A year ago, the equity bias – as the asset class most likely to offer the highest risk-adjusted return – was palpable. Four equity analysts from Colombo’s top brokerages forecasted weighted market earnings growth of 20% for 2015. The lowest of those estimates was 15% and the highest 25%. The conclusions about equity returns are far more sobering for the three quarters of 2015 for which returns have been published. In the September quarter 2015, market-wide earnings declined 6.2%, and in the four quarters to September 2015 earnings were up just 2.1%.
Equity weights of multi-asset class fund managers are at historic lows. However, institutional investors cannot stay out of the market forever. They will be watching for macro economic queues of a turnaround like evidence that the budget deficit can be contained, that the government won’t crowd out private sector opportunities as widely feared and robust foreign direct investment.
Winners are harder to pick now than at any point before the long war ended in 2009, in the opinion of many analysts. We asked the panel to advise an investor who has already decided to allocate a portion of assets to equity about a feasible strategy.
Chief Operating officer and Head of Research of Softlogic Stockbrokers Danushka Samarasinghe, Head of Research at Bartleet Religare Securities Nikita Tissera, Assistant Manager of Research at Candor Equities Ranuka De Silva and Head of Research of LOLC Securities Shehan Bartholomeuz participated in this roundtable discussion.
[pullquote]The issue with next year (2016) is that it’s not going to be a high-growth year for earnings. In that context, we have to compete with other markets to get international fund managers’ money
Danushka[/pullquote]
Market-wide earnings were flat in 2015, and below expectations from a year ago. What happened?
● Danushka Samarasinghe: It was because of two elections. Expectations were set after the presidential election, but there was a period of no drive towards economic development or policy. Expectations were high for a fast policy change, but that didn’t come through. Although investors and the business community expected a change in the investment climate, the priority was the process of democratization. That hampered the market.
● Shehan Bartholomeuz: We are in a period of transition. Things are slowly being put into place. But in small island economies like Sri Lanka, you need concrete decision making. Whatever direction we are going in, we need to have strong policymakers. Compared to developed countries, we don’t have a set of policies that will continue during different regimes. When a new regime comes in, they transform the overall economy. I think it’s unfair to expect that transition very fast. The 2016 budget is geared towards fiscal expansion. We are now facing an expanding fiscal deficit, and the currency and interest rates are taking a hit. I think we need to settle on the policies that will come in place for the long term.
● Ranuka De Silva: I agree that expectations were way too high. Another thing we very evidently need is the follow up of policies. This government should really try to follow through with policies. If you look at even the Maldives, their tourism policies do not change whatever government comes in because they know that is where their income comes from. We should also have policies like that going forward.
● Nikita Tissera: I just need to add that, in a year like 2015 where the complete focus was on the changing of governance, political campaigns have been largely peaceful, but still it takes a huge slice off the focus on the economy and growth. One of the reasons the market came to a halt was the interim budget, which was not one expected from a business-friendly government. The focus on policy was regressive, nonrecurring taxes with retrospective effect hurt investments coming in.
What are the key themes that will matter in 2016?
● Danushka: You asked what happened to the optimism. We’ve forgotten one side. In the past, economic growth was infrastructure driven. This year, with the presidential election, the infrastructure drive of the government came to a standstill, but still during the first three quarters, growth is 6%. That shows the optimism. It was the private consumer who was driving the economy. That was reflected to a certain extent with listed company earnings. Going forward, the challenges are not limited to our shores. We have to adjust to a global scenario of rising interest rates, and we have to expect capital flight from our country. That creates additional pressure not visible during the past seven years.
Global economic powers like China have slowed, and that slowing down of trade will have ripple effects. Sri Lanka is a key linking point, and our infrastructure strategy has been to make the country a service hub. The good thing about this government is that they seem to understanding the concept and are continuing it; but there are challenges. With the unrest in the Middle East, the benefits that were due to us in increasing tea exports to Iran and cheaper oil haven’t come through. Our export markets are not growing. These challenges will continue in 2016.
● Shehan: China slowing is a significant factor. Energy markets were basically driven by China – their consumption of commodities and fuel. China consumes about 50% of base metal.
