Asia Securities Equity Strategy 2018 Picking The Resilient Amongst Uncertainties 10 Jan 2018

SRI LANKA EQUITY | STRATEGY
OUTLOOK | 10 JANUARY 2018
Sri Lanka: Equity Strategy 2018

Picking the resilient amongst uncertainties
We take
Kanishka Perera We see 2018 as a more positive year for equities when compared with 2017. However,
kanishka@asiasecurities.lk upside will continue to be driven through earnings growth more than a substantial rerating
+94 11 772 2044 of the market. We place the ASPI at 6,920 (+8.6% YoY) by year end driven through an EPS
growth of 14.9% YoY and a slight upward rerating to 10.5x 2018E EPS (currently trading at
Lakshini Fernando 9.7x). At a macro level, we expect GDP growth to recover to 4.8% on the back of a
lakshini@asiasecurities.lk
normalization in weather conditions and loosening monetary policy. We are positive on the
+94 11 772 2045
Banking and Telecommunications industries but, note that negative policy proposals (which
Mangalee Goonetilleke we believe will see weak implementation) will lead to depressed valuations in the near-
mangalee@asiasecurities.lk term. Furthermore, we see an increasing level of uncertainty given the upcoming local
+94 11 772 2042 government elections. The country remains vulnerable to global growth given the high
reliance on exports and remittances. We continue to take a bottom-up approach for our
Naveed Majeed conviction calls for this year. Our model portfolio (ADV weighted), is expected to return
naveed@asiasecurities.lk 21.9% over the next 12-months.
+94 11 772 2043
We forecast the ASPI at 6,920 by year end 2018 (+8.6% YoY)
Our year end ASPI target is at 6,920 (+8.6% YoY; +6.0% to yesterday’s close) driven through an
Our key picks
earnings growth of 14.9% YoY (+9.1% YoY for CY17E) along with an upward rerating to 10.5x
BBG P/E ROE (currently trading at 9.7x). Earnings growth continues to be our key driver of rerating given the
ticker (x) (%)
lack of transparency in government policy making. We note that the government budget for
MGT SL 14.8 7.0
2018 contains negative policy proposals for the Banking and Telecommunications industries
LION SL 372 1.4
which have a substantial weighting on the index. While we are largely convinced that these
SDB SL 11.8 7.7 proposals will be watered down prior to implementation, the uncertainty surrounding these
DIAL SL 7.6 21.9 will lead to depressed valuations. From a flow perspective we expect net foreign inflows to
CARG SL 15.6 19.2 taper off from the levels seen in CY17.
SAMP SL 6.2 19.5
HEMS SL 19.0 15.4 We see 2018 as a recovery year and forecast GDP growth of 4.8%
TKYO SL 7.7 22.8 2017 came largely below our expectations on the growth front with our GDP growth forecast
being cut down to 4.0% YoY from the 5.1% forecast made in Jan 2017. Adverse weather effects
Source: Asia Securities
led to a contraction in the Agricultural sector which spilled into consumer spending power
Note: FY18E/CY18E data
through supply led inflation. However, all other macro indicators showed a strong
improvement. Key amongst them: FX reserves and the fiscal deficit. These, we believe, will
allow the Central Bank to loosen monetary policy. As such, we believe that 2018 will be a
recovery year driving our GDP growth forecast of 4.8%.
Banking and Telecom to be key growth sectors; valuations to be depressed in near-term

We believe that the strong macro environment will support growth for the Banking sector
while Telecommunications will also see growth coming from the data side. However,
valuations are likely to be depressed in the near-term as the budget for 2018 proposes
negative policies for these two sectors. Given the importance of these two sectors on the
economy we believe that these policies will see weak implementation. We see a recovery in
the Construction sector from mid-2018 onwards on our expectations of a resumption in
government infrastructure spending while we expect the Consumer sector to recover in the
same period on our expectations of a normalization in consumer spending power.
Uncertainty set to pick up with upcoming elections; external vulnerability remains a risk
The key risk from a local perspective is the local government election slated to be held in Feb
2018. If there is a shift in votes towards one party of the Unity government, we believe that
there will be an increase in uncertainty in the near-term as both parties start building new
alliances in readiness for the Presidential elections in early 2020 and the Parliamentary
elections in mid-2020. On the external front, the key risk remains global growth given the
country’s continued reliance on exports and remittances.
Our 2017 picks returned 15.3%; we forecast our 2018 portfolio to return 21.9%
Our key picks for 2017, recommended in Jan 2017, returned 15.3% on an ADV basis vs. a total
return of 3.5% for the broader ASPI and 9.4% for the more liquid S&P SL20. HHL and TKYO were
key performers during the year, amply supported by the Banking sector. Our key picks for 2018
are: 1) MGT, 2) LION, 3) SDB, 4) DIAL, 5) CARG, 6) SAMP, 7) HHL, and 8) TKYO. Furthermore,
we believe that CFIN, NDB, and LIOC have the potential to deliver strong returns provided
certain trigger conditions are met. We do not include these stocks into our core
recommendations as the timing of the trigger conditions are highly uncertain.
1
This report is strictly for direct recipients from Asia Securities. Redistribution of this report is prohibited. Please see page 102 for analyst &
company certification and important disclosure.
Table of Contents
Equity Strategy ____________________________________________ 3

Key picks ____________________________________________________________ 13
Model portfolio _______________________________________________________ 15
Macro Outlook - 2018 _____________________________________ 17
Sector Outlook - 2018 _____________________________________ 28

Banking _____________________________________________________________ 31
Telecommunications ___________________________________________________ 34
Alcoholic Beverages ____________________________________________________ 36
FMCG/R _____________________________________________________________ 38
Conglomerates ________________________________________________________ 41
Construction _________________________________________________________ 43
Manufacturing ________________________________________________________ 47
Healthcare ___________________________________________________________ 50
Leisure ______________________________________________________________ 52
Insurance ____________________________________________________________ 55
Non-Bank Financial Institutions ___________________________________________ 57
Energy ______________________________________________________________ 60
TOP PICKS ___________________________________________

Hayleys Fabric [MGT]: BUY [+42%] ________________________________________ 64
Lion Brewery [LION]: BUY [+30%] _________________________________________ 67
Sanasa Dev. Bank. [SDB]:BUY [+29%] ______________________________________ 70
Dialog Axiata [DIAL]:BUY [+28%] __________________________________________ 73
Cargills (Ceylon) [CARG]: BUY [+25%] ______________________________________ 76
Sampath Bank [SAMP]: BUY [+17%] ________________________________________ 79
Hemas Holdings [HHL]: HOLD [+11%] ______________________________________ 82
Tokyo Cement [TKYO]: HOLD [+5%] _______________________________________ 85
WILDCARDS __________________________________________
Central Finance [CFIN]: HOLD [+6%] _______________________________________ 89
National Dev. Bnk.[NDB]:HOLD [+10%] _____________________________________ 92
Lanka IOC [LIOC]: HOLD [-9%] ____________________________________________ 95
COVERAGE UNIVERSE ______________________________________ 99
2
Equity Strategy
• ASPI closes 2017 with marginal gain in line with our expectations
• We forecast the ASPI at 6,920 by year end 2018 (+8.6% YoY)
• Our 2018 macro forecasts show an improvement
• Construction and Consumer to deliver results from 2H CY18E
• Policy uncertainty to hit Banking and Telecommunications
• Market earnings growth to pick-up but, with some downside risk
• Net foreign inflows continue to drive market valuations
• Valuations to be challenged on policy uncertainty
• Our country proxy stock of choice is COMB
• Market activity up in CY17 but, to remain largely in line for CY18E
• Our 2017 picks returned 15.3%; we forecast our 2018 portfolio to return 21.9%
• Wildcards to generate returns >30.0% if trigger conditions are met
ASPI closes 2017 with marginal gain in line with our expectations
The ASPI closed 2017 at LKR 6,369.26 (+2.3% YoY), coming 0.7% below our expectation of LKR
6,410.00, while the more liquid S&P SL20 closed at 3,671.72 (+5.0% YoY). On a total return
basis, the ASPI generated a return of 2.7% and the S&P SL20 generated 8.6%.
ASPI was up 2.3% and the S&P SL20 5.0% in CY17 ASPI total return was 2.7% and the S&P SL20 8.6% in CY17
Index value Index value Index value Index value
7,000 4,000 9,100 5,800

6,800 3,900 8,900 5,600
6,600 3,800 8,700 5,400
6,400 8,500 5,200
3,700
6,200 8,300 5,000
3,600
6,000 8,100 4,800
5,800 3,500 7,900 4,600
5,600 3,400 7,700 4,400
5,400 3,300 7,500 4,200
Jan-17 Apr-17 Jul-17 Oct-17 Jan-17 Apr-17 Jul-17 Oct-17
ASPI (LHS) S&P SL20 (RHS) ASPI TRI (LHS) S&P SL20 TRI (RHS)
Source: CSE, BBG, Asia Securities Source: CSE, BBG, Asia Securities
The ASPI peaked at The market performed steadily up to July 2017, peaking at LKR 6,766.14 on the 14th of July,
LKR 6,766.14 on before softening into December 2017. A general positive sentiment was prevalent through the
the 14th of July early part of the year with expectations of a resumption of infrastructure led construction
demand while cheap valuations in combination with Pakistan being classified into the MSCI
Emerging Markets index led to net inflows to the market.
However, poor weather conditions through the first half of the year led to a substantial hit on
Agricultural sector GDP growth leading to a cut in growth estimates. Most of the hit came to the Agricultural
contracted by 3.2% sector which declined by 3.2% YoY for 9M CY17. Furthermore, the Construction sector saw a
YoY in 9M CY17 slowdown on continued delays in infrastructure projects as the government doubled down on
fiscal consolidation. Retail led construction activity also saw a slowdown with an uptick in
construction costs.
More importantly, the year was a tough one for consumers. While recent data from the
Consumer spending Department of Census and Statistics (DoCS) indicates that household income levels have
power came under increased at a 5.0% CAGR on a real basis over the three years to 2016 (+0.9% CAGR FY10-13),
pressure this year saw substantial headwinds: 1) broader inflation picked up from the YoY impact of the
VAT hike carried out in November 2016, 2) adverse weather conditions led a sharp pick-up in
food inflation from 3Q CY17 onwards, and 3) LPG prices were increased by 8.3% in September
this year.
With these factors, overall market earnings expectations were gradually toned down with the
Banking sector saw market correcting up to September. The banking sector led a market rally up to November
investor interest in with improving expectations of macro stability and an increasing likelihood of looser monetary
4Q policy in CY18E.
3
Budget proposals However, the budget proposals for 2018 (announced in November) contained significantly
for 2018 contain negative implications for the index heavy banking and telecom sectors (~21.0% of ASPI
substantial weighting). Along with this the market saw a correction towards the end of the year and closed
negatives at LKR 6,369.26.
We forecast the ASPI at 6,920 by year end 2018 (+8.6% YoY)

We forecast the ASPI at 6,920.00 by end CY18E (+8.6% YoY; +6.0% to 9th Jan 2018 close). We
We expect ASPI expect ASPI earnings to grow by 14.9% to LKR 658.69 and value the market at 10.5x earnings
earnings to grow (currently trading at 9.7x). From a macro point of view we expect a recovery in economic
by 14.9% YoY in growth from 1Q CY18E onwards. FX reserves, as at November 2017 was at a healthy 4.2 month
CY18E of imports (~USD 7.3bn) which we expect to improve to 4.4 months of imports leaving
headroom to loosen monetary policy. Furthermore, we forecast inflation to taper off from 2Q
CY18E onwards leading to a pick-up in consumer spending power. Barring an adverse shift in
weather conditions or a substantial global economic shock, we expect broader macro stability.
Unlike 2017, we do not see any one sector that will generate consistently strong shareholder
returns.
Our 2018 macro forecasts show an improvement

Our key macro forecasts for CY18E are: 1) GDP growth of 4.8% (+0.8pp YoY), 2) headline
inflation of 5.2% (-1.9pp YoY), 3) currency depreciation of 3.2% reaching 160.00 LKR/USD by
year end, 4) a 25bps cut in policy rates, 5) a fiscal deficit of 4.7% (-0.4pp YoY), 6) a current
account deficit of 2.6% (+0.1pp YoY), and 7) a debt/GDP ratio of 78.6% (-0.6pp YoY). For
further details please refer our macro outlook for 2018 below.
Key macro forecasts

Indicator 2014 2015 2016 2017E 2018E 2019E 2020E
GDP growth (%) 5.0 4.8 4.4 4.0 4.8 5.0 5.3
Headline inflation (%) 3.3 0.9 4.0 7.1 5.2 5.1 5.4
LKR/USD 131.05 144.06 149.80 155.00 160.00 165.80 169.15
Currency depreciation (%) 0.2 9.9 3.9 3.5 3.2 3.6 2.0
12M GSEC yield (%) 5.99 7.30 10.17 9.05 8.40 8.70 9.20
Fiscal deficit (% of GDP) (5.7) (7.6) (5.4) (5.1) (4.7) (4.5) (3.8)
Current deficit (% of GDP) (2.5) (2.3) (2.4) (2.5) (2.6) (2.5) (2.4)
FX reserves (months of imports) 5.1 4.6 3.7 4.1 4.4 4.5 4.0
Debt/GDP (%) 71.3 77.6 79.3 79.2 78.6 78 76.5
Foreign debt/total debt (%) 30.0 32.4 34.2 33.4 30.4 31.5 32.4
Source: CBSL, DoCS, Asia Securities
Construction and Consumer to deliver results from 2H CY18E

Construction will see a recovery in the second half along with a resumption in long-delayed
infrastructure projects while a moderation in home lending rates will lead to some level of
support from the retail construction side. We do not expect the first half to deliver substantial
earnings growth due to the pick-up in global commodity prices impacting home affordability
while interest rates are yet to settle down. For further details refer our recent update on the
Construction sector published on the 6 th of November 2017.
Moderating inflation will help a recovery in Consumer focused names which have carried out
Within Consumer capacity expansions over the year. However, this moderation will take place only from 2H
we are bullish on CY18E along with a normalization of food supply but, we do acknowledge that rising global
Modern Retail commodity prices would cause some level of headwinds. Within the Consumer space we are
more bullish on earnings from the Modern Retail side, relative to others, which has carried out
an aggressive store expansion plan and will continue to do so through most of the next two
years (CY18E-19E).
4
Policy uncertainty to hit Banking and Telecommunications
Proposed Back in November we were turning positive on the outlook for the Banking sector. Key macro
transaction levy on factors had improved to the point of being able to loosen monetary policy in order to drive
the Banking sector growth while most Banks had completed their capital issuances in readiness for the higher
would take off minimum capital adequacy requirements coming out of Basel III implementation. While IFRS 9
~12.0% from our will cause headwinds, we believe that growth would have offset most of it. However, the
earnings estimates government budget for 2018 proposes implementing a transaction tax at 0.02% on all cash
for CY18E transactions carried out by financial institutions for the next three years. We estimate that it
will shave off ~12.0% from our earnings estimates for the sector provided that it is tax
deductible. Given that the modality of this is yet to be spelt out we remain cautious on the
earnings outlook for the sector but, highlight that in the absence of the tax, the Banking sector
would be strong key pick for CY18E. For further details refer our recent update on the Banking
sector published on the 5th of December 2017.
Telco levy on data Lastly, August this year saw the removal of the telecommunications levy (10.0%) on data
services was services driving consumption taxes on data down to 19.7% from 31.7%. We note that the
removed in August market expectation was an increase in the telecommunications levy to 25.0% which would have
2017 led to consumption taxes going to up to 49.7% leading to broadly muted valuations despite the
sector seeing signs of recovery from 2Q. On the back of this positive surprise, we upped our
earnings expectations while factoring in an expansion of valuation multiples. However, the
Budget for 2018 government budget for 2018 proposes a telecommunications tower levy of LKR 200,000 per
proposes a month for each tower which we estimate would eat in to ~30.0-40.0% of PBT. Our channel
substantial tax on checks indicate that this will most likely be watered down prior to implementation in April
towers next year. However, until there is a clear statement from the government we expect
valuations to remain muted.
Market earnings growth to pick-up but, with some downside risk

We believe that As mentioned earlier, we forecast market earnings to pick up by 14.9% YoY in CY18E vs. our
the market is forecast of a 9.1% YoY growth for CY17E (+7.5% YoY in 9M CY17). However, our forecast
underestimating earnings would be revised down in the event the transaction tax is implemented in its current
the hit on form on the financial sector. We note that our earnings forecast is below what Bloomberg
consumer spending consensus is factoring in at present (+16.3% YoY). Similar to last year, we believe that
power consensus is overly positive and in our view, is underestimating the hit on consumer spending
power this year. In our Equity Strategy Report for 2017, we forecasted earnings growth of 9.1%
for CY17E in while Bloomberg consensus had factored in 16.0%. However, we highlight that the
consensus earnings growth forecast has been cut to a 9.9% as at December 2017.
Our view is that 1Q CY18E will be a tough one especially when compared with 1Q CY17 which
saw earnings growing by 18.9% YoY. Key factors driving our view are: 1) muted consumer
spending power until food inflation normalizes (which we expect in 2H), 2) banks, accounting
for ~27.0% of index earnings, taking a hit from IFRS 9 provisioning, and 3) construction
continuing to post muted earnings with the halted infrastructure projects.
2H CY18E to be a
recovery period However, we expect 2H to see an uptick in earnings led by the Construction sector with a
for Construction resumption of large scale infrastructure projects and a recovery in housing construction.
and Consumer Furthermore, moderating food inflation will ease pressure from consumer spending power
driving a broader uptick on the Consumer side. But, as we highlighted earlier, earnings will see
pressure in the event the debt repayment levy is imposed on the banking sector.
Net foreign inflows continue to drive market valuations

The correlation between the ASPI and net foreign inflows (NFI) into the CSE, which we
presented in our 2017 Equity Strategy report, continues to remain in place. This is not
surprising as turnover is largely driven by foreign inflows and has accounted for an increasing
proportion in the last few years. As such, developing a view on NFIs remain a key part of
valuing the ASPI. We see two parts to this: 1) will flows into Emerging Markets (EM) see a
material change, and 2) how attractive is the Sri Lankan market when compared with regional
peers?
Sri Lanka saw NFI’s NFIs into EMs is a key driver of NFIs into the CSE. Our analysis of flow data shows that there is
double in CY17 a strong correlation with Sri Lanka accounting for an average 0.75% of total EM NFI over the
last ten years. CY17 saw this almost doubling to 1.45% along with a few frontier mandated
funds reallocating towards Sri Lanka with Pakistan exiting the MSCI FM index and entering the
MSCI EM index in May.
5
Net foreign inflows to the CSE remain closely linked to EM inflows
USD bn USD mn
40 400
30 300
20 200
10 100
- -
(10) (100)
(20) (200)
(30) (300)
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
TTM inflows - EM (LHS) TTM inflows - SL (RHS)
Source: Bloomberg, Asia Securities
Heading into CY18E, we expect foreign inflows to be lower when compared with CY17. The
first and straightforward factor is the absence of the reallocation impact.
Secondly, we note that growth expectations for Advanced Economies have been substantially
Advanced revised upwards by the IMF in CY17 after the cuts made in CY16. While EMs have also been
economies have revised upwards, the revisions are much smaller. Arguably, EMs are expected to generate
seen substantial better growth than Advanced Economies but, we believe that this upward revision will lead to
upward growth some level of funds remaining within those economies as opposed to inflows into EMs in a slow
revisions growth environment.
Advanced economies have seen substantial upward revisions of growth expectations
CY18E GDP growth revision (%)
10
(5)
(10)
(15)
Apr 2016 Oct 2016 Apr 2017 Oct 2017
Advanced economies Emerging market and developing economies
Source: IMF, Asia Securities
Thirdly, Bloomberg consensus expects more aggressive and a higher probability of Fed rate
hikes along with new expectations of strong growth from the US. On one hand it will raise the
cost of funds for economies which grew by taking on cheap foreign currency debt while on the
other hand it improves domestic yields which will lead to more funds remaining within the US.
6
US Fed rate expectations have been revised upwards since the beginning for CY17
US Fed rate (%)
2.4
2.2
2.0
1.8
1.6
1.4
1.2
Jan-17 Apr-17 Jul-17 Oct-17
1Q CY18E 2Q CY18E 3Q CY18E 4Q CY18E
Source: BBG, Asia Securities
As such, we believe that inflows into EMs will slowdown going into CY18E. The next question is
how well is Sri Lanka positioned to capture the flows that do come to EMs?
Valuations to be challenged on policy uncertainty

To reiterate, Sri Lanka has accounted for an average 0.75% of all net inflows into EMs over the
ASPI is currently at last ten years with CY17 seeing a substantial pick-up to 1.45%. What we have observed from
a discount to the the past is that when the premium the ASPI trades at vs. MSCI FM index expands at a very rapid
MSCI EM and FM pace, net outflows follow. This occurred in CY08-09 which saw the premium expand from
indexes ~11.0% to ~129.0% and led to substantial net outflows until end CY12. CY15-16 also saw the
same with premiums expanding and net outflows also picking up. At present the ASPI is trading
at a discount which should support net inflows.
Net foreign inflows taper off when the ASPIs relative premium expands
USD mn (%)
400 160
140
300 120
100
200 80
60
100 40
20
- -
(20)
(100) (40)
(60)
(200) (80)
(100)
(300) (120)
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
TTM inflows - SL (LHS) ASPI premium to MSCI FM (RHS) ASPI premium to MSCI EM (RHS)
As we mentioned earlier, we expect ASPI earnings to be up 14.9% YoY (Bloomberg consensus

expects 16.3% YoY). Consensus expects the MSCI FM index to post earnings growth of 15.6% YoY
and an average 14.5% YoY growth for regional peers leaving the ASPI largely in line in terms of
earnings expectations. However, we do see the year as a recovery year which should lead to an
expansion of valuations.
Furthermore, Sri Lanka is still the cheapest market regionally trading at a CY18E P/E of 9.7x
Sri Lanka remains vs. a peer average of 15.7x (Pakistan, Malaysia, Thailand, Indonesia, Vietnam, Philippines, and
the cheapest India) and 12.5x for the MSCI FM index and 12.5x for the MSCI EM index which will support
market regionally inflows, and subsequently, valuations.
7
Sri Lanka remains one of the cheapest markets
P/E (x)
24
22
20
18
16
14
12
10
8
6
EM
ASPI
China
FM Asia
Malaysia
Indonesia
FM
World
India
S&P SL 20
Pakistan
Thailand
Vietnam
Philippines
Sri Lanka Regional MSCI
CY17E CY18E
One key concern to us is the consistent lack of transparency from the government on policy
Lack of making which impacts key economic sectors. Both the proposed debt repayment levy and
transparency on tower tax will hit earnings of two index heavy sectors if implemented but, our main concern
government policy lies on the fact that these were made without consulting industry players. Previous budgets
making is a key also saw similar ad hoc proposals which included, amongst others, proposals to increase the
concern heading telecommunications levy, restrict banks from carrying out leasing activities, and a transaction
into CY18E tax on financial institutions. While these were ultimately not implemented, the
unpredictability of these will lead to an overhang on valuation in our opinion.
However, there are some positives on the policy front with the government passing the new
CY17 saw positive Inland Revenue Act (effective April 2018 onwards) which will support further fiscal
policy changes consolidation. In addition to these are a few key upcoming policy changes including a 1) fuel
with several key pricing formula to implemented by March, 2) an electricity pricing formula to be implemented
ones slated for by September, and 3) the Liability Management Act which will allow the government to create
CY18E a buffer for upcoming bunched up of debt repayments from CY19E onwards. While we are
positive on these policies we are largely cautious on implementation.
Local government elections will be held on the 10 th of February 2018 post which the United
National Party and the Sri Lanka Freedom Party will decide whether to continue the present
Local government Unity government. In the absence of a significant shift in votes towards one party or the other,
elections are set the status quo is likely to be maintained. If there is a moderate shift in votes towards one
for Feb 2018 party, we believe that there will be an increase in uncertainty in the near-term as both parties
start building new alliances in readiness for the Presidential elections in early 2020 and the
Parliamentary elections in mid 2020. All in all, we believe that this will lead to valuations
being depressed through most of the year as the market takes a wait and see approach.
However, a substantial shift towards one party will lead to a recovery in valuations as one of
the key issues with the present Unity government is contradictory information coming out from
both parties.
Combining these factors together, we value the ASPI at 10.5x CY2018E EPS leading to our year-
end target of LKR 6,920.00.
Our country proxy stock of choice is COMB

Key economic The market structure remains large unchanged with the Conglomerate and Banking sectors
drivers remain accounting for more >30.0% of market capitalization and >50.0% of trade volumes. Key
underrepresented contributors to the economy (Apparel, State Banks, Rubber Products) remain underrepresented
on the market and in some cases unrepresented on the Colombo Stock Exchange. Furthermore, we note that
market cap/GDP is one of the lowest within regional peers leading to a disconnect between
ASPI growth and broader GDP growth.
8
Sri Lanka’s market cap to GDP is the lowest amongst peers
Market cap/GDP (%)
140
120
100
80
60
40
20
-
Sri Lanka Pakistan India China Indonesia Vietnam Philippines Malaysia Thailand
Source: IMF, BBG, Asia Securities | Data as at end CY17
However, given the reach into multiple regions within the country as well as multiple sectors,
Within our Banks remain the key proxy play on the economy and our analysis of data shows that banks
coverage, Banks have the strongest correlation to GDP growth. As mentioned earlier, this is also one of the
are the key proxy more liquid sectors making it one of the more attractive sectors for foreign investors.
for the economy Additionally, it faces strong oversight and regulation from the Central Bank of Sri Lanka. As
such, in our view, the Banking sector is the key proxy for the economy.
From a purely technical point of view, within our coverage, our preference for the proxy stock
is COMB. Its earnings show the highest correlation with GDP growth and is one of the more
liquid stocks on the CSE. With our expectations on a recovery in GDP growth from CY18E
onwards, COMB is likely to see a strong uptick in earnings over the next few years. However,
from a valuation point of view we believe that most of this has already been factored in
leaving limited room for further upside.
COMB’s earnings growth shows the highest correlation with GDP growth over 2008-16
Earnings growth correlation with GDP growth
1.0
COMB
NTB
NEST
AHUN
MELS
ALUM
0.8
CFIN
NDB
SEYB
JKH
KHL
AHPL
0.6
SINS
SLTL
SAMP
LGL
CCS
AEL
PLC
LFIN
DIPD
KAPI
0.4
COCR
SPEN
TJL
ASIR
CARG
CINS
CTC
0.2
LIOC
SHL
-
HHL
(0.2)
UBC
JINS
RCL
SDB
HAYC
HNB
HASU
TILE
REG
TKYO
KFP
PINS
LLUB
(0.4)
MGT
LION
GLAS
LHCL
ACL
SIRA
DIAL
(0.6)
PARQ
CDB
AAIC
(0.8)
Source: IMF, BBG, Asia Securities | Data as at end CY17
Market activity up in CY17 but, to remain largely in line for CY18E

Market activity, as measured by average daily turnover (ADT), picked up by 29.9% in LKR term
Industrials led to LKR 892mn while it picked up by 24.4% YoY in USD terms to USD 5.8mn. The Industrials
turnover in CY17 sector (under GICS classification) became the highest turnover sector at an ADT of USD 1.9mn
(+46.7% YoY; #2 in ADT in 2016). This is largely unsurprising as the most liquid counter, JKH, is
classified under this sector and sees a pick up in activity when there are inflows into the CSE.
The Financial sector dropped a rank to #2 at an ADT of USD 1.7mn (-1.7% YoY) while Consumer
Staples remained unchanged at #3 but saw ADT picking up by 47.7% YoY to USD 945k.
9
ADT was up 24.4% YoY in CY17 Industrials showcased the highest jump in trade volumes
ADT (USD mn) ADT (USD mn)
12 2.0
10 1.6
1.2
8
0.8
6 0.4
4 -
Financials
Healthcare
Industrials
Real Estate
Staples
Telecom
Materials
Power
Energy
Discre.
2
-
CY12 CY13 CY14 CY15 CY16 CY17
CY16 CY17
Source: CSE, BBG, Asia Securities Source: CSE, BBG, Asia Securities | Based on GICS classifications
The market saw a pick-up in listings with four in CY17 for a total of LKR 3.3bn vs. three in
CY16 for a total of LKR 1.8bn. Additionally, there was a substantial pick up in M&A activity.
Three NBFIs were acquired for a combined total of LKR 2.3bn while the year saw the largest
Market saw four M&A transaction in the history of the CSE with the acquisition of 71% of SINS by HAYL for a
listing and four consideration of LKR 12.6bn (~USD 82mn). Looking ahead into CY18E, we believe that there
major acquisitions will be a pick-up in listings. Our expectations are driven by the need for the government to
continue driving fiscal consolidation while maintaining growth. A key way which this can be
done, and which the government has indicated that they will do, is by exiting non-strategic
investments by listing them on the CSE. While there is pressure to raise capital levels at State
Banks, and the government’s current preference is to achieve this through listing the two
major state banks, we do not expect tangible progress over CY18E given the continuous delays
on this.
Our 2017 picks returned 15.3%; we forecast our 2018 portfolio to return 21.9%
Our key picks for 2017 generated a total return of 15.3% vs. 3.5% for the broader ASPI and 9.4%
for the more liquid S&P SL20. While our picks have outperformed the broader market, we note
that it has fallen short of our expected return of 25.2%. Out of our 12 key picks, 8 generated
positive returns while 4 generated negative returns.
Our recommended portfolio has beaten the ASPI by >330% and the S&P SL20 by >60.0%
Index value
124
122
120
118 +15.3%
116
114
112
110 +9.4%
108
106
104 +3.5%
102
100
98
96
94
Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17
Asia Securities Recommended Portfolio S&P SL20 TRI ASPI TRI
Source: CSE, BBG, Asia Securities

Industrials led
turnover in CY17
10
HHL generated the Following our research calls, the top performer was HHL generating a total return of 45.1%
highest return on while ACL was the weakest performer with a total return of -26.8%. Despite a generally
our model lackluster earnings performance, HHL is increasingly being viewed as a more optimal proxy for
portfolio while ACL the country when compared against JKH leading to an expansion of valuations. ACL saw
was the weakest earnings come down as it followed a strategy of bearing the increase in aluminium and copper
prices in order to put pressure on smaller players.
HHL was the strongest performer while ACL was the weakest on our model portfolio
Total return (%)
50
40
30
20
10
-
(10)
(20)
(30)
(40)
HHL TKYO SAMP SINS CINS HNB CARG MELS AEL LLUB MGT ACL
Research recommendation Buy and hold
Source: CSE, BBG, Asia Securities
For our 2018 recommended portfolio we take out ACL, AEL, and LLUB as we do not expect to
We remove ACL, see a substantial recovery in earnings. We take out MELS as the excise duty changes made in
AEL, LLUB, MELS, November 2017 would lead to a shift away from hard liquor consumption and depress earnings.
SINS, CINS, and Lastly, we take out SINS, CINS, and HNB as they have largely achieved our return expectations
HNB for CY18E and we see limited return over the next 12-months.
We keep TKYO as the recently added capacity comes with substantial cost savings with cement
being one of the first products to see demand when there is a recovery in construction
We keep TKYO, activity. Despite underperformance on earnings, we keep MGT as we believe that their change
MGT, CARG, HHL, in strategy is now starting to generate returns. We believe that CARG has pole position to
and SAMP capture the shift into modern retail and maintain in our portfolio into 2018. We keep HHL as it
remains a good proxy for the country. Lastly, we keep SAMP as we believe that the share has
plenty of room to deliver returns and is our key large cap pick for the banking sector.
We add LION, SDB, and DIAL (see below for individual stock investment thesis) reducing the
We add LION, SDB, number of stocks in our portfolio to 8 from the 12 in last year’s portfolio. Similar to last year,
and DIAL we recommend an ADT weighted portfolio.
Our recommended portfolio for 2018 adds Telecom sector exposure and removes Energy and Insurance
Exposure (%)
35
30
25
20
15
10
-
Banking Telecom Alc. Bevs. Cons. Conglos. Mfg. FMCG Energy Insurance
2017 portfolio 2018 portfolio
11
We forecast our We forecast our return adjusted ADT weighted model portfolio to generate a total return of
2018 model 21.9%. Furthermore, we expect our equal weighted portfolio to return 23.5% and the free float
portfolio to return market cap weighted portfolio to return 17.7% over the next 12-months.
21.9%
Wildcards to generate returns >30.0% if trigger conditions are met
In addition to our core stock picks, we recommend three additional stocks which we believe
have the potential to generate substantial returns provided certain key factors are met and
are currently trading at deep discounts. However, the likelihood of these key factors being
triggered are low and as such, is not reflected in our published target price and make these
recommendations for risk taking investors only. Our wildcards for 2018 are: 1) LIOC, 2) CFIN,
and 3) NDB (see further below for individual stock investment thesis).
Provided that these trigger conditions are met, we expect CFIN to generate a total return of
41.4%, NDB 38.2%, and LIOC 31.8%.
12
Key picks: Our key criteria for stock picking this year are names which have 1) strong exposure to the broader macro improvement story, 2) had a muted performance on
2017 but, are well positioned to post a turnaround in 2018, and 3) have a strong business model
Our key picks for 2018 (1/2)

