip of this issue in 2010 mainly because the January issue of LMD reports that a top management survey among a representative cross section of organisations reveals that 64% of them stated that the key barrier to growth was inflation. Hence comes the contradiction of how a reported 3.4% inflationary indicator can drive consumer behaviour away from a brand. One argument can be that the 3.4% inflation in 2009 is on top of a 22.6% inflation registered in 2008 in Sri Lanka. But I feel this issue has to be addressed as a priority if we are to support the private sector that accounts for over 75% of Sri Lanka’s economy.

LTTE and world pressure
During the time of the conflict — in my previous responsibility attached to the government — I used to be a frequent traveler to the north-east. Whenever I had to board a Sri Lanka Air Force flight to Jaffna I used to travel with soldiers who were going for war and the thought crossed my mind that I might never see them again. The interaction was so honest and genuine that some used to ask me if the war will really end.
However the unthinkable happened where the total hierarchy was wiped out ending the saga of terror that engulfed our nation for the past 30 years, that costed the country over two hundred billion dollars or more. The political leadership that saw this through ably supported by the strong military sure shook Sri Lanka in 2009.

However sadly post this great victory Sri Lanka has not seen a robust peace building initiative that many envisaged. Even though we are closing on to year I feel it’s not too late to begin this journey. However, the challenge is the political will to actually do this. My worry is that if this is not done fast another group similar to the LTTE can emerge and that has to be avoided at any cost.

Private sector reforms
Focusing on the private sector, when the financial crisis started spinning work economies the sector that was first effected in Sri Lanka was the apparel industry given that over ninety percent of its export markets are in the EU and US. However, this great industry went through some painstaking internal reforms and made itself competitive in the world stage that sure shook Sri Lanka. As we speak it is likely that the industry will taper out to maintain its financial delivery of the previous year. This demonstrated to the world the resilience of the people of Sri Lanka to changing market conditions.

The best names of the industry that came to the country for the first ever Sri Lanka Designer Festival were astonished to see world class manufacturing facilities like the Brandix Green Factory as well as the skill set of the workforce on the ethical tag. I guess the challenge in 2010 is for the telecommunication industry to take a few best practices from the apparel industry and make the industry financially strong. Reports coming in say that the industry is bleeding due to the price war.

Reserve scare
In March 2009, when Sri Lanka’s reserves dwindled down to a dangerously low ebb Sri Lanka was heading towards a BOP crisis which shook Sri Lanka at that time. However, Sri Lanka recovered and exited 2009 at a commanding $5.2 billion in foreign reserves. Even though this achievement was fuelled by foreign inflows through debt instruments and IMF loans, rather than export proceeds, the fact of the matter is that we came through this crisis.

Now the challenge is to strengthen our export marketing strategies in apparel, tea and the BPO business by directing the savings from the war towards these industries. We also need to drive up the R&D investment from the current 0.14% to at least 2% of GDP so that we can give leadership to the world in our exports. Believe it or not the tea industry in Sri Lanka has been operating in the international market without having any protection to the ‘Ceylon Tea’ name. What this means is that any packer in the world in any country can market products under the Ceylon Tea name. If we are to secure legal protection it would cost 25-30 million which has not been done and that explains the R&D gap that exists in the country. The good news is that plans are in place to correct this in 2010 but, the fact of the matter is that this should have happened 100 years ago, before we became a dominant player in the word market.

Political reality
With the war coming to a close and the capture of KP the administration’s popularity reached a peak but the subsequent events that unfolded resulted in a tussle for power where now the country is now bracing for a mega presidential election showdown. It sure shook Sri Lanka that was looking very positively to a stable political environment where the only focus will be economic and business growth. The reality right now is a nation where the productivity of people are at the bottom of the pyramid as the topic at any forum is ‘Who is in the lead?’ The challenge right now is for Sri Lanka’s private sector to focus on business growth and let the politicians do their bit but in reality this becomes a tough task.

Global crisis
Whilst there was much rhetoric that the global economic downturn will not hit Sri Lanka the fact is that no country could be insulated. The first quarter of 2009 saw the Sri Lanka economy contracting to 1.5% and it did shake Sri Lanka. Even though the economy grew by 4.2% in the third quarter of 2009 the latest data reveal that 89,000 people lost their jobs in the industrial sector and another 240,000 in the farming sector which is alarming.

Hence, Sri Lanka needs a new wave of investments in to the country. Latest research reveal that the country’s labour force has increased by only 1% in the period 1990 to 2008 whilst the projection as at end 2020 is that the labour force will grow by only 0.3%. These numbers will not do justice to Sri Lanka as other Asian countries are estimating a 2% increase. This can lead to severe social issues in the future that policy makers must address today.

But in a political economy like today there are bigger issues that push these critical issues into the back burner. This is the challenge for Sri Lanka. We require a change in policy making so that the economic landscape can be changed and if Sri Lanka’s private sector does not drive this together with the public Sri Lanka will get lost once again in the new economic order that is emerging post the financial crisis.

If we take Tamil Nadu for instance their very focused economic reforms have resulted in 27 of the top 100 companies having production facilities in the state and the latest information is that the Tamil Nadu government wants to have its own ranking on the ‘ease of doing business’ in the WTO report. This portrays the opportunity that Sri Lanka is fast losing.

Conclusion
Whilst Sri Lanka’s private sector has withstood the global storm in 2009, we need be cognizant of the fact that the trade deficit contracting is not a very healthy sign for corporate Sri Lanka. The reason being that this indicator means that the country’s performance is not driven by exports increasing but, imports contracting. In other words the Sri Lankan economy is slowing down. This needs to be corrected. A study done recently has revealed that unless 4 billion dollars in new investment come in annually Sri Lanka cannot target 8% GDP growth which tells us the policy reforms required to attract investments and drive growth. For this to happen the public sector reforms become a must which gives us the challenge ahead. If we do not drive for fast track economic growth, every time the world sneezes Sri Lanka will shake.

By Rohantha Athukorala
(The author is a former Chairman of the Sri Lanka Export Development Board and the National Council for Economic Development (NCED) when the country achieved 7.4% GDP growth. He is currently in the international public sector – United Nations Operations (UNOPS) as the National Portfolio Development Manager for Sri Lanka and Maldives. The thoughts are strictly his personal views based on his Doctoral Research Studies.)

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