There is also a flight of dollars from Sri Lanka and frontier markets, and a selling out of energy markets due to the effect of the Federal Reserve interest rate hike. So our monetary sector is a bit exposed. We are running on a negative current account and looking at a BOP crisis. The government is not flexible about implementing fiscal policies that can drive the economy to the next stage at the moment.
● Nikita: We also expect some policy reform that is painful in the short term. For instance, increasing theamount of direct taxes, which was articulated by the PM days before the budget, wasn’t seen done. We saw direct taxes reduced. Before the change in governance, headline numbers looked good – very high GDP growth and very low inflation. The real problem is with revenue. Although we had high GDP growth and low inflation compared with our regional peers, in terms of our revenue toGDP ratio, we rank at the bottom. So I thought our main focus should have been to increase revenue, because we are paying close to 95% of our revenue in servicing our debt. We are looking at a capital flight scenario for external reasons, and on top of that we can’t pay a higher price due to a rating downgrade. When there is a risk of capital flight, and particularly when there are no major elections to look forward to, I believe policymakers should have made the shorter term a bit more painful for long-term gain.
So are we going to see a reemergence of inflation?
● Nikita: Yes, because Rs90 billion of the Rs223 billion forecast revenue comes from NBT, an indirect tax, which I believe could directly contribute to inflation.
● Ranuka: The currency is depreciating, so that makes exports more competitive. In terms of export markets, we’ll have to see if we get GSP+ as well. Overall, if you look at apparel alone, you have $2 billion imports for $4 billion exports. I don’t think taxation would be painful in the short term, but they should also consider sustainability; it’s about increasing the quality of life. The government has to factor macro-objectives as well.
How do you see the markets current valuation?
● Danushka: I think it’s evenly priced. The issue with next year (2016) is that it’s not going to be a high-growth year for earnings. In that context, we have to compete with other markets to get international fund managers’ money.
It’s not going to be a high GDP growth environment either. For an international fund manager, there would be better alternatives. We are isolated, and this would increase the pressure of portfolio flight andbuild pressure on the currency. Inflation will rise, but I don’t expect it will be as high as it has been in the past. But core inflation is averaging at five and a half percent already. We might see overall inflation hitting five and a half to six percent. This will push up rates as well.
● Nikita: We are currently enjoying the benefits of low crude oil, which comes in the form of savings on food prices and electricity. Besides the impact of low crude oil, I don’t see anything directly contributing to low inflation. But due to the consumption multiplier we get from the proportion of GDP spent on crude oil, I think we’ll be able to sustain low levels of inflation. I also don’t think inflation will rise to an alarming level. As a country, we are used to high levels of inflation.
The 15% corporation tax is one of the lowest rates in the world, but its impact on government revenue may cause inflation to rise. Do the two things cancel each other out in your opinion?
● Nikita: I still think the saving on corporate tax is bigger. Rs200,000 for an average Sri Lankan is a pretty large salary, and I don’t know how many income tax-paying citizens would be left. You are letting a large number of former taxpayers out of the tax bracket. You are now looking at more disposable income. I still think the more pressing issue for the government is revenue, especially if the infrastructure drive is going to continue, borrowing is going to be very difficult.
What’s the impact on earnings growth in 2016?
● Shehan: If you really do the numbers, from the 15% corporate tax reduction, and with the countless listed companies on the CSE, profits should rise. Most companies will benefit from the lower corporate tax.
But keep an eye on what’s happening globally, one of the main things is rising global interest rates. The Federal Reserve is likely to raise rates by 150-200 basis points (1.5% to 2%) in 2016. Companies will have a higher finance cost and additional costs coming from inflation pressures. Equity market valuations will also take a hit with interest rates going up. We have to be mindful that Sri Lanka is not the cheapest market in the frontier lot. We are trading around 14 to 15 times PE, whereas most other countries are trading at a discount to normal equity markets, at 9 to 10 times PE. Our premium PE is driven by high GDP growth expected after the end of the conflict.
[pullquote]If you really do the numbers, from the 15% corporate tax reduction, and with the countless listed companies on the CSE, profits should rise. Most companies will benefit from the lower corporate tax
Shehan[/pullquote]
What is your earnings growth forecast for 2016?
