DSR Sri Lanka - Value is Back in Equities

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Provides an overview of the equity bull market that ensued the end the war in Sri Lanka during 2009-2011, along with an outlook for the equity market and macroeconomic environment into 2012-13

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SRI LANKA: VALUE IS BACK IN EQUITIES

JULY 2012
150, St. Joseph’s Street, Colombo 14, Sri Lanka. Tel: +94 112490900, Email: [email protected], www.jbs.lk

PRIVATE & CONFIDENTIAL

Contents

The party – end of the 30 year conflict

The inevitable after party – exuberance led to irrationality

Sobering reality – some concerns remain

The lion is not beaten – And… the good news…

JB Securities Research July 2012

Page 2

Country Snapshot Market Snapshot
Name
Capital Commercial Capital Time zone Nationality Population Total Area Density Currency Exchange rates GDP (Nominal) Economic size (2011) GDP (PPP) GDP per capita (Nominal) GDP per capita (PPP) Sovereign rating Official languages Business language Literacy rate
*As at 06/07/2012

Democratic Socialist Republic of Sri Lanka
Sri Jayewardenepura Colombo Standard time zone UTC +5.30 Sri Lankan 20.9 Million 65,610 Sq.km 333/Sq.km Sri Lankan Rupee (LKR) LKR 135.38/US$| LKR 168.20/€ | LKR 210.53/£ USD 59.2 Billion Int’l D 115.2 Billion USD 2,836 Int’l D 5,609 S&P: (B+) ‘Stable’ Fitch: (BB-) ‘Stable’ Sinhala, Tamil English 91.9%
Colombo Sri Jayawaredenepura
6°54′N 79°54′E

Moody’s: (B1) ‘Positive’

JB Securities Research July 2012

Page 3

Equity Market Snapshot
Valuations
Market Capitalisation Market P/E* Market P/B Dividend Yield LKR 1,881.7Bn USD 13.89Bn 10.18x 1.76x 2.55% Other 19% Diversified 23%

Indices
Current All Share Price Index Milanka Price Index S&P Sri Lanka 20 Index 4,986.7 4,439.3 2,797.4 Change MTD 1.0% -0.1% 0.8% Change YTD -27.7% -31.0% -22.4% Oil Palms 6% Telecoms 6% Hotels & Travels 7% LKR 1,397.4Mn 17.9% 40.9%

Market Index Decomposition*
Banks & Finance 22%

Liquidity
Average daily Turnover** Annualised share volume velocity*** Free Float****

F&B, Tobacco 17%

* P/E data is as per Bloomberg L.P. ** and *** Figures are based on data from June 2011 to June 2012. Year-to-date figures are as follows: Average Daily Turnover – 796.12Mn, Velocity – 4.9% ****Free Float reflects the public shareholding of the companies that comprise the top 50% of CSE market capitalisation
JB Securities Research July 2012

*As at 05/07/2012

Page 4

May 2009 Jul 2009 Sep 2009 Nov 2009 Jan 2010 Mar 2010 May 2010 Jul 2010 Sep 2010 Nov 2010 Jan 2011 Mar 2011 May 2011 Jul 2011 Sep 2011 Nov 2011 Jan 2012 Mar 2012 May 2012

JB Securities Research July 2012

The party – end of the 30 year conflict

Page 5

The news buzz set the tone …
Foreign ministers of UK and France, visit Sri Lanka in a bid to set up a temporary cease fire. UNHCR holds a special day session on SL and under the backing of India, China and Russia, commends the government humanitarian effort. EU suspends Sri Lanka's preferential trade status (GSP +) over allegations of human rights violations. China lends USD 1.2 billion out of USD 2.2 billion, emerging as the largest lender surpassing ADB & World Bank in 2009.

January 2009 – June 2011
UN panel led by Maruzuki Darusman publishes its report on war Accountability in Sri Lanka

INTERNATIONAL

President Rajapakse opens the 1st phase of Hambanthota port, funded by China.

Sri Lanka announces bid for Commonwealth Games 2018 in Hambanthota

180 High point = 173

2009
Latter stages of the war

2010

2011
End Value = 141

160

140

120

DOMESTIC

100

Start Value = 96

Low point = 87

80

The UPFA capitalizes on the war victory and gets fresh mandates with prescheduled elections, gets parliament supermajority. Incumbent M. Rajapakse wins the presidential election with a clear majority against challenger Gen Sarath Fonseka, who led the SL Forces to victory in the recently concluded war. (6m votes to 4m). The Defeated candidate of the election Gen Sarath Fonseka arrested for allegedly violating rules preventing the discussion of political matters while being a member of the military.

With the 2/3rd Majority in the parliament government sweeps through major legislative reforms AG Mohan Pieris withdraws murder charges against former government MP. Former CJ questions legality. The President appoints an 8 member Lessons Learnt and Reconciliation commission, headed by former Attorney General C. R. De Silva The parliament passes 18th amendment to the constitution. Removes presidential term limits and increases presidential power over the Judiciary, police and civil service. Clashes over proposed new private sector pension bill intensifies. 1 worker killed and 60 seriously injured. Government temporarily suspends the bill.

War Ends with the killing of LTTE leader V. Prabhakaran. 60,000-100,000 total civilian casualties estimated in the 30 year old conflict.

The ruling United Peoples Freedom Alliance wins the parliamentary election with a large majority of seats (64%). The election saw the lowest ever voter turnout (62.26%).

Sources: Newspaper articles, Central Bank of Sri Lanka, LMD, The Nielson Company, JBS Research

JB Securities Research July 2012

Page 6

LMD Nielsons Business Confidence Index

International intervention fails to pause the war

The Government distances itself more from Western powers and inclines towards China and India

The incumbent government consolidated power …
• UPFA won the Parliamentary election with 63% of the votes in April 2010 • UPFA is led by the President Mahinda Rajapakse who won the recent Presidential Election(Jan 2010) with 58% of the votes. • In Q3 2010 17MP’s crossed over from the UNF to support the 18th amendment. • UNP, JVP(DNA) and TNA contested separately for the parliamentary election after their common candidate was defeated at the presidential election in Jan 2010 • UNP is the main opposition party
JB Securities Research July 2012

Composition of the 7th parliament-(2010-2016)

UPFA UNP-D SLMC UNP DNA TNA

144 (64%) 9 (4%) 8 (4%) 43 (19%) 7 (3%) 14 (6%)

Government (72%)

Opposition (28%)

17 MP’s crossed over to the government to support the 18th Amendment
Source: Parliament of Sri Lanka, JBS Research Analysis

Page 7

Easing inflation drove real interest rates back up…
Real Interest Rates
25%
T-bill rate Inflation*

14.0%

12.0%

20%

10.0%

8.0% 15% 6.0%

4.0% 10% 2.0%

5%

0.0%

-2.0%

0%
Oct-07 Jan-07 Jul-07 Apr-07

Conflict
Oct-08 Oct-09 Jan-08 Jan-09 Jul-08 Jul-09 Apr-08 Apr-09

Post-conflict
Oct-10 Jan-10 Apr-10 Jan-11 Jul-10 Apr-11

-4.0%
Jan-07 Jul-07 Apr-07

Conflict
Oct-07 Oct-08 Jan-08 Jan-09 Jul-08 Jul-09 Apr-08 Apr-09

Post-conflict
Oct-09 Oct-10 Jan-10 Apr-10 Jan-11 Jul-10 Apr-11

* CCPI 2002 – Core Inflation 12 month MA, 1 year treasury bill yield
JB Securities Research July 2012

Source : Central Bank of Sri Lanka, JBS Research Analysis

Page 8

Investment, private consumption and exports drove GDP growth
Expenditure on GDP
Private consumption Investment Net exports Government consumption

Growth in expenditure
190%
Private consumption

CAGR
35.3% Government consumption Investment Exports of goods and services Total consumption (Private + Govt') Imports of goods and services

180%

17.6%

15.6%

14.8%

170% 160%

28.6%

24.5%

27.8%

29.9%
150% 140%
18.3% 21.3% 21.3%

64.3%

130%

65.8%

69.8%
120%
6.6%

110%

-6.5%
2009

-9.1%
2010

-14.6%
2011

100% 2009

2010

2011
Source: CBSL annual report 2011, JBS Research Analysis

JB Securities Research July 2012

Page 9

Conflict affected areas rebounded from a low base …
Provincial contribution to GDP
YOY GDP growth 3.53% 8.01% 5.95%
3.2% 4.7% 4.5% 5.6% 6.4% 9.9% 9.8% 10.5% 3.2% 4.6% 4.5% 5.8% 6.1% 9.6% 9.8% 10.5% 3.4% 4.8% 4.5% 5.9% 6.3% 9.4% 10.0% 10.7% 125%

Provincial growth
CAGR % 2008/10 Northern
120%

Northern
North Central Uva
115%

10.13 8.83 6.84 6.63 6.45 5.34 5.27 4.78 2.90

Eastern Central Southern

Eastern
Sabara-gamuwa North Western
105% 110%

North Central Western Uva Sabaragamuwa North Western
100%

Central Southern
45.4% 45.8% 45.1%

Western
95%

90%

2008 100%= LKR4.4Bn

2009 LKR4.8Bn

2010 LKR5.6Bn

2008

2009

2010
Conflict affected areas Page 10

Source: Census and Statistics Sri Lanka, JBS Research Analysis

JB Securities Research July 2012

Tourist arrivals increased
Record number of tourist arrivals…
900
900,000

Earnings grew…
Tourist Receipts (USD millions)
50.0%

64.9%

839

70%

Other Pleasure

Business Growth

800

60%

46.1%

855,975
119,535
40.0%

700

Growth 576 410 13.2% 384 320 -6.3% -16.9% 45.7%

50%

40%

600

800,000

30% 500

20%

400

700,000

68,097

349
10%

654,476 54,668
600,000

300

30.0%

200

9.3%

0%

-10%

30.8% 83,270

100

-20%

-

-30%

500,000

494,008
110,654

20.0%

2006

2007

2008

2009

2010

2011

438,475
80,135

400,000

52,116
300,000

447,890 51,229 38,473
668,343 2.1% 516,538

Tourist nights increased…
10.0%

37,261

9,000

Tourist Nights('000)* Growth 5,793

8,560 60.7% 6,548

1

8,000

1

0.0%

7,000

1

200,000

6,000

0

331,238
100,000

321,079 -11.2%

358,188
5,000

4,940 21.9%
-10.0%

30.7% 4,166 4,075
0 0

4,000

-11.7%
-

3,000

0

2,000

-

-20.0%

2007

2008

2009

2010

2011

1,000

-14.7%

-15.7%

-2.2%

(0)