Market cap ADV 2018E
BBG Year CMP TP TSR
(USD TP date Investment thesis
Ticker end LKR USD (LKR) (LKR) (%) P/E P/B DY ROE ND/E*
k)
bn mn (x) (x) (%) (%) (%)
For the last two years, MGT has had a promising strategy of a shift away from
cotton-based products towards more value-added products which command
better margins. This has however, not materialized as customers have been
reluctant to move away from cotton-based apparels. In FY18E, with the
synthetic line having evolved, MGT is now able to achieve the exact levels of
comfort and feel of the cotton apparels, which has led to increased
MGT SL Mar-18 3 19 8 14.10 20.00 13-Nov-17 +41.8 14.8 1.0 - 7.0 146.3 acceptance for their synthetic line as orders are ramping up for 3Q FY18E
and 4Q FY18E. Furthermore, we are also seeing the reinstatement of GSP+ in
Sri Lanka help drive increased exports in the textiles and garments sector,
which will benefit large-scale fabric manufacturers like MGT. The company is
also moving away from the EU market, into the US market which is a faster
moving fashion market. We value the share at a 12-month TP of LKR 20.00
(+41.8% TSR). BUY.
For FY18E, we expect the reduction in excise duties to favourably impact
LION’s results, despite the low consumer sentiment in the country. With
prices on average down 32.0% post the duty revisions, we are already seeing
a switch from hard liquor to beer consumption. We also expect operating
LION SL Mar-18 45 294 223 564.70 735.00 16-Nov-17 +30.2 372 4.8 - 1.4 104.0
leverage to help margins as seen in 2Q. However, we believe there will be
some pressure on the bottom-line with high interest expense as debt level
still remain high. Adjusting for these factors, our DCF valuation indicates a
TP of LKR 735/share resulting in a TSR of +30.2%. BUY.
SDB is a unique bank with a focus on the unbanked rural economy. Strong ties
with cooperatives give it the key advantage of reaching this segment. The
Bank follows an unconventional model in Retail lending as well with a focus
on retired government employees by providing financing support for
SDB SL Dec-17 6 37 13 103.10 125.70 12-Dec-17 +29.2 11.8 0.8 7.3 7.7 140.9 individual enterprises. It has the lowest per branch opex in our coverage
which will lead to strong profitability with revenue growth. The private
placement carried out in December 2016 shores up its’ capital base for BIII
reqs. We value the stock at 0.9x CY18E BV leading to our TP of LKR 125.70
(+21.9% upside; +29.2% TSR) and rate it BUY.
The DIAL share has moved sideways over the last couple of years on the back
of unexpected adverse policy changes leading to headwinds on earnings.
However, August 2017 saw a cut on consumption taxes on data services which
in combination with declining smartphone prices will lead to a pick-up in
data adoption. Recently, DIAL acquired a non-bank finance company which
DIAL SL Dec-17 110 716 259 13.50 14.00 13-Nov-17 +7.2 10.0 2.1 3.5 19.2 24.1
allows it to provide all banking services bar a couple. While this won’t have a
near-term financial impact, we are bullish on the long-term prospects.
However, the proposed tower tax would lead to depressed valuations in the
near-term. As such, we value DIAL at 4.64 CY18E EBITDA leading to our TP of
LKR 16.70/share (+23.7% upside; +28.3% TSR) and rate it BUY.
Source: Asia Securities | Note: ND/E – Net Debt/Equity, Priced as at end 08 Jan 2018
13
This report is strictly for direct recipients from Asia Securities. Redistribution of this report is prohibited. Please see page 102 for analyst & company certification and important disclosure.
Our key picks for 2018 (2/2)
Market cap ADV 2018E
BBG Year CMP TP TSR
(USD TP date Investment thesis
Ticker end LKR USD (LKR) (LKR) (%) P/E P/B DY ROE ND/E*
k)
bn mn (x) (x) (%) (%) (%)
Over the past year, CARG performed better than peers amidst constrained
consumer spending, recording steady performance across all three segments.
The Retail business continues to be the largest private sector operation in
terms of both store network and revenues. We expect CARG to increase
market share with new store expansions, of which ~50.0% will be outside of
Western Province. Our key concern though is availability of the right real
CARG
Mar-18 44 287 61 196.40 240 17-Nov-17 +25.4 15.6 2.9 3.2 19.2 97.0 estate to keep these plans on track. CARG’s FMCG business continue to be
SL
the margin generator, with segment margins ~6pp higher than other
segments. With capacity expansion completed in most categories, the
segment will be driven by new product introductions. The Restaurant
business continues to perform well, recording strong margin improvements.
Our SOTP valuation derives a target price of LKR 240.00/share and including
a DPS of LKR 6.30, we arrive at a total return of +25.4% and rate it BUY.
SAMP is the 5th largest bank within the country by gross loans with a strong
presence in retail banking. Amidst headwinds faced by the pawning industry
we see SAMP focusing on the SME/mid-sized corporate market for growth.
With the strong risk management processes in place we believe that SAMP
SAMP SL Dec-17 71 466 752 329.00 365.00 20-Dec-17 +16.3 6.2 1.0 5.3 19.5 78.3 will be successful in driving growth from this segment with contained NPLs.
Furthermore, we expect the Bank’s cost/income ratio to improve along with
a faster growth in income when compared to the cost base. We value SAMP
at 1.1x CY18E BV leading to a target price of LKR 365.00 (+10.9% upside;
+16.9% TSR). BUY.
We expect Healthcare to continue to account for majority of earnings and
will benefit from its market leadership in pharmaceutical distribution and
MORI from its Government buyback programs. For FMCG, we expect the local
market to be relatively flattish, while Bangladesh to be under pressure due
to restructuring of the distribution network. In Maritime and Logistics, we
HEMS SL Mar-18 71 464 209 123.80 136.00 17-Nov-17 +11.0 19.0 2.8 1.1 15.4 (27.4)
expect the segment to be driven primarily by the maritime business. In
Leisure however, we remain cautious of the impact from increased
competition. Our SOTP based valuation derives a target price of LKR
136.00/share. Including a forecast DPS of LKR 1.40/share, we expect a total
return of 11.0%. HOLD
Despite having expanded its capacity, TKYO is currently amidst a slowdown
in the construction sector, which we expect will last in the near to medium-
term. The company expects to utilize only up to ~40.0% of its new capacity
in FY18E, which leaves considerable room to benefit from a pickup in
TKYO SL Mar-18 26 171 81 68.50 70.30 20-Nov-17 +5.0 7.7 1.6 2.3 22.8 41.1 construction in FY19E. Furthermore, while we do not expect a retail price
revision in FY18E, we believe there is a high probability of a revision in
FY19E. We value the share at 5.7x EV/EBITDA FY18E and arrive at a TP of LKR
70.30 (+2.6% upside; +5.0% TSR) for the voting share and LKR 61.10 for the
non-voting share (+2.2% upside; +4.8% TSR). HOLD.
14
Model portfolio: We present three options: equal weighted, free float market cap weighted and ADV weighted. Our preference is towards ADV weighted as it provides good
exposure to our key sectors while maintaining liquidity. Furthermore, we highlight that the free float figures have little correlation with share liquidity in Sri Lanka.
2018E
Upside TSR
Model portfolio ND/E* Sector allocation
(%) (%) P/E (x) P/B (x) DY (%) ROE (%)
(%)
Banks: 25.0%, Telecommunications: 12.5%, Alcoholic Beverages: 12.5%,
Equal weighted +20.4 +23.5 57.1 2.1 3.1 14.0 75.5
Conglomerates: 12.5%, Construction: 12.5%, FMCG/R: 12.5%, Manufacturing: 12.5%
Free float market cap weighted +13.7 +17.7 27.7 1.9 3.5 17.4 47.1
ADV weighted +18.3 +21.9 60.1 2.2 5.5 15.8 56.5
15
MACRO OUTLOOK
16
SRI LANKA MACRO | ECONOMICS & POLICY
Sri Lanka: Macro Outlook 2018

Reaping the benefits of policies done right
Lakshini Fernando 2017 comes in-line with baseline forecasts; sluggish growth prevails on slow industry and
lakshini@asiasecurities.lk negative agri growth
+94 11 772 2045 Looking back at Jan 2017, we forecasted GDP growth to come in at 5.1% which was cut down
to 4.6% in May. This was primarily due to the extreme weather conditions which prevailed for
most of the year. Our GDP forecast was cut down to 4.4% in September as a result of a
material slowdown in construction which negatively impacted the industry sector (for more
information on our view of the construction sector, please click here). This trend continued
into 3Q CY17 with the construction led industries sector slowing down to 1.9% YoY (+5.2% YoY
in 2Q CY17). This combined with seven consecutive quarters of negative growth in the agri
sector led us to revise our growth forecast further downward to 4.0% for CY17E.
We forecasted a 50bps rate hike in early 2017 in-line with the market expectation reflected in
the Reuters poll given 1) relatively high credit growth which was at 21.9% YoY in December
A further rate hike 2016, and 2) a low reserve level covering 3.3 months of imports during the month. We did not
after the 25bps factor in a high inflation at this point given that inflation picked up over the year due to supply
increase in March side disruptions as a result of the extreme weather conditions. However, with 1Q CY17 GDP
wasn’t expected coming in at a low 3.8% YoY, combined with credit growth showing signs of a marginal
for the remainder slowdown (20.4% YoY in March 2017) we revised our expectation to no further rate hikes
of the year following the 25bps rate hike in March, which we believed would have stifled the slow growth
macro environment even further.
Our headline inflation forecast was revised from 5.5% to 5.8% YoY due to the negative impact
on food inflation on the back of the flood. The expected normalization of food inflation did
not materialize, which drove overall inflation to end the year at 7.1% YoY (4.5% in Dec ’16) and
the rolling 12M average at a high 6.6% (4.0% in Dec ’16) overshooting our target, the Central
Bank’s mid-single digit target and the IMF’s 5.1% mid-point and 6.6% upper limit threshold.
We forecasted a higher than anticipated increase in Government expenditure as a result of

relief towards the affected areas following the floods. This resulted in our downward revision
of the fiscal balance from 4.9% of GDP in early CY17 to 5.0% of GDP in May 2017. This was
revised downwards to 5.1% of GDP in September 2017 due to the delay in the implementation
of the Inland Revenue Act (IRA) which was expected to be implemented by August 2017. This
will now be effective from April 2018. (For details of the IRA, please click here.)
We also anticipated a higher demand for rice and refined petroleum imports as a result of the
prolonged extreme weather conditions which began in October 2016 leading to a 113.8% YoY
The expected
increase in refined petroleum in December 2016. This has since tapered down to record a
demand for rice
65.2% YoY increase by September 2017.
imports
materialized with
The expected demand for rice imports also materialized, with cumulative rice import
expenditure on
expenditure amounting to USD 234mn for 9M CY17 (USD 10.2mn 9M CY16). Despite the pickup
rice imports
in overall agri exports and a somewhat muted view on the impact of GSP+ for CY17, we revised
amounting to USD
our trade deficit forecast from 11.0% of GDP to 11.7% of GDP as a result. Inflows into
176mn
Government securities and equities led to us leaving the current deficit forecast as is despite
the 0.7pp worsening of the trade deficit.
Despite the negative impact of the extreme weather conditions and delay in the
implementation of the IRA, there were some key positives during the year. Of which the main
is the Central Bank’s stance and timing of policy implementation which we had to some extent
underestimated at the beginning of the year. One of our key concerns in CY16 were the low
reserve level which materialized during the year, as reserves dipped to a dangerously low 2.7
month of imports in March 2017.
17
What we did not anticipate is the Central Bank’s response on how to improve this. Instead of
maintaining high yields on Government bonds which we expected as done in the past, the
Central Bank instead started buying Dollars in the local market at ~USD 200mn per month from
about June 2017 while ensuring minimal impact to the currency. Up to December 2017 total
purchases of USD by the Central Bank was ~USD 1.7bn which has helped boost reserves since its
dip in March. Reserves were further boosted with the fourth tranche of the IMF EFF together
with the first tranche of the Hambantota port lease agreement, which according to the Central
Bank will help reserves end the year at USD 7.8bn, covering ~4.4 months of imports. This has
been a key reversal of historical boom and bust policies implemented by the Central Bank,
A key positive was which saw reserves being utilized to defend the currency. This change in policy led to our
the reinstatement upward revision in forecast for reserves, which we forecasted to cover 4.0 months of imports
of GSP+ together since downgrading it from 4.5 months following the floods and the expectation of higher
with the removal demand for imports. This was revised in September along with the Central Bank’s policy
of the EU ban on initiatives to 4.1 months of imports. By November 2017, reserves cover ~4.2 months of imports
Sri Lankan fish (3.3 months in November 2016) mainly due to the high import bill as a result of high demand
exports for rice and fuel imports. Given the Central Bank’s disciplinary policies in strengthening
reserves, we also expected a lower than initially anticipated depreciation in the currency. This
led our revision of the LKR/USD to 155.00 from 158.00 at the beginning of CY17, a 3.5% YoY
depreciation (+5.5% previously).
One of the other key positives during the year was the reinstatement of GSP+ concessions in
June, together with the removal of the EU ban on Sri Lankan fish exports in March. This,
together with the pickup in tea export revenue as a result of higher global tea prices which
increased by 22.3% to USD 5.29/Kg in August (USD 4.33/Kg in August 2016) were signs of a
longer term strengthening of export demand.
Despite the third tranche being held back by the International Monetary Fund (IMF) Extended
Fund Facility as a result of the delay in the implementation of the IRA, the Government has
stood firm on its diligence of continuing the fiscal consolidation efforts. The IMF released its
fourth tranche on the 6th of December, noting that all fiscal targets had been met by the
Government by end September. The Government’s stance in continuing fiscal consolidation
was further echoed on the 2018 budget (Please click here for our report on the budget). With
the approval of the fourth trance which was released in early December, the IMF states that
the Government has met the targets set by the IMF but, have reiterated the need for further
consolidation including the structural reform in the form of fuel pricing formulas and better
tax administration together with faster SOE reform.
A key highlight during the year was also the finalization of the 99-year joint venture between
China Merchant Port Holdings Company Ltd (CMPort) which has a shareholding of 69.55% and
Sri Lanka Ports Authority (SLPA) holding a share of 30.45% for the Hambantota Port in July. The
total value of the deal is USD 1.1bn, of which USD 292mn was received in December. USD
146mn of the total investment is expected to materialize in the form of investments into the
Hambantota port.
Extreme weather conditions and the CB’s corrective policies led to our revisions during the year
Jan 2017 May 2017 Sep 2017 Dec 2017
GDP growth (%) 5.1 4.6 4.4 4.0
Headline inflation (%) 5.5 5.8 5.8 5.8
LKR/USD 158.00 158.00 155.00 155.00
12M GSEC yield (%) 10.70 10.70 10.00 10.00
Fiscal deficit (% of GDP) 4.9 5.0 5.1 5.1
Current deficit (% of GDP) 2.5 2.5 2.5 2.5
Trade deficit (% of GDP) 11.0 11.7 11.7 11.7
FX reserves (months of imports) 4.5 4.0 4.1 4.1
Source: Asia Securities | Red: Negative revision, Green: Positive revision, Black: no change
18
We forecast higher growth of 4.8% for 2018 on a loose monetary policy
Looking towards CY18E, we expect a GDP growth of 4.8%, slightly lower than the Central
Bank’s 5.0-5.5% forecast. Leading our forecast is our expectation of a 25bps cut in policy rates
in 1Q CY18E while we expect a pickup in the industries sector along with a reversal or flat
growth trend in the agri sector. We believe the Central Bank is poised to loosen policy rates
given 1) the low credit growth of 17.5% YoY in September 2017 compared with 21.9% in
December 2016, 2) supply side factors impacting inflation, 3) a healthy reserve level of 4.2
months of imports by November and 4) slow growth momentum in the economy with 3Q CY17
growth coming in at a concerningly weak 3.3%. We also factor in at least two further US Fed
rate hikes totaling to 50bps into our forecast during CY18E. We don’t expect multiple rate cuts
in CY18E given the lag effect of such policies.
Furthermore, we expect a pickup on the construction industry which stands to benefit from
the resumption of large infrastructure projects as well some level of residential led demand.
We expect a pickup We also expect the extreme weather conditions which have prevailed since October 2016 to
on the construction normalize to some extent. On the back of this, we expect the agri sector to break its negative
industry with the growth trend seen in the past six quarters, while we acknowledge that the industries and
resumption of services sectors will be the main drivers of growth for the next 2-3 years amidst a loose
large infra projects monetary policy.
In terms of exports, we expect apparel and textile sector to continue their steady growth
trajectory given the pickup in the US and EU markets. According to the University of Michigan
survey, consumer sentiments in the US picked up to 98.5 in November, above the Reuters
forecast of 98.0. Meanwhile consumer confidence in the in the Euro zone have increased to 0.1
in November, up from -1.1 in October (all time high was 2.1 in May 2000). This, along with
a continued pickup in tea exports which will help boost the trade balance.
We expect the implementation of the IRA in April 2018 to help boost Government revenue,
pushing the country towards the IMF’s 2020 target of reducing the fiscal deficit to 3.5% of GDP
(we forecast 3.8%).
The key positive we see going into CY18E is the more streamlined policy implementation by
The key positive both the Government (in terms of the IRA) and the Central Bank which we believe will help
we see going bring in more transparency than in the past. This was also evident in the detailed roadmap for
forward is more 2018 published by the Central Bank which clearly states the policy regulation and
streamlined CB implementation plans set out for 2018 and beyond (please click here for our review on the
policy 2018 roadmap). We believe the IMF monitoring to also help speed up the SOE reforms which
implementation will further relieve the Government’s debt burden. We that we believe fiscal reforms are
unlikely to go at a similar pace of what was seen with monetary policy due to political realities
in the country given that we are heading towards a Presidential election in Jan CY20E followed
by Parliamentary elections in 3Q CY20E.
GDP growth has moderated since post war boom …with a pickup in the industries sector
(%) (%)
6 10
8
5 6
4
4 2
0
CY14 CY15 CY16 CY17E CY18E CY19E CY20E
3 -2
CY14 CY15 CY17 CY18E CY19E CY20E -4
GDP growth Agri Industries Services
Source: DoCS, Asia Securities Source: CBSL, Asia Securities
On the negatives, our main concern is on the Local Government elections expected in 1Q
CY18E and the level of uncertainty this would bring in the event of a divide in the Unity
Government. We don’t expect any negative impact on the Central Bank’s policy
implementation but, are likely to see delays in policies like SOE reform and fuel price formulas
in the event of a divide.
19
Another key factor which was presented in the 2018 budget was a 0.02% cash transaction levy
on the financial sector amidst the banks gearing up to meet the higher capital requirement
placed by the Basel III requirements (Please click here for our banking sector report). While
this has been a step towards ensuring continued fiscal consolidation, we believe this will
negatively impact growth momentum directly through the financial sector.
In the event of this being implemented, we expect the services sector (of which financial
services accounted for over 60.0% of total GDP in 3Q CY17) to see somewhat of a slowdown
with banks being less aggressive on loan growth amidst a transaction levy and Basel III
requirements.
Aside from this, our focus will also be on the declining remittances resulting from the adverse
geopolitical conditions in the Middle East. While we expect the increase in tourism earnings
and capital market inflows to minimize the impact, with 52.0% overall remittances coming
from the Middle East, we believe there will be a material impact on the current balance.
What would lead to a positive change in our view would be 1) a higher than forecasted cut in
monetary policy, 2) a faster than forecasted normalization of inflation.
We will revise our
views downward if We will revise our views downwards if 1) the implementation of the 0.02% transaction levy
the 0.02% financial materializes, 2) a delay in the implementation of the Liability Management Act, and 3) any
transaction tax changes to implementation timeline for major infrastructure projects resulting in a prolonged
comes into play slowdown in the industries sector.
Current balance to worsen to 2.6% of GDP on remittance slowdown

One area of concern going into CY18E are remittances which in turn will have a negative
impact on the current account balance. Historically, remittances which are reflected in net
transfers have helped during times of a high trade deficit. Despite our expectation of an
improvement in the trade balance as a result of higher export earnings, we expect remittances
to decline because of 1) a pickup in local salaries as a result of labor shortages, making no
significant premium to salaries earned in the Middle East as in the past (currently unskilled
works earn ~USD 350.00 on average while skilled migrants earn ~USD 450.00) and 2) tighter
Government regulations on unskilled migration to negatively impact remittances. For the 8M
CY17 remittances were USD 5.0bn, down by 7.4% YoY compared to the USD 5.4bn recorded for
8M CY16.
We expect most macro indicators to improve; current account and inflation remains near-term challenge
USD bn
25 7.1
20 5.8
15
3.4
10 2.5
2.3 2.4
5 1.9
0
CY10 CY11 CY12 CY13 CY14 CY15 CY16
Exports Imports Net services and income Net transfers Current account balance
Source: CBSL, DoCS, Asia Securities | Note: percentages indicate current account deficit as % of GDP
According to the Central Bank of Sri Lanka, in CY16 over 52.0% of remittances originate from
the Middle Eastern region. Over the past 3 years, remittances have accounted for ~29.0% of
current account credit, a significant contributor to secondary income. As such, any continued
negative impact of a slowdown of migrant workers could result in pressure on the current
account.
20
However, we do note that remittances from the EU have grown at a faster CAGR of 10.0%
(CY10-CY16) compared with the Middle East which has grown at a CAGR of 7.8% during the
same period (while keeping in mind that EU remittances are growing from a smaller base
compared with the Middle East). According to the Central Bank, EU remittances originate from
a higher skilled workforce compared with the Middle Eastern workers.
Remittances from the EU have grown at a faster pace Remittances to remain flat in the next 2-3 years
USD mn (%)
4,000 3.0
2.5
3,000
2.0
2,000 1.5
1.0
1,000
0.5
- 0.0
CY10 CY11 CY12 CY13 CY14 CY15 CY16 CY14 CY15 CY16 CY17E CY18E CY19E CY20E
Middle East European Union Others
Source: CBSL, Asia Securities Source: CBSL, Asia Securities
Considering all these factors, we forecast a current account deficit of 2.6% of GDP for CY18E,
and expect the balance of payments to continue improving since its near crisis levels.
Reserves to remain strong on CB policies; to hit 4.4 months of imports in CY18E

By November 2017, reserves were at USD 7.3bn, up by 29.6% YoY, covering ~4.2 months of
While we expect imports. According to the CB, reserves look to end the year at USD 7.8bn following the inflows
reserves to remain from the IMF EFF and the first tranche of the Hambantota port lease agreement. This is a
high, we reiterate considerable improvement compared with the 2.7 months reserves covered in March 2017.
that export However, we reiterate that FDI, specifically towards export oriented areas are essential to
oriented FDIs will create a positive multiplier effect in the economy. For 9M CY17, FDIs were at USD 796mn;
lead to a multiplier close to exceeding total FDIs in CY16 (USD 801mn). The Board of Investments in Sri Lanka
effect expects FDIs to come in at USD 1.4bn for CY17E of which the manufacturing and services
sectors along with infrastructure and utilities sectors are the main areas of investment.
Manufacturing related FDIs have increased in CY17E
USD mn
900
800
700
600
500
400
300
200
100
0
CY12 CY13 CY14 CY15 CY16 CY17E
Infrastructure Manufacturing Others
Source: CBSL, Asia Securities | Note: Others include agri and services related FDI
With ~USD 2.6bn of debt payments coming up in CY18E we believe the Central Bank will
continue to strengthen reserves as done in CY17. This will be further boosted with the Liability
Management Act expected to be passed in CY18E. According to the Central Bank, this Act will
include aspects like 1) a separate account where funds from transactions like the Hambantota
Port deal, and divestments of stakes in SOEs will be remitted for the sole purpose of debt
repayment, and 2) a clause creating space to borrow above the annual requirement during
21
periods of low payment commitments to create an additional “reserve” for upcoming
repayments at low rates.
Reserves will continue to remain above 3.9 months of imports
5.4
5.3
5.1
5.0
4.7
4.6
4.5
4.4
4.1
4.0
3.7
CY10 CY11 CY12 CY13 CY14 CY15 CY16 CY17E CY18E CY19E CY20E
Months of imports
Currency to depreciate at a slower pace on corrective policy measures

In CY17 the Central Bank reduced its intervention of managing the currency which we see as a
We expect the positive. Despite the Central Bank’s moves to purchase Dollars, there was little impact on the
currency to currency which we believe also depicts the corrective and timely measures taken. On the back
depreciate of this, we don’t expect the currency to depreciate in a volatile matter but, at a steadier
moderately to LKR pace.
160.00 against the
USD, at a 3.2% On this basis we expect the LKR to depreciate moderately to 160.00 against the USD, by end
depreciation CY18E, a 3.2% depreciation (3.5% in CY17E).
Loose monetary policy will lead to lower yields of 8.90% in CY18E

With the expectation of a 25bps rate cut in CY18E, Government yields will see a dip from the
current levels given the positive correlation of rates against Government yields. During the
latter months of CY17 yields have dropped from a high of 10.17% in June to 9.34% by mid-
December on the back of low repayment pressure. Against this backdrop, we expect 1-year
Government bond yields to come in at 8.40% in CY18E.
Yields have a positive correlation against key policy rates… …and will pick up towards CY20E
(%) (%) (%) (%)

21 11 12 8
19 10
17 9 10 7
15
8
13 8 6
7
11
9 6 6 5
7 5
5 4 4 4
Jan-07 Sep-08 May-10 Jan-12 Sep-13 May-15 Jan-17 CY14 CY15 CY16 CY17E CY18E CY19E CY20E
1-yr Govt bond yield (LHS) SDFR (RHS) 1year Govt bond yield (LHS) SDFR (RHS)
Source: CBSL, Asia Securities Source: CBSL, Asia Securities
22
Inflation to dip to 5.2% in CY18E on lower non-food inflation
In an attempt to give more transparency and predictability in the economy, the Central Bank
has already taken steps towards an inflation targeting regime. While we expect this to come
into play during 2H CY18E, we expect the full impact by CY19E as a result of the overall
framework required to fully move towards such a model. According to the Central Bank, an
inflation rate of 4.0-6.0% will be targeted, where monetary policy will be used to control
inflation on a forward basis.
Food inflation to taper down from CY17 high
(%)
15
13
11
1
CY15 CY16 CY17 CY18E CY19E CY20E
CCPI Food inflation Non-food inflation
The key headwinds we see for food inflation is the 6-7 month lag effect of supply side factors
for food supply. On the back of this, we expect food inflation to come in at 5.2% in CY18E. We
don’t foresee significant fluctuations in non-food inflation. We expect the Government to
continue its interventions to help normalize food inflation following disruptions to three
consecutive cultivating seasons. During the year the Government has imposed price controls on
rice and a slash of commodity levies of six essential food items including dhal, dried fish and
potatoes.
Food inflation and int’l rice prices have a positive correlation …and will be a key factor of food inflation
(%) USD/MT (%) USD/MT

16 500 16 430
14 420
460
12 12 410
420 10
400
8 8
380 390
6
4 4 380
340
2 370
0 300 0 360
Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 CY14 CY15 CY16 CY17 CY18E CY19E CY20E
Food inflation (LHS) Global rice prices (RHS) Food inflation (LHS) Global price of rice (RHS)
Source: World Bank, CBSL, Asia Securities Source: World Bank, CBSL, Asia Securities
Continued consolidation to lead fiscal deficit improvement

While the Government continued on its fiscal consolidation efforts in CY17, their target of 4.7%
of GDP for the year was surpassed by October, with the delays of the IRA implementation
materializing. However, Government revenue continued to strengthen, amounting to ~11.9% of
GDP for 10M CY17 while overall expenditure was at ~16.7% of GDP.
We expect the fiscal deficit to improve to 4.7% in CY18E driven by a focus on more efficient
revenue collection through the IRA, higher taxes, and curbs on government expenditure.
Working against this is the local government election in the early part of the year which tends
to cause a spike in expenditure.
23
Furthermore, higher excise duties and the imposition of VAT on the Tobacco industry (which
contributes to ~6.8% of revenue) from November 2016 has shown a substantial decline in
revenue to the Government in CY17. As such, if focus shifts.
Fiscal consolidation to remain on track
7.6
7.0
6.2
5.6 5.7
5.4 5.4
5.1
4.7
4.5
3.8
CY10 CY11 CY12 CY13 CY14 CY15 CY16 CY17E CY18E CY19E CY20E
Fiscal deficit (% of GDP)
Source: MoF, Asia Securities
Pickup in exports to remain on track but, tariff removal a concern

From an external point of view, we expect a number of factors like the finalization of Free
Trade Agreements, a pickup in the global economy, the Government’s plans of creating a
“National Export Strategy” and a “Export market access program” and the removal of para
tariffs to come into play during the year. Of these, we perceive the most important to be the
removal of para tariffs on almost 1,200 imports which we believe will begin to take effect in
CY18E. Amidst these removals, we expect proper anti-dumping laws also to take form in order
Amidst the removal to protect an exodus of environmentally unsuitable imports coming into the country.
of para tariffs, we
expect clear anti- We also expect the higher crude oil prices as forecasted by the World Bank to will also add
dumping laws to pressure on the import bill. According to the World Bank forecasts, crude oil prices are
take form expected to increase by 5.7% YoY, while growing at a CAGR of 8.8% from CY16-CY20E.
However, we believe that fuel imports should come down with reservoir levels coming back to
reasonable levels, while vehicle imports will remain muted.
We are more positive for CY19E on the focus of Sri Lanka becoming a trade hub. Colombo
International Container Terminal (85.0% owned by China Merchants Port Holdings [CMPH]) is
South Asia only container terminal able to handle ULCCs, and has shown a significant uptake in
volumes. CMPH which took a 69.55% stake in Hambantota Port (located in the South of Sri
Lanka) in CY17 which bodes well for trade volumes in the longer term, giving a much-needed
boost to foreign inflows.
Within global growth, our concerns remain on growth in the UK which the IMF forecasts a
slower growth of 1.7% in CY17E (revised downwards from 2.0%) and 1.5% for CY18E which
negatively impacts demand for apparel. We are more positive on the US (IMF forecasts GDP
growth of 2.2% for CY17E and 2.3% for CY18E) and EU growth (IMF forecasts the Euro zone to
grow at 2.1% in CY17E and 1.9% in CY18E) leading to higher export demand.
Furthermore, with agri exports showing a turnaround during CY17, specially tea exports given
higher global tea prices, we believe this will help sustain the growth momentum on the export
side.
24
The current account set to remain flat while the trade balance will improve
11.7 11.5 11.3

11.2 10.9
10.4 10.4
2.5 2.3 2.4 2.5 2.6 2.5 2.4
CY14 CY15 CY16 CY17E CY18E CY19E CY20E
Trade deficit (% of GDP) Current deficit (% of GDP)
Source: CBSL, Asia Securities
PMI paints a positive near term picture

Lastly, we highlight that the PMI (both manufacturing and services) is significantly above the
50 level indicating that there is still underlying economic activity at present while remaining
broadly flat following the substantial pickup in March 2017.
PMI is at healthy levels
(%)
70
50
30
Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
12M ended to Nov 16 12M ended to Nov 17
25
Summary of Key Economic Indicators
Key indicators 2013 2014 2015 2016 2017E 2018E 2019E 2020E
Real GDP growth (%) 3.4 5.0 4.8 4.4 4.0 4.8 5.0 5.3
Headline inflation (%) 6.9 3.3 0.9 4.0 7.1 5.2 5.1 5.4
Core inflation (%) 2.1 3.2 4.5 4.4 4.3 4.2 5.0 4.0
LKR/USD 130.75 131.05 144.06 149.80 155.00 160.00 165.80 169.15
Depreciation (%) 2.8 0.2 9.9 3.9 3.5 3.2 3.6 2.0
Unemployment (%) 4.4 4.3 4.7 4.4 4.5 4.5 4.3 4.2
12M government bond yield (%) 8.87 5.99 7.30 10.17 9.05 8.40 8.70 9.20
Fiscal balance (% of GDP) (5.4) (5.7) (7.6) (5.4) (5.1) (4.7) (4.5) (3.8)
Trade balance (% of GDP) (10.2) (10.4) (10.4) (11.2) (11.7) (11.5) (11.3) (10.9)
Current balance (% of GDP) (3.4) (2.5) (2.3) (2.4) (2.5) (2.6) (2.5) (2.4)
FX reserves (months of imports) 5.0 5.1 4.6 3.7 4.1 4.4 4.5 4.0
Debt/GDP (%) 70.8 71.3 77.6 79.3 79.2 78.6 78 76.5
Foreign debt (% of total debt) 30.9 30.0 32.4 34.2 33.4 30.4 31.5 32.4
Source: CBSL, DoCS, MoF, Asia Securities | E: Baseline estimate Note: Historical data have been amended to reflect latest CB report
26
SECTOR OUTLOOK
27
SRI LANKA EQUITY | SECTOR
Sri Lanka: Sector Outlook 2018