● Shehan: Maybe 5-10%. The corporate tax rate is 12% for most companies in the construction and tourism sectors, and 10-12% for export companies currently. The effective rate of other firms is 20-25%, but with the current budget, there would be a flat rate of 15%. So the impact may not be as drastic as halving the tax. But there should be bottom-line growth.
● Ranuka: 5-10% earnings growth next year.
● Nikita: That would be a fair estimate. But I really doubt this earnings growth will come through business volume growth and higher consumption. It’s just going to be through tax savings. I think consumption-related stocks will continue to have their heyday. When such a tax break is given to such a large portion of the working class, a consumption boom is inevitable.
The banking sector, on the other hand, has taken a beating. If the banking sector was a beneficiary to this drive, I think overall growth would have been a bit higher, but growth is coming from trading and consumption, and maybe healthcare. I don’t see the banking sector growing in the same level it did over the past three years. Drifting to stocks, there was optimism about consumption-led growth even before the interim budget.
Are you as optimistic for consumption-related stock earnings growth in 2016 as you were for 2015?
● Nikita: I am. I don’t think Sri Lankans have a savings culture yet. We would continue to boost the FMCG sector going forward, but I wish the stock market had more exposure to listed FMCG firms. I’m as bullish as I was earlier on Hemas Holdings (HHL), maybe Cargills Ceylon (CARG), and also short-term finance providers like Singer Finance (SFIN) and Nations Trust Bank (NTB). Credit card exposure will continue to thrive, particularly with stamp duty taken off, but I don’t know how much of an activity impact it would have.
● Shehan: I have a feeling the first half of 2016 would be good for consumption, but the government may not be in a position to let it continue. This is because the budget gave a further allowance to state workers. The benefits will come to consumer sector firms. Even in the banking sector, people will borrow to consume because they will have more money. On the fiscal side, we are running into worrisome territory later in 2016. At the moment, we are at a 6% budget deficit figure, and if we don’t have the dollars to pay for our imports, inflation will pick up and there will be social unrest.
● Danushka: I mostly agree with Shehan, but I have some disagreements as well. The disagreement is that I think the first half of 2016 would be slow because the saving in PAYE would be effective only after April 2016. The port city project will also be re-launched, which will change the sentiment. The first quarter will see all this, but the impact on consumption-driven growth will be seen from the second quarter onwards.
But agreeing with everyone here, I don’t think it will continue like we have seen this year (2015). The dollar will bite us and uncertainty with regard to the banking system will hurt us. For example, last year, a bulk of consumption value was in vehicles. This will not happen in 2016 because of high taxation. But then again, we don’t know if the government will backtrack on the permit issue. Then the entire picture will change.
Is there another favoured group of stocks that are potentially better placed for 2016?
● Danushka: I can’t generalize like I did last year. I don’t think the consumer segment stands out either. There are selected firms like Ceylon Tobacco (CTC), which is benefitting from the increase in government servants’ salary, reductions in PAYE and a stoppage of smuggled cigarettes.
● Nikita: Does that still continue? We saw increased rates on cigarette smuggling from 2008-11, but I haven’t seen any recent headlines.
● Danushka: What I think is happening, Nikita, is that there is an actual stoppage of smuggling containers, because the system is more vigilant. It’s acting as a discouragement for potential smugglers. It’s not stopped completely, but some sort of corrective addressing is being done. That is justifying 20% volume growth for CTC.
● Nikita: That case is stronger for alcohol. This time in 2014, half of the total alcohol market in Sri Lanka was the grey market, illegitimate. Now, even with a new player coming in, Mendis, I’m seeing a market share reduction to the biggest player, Distilleries Company of Sri Lanka (DIST), but I’m not worried because the total size of the legitimate alcohol market is still growing. There has been a huge clamp down on the grey sector.
● Ranuka: They are cracking down on illegal things a lot because it affects government revenue. That’s how they are actually benefitting.
[pullquote]I’m as bullish as I was earlier on Hemas Holdings (HHL), maybe Cargills Ceylon (CARG), and also short-term finance providers like Singer Finance (SFIN) and Nations Trust Bank (NTB)
Nikita[/pullquote]
Does anyone else see an area of growth?