-

(0)

2006
* Tourist nights spent in both graded and ungraded establishments JB Securities Research July 2012

2007

2008

2009

2010

2011
Page 11

Source : Sri Lanka Tourism

GDP growth accelerated
18.52% 16.37% 15.19% 16.62% 14.59% 17.04% 16.64% 17.00% 15.58% Avg. Nominal Growth 12.08% 15.28%

Avg. Real Growth 4.76% 5.27% 7.52%

6.12% 4.22% 1.63%
Q1

7.06%

8.47%

7.95%

8.57%

7.91%

8.16%

8.44%

8.32%

2.14%
Q2 2009 Q3 Q4 Q1 Q2 2010 Q3 Q4 Q1 Q2 2011
Source: Census and Statistics Sri Lanka, JBS Research Analysis

Q3

Q4

JB Securities Research July 2012

Page 12

Strong economic growth led to fiscal consolidation…
Government Revenue
3yr CAGR 12.3 %

Government Expenditure
3yr CAGR 12.0 %

Fiscal Deficit

LKR Bn

(310) (476) 726 834 950 996 1,202 1,280 1,400 (446) (450)

686

2008

2009

2010

2011

2008

2009

2010

2011

2008

2009

2010

2011

Revenue as a % of GDP

Expenditure as a % of GDP

Deficit as a % of GDP

-7.0% 15.6% 15.0% 14.9% 14.5%
2008 2009 2010 2011

-9.9% 24.9% 22.6% 22.8% 21.4%
2008 2009 2010 2011

-8.0%

-6.9%

2008

2009

2010

2011

Source : Central Bank of Sri Lanka

JB Securities Research July 2012

Page 13

Primary balance improved…
Deficit as a % of GDP

Primary* deficit as a % of GDP
9.9% 6.9% 7.0% 8.0% 6.9% -1.8%
2007 2008 2009 2010 2011

-1.7% -2.2% -3.4%

-1.4%

Interest cost as a % of GDP

2007 2008

2009

2010

2011

6.4% 5.1% 4.8%

6.3%

5.5% * Primary balance is government revenue minus all expenses excluding interest. Assuming nominal interest rates equal nominal GDP growth a primary surplus reduces debt to GDP.

2007

2008

2009

2010

2011
Source : JBS Research Analysis, Central Bank of Sri Lanka

JB Securities Research July 2012

Page 14

Country Credit Standing improved…
IMF Stand-by Agreement
Jul ‘09 USD 329.1 Mn IMF approves 20 month Stand-By Arrangement of USD 2.6bn equal to 400% of the country’s quota

Sovereign ratings
Aug ‘09 • S&P: Outlook lifted to B 'stable‘ • Fitch: Outlook lifted to B+ 'stable‘
Jun ’10 Central Bank appoints top committee to boost sovereign rating

Review 1

Nov ‘09

USD 329.4 Mn

Jun ’10 S&P: Outlook lifted to B ‘positive‘

Feb ‘10

IMF holds back third tranche after Q409 budget goes off track USD 407.8 Mn

Dec ’08 S&P: Downgraded to B ‘Stable’”

Jul ‘11 • Moody's: B1 Outlook lifted to ‘Positive’ • Fitch: BB- ‘Stable’ • S&P: B+ ‘Positive’

Review 2+3

Jun ‘10

Dec ’08
Review 4

Jun ’10 May ‘09 S&P: Cut outlook to B ‘Negative’ Sep ’10 • Moody's initiating coverage with B1 ‘Stable’ • S&P: Rating raised to B+ ‘Stable’ • Fitch: B+ Outlook lifted to ‘Positive’

Jul ‘11

Sep ‘10 Oct ‘10

USD 212.5 Mn

Minister Sarath Amunugama highlights the importance of the IMF program for Sri Lanka

Review 5

Feb ‘11

USD 216.6 Mn

Feb ‘09 Fitch: Lowered to B+ ‘Negative’

Review 6

Apr ‘11

USD 218.3 Mn Sri Lanka may not take last IMF loan tranche: Fitch analyst

Jul ‘11

Conflict

Post-conflict
Positive
Source: Lanka Business Online, IMF

*
JB Securities Research July 2012

Negative

Page 15

Foreign appetite for sovereign paper increased
Sovereign bond issue Foreign holding of government securities
LKR Bn

3X

13 X

6X

7.5 X
Treasury bills

Templeton fund invests USD 875 mn (approx. LKR 100 Bn)

57 40

64

Oct ‘07

Oct‘09

Sep ‘10

Jul ‘11

Treasury bonds

$500mn 5yr 8.25%

$500mn 5.25yr 7.40%

$1billion 10yr 6.25%

$1billion 10yr 6.25%

184 145 6 50
2007

187

397 bp

499 bp

373 bp

332 bp

18
2008 2009 2010 Jun 11

Conflict
Number of times oversubscribed Spread over US treasury

Post-conflict

Conflict

Post-conflict

Source : Central Bank of Sri Lanka

JB Securities Research July 2012

Page 16

Foreign sources funded the fiscal deficit easing pressure on domestic sources Budget deficit
Domestic non bank Domestic bank Foreign borrowing

Financing of budget deficit

476 446 197

450 39 38.5% 52.6%

8.8%

Domestic non bank
97% with CBSL

LKR Bn

41.2%

45.8% 42.6%

310 246 129 16 101 (5) 2007 2008 2009 195 231 119 49

204

192 10.3%
6.4% 63.0% 244 219 41.0% -1.5% 2011 2007 2008 2009 48.4% 54.7%

Domestic bank

48.6%

Foreign borrowing

(2) 2010

-0.4% 2010 2011

* Foreign borrowings include the non resident holding of government treasuries

Source : JBS Research Analysis, Central Bank of Sri Lanka

JB Securities Research July 2012

Page 17

Reserves increased due to borrowed funds
Reserves built-up
USD Mn

Months of Imports
9.00
Gross official reserves Total reserves

10,000 9,000 8,000 7,000 6,000

8.00 7.00 6.00 5.00

5,000 4.00 4,000 3,000 2,000 1,000
Nov-09 Nov-10 Sep-09 Sep-10 Jan-09 Jan-10 Jan-11 Jul-09 Jul-10 Mar-09 Mar-10 May-09 May-10 Mar-11 Mar-09 Mar-10 Mar-11 May-09 May-10 May-11 May-11 Nov-09 Nov-10 Sep-09 Sep-10 Jan-09 Jan-10 Jan-11 Jul-09 Jul-10 Jul-11 Jul-11

3.00 2.00 1.00 -

-

Source : Central Bank of Sri Lanka

JB Securities Research July 2012

Page 18

Crowding out effect decreased enabling private sector credit expansion Credit, Monthly Change
Private Corps. Govt. 150 100 50 0 -50 -100 -150

Credit to Private Sector
Credit to the Private Sector Annual Change (%)

1,800 1,600 1,400 1,200 1,000 800 600 400 200 0

40% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10%

Jan-09

May-09

Jan-10

May-10

Jan-11

May-11

Sep-09

Sep-10

Jul-09

Jul-10

Mar-09

Mar-10

Mar-11

Nov-09

Nov-10

Jul-11

Jul-09

Jan-09

May-09

Jan-10

May-10

Jul-10

Jan-11

Net Credit to Govt.
Net Credit to Government Annual Change (%)

Credit to SOEs
Credit to SOEs

May-11
160 140 120 100 150% 100% 50% 0% -50%

Sep-09

Mar-09

Mar-10

Sep-10

Mar-11

Nov-09

Nov-10

900 800 700 600 500 400 300 200 100 -

120% 100% 80% 60% 40% 20% 0% -20%

250% 200%

Annual Change (%)

80 60 40 20 -

Jul-09

Jan-09

May-09

Jan-10

May-10

Jul-10

Jan-11

May-09

May-10

*All amounts in LKR Bn
JB Securities Research July 2012

May-11

Mar-09

Mar-10

Mar-11

Source : Central Bank of Sri Lanka

May-11

Sep-09

Mar-09

Mar-10

Sep-10

Nov-09

Nov-10

Mar-11

Nov-09

Nov-10

Jul-09

Jan-09

Jan-10

Jul-10

Sep-09

Sep-10

Jan-11

Page 19

Monetary conditions eased
Monetary policy instruments
LKR Bn
160 140 120 100 80 60 40 20 7% 0 -20 -40 Jan-09 Feb-09 Mar-09 Apr-09 Jun-09 Jul-09 Aug-09 Sep-09 Nov-09 Dec-09 Jan-10 Feb-10 Apr-10 May-10 Jun-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Feb-11 Mar-11 May-11 Jun-11 6% 500 0% -5% Sep-09 Mar-09 Mar-10 Sep-10 May-09 May-10 Mar-11 Nov-09 Nov-10 Jan-09 Jan-10 Jan-11 Jul-09 Jul-10 May-11 -10% 10% 1,500 20% 15% 9% 1,000 8% 5% 10%

Growth in monetary aggregates
LKR Bn
Consolidated Broad Money(M2b) Unsterilized absorption of the USD 1 billion sovereign bond

2,500

40% 35%

Liquidity Repo Reverse Repo SRR*

13%

Reserve Money M2b growth Credit to the Private Sector

12%

Reserve Money growth

2,000

30% 25%

11%

5%

* SRR – Statutory Reserve Requirement
JB Securities Research July 2012

Page 20

Improved liquidity kept interest rates in check…
Policy Rate Pass-through to Market Interest Rates
21% Repo Reverse Repo AWPLR AWDR Call Money Rate 3 month t-bill 15% 17% 19%

13%

11%

9%

7%

5% Nov-09 Nov-10 Feb-09 Feb-10 Aug-09 May-09 May-10 Aug-10 Dec-09 Feb-11 Oct-09 Oct-10 Jan-09 Jan-11 Jul-09 Jul-10 May-11 Page 21 Apr-09 Apr-10 Apr-11

