aitken spence plc (spen) - colombo stock exchange · pdf filea capital market development...

Sri Lanka | Diversified Holdings EQUITY RESEARCH

Initiation of coverage 10 July 2013

Aitken Spence PLC (SPEN)

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A capital market development initiative by the Colombo Stock Exchange in association with Amba Research

A play on tourism and power Aitken Spence PLC (SPEN), the third-largest conglomerate listed on the Colombo Stock Exchange (CSE) by market cap, has operations in the tourism, power, logistics and services industries, as well as smaller interests in a number of other businesses. We forecast SPEN to post a revenue CAGR of 3.4% over FY14E-FY16E. This modest revenue growth partly reflects the company’s significant exposure to the power sector, where the potential non-renewal of power purchasing agreements (PPAs) could hurt SPEN’s growth prospects. However, growth in SPEN’s tourism segment should offset the decline in its power operations. Our DCF valuation analysis and P/E analysis suggest a valuation range of LKR110-157, compared with the share price of LKR124 as of 9 July 2013.

We expect SPEN’s revenues to increase at a 3.4% CAGR over FY14E-FY16E.

The group’s top-line growth should be fuelled mainly by the tourism segment, which comprises hotels in Sri Lanka, the Maldives, Oman and India. A 13.8% addition to room inventory, a 430bps increase in blended occupancy levels and rising average room rates (ARRs) should boost the segment’s revenue over the forecast period. This, together with a modest 5.3% revenue CAGR over FY14E-FY16E from the cargo logistics and services segments, should help compensate for the anticipated 4.8% CAGR decline in the strategic investments segment revenue over the forecast period.

We expect SPEN’s EBITDA margin to rise 290bps to 21.6% in FY16E. SPEN’s

tourism segment accounted for 38% of overall firm revenue but 62% of EBITDA in FY13. Accordingly, the 150bps margin expansion in the tourism segment to 31.5% in FY16E will have a significant impact on SPEN’s overall EBITDA margin. The strategic investments segment’s EBITDA margin should increase marginally from its FY13 level to 10.8% in FY16E. Downside risk to margins comes from the possible renewal of the PPAs for the Matara and Horana thermal power plants, since the revised prices are likely to be below the original contract prices. In our view, the cargo logistics segment’s EBITDA margin should remain at its FY13 level of 13.0%, as new businesses in Fiji and in Bangladesh should compensate for the loss of contracts in Africa.

Low net debt and stable cash generation should allow for further investment.

SPEN has been able to maintain a low net debt position compared to its close local peers, despite new projects typically being funded by debt. A long-term debt-to-capital ratio of less than 30% and stable free cash flow (FCF) generation over the past few years (the company’s FCF has ranged from LKR1.2bn to LKR4.1bn over the past five years, with negative FCF posted only in FY12) reflects SPEN’s financial flexibility to reduce leverage further or pursue new growth opportunities should it choose to do so.

We establish a share price range of LKR110-157 in FY14E, compared with the current share price of LKR124. We used DCF analysis and P/E analysis to arrive at

a valuation range for the company. SPEN currently trades at a 12-month forward P/E of 13.0x FY14E; this has ranged between 10.6x-18.6x since July 2011. We have also used scenario analysis to arrive at the valuation range. Our bull-case scenario assumes a more positive tourism segment performance, with higher occupancies and ARRs, and renewal of operations at the Matara and Horana power plants, albeit at a lower tariff rate. Our bear case assumes lower occupancies and lower ARR growth in tourism, and renewal of the PPA for the Embilipitiya plant, upon its expiry in FY15E at a lower tariff rate. In the coming quarters, we will track SPEN’s performance across a number of key areas (see page 19) and update our valuation range in future earnings updates. Also see page 16 for potential upside/downside risks to our valuation range.

Key statistics CSE/Bloomberg tickers

Share price (9 July 2013)

No. of issued shares (m)

Market cap (USDm)

Enterprise value (USDm)

Free float (%)

52-week range (H/L)

Avg. daily vol (shares, 1yr)

Avg. daily turnover (USD

‘000)

SPEN.N0000/SPEN SL

LKR124

406

384

458

40%

LKR139/108

324,148

301

Source: CSE, Bloomberg Note: USD/LKR = 128.7 (avg. for the 1 year ended 9 July 2013)

Share price movement

Source: CSE, Bloomberg

Share price performance

3m 6m 12m

SPEN 3% 2% 8%

S&P SL 20 1% 7% 20%

All Share Price Index 3% 4% 22%


Summary financials

LKRm (year end 31 March) 2013 2014E 2015E

Revenue 36,606 36,042 38,015

EBITDA 6,840 6,954 7,829

EBIT 5,490 5,584 6,391

Net profit 3,267 3,875 4,486

Recurrent EPS 8.0 9.5 11.0

ROE (%) 12.3 13.1 13.6

P/E (x) 14.9 13.0 11.2

Source: SPEN, Amba estimates

80%

100%

120%

140%

Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13

SPEN ASPI S&P SL 20

Aitken Spence PLC

Table of Contents

SPEN’s revenue should grow at a 3.4% CAGR over FY14E-FY16E .................................................................................. 3

Higher room count, occupancy levels and ARRs to drive tourism revenue CAGR of 12.7% through FY16E ....................................... 3 Strategic investments segment revenue to decline at a CAGR of 4.8% over FY14E-FY16E ............................................................... 6 Cargo logistics and services segments to make a sizeable contribution to top-line growth .................................................................. 9

We anticipate a 290bps increase in EBITDA margin to 21.6% over FY14E-FY16E ......................................................... 10

Tourism segment EBITDA margin to expand 150bps over FY14E-FY16E ......................................................................................... 11 Strategic investments segment EBITDA margin likely to increase slightly to 10.8% in FY16E ........................................................... 11 Cargo logistics and services segments together make a noteworthy contribution to SPEN’s margin ................................................. 11

Relatively low net debt and stable liquidity position should allow for further borrowing for new projects .......................... 12

We expect shares to trade in the range of LKR110-157 per share ................................................................................... 13

DCF valuation gives a range of LKR111-157 per share ..................................................................................................................... 13 P/E analysis yields a valuation range of LKR110-135 per share ........................................................................................................ 15 Where is additional potential upside? ................................................................................................................................................. 16 Share price performance .................................................................................................................................................................... 17

Earnings release focus areas ............................................................................................................................................. 19

Appendix 1: Company overview......................................................................................................................................... 20

SPEN’s key businesses ...................................................................................................................................................................... 21 Management strategy and transparency ............................................................................................................................................ 22 Shareholding structure ....................................................................................................................................................................... 23 Board of directors ............................................................................................................................................................................... 24

Appendix 2: Key financial data ........................................................................................................................................... 26

Summary group financials (LKRm) ..................................................................................................................................................... 26 Key ratios............................................................................................................................................................................................ 27 Segmental summary ........................................................................................................................................................................... 28

Appendix 3: Industry analysis using Porter’s framework ................................................................................................... 30

Hotels ................................................................................................................................................................................................. 30

Appendix 4: SWOT analysis .............................................................................................................................................. 32

Appendix 5: Diversified sector overview ............................................................................................................................ 33

Appendix 6: Sri Lanka power sector overview ................................................................................................................... 36

Fact Sheet .......................................................................................................................................................................... 39

Sri Lanka investment environment overview ...................................................................................................................................... 39

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SPEN’s revenue should grow at a 3.4% CAGR over FY14E-

FY16E

SPEN’s revenue growth is likely to be fuelled primarily by the tourism segment (38% of FY13 revenue), which should, in turn, be driven by increasing occupancy levels, room inventory and ARRs. The strategic investments segment (49% of FY13 revenue) should remain a key contributor to the top line, although its relative share is likely to decline through FY16E (refer to Appendix 1 for a detailed discussion on SPEN’s revenue composition).