● Ranuka: Last year, consumption was the sector. This year, consumption is not going to grow as rapidly; I think it will hold pretty much flat. But it all depends on policies. We are actually looking at Access Engineering (AEL), as the government’s interest is on more road projects and construction. But again, it will depend on policy; there is still uncertainty.
Nikita and Shehan highlighted construction-related firms making bathroom fittings and tiles. Access seems to be a favourite. Is this a niche that will work in 2016?
● Danushka: In construction, Royal Ceramics Lanka (RCL) is a fantastic production company with a fantastic marketing concept, PE around 4.5x and ROE closer to 20%. But with overhangs with regard to policy uncertainty like a revision of import duty on tiles and the removal of cess, analysts can’t make a call on RCL despite all those convincing valuations. We are at the mercy of the policymaker. For Access – it all depends on the infrastructure drive here. The Chinese port city, in my opinion, will havea very minimal benefit for local construction companies, apart from some drivers, lorries and rocks. We are waiting to see the strategy on highways and roadways, whether an equitable share will be given to construction companies or if it will be selective. If transparent bidding on government contracts happens, that is a positive for all sectors.
● Ranuka: Even the aluminum industry, although it is in the negative list of the BOI, is going to benefit because whoever comes in will definitely buy from here due to the cost. As Danushka said, RCL is still a vague share. The numbers look attractive, but we can’t make a call on it.
● Nikita: I continue to be bullish on the tile sector for three reasons. One, if we are looking at a one-year horizon, I’m comfortable looking at the tile sector because regulatory concerns or the question of the industry’s competitiveness won’t be a factor to me in a sub-one year investment horizon. That said, not just RCL, but Lanka Walltiles (LWL) and others, leading to the budget, assumed the government would take away the protection, but it didn’t. That to me is a big plus. Second, for any of the three companies, I’m not expecting much volume growth in the short run, but you are looking at a saving in tax and the lower cost of production through energy. RCL is particularly able to switch between LP gas and kerosene at minimal cost. To them, the reduction in the LP gas price is very significant. Third, in the longer run, you are looking at much higher remittances over 2016-17 compared to 2012-14 because the contribution per foreign worker has improved, as we are no longer looking at housemaids in the Middle East alone. We are looking at skilled and semi-skilled workers. Remittances per worker have seen a massive increase, and I think that drives the private construction industry. All this benefits the three tile companies a lot more than we would have initially thought.
Is it highly unlikely that the cess will be removed in 2016?
● Nikita: I wouldn’t make that call. We’ve been having that question from day one. I would have been uncomfortable giving a long-term call on an industry that is not competitive in its own right. We feared protection would be withdrawn, but it didn’t happen. In the short run, it’s not going to happen. Furthermore, import tariffs have increased by about 5% nett. So the cost of imported tiles has gone up.
What about Tokyo Cement (TKYO)?
● Danushka: Cement companies globally are very shy around disclosure.
● Nikita: They have their reasons. You can’t even find clinker prices on Bloomberg. Cement should be alright because tiles can’t grow without cement.
Any other sector? What about Access?
● Nikita: Issues beyond the control of the management always bother analysts. For that reason, I believe they should trade at lower multiples.
● Shehan: I’m fine with Access. In the construction sector, you have to consider the shift of the model. Access’ core strength was in roads and highways, and water, but I think the construction sector and the whole economy is now shifting towards consumer-driven segments. Residential and high-rises will come to play in the near future, compared to infrastructure projects that Access was enjoying. In that area, Maga Engineering is probably the dominating company. On volumes, Access isn’t achieving as much as they did in the past few years. Looking at Access as a company, I really love their balance sheet and funding structure, and how they are not that reliant on the government. Even in a very adverse scenario, Access’ stronger balance sheet can help them steer through.
[pullquote]JKH losing the casino license is a big deal. We don’t get high spending tourists here, and I thought casinos could change that
Nikita[/pullquote]
How will consumption growth impact banking and finance sector stocks? This can’t be bad for banks?