Banks and Telcos to deliver results; uncertainty weighs in
Asdsd a
Kanishka Perera Out of our sectors under coverage, we recommend exposure to the Banking and
kanishka@asiasecurities.lk Telecommunications sectors. While the budget proposals for 2018 contain negative
+94 11 772 2044 changes for these two sectors, we believe that the final form will be diluted to a large
degree given the economic importance. We believe that the Consumer and Construction
Lakshini Fernando sectors will face a slowdown in the first half 2018 prior to posting a recovery. Given the
lakshini@asiasecurities.lk low probability of implementing the fuel pricing formula, we believe that Energy sector
+94 11 772 2045 profitability will remain under pressure driving our negative view on the sector. Despite a
fair amount of uncertainty when taking a top down approach we believe that there are
Mangalee Goonetilleke
mangalee@asiasecurities.lk opportunities for attractive returns.
+94 11 772 2042
Improved macro environment to drive Banking sector growth; transaction levy to depress
Naveed Majeed near-term valuations
naveed@asiasecurities.lk We take a cautiously optimistic view on the local Banking sector. Two years of tight monetary
+94 11 772 2043 and fiscal policy has improved key macro variables leaving headroom for growth focused
policies from CY18E onwards. We believe that this change in focus will drive a pick-up in GDP
growth over the next three years putting banks, which are strongly correlated to economic
growth, into growth mode. NIMs are likely to improve marginally prior to settling down from
CY18E onwards. We expect profitability to improve into CY20E on the back of improving
income and an increasing focus by industry players on driving branch efficiencies. Basel III
capital adequacy requirements are in effect which most banks are in compliance. However,
CY18E will see IFRS 9 implementation which will drive an uptick in credit costs. We believe
that these issues are navigable by the local industry driving our positive view. However, the
budget for 2018 proposes a transaction levy which would pose substantial headwinds driving
our cautious view. Absent of this levy, we would have a strong positive view on the sector.
Removal of levy on data services to drive Telco sector earnings

We are positive on the Telecommunications sector for CY18E. The removal of the
telecommunications levy on data services will generate a strong push on data adoption which
is now in line with voice in terms of profitability. Furthermore, most of the negative policy
announcements made in late CY16 were ultimately not implemented on the sector. However,
we do note that this year also includes a substantially negative policy proposal in the form of a
higher telecom tower tax. Given the importance of the sector to the economy, we believe that
the government will ultimately take a cautious approach to implementation.
Consumer and Construction sectors to recover from mid-CY18E onwards

2017 saw consumer spending constrained amidst a number of macroeconomic and weather-
related issues. As a result, most consumer companies saw earnings hit on 1) revenues due to
low spending, 2) cost due to higher raw material prices, and 3) interest costs. While our latest
macroeconomic analysis shows that the economy is now in a more stable condition, we expect
consumer demand to pick up only from mid-2018. While the Construction sector has been one
of the key sectors to be in over the past few years we believe a slowdown in demand will be
seen in CY18E. The slowdown will be led by the infrastructure sector stemming from a cut in
government expenditure and a slowdown in the residential market led by high interest rate. In
addition, we also expect rising raw material costs to have an impact on the profitability of the
sector. However, we expect the sector to pick up gradually in the latter part of CY18E with a
pick-up in government infrastructure spending.
Profitability pressure drives our negative view on the Energy sector

A very low probability of any retail price revisions along with an increase in global crude oil
prices driving a squeeze on margins lead our negative view on the Energy sector. While the IMF
has set a deadline of the of March 2018 to implement the transparent energy pricing formula,
we believe the Government will take a slow approach given upcoming elections. However,
given the need for the IMF program to continue, we believe that it will be eventually imposed
in FY19E.
28
Sector overviews for 2018 (1/2)
EV/
Div yld ROE ROA ND/E*
Sector Period P/E (x) EBITDA P/B (x) Outlook Rationale
(%) (%) (%) (%)
(x)
Two years of tight monetary and fiscal policy has improved key macro variables leaving headroom for
growth policies from CY18E onwards. This change in focus will drive a pick-up in GDP growth over the
Banks CY18E 6.3 na 0.9 5.1 15.0 1.5 97.7 Positive next three years putting banks into growth mode. Basel III requirements are in effect which most banks
are in compliance leading to lower expectations of dilutions. However, the budget for 2018 proposes a
transaction levy which would pose substantial headwinds leading our cautiously positive view.
The removal of the telecommunications levy from data services offsets most of the negative impact
from the imposition of VAT on the sector. This, we believe will lead to a resumption of data driven
Telecommunic
CY18E 7.8 3.3 1.1 4.2 14.2 7.6 26.7 Positive growth over the next 12-months. The budget for 2018 proposes the imposition of a substantial tax on
ations
towers which we believe will not be implemented in the current form given the importance of the sector
for the economy. However, it will lead to an overhang on valuations in the near-term.
Over the past few years, legal alcohol consumption has dropped significantly due to continuous price
Alcoholic increases while tighter consumer spending power will impact future growth. However, the recent
FY18E 19.4 8.8 1.4 1.1 7.0 5.2 (31.6) Neutral
Beverages changes in excise duties leads to beer becoming substantially cheaper when compared to hard-liquor. As
such, we expect a shift in earnings from the hard-liquor manufacturers to the beer manufacturers.
Our latest macroeconomic analysis shows that the economy is now in a more stable condition which
should lead to a recovery in consumer spending power. However, we expect a more tangible pick up
FMCGR FY18E 17.6 10.0 8.4 4.4 49.7 16.7 (5.5) Neutral
only towards mid-2018 onwards. We believe that low-mid income earner exposed counters will see a
faster recovery.
Provides exposure to multiple sectors in a more liquid manner when compared to buying individual
Conglomerates FY18E 14.4 7.1 1.2 3.0 8.8 5.5 (24.6) Neutral stocks. Out of our coverage we continue to believe that only one conglomerate has optimal exposure to
the key sectors of Healthcare, Consumer, Tourism, and Logistics.
We believe a slowdown in demand will be seen across the sector in the near-term led by both
infrastructure and retail demand. Towards the latter part of the year we believe that the government
Construction FY18E 8.3 4.4 1.0 4.7 13.2 7.8 16.9 Neutral
will resume infrastructure spending leading to a recovery. However, we believe that the recovery will be
impacted negatively to some degree given the pick-up in global commodity prices
We are particularly bullish on the textile industry post the reinstatement of the GSP+ in June 2017. With
GSP+ benefits yet to be strongly felt, delayed by soft market conditions in the EU, we expect the tax
Manufacturing FY18E 10.2 6.0 1.1 5.2 12.8 7.2 27.5 Neutral exemptions to bring about a surge from 2H FY18E onwards. However, we believe that the rest of the
export focused manufacturers will continue face headwinds on the back of increasing global
competition.
Corporate taxes will pick up to 28.0% from the present 12.0% from 01st April 2018. When VAT was
introduced in May 2016 there was a dip in revenue and profitability for the sector led by preventative
care and elective surgeries. Should sector players pass on the higher taxes, demand for tertiary care and
Healthcare FY18E 19.6 9.7 3.1 2.4 17.4 10.2 37.5 Neutral preventative care will remain subdued. However, we maintain our view that the long-term narrative for
the hospital industry remains intact. We are bullish on pharmaceuticals despite the recently imposed
price controls. The government imports a majority of drugs and is taking positive stance on local
manufacturers. However, there are limited options in which to play this sub-sector.
Source: Asia Securities | Note: Priced as at 08 Jan 2018 | *ND/E – Net Debt/Equity
29
Sector overviews for 2018 (2/2)
EV/
Div yld ROE ROA ND/E*
Sector Period P/E (x) EBITDA P/B (x) Outlook Rationale
(%) (%) (%) (%)
(x)
Our view is driven on that fact that an increase in rooms supply coupled with slower-than-expected
growth in arrivals will result in demand lagging supply in the near to medium-term. We also see the rise
Leisure FY18E 12.2 6.4 0.6 5.5 5.4 4.3 17.4 Neutral in the informal segment being a threat to the larger listed players, noting that the informal market has
eaten into the market share of established players, particularly in the popular Western and Southern
coasts of the country. However, we believe that most of the challenges have already been priced in.
We believe that General Insurance will be a steady performer while Life Insurance will see some
headwinds. Furthermore, we believe that the new Inland Revenue Act will hit industry profitability
Insurance CY18E 4.7 na 1.0 4.4 22.1 5.5 2.9 Neutral through higher taxes as well as through lower investment yields. Valuations are at some of the lowest
levels seen in the last five years but, we believe that there are too many negatives to lead an overall
upward rerating.
The sector continues to be affected by the tighter LTVs imposed from late 2015 onwards while pressure
on consumer spending power has led to lower vehicle affordability. The Central Bank is tightening
NBFI FY18E 4.7 na 0.8 5.4 18.9 3.5 132.7 Neutral regulations on the sector with an increase in the minimum capital requirements as well as a proposal to
increase the minimum capital adequacy ratio. While this will strengthen the sector in the long term,
there will be profitability pressure in the near-term.
We see no room for any upside due to a very low probability of any retail price revisions, especially with
the local government election around the corner. Furthermore, global crude oil prices have seen a sharp
Energy FY18E 46.2 13.5 2.0 4.8 5.0 4.4 31.1 Negative uptick which will lead to pressure on profitability. Over the long-term we believe that the government
will implement the fuel pricing formula which will support industry profitability given the push from the
IMF.
Source: Asia Securities | Note: Priced as at 08 Jan 2018 | *ND/E – Net Debt/Equity
30
Banking
Macro winds blow due growth
Kanishka Perera We take a cautiously optimistic view on the local Banking sector. Two years of tight
kanishka@asiasecurities.lk monetary and fiscal policy has improved key macro variables leaving headroom for growth
+94 11 772 2044 focused policies from CY18E onwards. We believe that this change in focus will drive a
pick-up in GDP growth over the next three years putting banks, which are strongly
correlated to economic growth, into growth mode. However, not all banks are made equal
and we believe that SME focused ones will see better growth than others in the near-term
while medium-term growth will be led by Retail focused ones. We have broadly flat
expectations on Corporate lending at all points in our forecast horizon. NIMs are likely to
improve marginally prior to settling down from CY18E onwards. We expect profitability to
improve into CY20E on the back of improving income and an increasing focus by industry
players on driving branch efficiencies. Basel III capital adequacy requirements are in effect
which most banks are in compliance with following capital issuances but, the State banks
remain woefully undercapitalized driving our expectation of a shift in market share
towards the Private banks. Furthermore, CY18E will see IFRS 9 implementation which will
drive an uptick in credit costs. We believe that these issues are navigable by the local
industry driving our positive view. However, the budget for 2018 proposes a transaction
levy which would pose substantial headwinds driving our cautious view. Absent of this
levy, we would have a strong positive view on the sector. Our key picks are SAMP and SDB.
Market cap ADV CY2018E

BBG Year CMP TP
LKR USD (USD TP date TSR ND/E*
ticker end (LKR) (LKR) P/E (x) P/B (x) DY (%) ROE (%)
bn mn k) (%) (%)
COMB SL Dec-17 138 901 749 141.00 150.50 12-Dec-17 +11.3 8.2 1.4 4.6 17.7 97.1
HNB SL Dec-17 119 775 371 255.00 286.00 12-Dec-17 +15.7 6.7 1.0 3.5 16.0 70.8
SAMP SL Dec-17 71 466 752 329.00 365.00 20-Dec-17 +16.3 6.2 1.0 5.3 19.5 78.3
SEYB SL Dec-17 26 167 5 87.90 92.40 12-Dec-17 +8.8 6.8 1.0 3.7 14.9 78.9
NDB SL Dec-17 24 155 98 138.60 149.10 12-Dec-17 +13.3 7.4 0.7 5.8 10.2 219.7
NTB SL Dec-17 18 117 46 78.10 86.40 12-Dec-17 +13.3 5.3 0.9 2.7 18.0 112.0
UBC SL Dec-17 14 94 9 13.20 13.20 12-Dec-17 +0.8 26.4 0.9 0.8 4.0 143.2
SDB SL Dec-17 6 37 13 103.10 125.70 12-Dec-17 +29.2 11.8 0.8 7.3 7.7 140.9
DFCC SL Dec-17 32 210 81 121.80 - na nm nm nm - - -
PABC SL Dec-17 7 47 5 16.30 - na nm nm nm - - -
Average 9.9 1.0 3.4 10.8 117.6
Source: Asia Securities | Note: *ND/E – Net Debt/Equity, Priced as at end 08 Jan 2018
Earnings outlook: We expect CY17E to close on a strong wicket with overall industry earnings
growing by 43.0% YoY led by loan growth with a reasonable improvement in NIMs. Most banks
have completed or are in the process of completing their capital issuances to maintain growth
in a Basel III environment. We do not expect to see any major capital issuance by the Private
banks in CY18E but, believe that the State banks would need to raise substantial levels of
capital in order to remain competitive. CY18E also brings along IFRS 9 implementation which
will see a front loading of impairments which we expect will lead to impairment charges
climbing by >40.0% YoY.
Despite some headwinds, we note that macro conditions have improved to the point where the
Central Bank can follow a looser monetary policy which will lead to the next stage of growth
for the Banking industry. The proposed transaction levy would cause substantial headwinds and
if implemented in the proposed form would lead us to cut our earnings estimates by 12.0%.
However, we believe that the Banks would pass this on to consumers through a combination of
higher lending rates, lower deposit rates, and higher fees. Furthermore, a focus on branch
automation will help the industry to maintain profitability to a large degree. As such, we
forecast CY18E earnings to be up 11.6% YoY vs. our expectations of closing CY17E at a YoY
growth of 31.1%.
31
We forecast industry loan growth at a 15.0% CAGR CY16-20E Sri Lanka has a low level of debt when compared to peers
LKR tn (%) Debt/GDP (%)

10 25 160
140 Thailand
8 20 Vietnam Malaysia
120
6 15 100
80
4 10 60 Philippines
India Sri Lanka
40
2 5
20 Pakistan Indonesia
- - -
CY14 CY15 CY16 CY17E CY18E CY19E CY20E - 5,000 10,000 15,000 20,000 25,000 30,000
Gross loans (LHS) Growth (RHS) GDP/capita (@ PPP, intl $)
Source: CBSL, Asia Securities Source: CBSL, World Bank, Asia Securities
Valuation outlook: Despite our expectation of a slowdown in earnings growth, we note that
this largely led by the dilutive impact of capital issuance carried out through CY17 and further
ones to follow in CY18E. Furthermore, IFRS 9 comes with frontloaded impairments contributing
to the lower earnings growth expectations. Looking through the cycle, we believe that CY18E
is when investors will start viewing the Banking industry more positively leading to an
expansion of valuation multiples. The sector is currently trading at 0.9x CY18E BV which we
believe is cheap leaving substantial headroom for an expansion of valuations.
Latter part of CY17 saw a rally in the banking sector Banks are trading at a steep discount to five-year average
Index value P/B (x)

250 2.0
200 1.8
150 1.6
100 1.4
50 1.2
0 1.0
Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17
Banks ASPI Banks ASPI Average
Source: Asia Securities, Bloomberg Source: Asia Securities, Bloomberg
What are the risks?

• Debt repayment levy: The main downside risk we see is the proposal to implement a
transaction tax of 0.02% on all cash transaction carried out by financial institutions (called
the “Debt Repayment Levy”). While the government intends on implementing this for only
a limited time period of three years, it sends the wrong message to investors in a period
where all Banks are raising capital to meet higher regulatory requirements.
• Monetary policy: We believe that the key upside risk is a loosening of monetary policy
than our expectations. At present we factor in only 25bp reduction in policy rates and
anything more than will lead to substantial upside for the industry.
Our key picks

Sampath Bank [SAMP] – BUY [+16.9% TSR] – Topping up for growth
SAMP is the 5th largest bank within the country by gross loans with a strong presence in retail
banking. Amidst headwinds faced by the pawning industry we see SAMP focusing on the
SME/mid-sized corporate market for growth. With the strong risk management processes in
place we believe that SAMP will be successful in driving growth from this segment with
contained NPLs. Furthermore, we expect the Bank’s cost/income ratio to improve along with a
faster growth in income when compared to the cost base. We value SAMP at 1.1x CY18E BV
leading to a target price of LKR 365.00 (+10.9% upside; +16.9% TSR). BUY.
32
Sanasa Development Bank [SDB] – BUY [+29.2% TSR] – The rural growth engine
SDB is a unique bank with a focus on the unbanked rural economy. Strong ties with
cooperatives give it the key advantage of reaching this segment. The Bank follows an
unconventional model in Retail lending as well with a focus on retired government employees
by providing financing support for individual enterprises. It has the lowest per branch opex in
our coverage which will lead to strong profitability with revenue growth. The private
placement carried out in December 2016 shores up its’ capital base for BIII reqs. We value the
stock at 0.9x CY18E BV leading to our TP of LKR 125.70 (+21.9% upside; +29.2% TSR) and rate it
BUY.
33
Telecommunications
Data set to drive growth
Kanishka Perera We believe that CY18E is the year for Telcos and take a positive view on the sector. The
kanishka@asiasecurities.lk effect of the higher consumption taxes through the imposition of VAT on the sector is
+94 11 772 2044 largely offset on the data side through the removal of the telecommunications levy.
Furthermore, most of the negative policy announcements made in late CY16 were
ultimately not implemented on the sector. However, we do note that this year also
includes a substantially negative policy proposal in the form of a higher telecom tower tax.
Given the importance of the sector to the economy, we believe that the government will
ultimately take a cautious approach to implementation. We forecast earnings growth to
recover to 28.1% YoY in CY18E vs. our expectations of closing CY17E at a flat 0.1% YoY
growth. Valuations continue to remain cheap with the sector trading at 3.3x EV/EBITDA
CY18E. Our key pick for the sector is DIAL.

BBG Year CMP TP
bn mn k) (%) (%)
DIAL SL Dec-17 110 716 259 13.50 16.70 13-Nov-17 +28.3 7.6 1.8 4.6 21.9 24.1
SLTL SL Dec-17 53 347 1 29.50 22.90 17-Nov-17 -19.4 12.1 0.7 3.0 6.3 47.9
Average 11.0 1.4 3.2 12.8 36.0
Earnings outlook: 2017 started on a negative tone with consumers cutting back on data usage
along with the imposition of VAT on the sector. However, some level of recovery was seen
towards 2Q while 3Q showcased a tangible uptick in earnings. The biggest positive came from
the government announcing the removal of the telecommunications levy from all data
services, making a U-turn from the previously announced decision to increase the
telecommunications levy on data services.
Data margins are now on par with voice margins and we expect the removal of the
telecommunications levy to lead to a higher contribution from the data side driving
profitability. However, the budget proposals for 2018 include a tower tax of LKR 200,000 per
month per tower which will lead to a substantial hit on earnings if implemented. We believe
that it is very likely to be moderated to a large degree given that the telecommunications
industry is one of the largest investors in the country.
We forecast earnings to grow at a strong 28.1% YoY in CY18E vs. our expectations on closing
CY17E at a muted 0.1% YoY growth. As mentioned earlier, our key driver behind earnings
growth is our expectation of higher data adoption.
Valuation outlook: The sector is currently trading at 3.3x EV/EBITDA CY18E continuing to be
one of the cheapest regionally. We believe that consistently negative government policy
proposals are holding back valuations at present. However, strong earnings performance will
lead to expanding valuations in our opinion. As we mentioned last year, another key catalyst
for driving valuations upwards would be if the smaller unprofitable players exited the market.
Telcos saw a sharp recovery in CY17 Valuations recovered towards mid CY17 but, weakened after
Index value P/E (x)

200 20
180 18
160 16
140 14
120 12
100 10
80 8
60 6
Telecom ASPI Telecom ASPI Average
34
What are the risks?
• Tower tax: The key downside risk heading into CY18E is the proposed tower tax which
would see industry earnings come down by ~28.0% if implemented in the current form.
However, we believe that the government will take a cautious approach to actual
implementation given the importance of the sector for the overall economy.
• M&A: The key upside risk we see continues to be M&A activity. Leaving aside the
competitive pressure from the smaller players, we note that they hold a substantial
amount of spectrum which, in our opinion, is currently underutilized. As such, any M&A
activity should lead to an improvement in profitability as well as give more room for
growth.
Our key picks

Dialog Axiata [DIAL] – BUY [+28.3% TSR] – Tuning in through the noise
The share has moved sideways over the last couple of years on the back of unexpected adverse
policy changes leading to headwinds on earnings. However, August 2017 saw a cut on
consumption taxes on data services which in combination with declining smartphone prices will
lead to a pick-up in data adoption. Recently, DIAL acquired a non-bank finance company which
allows it to provide all banking services bar a couple. While this won’t have a near-term
financial impact, we are bullish on the long-term prospects. However, the proposed tower tax
would lead to depressed valuations in the near-term. As such, we value DIAL at 4.64 CY18E
EBITDA leading to our TP of LKR 16.70/share (+23.7% upside; +28.3% TSR) and rate it BUY.
35
Alcoholic Beverages
Duty revisions reverses consumption trends
Mangalee Goonetilleke We take a neutral view on the Alcoholic Beverages industry for 2018. Our view is mostly
mangalee@asiasecurities.lk driven by the fact that over the past few years, legal alcohol consumption has dropped
+94 11 772 2042 significantly due continuous price increases. Overall macroeconomic conditions throughout
2017 also did not help the industry, as consumers either curtailed spending or switched to
illegal/illicit products, in particular toddy and moonshine. 2017 was relatively a better
year for hard liquor compared to beer, as the absence of the main beer producer LION
during the latter part of 2016, resulted in beer consumers switching to hard liquor.
However, with the recent excise duty revisions in favour of beer, consumption of beer has
become cheaper, compared to hard liquor. We believe this should provide a notable upside
for LION. However, despite this factor, we expect sector earnings to be down by 10.6%
YoY in FY18E, mainly due to earnings from MELS offsetting any gains at LION. We note that
despite the industry will see migration of consumers from arrack to beer, there is also
significant number of consumers that were lost to the illicit/illegal market. The sector is
trading at 19.4x FY18E EPS. Given the upside from tax revisions, we recommend LION.
Market cap ADV FY2018E

BBG Year CMP TP
bn mn k) (%) (%)
MELS SL Mar-18 70 457 56 60.20 60.00 21-Nov-17 +1.3 12.9 0.9 1.7 7.8 20.1
LION SL Mar-18 45 294 223 564.70 735.00 16-Nov-17 +30.2 372 4.8 - 1.4 104.0
Average 192 2.9 0.8 4.6 124.1
Earnings outlook: Looking at the overall market, the year saw a number of hits on consumer
spending, resulting in lower volumes for both hard liquor and soft liquor manufacturers. These
volumes however, have now shifted to the illegal/illicit liquor market as per industry sources.
In particular, there have been an increase in Toddy consumption, which is a cottage industry in
Sri Lanka, and also highly unregulated. The switch was predominantly due to pricing as taxes
over the past two years have driven up legal alcohol prices by over 50.0%.
Of the two main segments, hard liquor had a relatively better year compared to beer. Absence
of the main beer producer LION during the latter part of 2016 (due to flood related closures),
resulted in beer consumers switching to hard liquor with the main beneficiary being DIST.
However, while this impact has now normalized, volumes have declined due to curtailed
consumer spending, resulting from the overall monetary and fiscal tightening in the country.
The impact to LION SL on the other hand was two-fold. While some consumers switched to
hard liquor, another segment of consumers switched to other beer brands, which aggressively
distributed its products during the absence of LION.
However, on a surprise move during the 2018 budget presentation in early November 2017, the
government proposed to revise excise duties for beer and alcohol, with beer excise duties
falling by 33.0% and hard liquor going up by 2.0%. The budget also removed taxes for imported
beer cans. The duty changes were effective immediately and as a result, LION reduced its
prices on average by 32.0% while prices of the most popular hard liquor, Special Arrack by
DIST, is up ~6.0%.
As a result, on an equivalent alcohol basis, consumption of beer has become cheaper,

compared to hard liquor. We believe this should provide a notable upside for LION. Our recent
channel checks confirmed that there is more faster movement in LION strong beer, compared
to the 185ml Special Arrack bottle, sales of which seems to have dropped by nearly 30.0-40.0%
at the vendors we spoke to.
36
Cost of drinking beer drops by 25.0% post excise duty changes
Before Nov 17 After Nov 17
Beer
Cost of a strong beer can (LKR) 360 270
Alcohol content 8.8% 8.8%
Cost/ml of equivalent alcohol (LKR) 8.18 6.14
Growth -25.0%
Hard liquor
Cost - bottle of DIST Extra Special arrack 185ml (LKR) 380 400
Alcohol content 33.5% 33.5%
Cost/ml of equivalent alcohol (LKR) 6.13 6.45
Growth +5.0%
Source: Asia Securities | Costing done on an equivalent basis
However, despite this factor, we expect sector earnings to be down by 10.6% YoY in FY18E,
mainly due to earnings from MELS offsetting any gains at LION. We note that despite the
industry will see migration of consumers from arrack to beer, there is also significant number
of consumers that were lost to the illicit/illegal market, which our industry sources note,
haven’t switched back.
Valuation outlook: The Alcoholic Beverage sector is trading at 19.4 FY18E EPS, which is at a
26.1% upside to the five-year average of 15.4x. Our expectation for a higher multiple comes
from our bullish view on LION’s earnings on the back of the duty revisions. Also, the upcoming
listing of Distilleries Company of Sri Lanka (no dates given) would result in an upward re-rating
for the sector, in our view.
Sector has outperformed the ASPI over the past two years Valuations are in-line with the ASPI
Index value P/E (x)

220 21
200 19
180 17
15
160
13
140
11
120 9
100 7
80 5
Alcoholic Beverages ASPI Alcoholic Beverages ASPI Average
What are the risks?

• Government stance on illegal/illicit market: A softer approach by the government on
illicit and illegals producers remains the key threat to the sector. However, we think that
the likelihood of this occurring is narrow as the crackdown on the illegal/illicit market
have led to a boost to the government coffers.
• Taxation: Excise duty hikes, which have historically been carried out once a year, leads to
profitability pressure and dips in demand but, given the rote nature we believe that this is
factored into valuations
Our key picks

Lion Brewery [LION] – BUY [+30.2% TSR] – Share gains on the back of duty revisions
For FY18E, we expect the reduction in excise duties to favourably impact LION’s results,
despite the low consumer sentiment in the country. With prices on average down 32.0% post
the duty revisions, we are already seeing a switch from hard liquor to beer consumption. We
also expect operating leverage to help margins as seen in 2Q. However, we believe there will
be some pressure on the bottom-line with high interest expense as debt level still remain high.
Adjusting for these factors, our DCF valuation indicates a TP of LKR 735/share resulting in a
TSR of +30.2%. BUY.
37
FMCG/R
Consumer spending to bounce back in mid-2018
Mangalee Goonetilleke We take a neutral stance on the FMCG/Retail sectors for 2018. 2017 saw consumer
mangalee@asiasecurities.lk spending constrained amidst a number of macroeconomic and weather-related issues. As a
+94 11 772 2042 result, most consumer companies saw earnings hit on 1) revenues due to low spending, 2)
cost due to higher raw material prices, and 3) interest costs. However, our latest
macroeconomic analysis shows that the economy is now in a more stable condition.
However, we expect demand to pick up mid-2018. This results in our EPS growth forecast
of -1.0% YoY by end FY18E compared to +18.1% in FY17. While the sector is generally one
of the more expensive ones in our coverage, it is now trading at 17.6x FY18E EPS (~30.0%
below historical average), which we believe is due to the lackluster results reported so far
in FY18E. However, the sector is a significant ROE generator with our forecast for FY18E at
49.7% (average of 46.4% over the last five years). We believe this leaves an opportunity for
the sector to re-rate upwards next year. With much of the demand to occur in mid-CY18,
our picks are based on exposure to the low-mid income earner segment with strong brand
presence trading at reasonable valuations. Also, we believe one of the sub-sectors in
consumer to sustain demand would be food retailers and with reasonable valuations, we
recommend investing into CARG.

BBG Year CMP TP
bn mn k) (%) (%)
CTC SL Dec-17 199 1,300 41 1,065 1,120 20-Nov-17 +10.7 16.0 40.7 5.5 297 (336.3)
NEST SL Dec-17 91 594 114 1,698 1,800 14-Nov-17 +9.6 27.0 16.3 3.6 61.0 36.0
CCS SL Mar-18 90 588 125 950.00 730 30-Oct-17 -21.1 24.4 8.5 2.1 26.2 7.9
CARG SL Mar-18 44 287 61 196.40 240 17-Nov-17 +25.4 15.6 2.9 3.2 19.2 97.0
SINS SL Dec-17 16 104 3 42.50 48 13-Dec-17 +16.7 13.6 1.8 3.8 13.9 200.8
KFP SL Mar-18 3 22 1 130.10 125.00 1-Nov-17 +4.5 13.5 2.0 8.5 14.9 5.8
Average 18.4 12.0 4.4 72.1 1.9
Earnings outlook: 2017 saw consumer spending constrained amidst a number of

macroeconomic and weather-related issues. With balance of payment issues looming since
early 2016, the Government entered in to Extended Fund Facility (EFF) with the International
Monetary Fund (IMF) in mid-2016. As a result, the Government implemented a number of fiscal
and monetary policies to stay in line with IMF requirements, which led to increase in Value
Added Taxes (VAT) and higher interest rates, impacting consumer spending. In addition, floods
in both of May 2016 and 2017, and a drought that prevailed till recently for almost 1.5 years,
also impacted spending power, particularly in agriculture based communities. As a result, most
consumer companies saw earnings hit on 1) revenues due to low spending, 2) cost due to
higher raw material prices, and 3) interest costs.
However, as noted in our macro outlook section, we note that the economy is now in a more
stable condition and there is room for implementation of looser monetary policies in 1H
CY18E. Also, as per latest data available, household spending has picked up by a CAGR of
~10.0% 2012/13-2016, with the rural household seeing the fastest growth during this period.
With growth in income levels, one of the key changes to occur is allocation of expenses to non-
food categories, particularly housing related expenses, healthcare, education, and
transportation. This change is particularly prominent in the rural households, where we see
the highest shift in allocation to non-food expenses.
38
Rural households saw income levels grow faster in 2012/13-2016 Highest non-food allocation change was in the rural households
Household income (LKR/month)

35% 31% 35%
100 44% 51% 48%
8.3%
80
60
11.9% 65% 69% 65%
4.8% 56% 49% 52%
40
20
0 Urban Rural Estate Urban Rural Estate

Urban Rural Estate 2009/10 2016
2009/10 2012/13 2016 Non-food Food
Source: Asia Securities, DOCS Source: Asia Securities, DOCS
Looking at 2018, we believe that consumer spending should pick up towards mid-CY18E, as 1)
food inflation eases off with food supply going back to normal, 2) interest rates normalize, and
3) impact from VAT begins to normalize. With 1H FY18 being a relative slow period for most of
the consumer companies in our coverage, we forecast FY18E EPS to be down -1.0% in FY18E.
however, post this, we expect earnings to pick up and FY19E earnings to grow by +18.5% YoY.
We note that despite a tough year, nearly every consumer company in our coverage continued
to invest in capacity expansion, product introductions & innovations, and store expansions. In
FY17, capex in our coverage was up ~76.0% YoY. For FY18E, we expect capex to be up ~13.0%
YoY. While consumer sentiment is slow, the companies are essentially ready to cater to
consumer demand as and when it picks up mid next year.
Valuation outlook: While the sector is generally one of the more expensive ones in our
coverage, it is now trading at 17.6x FY18E EPS (~30.0% below historical average), which we
believe is due to the lackluster results reported so far in FY18E. The sector has always traded
at a premium to the rest of the market given the high ROEs (46.4% average over the past five
years) and despite the slow growth in FY18E, we expect an FY18E ROE of 49.7%, the highest in
our coverage. We believe this leaves an opportunity for the sector to re-rate upwards next
year. With much of the pick up to happen in mid-CY18, our key picks are based on exposure to
the low-mid income earner segment with strong brand presence trading at reasonable
valuations. As such we recommend investing into CARG and SINS.
Sector has outperformed the market since 2016 Valuations are cheaper but, remains above the ASPI
Index value P/E (x)

220 45
200 40
180 35
160 30
25
140
20
120 15
100 10
80 5
60 -
FMCG/R ASPI FMCG/R ASPI Average
What are the risks?

