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Strong corporate earnings but volatility to continue

The Colombo Bourse moved in the positive direction, reacting to developments in the political front. Although the market took a breather at the start of the week.

The ASPI and MPI closed the week at 1154.3 points and 1992.1 points and week on week basis the indices gained by 35.0 points (3.12%) and 70.95 points (3.69%). Four trading days, recorded a turnover of Rs. 1.22 billion at an average daily turnover of Rs. 307.05 million. The highlights during the week were Tuesday's internal transfer of 354,200 shares at Rs. 1800 of Carson Cumberbatch to the tune of Rs. 637.5 million and Friday's foreign buying of JKH amounting to Rs. 68 million. Foreign investors kept accumulating fundamentally strong stock at relatively bargain prices and helped to record a net foreign inflow of Rs. 458.7 million on the bourse. The actively traded stocks were SLT, JKH, Watawala Plantations and Associated Hotels.

Point of View:

Alliance spells out their economic policies

The SLFP-JVP alliance disclosed that they were focusing on a mixed economy, if the party was elected to power at the general elections to be held in 2004. They pledged that the present Cease Fire Agreement (CFA) would be continued, while negotiating for a political solution for the ethnic conflict. Further they stressed on the importance of good governance, which we feel was not a success during the last two years, under the UNF's regime.

Ambiguity in certain areas

While Minister Lakshman Kadirgamar insisted that the CFA would hold and the no war situation would continue, they would renegotiate a CFA, as the present CFA has lapsed since the Prime Minister's pull out from the process. However we believe that Minister Kadiragamar's statement was made with authority and certainty thus reducing ambiguity caused by contradicting statements.

The alliance pledged they would maintain the low interest rates to encourage businesses to borrow at lower rates. In another statement they mentioned the importance of providing adequate return to depositors and Non Resident Foreign Currency (NRFC) account holders. It was clearly highlighted that the alliance would work towards increasing the NRFC interest rates (for US dollar) from 1.5% to 3% as soon as possible. These statements directly contradicted with its policy to maintain low interest rates, thus we believe that the implementation of such policies could lead to practical difficulties.

Privatization policy needs further clarification

Meanwhile the privatization policy needed further clarification, as two former ministers of the Peoples Alliance expressed confidence that they would continue the trend maintained between 1994 and 2001.

More specific clarifications required

While acknowledging Alliance's firm commitment towards spelling out their future strategies, we still believe that they should be more specific on areas such as solution to the ethnic issue, interest rate management, policy on exchange rates and privatization. The need to maintain consistency in this context is important.

Such contradiction would only lead to uncertainty among the investors and the public, at a time they are desperately looking for positive policy statements from the Alliance. We also believe that consistency in implementation of such policies is essential, as governments in the past have failed to implement most of their policies pledged during election campaigns.

Strong corporate earnings but volatility to continue

Most corporate results released have shown strong growth and we expect certainty in the earnings which are to be released in the coming days. However we feel that the market would be more sensitive towards political developments than towards corporate results. Therefore we believe that the market would remain volatile in the coming week, thus creating trading opportunities and bargain hunting.

Hayleys results for the 9 months to December 2003

Hayleys Ltd. posted a healthy 18% increase in revenue to Rs. 11.2 billion, in comparison to the corresponding period of the previous year, largely because of higher contribution from rubber and environment sectors. The gross profit grew by 10% to Rs. 3.0 billion, although the operating profit showed a decrease of 13% to Rs. 898 million. However, the Profit attributable to shareholders increased marginally by 2% to Rs. 367 million.

The drop in operating profit, regardless of the surge in revenue was largely attributable to the 40% increase in distribution cost and 18% rise in administrative expenses. According to company sources, these escalations in costs were due to the setting up of ICO Marketing Company in Italy, a subsidiary of Dipped Products Ltd. (DPL) to distribute rubber gloves in Europe.

DPL sustains the revenue growth of Hayleys

DPL, a subsidiary of Hayleys Group which is a leading manufacturer of rubber gloves, has outperformed most of the other subsidiary companies mainly on the back of increased rubber prices. The revenue from this rubber related business has advances by a significant 58% to Rs. 3.4 billion during the nine months ended December 2003.

Increased production of rubber gloves, coupled with the average 50% increase in selling prices, assisted DPL to record this growth in revenue in comparison to the corresponding period of last year.