● Danushka: I’m not that bullish on the banking sector, because of a line item in the budget on the funding side of giving a sovereign guarantee to finance company depositors. Until that is clarified, banks are not a hot favourite for me because they will see funding issues. Then comes the 2% tax on withdrawals of over Rs1 million. That’s also a negative. As it stands now, it seems finance companies are to benefit, but again we have the question of uncertainty and backtracking of policy as the government might change their budget proposals one or two years down the line. So my advice is, even if these policies or newly introduced regulations are changed, see what companies will remain strong or solid. In the finance companies space, I prefer People’s Leasing & Finance (PLC). There are other very good and well-managed companies like Central Finance Company (CFIN), but as equity investors on valuations, PLC and LB Finance (LFIN) stand out. PLC’s ROE is closer to 20% and dividend yield is good at around 2%, and it has a market cap of almost Rs35 billion, bigger than many banks. Given this budget proposals and growth forecast
for the country, the banking sector could be a bit overvalued.
● Shehan: I agree, but on the positive side, this budget is promoting a banking culture by opening bank accounts for children and employees, and digitalization. They are trying to get the informal finance sector into a formal sector. These are positive. If the country is looking at a more formal financial system, it is relatively underpenetrated in terms of banking compared to similar GDP per capita countries in the region. There is an upside. Even though we have a widespread banking network, people are not that comfortable with banking products. Why I like banking stocks is not because I have a contrarian view but because of the price drop this year. National Development Bank (NDB) and Commercial Bank of Ceylon (COMB) dropped 20%+ YTD. Banks like COMB that have lean cost structures and high CASA (current account, savings account, in the deposit mix), and advances to corporates should withstand increasing interest rates. Banks like Sampath Bank (SAMP), which are more into SMEs and aggressive in the lower end of the spectrum, have higher growth potential. NDB prices have come down significantly and might be beneficial. So on the pricing and valuation sides, I see the potential for repricing of these particular stocks. But if you look at banks with low asset quality, they might struggle with a higher interest rate environment in 2016.
● Nikita: I have to agree with everything Danushka says, except the sovereign guarantee on NBFIs (non-bank financial institutions). I refuse to take it seriously because I think there is a structural problem. The Central Bank has a balance sheet of Rs50 billion, whereas the total NBFI sector is around 10x larger. So, as well meaning as it is, I don’t think the Central Bank is able to do that. I think what the finance minister meant was that he wanted to give coverage to senior citizen accounts or deposits less than Rs100,000 or Rs200,000. I’m sure there is some disclaimer, because what you are doing here is creating taxpayer-funded arbitrage. It just doesn’t make sense. So I don’t really think that would be a practical concern going forward, but we need to get some clarity.
● Danushka: It’s practical because the Central Bank can print the money. But then there is going to be an issue on the fiscal side. That is also my concern, we need clarity.
● Shehan: On the leasing side, although we are seeing it as a negative for the banking sector, the government pushing banks to move out of consumer finance into traditional banking might pan out well for banks in the long run. Banks have been comfortable with consumer finance products like leasing and asset-backed pawning, because we are a developing country.
● Nikita: I think it would be unfair to say that banks have taken their eye off the ball when it comes to core banking. I think leasing gave banks a good alternative when we had asset-liability repricing issues, and banks didn’t have much of an alternative in the longer end of the yield curve. I don’t know what else would give banking that option of investing in the longer run. I also think some of the bigger, practical problems the budget proposed with banking were proposals relating to forced growth.
Each bank should grow a minimum of 15% this year; I think it’s up to the banks to decide. Over the past four years, banks like SAMP and Hatton National Bank (HNB) have undertaken very rapid growth. Internally, these banks have decided how much they should grow to become the optimum size, to maximize ROE, and each bank has decided in what time period they should achieve this. I don’t think an external party can decide that all banks should have blanket growth with a minimum number of employees per branch. That would be the more practical challenge that banks would face. Of course if they did go through with the sovereign guarantee, that would be the biggest challenge in terms of getting deposits.
[pullquote]Last year, consumption was the sector. This year, consumption is not going to grow as rapidly; I think it will hold pretty much flat. But it all depends on policies
Ranuka[/pullquote]
Ranuka, you highlighted Sampath Bank. Any particular reason?
● Ranuka: Overall, the banking space doesn’t look very great. What Candor likes about SAMP is that they have one of the best CASAs – about 46%. We think they are more geared towards risk and lending going forward. Everyone talks about their tier 1 capital problems, and that’s the only negative we see, but we think it can be addressed. That’s why we are very bullish on SAMP, and we think it’s one of the banks geared to take over.