• Currency depreciation: Currency is a key vulnerability for the sector as most the raw
materials are imported. Furthermore, currency depreciation leads to a pick-up in inflation
(consumer goods account for ~22.0% of total imports) which in turn erodes consumer
spending power.
• Inflation: Following on from currency depreciation, we see inflation as a key risk as well.
We are not overly concerned on this risk as the IMF has placed strict limits on inflation
which, if breached, will lead to it withholding tranches.
39
Our key picks
Cargills (Ceylon) [CARG]: BUY [+25.4% TSR] - A steady performer amidst a bland outlook
Over the past year, CARG performed better than peers amidst constrained consumer spending,
recording steady performance across all three segments. The Retail business continues to be
the largest private sector operation in terms of both store network and revenues. We expect
CARG to increase market share with new store expansions, of which ~50.0% will be outside of
Western Province. Our key concern though is availability of the right real estate to keep these
plans on track. CARG’s FMCG business continue to be the margin generator, with segment
margins ~6pp higher than other segments. With capacity expansion completed in most
categories, the segment will be driven by new product introductions. The Restaurant business
continues to perform well, recording strong margin improvements. Our SOTP valuation derives
a target price of LKR 240.00/share and including a DPS of LKR 6.30, we arrive at a total return
of +25.4% and rate the share a BUY.
40
Conglomerates
Selecting the correct proxy for the economy
Mangalee Goonetilleke The giants of the CSE, the conglomerates accounted for >15.0% of the CSEs market
mangalee@asiasecurities.lk capitalization and more than >25.0% of trade volumes in 2017. These counters have a
+94 11 772 2042 footprint across multiple sectors and work well as a proxy for the country. Our key
question when we look at the Conglomerates is which one provides access to Sri Lanka’s
growth story at a reasonable price. Within our coverage, we have four options: 1) John
Keells Holdings (JKH) which is tilted towards Leisure, Consumer, and Logistics, 2) Hemas
Holdings PLC (HHL) which is exposed to Healthcare, Consumer, Leisure, and Logistics, 3)
Softlogic Holdings (SHL) which is exposed to Retail, Healthcare and Leisure, and Aitken
Spence (SPEN) which is tilted towards Leisure and Logistics. Our key pick is HHL.

BBG Year CMP TP
bn mn k) (%) (%)
JKH SL Mar-18 229 1,491 875 165.00 168.00 9-Nov-17 +5.2 14.8 1.2 3.3 8.5 (17.7)
HEMS SL Mar-18 71 464 209 123.80 136.00 17-Nov-17 +11.0 19.0 2.8 1.1 15.4 (27.4)
SPEN SL Mar-18 22 145 2 55.00 61.70 19-Dec-17 +14.9 7.8 0.5 2.7 7.0 46.8
SHL SL Mar-18 10 66 30 13.00 13.00 20-Nov-17 +3.8 27.7 1.1 3.8 4.0 296.7
Average 17.3 1.4 2.8 8.7 298.5
Earnings outlook: We forecast earnings growth to remain relatively subdued for our
Conglomerate coverage at +1.4% YoY in FY18E. The main driver behind this is revenue growth
from HHL while margins would broadly remain flat.
Valuation outlook: The sector is currently trading at 14.4x FY18E EPS which is at a ~19.0%
discount to the average 17.8x recorded over the last five years. There were a number of
reasons for the drop in valuations across the three companies. At JKH, the Consumer business
which contributes to ~43.0% of revs was hit by tight consumer spending during the year. At
HHL, while its Consumer business also had a similar impact, the Leisure business continued to
be under pressure from increased competition on the 3-4 star space. At SHL, earnings
continued to be impacted by higher interest costs due to its significant borrowing levels. at
SPEN, with its ~50.0% exposure to Leisure, overall results have remained pressured.
However, we note that the sector provides exposure to multiple sectors of the country and is
generally more liquid than a collection of individual counters which would provide exposure to
similar sectors. Given the earnings outlook and the cheaper valuation, we recommend
exposure to HHL.
Conglos have tracked the broader market over the past year Valuations are slightly more expensive than the index
Index value P/E (x)

140 35
130 30
120
110 25
100 20
90 15
80
70 10
60 5
Conglomerates ASPI Conglomerates ASPI Average
41
What are the risks?
• Consumer spending: Despite the exposure to myriad sectors all have exposure to
consumer demand in some form or the other. As such, any slowdown in consumer spending
growth has far reaching implications for the sector.
• Spin-offs: The main upside risk we see is if the holding companies spin-off the subsidiaries
allowing for better price discovery. However, this is a more longer-term possibility than a
near term one as the current structure is utilized raise capital for large scale projects
which would not have been possible if done on a standalone basis.
Our key picks

Hemas Holdings [HHL]: HOLD [+11.0% TSR] – A well-coordinated diversification
We expect Healthcare to continue to account for majority of earnings and will benefit from its
market leadership in pharmaceutical distribution and MORI from its Government buyback
programs. For FMCG, we expect the local market to be relatively flattish, while Bangladesh to
be under pressure due to restructuring of the distribution network. In Maritime and Logistics,
we expect the segment to be driven primarily by the maritime business. In Leisure however,
we remain cautious of the impact from increased competition. Our SOTP based valuation
derives a target price of LKR 136.00/share. Including a forecast DPS of LKR 1.40/share, we
expect a total return of 11.0%. HOLD.
42
Construction
A downswing in construction; long-term story still intact
Naveed Majeed While the Construction sector has been one of the key sectors to be in over the past few
naveed@asiasecurities.lk years, we take a neutral view on the sector over the year ahead as we believe a slowdown
+94 11 772 2043 in demand will be seen across the sector. The slowdown will be led by the infrastructure
sector stemming from a cut in government expenditure and a slowdown in the residential
market led by high interest rate. In addition, we also expect rising raw material costs to
have an impact on the profitability of the sector. While we expect the slowdown in
demand to last through FY18E, we expect the sector to pick up gradually in the latter part
of CY19 as the Government’s revenue base starts growing with the implementation of the
IRA. As such, we forecast EPS growth of 34.4% for FY19E against our forecast of -17.2% for
closing FY18E. The sector continues to trade cheap at 8.3x FY18E P/E and a growth PEG of
0.9x. We view Tokyo Cement (TKYO) as the company better positioned to benefit when
the construction sector picks up, given its exposure to both the infrastructure and housing-
led demand.

BBG Year CMP TP
bn mn k) (%) (%)
TKYO SL Mar-18 26 171 81 68.50 70.30 20-Nov-17 +5.0 7.7 1.6 2.3 22.8 41.1
AEL SL Mar-18 24 156 44 23.90 28.00 16-Nov-17 +22.4 9.1 1.2 5.2 13.4 21.6
RCL SL Mar-18 13 82 11 114.10 131.00 21-Nov-17 +21.8 4.1 0.6 7.0 16.7 36.5
TILE SL Mar-18 6 38 4 111.10 120.00 6-Nov-17 +15.2 5.3 0.8 7.2 15.8 (18.0)
ALUM SL Mar-18 6 37 10 18.90 22.50 6-Nov-17 +27.5 7.5 2.2 8.5 30.7 19.3
ACL SL Mar-18 5 34 7 44.00 53.40 17-Nov-17 +24.5 5.4 0.5 3.2 9.7 6.3
KAPI SL Mar-18 4 27 5 24.90 25.00 23-Nov-17 +0.4 nm 0.9 - (29.2) 349.5
PARQ SL Mar-18 2 12 7 65.00 73.40 6-Nov-17 +16.0 4.7 0.8 3.1 18.7 31.5
SIRA SL Mar-18 1 9 5 2.50 2.50 15-Nov-17 +10.0 6.9 0.8 10.0 11.3 82.0
Average 6.3 1.0 5.2 12.2 63.3
Earnings outlook: We believe headwinds in the demand side will result in a slowdown of the
topline for the sector as a whole in the first half of FY19E. The slowdown in the demand side
will be led by the Government cutting its expenditure on infrastructure development to meet
its fiscal targets.
Infrastructure slowdown will be led by cuts across expenditure on road development
LKR bn (%)
300 2.5
250
2.0
200
1.5
150
1.0
100
0.5
50
- -
2013 2014 2015 2016 2017E 2018E 2019E
Exp. Way (LHS) Highways (LHS) Roads (LHS)
Bridges & F/O (LHS) Irrigation (LHS) Water supply (LHS)
Other (LHS) As a % of GDP (RHS)
Source: MoF, Asia Securities
43
Cuts in expenditure on expressway, highways, roads, bridges and flyovers, which on average
have accounted for ~70.0% of total infrastructure expenditure in the past will be the main
driver of the slowdown. GDP data for 3Q CY17 showed a slowdown of construction growth (-
1.5% YoY in 3Q CY17 compared with +24.2% YoY in 2Q CY17) which has been one of the main
drivers of growth in the past.
The cut in expenditure is led by actions taken by the Government of Sri Lanka (GoSL) to bring
down the fiscal deficit of the country to 3.5% of GDP by CY20E, a target set by the IMF. While
Slowdown led by we expect the recurrent expenditure of the Government to continue to rise due to heavy debt
actions to reduce servicing expenses in CY19E-20E, we believe the GoSL will be forced to cut their expenses on
fiscal deficit the public investment front to meet the target, leading to a slowdown in expenditure on
infrastructure projects.
We are of the view that the GoSL will gradually increase its expenditure on infrastructure as
its revenue base starts to grow, with the implementation of the new Inland Revenue Act (IRA),
effective 01 April 2018. However, given the delays in implementing the IRA, which was
previously expected to be implemented in April 2017, we expect the slow down to spill over to
most of CY18E. As per estimates from the MoF, government expenditure on infrastructure is
expected to grow 46.3% in CY18E, mainly due to a low base in CY17E. However, we believe it
would be lower than the expected expenditure due to the delays in revenues expected to be
realized.
Housing approvals have slowed down since 2016
1995 = 100
160
150
140
130
120
110
100
90
80
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
2011 2012 2013 2014 2015 2016 2017
Greater Colombo housing index 2M Moving Avg
On the residential side, we believe a slowdown is currently evident, stifled mainly because of
Residential a tight monetary policy. While the Sri Lankan housing loan market saw
market stifled in substantial growth over 2014 to 2016 led by the availability of cheap credit. However, a
2017 due to 100bps policy rate hike in combination with a 150bps increase in the reserve ratio in 2016 and
higher lending a further 25bps policy rate hike in early 2017 saw lending rates picking up. Our checks with the
rates; expected large banks indicate that home loan rates have picked up by ~250bps since early 2016 to
to pick up post October 2017. However, we believe that the improving fiscal deficit (7.6% of GDP in 2015 vs.
CY18E, with room 5.4% in 2016; we expect a further 0.9pp improvement to 2019E) and moderating inflation (we
for loose expect inflation to settle down at 5.2% by end 2019E) will leave headroom for loosening up
monetary policy monetary policy from CY18E onwards.
On the profitability side, we believe rising cost of raw materials will be a direct hit on the
construction sector profitability. Over the past two years, the Sri Lankan construction industry
Rising global has enjoyed healthy margins due to low commodity prices prevailing in the global market.
commodity prices Some of the reasons for the low prices during this period include 1) tepid global demand led by
will impact economic shocks that slowed down most of the economies globally in CY15 leading to, 2) an
profitability of increase in supply and inventory of commodities. However, in CY17, global commodity prices
the sector have strengthened on the back of a recovery in economies which is driving an increase in
demand for global commodities, while supply shocks and cuts have also pushed prices up. As
such, going forward we do not expect the sector to enjoy the same levels of profitability as
enjoyed over the past two years.
44
Our view is that most of the Construction demand in 2018 will come towards the raw material
Cement industry side as projects are still getting off the ground and see the cement industry as the main
is optimally beneficiary. Despite the near-term headwinds, we are still of the view that the cement
positioned to industry is optimally positioned to capture growth from the construction industry in the long-
capture growth term, as it is a key raw material in many types of construction. As discussed earlier, with
from the construction expected to pick up again in the later part of 2018 onwards, we expect cement
construction production and imports to increase.
industry in the
long-term Looking ahead, we forecast the sector’s EPS growth at 34.4% YoY for FY19E, main due to a
lower base from our forecast of a decline of 17.2% in EPS for FY18E. This slowdown is led by
our assumptions of both a demand side hit on the topline and a supply side hit on the
profitability of the sector.
Valuation outlook: The sector is currently trading at 8.3x FY18E P/E which is slightly below
the historical average of 8.5x. Valuations peaked in Dec 2014 and started declining with the
change in the government which halted the major infrastructure projects on allegations of
malpractice. We maintain that construction will remain a vital part for Sri Lanka, as the
country strives to grow following the end of the 30-year civil war. Thus, the fact remains that
these projects are needed for developing the country which should result in the
recommencement of these projects in 2018. We believe that the earnings from these projects
should be realized in the medium to long-term which will result in a re-rating of the overall
industry. Furthermore, when growth is factored in, the sector remains the cheapest with a PEG
of 0.9x. For more information, please refer to our Construction Sector Update – “A hiatus
amidst a growth story”.
Sector has outperformed the ASPI over the last year Valuations have been below the ASPI
Index value P/E (x)

340 20
290
15
240
190 10
140
5
90
40 -
Construction ASPI Contruction ASPI Average
What are the risks?

• Government stance: To us the key risk to the sector remains government involvement
with the large-scale infrastructure projects. Further delays in infrastructure projects could
prolong the recovery of the construction sector.
• Rising input costs: Given the lack of resources in the country, the Sri Lankan construction
sector largely depends on the import of raw materials to drive construction. Thus, in the
case of a sharp increase in global commodity prices, we believe the sector’s profitability
will be impacted.
• Currency depreciation: Given that most of the construction material are imported into
the country. We believe a faster-than-expected depreciation of the LKR will have an
adverse effect on the industry profitability.
45
Our key picks
Tokyo Cement [TKYO]: HOLD [+5.0% TSR] - Expanded capacity provides fresh growth
driver
TKYO experienced strong growth in FY17, with sales growing 18.5% as the company benefited
from the uptick in construction. In FY17, the company operated at full capacity at its 1.8mn
mt/year grinding plant. To further its growth, TKYO went ahead with an additional 1mn
mt/year capacity expansion at its grinding plant which was completed in 4Q FY17, and started
commercial production in 1Q FY18. Despite having expanded its capacity, TKYO is currently
amidst a slowdown in the construction sector, which we expect will last in the near to
medium-term. The company expects to utilize only up to ~40.0% of its new capacity in FY18E,
which leaves considerable room to benefit from a pickup in construction in FY19E.
Furthermore, while we do not expect a retail price revision in FY18E, we believe there is a
high probability of a revision in FY19E. We value the share at 5.7x EV/EBITDA FY18E and arrive
at a TP of LKR 70.30 (+2.6% upside; +5.0% TSR) for the voting share and LKR 61.10 for the non-
voting share (+2.2% upside; +4.8% TSR). HOLD.
46
Manufacturing
GSP+ to give impetus to textile sector; non-textile exporters to see pressure
Naveed Majeed Manufacturing is a mixed bag for us when looking at the next 12-months. Only Regnis
naveed@asiasecurities.lk Lanka PLC (REG) caters primarily to the local market while the others are all exporters. Of
+94 11 772 2043 the exporters, we are particularly bullish on the textile industry post the reinstatement of
the GSP+ in June 2017. With GSP+ benefits yet to be strongly felt, delayed by soft market
conditions in the EU, we expect the tax emptions to bring about a surge from 2H FY18E
onwards. This leads our EPS growth forecast of 30.2% YoY in FY19E, compared to 6.2% in
FY18E. The sector is currently trading at 10.2x FY18E EPS and a PEG. We see little scope
for re-rating for the overall Manufacturing sector however, we see a re-rating of textile
subsector which, given the scale being the second largest foreign currency earner for Sri
Lanka, is best poised to benefit from GSP+. We are bullish on Hayleys Fabric (MGT).

BBG Year CMP TP
bn mn k) (%) (%)
TJL SL Mar-18 25 163 95 35.70 38.00 9-Nov-17 +12.0 12.3 2.1 5.6 17.6 3.6
PIRA SL Mar-18 6 37 6 5.90 7.00 13-Nov-17 +24.1 10.0 1.3 5.4 13.0 2.2
DIPD SL Mar-18 5 33 2 84.90 100.00 13-Nov-17 +21.3 6.3 0.5 3.5 8.6 58.6
HAYC SL Mar-18 4 29 1 148.90 161.00 16-Nov-17 +12.2 5.4 0.6 4.0 11.5 21.7
MGT SL Mar-18 3 19 8 14.10 20.00 13-Nov-17 +41.8 14.8 1.0 - 7.0 146.3
REG SL Dec-17 1 9 7 118.00 160.00 13-Nov-17 +48.3 4.7 0.8 12.7 17.6 14.0
Average 8.9 1.1 5.2 12.6 41.1
The apparel sector Earnings outlook: Despite the loss of GSP+ concessions in 2010, the apparels sector has
demonstrated its continued to grow in the period since. The sector demonstrated its resilience in 2017 despite
resilience in 2017 soft EU market conditions and rising cotton yarn prices. Now, with the reinstatement of GSP+
despite soft EU we believe that the apparel industry is best poised to benefit from the tax concessions being
market conditions the second largest contributor to the country’s exports at 47.5%. As such, we believe that the
and rising cotton textile sub-sector will continue to offer investors a strong return and recommend an increase
yarn prices in exposure to the sector.
The textile sector has been resilient despite the loss of GSP+ in 2010
LKR bn %
6 30
25
5
20
4
15
3 10
5
2
0
1
-5
- -10
2009 2010 2011 2012 2013 2014 2015 2016 YTD '17*
Textile and garment exports YoY Growth %
We see a bleak Looking at the non-textile-export names, we continue to see a bleak picture. HAYC, which
picture for the non- accounts for over 16.0% of the global market share in coconut shell activated carbon faced
textile export strong headwinds from rising coconut shell charcoal in 1H FY18. Cost of coconut shell charcoal
names rose across the market due to 1) a drought-induced shortage in supply in key coconut
manufacturing nations such as Sri Lanka, Indonesia and Thailand coupled with 2) rising global
demand for coconuts. We expect raw material availability in Thailand (25.0% of supply) and Sri
47
Lanka (50.0% of supply) to decline in 2H CY17E due to seasonal factors and as such do not
Consumer sector
expect supply to normalize until 2H FY19E.
slowdown will
impact GLAS in the
We are somewhat bearish on Piramal Glass (PIRA SL) in the near-term given the current
near-term
consumer sector slowdown led by disposable income being hit by tight fiscal and monetary
policies. We expect the market to view the counter positively only towards 2H FY19E, with the
expectation of the GoSL loosening up monetary and fiscal policies.
Overall, in the absence of a differentiating factor, the non-textile-export names rely more on
pricing to drive demand. We note that most of the Asian currencies have depreciated against
the USD relative to the LKR, leading to profitability pressure. We do not see the LKR being
allowed to depreciate at a very rapid pace as 1) there is pressure to increase policy interest
rates on the back of a Fed policy hike and continued credit growth, and 2) the local
government election scheduled for February 2018.
We see earnings growth picking up to 30.2% YoY in FY19E led by the Textile names.
Valuation outlook: The sector is trading at 10.2x FY18E earnings which is a small 3.6% discount
to the five-year average. We do not see much scope for re-rating at present. The Textile
names could pull the sector up on regaining GSP+ concessions but, the weak outlook on the
others would offset most of this.
Sector has significantly outperformed the ASPI this year Valuations are back in line with the ASPI
Index value P/E (x)

350 160
300 140
250 120
100
200
80
150
60
100 40
50 20
- -
Manufacturing ASPI Manufacturing ASPI Average
What are the risks?

• Global growth: Given the reliance on the export markets, global growth and stability
remains the key risk for this sector. Brexit and US elections resulted in apparel
manufacturers seeing some orders being postponed while weak global growth has caused
headwinds for the non-textile manufacturers. A pick up in global growth would provide
good upside but, nationalistic sentiments sweeping across the world could lead to lower
trade volumes.
• Raw material prices: Given the dependence on imports of raw materials such as cotton
yarn, rubber, coconut shell charcoal etc., rising global raw material prices poses a threat
to the profitability of the sector.
• Currency depreciation: Currency remains a weak point for this industry especially against
the backdrop of regional currencies depreciating at a faster pace when compared to the
LKR. However, over the past few months, the Central Bank indicated that it would allow
the LKR to depreciate at a steady pace in the future and will avoid using reserves to
defend the currency which should lead to it being competitive against regional peers.
48
Our key picks
Hayleys Fabric [MGT]: BUY [+41.8% TSR] - An inflection point in profit trajectory
For the last two years, MGT has had a promising strategy of a shift away from cotton-based
products towards more value-added products which command better margins. This has
however, not materialized as customers have been reluctant to move away from cotton-based
apparels. In FY18E, with the synthetic line having evolved, MGT is now able to achieve the
exact levels of comfort and feel of the cotton apparels, which has led to increased acceptance
for their synthetic line as orders are ramping up for 3Q FY18E and 4Q FY18E. Furthermore, we
are also seeing the reinstatement of GSP+ in Sri Lanka help drive increased exports in the
textiles and garments sector, which will benefit large-scale fabric manufacturers like MGT.
The company is also moving away from the EU market, into the US market which is a faster
moving fashion market. We value the share at a 12-month TP of LKR 20.00 (+41.8% TSR). BUY.
49
Healthcare
Higher corporate taxes to result in lower earnings in 2018
Mangalee Goonetilleke We expect to see a pick up in Healthcare during 2018, yet maintain our neutral view on
mangalee@asiasecurities.lk the sector. The key driver is a significant increase in corporate taxes (+16.0pp) which will
+94 11 772 2042 go into effect from 01st April 2018. This would result in a direct impact on earnings, in
particular for hospitals. While price controls on pharmaceuticals will lead to some pressure
on profitability, we see that as a short-term hit, and for the impact to normalize by early
2019. Furthermore, the government is incentivizing local producers with a buyback
program in order to save on imports. However, we note that there is no way in which to
play the pharmaceutical story. While our coverage includes to LHCL and ASIR, given the
impact from the increase in corporate taxes, we make no sector recommendation. We do
acknowledge that the long-term story is still intact for the sector and weaker valuations
would make good buying opportunities for long- term investors.

BBG Year CMP TP
bn mn k) (%) (%)
ASIR SL Mar-18 29 186 6 25.10 22.00 23-Aug-17 -10.4 21.5 4.3 2.0 19.3 96.1
LHCL SL Dec-17 14 90 2 62.00 70.00 21-Nov-17 +16.1 14.2 2.2 3.2 16.0 (4.7)
Average 17.8 3.2 2.6 17.7 91.5
Earnings outlook: In 2016, the Hospital sector became liable for VAT at 15.0% of revenue
while corporate taxes are set to increase to 28.0% from 1 st April 2018 onwards from the current
12.0%. Since May 2016, we saw a dip in revenue and profitability when VAT was initially
introduced to the sector. The VAT increase was primarily for preventative care segment and
elective surgeries. Furthermore, surgeries which were carried out in the private sector
supported by government subsidies saw a significant deferral to a later time or went into the
government sector for treatment despite the long wait time. However, there was some uptick
in earnings towards mid-2017 with dengue epidemic running rampant and demand for private
sector services increasing. While the impact from the dengue epidemic has subsided now, so
has the impact from the VAT imposition last year. However, we are still to see corporate taxes
increased in April 2018. We note that if the sector players do pass on the higher taxes, demand
for tertiary care and preventative care will remain subdued. In our space, the sector includes
ASIR and LHCL.
Private sector beds up 8.0% YoY in 2016 Asiri is currently the largest private sector player
No. beds % Dr. Neville

7,000 10 Fernando Teaching
9 Hospital *, 16%
6,000 Asiri, 9%
8
5,000 7 Nawaloka,
4,000 6 8%
5
3,000 Lanka
4 Other, 54% Hospital
2,000 3
, 4%
2
1,000 1 Durdans
- - , 5%
2011 2012 2013 2014 2015 2016 Hemas Hospitals
Browns Hospitals, 1% , 3%
Private beds YoY growth
Source: Asia Securities, Central Bank Source: Asia Securities, Central Bank | *to be transferred to Govt.
The pharmaceutical distribution business was also hit by price controls imposed on 48 drugs by
the Government in late 2016. While some distributors affected more severely than the others,
across the board, there was a notable impact on margins. To mitigate these, players in the
industry made arrangement with most of the Principals to share the additional costs. However,
we remain positive on the pharmaceutical industry as the government imports a vast majority
of its pharmaceutical requirements. We believe the impact of the price controls has now
minimized with the impact on margins normalizing by early 2018. Currently there are no pure
50
play Pharmaceutical distributors which are listed, and could only be accessed by investing in
HHL.
The other side of the coin in Pharma imports is that it is a drain on FX reserves and subject to
global currency movements. To offset this impact, a buyback program is in place which is
intended to encourage local producers. These players have over the years, benefited from the
buyback programs, enjoying steady growth. Again, there are limited options in which to play
this story, with the only player listed (JL Morison) being 98.0% owned by HHL.
As such, considering our coverage, we believe the sector earnings for FY18E to be up 12.1%.
This is mainly due to the impact from the dengue epidemic. In FY19E, we expect earnings to
be up 30.7% YoY, driven by addition of the Asiri Kandy Hospital.
Valuation outlook: The sector is trading at 19.6x FY18E EPS which is a ~34.0% discount to the
five-year average of 29.9x. We believe corporate taxes going up to 28.0% from 12.0% would
result in a considerable impact on the bottom-line during 2018, before the impact normalize in
early 2019. As a result, we do not believe the sector would see any upward re-rating over the
next 12-months. As such, we do not recommend any stock under this sector.
Healthcare sector is trading below the broader market Valuations are more expensive than the index
Index value P/E (x)

240 41
220 36
200
31
180
160 26
140 21
120
16
100
80 11
60 6
Healthcare ASPI Healthcare ASPI Average
We emphasize that the long-term narrative of Sri Lanka’s private sector healthcare industry
remains intact. It remains a fact that the public healthcare system has significant room for
improvement with no clear indication of Government spending to carry out the improvements.
As per capita income continues to grow, we see more and more patients opting for private
healthcare but remains more of a long-term story.
What are the risks?

• Public healthcare: Development of the public healthcare sector would lead to a shift
away from the private sector due to the significant price differentials on services.
• Price controls: Further price controls on drugs which could impact pharmacy sales at
hospitals
51
Leisure
Arrivals lag rising room supply; occupancy rates dilute
Naveed Majeed We take a neutral view on the Sri Lankan leisure industry over 2018. Our view is driven on
naveed@asiasecurities.lk that fact that an increase in rooms supply coupled with slower-than-expected growth in
+94 11 772 2043 arrivals will result in demand lagging supply in the near to medium-term. We also see the
rise in the informal segment being a threat to the larger listed players, noting that the
informal market has eaten into the market share of established players, particularly in the
popular Western and Southern coasts of the country. We forecast earnings growth of 22.0%
YoY in FY19E against our expectations on closing FY18E with a 11.5% decline. We believe
most of the challenges ahead have already been priced in with the sector trading at 12.2x
FY18E EPS, with a PEG of 1.1x.

BBG Year CMP TP
bn mn k) (%) (%)
AHPL SL Mar-18 25 164 6 56.80 45.00 13-Dec-17 -13.7 11.9 0.8 7.0 6.4 9.3
JKHL SL Mar-18 13 84 1 8.90 9.00 13-Dec-17 +4.5 10.1 0.5 3.4 5.1 17.2
AHUN SL Mar-18 10 68 2 31.00 30.00 13-Dec-17 +0.0 12.6 0.5 3.2 4.3 63.6
Average 11.5 0.6 4.5 5.3 30.1
Earnings outlook: In recent years, the government’s annual arrival targets have often been
Tourist arrivals for revised downward due to the actual momentum in arrivals being weaker than expected.
2017 came in at However, 2016 was a relatively strong year for the industry with the data from the SLTDA
2.12mn, below the (SLTDA) indicating that arrivals for the year crossed the 2.00mn mark, clocking 2.05mn as at 31
government’s December 2016. This was however, below the SLTDA’s forecast of 2.20mn tourists for the year.
target of 2.50mn
tourist arrivals for Tourist arrivals for 2017 came in at 2.12mn, below the government’s target of 2.50mn tourist
2017 arrivals for 2017. The government fell short of its target due to factors such as the partial
closure of the airport, adverse weather conditions in 2017 that lead to floods and the dengue
epidemic in the year.
Tourist arrivals to grow at 13.2% CAGR CY17-20E…
mn %
3.5 30
3.0 25
2.5
20
2.0
15
1.5
10
1.0
0.5 5
0.0 0
CY12 CY13 CY14 CY15 CY16 CY17 CY18E CY19E CY20E
Arrivals (LHS) YoY growth (RHS)
Source: SLTDA, Asia Securities

Lack of clear focus
by the government
on promoting the Despite these numerous attractions within the country, especially when compared with
country has been regional peers, we believe a lack of clear focus by the government on promoting the country
the key factor has been the key factor behind the slower-than-expected growth in arrivals. Sri Lanka was to
behind the slower- launch what was seen as its first big country promotion campaign in November 2016 but, is yet
than-expected to materialize. Political instability has been the driver behind this delay and the campaign is
growth in arrivals now slated to commence early next year. With the expectation of promotion campaign to take
place in next year, we expect tourist arrivals to grow 12.0% to 2.32mn in 2018.
52
On the supply side, we expect rising room inventory to impact the profitability of the sector in
the near to medium-term. Of the ~6,500 rooms that are currently in the pipeline to enter the
market from CY17E-20E, up to 2,500 new rooms being added in CY17E and another 3,000 rooms
to come up in CY18-19E. Colombo’s room inventory strength was mainly boosted by Jetwing
Colombo Seven (98 rooms), Manderina (80 rooms), Movenpick (219 rooms), Sunhill Hotel Mount
Lavinia (25 rooms) and also partly Chinese-owned ZMAX in Fort (181 rooms) in CY17. We
believe that demand (tourist arrivals) will lag the increase in hotel room supply in 2018. Due to
this, we expect occupancy rates to dilute slightly across the hotel industry. However, we
expect room rates at graded hotels to remain broadly stable in USD terms across the industry,
especially with the government retaining the minimum rates for city hotels.
Room count to increase over CY2017-20E Hotel room nights account for a lesser proportion
No. of rooms 15.3% 11.1%

26.3% 23.4% 26.8% 23.5%
35,000
1,000 25.0%
30,000 3,000 26.2%
2,500 23.6% 23.8% 23.9% 25.8%
25,000 22,336
20,000
15,000 58.5% 63.9%
50.1% 52.8% 49.2% 50.6%
10,000
5,000
- 2011 2012 2013 2014 2015 2016
2016 2017E 2018E - 2019E 2020E
Tourist Hotels Supplementary Establishments Others
Source: SLTDA, Asia Securities Source: SLTDA, Asia Securities
The informal segment has seen strong growth over the past few years with the government
encouraging home stay units and guesthouses. As Sri Lanka’s profile as an attractive
destination has increased, the number of backpackers into Sri Lanka has increased as well. This
While Sri Lanka’s
has increased the informal market locally, since these travelers are not willing to spend
attractiveness as a
premium rates for their hotel stays. According to data published by the Sri Lanka Tourist
destination has
Board, the amount of unregistered lodging establishments has increased at a 19.0% CAGR
increased, so has
during CY11-16 from 654 establishments to 1,558 establishment. This has resulted in the
the informal
percentage of tourist nights spent in informal accommodation rising from 41.5% in CY11 to
market
49.4% in CY16. We believe the rise in the informal sector will continue to pose a large threat
to the formal sector players going forward.
Other key risks to profitability include labour cost and energy costs where, according to the Sri
Key risks to Lanka Institute of Tourism and Hotel Management, the Sri Lankan hotel industry requires up to
profitability 150,000 new employees by CY20E to cater to the demand created by the new openings. We
include labour and note that labour costs account for ~17.0% of total revenue. As such, due to the shortage in
energy costs labour, we expect rising labour costs to impact the profitability of the sector in the medium to
long-term.
On the energy side, we note that the leisure sector has benefited from energy prices being
reduced by the present Government in 2015. However, with the GoSL expected to implement a
transparent energy pricing formula in March 2018, we believe the energy costs could rise
again. We note that energy costs account for ~5.0% of total revenue on average for the leisure
sector.
Looking ahead, we forecast the sector’s EPS growth at 22.0% YoY for FY19E, a pick up from the
11.5% decline we forecast for FY18E.
53
Valuation outlook: The leisure sector is trading at 12.2x FY18E EPS which is below its historic
five-year average of 13.2x. We note that the leisure sector index has fallen 19.1% in 2017. Our
sense is that most of the challenges ahead have already been priced in and do not expect
further re-ratings in the near-term.
Sector has underperformed the ASPI consistently in the past Valuations have been broadly in line with the ASPI
Index value P/E (x)

160 18
140 16
120
100 14
80 12
60 10
40
20 8
- 6
Leisure ASPI Leisure ASPI Average
What are the risks?