Higher room count, occupancy levels and ARRs to drive tourism

revenue CAGR of 12.7% through FY16E

We expect revenue from the tourism segment to post a CAGR of 12.7% over FY14E-FY16E, reaching LKR20.2bn and accounting for 50% of total revenue, in FY16E. Aitken Spence Hotel Holdings PLC (AHUN), a subsidiary in which SPEN owns 71.20%, is likely to account for approximately 85% of the segment’s revenue over the forecast period. The company’s other tourism businesses – inbound and outbound travel services as well as an airline general sales agency (GSA) – should account for the balance of segment revenue.

We forecast AHUN, which holds SPEN’s hotel portfolio, to post a revenue CAGR of 12.4% over FY14E-FY16E. The addition of 274 hotel rooms, a 13.8% increase from the current room count of 1,979, is likely to fuel this growth. Additionally, a 4.3ppt increase in blended occupancy levels (to 73% in FY16E from 69% in FY13) and a blended ARR growth of about 5.5% annually through FY16E should aid AHUN’s revenue growth. This includes our conservative assumption of a 1.5% annual depreciation of the rupee.

SPEN room inventory to increase 13.8% over FY14E-FY16E

SPEN stated that it plans to increase its total room count by 13.8% to 2,253 in Sri Lanka, the Maldives, Oman and India over FY14E-16E. The company’s room count of 743 in Sri Lanka (roughly 5% of total room inventory in the country) is likely to increase by 32.3% to 983 by end-FY16E, with the addition of 150 rooms at the new Heritance hotel on the former Browns Beach property in Negombo (a beach town 40km north of Colombo) and 90 rooms at The Sands in Kalutara (roughly 40km south of Colombo). SPEN plans to expand its presence in the Maldives and has already confirmed the addition of 34 water villas. In the absence of other concrete plans, we conservatively assume that the room count of 191 in India and 440 in Oman will remain flat over the forecast period.

Figure [1]: SPEN’s room inventory to increase 13.8% by FY16E


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Tourism segment to primarily drive total revenue growth

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Historically, SPEN has increased its exposure in the hotel industry through acquisitions and management contracts. AHUN is well positioned to continue to do so given its healthy financial position, with a long-term debt-to-equity ratio of under 20%, and strong cash balance position – cash and cash equivalents, and short-term deposits make up approximately 19% of total assets.

Figure [2]: SPEN’s tourism segment has grown in part through acquisitions

Year Investment

1994 Invested in Brown’s Beach Hotel in Negombo (around 40km north of Colombo) and Hotel Hilltop in Kandy (roughly 120km from Colombo)

1995 Acquired a majority stake in Hethersett Hotels Ltd, which owns The Tea Factory, a four-star hotel in Nuwara Eliya (180km from Colombo)

2007 Entered the Indian hospitality industry by securing management contracts for four resorts

2008 Acquired Vadoo Island Resort in the Maldives and entered the Omani market by securing management contracts for four hotels

2009 Secured management contract of a luxury desert camp in Oman

2010 Acquired the owning company of the Ramada Resort, Kalutara (about 50km south of Colombo – the resort was later refurbished and

rebranded as The Sands by Aitken Spence Hotels in 2012)

2012 Acquired Hotel Hilltop

Source: SPEN

Room occupancy to reach 73% and ARRs to post a CAGR of 5.5% through

FY16E

We believe the tourism segment’s top line should be further strengthened by gradually increasing occupancy levels and ARRs. Occupancy levels are likely to increase to a blended 73% in FY16E from 69% for the company’s hotel sector in FY13. In addition, we expect ARRs to record a CAGR of 5.5% over FY14E-FY16E.

Hotel occupancy in Sri Lanka to rise 6ppt and ARRs to post a 9.3% CAGR

over FY14E-FY16E

We expect SPEN’s hotels in Sri Lanka, which are likely to account for 44% of the company’s total room inventory by FY16E (compared with 38% of room inventory in FY13), to record a 6ppt increase in occupancy levels to 67% by FY16E from 61% in FY13. We expect ARRs to increase at a CAGR of 9.3% over FY14E-FY16E, as total room inventory rises by 32.3% over the period to 983 rooms.

Figure [3]: ARRs at SPEN’s Sri Lankan hotels to grow at a CAGR of 9.3% over FY14E-FY16E


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LKR Occupancy %

Occupancy rate (LHS) Average room rate (RHS)

Tourism segment revenue driven by higher occupancy rates and ARRs

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However, growth in both occupancy levels and ARRs could be capped by competitive forces because of the increasing number of new hotels. Local chains Jetwing, Chaaya, Amaya, and the numerous boutique hotels would add to the room inventory in the country, while hotels and resorts currently under construction by international chains Marriott, Shangri-La, Hyatt and Sheraton are all due to start operations over the next three years. Furthermore, the expanding informal sector including unregistered hotels, guest houses and home stays, which are now being promoted by the government, will also provide alternative lodging facilities.

Sri Lanka’s tourism industry has challenges to overcome

The numerous challenges facing Sri Lanka’s tourism industry will limit SPEN’s growth in the tourism segment and may stand in the way of the government’s projections that total tourist arrivals are likely to increase to 2.5m in 2016 from 1.0m in 2012 (up 17% YoY). Tourist visits to Sri Lanka substantially lag those of other countries in Southeast Asia. In 2012, the Philippines recorded 4.3m tourist arrivals (up 9% YoY), Vietnam received 6.8m arrivals (up 13% YoY) and Indonesia reported 8.0m visitors (up 11% YoY). Sri Lanka’s tourism infrastructure – in terms of airports, roads and transportation, and services – lags that in other countries in the region. Further, minimum room rate regulations could dampen Sri Lanka’s international competitiveness. In fact, the country’s tourism sector might just price itself out of the market if the costs of electricity and labor (due to a shortage of skilled labor and a proposed wage hike for workers in the tourism sector) continue to rise.

Figure [4]: SPEN to increase its room count in Sri Lanka by 240 by FY16E, while government forecasts call for tourist arrivals to post a 28.0% CAGR over FY14E-FY16E

Source: SPEN, Sri Lanka Tourism Development Authority, Amba estimates Note: Room inventory numbers are for the 12-month period ended 31 March of each year

Tourist arrivals in the Maldives to grow at a CAGR of 8.1%

The tourism industry in the Maldives, which was the largest contributor to SPEN’s hotel sector revenue and profits in FY13 (although the breakdown is not disclosed in SPEN or AHUN reports, the company stated that the Maldives is the single-largest contributor to its hotel segment) and accounts for about 31% of SPEN’s total room inventory, continues to thrive, with occupancy levels at 89% in FY13. The Maldives, where tourism accounts for roughly 28% of the economy, may continue to see some level of political instability. However, if there is no significant escalation of the crisis, it is unlikely to significantly impact industry growth. The Maldivian government expects tourist arrivals to post a CAGR of 8.1% over FY14E-FY16E. However, the country’s high-value tourism product is changing, with the highest growth stemming from the rapidly growing Chinese market. While the sharp increase in arrivals from China helps boost occupancy levels, weak demand for hotel activities, such as water sports, may impact margin expansion.

0

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YoY growth

Annual tourist arrivals (RHS) YoY growth in tourist arrivals (LHS) YoY growth in SPEN room inventory in Sri Lanka (LHS)

Sri Lanka’s tourism sector faces challenges including less developed infrastructure and lagging tourist arrival numbers compared with those in other countries in the region

Maldivian operations to continue growing

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Figure [5]: The Maldivian government expects tourist arrivals to post a CAGR of 8.1% over FY14E-FY16E

Source: Maldivian Ministry of Tourism Arts and Culture

Omani operations to contribute to tourism revenue growth

Oman’s emergence as a tourist destination – the country saw a record 2.6m inbound tourists in 2012 – and new infrastructure in the form of an international airport and a large-scale convention and exhibition center, bode well for SPEN’s 440-room operations in the country. On the back of improved occupancy rates and higher room rates, the company reported 34% YoY revenue growth in Oman in FY13. We expect this trend to continue owing to the country’s growing popularity as a tourist destination and the government’s ambitious target of 12.0m tourist arrivals by 2020, as well as growth in disposable income in the region.