Haycarb is expected to recover during the 4Q

Haycarb is a pioneer manufacturer of activated carbon with a global market share of 15%. Since activated carbon is produced mainly using coconut shell charcoal, the fortunes of this business in largely influenced by coconut production in Sri Lanka.

The drought experienced at the end of the year 2001 hampered the production of coconut in the country, which resulted in a heavy shortage of shell charcoal.

Therefore, Haycarb had to import 30 to 40% of its charcoal requirements paying high freight, with imports costing around Rs. 22,000 an MT. Due to the shortage, the local prices too increased over 25% to Rs. 19,000 an MT.

Irrespective of the coconut shell activated carbon business (coming under the environment segment of Hayleys) recording 19% increase in revenue to Rs. 1.8 billion, the operating profit of this business slipped over 85% to Rs. 25 million.

The company believes that, with improved weather conditions and effects of the drought now over, increase in coconut production would help the company to recover from the current position. But it should be noted that if the present drought condition in the country prolongs, it could again have an adverse impact on this sector.

Considerable rise in profits from associate companies, while finance cost declines

HAYL's share of associate companies' profits increased significantly by 233% to Rs. 148 million. The Hayleys Mgt Knitting Mills has contributed around 40% to the above figure and the rest has been from the other associate companies such as DIMO and Quality Seeds Ltd. Moreover the finance cost has come down by 24% to Rs. 200 million largely due to the prevailing low interest rate environment in the country, thus saving over Rs. 60 million during the period under review.

4th Quarter usually outperforms the rest

Historically, the final quarter of the year has been the best quarter for Hayleys, where the fourth quarter generally accounts for 35%-40% of the full year's earnings. This is mainly because earnings contribution from the coir sector, (which contributes 15% to the groups turnover) in the final quarter is clearly higher than the other quarters as the amount of fibre dried during this period of dry climatic conditions is high. Based on the annualized EPS of Rs. 9.85, the annualized PE stands at 11.57x at the current market price of Rs. 114. A detailed research report on Hayleys together with the forecast would be made available soon.

Asiri in a stronger footing

Asiri Hospitals Limited one of the largest entities in the private health care sector is progressing steadily, with its subsidiary Asiri Medical Services (AMS) commencing operations recently. Asiri, accounts for approximately 15% of the market share. Asiri currently conducts around 500 different tests with 75 of them being exclusive. The hospital conducts around 5000 lab tests daily, which is around 30% of the total lab tests conducted by the private heath care institutions in the country. Asiri's policy to cater to the middle and lower income market through its successful pricing strategy has enabled them to maintain its market share despite fierce competition.

AMS shows positive signs

The AMS project has cost the group approximately Rs. 1 billion and was financed partly through debt which the group raised at lucrative interest rates using its strong credit rating. The investment in the building has cost the group around Rs. 600 million while Rs. 400 million was spent on purchase of modern equipment. The equipment includes modern CT scanner and image assisted surgery equipment, which is exclusive to AMS. With AMS commencing its operations the bed capacity of the Asiri Group has risen from 120 to 220. At a recent company visit, management expressed their confidence that AMS would reach an occupancy level of around 95% - 100 % by July 2004.

The surgical and oncology areas have been shifted to AMS from its current location in the main hospital. This has partly solved the growing problem of parking, which was a serious concern earlier. AMS has a 7-story car park, which could accommodate around 350 vehicles.

As the AMS project is BOI approved it's entitled to a 10-year tax holiday from the first year of net profits.

This would be a key factor to AMS, as it would enable it to a rapid movement towards profitability. In addition other tax benefits on dividends, equipment would be available to AMS.

Refurbishment of existing hospital

The group hopes to refurbish its main hospital premises, later this year at an approximate cost of Rs. 50 million, which is expected to be financed through internal funding and debt. We feel that this is essential towards being in line with the industry standards.

Asiri's provisional earning forecasts for FY 2004 stands at Rs. 140 million, which is a 16.7% improvement compared to Rs. 120.1 million reported in FY2003.

Group EPS stands at Rs. 3.69, and based on market price of Rs. 28.00 the share is trading at PE multiples of 7.59x.

The views based herein are expressed with no malafide intension to any party whatsoever based on already published data and from the information obtained by the research team. No matter published as above creates any liability of any kind whatsoever on HNB Stock Brokers Pvt Ltd or its associates. The views cannot be reproduced in any form without the explicit (written or otherwise and photocopied) permission from HNB Stock Brokers (Pvt) Ltd.

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