• Delays in implementing promotion campaign: In our view, Sri Lanka is in much need of a
promotion campaign to create awareness about the country and boost its arrivals, given
that the supply in the sector has been growing rapidly. While the Tourism authorities have
delayed the campaign in the past, we are of the expectation that a campaign will be
launched in 2018.
• Delays in supply being absorbed: We believe further delays in the campaign and a
resultant slow pickup in arrivals can lead to the expanded capacities being underutilized
and players in the sector being challenged to cover their fixed costs at minimal.
• Unforeseen events impacting arrivals: In 2017, event such as the floods and the dengue
epidemic resulted in travel advisories being issues against Sri Lanka in traditional markets.
We note that any such similar events in 2018 could also lead to a slowdown in tourist
arrivals in 2018.
• An increase in labour and energy cost: As discussed above, we believe the shortage of
labour in the hotel sector and the implementation of the transparent energy pricing model
will be a threat to the sector’s profitability.
54
Insurance
Higher taxes and lower yields to hit industry returns
Kanishka Perera We continue to take a neutral stance on the insurance industry over the next 12-months.
kanishka@asiasecurities.lk 2017 turned out better than expected with both small and large players focusing more on
+94 11 772 2044 bringing claims ratios under control. While the year saw another national catastrophe level
flood, the impact was muted as it was concentrated outside the more economically active
Colombo district. Headwinds on consumer spending power spilled over to the Life
Insurance industry which has a large presence in rural areas which tends to be more
sensitive to any squeeze on spending power. Looking in CY18E we believe that General
Insurance will be a steady performer while Life Insurance will see some headwinds.
Furthermore, we believe that the new Inland Revenue Act will hit industry profitability
through higher taxes as well as through lower investment yields. We forecast earnings
growth to slowdown to 12.4% YoY in CY18E vs. our expectations of 24.4% for CY17E.
Valuations are at some of the lowest levels seen in the last five years at 1.0x CY18E BV
but, we believe that there are too many negatives to lead an overall upward rerating. As
such, we make no recommendations from the Insurance industry for CY18E.

BBG Year CMP TP
bn mn k) (%) (%)
CINS SL Dec-17 37 243 8 1,597 1,563 17-Nov-17 -0.4 6.7 1.3 1.7 21.1 (7.2)
JINS SL Dec-17 9 57 13 16.00 17.30 22-Nov-17 +14.4 3.8 0.9 6.3 22.6 3.7
AAIC SL Dec-17 8 54 72 22.10 20.20 16-Nov-17 -4.1 6.5 2.7 4.5 50.0 (0.7)
PINS SL Dec-17 5 30 8 22.80 21.00 27-Oct-17 -0.4 6.0 1.5 7.5 26.9 8.8
HASU SL Dec-17 4 24 5 72.60 67 8-Nov-17 -0.1 4.4 1.1 8.1 28.0 13.3
Average 5.5 1.5 5.6 29.7 3.6
Earnings outlook: 2017 was a positive year for the General Insurance (GI) industry. Our
expectations of a slowdown in new vehicle registrations materialized but, in a shift from the
norm, most players started concentrating on profitability rather than aggressively pursuing
market share. We note that some of the smaller players recorded GWP growth in excess of
25.0% YoY purely on the back of higher pricing on high claim products and customers leading to
gains in overall industry claims ratios. However, May 2017 saw another national catastrophe
level flood but, had a lesser economic impact when compared against the May 2016 flood as it
was concentrated outside of the Colombo district. The year saw no further M&A activity. The
Sri Lanka Insurance Corporation (SLIC; state owned) and CINS continue to be the top two
players while JINS was the third largest player and Fairfirst was a close fourth. Looking into
CY18E we see limited opportunities as we believe that the best assets have now been acquired
by incumbents. GI penetration remains well below 1.0% of GDP indicating significant scope for
growth over the long term.
Life Insurance (LI) had a mixed year in 2017. Heavy headwinds on consumer spending power
led to a slowdown in growth from the rural sector where LI is seen more as a luxury. While we
expect somewhat of a recovery in CY18E, we believe that it will be a slow one. However,
players who concentrated on high middle income customers continued to see growth coming
through. A key highlight of the year was the shift to valuing LI liabilities on a GPV basis from an
NPV basis. This led to substantial levels of surpluses being recorded by the industry. However,
the regulator has requested all players to retain the excess surplus and not to distribute to
shareholders until further notice is given.
We forecast EPS to grow by 12.4% YoY in CY18E led through: 1) a 0.7pp improvement in the
underwriting margin as players continue to remain focused on profitability, 2) flattening
investment yields, and 3) a slowdown in LI led growth with the upcoming changes from the
new Inland Revenue Act which amongst other things taxes surplus transfers to shareholders at
the corporate tax rate.
55
Investment yields to dip in near-term and flatten out GI claims ratio to improve but, marginally
(%) (%)
15 68
14 66
13 64
12 62
11 60
10 58
9 56
8 54
CY12 CY13 CY14 CY15 CY16 CY17E CY18E CY19E CY12 CY13 CY14 CY15 CY16 CY17E CY18E CY19E
Interest and dividend yield GI claims ratio
Source: Company reports, Asia Securities Source: Company reports, Asia Securities
Valuation outlook: Our Insurance coverage universe currently trades at 1.0x CY18E book value
which is significantly cheaper compared to the average 1.8x it used to trade at over the last
five years. While profitability has recovered from a strong focus on claims ratios, the new
Inland Revenue Act will lead to a decline in investment yields. Furthermore, LI players will pay
a higher amount of corporate taxes due to life surplus transfers becoming taxable. As such, we
are more optimistic on the GI side while turning more bearish on the LI side and believe that
investors will take a more neutral view on the sector as a whole.
Sector has outperformed the ASPI in the last five years Valuations have fallen below the five year average
Index value P/B (x)

380 2.4
330 2.2
280 2.0
230 1.8
180 1.6
130 1.4
80 1.2
Insurance ASPI Insurance ASPI Average
What are the risks?

• Competition: While price competition has come down last year, it remains the key threat
for the GI industry given the largely homogenous nature of the product. Furthermore, we
have seen a pick-up in competition in the LI industry especially at the mid-high income
level bracket. However, LI penetration remains quite low leaving headroom for players to
grow into prior to taking on a more aggressive stance on competition
• Interest rates: A substantial concentration of invested assets into fixed income

instruments leaves the industry’s investment yields substantially exposed to rate
movements.
56
Non-Bank Financial Institutions

Separating the weak from the strong
Lakshini Fernando We take a neutral view on the Sri Lankan NBFI sector which has seen a number of
lakshini@asiasecurities.lk headwinds in the past 2 years, which we expect to last over the medium-term. This has
+94 11 772 2045 come in the form of higher import duties and a depreciating currency combined with the
lowering of the loan to value ratio which have reduced vehicle affordability (vehicle leases
account for over 70.0% of all leases). All companies under coverage have recorded
significant impairments since FY17 which have continued into 1H FY18 on the back of 1)
significant net advance growth during a conducive environment in FY14 and FY15, 2) a
high inflationary and slow growth environment, combined with 3) extreme weather
conditions. Furthermore, the Central Bank has taken steps to tighten regulation on the
sector, starting with increasing the core capital requirement by 5x to LKR 2.0bn by 2020,
and to LKR 2.5bn by 2021. We expect this to drive consolidation during this period given
that 12 out of the 30 listed companies currently do not meet this requirement. In addition,
we expect the tighter regulations to create a more transparent and stringent sector in the
longer-term. In the short-medium term, we expect the stronger NBFIs to remain resilient
amidst the changes in the industry while reducing its dependence on vehicle leasing which
has been the dominant product for NBFIs in the past.

BBG Year CMP TP
bn mn k) (%) (%)
PLC SL Mar-18 27 175 20 17.00 17.30 30-Oct-17 +9.1 6.4 1.0 7.4 15.5 267.5
CFIN SL Mar-18 20 131 66 93.00 95.10 4-Dec-17 +4.8 3.7 0.6 2.5 15.9 6.2
LFIN SL Mar-18 18 115 11 127.00 132.90 27-Oct-17 +11.7 4.4 1.2 7.1 28.8 184.1
COCR SL Mar-18 14 89 17 43.00 39.10 12-Dec-17 -5.6 4.7 1.1 3.5 24.6 105.6
CDB SL Mar-18 3 20 7 65.60 68.00 12-Dec-17 +9.0 3.2 0.5 5.3 17.2 187.8
Average 4.5 0.9 5.2 20.4 150.2
Earnings outlook: Our view is driven on 1) a slow NIM pickup in the short term despite loose
monetary policy, 2) high impairments which will pressure NPLs and 3) a higher core capital
requirement to fuel further consolidations. Furthermore, the recently published Roadmap for
2018 and beyond stipulates that the Central Bank will look to imposing a total capital
adequacy ratio of 12.0% with the intention of improving the sensitivity to risks while focusing
on credit risk based on borrowers’ risk profiles. Currently all NBFIs under our coverage (PLC,
CFIN, COCR, CDB and LFIN) meet this requirement. In addition, the new regulations by the
Central Bank and external factors like prolonged extreme weather conditions have had a
significant negative impact on the coverage company’s impairments.
While secondhand leasing has taken off in the recent past, our concern with more NBFIs
moving into the secondhand leasing market remains that there are currently significantly large
players in this area with dominating market share. With several companies vying for market
share, we expect stiff competition within the secondhand market to put pressure on margins.
In addition, companies have moved into other loan products like the SME loan sphere where
still competition from the banks exists. Gold loans are another popular type of loans for NBFIs.
However, we are cautious on loan growth through gold loans due to at least two further rate
hikes in CY18E in addition to the 25bps rate hike in December 2017.
57
Impairments have picked up over the last 12M NIMs to flatten in FY18E and pick up from FY19E onwards
LKR mn (%)
4,000 13.5
13.0
3,000 12.5
12.0
2,000 11.5
11.0
1,000 10.5
10.0
0 9.5
LFIN CDB CFIN PLC COCR FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E
TTM 2Q FY17 TTM 2Q FY18 NIM
Source: Company report, Asia Securities Source: Asia Securities, Bloomberg
The headwinds in the industry has brought about a diversification strategy away from the key
product which has been vehicle leasing, into areas of SME leasing, gold loans and other loan
products in most of the companies under coverage. While we perceive the change in the NBFI
industry to be a negative in the short-medium term, we expect this to be beneficial in the
longer term once the tighter regulations imposed by the Central Bank and a somewhat new
normalization of the entire sector come into play. We expect the stronger NBFIs to remain
resilient to the headwinds experienced in the sector, while we foresee considerable
consolidation with the smaller NBFIs.
Timeline Core capital requirement (LKR bn)
1st Jan 2018 1.0
1st Jan 2019 1.5
1st Jan 2020 2.0
1st Jan 2021 2.5
While we are negative on the broader industry, we believe that there are still some options.
We like Finance companies which are 1) exposed to the upcoming infrastructure led growth, 2)
have limited exposure to pawning, and 3) has a solid funding base. As such, we recommend
exposure into PLC. However, we note that the broader negative sentiment on the industry
could result in slower price discovery.
We factor in earnings growth of 10.7% in FY19E. This is led by our expectations on demand
from the commercial vehicle side and non-core loan products. However, upcoming Fed rate
hikes will lead to pressure on gold prices which will in turn lead to impairment losses for the
Finance industry which has a significant exposure to it through pawning. This impact will be
offset to an extent through the tighter LTVs being given by the Finance companies along with a
very short duration loans on such asset classes. We expect an overall NIM squeeze experienced
for most of FY18E to taper down in FY19E.
Valuation outlook: Our coverage universe is trading at 0.8x FY18E BV but, has come down
significantly from the 1.3x recorded over the past five years. We forecast ROEs, which
averaged 27.5% during the same period, to decline to 18.9% on the back of the earnings
slowdown. Furthermore, the Central Bank plans on increasing the minimum capital
requirement of Finance companies by 5x to LKR 2.0bn by 2020. While our coverage universe is
unaffected by this, it will lead to the overall industry being viewed in a negative light. As such,
we do not foresee an upward re-rating of the sector in the near term. Longer term however,
we believe that commercial leasing focused counters would post strong earnings growth which
in turn could lead to upward revisions on the overall sector.
58
Performance has declined since peak in 2015 Valuations have dipped below the ASPI
Index value P/B (x)

300 2.0
250 1.8
1.6
200
1.4
150
1.2
100
1.0
50 0.8
- 0.6
Financials ASPI Financials ASPI Average
What are the risks?

• Gold prices: A greater than expected decline in gold prices is the key negative risk we see
for the industry. We believe that most of the bad news is already factored in and do not
see any further negative risks
• Vehicle imports: What would change our view to a positive is if vehicle import duties are
reduced along with a relaxation of the new LTV requirements. Given the government’s
focus on preserving FX reserves, we believe that such an event is highly unlikely in the
near term and is more probable over the longer term.
59
Energy
Negative sentiments driven by low probability of price hike
Naveed Majeed We remain negative on the Energy sector in FY18E as we see no room for any upside due
naveed@asiasecurities.lk to a very low probability of any retail price revisions, especially with the local government
+94 11 772 2043 election around the corner in February 2018. However, with the GoSL being set a deadline
of March 2018 to implement the transparent energy pricing formula, we believe the
Government will be compelled to adhere to this to benefit from the Extended Fund Facility
Programme (EFF) of the IMF. While we view this positively, we are cautious given a history
of having missed deadlines in the past. Given that it is imperative for the GoSL to
implement the pricing formula for fiscal consolidation, we factor in the impact of the
pricing formula from FY19E onwards. These factors lead our EPS growth forecast of 341%
YoY for FY19E, mainly on the back of a low base in FY18E, where we forecast a 73.3% YoY
decline. The sector is presently overvalued at 46.2x FY18E EPS mainly due to low
profitability expected from retail prices being left low in FY18E. We expect this to
normalize in FY19E with price hikes/fuel pricing formula coming into play and expect the
sector to trade at 11.0x P/E FY19E.

BBG Year CMP TP
bn mn k) (%) (%)
LLUB SL Dec-17 29 188 131 120.00 140.00 20-Oct-17 +25.0 10.5 6.8 8.3 68.2 (57.8)
LIOC SL Mar-18 17 108 10 31.10 27.00 5-Jan-18 -10.0 nm 0.8 3.2 (2.0) (31.9)
LGL SL Mar-18 9 60 2 27.70 24.80 20-Nov-17 -10.5 nm 1.3 - (10.5) 375.3
Average 10.5 3.0 3.8 18.6 95.2
Earnings outlook: 2017 saw poor results from the fuel and LPG players which were pressured
into losses from regulated retail prices that were kept low, in combination with a pickup in
global oil, propane and butane prices. In addition, stiff competition in the lubricants market
saw LLUB being hit severely during the year with the share price falling 24.2% YTD. The fuel
market as it remains is driven mostly through a political thought process rather than an
economic one. We note that fuel prices tend to be depressed by the government in periods
leading up to elections putting pressure on profitability, and as showcased in LIOC’s and LGL’s
results in 1H FY18. As such, with the local government elections set to take place in February,
we do not expect any changes to retail prices in FY18E.
Prices have remained unchanged at the pumps since 2015… …while global crude oil prices have picked up
LKR/litre USD/bbl
190 100
170 90
150 80
130
70
110
60
90
50
70
50 40
Jan-06 Nov-07 Sep-09 Jul-11 May-13 Mar-15 Jan-17 30
Petrol 92 Octane Petrol 95 Octane 2014 2015 2016 2017E 2018E 2019E 2020E 2025E 2030E
Auto Diesel Super Diesel Crude oil, avg
Source: CBSL, Asia Securities Source: World Bank, Asia Securities
Fuel prices were last reduced sharply in January ‘15, where the price of a litre of 92-octane
petrol was reduced from LKR 150 to LKR 117 (-22.0%), while the price of 95-octane petrol was
reduced from LKR 158 to LKR 128 (-19.0%). Auto diesel prices were reduced from LKR 111 to
LKR 95 (-14.4%) while super diesel was reduced from LKR 138 to LKR 110 (-20.2%). While losses
on petrol were borne since the price reduction in January ’15, diesel was profitable up until
August ’16 after which margins plummeted following the imposition of the LKR 10/liter hike in
excise duties on Diesel. This saw the excise duties on Diesel being quadrupled to LKR
60
13.00/litre from LKR 3.00/litre previously. Despite the reduction of retail prices and duties,
margins were sustained with global crude oil prices hitting as low as USD 26.55/barrel in 2016.
However, with global crude oil prices reaching USD 58.36/bbl as of 01 December, compared to
an average price of USD 42.80/bbl in 2016, LIOC was driven into severe losses in 2017. We note
that, at the current prices, LIOC bears a loss of LKR 7.56/litre of 92-octane petrol, LKR
4.06/litre of 95-octane petrol and LKR 3.61/litre of Auto Diesel as of November 2017.
Meanwhile, we note that propane prices averaged USD 447/tonne (+53.1% YoY) in 2Q FY18 and
butane prices averaged USD 468/tonne (+52.7% YoY), while retail LPG prices were revised
upwards by only 8.3% in September ‘17. While we expect the full benefit of the price revision
to be felt from 3Q FY18E, we do not expect LGL to turn around a profit, but reduce its losses
in the Local Energy segment.
We take a take a We take a take a bearish view on the lubricants market for 2018. Our view is driven through
bearish view on the prospects of 1) higher competition, 2) longer drip intervals, and 3) slower demand from the
lubricants market motor side as well as a drop in demand from the thermal IPP side. As such, despite LLUB being
for 2018 driven one of our key picks in 2017, we do not see any major upside to the share over 2018.
through prospects
of 1) higher We note that the IMF push for a fuel pricing formula would be a game changer in protecting
competition, 2) the sector from political currents but, implementation has been delayed continuously in the
longer drip past. While we like the LPG market, we note that there is no sound manner in which to play it
intervals, and 3) with the only listed player, Laufgs (LGL SL), significantly leveraging the balance sheet and the
slower demand result interest expenses bearing down on profits. As such, our pick in a scenario of the pricing
from the motor formula being implemented would be LIOC. We believe its significant cash position (~LKR 8bn)
side and low leverage (~15.0%) could make it a significant outperformer if the pricing formula was
implemented.
We expect an EPS decline of 73.3% in FY18E in light of the low regulated retail prices and
rising global commodity prices. Higher interest payments on the more leveraged names and
higher taxes on diesel are the other key drags on earnings growth in our view for FY18E.
However, under the assumption of the pricing formula being implemented in FY19E, we factor
in earnings growing faster in FY19E. As such, we expect EPS growth of 341% in FY19E, mainly
on the back of a lower base in FY18E.
Valuation outlook: The sector is presently overvalued at 46.2x FY18E EPS mainly due to low
profitability expected from retail prices being left low in FY18E. We expect this to normalize
in FY19E with price hikes/fuel pricing formula coming into play and expect the sector to trade
at 11.0x P/E FY19E. Given the political influence on the fuel market we do not see much scope
for an upward re-rating in FY18E, as fuel pricing remains a key lever which the government
utilizes during elections with local government elections set to be held in February 2018.
However, with March 2018 set as the deadline to implement the pricing formula, we believe it
would help re-rate the sector upwards in FY19E. While we do not have a key pick on the sector
however, we believe the pricing formula coming aboard will largely benefit LIOC given its
strong cash position and low debt levels. While LGL too will benefit from the pricing formula,
we believe the company’s earnings will be dragged down by interest expenses and its
expansions plans going through to FY20E.
Sector has outperformed the ASPI but, is flattening out Sector has remained overvalued in 2017
Index value P/E (x)

250 24
22
200 20
18
150 16
100 14
12
50 10
8
- 6
Energy ASPI Energy ASPI Average
61
What are the risks?
• Crude oil prices: Our estimates factor in the World Bank estimate for Brent at USD
56.00/bbl for 2018E. Any major positive or negative deviation from that will result in
changes to our view as none of our coverage hedges against crude oil price movements.
• Fuel pricing formula: A key positive risk we see is the implementation of a fuel pricing
formula which would significantly negate the political influence on fuel pricing. This was
one of the requirements of the IMF when providing the extended fund facility but, has not
been implemented as of yet. Post the end of the local government election in February,
we believe there is a high probability of the government implementing the pricing in March
2018 to benefit from the EFF.
• Vehicle imports: Relaxation of vehicle imports through duty reductions and lower interest
rates would also give the sector a positive boost. Given the need to preserve FX the
probability of such an event remains muted in the next 12-months.
62
TOP PICKS
63
SRI LANKA EQUITY | TEXTILES
INVESTMENT THESIS | 09 JANUARY 2018
Hayleys Fabric [MGT]: BUY [+42%] Naveed Majeed

naveed@asiasecurities.lk
+94 11 772 2043
An inflection point in profit trajectory
For the last two years, MGT has had a promising strategy of a shift away Key statistics
from cotton-based products towards more value-added products which BBG ticker MGT SL
command better margins. This has however, not materialized as customers CSE ticker MGT.N0000
have been reluctant to move away from cotton-based apparels. In FY18E, GICS subsector Textiles
with the synthetic line having evolved, MGT is now able to achieve the
Price at 08 Jan 18 (LKR) 14.10
exact levels of comfort and feel of the cotton apparels, which has led to
52 week Hi/Lo (LKR) 17.10/13.30
increased acceptance for their synthetic line as orders are ramping up for
3Q FY18E and 4Q FY18E. Furthermore, we are also seeing the Market cap (LKR mn) 2,929
reinstatement of GSP+ in Sri Lanka help drive increased exports in the Market cap (USD mn) 19
textiles and garments sector, which will benefit large-scale fabric No. of shares (mn) 208
manufacturers like MGT. The company is also moving away from the EU ADT (LKR mn) - 3M 1.1
market, into the US market which is a faster moving fashion market. We ADT (USD k) - 3M 7.5
value the share at a 12-month TP of LKR 20.00 (+41.8% TSR). BUY. ADT (shares k) – 3M 72.9
Free float (%) 17.4
Synthetic business gaining traction; orders materializing at a fast pace
Public float (%) 36.9
MGT has seen an increased number of synthetic fabric orders materialize in
Company website | CSE website
FY18 and expects the synthetic line to make progress going into FY19E. Even
though the ASP commanded by cotton and synthetic fabrics are the same, the Source: CSE, Bloomberg, Company data
cost of producing synthetic fabric is much cheaper and thus yields better Note: LKR converted at 153 LKR per USD
margins. According to management, with the shift to synthetic products, it now
Valuation summary
only takes 500t/month to breakeven compare to 725t/month previously. MGT
struck a mix of 26:74 (Synthetic vs Cotton) in FY17, and expects to hit a mix of Price at 08 Jan 18 (LKR) 14.10
35:65 by the end of FY18E and looks to expand to a 50:50 mix in the long-term. Target price (LKR) 20.00
We also view the shift away from cotton fabrics as a key positive as it reduces Upside (%) +41.8
MGT’s exposure to the volatility of cotton prices, which impacted MGT’s FY18E DPS (LKR) -
profitability in FY18. With the value-added products finally starting to pay Total return (%) +41.8
dividends, we believe a turnaround story is on the cards for MGT. Source: Asia Securities
MGT will benefit from higher volumes following reinstatement of GSP+ Share price movement (indexed to MGT)
Export revenue from textiles and garments to Sri Lanka grew 9.6% YoY in July LKR
CY17, the fastest growth seen for the sector in CY17 supported by GSP+ making 20
Sri Lankan goods more competitive in the EU market. We believe this pickup in 19
volume will largely benefit large-scale fabric manufacturers like MGT. 18
17
Fast moving US fashion market will help better margins 16
MGT has been moving away from the EU and into the US market, which is a 15
14
faster moving market in terms of fashion. The EU market continues to be a low
13
margin region with stiff competition from the likes of Bangladesh and Vietnam.
12
With the GSP+ expected to be short lived till CY20E, we view MGT’s move to Jan-17 May-17 Sep-17 Jan-18
establish itself in the US market a positive. As of FY17, MGT had 20.0%
exposure to the US market and 75.0% to the EU. (~99.0% EU 3 years ago). MGT ASPI S&P SL20
Movement (%) YTD 3M 12M

We value MGT at a TP of LKR 20.00/ share
MGT 4 (9) (6)
We expect MGT to post strong topline going into 2H FY18E and FY19E helped by
GSP+, while falling cotton prices should also help profitability. As such, we ASPI 3 0 6
value the share at 12.5x P/E and arrive at a TP of LKR 20.00/ share (+41.8% S&P SL20 4 0 10
TSR). BUY. Source: CSE, Bloomberg
Financial summary
In LKR mn (FY ended March) FY15 FY16 FY17 FY18E FY19E FY20E
Revenue 8,636 8,495 8,333 9,605 10,875 11,504
EBITDA 492 666 527 694 979 1,093
Recurring net profit 90 262 74 198 470 536
Diluted recurring EPS (LKR) 0.43 1.26 0.35 0.95 2.26 2.58
ROE (%) 5.2 11.2 2.8 7.0 15.0 14.7
P/E (x) 32.4 11.2 39.8 14.8 6.2 5.5
EV/EBITDA (x) 13.6 10.8 14.7 14.2 10.0 9.0
P/B (x) 1.4 1.1 1.1 1.0 0.9 0.7
Source: Company data, Asia Securities
64
Key ratios
FY ended March FY15 FY16 FY17 FY18E FY19E FY20E
Revenue growth (%) 6.7 (1.6) (1.9) 15.3 13.2 5.8
EBITDA growth (%) 85.2 35.3 (20.9) 31.7 41.2 11.6
Recurring net profit growth (%) (149.2) 189.8 (71.9) 168.6 137.9 14.1
EBITDA margin (%) 5.7 7.8 6.3 7.2 9.0 9.5

Net margin (%) 1.0 3.1 0.9 2.1 4.3 4.7
Recurring diluted EPS (LKR) 0.43 1.26 0.35 0.95 2.26 2.58
DPS (LKR) - - - - - -
Tan. BVPS (LKR) 10.06 12.41 13.03 13.98 16.24 18.83
OCF (LKR mn) (64) 472 396 804 792 956

Unlevered FCF (LKR mn) (293) 83 (282) 372 302 439
Levered FCF (LKR mn) 413 (362) 50 384 51 285
OCF/EBITDA (%) (12.9) 70.9 75.2 116.0 80.9 87.5

Unlevered FCF/EBIT (%) (130.2) 22.2 (139.6) 110.6 50.0 63.6
Levered FCF/Recurring net profit (%) 457.4 (138.5) 68.2 194.4 10.9 53.2
ROA (%) 4.0 6.1 3.5 4.2 7.2 7.7

ROE (%) 5.2 11.2 2.8 7.0 15.0 14.7
P/E (x) 32.4 11.2 39.8 14.8 6.2 5.5
EV/EBITDA (x) 13.6 10.8 14.7 14.2 10.0 9.0
P/B (x) 1.4 1.1 1.1 1.0 0.9 0.7
Dividend yield (%) - - - - - -
Dividend payout (%) - - - - - -
Company profile
Hayleys Fabric is the pioneer in textiles manufacturing in Sri Lanka. Its parent company, Hayleys PLC (HAYL SL EQUITY), is
one of Sri Lanka’s oldest conglomerates. They provide a complete portfolio of end to end solutions from design to
manufacturing of fabric made out of natural and synthetic fibers. They have leading global fashion brands, such as
Decathlon, Intimissimi, Victoria’s Secret, NEXT, BHS, Marks and Spencer, TESCO, George, and DBA as their partners. The
company was established in 1993.
65
Top 10 shareholders – Voting (% held)
Shareholder Sep-16 Jun-17 Sep-17 Δ YoY (pp) Δ QoQ (pp)
Hayleys PLC No.3 Share Investment Account 58.96 58.96 58.96 - -
The Ceylon Investment PLC. A/C No 02. 5.42 5.42 4.52 -0.90 -0.90
The Ceylon Guardian Investment Trust PLC. A/C No 02. 5.24 4.52 4.41 -0.83 -0.11
Employees Provident Fund 2.67 2.67 2.67 - -
Hayleys Advantis Limited 2.42 2.42 2.42 - -
Union Assurance PLC/ A/C NO.05 (Unit-Linked Life Insurance Fund-

- - 2.41 +2.41 +2.41
Equity Fund)
Hayleys Agriculture Holdings Limited 1.67 1.67 1.67 - -
The Ceylon Chamber of Commerce Account No.02 1.23 1.21 1.21 -0.02 -
Mr. A.N.Esufally 0.86 0.87 0.87 +0.01 -
Mr. A.M.Weerasinghe 0.87 0.87 0.87 - -
66
SRI LANKA EQUITY | ALCOHOLIC BEVERAGES
Lion Brewery [LION]: BUY [+30%] Mangalee Goonetilleke

kanishka@asiasecurities.lk
+94 11 772 2042
Excise duty revisions to result in market share gains
For FY18E, we expect the reduction in excise duties to favourably impact Key statistics
LION’s results, despite the low consumer sentiment in the country. With BBG ticker LION SL
prices on average down 32.0% post the duty revisions, we are already CSE ticker LION.N0000
seeing a switch from hard liquor to beer consumption. We also expect GICS subsector Alcoholic Beverages
operating leverage to help margins as seen in 2Q. However, we believe
there will be some pressure on the bottom-line with high interest expense
52 week Hi/Lo (LKR) 570.00/405.50
as debt level still remain high. Adjusting for these factors, our DCF
valuation indicates a TP of LKR 735/share resulting in a TSR of +30.2%. BUY. Market cap (LKR mn) 45,176
Market cap (USD mn) 297
Reduction in excise duties to aid growth in FY18E as beer becomes cheaper No. of shares (mn) 80
On the back of a low base in 2Q FY17, revenues in 2Q FY18E were up 49.2% ADT (LKR mn) - 3M 40.1
YoY. Yet, this is still 32.0% below the corresponding period in FY16, prior to the ADT (USD k) - 3M 263.6
floods. However, we believe excise duty reductions imposed by the 2018 ADT (shares k) – 3M 74.8
budget last week, should provide significant upside afor LION. There was a Free float (%) 10.2
33.0% reduction in taxes for beer and a 2.0% increase for hard liquor, effective
immediately. The budget also removed taxes for imported beer cans. As a
result, LION prices on average are down ~32.0% while the most popular hard
liquor, Special Arrack by DIST SL, is up ~6.0%. Hence, we expect LION to gain Source: CSE, Bloomberg, Company data
market share lost to DIST over the past two years. Our channel checks also Note: LKR converted at 153 LKR per USD
confirmed that there is faster movement in LION strong beer, compared to the
Valuation summary
185ml Special Arrack bottle, sales of which seems to have dipped by nearly
30.0-40.0% at the vendors we spoke to. Our one concern is the competing Price at 08 Jan 18 (LKR) 564.70
brands Anchor and Tiger which grabbed market share while LION was not in the Target price (LKR) 735.00
market last year. Some consumers did not switch back, despite these brands Upside (%) +30.2
being priced on par or higher. Despite this, we believe there will be meaningful FY18E DPS (LKR) -
recovery in growth and we expect FY18E revenues to be up 41.0% YoY. Total return (%) +30.2
Operating leverage to result in margin recovery
With the impact from the closure of the factory behind them, LION is now Share price movement (indexed to LION)
beginning to see improving margins, on the back of better sales. With stronger
LKR
growth in volumes over the next few quarters, we expect to see some recovery 600
in margin. However, we do not believe EBIT margins would recover to the pre-
flood levels of 10.0-11.0% in FY18E. 550
Levered FCF to be impacted by high interest costs and loan repayments 500
We expect levered free cash flow to remain negative over our forecast period,
mainly due to loan repayments (flood related) and interest payments. LION is 450
still in the process of finalizing insurance claims, some of which will be used to
repay the loans. Fitch affirmed that, despite its expectations for market share 400
Jan-17 May-17 Sep-17 Jan-18
gains for LION, it will maintain its 'A+(lka)' rating with a negative outlook,
mainly due to its net leverage position, which is yet to improve. LION ASPI S&P SL20
We rate the share a BUY with a target price of LKR 735/share Movement (%) YTD 3M 12M
Despite the stock being up ~25.0% YoY, we believe there is further upside to LION 5 13 25
the stock. Hence, our DCF based valuation (WACC 11.0%) derives a target price ASPI 3 0 6
of LKR 735/share. This gives us a TSR of +30.2%. BUY. We do not expect to S&P SL20 4 0 10
LION to pay a dividend in FY18E due to repayment of debt. BUY. Source: CSE, Bloomberg
Financial summary
Revenue 32,350 35,526 21,211 29,911 40,143 50,179
EBITDA 4,403 4,963 831 2,532 3,657 5,370
Recurring net profit 1,579 2,088 (1,105) 122 838 2,019
Diluted recurring EPS (LKR) 19.74 26.10 (13.81) 1.52 10.48 25.24
ROE (%) 21.3 23.3 (12.1) 1.4 8.2 17.1
P/E (x) 28.6 21.6 (40.9) 370.8 53.9 22.4
Dividend yield (%) 0.7 0.5 - - 0.7 0.7
P/B (x) 5.7 4.5 5.4 4.8 4.1 3.6
67
Key ratios
Revenue growth (%) 25.4 9.8 (40.3) 41.0 34.2 25.0
EBITDA growth (%) 49.9 12.7 (83.3) 204.7 44.5 46.8
Recurring net profit growth (%) 40.9 32.3 (152.9) 111.0 (588.3) 140.8
EBITDA margin (%) 13.6 14.0 3.9 8.5 9.1 10.7

Net margin (%) 4.9 5.9 (5.2) 0.4 2.1 4.0
Recurring diluted EPS (LKR) 19.74 26.10 (13.81) 1.52 10.48 25.24
DPS (LKR) 4.00 3.00 - - 4.00 4.00
Tan. BVPS (LKR) 99.08 124.83 103.93 117.95 136.93 158.17
OCF (LKR mn) 4,123 5,316 1,839 2,998 4,066 3,911