SPEN has indicated that the company plans to restructure its Indian operations, as its investments in the country have not been performing as well as expected.

Strategic investments segment revenue to decline at a CAGR of

4.8% over FY14E-FY16E

The strategic investments segment comprises the group’s power, plantation, printing and garment manufacturing operations. It generated close to 49% of total revenue in FY13. We believe the power sector accounted for the majority (83% in FY13) of the segment’s revenue.

We expect segment revenue to decline at a CAGR of 4.8% to around LKR15.5bn by FY16E, assuming the Ceylon Electricity Board (CEB) does not renew the expired PPAs for SPEN’s power plants in Horana and Matara. We also assume that the 100MW Embilipitiya plant should continue until the end of FY16. This segment’s revenue growth will stem entirely from printing, garment manufacturing and plantation operations since we have very conservatively assumed decreasing revenues in the power sub-segment.

Power sector revenue to decline at a 6.9% CAGR over FY14E-FY16E

We forecast that SPEN’s power sector revenue will decrease at a CAGR of 6.9% over the forecast period. Without the renewal of the PPAs, the power sector’s contribution to the strategic investments segment’s revenue will likely erode to 78% by FY16E from 83% in FY13.

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2010 2011 2012 2013 2014E 2015E 2016E

No. of tourists YoY

Annual tourist arrivals (RHS) YoY growth in tourist arrivals (LHS)

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Figure [6]: Power sector contribution to strategic investments segment revenue to decline to 78% in FY16E from 83% in FY13


SPEN has five completed power plants and three planned ones in its portfolio

SPEN is a large independent power producer (IPP) and owns three thermal power plants in Sri Lanka that have a combined installed power-generating capacity of 148MW. The three thermal plants together account for about 18% of the country’s total IPP capacity and 5% of the total national installed generating capacity. However, the company’s plants in Horana and Matara are currently not operational, as their 10-year power purchase agreements (PPAs) expired in FY13. The CEB has decided not to renew the PPAs, and, as a result, SPEN has put both units, which we estimate accounted for roughly 20% of total revenue in FY12 (the last full year that both were fully operational), up for sale.

The 10-year PPA for the Embilipitiya plant (which accounted for approximately 32% of total SPEN revenue in FY13) is due to expire at the end of FY15. In light of the challenging industry dynamics for thermal power plants in Sri Lanka, SPEN is also focusing on developing renewable energy power plants. The group commissioned a 3MW wind power plant in Ambewela and a 2.5MW mini-hydro power plant in Matale in FY13. However, revenue from these operations should be quite low, accounting for less than 1% of total revenue in FY16E.

We believe that in order to compensate for the closure of the two Sri Lankan plants, the company has ventured into Bangladesh and hopes to open two thermal power plants there, with capacities of 150MW and 50MW. SPEN is currently finalizing the land agreement for the smaller plant, while the startup of the larger plant is less certain, with the company awaiting the outcome of its initial bid. Given the limited visibility on these two plants, we have not factored them in to our forecasts.

SPEN is also proposing a 10MW waste-to-energy power project in Meethotamulla, a Colombo suburb, to supply electricity to the national grid by converting municipal solid waste. The project is facing several protests from residents in the surrounding cities and will be able to proceed only if these issues are resolved. Therefore, we have not considered it in our forecasts.

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FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E

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Strategic investments segment revenue - Other (RHS) Strategic investment segment revenue - Power (RHS)

Power segment revenue as a % of total segment revenue (LHS)

SPEN has installed capacity of 153.5MW, of which thermal power accounts for 148MW. However, the Matara and Horana plants (24MW each) are currently not operational

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Figure [7]: SPEN power plant portfolio

Location Status Source Capacity

Embilipitiya Operational Thermal 100MW

Horana Dormant Thermal 24MW

Matara Dormant Thermal 24MW

Ambewela Operational Wind 3MW

Matale Operational Mini-hydro 2.5MW

Bangladesh 1 Awaiting outcome of initial bid Thermal 150MW

Bangladesh 2 Finalizing land agreement Thermal 50MW

Meethotamulla Pending approval Biomass 10MW

Source: SPEN

However, 31% of SPEN capacity is idle due to the non-renewal of PPAs

As discussed above, of SPEN’s three thermal power plants, only the 100MW Embilipitiya plant is currently part of the national grid. The Horana and Matara power plants (24MW each) are not operational, because the CEB has decided not to renew the expired PPAs of private power producers. PPAs are the contracts that set out the terms and conditions of sale of power to the CEB, the state-owned power transmitter (please refer to Appendix 6 of this report for industry context and background).

In March 2013, the government made a policy decision not to renew the expired PPAs with IPPs, according to a press article, as the price point in many of these agreements was deemed to be unsustainably high. The 11 thermal IPPs in Sri Lanka account for about 26% of total power capacity; the balance is controlled directly by the CEB and, to a much lesser extent, small power producers (SPP). The Matara and Horana power plants have been lying idle since the PPAs with the state-owned CEB expired in March and December 2012, respectively. Currently, these two plants do not contribute revenue to the group.

If at all, the expired PPAs may be renewed under a competitive bidding process

We are not optimistic that these contracts will be renewed soon, even though IPPs are important in the country’s power generation scheme and considering Sri Lanka’s need for additional power, to help stave off additional escalating price hikes. At present, 11 thermal IPPs account for about 26% of the country’s total installed power-generation capacity. The IPPs are likely to maintain their industry relevance at least until the CEB-sponsored power plants that are in the pipeline are commissioned over the next few years, increasing power-generation capacity by 37% over 2016.

If the government does decide to go ahead with the renewal of the PPAs, we expect it to happen under a competitive bidding process, whereby IPPs that are vying for approval or renewal of PPAs would be forced to be more efficient, build cheaper plants and produce energy at a lower cost than competing power plant operators. The new PPAs for the Matara and Horana plants are likely to be at substantially lower rates than those in the original agreements. We believe the capacity charge, which represents a fixed charge to cover the cost of building the plant, maintenance and a profit share, will definitely be low, as the two plants are now fully depreciated. The energy charge, which is a pass-through based on the power delivered, should also be a competitive quote. However, we have assumed that the two PPAs will not be renewed. A renewal will bring definite upside to our revenue forecasts, although overall margins may decline slightly compared to when all three plants were fully operational, given the likely lower tariff levels.

Significantly, though, we have made only approximate forecasts of total revenue stemming from the company’s power activities. While SPEN’s annual report states that revenue for the power generation segment grew 24.9% YoY in FY13, there is no significant breakdown of supporting data relating to individual plants.

Government may overhaul the current procedure for awarding PPAs and may opt for a competitive bidding process instead

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Printing, garment manufacturing and plantation sub-segments to post

revenue CAGR of 5.0% through FY16E

Since SPEN does not divulge revenue, or any specific financial performance data, by sub-segment, it is difficult to assess historical performance or make projections. We estimate that the other (non-power) operations of SPEN’s strategic investments segment generated 17% of segment revenue (or 8% of overall revenue) in FY13. Going forward, we expect this contribution to grow to 22% in FY16E, driven by investments in improving capacity and efficiency in printing and garment manufacturing operations, as well as the plantation sub-segment’s diversification into the profitable palm oil sector and an uptake in tea prices. We project these three sub-segments combined will grow at a CAGR of 5.0% over FY14E-FY16E.

Cargo logistics and services segments to make a sizeable

contribution to top-line growth

Though smaller in comparison to the main segments discussed above, the cargo logistics segment still contributes around 16% of SPEN’s top line, which we expect to be maintained through FY16E. We forecast the segment to grow at a 4.7% CAGR over FY14E-FY16E to reach LKR6.6bn, with revenue initially taking a slight hit from the expiry of contracts in Africa. However, we expect the top line to pick up from the latter half of FY14E as SPEN’s cargo handling operations in Fiji and its shipping agency in Bangladesh increase top-line contribution.