Source : Central Bank of Sri Lanka, JBS Research Analysis

JB Securities Research July 2012

Earnings rapidly picked up…
LKR Bn

CSE Quarterly Earnings March 2009 – June 2011

50

270%
40.7

46.7

45.7

43.3
Other Hotels & Travels Investment Trusts Oil Palms Telecommunications Manufacturing Food, Bev and Tobacco

40

30

25.7

29.0

30.0

20

11.7
10

6.3

14.5
Banking & Finance

Diversified
0

-10 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11
*Earnings figures have not been adjusted for the effect of Cross Holdings

Source : JBS Research Analysis, Colombo Stock Exchange

JB Securities Research July 2012

Page 22

Employee Provident Fund* increased their asset allocation into equities Equity asset allocation Overall equity exposure
LKR Bn

EPF is the largest investor in the CSE

8.0%

79.0

4.0% 1.1%
Sep. 2008

33.3 6.7 7.4
Sep. 2009 Sep. 2010 Dec. 2011

1.0%
Sep. 2009 Sep. 2010 Dec. 2011

Sep. 2008

*The Employee Provident Fund (EPF) is the largest superannuation fund in the country. As at September 2011, the EPF accounted for close to 13.25% of financial sector assets of the country, with over 2.3 million active accounts. It is administered by the Commissioner of Labour, while the management of the fund is undertaken by the Monetary Board of the Central Bank of Sri Lanka
Source : CBSL Financial System Stability Reviews and Annual Reports

JB Securities Research July 2012

Page 23

Massive bull market ensued…
8,000

377%
7,000

All Share Price Index

6,000 CBSL reaffirms its commitment to equity investment with a “long term” outlook

5,000

4,000

Galleon Fund begins exiting the market

Share Volume increased rapidly during the boom Janus Fund enters the market

3,000

2,000

1,000 Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Source : Central Bank of Sri Lanka, JBS Research Analysis

JB Securities Research July 2012

Page 24

Excess liquidity chased a limited number of shares… Company wise contribution to market cap growth March 2009 – June 2011
2.4% 2.5% Contribution to Growth Free Float* 3.1% 3.9% 6.5% 70.3% 7.1% 28.0% 7.3% 78.5% 31.0% BUKI JKH CARS COMB HNB 60.0% 53.9% 3.1% 15.6% 2.8% 3.0% 14.7% 15.8% 5.5% 18.5% 2.0% 84.5% 49.0%

1.8%
18.7%

2.0% 2.3%

50%
More than 50% of the Market Cap growth during the period can be attributed to growth in 14 companies, most of which have relatively small free floats*

.
SPEN LOLC DIAL CTC SLTL CARG DFCC SAMP AHPL

*Free float has been calculated as the average of period beginning and period end public holding percentage ** The ASI started from a low of 1639 to peak at 7811 within the period.
JB Securities Research July 2012

Source : JBS Research Analysis

Page 25

New capital raisings exploded …….Money like jam
CSE - Primary and secondary offerings January 2009 to December 2011
LKR Mn

Average degree of oversubscription at IPOs* January 2009 to December 2011
141.0

Secondary offerings 20,000

Primary offerings

15,000

Secondary offerings accounted for approx. 75%

10,000 15.9 5,000 11.9

21.2 21.8

1.1 09Q1 09Q2 09Q3 09Q4 10Q1 10Q2 10Q3 10Q4 11Q1 11Q2 11Q3 11Q4

1.7

2.9

4.4 1.4

09Q1 09Q2 09Q3 09Q4 10Q1 10Q2 10Q3 10Q4 11Q1 11Q2 11Q3 11Q4

Source: JBS Research Analysis, CSE Data

Total amount of capital attracted by IPOs Quarterly degree of = oversubscription Total amount of capital offered in IPOs
Page 26

JB Securities Research July 2012

and penny stocks became the new craze…
Penny stocks - Share volume velocity* Volatility of returns*

59%

44% 37% 35% 36% 30% 25% 26% 20% 21%

135%

94% 71% 53% 19%
09Q2 15% 10% 6% 6% 5% 6% 8% 4%

9% 5%

9%
09Q1

20%
09Q3

17%
09Q4

27%

31%

10Q1

10Q2

10Q3

10Q4

11Q1

11Q2

09Q1

09Q2

09Q3

09Q4

10Q1

10Q2

10Q3

10Q4

11Q1

11Q2

*Figures have been annualized Penny stocks – stocks whose prices were less than LKR 10 at either the beginning or end of a given quarter.
Source: JBS Research Analysis, CSE Data

Penny Stocks

Overall Market

JB Securities Research July 2012

Page 27

Bullish expectations drove the market … Contribution to Market Cap growth Disaggregation of Market Cap growth 42%
20.3%

305%

32% 132%

15.4% 64.3%

100%

P/E Growth

Earnings Growth

Combined Effect

Jun-09

P/E Growth

Earnings Growth

Combined Effect

Jun-11

Source: JBS Research Analysis

JB Securities Research July 2012

Page 28

The future looked increasingly rosy….
Decomposition of market value June 2009 Decomposition of market value June 2011

43.9%

49.5%

54.1%

Franchise Value

68.7%

72.6%

75.6%

56.1%

50.5%

45.9%

Tangible Value

31.3%

27.4% 16% Cost of Equity

24.4% 18%

18%

20% Cost of Equity

22%

14%

Source: JBS Research Analysis

JB Securities Research July 2012

Page 29

May 2009 Jul 2009 Sep 2009 Nov 2009 Jan 2010 Mar 2010 May 2010 Jul 2010 Sep 2010 Nov 2010 Jan 2011 Mar 2011 May 2011 Jul 2011 Sep 2011 Nov 2011 Jan 2012 Mar 2012 May 2012

JB Securities Research July 2012

The inevitable after party – exuberance turned to irrationality

Page 30

Hubris displaced humility and benevolence …. INTERNATIONAL
Sri Lanka announces bid for Commonwealth Games 2018 in Hambanthota Natural gas deposits discovered for the first time in Sri Lanka by Cairn India. EU expresses concerns over censorship of dissident websites in Sri Lanka. Sri Lanka loses bid to host the 2018 Commonwe alth games. US issues sanctions on Iranian oil. SL currently imports 93% of all its crude oil from Iran. British Television station Channel 4 airs video footage of claimed atrocities against civilians in the latter stage of the war News report appears stating India may not support Sri Lanka at the UN HR vote due to increased political pressure from parties in Tamil Nadu. SL loses key UNHRC vote on war crimes. The council urges Sri Lanka to “credibly investigate” allegations of war crimes during the end of the conflict.

High point = 173

2011
Q3 Q4

2012
Q2 Q1 Q2

160

140 Start Value = 150

120

Low point = 105

End Value = 107

100

80

With the 2/3rd Majority in the parliament government sweeps through major legislative reforms Abductees found left near a police station. Activist Gunarathna deported from country citing visa irregularities

Clashes over proposed new private sector pension bill intensifies. 1 worker killed and 60 seriously injured. Government temporary suspends the bill.

Nearly 20,000 metric tonnes of tainted petrol released to the public causing close to a thousand vehicles to suffer engine failure.

Parliament scraps emergency laws for the first time in 6 years. Strengthens Prevention of Terrorism Act temporarily.

Controversial expropriation bill nationalizing 37 businesses deemed to be “underperforming or underutilized”

Former parliamentari an Bharatha Laksman and others killed in a post election interparty shoot-out. Dozens more injured.

President appointed commission on Lessons Learnt and Reconciliati publishes its report. Makes key recommend ations.

Sarath Fonseka, ex-army chief jailed for three years over charges of making false statements about the president’s brother, who is also the secretary of defense.

Left wing political activists Kumar Gunarathnam and Dimuthu Atygala abducted by unknown gunmen.

DOMESTIC

Presidential pardon given to Sarath Fonseka. Civic rights abolished.

Sources: Newspaper articles, Central Bank of Sri Lanka, LMD, The Nielson Company, JBS Research

JB Securities Research July 2012

Page 31

LMD Nielsons Business Confidence Index

Intense diplomatic pressure exercised by Western nations over SL Government

180

Credit growth persisted…
Credit to Private Sector
Credit to the Private Sector Annual Change (%) 2,500 2,000 1,500 34.0% 1,000 33.5% 500 0 33.0% 32.5% 80 100 120 35.5% 35.0%

*All amounts in LKR Bn

Credit, Monthly Change
160

Private
34.5%

Corps.

Govt.

140

Apr-12

Jun-11

Jul-11

Jan-12

Net Credit to Govt. and SOEs
Credit to SOEs Net Credit to Government Credit to Govt. growth Credit to SOEs growth 1,200 1,000 800 60% 600 400 200 40% 100% 80% 1,400 120%

May-12

Sep-11

Dec-11

Feb-12

Oct-11

Mar-12

Aug-11

Nov-11

60

40

20

0

-20

Apr-12

Jun-11

Jul-11

Jan-12

20% 0%

Feb-12

Apr-12

Oct-11

Jun-11

Jul-11

Jan-12

May-12

Sep-11

Dec-11

Mar-12

Aug-11

Nov-11

Source : Central Bank of Sri Lanka

JB Securities Research July 2012

May-12

Sep-11

Dec-11

Feb-12

Oct-11

Mar-12

Aug-11

Nov-11

Page 32

CBSL attempted the impossible trinity – fixed exchange rate …
CBSL sold USD to hold the peg
USD Mn
200 100 (100) (200) (300) (400) (500) (600) (700)
Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 100
INR devaluation

Currency mispriced…
104 LKR/USD(RHS) 103 NEER(LHS) REER(LHS) 102

CBSL says intervention will be limited to settlement of oil bills

LKR
140

135

130

101

125

120

99

115

Reserves drained out
-28%

USD Mn
9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 95 May 11 Jun 11 Jul 11 Jan 12 May 12 Sep 11 Feb 12 Apr 11 Dec 11 Mar 12 Aug 11 Nov 11 Apr 12 Oct 11 95 96 97
Peg maintained