Unlevered FCF (LKR mn) (3,785) 3,876 (1,452) 1,798 2,857 2,399
Levered FCF (LKR mn) (4,789) 1,606 2,544 (1,901) (1,738) (1,865)
OCF/EBITDA (%) 93.6 107.1 221.3 118.4 111.2 72.8

Unlevered FCF/EBIT (%) (104.4) 99.7 469.3 126.6 109.1 56.2
Levered FCF/Recurring net profit (%) (303.3) 76.9 (230.2) (1,560.8) (207.3) (92.4)
Net debt/equity (x) 1.4 0.8 1.3 1.0 0.8 0.6

Net debt/EBITDA (x) 2.6 1.7 12.5 3.9 2.3 1.4
EBITDA/interest (x) 5.7 4.2 0.5 1.5 2.3 4.2
ROA (%) 8.1 10.7 0.3 3.7 6.0 9.7

ROE (%) 21.3 23.3 (12.1) 1.4 8.2 17.1
P/E (x) 28.6 21.6 (40.9) 370.8 53.9 22.4
EV/EBITDA (x) 12.7 11.3 67.5 22.1 15.3 10.4
P/B (x) 5.7 4.5 5.4 4.8 4.1 3.6
Dividend yield (%) 0.7 0.5 - - 0.7 0.7
Dividend payout (%) 20.3 11.5 - - 17.4 15.9
Company profile
Lion Brewery PLC is a leading beer manufacturer in Sri Lanka with a 90.0% share of the beer production in Sri Lanka. The
company have been in operation since 1860 and was listed on the Colombo Stock Exchange in 1997. The company
predominantly operates in the Sri Lankan market while around 1.0% of revenues are generated through exports. LION
currently has a market capitalization of LKR 45bn (USD 297mn).
68
Shareholder Sep 2016 Jun 2017 Sep 2017 Δ YoY (pp) Δ QoQ (pp)
Ceylon Beverage Holdings PLC 52.25 52.25 52.25 - -
Carlsberg Brewery Malaysia Berhad 25.00 25.00 25.00 - -
Carson Cumberbatch Plc A/C No.02 5.13 5.13 5.13 - -
Carson Cumberbatch Plc A/C No.01 1.75 1.75 1.75 - -
Bukit Darah Plc A/C No.02 1.63 1.63 1.63 - -
HSBC Intl Nom Ltd – MSCO - Route One Offshore Master Fund L.P. 1.57 1.57 1.57 - -
HSBC Intl Nom Ltd - BBH - Fidelity Funds 1.12 1.44 1.44 +0.32 -
HSBC Intl Nom Ltd - MSCO - Route One Fund 1,L.P. 1.38 1.38 1.38 - -
HSBC Intl Nominees Ltd -JPMLU-T Rowe Price Funds Sicav 0.00 0.00 1.08 +1.08 +1.08
RBC Investor Services Bank-Coeli Sicav I - Frontier Markets Fund 0.00 0.97 0.97 +0.97 -
69
SRI LANKA EQUITY | BANKS
Sanasa Dev. Bank. [SDB]:BUY [+29%] Kanishka Perera

+94 11 772 2044
The rural growth engine
We rate Sanasa Development Bank (SDB) BUY. SDB is a unique bank with a Key statistics
focus on the unbanked rural economy. Strong ties with cooperatives give it BBG ticker SDB SL
the key advantage of reaching this segment. The Bank follows an CSE ticker SDB.N0000
unconventional model in Retail lending as well with a focus on retired GICS subsector Diversified Banks
government employees by providing financing support for individual Price at 08 Jan 18 (LKR) 103.10
enterprises. It has the lowest per branch opex in our coverage which will 52 week Hi/Lo (LKR) 115.54/91.98
lead to strong profitability with revenue growth. We value the stock at 0.9x
Market cap (LKR mn) 5,648
CY18E BV leading to our TP of LKR 125.70 (+21.9% upside; +29.2% TSR) and
rate it BUY. Market cap (USD mn) 37
No. of shares (mn) 55
Unique positioning in economy sets stage for growth ADT (LKR mn) - 3M 1.9
SDB has greater exposure to the rural economy focusing on an unbanked ADT (USD k) - 3M 12.3
segment of the population. Over the past 20 years, it has worked closely with ADT (shares k) – 3M 18.6
cooperative societies giving a unique advantage in reaching SMEs operating in Free float (%) 52.1
such regions. SDB’s Retail strategy is also an unorthodox one with a focus on Public float (%) 99.9
retired government employees and former armed force personnel. This
segment sees their income drop by ~30.0% upon retirement with another 20-35
Source: CSE, Bloomberg, Company data
years of life expectancy. Our channel checks indicate that they tend to take a
commuted pension and start a small enterprise with SDB’s Retail product Note: LKR converted at 153 LKR per USD
portfolio specifically catering to the needs of such enterprises. While this
Valuation summary
seems like a risky business, NPLs from these are virtually nil given that they are
primarily individual business loans as opposed to consumption loans. These
factors lead our CY16-20E loan CAGR of 20.0% with an average 2.40% gross NPL Target price (LKR) 125.70
ratio despite overall tighter economic conditions. Upside (%) +21.9
CY18E DPS (LKR)* 7.50
Low cost base provides strong profitability support Total return (%) +29.2
SDB has the lowest per branch operating cost within our coverage (31.7% lower Source: Asia Securities |*incl. scrip dividend
than the next lowest) driven by the rural operating model. Recently, the Bank
commenced a systems implementation program which will lead to a reduction Share price movement (indexed to SDB)
in manual input and allows shifting the branch staff towards a sales model. LKR
These drive our 21.9pp improvement in the cost income ratio by end CY20E. 120
115
Private placement alleviates BIII concerns and provides technical knowhow 110
In December 2016, SDB carried out a private placement totaling LKR 1.5bn with 105
the IFC, FMO, and SBI-FMO driving our CY17E T1 CAR to 13.15%, well above the 100
BIII minimum of 7.25% applicable this year. Furthermore, as part of the private 95
placement, the IFC will provide technical knowledge in driving SME lending and 90
associated systems implementation. 85
80
We value SDB at LKR 125.70 and rate it BUY
SDB is currently trading at 0.8x CY18E BV along with an ROE of 10.5%. While SDB ASPI S&P SL20
this seems abysmal, when compared with peers trading at a forward P/B of
0.9x with an average of ROE 13.7%, we expect SDB’s strategy to pay off leading
to an ROE of 15.6% by end CY20E. Lastly, SDB has completed its capital raising SDB 1 7 4
for meeting BIII requirements. We value the share at 0.9x CY18E BV leading to ASPI 3 0 6
our target price of LKR 125.70/share (+21.9% upside; +29.2% TSR) and rate it S&P SL20 4 0 10
BUY. Source: CSE, Bloomberg
Financial summary
In LKR mn CY15 CY16 CY17E CY18E CY19E CY20E
Net interest income 3,368 3,330 3,928 4,654 5,616 6,755
Pre-impairment income 1,434 1,035 1,480 2,077 2,839 3,643
Recurring net profit 721 404 498 807 1,201 1,542
Gross loans and advances 46,860 54,765 64,548 77,500 93,590 113,393
ROE (%) 14.4 7.5 7.7 10.5 14.1 15.6
P/E (x) 6.2 11.1 11.8 7.6 5.4 4.3
P/B (x) 0.9 0.9 0.8 0.8 0.7 0.6
70
Key ratios
CY2015 CY2016 CY2017E CY2018E CY2019E CY2020E
Recurring net income growth (%) 42.8 (44.0) 23.3 62.0 48.9 28.4
Diluted recurring EPS growth (%) 42.8 (44.0) (5.8) 55.1 42.5 25.5
Loan growth (%) 41.7 16.9 17.9 20.1 20.8 21.2
Gross NPL (%) 2.37 2.10 2.55 2.45 2.30 2.30
Net NPL (%) 0.07 0.04 0.05 0.05 0.05 0.05
NIM (%) 6.87 5.41 5.63 5.68 5.75 5.79
NIS (%) 6.2 4.7 4.8 4.7 4.8 4.9
Cost/income (%) 60.6 71.2 64.8 58.1 52.5 49.3
CASA (%) 18.8 17.6 17.5 17.5 17.5 17.5
Loans/deposits (%) 108.9 119.9 119.0 115.0 112.0 110.0
Tier 1 ratio (%) 12.07 11.80 13.15 11.41 10.70 10.51

Total capital ratio (%) 12.51 12.27 15.25 13.52 13.15 12.68
ROA (%) 1.4 0.6 0.7 1.0 1.2 1.3

ROE (%) 14.4 7.5 7.7 10.5 14.1 15.6
P/E (x) 6.2 11.1 11.8 7.6 5.4 4.3
P/B (x) 0.9 0.9 0.8 0.8 0.7 0.6
Dividend yield (%)* 9.0 6.9 7.3 7.3 7.3 7.3
Dividend payout (%)* 55.9 76.8 86.0 55.5 38.9 31.0
DPS (LKR) 9.23 7.11 7.50 7.50 7.50 7.50
Tan. BVPS (LKR) 112.53 117.93 128.19 133.69 144.70 164.59
No. of employees 1,198 1,248 1,300 1,263 1,244 1,241

No. of branches 87 88 100 101 102 102
Source: Company data, Asia Securities | Note: *Dividend yield and Dividend payout include both cash and scrip dividends
Company profile
Sanasa Development Bank (SDB) has a 20-year history in operating in Sri Lanka and has been listed on the Colombo
Stock Exchange (CSE) since 2012. The Bank came into inception in 1985 as an alternative bank for the Sanasa
Federation, a group of Thrift and Credit Union in Sri Lanka. In 1997, it was granted a banking license and was formed
with capital contributions primarily from the Sanasa Societies (cooperatives). In 2012 the Bank was listed on the CSE
through an introduction and subsequently raised LKR 1.0bn through a rights issue (1:2 @ LKR 80.00/share) in 2014.
The Bank’s target customer base is at a lower income level and more rural based when compared with other private
commercial banks. A key differentiator for SDB is the strategic tie-ups with cooperative societies which gives it a
unique on the ground advantage.
71
This report is strictly for direct recipients from Asia Securities. Redistribution of this report is strictly prohibited. Please see page 102 for
analyst & company certification and important disclosures
Dr. Thirugnanasambandar Senthilverl* 14.20 12.00 12.00 -2.20 -
Global Rubber Industries (Pvt) Ltd 10.47 10.84 10.84 +0.37 -
SBI FMO Emerging Asia Financial Sector Fund PTE. LTD - 8.96 8.96 +8.96 -
CB NY S/A International Finance Corporation 2.39 8.86 8.86 +6.47 -
Nederlandse Financierings Maatschappij Voor Ontwikkelingslanden - 3.98 3.98 +3.98 -
People's Leasing & Finance PLC 4.64 3.72 3.72 -0.92 -
Seemasahitha Sanasa Rakshana Samagama (General) 2.58 2.06 2.06 -0.52 -
Kegalle Sanasa Share Holders Trust Company Limited 2.30 1.85 1.85 -0.45 -
Seemasahitha Sanasa Rakshana Samagama (Life) 2.02 1.62 1.62 -0.40 -
Sanasa Federation Limited 1.50 1.22 1.27 -0.23 +0.05
Source: Company data | Note: *Total holding
72
SRI LANKA EQUITY | TELECOMMUNICATIONS
Dialog Axiata [DIAL]:BUY [+28%] Kanishka Perera

+94 11 772 2044
Tuning in through the noise
We rate Dialog Axiata (DIAL) BUY. The share has moved sideways over the Key statistics
last couple of years on the back of unexpected adverse policy changes BBG ticker DIAL SL
leading to headwinds on earnings. However, August 2017 saw a cut on CSE ticker DIAL.N0000
consumption taxes on data services which in combination with declining GICS subsector Wireless Telecom. Serv.
smartphone prices will lead to a pick-up in data adoption. Recently, DIAL Price at 08 Jan 18 (LKR) 13.50
acquired a non-bank finance company which allows it to provide all banking 52 week Hi/Lo (LKR) 13.50/10.40
services bar a couple. While this won’t have a near-term financial impact,
we are bullish on the long-term prospects. However, the proposed tower
tax would lead to depressed valuations in the near-term. As such, we value Market cap (USD mn) 723
DIAL at 4.64 CY18E EBITDA leading to our TP of LKR 16.70/share (+23.7% No. of shares (mn) 8,144
upside; +28.3% TSR) and rate it BUY. ADT (LKR mn) - 3M 39.6
ADT (USD k) - 3M 260.6
Data story comes to the fore ADT (shares k) – 3M 3,000.2
We believe that DIAL’s dominant mobile market share (>44.0% @ 3Q CY17; next Free float (%) 11.3
largest Mobitel stands at the mid-20s) gives it pole position to benefit from the Public float (%) 16.7
broader shift towards data on the back of 1) declining smartphone prices, and
2) low data rates. Entry-level smartphone prices have declined to ~USD 40 from
~USD 75 a couple of years ago while making a voice call on Viber/Whatsapp
costs ~61.3% less than a conventional voice call. The imposition of VAT (15.0%) Note: LKR converted at 153 LKR per USD
on telecom services in 2016 took total consumption taxes on voice to 49.7% and
31.7% on data leading to a hit on earnings as well as the whole sector becoming Valuation summary
unattractive for investors. However, August 2017 saw the telecom levy (10.0%) Price at 08 Jan 18 (LKR) 13.50
being removed from data services bringing consumption taxes to a moderate Target price (LKR) 16.70
19.7% while 3Q data showed that voice continues to grow through subscriber Upside (%) +23.7
adds. As such, we believe that data driven growth will be a key theme over the CY18E DPS (LKR) 0.62
next three years with little drag from the voice side. Total return (%) +28.3
CTF acquisition sets stage for long-term FinTech play
In September 2017, DIAL acquired a Sri Lankan non-bank finance company Share price movement (indexed to DIAL)
named Colombo Trust Finance (CTF). The financial impact is minimal in the
near-term but, we note that it allows DIAL to provide all banking services bar LKR
14
current accounts and FX transactions. The company expects to take a measured
pace in driving this new business over the near term and targets a gross loan 13
book of LKR 5.0bn (~USD 33mn) by 2020. We are bullish on the long-term
12
prospects as DIAL has 1) a mobile customer base of ~12mn, 2) an already fully
functional digital payment platform, and 3) a focus on driving growth through 11
digital advertising leading to a low opex.
10
We value DIAL at LKR 16.70/share and rate it BUY 9

DIAL is currently trading at 3.7x CY18E EBITDA which we argue is quite low. The Jan-17 May-17 Sep-17 Jan-18
company has showcased credible resilience on the voice side despite strong DIAL ASPI S&P SL20
headwinds while the removal of the telecom levy on data gives it a much
stronger growth trajectory. Furthermore, the acquisition of CTF gives the Movement (%) YTD 3M 12M
potential of exponential growth over the long-term. However, the proposed DIAL 4 13 27
tower tax would cause substantial headwinds which would lead to a slow pace ASPI 3 0 6
of price discovery in the near-term. We value DIAL at 4.4x CY18E EBITDA
S&P SL20 4 0 10
leading to our target price of LKR 16.70/share (+23.7% upside; +28.3% TSR) and
Source: CSE, Bloomberg
rate it BUY.
Financial summary
In LKR mn CY14 CY15 CY16 CY17E CY18E CY19E
Revenue 67,286 73,930 86,745 95,702 106,902 118,220
EBITDA 21,240 23,969 29,136 33,020 38,033 42,455
Recurring net profit 6,114 7,637 9,841 11,034 14,415 16,724
ROE (%) 14.5 16.6 19.4 19.2 21.9 22.0
P/E (x) 18.0 14.4 11.2 10.0 7.6 6.6
EV/EBITDA (x) 6.6 5.8 4.8 4.2 3.7 3.3
P/B (x) 3.0 2.9 2.5 2.1 1.8 1.5
73
Key ratios
CY2014 CY2015 CY2016 CY2017E CY2018E CY2019E
Revenue growth (%) 6.3 9.9 17.3 10.3 11.7 10.6
EBITDA growth (%) 6.9 12.8 21.6 13.3 15.2 11.6
Recurring net profit growth (%) 6.7 24.9 28.9 12.1 30.6 16.0
Recurring diluted EPS growth (%) 4.6 24.9 28.9 12.1 30.6 16.0
EBITDA margin (%) 31.6 32.4 33.6 34.5 35.6 35.9

Net margin (%) 9.1 10.3 11.3 11.5 13.5 14.1
DPS (LKR) 0.13 0.32 0.39 0.47 0.62 0.72
Tan. BVPS (LKR) 4.51 4.67 5.49 6.30 7.45 8.78
OCF (LKR mn) 24,801 21,827 24,313 34,208 37,464 41,795

Unlevered FCF (LKR mn) 8,060 5,545 (3,797) 11,594 12,139 13,708
Levered FCF (LKR mn) 7,689 (2,867) 3,199 3,411 5,341 10,155
OCF/EBITDA (%) 116.8 91.1 83.4 103.6 98.5 98.4

Unlevered FCF/EBIT (%) 101.9 57.1 (29.6) 79.2 66.2 66.0
Levered FCF/Recurring net profit (%) 125.8 (37.5) 32.5 30.9 37.1 60.7
Net debt/equity (x) 0.5 0.4 0.5 0.4 0.2 0.1

Net debt/EBITDA (x) 1.0 0.9 1.0 0.7 0.4 0.2
ROA (%) 6.3 7.4 9.1 9.5 11.1 11.8

ROE (%) 14.5 16.6 19.4 19.2 21.9 22.0
P/E (x) 18.0 14.4 11.2 10.0 7.6 6.6
EV/EBITDA (x) 6.6 5.8 4.8 4.2 3.7 3.3
P/B (x) 3.0 2.9 2.5 2.1 1.8 1.5
Dividend yield (%) 1.0 2.4 2.9 3.5 4.6 5.3
Dividend payout (%) 17.4 50.2 35.1 35.0 35.0 35.0
Company profile
Dialog Axiata is a company offering telecommunications services in Sri Lanka. The company was listed on the Colombo
Stock Exchange in 2005 while it entered the Sri Lankan telecom market in 1995 as the 4 th mobile network operator. It is
currently the largest mobile operator in the country with a market share of 44.2%. The company follows a wireless
service model. Dialog Axiata is closely held by Axiata Group Berhad (AXIATA MK, 83.32% ownership) and accounted for
c. 10.9% of their revenue and 10.0% of EBITDA as at end 1H CY17.
74
Axiata Investments (Labuan) Limited 83.32 83.32 83.32 - -
Employees Provident Fund 2.22 2.22 2.22 - -
CITI Bank New York S/A Norges Bank Account 2 1.25 1.27 1.28 +0.03 +0.01
HSBC International Nominees Limited - JPMCB - Scottish ORL SML

0.58 1.02 1.02 +0.44 -
TR GTI 6018
CB NY S/A International Finance Corporation 0.79 0.79 0.79 - -
Pershing LLC S/A Averbach Grauson and Co. - 0.77 0.77 +0.77 -
HSBC International Nominees Limited - MSIP - SAGA Tree Asia

- 0.73 0.75 +0.75 +0.02
Master Fund
BNYM SA/NV RE - CF Ruffer Investment Funds: CF Ruffer Pacific
0.70 0.70 0.70 - -
Fund
HSBC International Nominees Limited - MSIP - Vittoria Fund-ST,L.P. - 0.65 0.67 +0.67 +0.02
BNYM SA/NV RE - First State Investments ICVC - Stewart Investors

0.58 0.60 0.58 - -0.02
Asia Pacific Sustainability Fund
75
SRI LANKA EQUITY | FMCG
Cargills (Ceylon) [CARG]: BUY [+25%] Mangalee Goonetilleke

mangalee@asiasecurities.lk
+94 11 772 2042
A steady performer amidst a bland outlook
Over the past year, CARG performed better than peers amidst constrained Key statistics
consumer spending, recording steady performance across all three BBG ticker CARG SL
segments. The Retail business continues to be the largest private sector CSE ticker CARG.N0000
operation in terms of both store network and revenues. We expect CARG to GICS subsector Consumer Staples
increase market share with new store expansions, of which ~50.0% will be
outside of Western Province. Our key concern though is availability of the
52 week Hi/Lo (LKR) 220.00/181.00
right real estate to keep these plans on track. CARG’s FMCG business
continue to be the margin generator, with segment margins ~6pp higher Market cap (LKR mn) 43,994
than other segments. With capacity expansion completed in most Market cap (USD mn) 289
categories, the segment will be driven by new product introductions. The No. of shares (mn) 224
Restaurant business continues to perform well, recording strong margin ADT (LKR mn) - 3M 9.2
improvements. Our SOTP valuation derives a target price of LKR ADT (USD k) - 3M 60.3
240.00/share and including a DPS of LKR 6.30, we arrive at a total return of ADT (shares k) – 3M 45.3
+25.4% and rate the share a BUY. Free float (%) 10.7
New store expansion plan to aid CARG’s market leadership position
Over the past year, CARG ramped up its store growth plan to 80/year from
40/year. We believe the new store expansion targets bode well for CARG as it Source: CSE, Bloomberg, Company data
would aid in increasing market share, particularly outside of the Western Note: LKR converted at 153 LKR per USD
province. CARG notes that ~50.0% of the new stores would be in other
Valuation summary
provinces. While we do expect some revenue cannibalization within the
Western Province, we remain conservative in our store forecasts as we believe Price at 08 Jan 18 (LKR) 196.40
the run rate is reliant upon availability of real estate, particularly as its close Target price (LKR) 240.00
competitor Keells is also on a strong expansion drive. Upside (%) +22.2
FY18E DPS (LKR) 6.30
FMCG to leverage on capacity expansion Total return (%) +25.4
CARG’s FMCG business continue to be the margin generator, with margins Source: Asia Securities
~7.0pp higher than other segments. We believe market leadership in the
impulse segment of frozen confectionary market and a strong presence in the Share price movement (indexed to CARG)
Agri business through the KIST brand bodes well for CARG. In processed meat,
LKR
CARG continues to focus on its take-home range, given higher margins 230
compared to the HORECA channel. With capacity expansion completed in most
220
categories, we expect the segment to be driven over the next 12-months
through expanding product ranges including new product introduction. 210
200
KFC continues its upward trajectory; TGIF yet to breakeven 190
CARG’s restructured KFC operations continued to do well, with margins now
180
running at ~12.0% compared to ~4.0% in FY16. KFC’s refocus on its core
products and service quality has helped turnaround operations over the past 170
two years. We also believe it has a competitive advantage due to its unique Jan-17 May-17 Sep-17 Jan-18
chicken based products and value for money meals, compared to competitors. CARG ASPI S&P SL20
We rate CARG a BUY our SOTP valuation Movement (%) YTD 3M 12M
Currently, the stock is trading at 15.6x our FY18E EPS. We expect the stock to CARG (2) (4) 5
trade at a P/E of 19.0x at a Group level, which derives a target price of LKR ASPI 3 0 6
240.00/share. Including a dividend yield of 3.2%, we arrive at a total return of S&P SL20 4 0 10
+25.4%. BUY. Source: CSE, Bloomberg
Financial summary
Revenue 61,631 71,017 84,191 94,503 109,187 125,304
EBITDA 3,222 5,172 7,094 7,909 9,375 10,828
Recurring net profit 162 1,571 2,150 2,820 3,679 4,663
ROE (%) 1.3 11.8 15.3 19.2 22.6 25.4
P/E (x) 271.7 28.0 20.5 15.6 12.0 9.4
Dividend yield (%) 1.0 1.8 2.9 3.2 4.2 5.3
P/B (x) 3.5 3.1 3.2 2.9 2.6 2.3
76
Key ratios
Revenue growth (%) 9.8 15.2 18.6 12.2 15.5 14.8
EBITDA growth (%) -23.0 60.5 37.2 11.5 18.5 15.5
Recurring net profit growth (%) -79.9 870.1 36.9 31.2 30.4 26.8
EBITDA margin (%) 5.2 7.3 8.4 8.4 8.6 8.6

Net margin (%) 0.3 2.2 2.6 3.0 3.4 3.7
DPS (LKR) 2.00 3.50 5.60 6.30 8.30 10.50
Tan. BVPS (LKR) 55.99 63.04 62.31 68.60 76.72 87.04
OCF (LKR mn) 1,686 6,132 5,157 6,694 7,721 9,140

Unlevered FCF (LKR mn) 53 3,885 533 1,705 2,502 6,283
Levered FCF (LKR mn) (7,367) 2,994 3,450 1,237 2,030 2,854
OCF/EBITDA (%) 52.3 118.6 72.7 84.6 82.3 84.4

Unlevered FCF/EBIT (%) 3.4 112.5 10.2 29.6 35.9 75.9
Levered FCF/Recurring net profit (%) -4549.5 190.6 160.5 43.9 55.2 61.2
Net debt/equity (x) 0.8 0.6 1.0 1.0 0.9 0.7

Net debt/EBITDA (x) 3.3 1.8 2.0 1.9 1.7 1.2
ROA (%) 1.0 4.9 6.2 7.5 8.6 9.7

ROE (%) 1.3 11.8 15.3 19.2 22.6 25.4
P/E (x) 271.7 28.0 20.5 15.6 12.0 9.4
EV/EBITDA (x) 15.3 9.5 6.9 6.2 5.2 4.5
P/B (x) 3.5 3.1 3.2 2.9 2.6 2.3
Dividend yield (%) 1.0 1.8 2.9 3.2 4.2 5.3
Dividend payout (%) 87.0 48.3 58.4 50.0 50.5 50.4
Company profile
Company operations commenced in 1844 as a general warehouse, import and wholesale business. The company was
incorporated as a public company in 1946 and was acquired by Ceylon Theaters in 1981. CARG currently operates in a
number of FMCG segments and a supermarket chain. Also has an associate stake in Cargills Bank.
Retail
CARG established the first supermarket chain in Sri Lanka in 1983 and currently operates 297 across the island through its
subsidiary Cargills Foods Company (Private) Limited. Retail stores are operated under two formats, ‘Cargills Food City’
and ‘Cargills Food City Express’.
FMCG
• Processed meats - Manufactures and distributes its products under the Goldi, Sams’ and Cargills Finest brands.
• Dairy – CARG entered the dairy market in 2002 with its investments in a dairy processing plant and launched its
Cargills Magic ice cream range. It also acquired Kotmale Holdings PLC in 2010, which expanded its ice cream
range and added UHT, pasteurized milk and yoghurt to the product portfolio.
• Agri foods - In 2002, CARG launched its agrifoods business with Cargills Kist which now includes a range of jams,
sauces and cordials.
• Confectionary - engaged in the manufacturing, distribution and marketing of biscuits and confectioneries under
the Brand name ‘Kist’. It presently manufactures soft & hard dough biscuits & wafers
Restaurants
Currently, CARG owns franchise licenses for KFC and TGIF Friday. It received the license for KFC in 1996 and the license
for TGIF in 2012. There are 27 KFC restaurants in Sri Lanka and one TGIF restaurant located in Colombo.
77
C T Holdings PLC 70.20 70.20 70.20 - -
Mr. V R Page 6.68 6.70 6.70 +0.02 -
Employees’ Provident Fund 3.28 3.28 3.28 - -
Odeon Holdings (Ceylon) (Private) Limited 2.15 2.15 2.15 - -
Ms. M M Page 1.84 1.93 1.93 +0.09 -
Ceylon Guardian Investment Trust PLC - A/C No.1 1.86 1.86 1.86 - -
HSBC Intl Nom Ltd - SSBT- First State Investments ICVC - Stewart
1.75 1.75 1.75 - -
Investors Indian Subcontinent Fund
BNYMSANV RE-CF Ruffer Investment Funds : CF Ruffer Pacific Fund 1.43 1.55 1.55 +0.12 -
BNYMSANV RE-Butterfield Trust (Bermuda) Limited 0.58 0.58 0.61 +0.03 +0.03
Mellon Bank N.A. - Florida Retirement System 0.58 0.58 0.58 - -
78
Sampath Bank [SAMP]: BUY [+17%] Kanishka Perera

+94 11 772 2044
Topping up for growth
We rate Sampath Bank (SAMP) BUY. SAMP is the 5 th largest bank within the Key statistics
country by gross loans with a strong presence in retail banking. Amidst BBG ticker SAMP SL
headwinds faced by the pawning industry we see SAMP focusing on the CSE ticker SAMP.N0000
SME/mid-sized corporate market for growth. With the strong risk GICS subsector Diversified Banks
management processes in place we believe that SAMP will be successful in Price at 08 Jan 18 (LKR) 329.00
driving growth from this segment with contained NPLs. Furthermore, we 52 week Hi/Lo (LKR) 345.20/239.70
expect the Bank’s cost/income ratio to improve along with a faster growth
in income when compared to the cost base. We value SAMP at 1.1x CY18E
BV leading to a target price of LKR 365.00 (+10.9% upside; +16.9% TSR). Market cap (USD mn) 467
BUY. No. of shares (mn) 217
ADT (LKR mn) - 3M 112.3
SME/mid-sized corporates to drive growth amidst pawning slowdown ADT (USD k) - 3M 734.1
SAMP recorded significant loan growth posting a CAGR of 21.7% CY06-16. This ADT (shares k) – 3M 339.6
was primarily led by pawning which, at the peak, accounted for 24.9% of the Free float (%) 58.6
loan book. However, with the slump in gold prices and consequent impairment Public float (%) 88.4
losses the Bank started moving away from the pawning sector. A key segment
that the Bank focused on for growth was the SME/mid-sized corporate market.
We contend that this market remains underserved by the major banks while
SAMP has the necessary risk management processes in place to drive growth Note: LKR converted at 153 LKR per USD
even towards the marginal customers. We note that SAMP has the best gross
Valuation summary
NPLs within the industry at 1.74% as at end 3Q CY17.
Opex remains the lowest amongst peers; C/I to improve on gross income Target price (LKR) 365.00
The Bank’s per branch cost is the lowest amongst the peer group by an average Upside (%) +10.9
19.6% (over CY12-16) led by a low per employee cost. Due to the rapid branch CY18E DPS (LKR)* 19.50
expansion carried out in CY08-CY11 the cost base increased without a Total return (%) +16.9
proportionate increase in gross income putting pressure on the cost/income Source: Asia Securities |*incl. scrip dividend
(C/I) ratio. Amidst limited plans on further branch openings and a focus on
electronic channels we believe that revenue growth will outpace cost growth Share price movement (indexed to SAMP)
leading to a 5.9pp improvement in the C/I ratio over the next four years. LKR
360
Additional rights issuance alleviates all capital concerns 340
320
Following on from the successful completion of the LKR 7.6bn rights issuance
300
(proportion of 1 for 6 [2.2 for 13] at an exercise price of LKR 245.00/share for a
280
total of 31mn new shares) SAMP announced another rights issuance on the 19th
260
of Dec 2017. This is substantially larger at LKR 13bn and the issuance will be in 240
the proportion of 3 for every 13 at an exercise price of LKR 250.00/share for a 220
total of 50mn new shares. If fully subscribed, the issuance will lead to an EPS 200
dilution of 18.8%. Jan-17 May-17 Sep-17 Jan-18
SAMP ASPI S&P SL20

We value SAMP at LKR 365.00/share and rate it BUY
SAMP is currently trading at a CY18E P/B of 1.0x which is in line with the peer Movement (%) YTD 3M 12M
average of 0.9x while we forecast a 3Y fwd. average ROE of 16.8% compared to SAMP 4 5 37
a peer average of 13.7%. We estimate that the proposed transaction levy would
ASPI 3 0 6
shave off 4.4-6.7% off our forecast earnings. We value SAMP at 1.1x BV
S&P SL20 4 0 10
resulting in a 12-month target price of LKR 365.00/share (+10.9% upside;
+16.9% TSR) and rate it BUY. Source: CSE, Bloomberg
Financial summary
Gross loans and advances 393,654 480,917 572,213 687,720 835,807 1,022,493
ROE (%) 18.0 21.4 19.5 16.6 16.8 16.9
P/E (x) 8.8 6.1 6.2 6.7 5.7 4.9
P/B (x) 1.5 1.2 1.0 1.0 0.9 0.8
79
Key ratios
Recurring net income growth (%) 25.8 43.4 20.8 16.1 26.7 19.9
Diluted recurring EPS growth (%) 25.8 43.4 (0.4) (8.7) 17.3 17.4
Loan growth (%) 24.2 22.2 19.0 20.2 21.5 22.3
Gross NPL (%) 1.64 1.61 1.85 1.80 1.80 1.80
Net NPL (%) 0.46 0.62 0.71 0.69 0.69 0.69
NIM (%) 4.04 4.23 4.33 4.37 4.36 4.31
NIS (%) 3.9 4.0 4.1 4.1 4.0 4.0
Cost/income (%) 52.2 47.9 45.3 45.0 42.5 41.0
CASA (%) 47.7 38.8 37.0 36.0 35.5 35.5
Loans/deposits (%) 96.7 93.7 95.5 95.0 95.0 95.0
Tier 1 ratio (%) 8.04 8.43 10.05 11.66 11.25 10.98