The services segment will likely record a revenue CAGR of 11.4% over FY14E-FY16E to LKR0.7bn, as money transfers, the largest sub-segment, will be driven by the continuing growth of foreign remittances and the increased use of formal inward money transfer channels.

While their exact contribution is not disclosed, SPEN’s printing, garment manufacturing and plantation operations should all contribute to the strategic investments segment’s revenue growth

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We anticipate a 290bps increase in EBITDA margin to

21.6% over FY14E-FY16E

We expect SPEN’s EBITDA to grow at a CAGR of 8.5% and the margin to expand to 21.6% in FY16E from 18.7% in FY13. This 290bps expansion in the EBITDA margin should come mainly from the tourism segment; we forecast the margin in this segment to grow to 31.5% in FY16E from 30.0% in FY13. SPEN’s margin should also be aided by a slightly higher margin of 10.8% in FY16E – from 10.2% in FY13 – in the strategic investments segment.

Figure [8]: SPEN’s EBITDA margin to grow 290bps over FY14E-FY16E


The tourism segment is the primary driver of SPEN’s forecasted EBITDA margin growth. The segment reports EBITDA margins that are above the group level (we do not consider the services segment in this instance as its contribution to total margin is marginal) and is also the highest contributor to SPEN’s margin – growing to 70% in FY16E from 62% in FY13. Accordingly, a relatively modest growth in the tourism segment’s EBITDA margin results in a disproportionately higher growth in the total group’s EBITDA margin, as illustrated in Figure 9 and Figure 10 below.

Figure [9]: Tourism segment’s contribution to EBITDA to reach 70% in FY16E

FY11 FY12 FY13 FY14E FY15E FY16E

Tourism 39.5% 48.1% 61.6% 64.9% 67.6% 69.9%

Strategic investments 33.5% 33.4% 24.3% 20.6% 18.6% 16.9%

Cargo logistics 11.7% 15.1% 10.9% 10.9% 10.3% 9.8%

Services 15.3% 3.4% 3.2% 3.6% 3.5% 3.4%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Figure [10]: Tourism segment posts EBITDA margins above group level

FY11 FY12 FY13 FY14E FY15E FY16E

Tourism 24.8% 27.9% 30.0% 28.1% 30.3% 31.5%

Strategic investments 21.4% 16.6% 10.2% 10.5% 10.7% 10.8%

Cargo logistics 17.2% 17.5% 13.0% 13.1% 13.0% 13.0%

Services 62.2% 45.8% 40.9% 41.9% 41.2% 40.5%

SPEN 24.4% 17.9% 18.7% 19.3% 20.6% 21.6%


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Tourism segment EBITDA margin to expand 150bps over FY14E-FY16E

We expect higher tourism revenue to result in an increase in the EBITDA margin to 31.5% from 30.0% over FY14E-FY16E. We expect to see some margin pressure from growth in energy prices and the increasing cost of labor, stemming in part from the shortage of skilled labor in the industry. However, we still believe that revenue growth, through increased occupancy rates and higher ARRs, should offset these increased costs and lead to a slight margin expansion.

Strategic investments segment EBITDA margin likely to increase

slightly to 10.8% in FY16E

We expect the strategic investment segment’s EBITDA margin to remain in the 10.5-10.8% range over FY14E-FY16E. However, there could be a slight margin contraction, compared with FY12 levels when all three plants were last operational, if the Matara and Horana plant PPAs are renewed with the CEB, as new contract prices will almost certainly be lower than the original contracts.

The company’s three power plants are old, and therefore, fully depreciated. As such, if the PPAs are renewed, the new capacity charge, which is the fixed charge that incorporates a profit portion (please refer to the discussion of the Sri Lankan power industry in Appendix 6 of this report), is likely to be low. Furthermore, the energy charge may be opened up for market bidding. Additionally, maintenance costs are bound to increase as the plants age, and would be a slight strain on margins.

Cargo logistics and services segments together make a noteworthy

contribution to SPEN’s margin

The cargo logistics segment’s EBITDA margin should come in at 13.0% in FY16E, flat compared with FY13; the dip in FY13 was due to the cessation of some African port management contracts. SPEN has lined up new businesses, such as the foray into Fijian port operations and managing a shipping agency in Bangladesh, which should help margins stabilize in this segment. However, we do not have any visibility on when these projects will begin operations and their impact on revenue and profitability.

The services segment has generally enjoyed sound EBITDA margins, improving consistently to 62.2% in FY11 from 38.6% in FY09, but dipped to 40.9% in FY13 (the reason for the decline is not provided in company reports). We assume margins to remain at the FY13 level of about 40.0% over the forecast period.

SPEN’s EBITDA margin to be driven by the tourism segment

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Relatively low net debt and stable liquidity position should

allow for further borrowing for new projects

SPEN has a fairly low net debt position compared to that of its largest local peers (with the exception of John Keells Holdings PLC, which has a net cash position). SPEN tends to avoid equity financing, and instead uses debt to launch new projects. The company had an interest cover (EBIT/interest expense) of 3.8x in FY13, compared to a peer average of 4.4x.

Figure [11]: SPEN’s net debt position is smaller than that of the biggest local conglomerates, with the exception of JKH

Source: SPEN, Bloomberg Note: All data as of FY13

SPEN has maintained a long-term debt-to-capital ratio of less than 30% over the past few years, and its FY13 ratio of 15.7% is marginally above the domestic peer average of 13.9%. The company has taken on some additional debt over the past few years to finance new investments, such as those in its printing and packaging sub-segment. Although this results in an increase in its finance expense burden, we believe SPEN’s strong FCF generation should allow for further borrowing, if necessary, to finance new growth projects. As shown in Figure 13, SPEN has generated positive FCF ranging from LKR1.0bn-4.1bn, with the exception of FY12 – in which the company posted negative FCF of LKR1.4bn.

Figure [12]: SPEN’s long-term debt-to-capital ratio is higher than the peer average

Figure [13]: SPEN regularly generates positive free cash flows

Source: SPEN, Bloomberg Source: SPEN, Bloomberg

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SPEN maintains a relatively low net debt position and has stable cash inflows

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We expect shares to trade in the range of LKR110-157 per

share

We forecast a 12-month price range for SPEN shares of LKR110-157, compared with the current share price of LKR124. Our valuation range is based on DCF and P/E-based relative valuation methods. For comparison, we also assess SPEN’s valuation levels relative to a group of peers.

Figure [14]: Valuation range analysis provides a range of LKR110-157 per share (current share price LKR124)

Source: Amba estimates, SPEN, Bloomberg

DCF valuation gives a range of LKR111-157 per share

In valuing SPEN shares, we made an explicit combined EBIT forecast for all four of the company’s business segments. The combined EBIT was adjusted for non-cash items to arrive at the free cash flow to the firm (FCFF). We were unable to value the company’s segments separately, as the company’s level of segmental disclosure is insufficient to make defensible assumptions on a segmental basis.

SPEN’s current capital structure is roughly 20% debt and 80% equity. We have assumed a balanced capital structure of 50/50 debt to equity and a terminal growth rate of 3%. For our base-case scenario, we have also assumed a risk-free rate of 9.5% and a market risk premium of 5.0%. Figure 15 sets out our DCF assumptions in detail.