98
President in his capacity as Finance Minister depreciates the rupee by 3%

110

105

100

Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12

*NEER is the weighted average of nominal exchange rates of the 24 trading partner and competitor countries including USD, GBP, JPY, INR and SDR
Source : Central Bank of Sri Lanka, JBS Research Analysis

JB Securities Research July 2012

Page 33

Impossible trinity …and an accommodative monetary policy…
Policy instruments accommodative
LKR Bn
120

Monetary aggregates expanded
LKR Bn
10.0% 9.5% 9.0% 8.5% 8.0% 7.5% 1,500 20% 7.0% 1,000 6.5% 6.0% 15% 30% 2,000 25%
Consolidated Broad Money(M2b:) Reserve Money M2b growth Credit to the Private Sector Reserve Money growth

3,000

40%

Money market liquidity Repo

100

Reverse Repo SRR*

2,500

35%

80

60

40

20

0 5.5% -20 Apr-11 Apr-11 May-11 Jun-11 Jul-11 Jul-11 Aug-11 Sep-11 Sep-11 Oct-11 Nov-11 Dec-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 Apr-12 May-12 Jun-12 5.0% Aug-11 Sep-11 Jun-11 Mar-12 Nov-11 Dec-11 Feb-12 Oct-11 Apr-11 Jan-12 Jul-11 May-11 Apr-12

500

10%

-

5%

* SRR – Statutory Reserve Requirement
Source: Central Bank of Sri Lanka, JBS Research Analysis

JB Securities Research July 2012

Page 34

Imports exploded leading to a doubling of the trade deficit in 2011…
USD Mn 2.01 X

Increase in Imports
245 426 472 506 509 698 802 1,078 254

182 835 327 321

Increase in Exports

1,933 = 1.22 X 2010

289

123

100

71

50

9

85
16.4%

1,754
9.7%
6,926 = 1.52 X 2010

9,706

4,821

2010

Petroleum

Other Building Diamonds Intermediate Materials and Precious Goods Metals

Textiles

Other Transport Consumer Equipment & Goods Other

Vehicles

Machinery and Equipment

Food and Beverages

Ceramic Products

Textiles and Garments

Rubber Products

Other Industrial Exports

Petroleum Products

Gems, Diamonds and Jewellery

Coconut

Other Agricultural Products

Tea

Mineral

Unclassified*

2011

As a % of GDP *Change in unclassified imports of USD 108mn and unclassified exports of USD 193mn have been netted off

Source: Central Bank of Sri Lanka, JBS Research Analysis

JB Securities Research July 2012

Page 35

…and built pressure on the Current Account…
USD Mn

Services Account
507
51% 22%

Income Account
10 531 709 1,098 19 8 448 385 647

954 1,392

830

501

355

Inflows

Outflows

Inflows

Outflows

Inflows BPO, ITES

Inflows

Outflows Total

Outflows

Inflows

Outflows

Inflows

Outflows

Inflows Income account balance

10,559

Transportation

Travel

Other

Interest and Other Charges

Direct Investment

Compensation of Employees

20,269

101% 16.4%

25% 12%

45%

19%

96%

25%

467

3,084

1,114

15.6%

Private remittances easing the pressure
11% 15%

1,985 5,145 9,258

9,710

562
Services and Income Accounts almost offsetting each other

60

329%

7.8%

4,615

Imports

Exports

Trade deficit

Receipts

Payments

Receipts

Payments Goods, Services and Income(net)

Private receipts

Private Official payments transfers(net) Current transfers Current account deficit

Merchandise trade
As a % of GDP
Percentage increase over 2010

Services

Income

Source: Central Bank of Sri Lanka, JBS Research Analysis

JB Securities Research July 2012

Page 36

…resulting in a depletion of reserves
Reserves fell by USD 2.2 Bn in 8 months
USD Mn
Gross official reserves Total reserves

Months of Imports

10,000 9,000 8,000

8.00

-23%
7.00 6.00

7,000 6,000 5,000 4,000 3,000 2.00 2,000 1,000
Aug-11 Aug-11 Sep-11 Mar-12 Nov-11 Feb-12 Dec-11 Dec-11 Feb-12 Oct-11 Oct-11 Jan-12 Jul-11 Mar-12 Nov-11 Sep-11 Aug-11 Dec-11 Feb-12 Apr-12 Apr-12 Oct-11 Jan-12 Jul-11

5.00 4.00 3.00

1.00 -

-

Source: Central Bank of Sri Lanka

JB Securities Research July 2012

Page 37

Liquidity rapidly dried up… Interest rates shot up…
Money market net liquidity
LKR Bn
160 Money market liquidity Reverse Repo AWDR 3 month t-bill Repo AWPLR Call Money Rate 15% 14% 13% 12% 100 11% 80 10% 60 9% 40 8% 20 7% 6% 5% Jun-11 Mar-11 May-11 Mar-12 Nov-10 Nov-11 Sep-11 Aug-11 Dec-10 Dec-11 May-12 Jun-12 Jan-11 Jan-12 2007 2008 2009 2010 2011

Loan to deposit ratio of banks

140

120

85% 70% 70% 61% 76%

0

-20

Source: Central Bank of Sri Lanka, JBS Research Analysis

JB Securities Research July 2012

Page 38

The MPI was an early precursor of the impending collapse… The ASI and MPI

8,000 7,500 7,000 6,500 6,000 5,500 5,000

≈ 4½ months
4,500 4,000 3,500

MPI peaks in early October 2010

ASI peaks in mid February 2011

MPI
3,000 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11

ASI
Dec-11 Mar-12 Jun-12

The All Share Price Index (ASI) and the Milanka Price Index (MPI) are market capitalization weighted indices. Whereas the ASI includes every company listed in the CSE, the MPI only contains 25 companies. Criteria for inclusion in the MPI are as set out in http://cse.lk/mpi.do
Source : JBS Research Analysis

JB Securities Research July 2012

Page 39

The regulator tried in vain…
8,000

The regulator became regulated…

7,000

6,000

SEC mandates the force sale of securities by T+5 SEC relaxes rules on debt settlement SEC mandates stock broker companies to refrain from extending credits to any investor beyond T+3 days SEC suspends trading of heavily manipulated shares and imposes a 10% price band on all securities SEC relaxes rules on price bands SEC Director General leaves office SEC Chairperson resigns

5,000

4,000

3,000

2,000

1,000

SEC introduces new rules on share allotment to retail investors, while Central Bank places a cap on total number of bank guarantees to be issued for IPO subscriptions

SEC further relaxes rules on debt settlement

SEC directive permits brokers to extend credit to investors up to three times net adjusted capital SEC revokes directive on price bands all together

0
Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12

MPI

ASI
Source : Securities and Exchange Commission of Sri Lanka

JB Securities Research July 2012

Page 40

Earnings plateaued out…
LKR Bn

50

46.6 40.7

45.7

46.3
43.3

47.3
Other Hotels & Travels Investment Trusts Oil Palms Telecommunications Manufacturing Food, Bev and Tobacco

40

30

30.0

20

Banking & Finance
10

Diversified
0 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11
Source : JBS Research Analysis, Colombo Stock Exchange

*Earnings figures have not been adjusted for the effect of Cross Holdings

JB Securities Research July 2012

Page 41

Even the penny stocks began to lose their luster….
Penny Stocks - Share volume velocity* Volatility of returns*
59%

36%

37%

135% 94% 71% 53% 31%

126%
20%

26% 21% 17% 5% 1% 3%

45%

6%

8% 4%

9%

10Q2

10Q3

10Q4

11Q1

11Q2

11Q3

11Q4

10Q2

10Q3

10Q4

11Q1

11Q2

11Q3

11Q4

*Figures have been annualized

Penny Stocks

Overall Market
Source : JBS Research Analysis,

JB Securities Research July 2012

Page 42

The market lost more than 40% of its value during the bust…
8,000

ASI -38.6%

7,500

7,000

6,500

6,000

5,500

5,000

4,500

4,000

3,500

MPI -45.8%

3,000 Jun-10

Sep-10

Dec-10

Mar-11

Jun-11

Sep-11

Dec-11

Mar-12

Jun-12

MPI
JB Securities Research July 2012

ASI
Page 43

May 2009 Jul 2009 Sep 2009 Nov 2009 Jan 2010 Mar 2010 May 2010 Jul 2010 Sep 2010 Nov 2010 Jan 2011 Mar 2011 May 2011 Jul 2011 Sep 2011 Nov 2011 Jan 2012 Mar 2012 May 2012

JB Securities Research July 2012

Sobering reality – some concerns remain

Page 44

Governance is slipping…
Concentration of power leading to a weakening of state and civil institutions…
Constitutional amendments have strengthened the executive at the expense of other branches of government. This relative weakening of parliamentary and judicial powers along with other civil institutions has contributed to greater concerns regarding the quality of governance in the country.*

51.7

56.9 52.6**

42.8

40.7**

31.8**

2004

2006

2008

2010

2004

2006

2008

2010

2004

2006

2008

2010

Control over corruption and unfair dealing is slipping
“ the extent to which public power is exercised for private gain, including both petty and grand forms of corruption, as well as "capture" of the state by elites and private interests. “

The perception of the rule of law has deteriorated
“ the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights, the police, and the courts… “

Social freedoms and rights of franchise are under friction
“the extent to which a country's citizens are able to participate in selecting their government, as well as freedom of expression, freedom of association, and a free media. “

*Three of the six major dimensions of governance that are included in the World Banks’s indicative framework for governance as they apply to Sri Lanka are highlighted above. **The ranking is based on a percentile; Higher values imply a better score. *** The rankings provide a directional indication and not an absolute measure of governance. Therefore they should not be construed an absolute quantification of the country’s level of governance, and at higher confidence levels the directional weakening suggested by the indicators may become statistically insignificant.
Source: World Bank, http://info.worldbank.org/governance/wgi/index.asp

JB Securities Research July 2012

Page 45

Devolution of Power – 25 years and still a work-in-progress
The 13th Amendment is a product of the Indo-Sri Lanka Accord of 1987. Drawing closely on the Indian federal system, it proposes a framework for devolution of power which constitutes of the following:  Establishment of a Provincial Council (PC) along with a High Court for each province.  Making Tamil an official language while setting English as the link language.  Delegation of certain legal and executive powers into the hands of the PCs as stipulated under three lists; the Reserved List, Provincial Council List and the Concurrent List.  Limited executive and legislative powers are delegated to PCs under the Provincial Council and Concurrent Lists. These powers cover issues related to law and order, land and land settlement, provincial finances and education. However, despite the 13th amendment being cited as one of the major stepping stones in achieving reconciliation, full implementation of the provisions enshrined in the amendment has remained elusive under various governments over the past quarter of a century.