ROA (%) 1.3 1.6 1.6 1.6 1.7 1.7

ROE (%) 18.0 21.4 19.5 16.6 16.8 16.9
P/E (x) 8.8 6.1 6.2 6.7 5.7 4.9
P/B (x) 1.5 1.2 1.0 1.0 0.9 0.8
Dividend yield (%)* 3.8 5.7 5.3 5.9 6.7 6.7
Dividend payout (%)* 33.8 34.9 32.7 40.0 38.4 32.7
DPS (LKR) 12.66 18.75 17.50 19.50 22.00 22.00
Tan. BVPS (LKR) 218.89 279.05 315.86 338.19 364.97 426.49
No. of employees 3,993 3,960 3,990 3,965 3,967 3,967

No. of branches 225 229 232 236 239 239
Company profile
Sampath Bank (SAMP) has 30 years of history in operating in Sri Lanka and has been listed on the Colombo Stock
Exchange since 1987. Post an aggressive expansion plan carried out in CY08-CY11 it now accounts for the 5 th largest
network with 229 branches. SAMP is rated A+(lka) with a negative outlook by Fitch.
SAMP has four strategic subsidiaries, namely: 1) Siyapatha Finance PLC, 2) Sampath Centre Ltd, 3) SC Securities, and 4)
Sampath Information Technology Solutions Ltd.
• Siyapatha Finance PLC (SF) is a 100.0% owned subsidiary incorporated in 2005. It has a focus of providing
leasing, hire purchase, pawning, and factoring services to SME/retail clients. SF contributed to 3.3% of group
net profits in 1H CY17.
• Sampath Centre (Pvt.) Ltd. is a 97.1% owned subsidiary which owns and manages the building which SAMP’s
head office occupies.
• SC Securities (Pvt.) Ltd. is a 100.0% owned subsidiary which was incorporated in 1992. It primarily functions as
a stock brokerage.
• Sampath Information Technology Solutions is a 100.0% owned subsidiary incorporated in 2006. It is mainly
focused on developing software solutions for financial markets.
80
Vallibel One PLC 14.95 14.95 14.95 - -
Mr Y S H I Silva 9.98 9.99 9.99 +0.01 -
Employees' Provident Fund 9.97 9.97 9.97 - -
Rosewood (Pvt) Limited - Account No.1 6.71 6.03 5.39 -1.32 -0.64
HSBC INTL NOM LTD-BBH-Matthews International Funds-Matthews

4.58 4.58 4.58 - -
Asia Growth Fund
HSBC INTL NOM Ltd-State Street Luxembourg C/O SSBT - ABN Amro
2.61 2.47 2.47 -0.14 -
Multi Manager Funds
City Bank Newyork S/A Norges Bank Account 2 1.47 2.32 2.32 +0.85 -
Akbar Brothers Pvt Ltd A/C No. 1 1.35 1.85 1.86 +0.51 +0.01
HSBC INTL NOM Ltd-BBH-MATTHEWS Emerging Asia Fund 1.39 1.74 1.74 +0.35 -
Sampath Bank PLC Account No. 4 (Sampath Bank Pension Fund) 1.63 1.63 1.63 - -
81
SRI LANKA EQUITY | CONGLOMERATES
Hemas Holdings [HHL]: HOLD [+11%] Mangalee Goonetilleke

mangalee@asiasecurities.lk
+94 11 772 2042
A well-coordinated diversification
We expect Healthcare to continue to account for majority of earnings and Key statistics
will benefit from its market leadership in pharmaceutical distribution and BBG ticker HEMS SL
MORI from its Government buyback programs. For FMCG, we expect the CSE ticker HHL.N0000
local market to be relatively flattish, while Bangladesh to be under pressure GICS subsector Conglomerates
due to restructuring of the distribution network. In Maritime and Logistics,
we expect the segment to be driven primarily by the maritime business. In
52 week Hi/Lo (LKR) 154.30/98.00
Leisure however, we remain cautious of the impact from increased
competition. Our SOTP based valuation derives a target price of LKR Market cap (LKR mn) 71,167
136.00/share. Including a forecast DPS of LKR 1.40/share, we expect a total Market cap (USD mn) 468
return of +11.0%. HOLD. No. of shares (mn) 573
ADT (LKR mn) - 3M 31.2
Healthcare continues to drive Group performance; HHL enters Myanmar ADT (USD k) - 3M 205.3
Hemas Pharmaceuticals continues to maintain its market leadership position ADT (shares k) – 3M 243.4
while MORI continues to benefit from the Government’s buyback program. The Free float (%) 32.5
new manufacturing plant is set to increase capacity by 2x and MORI is already
in talks with the Government for new buyback contracts. Hospitals continue to
do well, particularly with demand for surgeries picking up with HHL’s expansion
into tertiary care. In August, HHL entered Myanmar to commence pharma Source: CSE, Bloomberg, Company data
distribution under a JV agreement, but is yet to gain meaningful traction. Note: LKR converted at 153 LKR per USD
Valuation summary
FMCG to remain relatively subdued in FY18
Amidst low consumer demand, local business remains relatively flat with most Price at 08 Jan 18 (LKR) 123.80
of the growth driven by price. Bangladesh operations were disrupted due to Target price (LKR) 136.00
restructuring of the distribution network, which resulted in a hit on margins. Upside (%) +9.9
HHL noted that the restructuring is nearly completed. For FY18E, while we FY18E DPS (LKR) 1.40
expect the local market to remain relatively subdued, we believe new product Total return (%) +11.0
development and promotions to sustain the business in FY18E. Source: Asia Securities
Maritime is the key driver; new logistics facility to expand 3PL/4PL services Share price movement (indexed to HHL)
The Maritime business continues to be the main segment driver, with Evergreen
LKR
being the key contributor. Since the addition of the business, EBIT margins 160
have improved by 24pp to-date. The logistics facility is under construction and 150
is to be fully operational by early FY19E. The facility will be a critical in terms
140
of growing the Group’s logistics business, particularly 3PL and 4PL services.
130
120
Challenging FY18E for Leisure amidst lower arrivals and tough competition
HHL’s mid-tier hotels under the Serendib Group continue to be impacted by 110
high inventory levels from both formal and informal sector players. In addition, 100
arrivals remained low for the first half of the year due to flood and dengue 90
warnings. Also, profits remain subdued at the newly opened Anantara hotels Jan-17 May-17 Sep-17 Jan-18
which are yet to breakeven. HHL ASPI S&P SL20
We maintain our HOLD rating and target price of LKR 136.00/share Movement (%) YTD 3M 12M
The stock is currently trading at 19.1x our FY18E earnings. Our SOTP based HHL (2) 1 26
valuation derives a TP of LKR 136.00/share. Including a forecast DPS of LKR ASPI 3 0 6
1.40/share, we expect a total return of +11.0%. HOLD. S&P SL20 4 0 10
Financial summary
Revenue 32,497 37,977 43,404 48,736 55,153 64,237
EBITDA 3,775 4,985 5,964 6,413 8,053 9,916
ROE (%) 13.7 15.5 16.3 15.4 17.9 18.9
P/E (x) 37.4 26.7 20.3 19.1 14.3 11.5
Dividend yield (%) 0.9 0.9 1.1 1.1 1.1 1.1
P/B (x) 4.4 3.2 2.8 2.8 2.4 2.0
82
Key ratios
FY ended March FY2015 FY2016 FY2017E FY2018E FY2019E FY2020E
Revenue growth (%) 19.2 16.9 14.3 12.3 13.2 16.5
EBITDA growth (%) 19.0 32.1 19.6 7.5 25.6 23.1
EBITDA margin (%) 11.6 13.1 13.7 13.2 14.6 15.4

Net margin (%) 5.8 7.0 8.0 7.6 9.0 9.6
DPS (LKR) 1.10 1.10 1.40 1.40 1.40 1.40
Tan. BVPS (LKR) 27.88 38.75 44.16 44.84 52.10 61.44
OCF (LKR mn) 3,615 4,010 2,707 5,477 5,683 6,941

Unlevered FCF (LKR mn) 2,571 2,899 488 2,553 2,925 3,729
Levered FCF (LKR mn) 2,628 1,881 (615) 1,969 2,346 3,155
OCF/EBITDA (%) 95.79 80.43 45.39 85.42 70.57 70.00

Unlevered FCF/EBIT (%) 88.10 71.60 9.95 48.69 43.32 44.18
Levered FCF/Recurring net profit (%) 138.85 70.91 -17.61 52.97 47.31 51.30
Net debt/equity (x) 0.0 -0.3 -0.2 -0.3 -0.3 -0.3

Net debt/EBITDA (x) 0.2 -1.3 -1.1 -1.3 -1.3 -1.4
ROA (%) 6.8 7.8 8.6 8.4 10.0 10.9

ROE (%) 13.7 15.5 16.3 15.4 17.9 18.9
P/E (x) 37.4 26.7 20.3 19.1 14.3 11.5
EV/EBITDA (x) 20.2 15.3 12.8 11.9 9.5 7.7
P/B (x) 4.4 3.2 2.8 2.8 2.4 2.0
Dividend yield (%) 0.9 0.9 1.1 1.1 1.1 1.1
Dividend payout (%) 32.7 23.7 22.9 21.5 16.2 13.0
Company profile
Hemas Holdings PLC (HHL) is a leading conglomerate in Sri Lanka with businesses in Fast Moving Consumer Goods,
Healthcare, Leisure and Transportation. We note that the Power segment was divested in December 2014. The Group was
listed in 2003.
• Healthcare - HHL is the largest private sector organization operating in the healthcare industry through the
company’s Hospitals, Pharmaceuticals Distribution and Pharmaceuticals Manufacturing businesses.
• Fast Moving Consumer Goods - The FMCG segment includes manufacturing and marketing of personal care,
personal wash and home care branded products. In 2013, HHL acquired J L Morison Sons & Jones (Ceylon) PLC,
expanding their consumer portfolio.
• Leisure - The segment includes the Serendib Leisure Group which comprises of four hotels with a 410 room
inventory and Diethelm Travels Sri Lanka.
• Transportation - The segment comprises of aviation services, maritime and logistics.
• Other - The segment mainly includes the operations of N-able, the IT services business of the Group and the Agro
business of MORI. The segment also includes a BPO operation through which it offers shared services to the
Group. In addition, the Group’s corporate costs are also allocated to this segment.
83
A Z Holdings (Pvt) Ltd. 15.85 15.83 15.81 -0.04 -0.02
Saraz Investments (Pvt) Ltd. 15.09 15.07 15.05 -0.04 -0.02
Blueberry Investments (Pvt) Ltd. 14.98 14.96 14.94 -0.04 -0.02
Amagroup (Pvt) Ltd. 14.98 14.96 14.94 -0.04 -0.02
HSBC Intl Nominees Ltd - JPMLU-Franklin Templeton Investment

9.11 7.79 7.78 -1.33 -0.01
Funds
Citi Bank New York S/A Norges Bank Account 2 0.00 2.36 2.99 +2.99 +0.63
HSBC International Nominees Ltd. - JPMCB- Templeton Global

2.61 2.61 2.61 - -
Investment Trust - Templeton Emerging Markets S
Bnymsanv Re-First State Investments ICVC - Stewart Investors
2.09 2.09 2.08 -0.01 -0.01
Indian Subcontinent Fund
Bnymsanv Re-First State Investments ICVC - Stewart Investors Asia
1.45 1.70 1.70 +0.25 -
Pacific Sustainability Fund
HSBC Intl Nom Ltd-JPMCB- Pacific Assets Trust PLC 0.76 1.19 1.18 +0.42 -0.01
84
SRI LANKA EQUITY | CONSTRUCTION
Tokyo Cement [TKYO]: HOLD [+5%] Naveed Majeed

naveed@asiasecurities.lk
+94 11 772 2043
Expanded capacity provides fresh growth driver
TKYO experienced strong growth in FY17, with sales growing 18.5% as the Key statistics Voting | Non-voting
company benefited from the uptick in construction. In FY17, the company BBG ticker TKYO SL | TKYOX SL
operated at full capacity at its 1.8mn mt/year grinding plant. To further its CSE ticker TKYO.N0000 | TKYO.X0000
growth, TKYO went ahead with an additional 1mn mt/year capacity GICS subsector Construction materials
expansion at its grinding plant which was completed in 4Q FY17, and
Price at 08 Jan 18 (LKR) 68.50 | 59.80
started commercial production in 1Q FY18. Despite having expanded its
77.40/47.50|
capacity, TKYO is currently amidst a slowdown in the construction sector, 52 week Hi/Lo (LKR)
69.60/41.70
which we expect will last in the near to medium-term. The company Market cap (LKR mn) 26,302
expects to utilize only up to ~40.0% of its new capacity in FY18E, which Market cap (USD mn) 172
leaves considerable room to benefit from a pickup in construction in FY19E. No. of shares (mn) 267 | 134
Furthermore, while we do not expect a retail price revision in FY18E, we
ADT (LKR mn) - 3M 9.9 | 4.3
believe there is a high probability of a revision in FY19E. We value the
ADT (USD k) - 3M 64.9 | 28.0
share at 5.7x EV/EBITDA FY18E and arrive at a TP of LKR 70.30 (+2.6%
upside; +5.0% TSR) for the voting share and LKR 61.10 for the non-voting ADT (shares k) – 3M 144.8 | 73.0
share (+2.2% upside; +4.8% TSR). HOLD. Free float (%) 34.1 | 83.0
Public float (%) 31.4 | 27.9
New facility poised to cater growing demand while supporting profitability Company website | CSE website
Following the commencement of commercial production at the new grinding Source: CSE, Bloomberg, Company data
facility, management expects up to 40.0% of the new 1mn mt/year (+56% to Note: LKR converted at 153 LKR per USD
current) grinding facility to supply the bagging ops at the Colombo Port facility
in FY18E. We believe the plant will open up a fresh growth driver for the Valuation summary Voting | Non-voting
company in FY19E to supply to future construction demand. Price at 08 Jan 18 (LKR) 68.50 59.80
Target price (LKR) 70.30 61.10
GoSL cuts CY17E expenditure on infrastructure amidst tight fiscal policy
Upside (%) +2.6 +2.2
The Sri Lankan construction sector is currently undergoing a slowdown amid a
FY18E DPS (LKR) 1.60 1.60
tight fiscal policy which has seen budgets for infrastructure expenditure
reduced for CY17E. Furthermore, tight monetary policies have also resulted in Total return (%) +5.0 +4.8
a slowdown in the residential market. We expect the slowdown to impact Source: Asia Securities
earnings over FY18E. For more information, please refer to our Construction
Share price movement (indexed to TKYO)
Sector Update – “A hiatus amidst a growth story”.
LKR
Low probability of price hike in FY18E 90
With the recent 8.3% increase in LP Gas prices, and currency depreciation 80
slowing down to only 2.2% YTD Sep ‘17 (3.9% CY16), we believe that the
Consumer Affairs Authority (CAA) would delay any cement price revisions in the 70
near-term. As the cement industry players have been lobbying for a retail price 60
revision, we believe it is more likely to come to fruition in FY19E.
50
We value TKYO at 5.7x EV/EBITDA FY18E 40
TKYO currently trades at 5.6x EV/EBITDA FY18E, however, while we see no Jan-17 May-17 Sep-17 Jan-18
further upside in FY18E and we note that TKYO is best poised to capture growth TKYO TKYO.X
from a pickup in construction which we expect in FY19E. As such, we value the ASPI S&P SL20
share slightly higher at 5.7x EV/EBITDA FY18E and arrive at a target price of Movement (%) YTD 3M 12M
LKR 70.30 (+2.6% upside; +5.0% TSR) for the voting share and LKR 61.10 for the TKYO 4 (2) 44
non-voting share (+2.2% upside; +4.8% TSR). We continue to believe that TKYO
ASPI 3 0 6
is a key way to play the Sri Lankan construction story in the long-term, given its
S&P SL20 4 0 10
exposure to both infrastructure and residential construction demand. HOLD.
Financial summary
Revenue 29,674 30,117 35,703 40,342 46,017 54,018
EBITDA 3,260 3,735 5,462 6,313 7,276 8,528
ROE (%) 16.2 18.0 26.0 22.8 21.8 21.3
P/E (x) 17.8 14.2 8.2 7.7 6.7 5.7
EV/EBITDA (x) 9.5 9.1 6.4 5.6 4.8 4.1
P/B (x) 2.8 2.4 1.9 1.6 1.3 1.1
85
Key ratios
Revenue growth (%) 2.7 1.5 18.5 13.0 14.1 17.4
EBITDA growth (%) (14.6) 14.6 46.2 15.6 15.3 17.2
Recurring net profit growth (%) (26.2) 25.1 73.0 7.5 14.8 16.2
EBITDA margin (%) 11.0 12.4 15.3 15.6 15.8 15.8

Net margin (%) 5.2 6.4 9.4 8.9 9.0 8.9
DPS (LKR) 0.99 1.13 1.56 1.60 2.00 2.50
Tan. BVPS (LKR) 24.81 28.49 35.61 42.96 51.24 60.69
OCF (LKR mn) 3,245 3,062 4,440 5,474 5,711 6,329

Unlevered FCF (LKR mn) 1,845 (2,349) (153) 1,429 3,637 3,895
Levered FCF (LKR mn) 1,397 (2,006) 1,838 (409) 1,472 2,013
OCF/EBITDA (%) 99.5 82.0 81.3 86.7 78.5 74.2

Unlevered FCF/EBIT (%) 79.5 (86.4) (3.5) 27.9 61.3 55.5
Levered FCF/Recurring net profit (%) 90.5 (103.9) 55.0 (11.4) 35.7 42.0
ROA (%) 10.2 10.9 14.9 14.1 14.5 15.2

ROE (%) 16.2 18.0 26.0 22.8 21.8 21.3
P/E (x) 17.8 14.2 8.2 7.7 6.7 5.7
EV/EBITDA (x) 9.5 9.1 6.4 5.6 4.8 4.1
P/B (x) 2.8 2.4 1.9 1.6 1.3 1.1
Dividend yield (%) 1.4 1.6 2.3 2.3 2.9 3.6
Dividend payout (%) 23.5 23.4 18.7 18.0 20.0 21.0
Company profile
Tokyo Cement Company Lanka PLC is a cement manufacturer and supplier in Sri Lanka. The company was listed on the
Colombo Stock Exchange in 1984 while it entered the cement market in 1982. The company follows a strategy of
generating profitable growth through vertical integration. The company operates through six main subsidiaries:
• Tokyo Cement Company Lanka: Owns 900k mt/annum cement factory in Trincomalee
• Tokyo Super Cement Company Lanka: Owns 900k mt/annum cement factory in Trincomalee
• Tokyo Eastern Cement Company (Pvt) Limited: Owns 1000k mt/annum cement factory in Trincomalee
• Tokyo Cement Colombo Terminal: Owns 600k mt/annum bagging plant at the Colombo Port
• Tokyo Cement Power: Owns 5 MW Dendro Plant in Mahiyangana
• Tokyo Eastern Cement Company Limited: New USD 50mn expansion project
• Tokyo Super Aggregate Ltd: Sand manufacturing
86
St. Anthony's Consolidated (Pvt) Ltd 27.50 27.50 27.50 - -
South Asian Investment (Pvt) Ltd 20.13 20.10 20.13 - +0.03
Ube Singapore Holdings Pte. Ltd 2.00 10.00 10.00 +8.00 -
Marina Bay Holding And Investment Pte.Ltd. - - 5.00 +5.00 +5.00
Capital City Holdings (Private) Limited 3.00 3.00 3.00 - -
Hsbc Intl Nominees Ltd-Jpmlu-T Rowe Price Funds Si - - 2.65 +2.65 +2.65
Nippon Coke & Engineering Co. Ltd 17.74 7.10 1.99 -15.75 -5.11
The Ceylon Guardian Investment Trust Plc A/C # 02 2.41 2.10 1.71 -0.70 -0.39
J.B. Cocoshell (Pvt) Ltd - 1.90 1.62 +1.62 -0.28
The Ceylon Investment Plc A/C # 02 2.36 2.10 1.38 -0.98 -0.72
Top 10 shareholders – Non-voting (% held)

Hinl-Jpmcb-Butterfield Trust ( Bermuda ) Limited 11.44 12.20 12.16 +0.72 -0.04
Northern Trust Company S/A Apollo Asia Fund Limite - 4.10 7.90 +7.90 +3.80
Hsbc Intl Nom Ltd-State Street Luxembourg C/O Ssbt 4.26 5.10 5.11 +0.85 +0.01
Employees Provident Fund 3.52 4.20 4.22 +0.70 +0.02
Deutsche Bank Ag As Trustee For Jb Vantage Value E 3.06 3.70 3.68 +0.62 -0.02
Pershing Llc S/A Averbach Grauson & Co. 1.19 3.50 3.47 +2.28 -0.03
Citibank Newyork S/A Norges Bank Account 2 4.69 4.90 3.14 -1.55 -1.76
Deutsche Bank Ag-National Equity Fund 1.94 2.80 2.78 +0.84 -0.02
Mas Capital (Private) Limited 2.18 2.60 2.59 +0.41 -0.01
Citibank London S/A Old Mutual Global Investors Se - 2.00 2.21 +2.21 +0.21
87
WILDCARDS
88
SRI LANKA EQUITY | NON-BANK FINANCIAL INSTITUTIONS
WILDCARD | 09 JANUARY 2018
Central Finance [CFIN]: HOLD [+6%] Lakshini Fernando

+94 11 772 2045
Higher payout holds the key
We view CFIN as the wildcard of the NBFI sector. Despite multiple Key statistics
headwinds in the industry, CFIN has maintained its growth momentum, BBG ticker CFIN SL
albeit at a slower rate as its competitors but, have maintained its position as CSE ticker CFIN.N0000
a leading NBFI despite little or no diversification away from its core business GICS subsector Consumer Finance
of leasing. With a strong NIM position with the highest core capital in the Price at 08 Jan 18 (LKR) 93.00
industry of 30.5%, the lower than average payout ratio is the main
52 week Hi/Lo (LKR) 101.90/84.00
drawback for the attractiveness of the company. The company has recently
increased its dividend payouts, and we believe if it continues to do so to
match the peer average of 28.0%, CFIN will have a significant upside to its Market cap (USD mn) 132
current share price leading to a TSR of 41.4%. No. of shares (mn) 217
NPLs and impairments to be supported through conservative strategy ADT (USD k) - 3M 64.6
We see lower impairment costs compared with other NBFIs given CFIN’s ADT (shares k) – 3M 104.5
conservative approach to advances. The company didn’t deviate from its Free float (%) 32.1
business plan and aggressively go after vehicle leases during the FY14-FY15 Public float (%) 59.9
period as its competitors which indicates the company’s stand on changing its Company website | CSE website
business strategy per the current environment. We also expect the higher Source: CSE, Bloomberg, Company data
absolute value in recovery value of three-wheelers to help reduce NPLs which Note: LKR converted at 153 LKR per USD
are already below the industry average.
Valuation summary
NIMs maintained at one of the highest within our coverage Price at 08 Jan 18 (LKR) 93.00
The company has continued to record strong NIMs, one of the highest within
Published TP (LKR) 95.10
our coverage despite somewhat shrinking along with the sector in FY17.
Published TSR +6.0
However, we see a recovery from this, with NIMs picking up by 108bps in 2Q
FY18 to 16.63% (8.27% - PLC, 11.42% LFIN) and we expect this trend to continue Wildcard TP (LKR) 124.00
into FY19E to reach 15.61%. This, combined with the low impairment factor Wildcard TSR +41.4
positions CFIN as an ideal undervalued stock for an investor. Source: Asia Securities
Share price movement (indexed to CFIN)

Payout ratio to match its peers holds the key
In FY17, CFIN had the lowest dividend payout within our sector coverage, LKR
coming in at 10.6% against the peer average of 28.0%. This resulted in a 115
dividend yield of 2.5% (peer average was 5.7%) which was a key concern in 110
terms of investment potential. However, the company has since increased its 105
payout which leads us to view the stock in a more positive light. Our 100
discussions with management also indicates that the company is also making 95
headway to continue this trend of maintaining a higher payout than in FY17. 90
We believe if CFIN increases its dividend payout to match that of the industry 85
average of 28.0%, the stock would have a significant upside. 80
Potential to reach LKR 124.00 with a 41.4% TSR
CFIN ASPI S&P SL20
In the event CFIN matches the dividend payout peer average of 28.0% by
increasing the dividend forecast from LKR 3.50 to LKR 7.50, we believe the Movement (%) YTD 3M 12M
company will trade at a higher multiple than the current 0.6x (while the sector
CFIN 1 9 (4)
is trading at 0.9x). As such, we expect CFIN to trade at a multiple of 0.8x
ASPI 3 0 6
taking into account the company’s conservative business strategy. This leads to
a dividend implied target price of LKR 124.00 (+33.3% upside, +41.4% TSR). As S&P SL20 4 0 10
such, we view significant potential for CFIN given its current undervaluation. Source: CSE, Bloomberg
Financial summary
ROE (%) 16.0 15.4 16.2 16.0 15.0 15.6
P/E (x) 5.6 5.1 4.2 3.7 3.5 3.0
P/B (x) 0.8 0.7 0.6 0.6 0.5 0.4
89
Key ratios
FY2015 FY2016 FY2017 FY2018E FY2019E FY2020E
Diluted recurring EPS growth (%) 10.4 9.9 20.4 12.5 6.2 18.0
Net advance growth (%) 10.6 13.1 7.5 11.0 10.0 10.0
Gross NPL (%) 4.53 3.86 3.52 3.80 3.70 3.70
Net NPL (%) - - - - - -
NIM (%) 15.37 14.90 14.98 16.04 15.61 16.50
NIS (%) 12.5 12.1 11.7 12.5 11.9 13.0
Cost/income (%) 35.6 38.1 41.5 42.0 41.4 39.0
Loans/deposits (%) 159.8 176.2 182.9 181.3 175.7 184.7
Tier 1 ratio (%) 28.80 29.91 30.00 29.00 29.70 28.60

ROA (%) 5.3 5.4 5.9 6.1 6.0 6.5

ROE (%) 16.0 15.4 16.2 16.0 15.0 15.6
P/E (x) 5.6 5.1 4.2 3.7 3.5 3.0
P/B (x) 0.8 0.7 0.6 0.6 0.5 0.4
Dividend yield (%) 3.8 4.3 2.5 3.8 4.3 4.3
Dividend payout (%) 20.9 21.7 10.6 14.0 15.1 12.8
DPS (LKR) 3.50 4.00 2.35 3.50 4.00 4.00
Tan. BVPS (LKR) 111.34 126.33 145.70 165.70 186.84 212.50
No. of employees 1,624 1,642 1,642 1,660 1,713 1,766

No. of branches 92 93 93 94 97 100
Company profile
Central Finance Company Plc (CFIN) has over 70 years of history in operating in Sri Lanka’s finance industry and has been
listed on the Colombo Stock Exchange since 1969. In FY16 the company’s total assets were LKR 72.3bn and is one of the
largest NBFIs. CFIN is rated A+(lka) by Fitch Ratings Lanka Ltd.
With a range of diversified services including asset leasing, contract hire, fleet management, insurance broking, micro
finance and SME lending together with a broad portfolio of savings and deposit products, CFIN offers a wide range of
products to its client base. The company also has a wide range of subsidiaries under its umbrella which ranges from power
generation, medical services, manufacturing and real estate amongst others.
90
Corporate Services (Pvt) Ltd.A/C No.01 16.11 16.11 16.11 - -
E.H. Wijenaike 15.41 15.41 15.41 - -
Employees' Provident Fund 10.74 10.74 10.74 - -
Thurston Investments Limited 5.82 5.82 5.82 - -
A.J. Wijenaike 3.12 3.12 3.12 - -
N.W. Wijegoonawardene 2.06 2.06 2.06 - -
J.B. Cocoshell (Pvt) Ltd 1.28 1.51 1.76 +0.48 +0.25
G.S.N. Peiris 1.74 1.74 1.74 - -
B.P.De Silva Holdings (Pvt) Ltd. 1.67 1.67 1.67 - -
C.R. Dunuwille 1.29 1.29 1.29 - -
91
WILDCARD | 09 JANUARY 2018
National Dev. Bnk.[NDB]:HOLD [+10%] Kanishka Perera

+94 11 772 2044
Capital market cluster to drive valuations
NDB is a compelling wildcard story in our view. The core banking business Key statistics
has improved substantially over the last few quarters and generates one of BBG ticker NDB SL
the strongest ROEs in the industry. However, muted capital markets activity CSE ticker NDB.N0000
and overcapitalization has led to ROEs being at some of the lowest levels GICS subsector Diversified Banks
within the industry at a group level. With a need for additional capital in Price at 08 Jan 18 (LKR) 138.60
CY18E, we believe that exiting the capital markets cluster or optimizing the 52 week Hi/Lo (LKR) 150.00/127.00
capital structure will lead to an expansion in valuation multiples. The share
is currently trading at a cheap 0.6x CY18E BV which we believe should
rerate upwards to 0.8x in the event the Bank takes tangible steps to Market cap (USD mn) 155
optimize the capital structure. In such an instance, NDB will have a No. of shares (mn) 177
substantial upside to the current share price with a TSR of 38.2% ADT (LKR mn) - 3M 9.7
ADT (USD k) - 3M 63.3
Core banking business shows strong returns ADT (shares k) – 3M 71.6
NDB’s earnings continue to improve with the 3Q EPS coming in at LKR 6.03 Free float (%) 38.9
(+17.3% YoY; +38.3% QoQ). However, the result included a one-off expense on Public float (%) 90.3
the back of an early settlement of a foreign currency loan. Excluding which,
based on our calculations, the EPS for the quarter would have come in at ~LKR
7.13 (+38.6% YoY; +63.4% QoQ). Improvements were seen across the board with
a strong 30.5% YoY growth in net interest income, and a 35.6% YoY growth in Note: LKR converted at 153 LKR per USD
non-interest income while recurring opex grew by a moderate 14.8% YoY
Valuation summary
leading to a cost/income ratio of 45.9% (-7.0pp YoY; -1.5pp QoQ). At a bank
level, NDB recorded a TTM ROE of 17.9% (16.7% in 2Q CY17; 11.9% in 3Q CY16),
one of the best within the industry. Published TP (LKR) 145.00
Published TSR +10.4
Capital markets cluster bears down on group level returns Wildcard TP (LKR) 183.60
However the ROE declines to 10.7% at a group level with the consolidation of Wildcard TSR +38.2
the capital markets cluster. We believe that this segment is overcapitalized Source: Asia Securities |*incl. scrip dividend
leading to the muted group level ROE. Our base case expectation is that the
capital markets cluster will continue to bear down on returns given the largely Share price movement (indexed to NDB)
muted capital market activity. Exiting the capital market cluster will, in our LKR
opinion, free up capital at a Bank level to meet Basel III requirements 180
(currently at a T1 CAR of 8.77% vs. a minimum requirement of 8.50% by 1st Jan 170
2019). Furthermore, we estimate that the Bank would need at a capital 160
issuance of at least LKR 4.0bn to meet this minimum CAR which investors 150
wouldn’t look at favourably given the low group level ROE. 140
130
Potential to reach LKR 183.60 with a 38.2% TSR 120
We note that the share currently trades at 0.6x CY18E BV which is one of the 110
100
lowest valuations within the industry. Exiting the capital markets cluster or
optimizing capital will in our view, lead to investors looking more positively on
NDB. In such an instance, we would value NDB at 0.8x CY18E BV leading to a NDB ASPI S&P SL20
target price of LKR 183.60/share (+32.5% upside; +38.2% TSR).
NDB 2 6 (6)
ASPI 3 0 6
S&P SL20 4 0 10
Financial summary
ROE (%) 12.6 9.2 10.2 9.0 11.7 13.4
P/E (x) 6.4 8.5 7.4 7.3 4.8 3.7
P/B (x) 0.8 0.8 0.7 0.6 0.5 0.5
92
Key ratios
Recurring net income growth (%) (14.3) (24.0) 19.4 1.3 52.3 32.5
Diluted recurring EPS growth (%) (14.4) (24.2) 15.0 1.3 52.3 30.2
Loan growth (%) 19.3 8.7 14.1 14.4 16.2 17.4
Gross NPL (%) 2.43 2.63 2.45 2.40 2.40 2.40
Net NPL (%) 1.01 1.16 1.08 1.04 1.04 1.04
NIM (%) 2.79 2.84 3.02 3.01 3.37 3.30
NIS (%) 2.3 2.3 2.5 2.5 3.0 3.0
Cost/income (%) 51.4 52.3 49.9 50.6 47.5 46.3
CASA (%) 25.7 22.8 22.8 22.8 22.8 22.8
Loans/deposits (%) 116.8 114.8 111.5 109.0 105.0 105.0
Tier 1 ratio (%) 8.51 9.31 8.57 9.43 9.31 9.23