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157

124

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P/E analysis

DCF

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Our base-case assumptions include a risk-free rate of 9.5% and a market risk premium of 5.0%

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Figure [15]: SPEN DCF assumptions

Explicit forecast period 3 years

Fade period 7 years

WACC 12.4%

Effective tax rate 15.0%

Terminal growth rate 3.0%

Risk free rate 9.5%

Equity risk premium 5.0%

Beta 1.0

Cost of equity 14.5%

Cost of debt 12.0%

Debt/Capital 50.0%

Equity/Capital 50.0%

Source: Amba estimates

Our base-case scenario yields a share price of LKR126. We have also constructed bull- and bear-case scenarios to supplement our base-case DCF valuation. The key distinguishing factors of these are as follows:

Bull case: Under this scenario, we assume that the tourism segment will perform better than our expectations, with blended occupancy rates rising to 75% (vs. our base case assumption of 73%) by FY16E. Further, we assume that ARRs will grow at a CAGR of 6.2% (vs. our base case of 5.5%) over FY14E-FY16E. These factors would likely push the revenue CAGR to 14.1% through FY16E, compared to our base case projection of 12.7%. EBIT margins for the segment are also likely to rise to 31.3% in FY16E, compared to 27.0% in our base case, due mainly to the improvement in Maldivian operations, typically a higher-margin market.

For the strategic investments segments, we assume that the Matara and Horana plants will resume operations in FY14E, although at a lower tariff, in accordance with the government’s policy to renegotiate IPP tariffs. Revenue is likely to grow at an 8.1% CAGR through FY16E (vs. our base case of a decline of 4.8%). We expect margins to improve to 10%, slightly lower than the historical average when all three plants were operational, due to the lower tariff rates. This leads to a share price of LKR157.

Bear case: Here we assume that the tourism segment will perform below expectations, and that blended ARRs will rise only at a 4.5% CAGR (vs. our base case of 5.5%) and occupancy levels will increase marginally to 70% by FY16E (vs. our base-case assumption of 73%). Margins are also likely to suffer, falling to 24.9% in FY16E. We also assume that the tariff rate for the Embilipitiya plant will be revised for FY16E, following the expiration of the PPA, and the lower tariff will affect the strategic investment segment’s revenue, which will then decline at a 5.5% CAGR over FY14E-FY16E, and margins will fall 60bps to 7.5% in FY16E (vs. our base case of a 10bps decline to 8.0%). This yields a share price of LKR111.

Figure [16]: Revenue growth assumptions

Base case Bull case Bear case

2014E 2015E 2016E 2014E 2015E 2016E 2014E 2015E 2016E

Tourism 14.1% 9.1% 10.8% 15.7% 10.1% 12.2% 11.9% 7.0% 8.7%

Strategic investments -16.5% 0.6% 0.8% 21.8% 4.5% 0.5% -16.5% 0.6% -1.6%

Cargo logistics 1.4% 6.4% 6.4% 1.4% 6.4% 6.4% 1.4% 6.4% 6.4%

Services 11.4% 11.4% 11.4% 11.4% 11.4% 11.4% 11.4% 11.4% 11.4%

SPEN -1.5% 5.5% 6.5% 16.1% 7.0% 6.1% -2.4% 4.5% 4.6%


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Figure [17]: EBIT margin assumptions

Base case Bull case Bear case

2014E 2015E 2016E 2014E 2015E 2016E 2014E 2015E 2016E

Tourism 23.2% 25.5% 27.0% 26.7% 30.4% 31.3% 22.8% 24.1% 24.9%

Strategic investments 8.0% 8.0% 8.0% 10.0% 10.0% 10.0% 7.5% 7.5% 7.5%

Cargo logistics 10.2% 10.2% 10.2% 10.2% 10.2% 10.2% 10.2% 10.2% 10.2%

Services 29.8% 29.8% 29.8% 29.8% 29.8% 29.8% 29.8% 29.8% 29.8%

SPEN 15.5% 16.8% 17.9% 16.7% 18.4% 19.2% 15.0% 15.8% 16.5%


P/E analysis yields a valuation range of LKR110-135 per share

SPEN’s 12-month forward P/E has ranged between 10.6x and 18.6x since July 2011. The share’s 12-month historical forward P/E averaged 12.8x during this period. The stock currently trades at 13.0x its 12-month forward EPS (based on our forecasts), 2% above its historical average.

Figure [18]: SPEN has historically traded at an average forward P/E of 12.8x

Source: Bloomberg

In determining our P/E valuation range, we apply two scenarios:

Optimistic scenario: Here we expect shares to trade at a 14.1x forward multiple, at an approximately 10% premium to the historical average. This improved valuation outlook could stem from a number of positive developments, such as continued strength in tourist arrivals and improved sentiment towards companies that are highly levered to improvements in occupancy rates and ARRs. Alternately, or perphaps additionally, the CEB’s approach towards the power sector could become more amenable to IPPs; even if this would impact SPEN’s assets specifically, it could result in a more upbeat attitude on the part of portfolio investors towards the sector, to the benefit of valuations assigned to the company’s shares. The continuing level of EPS growth could justify this premium. We applied the 14.1x forward P/E to our FY14E EPS estimate of LKR9.5 to arrive at a fair value of LKR135 per share.

Conservative scenario: In this scenario, investors may be concerned by the volatility and uncertainty in SPEN’s power business and the lack of visibility in the cargo logistics and services segments, and apply a discount to the historical average valuation of the shares. By assigning a 10% discount to its 12-month forward P/E, implying an 11.6x multiple applied to FY14E EPS, we arrive at a share price of LKR110.

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Our optimistic scenario assumes a 10% premium, while our conservative scenario applies a 10% discount to the recent historical average

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Figure [19]: SPEN forward P/E band chart

Source: SPEN, Bloomberg

Where is additional potential upside?

We have been conservative in our modeling of SPEN’s financial performance in some respects. We have not factored in the following possible sources of valuation upside:

Hotels: If the Sri Lankan government’s forecasts of tourist arrivals are achieved, demand for hotel rooms may increase sharply, driving up occupancy rates and ARRs, benefitting SPEN’s hotel assets in Sri Lanka. Additionally, given the recent weak performance of the company’s hotels in India, even a modest improvement could result in overall outperformance of the segment.

Power: As discussed above in our financial forecasts, we assume that the company’s two plants that are currently dormant will not restart during the period. If the company and the CEB come to an agreement to restart the assets, we would likely need to revise our revenue forecasts. Alternately, the sale of some of these assets – to investors in Sri Lanka, or maybe to investors who would intend to move them elsewhere – could have a one-off impact on our EPS forecasts.

Non-power strategic investments operations: There is little disclosure of the performance of the company’s printing and packaging, garment manufacturing and plantations operations. Therefore, there is scope for these sub-segments to deliver results that are stronger than we forecast – given the limited segmental information available to make detailed projections.

There is scope for downside from our estimates for SPEN’s earnings, of course. Tourist arrivals and growth in Sri Lanka’s – and SPEN’s – ARRs and occupancy levels could be lower than expected, pressuring the company’s financial results. Further government pressure on the IPPs could result in lower tariffs than we expect. In addition, the company’s non-power strategic investments operations could fare worse than we expect, particularly in the plantation sector, with tea prices being volatile over the last few years and an ongoing shortage of labor.

Relative valuation is not factored into our price range

Figure 20 presents SPEN’s valuation metrics relative to its peers. SPEN trades at a discount to the average of its peers based on P/E valuation metrics. The share is trading at an FY14E P/E of 13.0x, at a 7% discount to its peer average.