Signing of Indo-Lanka Peace Accord

13th Amendment debated and certified

President Jayawardena authorises the merger of North & East provincial councils

IPKF withdrawal completed

Supreme Court orders demerger of North and East

President Rajapakse pledges 13+ solution to India

President announces that a 13+ solution should be sought through a Parliamentary Select Committee (PSC)

1987

1988

1989
1st ever PC election takes place in 4 provinces

1990

1991

1992

2006

2009

2010

2011

2012

Indian Peace Keeping Force (IPKF) arrives in Sri Lanka

Sri Lanka & India agree on terms of withdrawal for IPKF

President discusses 13+ solution with Indian FM and Congress Party delegation

President reaffirms his confidence in a PSC in reaching a lasting solution

Further to the 13th amendment, several committees have been appointed by various government to explore the issue of devolution of power and other matters relating to the 13th Amendment. These include the Mangala Moonesinghe PSC of 1992, the Gunewardena Committee of 1995, the All Party Representative Committee (APRC) of 2006.
JB Securities Research July 2012 Page 46

Food Inflation

Non Food Inflation

JB Securities Research July 2012

Inflation is on the increase…

11.2%

7.1%

Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% -5% Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12
Source : Ministry of Finance and Planning

-4% 3% 4%

-3%

-2%

-1%

10%

11%

12%

13%

14%
9.3%

15% Headline - YoY Core - YoY Headline - 12m MA Core - 12m MA

2%

5%

6%
5.8%

7%

8%

9%

10%

Page 47

Government revenue low compared to peers…
Revenue as a % of GDP
27.6% 24.7% 21.4%
15.8% 14.9% 14.5% 14.2% 13.3%

Sources of revenue
16.6% 15.6% 15.0% Tax Tax + Non tax Tax + Non tax + Grants 14.9% 14.6% 15.0% 14.5% 14.7% 14.3% 13.3% 12.9% 12.8% 12.4%

18.5%
14.5% 12.0%
5.1% 9.4% 4.5% 10.1% 3.6% 11.1%

2007

2008

2009

2010
2.0% 11.1%

2011

2012 F

1.6% 12.9%

Grants 85.5% 85.3% 85.3% 86.9% 85.5% Non tax Tax

Vietnam

Malaysia

Thailand

India

Sri Lanka Bangladesh
2007 2008 2009 2010 2011
Page 48

Source : IMF, Central Bank of Sri Lanka

JB Securities Research July 2012

The SOE monsters keep bleeding …
Combined operating losses of main State Owned Enterprises
2.0 7.1 (11.1) (22.3) (6.1)
19.3 0.17

Combined operating loss as a % of GDP
-0.5% -1.5% -0.5% -0.3%

5.0 (7.7) (7.4) (6.6) (4.6)
26.4 0.23

(20.3) (0.3) (0.8)
16.4 0.15

(33.9)

5 year average of -0.9%

(85.2) (11.0) (8.0) 2007 2008 2009 2010

-1.8%

2011

LKR Bn

64.0 0.59 Sri Lanka Transport Board Airlines Ceylon Electricity Board Ceylon Petroleum Corporation

Combined earnings of the market
Combined earnings (USD Bn) 1.65 1.29

LKR Bn (19.3) (13.5) (2.0)
0.68 0.51

182.7 146.3

Combined loss (LKR Bn) Combined loss (USD Bn) 120.0 1.08

73.8

58.2

2008

2009

2010

2011

2007

2008

2009

2010

2011

* Cross holdings have not been eliminated Source: Ministry of Finance and Planning, CSE, JBS Research Analysis

JB Securities Research July 2012

Page 49

Shift in reliance to non-concessional and commercial loans…
Foreign borrowings of the government (%GDP)
37.1% 1.3% 5.1% 32.8% 1.3% 3.7% 36.4% 1.6% 8.5% 10.9% 11.7% 36.1% 2.6% 35.6% 3.6% 3.4% 13.7% 4.0% 11.3% 23.3% 30.2% 4.5% 7.3% 10.1%
NonConcessional Loans

Loan mix

32.8%

Commercial Loans

30.7%

27.8%

26.3% 22.6% 20.3%

82.9%

84.7% 72.2%
62.6% 57.0%
Concessional Loans

2007

2008

2009

2010

2011

2007

2008

2009

2010

2011
Source : Central Bank of Sri Lanka

* Sovereign bonds and foreign holding of treasuries are classified as commercial loans
JB Securities Research July 2012

Page 50

Investment - savings gap has widened
Investment/GDP
6.2%
Government

6.3%

6.6% 23.7%

Investment savings gap/GDP
21.6%
2009 2010 2011

Private

17.9%

-0.7%
2010 2011

2009

National Savings/GDP
Net private transfers

-

-3.1%

5.8%

6.0% 6.7%

-7.8%

Private

21.7%

20.8%

16.5% -1.1%
2011
Source: Central Bank of Sri Lanka , JBS Research

Government

-3.7%
2009

-2.1%
2010

JB Securities Research July 2012

Page 51

Mostly financed by govt. borrowings
Investment savings gap/GDP
2009 2010 2011 0.7% 1.6%

Financing the resource gap/GDP

-0.7%

-3.1%

5.3% 4.7%

4.2%

Government borrowing

0.7%

0.4% 0.4% 0.9% -0.5% -1.8% 1.5% -0.3% -0.1% -1.1% -1.8%

Grants and transfers FDI FPI Trade liabilities Reserve movement Other – Commercial bank net assets & errors

-7.8%

0.0%

0.9%

-6.5%

-2.2%

-0.4%
Source: Central Bank of Sri Lanka, JBS Research Analysis

JB Securities Research July 2012

Page 52

FDI yet low…
Foreign Direct Investment FDI as a % of GDP

956 USD Mn 752 603 159 131 221 231 411 223 44 19 154 2008 2009 195 2010 218 Reinvested earnings 33 Equity capital 404 239
Includes land purchases

1.86%

1.85% 0.96% 0.96%

1.62%

210 478

705

Other capital

2007

2008

2009

2010

2011

Low compared to peers…

* All data for 2010 except for Sri Lanka(2011)

7.5% 3.9% 3.0% 1.6%
Sri Lanka Vietnam Thailand Malaysia

1.4%
India

0.9%
Bangladesh Page 53

2007

2011

* FDIs excludes loans as per the UNCTAD presentation
JB Securities Research July 2012

Source : Central Bank of Sri Lanka, World Bank

Capital intensity driving growth NOT total factor productivity (TFP)
113,439
22%

2,863,854

396,853

-11,938

80%

-2%

2,365,501

Contribution to GDP

LKR Mn

GDP-2008

Capital intensity
CAGR

Capital productivity
CAGR

Labour force growth
CAGR

GDP-2011
CAGR

CAGR
2008/11

5.31%

X

-0.14%

X

1.33%

=

6.58%

Labour productivity

5.19%
Note CAGR of GDP = [(1+CAGR of Capital Intensity)*(1+CAGR of Capital Productivity)*(1+CAGR of Labour Force)]-1 JB Securities Research July 2012
Source: Census and Statistics Sri Lanka, JBS Research Analysis

Page 54

The lion is not beaten – And… the good news…

JB Securities Research July 2012

Page 55

Competitiveness is improving relative to peers…
High Competitiveness Low

Thailand Sri Lanka
2001 2002 2003 2004 2005 2006 2007 2008 2009
End of war

India
57/75 54/80 56/102 55/104 45/117 43/125 48/131 50/133 49/133 51/139 56/142

Vietnam
60/75 65/80 60/102 77/104 81/117 77/125 68/131 70/133 75/133 59/139 65/142

33/75 35/80 32/102 34/104 36/117 35/125 28/131 34/133 36/133 38/139

61/75 59/80 68/102 73/104 98/117 79/125 70/131 77/133 79/133 62/139 52/142

2010 2011

Competitiveness ranking has increased by 38% after the war

39/142

Ranking/No of countries ranked
Source: World Economic Forum, World investment report 2011 UNCTD, Central Bank of Sri Lanka, JBS Research Analysis

JB Securities Research July 2012

Page 56

Key contributor being the greater stability from the end of the conflict…
High
Overall Ranking Overall BasicRequirements requirements Basic Institutions Infrastructure Macroeconomic environment health & primary education Efficiency Enhancements Efficiency enhancers Higher education & training Goods market efficiency Labour market efficiency Fin. market development Technological readiness Market size Innovation & sophistication Innovation Sophistication Business sophistication Innovation
Current Rank - 2012 Improving competitiveness will depend on improving these key problem areas 2012 Ranking out of 142 Countries 2009 Ranking out of 134 Countries

Competitiveness

Low

Improvement

Improvement over 2009 Deterioration over 2009

0%
JB Securities Research July 2012

25%

37%

50%

57%

75%

100%
Page 57

Source: World Economic Forum, World Investment Report 2012 UNCTD, JBS Research Analysis

Ease of doing business rank has improved
The World Bank Doing Business Ranking out of 183 countries Thailand Sri Lanka Vietnam India Philippines
134 132

17 89 98 132 136

Sri Lanka
2011 2012

Vietnam
2011 2012 2011

India
2012

Overall
Starting a business Construction permits Getting electricity

102 34 169 n/a 155 72 74 166 72 137 43

89 38 111 95 161 78 46 173 53 136 42

78 100 62 n/a 43 15 173 124 63 31 124

98 103 67 135 47 24 166 151 68 30 142

134 165 177 n/a 94 32 44 164 100 182 134

132 166 181 98 97 40 46 147 109 182 128

102 78

98

89

Registering property Getting credit Protecting investors Paying taxes Trading across borders Enforcing contracts Resolving insolvency