ROA (%) 1.2 0.8 0.9 0.8 1.1 1.3

ROE (%) 12.6 9.2 10.2 9.0 11.7 13.4
P/E (x) 6.4 8.5 7.4 7.3 4.8 3.7
P/B (x) 0.8 0.8 0.7 0.6 0.5 0.5
Dividend yield (%)* 7.9 5.8 5.8 5.8 5.8 5.8
Dividend payout (%)* 51.2 49.1 42.7 42.1 27.7 21.2
DPS (LKR) 11.00 8.00 8.00 8.00 8.00 8.00
Tan. BVPS (LKR) 170.63 178.90 189.14 229.52 262.30 294.40
No. of employees 1,960 2,108 2,332 2,559 2,660 2,652

No. of branches 93 104 116 128 133 133
Company profile
National Development Bank (NDB SL) was incorporated in 1979 as a Licensed Specialized Bank and was fully state
owned. The Bank was privatized and listed on the Colombo Stock Exchange in 1993. The privatization resulted in the
Government’s stake coming down to 39.0% which was further privatized in 1997 reducing the Government’s direct
holding to 12.2%. Currently, the state has no direct ownership but, has a cumulative indirect holding of 33.5% through
a state owned bank, insurance company, and pension funds.
In 2001, NDB incorporated a commercial bank under the name “NDB Bank Limited” which took over the operations of
ABN Amro NV Colombo Branch. In 2005 NDB acquired NDB Bank Limited and converted into the present state of a
Licensed Commercial Bank. In 2014 the Bank was to merge with DFCC in line with the Central Bank’s financial sector
consolidation plan. However, this was called off in 2015 following the change in government which took a view that
mergers should be a natural decision made by shareholders as opposed to being government led.
93
BANK OF CEYLON NO. 1 ACCOUNT 9.91 9.91 9.91 - -
EMPLOYEES PROVIDENT FUND 9.69 9.69 9.69 - -
MR. R.S. CAPTAIN 8.16 8.14 8.15 -0.01 +0.01
SRI LANKA INSURANCE CORPORATION LTD-GENERAL FUND 5.68 5.68 5.68 - -
DR. S. YADDEHIGE 5.18 5.18 5.18 - -
SRI LANKA INSURANCE CORPORATION LTD-LIFE FUND 4.73 4.73 4.73 - -
PERPETUAL TREASURIES LIMITED 3.73 4.45 4.45 +0.72 -
EMPLOYEES TRUST FUND BOARD 3.46 3.46 3.46 - -
SOFTLOGIC LIFE INSURANCE PLC ACCOUNT NUMBER 03/LIFE

3.00 3.04 3.04 +0.04 -
SHAREHOLDERS FUND
SBI VEN HOLDINGS PTE LTD 3.03 3.03 3.03 - -
94
SRI LANKA EQUITY | ENERGY
Lanka IOC [LIOC]: HOLD [-9%] Kanishka Perera

+94 11 772 2044
Energy pricing formula will be a game changer
We see LIOC as the wild card of the energy sector. While it is still uncertain Key statistics
if the transparent energy pricing formula will come aboard in March 2018 BBG ticker LIOC SL
given a record of having consistently missed deadlines in the past, we are of CSE ticker LIOC.N0000
the view that LIOC would be a key way to play the energy sector if the GICS subsector Oil & gas refining
formula comes to play. Despite having posted losses in the last three Price at 08 Jan 17 (LKR) 31.10
quarters, given the strong fundamentals and being the largest listed player 52 week Hi/Lo (LKR) 35.00/26.00
in the auto fuels market, we believe the pricing formula coming into play
will immediately pull LIOC out of losses bringing profitability to levels
Market cap (USD mn) 108
experienced in FY17. We expect a TSR of 31.8% in the event the pricing
formula is implemented. No. of shares (mn) 532
Energy pricing formula will change tides if implemented ADT (USD k) - 3M 10.1
The GoSL is set a deadline for March ’18 to implement the pricing ADT (shares k) – 3M 52.9
formula, which was also reiterated by the Central Bank Governor in Oct ‘17. Free float (%) 19.6
Given that it is imperative for the GoSL to implement the pricing formula for Public float (%) 24.9
fiscal consolidation, we factor in the impact of the pricing formula from FY19E Company website | CSE website
onwards. We note that the company has posted three consecutive quarters of
losses led by retail prices being left unchanged since 2015 in spite of rising
global oil prices. Despite the losses, we positively view that the company has Note: LKR converted at 153 LKR per USD
remained resilient maintaining its dividend payout over the past two years, Valuation summary
while its cash balance of ~LKR 8.6bn as of 2Q FY18 ensures that its losses can
be borne in the near-term. Furthermore, its low debt levels (15.4% Debt to
Published TP (LKR) 27.20
Equity) also provides room to borrow for expansion if required. As such, if the
energy pricing formula comes into play, we see the company coming out of Published TSR -9.3
losses almost immediately, while on a more long-term basis we believe it will Wildcard TP (LKR) 40.00
provide the company with a lot of stability protecting it from political currents. Wildcard TSR +31.8
Probability of price revision in FY18E very low
Fuel prices were last reduced sharply in January ’15. With an increase in crude Share price movement (indexed to LIOC)
oil prices since OPEC restricted supply since September ’16, the company now LKR
bears a loss of LKR 7.56/litre of 92-octane petrol, LKR 4.06/litre of 95-octane
37
petrol and LKR 3.61/litre of Auto Diesel. Despite LIOC having stated that it
looked to increase the prices at the pumps in Oct ‘17 this has not come to 35
fruition yet. With LPG prices hiked by 8.3% in Sep ’17, rising inflation and the 33
local government elections set for Feb ’18, we see the likelihood of an upward 31
retail price revision in FY18E being very low. Despite this, we believe LIOC’s 29
strong cash position will help the company to bear the losses in FY18E.
27
25
Potential to reach LKR 40.00/ share with a TSR of 31.8%
In the event of the pricing formula coming into play, our view on the energy
sector will turn positive for the longer-term as the fuel market will be driven LIOC ASPI S&P SL20
more through an economic thought process rather than a political one. This we
believe will provide stability to LIOC as it protects the company from political
currents, while we expect profitability to be on the positive side as prices will LIOC 11 2 1
be determined by the market. As such, under the scenario of the formula being ASPI 3 0 6
implemented, we arrive at a long-term target price of LKR 40.00 (+28.6% S&P SL20 4 0 10
upside; + 31.8% TSR) based on our DCF valuation (WACC @ 15.8%). Source: CSE, Bloomberg
Financial summary
Revenue 79,901 71,307 81,039 90,469 96,593 103,287
EBITDA 2,351 2,842 3,476 (500) 3,428 3,666
Recurring net profit 1,886 2,221 3,065 (338) 3,006 3,338
Diluted recurring EPS (LKR) 3.54 4.17 5.76 (0.64) 5.65 6.27
ROE (%) 10.7 12.2 15.6 (1.7) 14.2 14.1
P/E (x) 8.8 7.5 5.4 nm 5.5 5.0
EV/EBITDA (x) 3.6 2.6 1.8 nm 1.6 1.5
P/B (x) 0.9 0.9 0.8 0.8 0.7 0.7
95
Key ratios
FY15 FY16 FY17 FY18E FY19E FY20E
Revenue growth (%) (2.3) (10.8) 13.6 11.6 6.8 6.9
EBITDA growth (%) (60.4) 20.9 22.3 (114.4) (786.2) 6.9
Recurring net profit growth (%) (60.8) 17.8 38.0 (111.0) (988.2) 11.0
EBITDA margin (%) 2.9 4.0 4.3 (0.6) 3.5 3.5

Net margin (%) 2.4 3.1 3.8 (0.4) 3.1 3.2
Recurring diluted EPS (LKR) 3.54 4.17 5.76 (0.64) 5.65 6.27
DPS (LKR) 1.00 1.25 1.25 1.00 1.00 1.50
Tan. BVPS (LKR) 34.04 34.53 39.05 37.41 42.06 46.82
OCF (LKR mn) 2,345 2,149 1,701 979 2,553 2,723

Unlevered FCF (LKR mn) 1,758 1,519 1,292 255 1,781 1,897
Levered FCF (LKR mn) (695) (717) (205) 162 1,697 1,813
OCF/EBITDA (%) 99.8 75.6 48.9 (196.0) 74.5 74.3

Unlevered FCF/EBIT (%) 84.1 59.6 41.0 (30.0) 58.6 58.5
Levered FCF/Recurring net profit (%) (36.9) (32.3) (6.7) (48.0) 56.4 54.3
ROA (%) 7.8 9.4 12.4 (1.0) 11.8 11.8

ROE (%) 10.7 12.2 15.6 (1.7) 14.2 14.1
P/E (x) 8.8 7.5 5.4 nm 5.5 5.0
EV/EBITDA (x) 3.6 2.6 1.8 nm 1.6 1.5
P/B (x) 0.9 0.9 0.8 0.8 0.7 0.7
Dividend yield (%) 3.2 4.0 4.0 3.2 3.2 4.8
Dividend payout (%) 28.2 30.0 21.7 (157.3) 17.7 23.9
Company profile
Lanka IOC is involved in the sale of auto fuels, bunker fuel, lubricants and bitumen in Sri Lanka. Manufacturing activity
is limited to production of lubricants and blending of high performance additives to make branded fuels at Lanka IOC’s
Trincomalee terminal. Lanka IOC is a leading bunker fuel supplier in Sri Lanka and have many years of experience in
the marine fuel industry. They have bunkering plants in the Colombo Port and in Trincomalee Port. Lanka IOC has 179
fuel stations. The Company also has 17 lube distributors and 144 ‘SERVO’ Shops spread across the island and has 174
employees.
The Indian Oil Corporation Ltd holds 75.12% of the shares of the company. The balance shares are held by individuals
and institutional shareholders. Lanka IOC was established in 2002 and quoted on the Colombo Stock Exchange in 2004.
The company has four segments, namely, Auto fuels, Bunker fuels, Bitumen and Lubricants.
96
Indian Oil Corporation Limited India 75.12 75.12 75.12 - -
J B Cocoshell (Pvt) Ltd. 2.12 2.12 2.06 -0.06 -0.06
Deutsche Bank AG- as Trustee for JB Vantage Value Equity Fund 1.04 1.04 1.04 - -
Bank of Ceylon A/c Cey Bank Unit Trust 1.26 1.25 0.97 -0.29 -0.28
HSBC Intl Nom Ltd-JPMCB NA-Fidelity Asian Values PLC - - 0.85 +0.85 +0.85
Mellon Bank N. A- Acadian Frontier Markets Equity Fund 0.80 0.82 0.82 +0.02 -
British American Technologies (Pvt) Ltd 0.56 0.75 0.75 +0.19 -
Deutsche Bank AG- National Equity Fund 0.75 0.75 0.75 - -
Deuische Bank AG- as Trustee for national Aquity Fund 0.58 0.58 0.58 - -
E W Balasuriya & Co. (Pvt ) Ltd 0.47 0.47 0.47 - -
97
COVERAGE UNIVERSE
98
Year Market cap ADV CMP TP Upside P/E (x) DY (%) P/B (x) ROE (%) ROA (%)
Ticker Last update TR (%) Rec* PEG
end LKR bn USD mn (USD k) (LKR) (LKR) (%) 1FY 2FY 1FY 2FY 1FY 2FY 1FY 2FY 1FY 2FY
Conglomerates
JKH Mar-18 9-Nov-17 229 1,491 875 165.00 168.00 +1.8 +5.2 HOLD 14.8 12.1 1.36 3.3 3.3 1.2 1.2 8.5 10.0 5.7 6.8
HHL Mar-18 17-Nov-17 71 464 209 123.80 136.00 +9.9 +11.0 HOLD 19.0 14.3 0.92 1.1 1.1 2.8 2.4 15.4 17.9 8.4 10.0
SPEN Mar-18 19-Dec-17 22 145 2 55.00 61.70 +12.2 +14.9 HOLD 7.8 6.1 0.42 2.7 2.7 0.5 0.5 7.0 8.5 4.7 5.4
SHL Mar-18 20-Nov-17 10 66 30 13.00 13.00 - +3.8 HOLD 27.7 18.1 1.52 3.8 3.8 1.1 1.1 4.0 6.1 3.5 3.7
Average 17.3 12.6 1.05 2.8 2.8 1.4 1.3 8.7 10.6 5.6 6.5
Banks
COMB Dec-17 12-Dec-17 138 901 749 141.00 150.50 +6.7 +11.3 HOLD 8.2 7.9 0.95 4.6 5.7 1.4 1.2 17.7 16.2 1.5 1.5
HNB Dec-17 12-Dec-17 119 775 371 255.00 286.00 +12.2 +15.7 BUY 6.7 5.7 0.46 3.5 3.7 1.0 0.9 16.0 16.5 1.8 2.0
SAMP Dec-17 20-Dec-17 71 466 752 329.00 365.00 +10.9 +16.3 BUY 6.2 6.7 2.84 5.3 5.9 1.0 1.0 19.5 16.6 1.6 1.7
SEYB Dec-17 12-Dec-17 26 167 5 87.90 92.40 +5.1 +8.8 HOLD 6.8 6.2 0.49 3.7 3.7 1.0 0.9 14.9 14.6 1.2 1.2
NDB Dec-17 12-Dec-17 24 155 98 138.60 149.10 +7.6 +13.3 HOLD 7.4 7.3 0.35 5.8 5.8 0.7 0.6 10.2 9.0 0.9 0.8
NTB Dec-17 12-Dec-17 18 117 46 78.10 86.40 +10.6 +13.3 HOLD 5.3 4.9 0.31 2.7 2.7 0.9 0.8 18.0 18.3 1.4 1.5
UBC Dec-17 12-Dec-17 14 94 9 13.20 13.20 - +0.8 HOLD 26.4 20.6 1.45 0.8 0.8 0.9 0.9 4.0 4.6 0.5 0.5
SDB Dec-17 12-Dec-17 6 37 13 103.10 125.70 +21.9 +29.2 BUY 11.8 7.6 nm 7.3 7.3 0.8 0.8 7.7 10.5 0.7 1.0
DFCC Dec-17 na 32 210 81 121.80 - -100.0 -100.0 UR nm nm nm - - nm nm - - - -
PABC Dec-17 na 7 47 5 16.30 - -100.0 -100.0 UR nm nm nm - - nm nm - - - -
Average 9.9 8.4 0.98 3.4 3.6 1.0 0.9 10.8 10.6 1.0 1.0
FMCG/R
CTC Dec-17 20-Nov-17 199 1,300 41 1,065 1,120 +5.2 +10.7 HOLD 16.0 14.3 1.84 5.5 6.2 40.7 30.8 297 245 53.7 56.7
NEST Dec-17 14-Nov-17 91 594 114 1,698 1,800 +6.0 +9.6 HOLD 27.0 23.8 15.3 3.6 4.1 16.3 16.0 61.0 67.9 23.8 25.0
CCS Mar-18 30-Oct-17 90 588 125 950.00 730 -23.2 -21.1 SELL 24.4 19.2 1.41 2.1 2.1 8.5 7.3 26.2 28.7 15.4 17.2
CARG Mar-18 17-Nov-17 44 287 61 196.40 240 +22.2 +25.4 BUY 15.6 12.0 0.53 3.2 4.2 2.9 2.6 19.2 22.6 7.5 8.6
SINS Dec-17 13-Dec-17 16 104 3 42.50 48 +12.9 +16.7 BUY 13.6 9.6 0.98 3.8 5.4 1.8 1.7 13.9 18.2 6.1 6.9
KFP Mar-18 1-Nov-17 3 22 1 130.10 125.00 -3.9 +4.5 HOLD 13.5 12.2 3.71 8.5 8.5 2.0 2.0 14.9 16.6 10.7 11.9
Average 18.4 15.2 3.95 4.4 5.1 12.0 10.1 72.1 66.5 19.5 21.1
Alcoholic Beverages
MELS Mar-18 21-Nov-17 70 457 56 60.20 60.00 -0.3 +1.3 HOLD 12.9 12.8 (6.66) 1.7 2.0 0.9 0.9 7.8 7.4 5.5 5.3
LION Mar-18 16-Nov-17 45 294 223 564.70 735.00 +30.2 +30.2 BUY 372 53.9 (1.68) - 0.7 4.8 4.1 1.4 8.2 3.7 6.0
Average 192 33.3 (4.17) 0.8 1.4 2.9 2.5 4.6 7.8 4.6 5.7
Source: Asia Securities | Notes: Priced as at end 09 Jan 2016, *Recommendation could vary from analyst published one due to price movements
99
This report is strictly for direct recipients from Asia Securities. Redistribution of this report is strictly prohibited. Please see page 102 for analyst & company certification and important
disclosures
Telecommunications
DIAL Dec-17 13-Nov-17 110 716 259 13.50 16.70 +23.7 +28.3 BUY 10.0 7.6 0.52 3.5 4.6 2.1 1.8 19.2 19.2 9.5 11.1
SLTL Dec-17 17-Nov-17 53 347 1 29.50 22.90 -22.4 -19.4 SELL 12.1 9.9 4.44 3.0 3.0 0.7 0.7 6.3 7.3 3.6 4.2
Average 11.0 8.8 2.48 3.2 3.8 1.4 1.3 12.8 13.3 6.6 7.7
Construction
TKYO Mar-18 20-Nov-17 26 171 81 68.50 70.30 +2.6 +5.0 HOLD 7.7 6.7 0.60 2.3 2.9 1.6 1.3 22.8 21.8 14.1 14.5
AEL Mar-18 16-Nov-17 24 156 44 23.90 28.00 +17.2 +22.4 BUY 9.1 7.5 0.76 5.2 6.3 1.2 1.1 13.4 15.2 7.6 8.7
RCL Mar-18 21-Nov-17 13 82 11 114.10 131.00 +14.8 +21.8 BUY 4.1 3.7 1.00 7.0 7.9 0.6 0.6 16.7 16.3 8.7 8.9
TILE Mar-18 6-Nov-17 6 38 4 111.10 120.00 +8.0 +15.2 BUY 5.3 5.0 6.22 7.2 7.2 0.8 0.7 15.8 15.4 13.1 13.1
ALUM Mar-18 6-Nov-17 6 37 10 18.90 22.50 +19.0 +27.5 BUY 7.5 5.8 0.50 8.5 8.5 2.2 1.8 30.7 34.2 18.1 20.8
ACL Mar-18 17-Nov-17 5 34 7 44.00 53.40 +21.4 +24.5 BUY 5.4 4.8 1.76 3.2 4.5 0.5 0.5 9.7 10.0 6.8 7.0
KAPI Mar-18 23-Nov-17 4 27 5 24.90 25.00 +0.4 +0.4 HOLD nm nm nm - - 0.9 0.9 (29.2) - (0.4) 4.7
PARQ Mar-18 6-Nov-17 2 12 7 65.00 73.40 +12.9 +16.0 BUY 4.7 4.3 0.69 3.1 3.5 0.8 0.7 18.7 17.6 12.2 12.1
SIRA Mar-18 15-Nov-17 1 9 5 2.50 2.50 - +10.0 HOLD 6.9 4.6 1.01 10.0 12.0 0.8 0.7 11.3 16.1 7.4 9.7
Average 6.3 5.3 1.57 5.2 5.9 1.0 0.9 12.2 16.3 9.7 11.1
Manufacturing
TJL Mar-18 9-Nov-17 25 163 95 35.70 38.00 +6.4 +12.0 HOLD 12.3 9.6 0.89 5.6 6.3 2.1 1.9 17.6 21.0 11.6 13.7
GLAS Mar-18 13-Nov-17 6 37 6 5.90 7.00 +18.6 +24.1 BUY 10.0 7.9 0.49 5.4 7.1 1.3 1.2 13.0 15.4 8.4 9.5
DIPD Mar-18 13-Nov-17 5 33 2 84.90 100.00 +17.8 +21.3 BUY 6.3 5.6 0.64 3.5 4.1 0.5 0.5 8.6 9.0 4.1 4.3
HAYC Mar-18 16-Nov-17 4 29 1 148.90 161.00 +8.1 +12.2 HOLD 5.4 4.7 0.55 4.0 4.0 0.6 0.5 11.5 12.0 6.6 7.1
MGT Mar-18 13-Nov-17 3 19 8 14.10 20.00 +41.8 +41.8 BUY 14.8 6.2 0.16 - - 1.0 0.9 7.0 15.0 4.2 7.2
REG Dec-17 13-Nov-17 1 9 7 118.00 160.00 +35.6 +48.3 BUY 4.7 3.5 0.43 12.7 12.7 0.8 0.7 17.6 22.5 4.3 3.4
Average 8.9 6.3 0.53 5.2 5.7 1.1 1.0 12.6 15.8 6.5 7.5
Energy
LLUB Dec-17 20-Oct-17 29 188 131 120.00 140.00 +16.7 +25.0 BUY 10.5 9.4 (3.12) 8.3 10.0 6.8 6.5 68.2 71.3 38.4 41.6
LIOC Mar-18 5-Jan-18 17 108 10 31.10 27.00 -13.2 -10.0 HOLD nm 5.5 nm 3.2 3.2 0.8 0.7 (2.0) 14.2 (1.3) 11.8
LGL Mar-18 20-Nov-17 9 60 2 27.70 24.80 -10.5 -10.5 HOLD nm 16.4 nm - 3.6 1.3 1.3 (10.5) 8.1 2.0 5.5
Average 10.5 10.4 (3.12) 3.8 5.6 3.0 2.9 18.6 31.2 13.0 19.6
100
disclosures
Insurance
CINS Dec-17 17-Nov-17 37 243 8 1,597 1,563 -2.1 -0.4 HOLD 6.7 5.7 0.36 1.7 1.7 1.3 1.1 21.1 20.7 4.4 4.6
JINS Dec-17 22-Nov-17 9 57 13 16.00 17.30 +8.1 +14.4 HOLD 3.8 3.7 0.70 6.3 8.1 0.9 0.7 22.6 20.0 6.5 6.4
AAIC Dec-17 16-Nov-17 8 54 72 22.10 20.20 -8.6 -4.1 HOLD 6.5 6.5 0.40 4.5 4.5 2.7 2.0 50.0 35.2 12.4 11.6
PINS Dec-17 27-Oct-17 5 30 8 22.80 21.00 -7.9 -0.4 HOLD 6.0 5.1 0.68 7.5 8.8 1.5 1.3 26.9 27.0 10.3 10.4
HASU Dec-17 8-Nov-17 4 24 5 72.60 67 -8.3 -0.1 HOLD 4.4 4.2 0.28 8.1 8.4 1.1 1.0 28.0 24.6 5.3 4.8
Average 5.5 5.0 0.48 5.6 6.3 1.5 1.2 29.7 25.5 7.8 7.6
Non-Bank Financial Institutions

PLC Mar-18 30-Oct-17 27 175 20 17.00 17.30 +1.8 +9.1 HOLD 6.4 5.6 0.68 7.4 7.4 1.0 0.9 15.5 16.3 2.6 2.7
CFIN Mar-18 4-Dec-17 20 131 66 93.00 95.10 +2.3 +4.8 HOLD 3.7 3.5 0.31 2.5 3.8 0.6 0.5 15.9 14.9 6.1 6.0
LFIN Mar-18 27-Oct-17 18 115 11 127.00 132.90 +4.6 +11.7 HOLD 4.4 3.9 0.27 7.1 7.1 1.2 1.0 28.8 26.7 5.0 4.9
COCR Mar-18 12-Dec-17 14 89 17 43.00 39.10 -9.1 -5.6 HOLD 4.7 4.3 1.30 3.5 3.5 1.1 0.9 24.6 22.2 3.4 3.6
CDB Mar-18 12-Dec-17 3 20 7 65.60 68.00 +3.7 +9.0 HOLD 3.2 3.0 0.58 5.3 5.3 0.5 0.5 17.2 16.0 2.3 2.1
Average 4.5 4.1 0.63 5.2 5.4 0.9 0.7 20.4 19.2 3.9 3.9
Healthcare
ASIR Mar-18 23-Aug-17 29 186 6 25.10 22.00 -12.4 -10.4 HOLD 21.5 15.5 0.69 2.0 2.0 4.3 3.6 19.3 23.4 9.3 11.4
LHCL Dec-17 21-Nov-17 14 90 2 62.00 70.00 +12.9 +16.1 BUY 14.2 13.5 2.22 3.2 3.2 2.2 2.0 16.0 15.5 12.8 12.6
Average 17.8 14.5 1.46 2.6 2.6 3.2 2.8 17.7 19.5 11.1 12.0
Leisure
AHPL Mar-18 13-Dec-17 25 164 6 56.80 45.00 -20.8 -13.7 HOLD 11.9 11.4 7.40 7.0 7.0 0.8 0.7 6.4 6.6 5.4 5.5
KHL Mar-18 13-Dec-17 13 84 1 8.90 9.00 +1.1 +4.5 HOLD 10.1 7.8 1.38 3.4 3.9 0.5 0.5 5.1 6.3 4.6 5.6
AHUN Mar-18 13-Dec-17 10 68 2 31.00 30.00 -3.2 +0.0 HOLD 12.6 8.0 nm 3.2 6.5 0.5 0.5 4.3 6.5 3.3 4.1
Average 11.5 9.1 4.39 4.5 5.8 0.6 0.6 5.3 6.5 4.4 5.1
Property
RIL Mar-18 21-Nov-17 4 29 9 7.30 8.40 -20.8 +16.4 BUY 4.2 5.9 (0.22) 1.4 1.4 0.2 0.2 5.8 4.3 5.6 4.7
All 17.0 9.3 1.20 4.2 4.7 2.5 2.1 20.0 20.9 7.5 8.5
Industrials 22.1 10.8 1.43 4.1 4.7 3.2 2.7 21.1 23.2 9.7 11.2
Financials 7.1 6.2 0.73 4.4 4.7 1.1 0.9 17.9 16.5 3.4 3.4
101
disclosures
Analyst Certification
I, Kanishka Perera, certify that the views expressed in this report accurately reflect my personal views about the
company. I also certify that no part of my compensation was, is, or will be, indirectly or directly, related to the specific
view or recommendation expressed in this report.
I, Lakshini Fernando, certify that the views expressed in this report accurately reflect my personal views about the
I, Mangalee Goonetilleke, certify that the views expressed in this report accurately reflect my personal views about the
I, Naveed Majeed, certify that the views expressed in this report accurately reflect my personal views about the
Company Certification
Asia Securities (Private) Limited has no direct affiliation with the company/companies covered in this report and does not
receive any material benefit from the company for publishing this report.
Disclaimer
The report has been prepared by Asia Securities (Private) Limited. The information and opinions contained herein has
been compiled or arrived at based upon information obtained from sources believed to be reliable and in good faith. Such
information has not been independently verified and no guaranty, representation or warranty, express or implied is made
as to its accuracy, completeness or correctness, reliability or suitability. All such information and opinions are subject to
change without notice. This document is for information purposes only, descriptions of any company or companies or their
securities mentioned herein are not intended to be complete and this document is not, and should not be construed as,
an offer, or solicitation of an offer, to buy or sell any securities or other financial instruments. In no event will Asia
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102
Research
Kanishka Perera – Head of Research Mangalee Goonetilleke Naveed Majeed
Strategy | Banks | Insurance | Conglomerates | Consumer | Manufacturing | Leisure |
Telecommunications Healthcare Energy | Construction
kanishka@asiasecurities.lk mangalee@asiasecurities.lk naveed@asiasecurities.lk
+94 11 772 2044 +94 11 772 2042 +94 11 772 2043
Lakshini Fernando
Economics | Finance
+94 11 772 2045
Osadi Hettiarachchi Thilini Amarasiri

osadi@asiasecurities.lk thilini@asiasecurities.lk
+94 11 772 2041 +94 11 772 2048
Institutional Sales
Sabri Marikar Shiyam Subaulla Niroshan Wijekoon
CEO Head of Institutional Sales niroshan@asiasecurities.lk
sabri@asiasecurities.lk shiyam@asiasecurities.lk +94 11 772 2007
+94 11 772 2022 +94 11 772 2011 +94 77 771 3645
+94 77 357 6868 +94 77 350 2016
Anushan Kandasamy Ruwan Hettiarachchi Gagani Jayawardhana

anushan@asiasecurities.lk ruwan@asiasecurities.lk gagani@asiasecurities.lk
+94 11 772 2019 +94 11 772 2020 +94 11 772 2014
+94 77 722 2519 +94 77 741 0164 +94 71 408 4953
Niroshan Ratnam Miflal Farook Charith Perera

ratnam@asiasecurities.lk miflal@asiasecurities.lk charith@asiasecurities.lk
+94 11 772 2006 +94 11 772 2010 +94 11 772 2015
+94 77 371 7515 +94 77 225 3730 +94 77 359 8937
Foreign Sales
Dinusha Gomes
Head of Foreign Sales
dinusha@asiasecurities.lk
+94 11 772 2080
+94 77 300 2274
Retail Sales
Subeeth Perera Priyantha Hingurage Romesh Priyadarshana
Head of Retail Sales priyantha@asiasecurities.lk romesh@asiasecurities.lk
subeeth@asiasecurities.lk +94 11 772 2033 +94 11 772 2032
+94 11 772 2035 +94 77 350 2015 +94 77 254 8795
+94 71 404 2683
Kalana Hewawasam Nuwan Eranga Perera Uthpala Karunathilaka

kalanag@asiasecurities.lk eranga@asiasecurities.lk uthpala@asiasecurities.lk
+94 11 772 2028 +94 11 772 2026 +94 31 567 6881
+94 77 395 9438 +94 77 736 8012 +94 77 369 1685
Bhanu Ganegama Ashan Silva

bhanu@asiasecurities.lk ashan@asiasecurities.lk
+94 11 772 2031 +94 11 772 2005
+94 77 184 8789 +94 77 045 8028
Asia Securities (Pvt) Ltd., 2nd Floor, 176/1 – 2/1, Thimbirigasyaya Road, Colombo 05, Sri Lanka. | Tel: +94 11 772 2000 | Web: www.asiasecurities.net

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SRI LANKA EQUITY | STRATEGY

OUTLOOK | 10 JANUARY 2018

Sri Lanka: Equity Strategy 2018

Banking and Telecom to be key growth sectors; valuations to be depressed in near-term

Equity Strategy ____________________________________________ 3

Macro Outlook - 2018 _____________________________________ 17

Sector Outlook - 2018 _____________________________________ 28

TOP PICKS ___________________________________________

COVERAGE UNIVERSE ______________________________________ 99

Index value Index value Index value Index value

7,000 4,000 9,100 5,800

We forecast the ASPI at 6,920 by year end 2018 (+8.6% YoY)

Our 2018 macro forecasts show an improvement

Key macro forecasts

LKR/USD 131.05 144.06 149.80 155.00 160.00 165.80 169.15

Debt/GDP (%) 71.3 77.6 79.3 79.2 78.6 78 76.5

Source: CBSL, DoCS, Asia Securities

Construction and Consumer to deliver results from 2H CY18E

Market earnings growth to pick-up but, with some downside risk

Net foreign inflows continue to drive market valuations

TTM inflows - EM (LHS) TTM inflows - SL (RHS)

Source: Bloomberg, Asia Securities

Advanced economies have seen substantial upward revisions of growth expectations

CY18E GDP growth revision (%)

Advanced economies Emerging market and developing economies

Source: IMF, Asia Securities

US Fed rate (%)

1Q CY18E 2Q CY18E 3Q CY18E 4Q CY18E

Source: BBG, Asia Securities

Valuations to be challenged on policy uncertainty

Source: BBG, Asia Securities

As we mentioned earlier, we expect ASPI earnings to be up 14.9% YoY (Bloomberg consensus

Source: BBG, Asia Securities

Our country proxy stock of choice is COMB

Market cap/GDP (%)

Source: IMF, BBG, Asia Securities | Data as at end CY17

Earnings growth correlation with GDP growth

Source: IMF, BBG, Asia Securities | Data as at end CY17

Market activity up in CY17 but, to remain largely in line for CY18E

ADT (USD mn) ADT (USD mn)

Asia Securities Recommended Portfolio S&P SL20 TRI ASPI TRI

Source: CSE, BBG, Asia Securities

Total return (%)

Research recommendation Buy and hold

Source: CSE, BBG, Asia Securities

2017 portfolio 2018 portfolio

Source: Asia Securities

Our key picks for 2018 (1/2)

Sri Lanka: Macro Outlook 2018

We forecasted a higher than anticipated increase in Government expenditure as a result of

GDP growth (%) 5.1 4.6 4.4 4.0

Headline inflation (%) 5.5 5.8 5.8 5.8

LKR/USD 158.00 158.00 155.00 155.00

12M GSEC yield (%) 10.70 10.70 10.00 10.00

Fiscal deficit (% of GDP) 4.9 5.0 5.1 5.1

Current deficit (% of GDP) 2.5 2.5 2.5 2.5

Trade deficit (% of GDP) 11.0 11.7 11.7 11.7

FX reserves (months of imports) 4.5 4.0 4.1 4.1

Source: DoCS, Asia Securities Source: CBSL, Asia Securities

Current balance to worsen to 2.6% of GDP on remittance slowdown

Source: CBSL, Asia Securities Source: CBSL, Asia Securities

Reserves to remain strong on CB policies; to hit 4.4 months of imports in CY18E

Manufacturing related FDIs have increased in CY17E