Business Letter:

The real potential of Ceylon Leather Products

The Ceylon Leather Products Ltd, formerly government owned Ceylon Leather Corporation in the recent past has become very popular among the investors/brokers of the Colombo Stock Exchange.

The assets rich company with 8.1 acres at Mattakkuliya within the Colombo Municipality has been making profits from 1998 except for two years due to high cost of borrowing, high gearing and enlarged working cycle.

The company also derived a substantial portion of revenue from exports and the tannery located in a land in extent of 4.7 acres is considered the largest in the country.

Stock analysts and research divisions of leading stockbrokering companies have been conducting in depth studies in the recent past to ascertain actual value of the company mainly based on the valuable substantial land holdings.

It is the considered view of many analysts that actual present and potential value is far in excess of the value presently known to many. Consequent to the US$500m bond issue cash position of the government has improved.

The company has an unusual enlarged working capital cycle due to the fact. CLPL is the largest supplier to government forces with delayed payment. Consequently CLPL would be able to obtain early payments and reduce the enlarged working cycle which would be beneficial to the CLPL.

There are many established affluent foreigners of Sri Lankan origin who do not wish to obtain dual citizenship but still prefer to invest in land in Colombo and its suburbs consequent to the budget proposals regarding waiver of 100% tax based on investment in homeland bonds.

It is therefore expected an upward movement of land values near to medium term and accordingly this would have a favourable impact on land owned by CLPL too.

According to budget proposals any company which relocates its operations outside Colombo and Gampaha Districts may either claim investment relief for total relocation cost or claim five years tax holiday and accordingly CLPL would benefit from the profits generated by the tannery after its relocation.

It is also prudent for the company if the tannery is relocated for instance in Eastern Province to obtain maximum benefits.

The company on October 10 sold one of the two lands in extent of 3.4 acres for Rs. 307m and consequently financial position of the company has improved substantially.

According to Orix Securities research report dates 27.11.2007 CLPL is projected to earn a net profit of Rs. 277 m with an earnings per share of Rs. 22.20 with a price earnings ratio of only 3.69 during current financial year.

The company has recently purchased a vacant factory at Bellummahara for Rs. 50 m and further expenditure of Rs. 20m would be incurred for relocation and refurbishment. The factory would be redesigned and layout completed according to international standards with the assistance of resident foreign consultants.

The remaining 4.7 acres is located within 300 metres to Mattakkuliya town and according to the Orix Research Report the company proposes to relocate the tannery in the Eastern Province with five year tax benefits with substantial funding of Rs. 100m from a donor agency at a very low cost to support growth plans of the company.

It is expected the relocation plan would commence after relocation of the factory and office.

According to above research report a perch has been valued at Rs. 750,000, when the land is available for sale on a priority basis within a short period prior to completion of new road and the sale proceed would amount to Rs.570m with a capital gain of Rs. 395m to the profitability of CLPL.

Since relocation cost is expected to be met from a very concessionary funding a net interest income of Rs. 114m could be derived by investing this sum in fixed interest instrument at 20% net.

The Orix report forecast a net profit of Rs. 46.1m from normal operations during next year and the total net profits therefore would be in the range of Rs. 160.1 (without capital gain) with an earnings per share of Rs. 12.80.

If we are to consider overall PE of 12.36 on 1.11.07 the theoretical price may increase to Rs. 158.30. If the capital gain too is included net profit would amount to Rs. 555m with EPS of Rs. 44.40.

It is likely the relocation of factory will be completed by April ‘08 and the land would be available for disposal/development during last quarter of 2008/09 by which time the super highway would near completion.

The proposed super highway from Mutuwal to Wattala it is now reported would be stretched up to Negombo by widening the existing canal road and a four Km stretch on the canal road from the new bridge over Kelani river at Mattakkuliya constructed with Chinese aid is already under construction.

Many multi-national and reputed companies have their commercial and processing units located adjacent to the canal road and the new highway would have easy access to the Pettah, Fort and Kollupitiya the Commercial hub of Colombo which includes the Port, financial institutions and head offices of respective companies. Similarly those travelling from Pettah, Fort and Kotahena to Negombo, airport would be a convenient route via the new road.

The present Negombo-Colombo road via Peliyagoda is highly congested and hence construction of proposed road on a priority basis.

The proposed super highway would entirely change the landscape of Mattakkuliya, Mutwal, Kotahena and when nearing completion land value is expected to skyrocket.

With this expectation many high rise residential and commercial buildings are presently under construction in Mutwal, Mattakkuliya, Grandpass and Kotahena areas. Case in point is proposed 30 and 36 luxury apartment towers undertaken by a subsidiary of quoted company CT Land Ltd.

The Orix research estimate the value of the Mattakkuliya land to increase to over Rs. 1m per perch and analysts expect the realisable price to be around Rs. 1.325 m. Consequently 12 months projections after the sale of land on this basis is as follows:-

Consequent to the delisting of BATA, CLPL is the only company involved in the manufacture of Leather Products and should be categorised separately.

It is a very important segment in the economy due to high number of employment and many manufacturing units of leather products in the country.

Ascot should be now categorised under land sector and other two companies manufacturing textiles which has no relationship to CLPL.

Hence it is logical and most appropriate to consider overall PE for the above exercise. Cost of relocation has not been taken into consideration since company expects substantial funding at a very concessionary rate).

According to the Orix report, CLPL may add value to the revenue generation of proposed sale of land by developing the tannery land as a low cost housing complex which may give substantial profits far in excess of the above projections but no financial study has been undertaken at present.

The assets rich CLPL expected to be the highest cash rich company in relation to the paid up capital in the Colombo Stock Market.

The company is an integrated genuine leather producing company. Its real potential is still not understood by majority of brokers/investors.

S. Dharmasooriya,
Pannipitiya