2011 India

Vietnam

2012 Sri Lanka

Source: Doing Business, The World Bank, 2012

JB Securities Research July 2012

Page 58

Country is experiencing a demographic dividend…
% of population in productive age Dependency Ratio

69.5% 56.0% 51.5% 64.1% 43.9%

66.7%

66.0%

60.0%

Sri Lanka

Vietnam
2010

India

Pakistan

Sri Lanka

Vietnam
2010

India

Pakistan

Population between the age of 15-64 years

Population aged 0-14 and above 64, divided by 15-64 age

Source : Key Indicators for Asia and the Pacific 2011 - ADB

JB Securities Research July 2012

Page 59

Labour force is literate…
Primary school completion rate *
97.5% 102.3% 94.8%

Literacy rate

61.1%

91.9%

92.8%

62.8%
Sri Lanka Vietnam India Pakistan

55.5%

Average years of schooling**
8.4 6.4 5.1 5.6 Sri Lanka
*

Vietnam

India

Pakistan

The primary completion rate =(No. of primary school graduates/No. of children in primary school age). The ratio can go above 100 percent, which can be a symptom of late entry, grade repetition, or of an enrollment push at some point in the past, perhaps as a consequence of a school enrollment campaign

Sri Lanka

Vietnam

India

Pakistan

** The years of formal schooling received, on average, by adults over age 15
Source: Key Indicators for Asia and the Pacific 2011 – ADB, Annual Report 2011

*Latest data available
JB Securities Research July 2012

Page 60

Socio Economic indicators are healthy… Total Healthcare Expense*
(% of GDP | 2010)
8% 72 7% 6% 5% 4% 3% 2% 1% 0% Sri Lanka Vientnam Thailand India Bangladesh 2.90%
S. Asia Avg. 3.8%

Life Expectancy (Years | 2010)
76 74
Global Avg. 70

75

75 74

6.80%

70 68 66 64 3.90% 4.10% 3.50% 62 60 Sri Lanka 60 50 40 30 Vientnam Thailand India
S. Asia Avg. 65

69

65

Bangladesh

Infant Mortality Rate (Per 1,000 live births | 2010)
51 48 38

S. Asia Avg. 52

*Total Healthcare expenditure includes private and government expenditure on healthcare

20 10 0

14

11

Global Avg. 41

Source :World Development Indicators 2012 – World Bank 2012

Sri Lanka

Vientnam

Thailand

India

Bangladesh Page 61

JB Securities Research July 2012

Labour supply conditions are favourable…
Current labour supply, YE2011
In 000’ Total Population 20,869 10% 16% Older (55+)

Composition of Working age population (aged 15 to 64 years)

Population < 15 Years Working Age Population, 15+ Years Not Participating

5,410

15,459

61%
63%
26% 74%

Prime (25-54)

8,446

Total Labor Force

7,013

34%

66%

Unemployed Labor Force

322

28%

21%

Young (15-24)

Employed Labor

6,691

Male Female

2010

E2017

100% (000’) = 13,921

14,402

Source: United Nations ,Population Division (2011). World Population Prospects: The 2010 Revision/ Sri Lanka Labour Force Survey 2011

JB Securities Research July 2012

Page 62

Relatively higher tertiary educated labour force.…quality concerns exist
Educational attainments of the workforce, 2010
(% of working age population)

No of graduates from the government universities
13,952

Sri Lanka

12,958 30% 53% 16% 11,713
730 327 809

1388 425 1,157 943

13,042
1,382 392 1,307 797

12,005
1067 208 894 901 1,492

1372 345 1,114 1294

other Law L.L.B. Engineering B.Sc. (Eng.) Medicine M.B.B.S.

Malaysia

25%

61%

13%

896

2,504 2,348 2,028 2,274 2,301 2,705 2,547

India

70%

23%

7%

2,198

2,704

Science B.Sc. Commerce & Mgt. Studies
4,432

4,405

5,142 4,012

4,830

Indonesia

46%

46%

8%

Arts & Oriental Studies 2009 2010

Primary or lower

Secondary

Tertiary

2006

2007

2008

Source: McKinsey Global Institute -The world at work – Jobs, pay, and skills for 3.5billion people, June 2012/CBSL annual report 2012

JB Securities Research July 2012

Page 63

Urbanization will be a growth enabler…
Urbanization* forecasted to increase
30% 25% 20% 15% 10% 5% 0% 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050
Urbanization* is officially defined as people belonging to the smallest administrative division (i.e. Municipal Council or village council). Other methodologies place Sri Lanka’s real urbanization rate as high as 40%. Bangkok = $88Mn/km2

Economic Density* low compared to the region

Population Density (ppl per Km2)

1,750 1,500 1,250 1,000 750

Potential for bridging the gap
Western

Colombo = $15Mn/km2 Singapore= $269Mn/km2 Ho Chi Minh city = $73Mn/km2

Central
500

Sab.
250 50 100 150 200

Southern North. W. North. C
250 300 350 400

Nothern

R2 =0.89
450 500

Gross Regional Product Per Capita (LKR 000’s)

World Urbanization Prospects: The 2011 Revision – UNDESA 2011, Annual Report 2011 – CBSL 2012

Economic Density = GDP per unit Area Sri Lanka: Reshaping Economic Geography – WB 2011 Page 64

JB Securities Research July 2012

Diaspora opportunity…
Regions with significant populations of Sri Lankans*
Denmark 13,000 Canada 300,000 U.S.A. 35,000 U.K. 200,000 Italy 60,000 India 200,000 Norway 14,000 Sweden 8,000 S. Korea 20,000 Japan 20,000

Aggregate (000's)
Mid. East Europe N. America S. & East Asia Australasia 1,408 560 335 240 107 2,650

W. Europe (000's)
France Germany Switzerland Netherlands 150 60 55 10 275

Mid. East (000's)
Saudi Arabia U.A.E. Kuwait Qatar Lebanon Israel 600 300 300 100 100 8 1,408

Australia 100,000

New Zealand 7,000

*Currently living or working on a temporary or permanent basis outside of SL *Not official estimates of the Government of Sri Lanka
JB Securities Research July 2012 Page 65

Ongoing infrastructure development plans – Power and Highways
Major Power Projects underway and planned
Project Investment
USD 335Mn USD 891Mn USD 526Mn USD 500Mn

Completion
June 2012 2013 2015 2017

1 2 4 3 4 2

Upper Kotmale Hydro Power Plant (150MW) Norochcholai Coal Fired Power Plant – Phase II (600MW) Uma Oya Development Project (120MW) Trincomalee Coal Power Plant (500MW)

Major Road Development projects underway and planned
Project Investment
USD 168Mn* USD 292Mn USD 935Mn USD 1,231Mn (Feasibility Stage)

Completion
2013 2012/13 2015 n/a

8 6 7

5 1 3 6 7 8 5

Southern Expressway Extension (35km) Colombo-Katunayake Expressway (25km) Colombo Outer Circular Highway (29.1km) Colombo-Kandy Expressway (98km)

*Estimated figure
Source: Ministry of Ports and Highways, Ministry of Power and Energy, Department of External Resources, Treasury Annual Reports, Central Bank of Sri Lanka, RDA

JB Securities Research July 2012

Page 66

Ongoing infrastructure development plans – Ports and Telecommunications
Major Port and Airport Projects undergoing and planned
Project Investment
USD 1,075Mn USD 1,037Mn JPY 14.5Bn + LKR 525Mn EUR 46.1Mn USD 209Mn USD 425Mn

Completion
2013&14 2011,12&15 n/a n/a 2012 2015

1 2 3 4 5 4 6 1 5 3 2
JB Securities Research July 2012

Colombo – South Harbour Development Project – 9.6mn TEU of transshipments Hambantota – Commercial operations & Bunkering tank farm (80,000MT) Galle – Yacht marina and general infrastructure development Oluvil – Fisheries port development Mattala International Airport (1 million passengers p/a) Bandaranaike International Airport Expansion – (6 million passengers p/a)

6

Major Telecommunications projects currently undergoing
Telecommunications – National Backbone (NBN)

• •

• •

Telecommunication Regulatory Commission of Sri Lanka (TRCSL) has initiated an island-wide fibre backbone network The key goal is to provide all-island broadband connectivity through 5 fibre optical cable rings Completion by 2014 This will provide high speed internet connectivity to all regions of the country
Source : Sri Lanka Ports Authority, Ministry of Ports and Highways, TRCSL

Page 67

Internet and Broadband usage expanding but trailing peers

6%

Internet and Email Subscribers
(As a percentage of tot. population |Dec 2011)

Broadband connections
(Per 100 people| 2012)

5%
4.13

4.61

4%

• 2.3 Mn Internet users as of Dec/11 • Mid-year population 20.9 Mn in 2011

3%
2.32

2%
Wireless

1.23

1%

0.79

0.90

1.09
Fixed

0%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 March

Indonisia

India

Sri Lanka

Vietnam

Thailand

Source: TRC Sri Lanka

Source: www.internetworldstats.com, TRCSL

JB Securities Research July 2012

Page 68

Primary balance improvements not at the expense of capital exp...
Revenue as a % of GDP

15.6% 15.0% 14.9% 14.5% 15.0%

Primary deficit as a % of GDP

2008

2009

2010

2011

2012 F

-1.7%

-1.4%

-1.3%

Primary Expenditure as a % of GDP
17.8% 18.5% 16.6% 5.3% 5.7% 5.4% 5.5% 6.0% 15.9% 16.3%

Capital Expenditure Primary Recurrent Expenditure + Net Lending

-2.2%

-3.4%

12.5%

12.7%

11.2%

10.4%

10.3%

2008

2009

2010

2011

2012 F

2008

2009

2010

2011

2012 F

Source: Central Bank of Sri Lanka, JBS Research Analysis

JB Securities Research July 2012

Page 69

Large economic opportunity at the country’s door step…
Four southern states of India - 7x Sri Lanka’s GDP
(2011, Nominal GDP $Mn)

Sri Lanka
GDP CAGR* Contribution to national economy In 2011 8.68% 7.82%

59,183

7x

GDP of Southern states of India

407,702

GDP CAGR* Contribution to national economy In 2011 GDP CAGR* Contribution to national economy In 2011 CAGR 2007/11*

8.41% 5.73%

GDP CAGR* Contribution to national economy In 2011

8.01%

Kerala
8.01%

62,107

8.09% 3.96%

Karnataka

90,835

Andhra Pr.