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Figure [20]: SPEN vs. domestic and international peers

Company name

P/E EPS CAGR FCF yield

FY11 FY12 FY13 FY14E FY15E FY14E-FY15E FY12 FY13

Aitken Spence PLC 26.0x 13.1x 14.9x 13.0x 11.2x 11.2% -3.0% 3.4%

Domestic peers

John Keells Holdings PLC 21.6x 17.9x 17.2x 17.6x 14.1x 9.3% 6.3% 4.5%

Hemas Holdings PLC 19.5x 11.6x 8.4x 9.8x 9.0x 7.9% -0.6% 4.4%

Hayleys PLC 41.8x 26.0x 12.1x NA NA NM -13.8% 0.9%

Richard Pieris& Co. PLC 15.4x 5.6x 6.7x 6.9x 6.3x 5.9% 4.6% NA

CT Holdings PLC 39.5x 23.5x 19.9x NA NA NM -12.8% -15.9%

International peers

Astra International – Indonesia 16.8x 15.8x 13.2x 11.6x 10.4x NM 1.3% 0.5%

Vingroup Inc.- Vietnam 46.9x 35.2x 10.6x 11.7x NA NM -9.2% NA

ITC Limited – India 28.0x 28.2x 31.9x 30.6x 25.8x 17.9% 2.3% NA

Larsen & Toubro Ltd. – India 23.0x 17.0x 16.1x 16.1x 13.9x 10.8% -18.9% NA

Cheung Kong Holdings – China 4.7x 8.6x 8.8x 7.9x 7.4x NM 2.4% NA

Hutchison Whampoa – China 5.0x 13.2x 12.5x 11.1x 9.7x 13.6% 2.0% NA

Genting Group – Malaysia 15.4x 17.7x 16.5x 14.5x 13.3x NM 7.4% NA

Sime Darby Berhad – Malaysia 15.1x 14.1x 17.1x 15.9x 14.5x NM 1.6% NA

Siam Cement - Thailand 13.8x 22.4x 15.3x 13.0x 11.0x NM 2.4% NA

Mean 21.9x 18.3x 14.7x 13.9x 12.3x 10.1% -1.8% -1.1%

Median 18.2x 17.4x 14.3x 12.3x 11.0x 9.7% 1.8% 0.9%

High 46.9x 35.2x 31.9x 30.6x 25.8x 17.9% 7.4% 4.5%

Low 4.7x 5.6x 6.7x 6.9x 6.3x 5.4% -18.9% -15.9%

Source: SPEN, Bloomberg, Amba estimates Note: SPEN multiples are based on Amba estimates. Peer multiples are Bloomberg estimates. FY13 P/E multiples for all international peers (except for ITC Limited and Larsen & Toubro Ltd.) are Bloomberg estimates, and not actuals

Selecting an adequate peer group for a conglomerate is challenging. No potential peer has an identical slate of business segments. However, while the companies in Figure 20 are imperfect – at best – points of comparison, we have included this data to provide some measure of comparison with other regional conglomerates.

Share price performance

SPEN shares closed at LKR124 on 9 July 2013, LKR9 higher than 12 months earlier, for an appreciation of 8%, compared to a 20% increase in the S&P SL20 and a 22% jump in the All Share Price Index (ASPI) over the same period.

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Figure [21]: SPEN has recently performed in line with the S&P SL20 and ASPI


The following table shows that SPEN has recently performed in line with the indices, but has lagged over longer time periods.

Figure [22]: SPEN vs. key indices

3 months 6 months 1 year 2 years 3 years

SPEN 3% 2% 8% -13% 24%

S&P SL 20 1% 7% 20% -7% 33%

ASPI 3% 4% 22% -13% 33%


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Earnings release focus areas

What follows is a checklist of items that investors should track in the next – and subsequent – quarterly earnings release. We will closely track SPEN’s performance across these key areas and revise our forecasts and update our valuation range in earnings update notes. Please refer to the company profile for the context of these questions.

For SPEN as a whole

1. Has there been a change in the segmental revenue contribution mix now that the strategic investments segment’s contribution to overall revenue has come down due to the non-renewal of the PPAs for Horana and Matara?

2. Has there been an increase in borrowing levels? Increased gearing could potentially put a cap on expansion activities as SPEN has not raised equity finance over the past several years.

Tourism segment

1. Have the opening dates been confirmed for the Heritance property in Negombo (former Brown’s Beach property) and the new wing at The Sands, Kalutara?

2. Are there any plans of further expansion or acquisitions in the Maldives?

3. How have actual tourist arrivals compared to government projections? For 2013, the Sri Lankan government is targeting 1.2m tourist arrivals, compared with just over 1m arrivals in 2012.

4. What have been the occupancy rates at star-class hotels? One source of concern in recent months has been declining occupancy at higher-end hotels despite rising tourist arrivals.

5. What is the trend in minimum average room rates?

Strategic investments segment

1. Have there been any further developments in the negotiations for the two PPAs?

2. If the two power plants in Matara and Horana are sold, what does the company aim to do with the proceeds?

3. What is the status of the plans for the two new thermal plants in Bangladesh?

4. Has there been any progress on the proposed Meetotamulla plant?

Cargo logistics segment

1. Did the company sign any new port operation agreements?

2. Have the operations in Fiji and Bangladesh commenced, and what sort of revenue impact have they had?

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Appendix 1: Company overview

Aitken Spence PLC (SPEN) is the tenth-largest publicly traded company on the Colombo Stock Exchange (CSE) by market cap, which stood at LKR50bn (USD384m) as of 9 July 2013, and the second most-traded conglomerate stock on the CSE in terms of turnover over the past 12 months, with an average daily trading value of USD300,827 per day. The stock has a free float of 40.1%.

Established in 1868 as a company focused on trading and maritime services, SPEN has evolved into a diversified conglomerate. The company currently operates in four segments: tourism, strategic investments, cargo logistics and services. The tourism and strategic investments segments are the largest contributors to the company’s top line and prof it, generating approximately 87% of revenue and nearly 86% of EBITDA in FY13.

Figure [23]: Strategic investments and tourism account for 87% of FY13 revenue

Figure [24]: Strategic investments and tourism are also the largest contributors to EBITDA

Source: SPEN

Note: Individual segmental revenues are inclusive of inter-segmental revenue

Source: SPEN

SPEN’s revenue grew at a 6.1% CAGR over FY09-FY13 to LKR36.6bn (year ending 31 March 2013). However, revenue remains volatile – down 18%YoY in FY10 and up 20%YoY in FY13. The group generated EBITDA at a 7.7% CAGR over FY09-FY13 to LKR6.8bn. SPEN’s profit trajectory reflects sharp volatility – rising just 5.5% in FY10, declining 9.3% in FY12 and again rising 25.2% in FY13. The company’s EBITDA margins reflect this volatility – reaching 24.4% in FY11 before falling to 18.7% in FY13.

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SPEN’s key businesses

The strategic investments segment – the largest contributor to SPEN’s top line (49% of FY13

revenue) – engages in power generation, printing and packaging, garment manufacture and plantation management. The segment’s activities are as follows:

Power generation – SPEN operates one 100MW thermal power plant (Ace Embilipitiya), a 2.5MW hydropower plant and a 3MW wind power plant, which supply power to the national grid. The company has invited proposals from prospective buyers for its two 24MW thermal power plants (Ace Horana and Ace Matara). These plants are not in operation since their power purchasing agreements with the CEB, the state-owned power supplier and transmitter, expired in March and December 2012, respectively. SPEN is focusing on investing in the power sector outside Sri Lanka and in renewable energy sources. The company reports that it is in talks to build two power plants in Bangladesh with a combined capacity of 200MW; the prospects and schedule of these efforts are unclear, though, and we do not include them in our forecasts. The power generation division has historically been the largest revenue contributor to the strategic investments segment. SPEN does not release the breakdown of revenue contribution from businesses within each segment. Based on our estimates of tariff and capacity utilization, we believe power generation accounted for 41% of the company’s total revenue in FY13 and 83% of the strategic investments segment’s revenue.

Printing and packaging – SPEN has been in this business for five decades, servicing the FMCG, tea, confectionary, cosmetics, pharmaceuticals and apparel industries.

Garment manufacturing – This division has been operational since 1979 and produces garments for a number of clothing labels, including Columbia Sportswear, Marks & Spencer, Tesco and Sainsbury. The division’s revenue grew 17.5% YoY in FY13 on the back of increased production efficiency and a full order book during the year.

Plantation management – SPEN owns and manages 13 plantations through investment associates Aitken Spence Plantations Managements Ltd. These plantations, which primarily focus on tea, are now being diversified to include rubber and palm oil cultivation, as well as hydropower projects, in order to offset the volatility in the tea market. Aitken Spence Plantations listed 21.3m ordinary voting shares on the stock exchange’s Diri Savi Board, the market for smaller, high-growth companies, in May 2013.