Danushka, you like Overseas Realty (Ceylon) (OSEA). What’s the story here?
● Danushka: That’s because I’m looking at a not-so-great year ahead for equity markets in terms of growth. As we were discussing, it should be around 5-10% earnings growth, as there will be drags from the plantation sector etc. OSEA is a good dividend pay, close to five and a half percent dividend yield at the current price; and the World Trade Center is still by far the only international-standard office complex in the entire country. Built property prices are valued in dollars, and with a depreciating rupee, the cost of replacing that building has escalated. Revaluation of assets should also be factored into the company. They also have their residential units coming up and we might see pre-sales, but not as strong as last year. They are going for measured growth.
● Nikita: Danushka, aren’t you worried about a possible oversupply in high-end units?
● Danushka: I am worried about oversupply in high-end residencies, but with new projects coming in like John Keells Holding’s (JKH) Water Front, Shangri-La and Altair, Havelock City has been pushed down to mid-end in terms of pricing.
● Nikita: The thing is their pre-sales have been about 20% last year, and 22% at the beginning of this month, and growing about 2% for the whole year.
● Danushka: The way I look at it, if there is a huge increase in pre-sales from Havelock city, it is a bonus.
You are also bullish about firms with exposure to the export market?
● Danushka: That is because those companies; Dipped Products (DIPD), Haycarb (HAYC) and
Hayleys (HAYL) as a group, are trading at an average of around seven and a half to eight times PE, and not-so-great ROEs but decent, in high teens. DIPD and HAYC dividend yields are also rather ok at 5%, but you might expect a bit more for export companies.
Shehan, what’s your stand on JKH?
● Shehan: JKH is a diversified conglomerate that is basically a proxy for the economy. It has taken a hit in the price because of warrants. However, for a new investor, it’s not an issue that the previous investor has exercised warrants at a cheaper price. Its shareholding is well diversified with more than 50% held by foreign investors, and none of the shareholders having more than 20%. Apart from operational excellence, and individual subsidiaries contributing to the bottomline and valuation, JKH stands out. This is the most liquid company listed on the CSE. JKH is also a small cap in the frontier market, but from a fund manager’s point of view, you are looking at investorbility. When you compare JKH multiples with others, JKH may have a higher premium, even if you look at history. Even with the drop in prices, JKH’s fundamentals have not changed significantly.
About a fourth of the valuation of the overall company comes from the new Waterfront project. People are questioning the feasibility of the project, whether it can add value to the overall group structure. I’m quite confident about the project even though they lost out on the casino. It’s a long-term project that is coming to play in 2018, when Sri Lanka should be doing well overall. For an investor looking at Sri Lanka, JKH should be a first entry. Waterfront will be the next stage for JKH. SAGT is a cash cow, and is stagnant. The leisure sector is picking up. On the consumer side, Ceylon Cold Stores (CCS) will definitely get more money. I believe ROE has room for growth for JKH as an overall group. I don’t see much risk for an investor.
Nikita: It’s difficult to build a case against JKH generally. For a sizeable foreign fund coming in here, whether you like the fundamentals or not, that’s the only company you can put your money into – that and Commercial Bank. But for the rest of us being bullish on JKH for CCS (a separately investable option) is not making sense. I’m very bullish on CCS right now. For the past two years, I’ve been horribly wrong on CCS. Every time I increase my forecast, they’ve done multiples better beyond my forecast. The turnaround CCS has made has been phenomenal. It’s like Apple (NASDAQ: AAPL) – every analyst, every year, gets Apple forecasts wrong. There is no growth in SAGT. Hotel growth is to come, but it’s below par. JKH losing the casino license is a big deal. We don’t get high spending tourists here, and I thought casinos could change that. We may still have an upside on JKH for a minority investor, and I would still pay a premium for CCS right now.
● Ranuka: CCS’s turnaround is great and they are looking into other businesses now. If you look at consumption, this is definitely at the forefront. Footfalls alone are fantastic, and how they turned the company around in terms of structuring has been pretty good and reflected in the numbers. I’m referring to CCS alone. For JKH, I have similar concerns with SAGT and hotels, but indeed it seems the hot favourite for anyone coming in. I would rather go for CCS alone.