132,054

Tamil Nadu
GDP CAGR* 6.42%

122,706

Source: Directorate of Economics Statistics of respective State Governments, and for All-India — Central Statistical Organization / CBSL Annual report 2011

JB Securities Research July 2012

Page 70

Progressing towards a ports and maritime hub
Sri Lanka’s Competitiveness as a Maritime Hub Major Trade Route Regional Growth Poor Regional Infrastructure
Sri Lanka is ideally located along the major East-West trade route. Trade growth in the Indian Subcontinent (ISC) Congestion within Indian ports and strict cabotage laws make transshipments at Sri Lankan ports a more viable option for ship owners

Regional trade routes with Sri Lanka as a Hub

Sri Lanka

World’s top 10 liner routes (TEU Mn)*
China - US China - EU Other Asia - Other Asia China - Other Asia Other Asia - EU US - China EU -ME & Africa EU - Other Asia EU - China China - ME & Africa Trade routes that pass by Sri Lanka 3.2 3.2 3.0 2.9 2.7 3.6 4.6 5.2 5.8 7.1

Colombo’s reckoning as a maritime hub
2010 Ranked 29th among the world’s major ports

Sri Lanka’s strategic location places it on 6 of the 10 largest trade routes in the world and within reach of over 26% of all the world’s container traffic

2005 Ranked 35th among the world’s major ports

2.4 Mn TEU
2005

4.1 Mn TEU

* Liner Volumes are for 2009
JB Securities Research July 2012

Source : IHS Fairplay, World Trade Service, World Shipping Council.

2010
Page 71

Ports and maritime hub cont... Major Ports of Sri Lanka Bunkering Services
Colombo & Hambantota
Trincomalee

Current Sri Lankan bunkering capacity: ≈ 35,000 MT Capacity after completion of proposed expansions: > 115,000 MT

Colombo Galle Hambantota

524 168
2007

253
2008

133
2009

259
2010 2011

Bunkers and Aviation fuel sales in Sri Lanka (USD Mn)

Commercial Ship repair
Colombo, Galle & Hambantota
Current maximum commercial dry docking capacity : 125,000dwt (at Colombo) Capacity for afloat repairs should increase at Colombo once port expansion concludes.
Ship repair volumes - Colombo
101 82 82 75 91 Dry dockings Afloat repairs

Transshipment Services
Colombo & Hambantota
Current Sri Lankan transshipment capacity: ≈ 4.5mn TEU Capacity after completion of proposed expansion: > 14mn TEU
TEU Millions 20 15 10 5 -

Transshipment Activity in the Indian Subcontinent

Total container volume handled at ports within the Indian Subcontinent

Total transshipment activity related to the ISC Container volume transshipped from Colombo 2000 2003 2006 2009

89

78 2008

66 2009

74 2010

74 2011

2007

Source : Colombo Dockyard PLC annual reports, Drewry Maritime Research, Treasury Annual Reports

JB Securities Research July 2012

Page 72

Tourism – “One Island, A Thousand Treasures”
Tourist arrivals (adjusted for VFF)
2,500,000
Total tourist arrivals including VFF (SLTDA) Tourists Visiting Friends and Family (VFF) VFF=SLTDA arrivals –(Foreign guest nights /10) Scenario 1: Tourist arrivals estimated by SLTDA(2.5Mn) Scenario 2: Tourist arrivals increase by 2x 200,000

1,651,777 3x
200,000

2,300,000

855,975 654,476
116,907 130,086

1,451,777

2x

327,902
725,889 537,569
52,464.32

387,622
58,143

275,438

329,479

2010

2011

Jan-May Jan-May 2011 2012

F2016 F2016 Scenario Scenario 1 2
Source : SLTDA

Note: 2011/12 VFF figures are based on 14-16% of total arrivals, this category is forecasted to grow at 10% till 2016

JB Securities Research July 2012

Page 73

Tourism – Room inventory projected to increase …
Required room stock
Current room inventory (YE2011)
Un-graded

Approved new hotel projects Expected investment
6,141 20,794

209 $2,046Mn

14,653

Graded

Expected room inventory based on approved projects

13,967

Incentives on offer for selected hotel projects: • Tax holidays for 1st 10 yrs. • Reduced tax rate of 6% or half the applicable rate (currently 12%) • Payee tax exemptions on expatriate workers • Withholding tax exemptions (i.e. interest on deposits, management fees, royalty & marketing fees) • Exemptions on VAT, PAL & Customs duty on imported or locally purchased project related goods

Inventory mismatch

6,350 7,313

+ -

Major hotel brands entering Sri Lanka

Projected room inventory to meet demand in YE2016

Scenario 1

42,074

Scenario 2

28,411

Forecast assumptions Avg. occupancy 70% Avg. stay 8days Avg. room sharing 1.6persons

Scenario 1: Tourist arrivals estimated by SLTDA (2.5Mn) Scenario 2: Tourist arrivals increase by 2x of YE2011 Note: Major portion of room inventory expected in 2016
Source : SLTDA ,JBS Research Analysis

JB Securities Research July 2012

Page 74

Potential for bridging the fossil fuel deficit…
Reserve Guestimate for the Mannar basin
TOE Mn C4 C3 C5 C2 C1 4.4 Furnace Oil M1 M2 M3 M4 M5 M8
Operated by Cairn Lanka Pvt. Ltd Appraisal of commercial viability

Confirmed existence of Working Hydrocarbon systems Other 139.5

5% 4% 6%

Kerosene LPG

32 X

Energy 47% decomposition 17% (TOE basis) 21% Petrol

Diesel

Expectedenergy energyyeild yield Expected from exploration from exploration

Energy demand (YE2011)
2010 2011 2012

TOE-Ton of oil equivalent : Energy released by burning 1 MT of crude oil

Time line
2013 2014 2015 2016 2017 2018

Seismic Surveys Exploratory Drilling

100 1,500 500 1,000
Cost ($Mn) incurred by Cairn Lanka Open to investors

M6 M9 M10 M7 S1 Exploration Blocks : Mannar basin Cauvery basin M1 Southern

Setting up sub- sea completion (Upstream) Setting up transport infrastructure (midstream) Downstream activities

Source : PRDS Sri Lanka, CBSL annual report 2011,JBS Research

JB Securities Research July 2012

Page 75

$ 2,250 Mn

150

Apparel – largest industry…moving up the value chain
Drivers of competitiveness
Sri Lanka is an experienced player with a comparatively long involvement in the global apparel industry Highly skilled labor force combined with closely involved local entrepreneurship Broader skill set that transcends the ability to simply cut-make and trim, extending into greater value added portions of the supply chain Increasing tendency of exporters to extend product lines into the greater value added segments and develop strategic relationships with buyers Solid CSR track record , close compliance with labour laws and reputation for being the source of “clothing with a conscience”

Apparel Exports - Composition
USD Mn

Presence

1,816

1,898

1,764

1,842

1,892

Labour

1,786
2007

1,921
2008 Knit

1,774
2009 Woven

1,887
2010

2,068

Capabilities

2011

Apparel Exports – Value added*
LKR Bn

Value Addition

84.6

87.2

87.8

92.3

102.3

Reputation

2007
Source: World Bank, Central Bank of Sri Lanka

2008

2009

2010

2011
Page 76

* 2002 Constant Factor Prices

JB Securities Research July 2012

Ceylon tea … the connoisseur’s choice
Commanding a price premium..
Annual average tea prices (USD/kg)*

Higher value addition
Composition of Black tea Exports (MT)

22 3.28 3.14 2.99 2.87
Colombo

21 85 20 79

31 148

28 155

3.26

74

211

208

185

142

133

2.71 2.49 2.31

2.73 2.47

Mombasa

2007
World

2008
Bulk

2009
Packets

2010
Bags

2011

Greater diversification of markets
Export destinations – USD Mn

Kolkata Chittagong Cochin 155 89 121 185 475 623 598 695 667
Middle East

271 209 102 136 202 196 95 117 179 120 135 220

302 126 145 251

Other Other OECD EU Russia

2008

2009

2010

2011

Mar 2012 2012
2007 2008 2009 2010 2011
Page 77
Source: World Bank, Central Bank of Sri Lanka, Sri Lanka Tea Board

*World price is as at 31st March of every year. March 2012 prices are spot prices and have not been averaged over a given period.
JB Securities Research July 2012

IT/BPO industry – a rising star
Industry recovering after the global economic crisis
450 Nominal USD Mn. 400 350 300 250 200 150 100 50 0 2007 2008 2009 2010 2011 Year on Year Growth Series2 Series1 Export Revenue Industry 7% 8% 46% 79% 90% 80%

Sri Lanka Ranked 21st in the AT Kearney Global Services Location Index
India China Malaysia Egypt Indonesia Mexico Thailand Vietnam Philippines Chile Estonia Brazil Latvia Lithuania UAE UK Bulgaria USA Costa Rica Russia 0.91 2.82 0.45 2.84 2.48 3.20 2.97 3.05 2.14 2.54 0.76
2.17 1.27 1.03 2.27 0.69 1.16 0.78 1.58 1.28 0.76 1.11 1.09 0.77 0.81 2.88 0.94 1.79 0.95

3.11 2.62 2.78 3.10 3.24 2.68 3.05 3.27 3.18 2.44 2.31 2.02 2.56 2.48 2.41
2.26 0.88 1.27 0.95 2.07 0.93 0.93 0.94 1.60 1.38 1.19 1.31 1.38 1.36 1.53 2.55

2.76 1.31 1.83 1.35 1.01 1.44 1.29 1.24 1.16 1.82 2.24 1.38 1.96 2.02 2.05 2.23 1.67 2.01 1.56 1.07 1.11 1.49 1.37 1.81 1.65

1.14

387
70% 60% 50% 40% 30% 20% 10% 0%

265 230 245

175
31%

Moved up 4 places in 2011

Sri Lanka Jordan Tunisia Poland Romania Germany Ghana Pakistan Senegal Argentina 2.45

Financial attractiveness People skills and availability Business environment
6 8

3.21 3.23 3.23

Source: Treasury Report 2011, Ministry of Finance & Planning, AT Kearney Global Services Location Index – 2011, ATKEARNEY