SPEN’s tourism segment (38% of FY13 group revenue) includes a range of hotels in Sri Lanka

(Heritance and Aitken Spence brands), the Maldives (Adaaran brand), India and Oman, as well as inbound and outbound travel services and an airline general sales agency (GSA).

Sri Lankan hotels – SPEN has nine Sri Lankan hotels in its portfolio, all of which are located outside Colombo. The company owns six of these hotels, including Heritance

Figure [25]: Revenue grew at a 6.1% CAGR over FY09-FY13 Figure [26]: EBITDA grew at a 7.7% CAGR over FY09-FY13

Source: SPEN Source: SPEN

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Kandalama and Heritance Tea Factory, and has management contracts on two hotels, Earl’s Regency and Bandarawela Hotel. Besides, Brown’s Beach, in which SPEN holds a minority stake, is being rebuilt and is due to open for business in late-FY14. Occupancy rates at the company’s Sri Lankan hotels average around 65%, with average room rates of approximately USD110-130 per day.

Maldivian hotels – This division has six hotels operating under the Adaaran brand. These hotels record occupancy rates of about 85% and are the largest contributors to the company’s leisure segment.

Oman hotels – The company operates four hotels and a desert camp in Oman. Occupancy averages around 59%.

Indian hotels – SPEN operates five hotels in India, with occupancy levels of around 60%. Management has indicated that it plans to restructure the Indian hotel operations to improve performance.

Travel services – A joint venture between SPEN and TUI Travel PLC, this division provides services such as airline ticketing, aircraft handling and supervision, inland transport and tour packages.

Airline GSA – SPEN is the general sales agent for Singapore Airlines.

The company’s cargo logistics segment contributed 16% to the group’s FY13 revenue and is

involved in integrated logistics, cargo aviation, freight forwarding, maritime services, and mail and courier services.

Maritime services – SPEN provides container-handling and cargo-consolidation services. In FY13, it entered into a 15-year agreement to manage the cargo-handling operations at the ports of Suva and Lautoka in Fiji.

Integrated logistics – This division includes SPEN’s land-based logistics operations, including warehousing, container freight station operations and bulk liquid transportation services.

Freight forwarding and courier services – The company is the GSA for Singapore Airlines Cargo and Qatar Airways, and has been the agent for TNT Express, a global courier company, for over three decades.

The services segment is a small contributor to SPEN’s total revenue (2% of FY13 revenue and

about 3% of total EBITDA). This segment is an amalgamation of a number of businesses, including the distribution agency for OTIS elevators, the primary agency for Western Union Money Transfer, the insurance agency for Lloyds of London and financial accounting outsourcing.

Management strategy and transparency

As a practice, SPEN does not release a detailed presentation of its strategy and business approach. We believe improved articulation regarding the company’s business strategy and segmental financial disclosure could help investors (particularly institutional investors) better understand the company. This could ultimately benefit SPEN through enhanced capital raising opportunities should the company decide to approach equity investors.

We see room for improvement in the following areas:

Revenue composition within segments is not disclosed. The strategic investments segment, for example, is made up of four very diverse businesses: power generation, printing and packaging, garment manufacturing and plantation management. However, the company does not provide any indication of revenue contributions (or margins) from these sub-segments.

SPEN discloses only the segment EBIT and not the margins of businesses within each segment.

Quarterly reports do not include any management comments to shed light on the figures.

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Shareholding structure

International investors (including companies and funds incorporated abroad) hold just under half of SPEN’s shares, and institutional investors (both domestic and international) hold 90% overall. Management holds a 4% stake in the company. However, we estimate that through a range of structures, SPEN chairman Harry Jayawardena controls around 60% (or more) of total shares outstanding.

Figure [27]: SPEN’s domestic investor base is approximately 55% Figure [28]: Local individual shareholders form 9% of total

shareholding

Source: SPEN, as of March 2013 Source: SPEN, as of March 2013

The top five shareholders as of March 2013 are presented below. Just over 87% of SPEN’s shares are held by the top 20 shareholders.

Name of shareholder Description Stake

Melstacorp Limited A 100%-owned subsidiary of Distilleries Company of Sri Lanka

PLC, in which the SPEN chairman holds a sizeable stake 39.8%

Rubicond Enterprises Limited An offshore investment company in which the SPEN chairman is

believed to have a considerable shareholding 16.3%

HSBC International Nominees Limited-BPSS LUX-Aberdeen

Global-Asian Smaller Companies Fund

A global fund manager 8.1%

HSBC International Nominees Ltd-BPSS LDN- Aberdeen Asia

Pacific Fund


HSBC International Nominees Ltd-BPSS Lux-Aberdeen Global-

Emerging Markets Smaller Companies Fund


Source: SPEN

Mgmt & connected

parties 4%

Other domestic investors

51%

International investors

45%

Mgmt & connected

parties 4%

Local retail investors

5%

Institutional investors

91%

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Board of directors

As of March 2013, SPEN’s board comprised nine directors. Their details are provided below.

Name of director Description

Mr. Harry Jayawardena Chairman. He has been a member of the board since April 2000 and the chairman since April 2003. He is a leading

businessman with interests in many industries including distilleries, tea, banking and telecommunications.

Mr. Rajan Brito Deputy chairman and managing director. He was appointed to the board of directors in April 2000 and has been the

company’s managing director since January 2002.

Dr. Rohan Fernando Executive director. He heads the company’s plantations and business development functions. A veteran in the

country’s plantation sector, he played a key role in the plantations privatization program. Appointed to the board in

April 2005.

Dr. Parakrama Dissanayake Executive director. He heads the group’s maritime, logistics and cargo division. He is a former chairman/CEO of the

Sri Lanka Ports Authority. He was appointed to the board in September 2009.

Mr. G.C. Wickramasinghe Independent non-executive director. He has been with SPEN since 1954 and holds 40 years of continuous service

on the board of directors.

Mr. Charles Gomez Independent non-executive director. He is an investment banker with over 20 years of experience in the finance

industry. Appointed to the board in May 2002.

Mr. N.J. de Silva Deva Aditya Independent non-executive director. He was appointed to the board in September 2006 and is a member of the

Conservative Party of the European Parliament elected from South East England.

Mr. Manilal Fernando Independent non-executive director. He is an attorney-at-law. Appointed to the board in May 2008.

Mr. Rajan Asirwatham Independent non-executive director. He was a senior partner and country head of KPMG from 2001 to 2008.

Appointed to the board in September 2009.

Mr. Chitta Rajan de Silva Independent non-executive director. He was the former Attorney General and Solicitor General of Sri Lanka and

was appointed to the SPEN board in April 2013.

Source: SPEN

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Figure [29]: SPEN Corporate Holding Structure

Source: SPEN

Of SPEN’s subsidiaries, only Aitken Spence Hotel Holdings PLC is listed on the CSE. The company also has two listed associates in its group structure, namely Aitken Spence Plantation Managements PLC (38.97%) and Browns Beach Hotels PLC (27.96%).