● Nikita: It’s not just footfall turnaround, you need to look at their manufacturing. You are looking at a huge decline in commodity prices like sugar and milk powder, which are the main raw ingredients for their biggest cash generators.
● Danushka: I think it’s a macro play. I think JKH right now is evenly valued. You don’t see a significant upside nor a downside, but it’s a call on the country basically – how GDP growth will pave out and from where, if FDI will come through, and how bullish you are on Sri Lanka. It’s more an impact from international thinking than domestic thinking. Com Bank has also been elevated to that level. Those two companies together are a proxy.
Who likes Aitken Spence Hotel Holdings (AHUN)? Why aren’t the others optimistic about hotels?
● Nikita: It’s very hard to build a case for it. The upside is higher because of the fall it took. All three hotels on my list are on by weakness rather than growth going forward. I have John Keells Hotels (KHL) and Asian Hotels & Properties (AHPL). I think AHUN has extremely good brands and phenomenal access to credit. Their cost of credit is actually cheaper than our sovereign; for a Sri Lankan company, that’s phenomenal. But increased capacity will only reap rewards post-2017, or even 2018. If you are in it, you have to be in it for the long run. AHUN would go at 12/13x forward and AHPL is going at about 20x. I’m looking at cash flow valuation; and if you are taking a 3-5 year view, I think the shares are mispriced right now. Keep in mind that I’m not looking at growth for these hotels.
[pullquote]I think it will be very measured growth in the market. As it stands, it will be flat or we might see very marginal, single-digit growth
Danushka[/pullquote]
● Shehan: More or less, all my views are on price mismatches. I’m not really optimistic about 2016. When you asked me to give my view from the top down, I’m looking at balance sheets of the companies and AHUN has very strong funding lines and is very stable. It’s also a strong brand name in the Maldives. Going forward, it will be a stable company, and with the current price reductions, it’s trading at a discount.
● Danushka: For AHUN, since you mentioned we are looking at a one-year horizon, they are in a capex drive. They are investing; so for that asset to turn around and make money, it will take more than 12 months. I’m talking about the JV with the Spanish company RUI. Once it’s done, it will be a sure bet, and they can start with about 70% occupancy because the charters are already organised.
● Ranuka: I think the industries have switched. Today, you are looking at not many high-end tourists. Even if they come, there are boutique properties that are more focused towards that customer base. AHUN has a plan with charter flights, but I don’t see topline growth coming from tourists because they have so many options. AHUN is doing really well in the Maldives. If you look at numbers, the Maldives seems to be carrying the rest of the group in terms of hotels. I think focusing on the Maldives is exactly right. In the longer term, you might be able to see some growth.
● Danushka: In the hotel sector, the challenge is resort pricing. We are expensive and the quality of service is sub-standard. We are talking about trying become a service hub. Sri Lanka sucks at service. The way you serve customers, we don’t have it in our blood. Unless we shake up our human capital and make them service oriented, we are not going to make much headway.
Final thoughts?
● Shehan: Overall, I have a bearish view on the market for 2016 due to policy uncertainty. We are going to see more Fed rate hikes and the last budget proposals bring uncertainty. Overall, in 2016, with the high interest rate regime, the fiscal slippage might lead towards a weaker currency and higher inflation. Saying that, the lower tax regime introduced by the budget will have a positive upside for bottomlines and valuations. In valuations, the cost of equity will increase with higher interest rates, and there will be a slowdown of the economy. So generally, I’m taking a bearish view.
[pullquote]I don’t think taxation would be painful in the short term, but they should also consider sustainability; it’s about increasing the quality of life. The government has to factor macro-objectives as well
Ranuka[/pullquote]
● Ranuka: You are looking at interest rates under pressure and inflation being affected with the currency under pressure as well. Overall, the outlook does not look great, but there are counters we should look at.
● Danushka: I think it will be very measured growth in the market. As it stands, it will be flat or we might see very marginal, single-digit growth. What I want to emphasize is that the sentiment changer would be the port city, the megapolis development plan with a properly structured implementation mechanism, some highway projects being kicked off and FDIs. If those things happen, it could basically prop up the market very easily. It’s a small country and a small economy, so the sentiment could change and there could be 20% growth if that happens.