0

2

4

JB Securities Research July 2012

Page 78

Remittances remain healthy…
Departures for Employment
No. of persons

Inward Remittances
8.7% 5,141
USD Mn

266,445 247,209 15,918 64,755 56,194 17,489

262,960 19,829

8.9%

239,021 18,707

Other

As a % of GDP

4,416 568

288 103 206 232 401 885

Other AUS & NZ SE Asia Non EU Far East

67,612

60,757

Semi and Unskilled

7.9% 7.2% 2,918 200 90 55 128 175 525 3,330 224 10057 148 203 603

82 144 177 247 724

EU

50,848

61,320

71,114

67,703

Skilled

House Maids
108,709 113,777 113,087 107,816 1,745 1,995

3,030 2,474 Middle East

2008

2009

2010

2011

2008

2009

2010

2011
Source: Central Bank of Sri Lanka

JB Securities Research July 2012

Page 79

Structural reforms easing pressure on the trade account…
Price subsidies being reduced…
Furnace Oil Rs. Per Ltr 90 32
181.3%

Merchandise trade
2012 106 2009 Imports Exports Balance of Trade

USD Mn

Kerosene

51

107.8%

2,500
1,986 1,876 1,915

1,837

1,770

1,763

1,683

1,634

1,669

1,568

Electricity tariff (Rs./KWh)

954

923

931

933

889

886

858

880

836

817

749

820

836

15%

918

10.50 7.50 10.50
40%

962

Industrial Domestic(> 60 units)

12.08

1,236

Petrol (90 Octane)

115

1,441

149
29.6%

1,490

1,581

1,697

57.5%

1,757

Auto Diesel

115 73

2,000

1,500

1,000
680

500

LKR. Per Ltr

150 130 110 90 70

Petrol (90 Octane) Auto Diesel Kerosene Furnace Oil
-419

0

-500
-703 -742 -701 -761

-645

-847

-848

-808

-883

-904

-868

-942

-1,101

-997

-861

-1,000

-1,500 May 11 Jan 11 Sep 11 Feb 11 Apr 11 Jan 12 Feb 12 Mar 11 Dec 11 Mar 12 Aug 11 Nov 11 Apr 12 Oct 11 Jun 11 Jul 11

50 30

2007

2008

2009

2010

2011

2012

* April 2011 – April 2012 figures are provisional
Source: Central Bank of Sri Lanka, Ceylon Petroleum Corporation

JB Securities Research July 2012

Page 80

LKR devaluation has kept up with peers…expected to stabilise…
USD against regional currencies
30%
Sri Lankan rupee (LKR) Bangladeshi taka (BDT) Vietnamese dong (VND) Indian rupee (INR) Chinese yuan (CNY) LKR
105 LKR/USD(RHS) 104 REER(LHS) 135 103 NEER(LHS) 140

25% 20%
102

130

15% 10% 5% 0%

101 125 100 120 99

98

115

97

-5%
96

110

-10%
Apr 11 Jun 11 Aug 11 May 11 Sep 11 Apr 12 Jan 11 Jan 12 May 12 Mar 11 Oct 11 Mar 12 Nov 11 Dec 11 Feb 11 Jul 11 Feb 12

95 Apr 11 May 11 Apr 12 Jun 11 Jan 11 Jul 11 Jan 12 May 12 Feb 11 Mar 11 Sep 11 Feb 12 Mar 12 Oct 11 Aug 11 Nov 11 Dec 11

105

Source: forexpros.com, Central Bank of Sri Lanka, JBS Research

JB Securities Research July 2012

Page 81

Sustainable GDP growth expected to average 6% in the medium term…
Medium term GDP growth projections (2012 – 2017)

8.0%

8.3%

7.8% 6.8% 6.0%

7.8% 5.9% 4.1%

2010

2011

CBSL Estimate*

IMF Estimate

JBS Estimate** Developing Asia

ASEAN-5

Newly industrialized Asian economies

* CBSL expects GDP growth of 7.2% in 2012 and 8% in the medium term ** JBS estimate = Investment rate (27%) / ICOR average (4.5)
JB Securities Research July 2012

Source : Central Bank of Sri Lanka, IMF, JBS Research

Page 82

Equity valuations have reversed to more reasonable levels…
Decomposition of market value June 2011 Decomposition of market value July 2012

34.5% 68.7% 72.6%
Franchise Value

42.2%

48.3%

75.6%

Tangible Value

65.5%

57.8%

51.7%

31.3%

27.4% 16% Cost of Equity

24.4% 18% 15% 17% Cost of Equity 19%

14%

*Current treasury rates: 1yr 12.99%, 5yr 14.15%, 10yr 14.75% (6th July 2012)
JB Securities Research July 2012

Source : JBS Research Analysis

Page 83

Sector Multiples – Banking…

Bank P/B Multiples – Sri Lanka*

Bank P/B Multiples – Peers**

3.42 1.71 1.28 1.37 1.32 1.75 1.12

2009

2010

2011

June 2012 March 2011

Thailand

Phillippines

India

*Peer comparisons are for March 2012 ** P/B Multiples are for “Systemically Important” banks. In cases where such classification was not available, the six largest listed banks by asset size were taken into consideration
Source: Various Stock Exchange Filings

JB Securities Research July 2012

Page 84

Sector Multiples – Diversified…

Major Conglomerates – P/E Multiples

Major Conglomerates – Returns on Equity

21.0 15.7 12.0

20.9

15.0%

15.8% 11.4%

16.9% 14.9% 12.2%

9.7

9.2

JKH

SPEN

CTHR

CARS

HAYL

HHL

JKH

SPEN

CTHR

CARS

HAYL

HHL

Source: Various Stock Exchange Filings

JB Securities Research July 2012

Page 85

Concluding remarks - Economy
 Economy sailing through head winds in the short term due to weak global conditions and domestic structural imbalances.  Next major elections are in 2015 thus fiscal consolidation can continue – this will mean more taxes and fewer subsidies. Ideally it should be done by casting the tax net wider and better targeting of subsidies.  Inflation differentials accumulated over the last 5 years led to the large depreciation of the currency – the currency should stabilize going forward.  Tight monetary conditions will have to continue for at least the next 12 months to keep inflation and the exchange rate in check.  Absence of a conflict is a necessary condition but not a sufficient condition for high rates of economic growth. Sustainable medium term economic growth will be around 6% due to low domestic savings and low capital productivity.  Higher economic growth is possible by focusing on improving total factor productivity – this will require economic restructuring (shift of resources to more productive activity - SOE privatization, a more liberal trade policy, controlling rent seeking behaviour, etc.), investments in human resources (education and skills upgrading) and technical progress (technological and organization advances).  The best years for the country lie ahead – there lies a real possibility of Sri Lanka being a “Breakout Nation*”
* Cited in “Breakout Nations” by Ruchir Sharma, Head of Emerging Market Equities & Global Macro at Morgan Stanley Investment Management

JB Securities Research July 2012

Page 86

Concluding remarks - Equities
 Bull markets are 7 year cycles (1993-4, 2002-3 and 2009-11) – next one is not due anytime soon. Thus there will be no rising tide to lift ALL boats.  Equity market is in its consolidation phase – market will go sideways for the remainder of this year. Nevertheless, a sideways market offers many opportunities to invest in undervalued securities as the potential for mispricing is larger.  The low free float large market cap stocks in the indices are masking the true extent of the fall in the market – many stocks have fallen 50-60% from their peak.  Nominal GDP growth will be around 13-14% in the medium term – large firm revenues will grow at a CAGR of around 16-17%, EBITDA will grow 18-19%.  Free float is further constrained since there will be reluctance to sell at a loss especially amongst state controlled institutions.  Value is returning to the market – some stocks are now trading below their intrinsic values.  Trying to time the market is futile – jumping on the band wagon when its moving is a losing proposition.  Build a diversified portfolio by accumulating equities in stages – 10%:20%:30%:40%.

JB Securities Research July 2012

Page 87

About us
JB Securities Ltd is a full service brokerage firm that is licensed to operate on the Colombo Stock Exchange (CSE). The firm was a founding member of the Colombo Stock Exchange in 1985 and has extensive experience dealing with domestic and foreign institutional investors and high net worth individuals and family offices. In order to provide unique investment insights to our clients we conduct extensive deep-dive research in the industry verticals pertaining to the large listed companies to identify their industry and business dynamics. This process is aided by the largest team of equity analysts in the country, a majority of them either being CFA charter holders or CFA candidates who have undergone a 20 month intensive in-house training program based on international curricula. The firm continues to invest in the development of its analyst team to widen and deepen its research coverage. The firm is part of the family owned Jafferjee Brothers group based in Sri Lanka that was founded in 1944. The group’s business interest spans a wide array of activities in trading, manufacturing and services and has extensive experience dealing with global companies. The core ethical values of the family have been enshrined in all its businesses. All employees of JB Securities have signed off on a code of ethics and standards of professional conduct that is based on that of the CFA Institute.

JB Securities Research July 2012

Page 88

Legal disclosures

© Copyright 2012, JB Securities (Pvt) Ltd, All rights reserved.
This research is for our clients only. Other than disclosures relating to JB Securities, this research is based on current publicly available information that we consider reliable, but we do not represent it as accurate or complete, and it should not be construed as such. We seek to update our research as appropriate. JB Securities shall have no liability, contingent or otherwise, to the user or to third parties, for the quality, accuracy, timeliness, continued availability or completeness of the data or calculations in this document, nor for any special, indirect, incidental or consequential damages which may be incurred or experienced because of the use of the data or calculations made available herein. JB Securities does and seeks to do business with companies covered in its research reports. Investors should be aware that the firm may have a conflict of interest that could affect the objective of this report. Investors would consider this report as only a single aid in making their investment decision. No part of this material may be modified or altered without the prior consent of the firm.

JB Securities Research July 2012

Page 89

For further information contact: Murtaza Jafferjee CFA +94 11 2490900 [email protected]

150, St. Joseph’s Street, Colombo 14, Sri Lanka. Tel: +94 112490900, Email: [email protected], www.jbs.lk
JB Securities Research July 2012 Page 90

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