Aitken Spence PLC

Tourism

Cargo logistics

Strategic investments

Services

Aitken Spence Cargo (Pvt) Ltd. (100%)

Aitken Spence Exports (Pvt) Ltd. (100%)

Ace Freight Management (Pvt) Ltd. (100%)

Aitken Spence Maritime Ltd. (100%)

Ace Power Generation (Pvt) Ltd. -Embilipitiya (74%), Horana (51%), Matara (51%)

Aitken Spence Plantation Managements PLC (38.97%)

Aitken Spence Printing & Packaging (Pvt) Ltd. (100%)

Aitken Spence Apparels (Pvt) Ltd. (100%)

Browns Beach Hotels PLC (27.96%)

Aitken Spence Hotel Managements (Pvt) Ltd. (100%)

Aitken Spence Hotel Holdings PLC (71.20%)

Aitken Spence Insurance (Pvt) Ltd. (100%)

Aitken Spence Technologies (Pvt) Ltd. (100%)

Aitken Spence Property Developments (Pvt) Ltd. (100%)

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Appendix 2: Key financial data

Summary group financials (LKRm)

INCOME STATEMENT 2011 2012 2013 2014E 2015E 2016E

(For the year ended 31 March)

Revenue 24,729 30,543 36,606 36,042 38,015 40,479

EBITDA 6,022 5,461 6,840 6,954 7,829 8,748

Operating income (EBIT) 3,952 4,316 5,490 5,584 6,391 7,238

Interest expense (660) (776) (1,444) (950) (940) (962)

Associate/JV income/(expense) 95 86 182 232 255 257

Earnings before tax (EBT) 3,811 5,183 5,001 5,934 6,874 7,904

Net profit 2,532 3,488 3,267 3,875 4,486 5,151

BALANCE SHEET 2011 2012 2013 2014E 2015E 2016E

(As at 31 March)

Current assets

Cash and cash equivalents 736 2,177 2,218 3,057 4,344 5,126

Short-term investments 5,309 4,597 6,764 6,764 6,764 6,764

Accounts receivable 4,129 8,948 9,941 9,381 9,894 10,536

Inventories 1,608 1,783 1,825 2,243 2,366 2,519

Total current assets 12,676 18,658 22,408 22,839 24,809 26,444

Non-current assets

Property, plant and equipment 23,926 22,586 24,042 25,231 26,492 27,856

Intangible assets 134 644 654 654 654 654

Investments in associates/JVs 1,335 1,770 1,931 2,124 2,337 2,570

Total non-current assets 27,469 32,327 33,743 35,125 36,598 38,196

Total assets 40,145 50,985 56,151 57,963 61,407 64,640

Current liabilities

Short-term debt 4,630 7,003 6,959 7,071 6,860 6,860

Accounts payable 3,939 6,716 7,708 6,960 7,341 7,817

Income tax payable 180 287 501 501 501 501

Total current liabilities 8,753 14,558 15,451 14,815 14,985 15,461

Non-current liabilities

Long-term debt 4,144 5,743 6,245 6,042 6,121 6,287

Post-retirement benefit obligation 336 391 447 447 447 447

Total non-current liabilities 4,746 6,563 7,197 6,195 5,473 3,639

Equity

Common share capital 2,135 2,135 2,135 2,135 2,135 2,135

Retained profit 8,309 10,565 13,222 16,322 19,911 24,032

Minority interest 5,130 4,709 5,449 5,800 6,207 6,678

Total equity 26,646 29,863 33,503 36,953 40,949 45,540

Total liabilities and equity 40,145 50,985 56,151 57,963 61,407 64,640

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CASH FLOW STATEMENT 2011 2012 2013 2014E 2015E 2016E


Operating activities

Net cash flow from operating activities 6,148 2,258 4,325 6,085 6,876 7,589

Investing activities

Purchase of PPE and intangible assets (2,013) (3,609) (2,665) (2,559) (2,699) (2,874)

Dividends received from associates/JVs 34 - 26 - - -

Net cash flow from investing activities (2,404) (4,246) (4,906) (1,812) (1,868) (1,884)

Financing activities

Debt issuance/(repayment) (647) 1,484 (248) (91) (133) 166

Common share issuance/(repurchase) 618 - (11) - - -

Interest paid (660) (639) (1,328) (950) (940) (962)

Dividends paid to common shareholders 797 (405) (567) (775) (897) (1,030)

Net cash flow from financing activities (960) 1,568 (134) (3,434) (3,720) (4,923)

Net increase/(decrease) in cash and cash equivalents 2,785 (421) (715) 839 1,287 781

Key ratios

2011 2012 2013 2014E 2015E 2016E

Growth

Revenue growth (%) 3.9 23.5 19.9 (1.5) 5.5 6.5

EBITDA growth (%) 6.0 (9.3) 25.2 1.7 12.6 11.7

EBT growth (%) 13.8 36.0 (3.5) 18.6 15.8 15.0

Net profit growth (%) 23.2 37.8 (6.3) 18.6 15.8 14.8

Recurrent diluted EPS growth (%) 23.2 37.8 (6.3) 18.6 15.8 14.8

Margins

EBITDA margin (%) 24.4 17.9 18.7 19.3 20.6 21.6

EBT margin (%) 15.4 17.0 13.7 16.5 18.1 19.5

Net profit margin (%) 10.2 11.4 8.9 10.8 11.8 12.7

ROE (%) 12.5 14.9 12.3 13.1 13.6 14.0

Liquidity and efficiency

Current ratio (x) 1.4 1.3 1.5 1.5 1.7 1.7

Total asset turnover (x) 0.6 0.6 0.7 0.6 0.6 0.6

Gearing and cash Flow

Debt/Capital (%) 24.8 29.9 28.3 26.2 24.1 22.4

Interest cover (x) 6.0 5.6 3.8 5.9 6.8 7.5

Free cash flow (FCF) yield (%) 6.3 (3.0) 3.4 7.0 8.3 9.4

Net debt/FCF (x) (0.7) 4.4 (2.5) (0.9) (0.4) (0.3)

Valuation

P/E (x) 26.0 13.1 14.9 13.0 11.2 9.7

P/BV (x) 3.1 1.8 1.7 1.6 1.4 1.3

EV/Sales (x) 3.0 1.8 1.6 1.7 1.6 1.5

EV/EBITDA (x) 12.2 10.3 8.5 8.6 7.6 6.8

EV/EBIT (x) 18.7 13.1 10.6 10.7 9.4 8.3

EV/FCF (x) 17.8 (41.8) 35.1 17.0 14.3 12.7

Dividend yield (%) 0.6 1.2 1.3 1.5 1.8 2.1

Dividend cover (x) 6.2 6.1 5.4 5.0 5.0 5.0

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PER SHARE DATA 2011 2012 2013 2014E 2015E 2016E

Recurrent basic EPS (LKR) 6.2 8.6 8.0 9.5 11.0 12.7

Recurrent diluted EPS (LKR) 6.2 8.6 8.0 9.5 11.0 12.7

Common dividend per share (LKR) 1.0 1.4 1.5 1.9 2.2 2.5

Book value per share (BVPS) 53.0 62.0 69.1 76.7 85.6 95.7

Net operating cash flow per share 15.1 5.6 10.7 15.0 16.9 18.7

Net cash flow per share 6.9 (1.0) (1.8) 2.1 3.2 1.9


Segmental summary


Tourism 2011 2012 2013 2014E 2015E 2016E

Revenue 9,967 11,262 14,063 16,046 18,203 20,154

EBITDA 2,388 3,147 4,219 4,513 5,295 6,110

EBIT 1,602 2,628 3,443 3,725 4,468 5,242

YoY growth

Revenue 17.1% 13.0% 24.9% 14.1% 13.4% 10.7%

EBITDA 23.7% 31.8% 34.1% 7.0% 17.3% 15.4%

EBIT 36.6% 64.0% 31.0% 8.2% 19.9% 17.3%

Margins

EBITDA 24.8% 27.9% 30.0% 28.1% 30.3% 31.5%

EBIT 16.1% 23.3% 24.5% 23.2% 25.5% 27.0%

Cargo logistics 2011 2012 2013 2014E 2015E 2016E

Revenue 4,128 5,663 5,743 5,825 6,199 6,597

EBITDA 710 989 749 760 807 856

EBIT 602 852 587 595 633 674

YoY growth

Revenue 15.9% 37.2% 1.4% 1.4% 6.4% 6.4%

EBITDA -4.8% 39.2% -24.3% 1.4% 6.1% 6.1%

EBIT -3.5% 41.6% -31.1% 1.4% 6.4% 6.4%

Margins

EBITDA 17.2% 17.5% 13.0% 13.1% 13.0% 13.0%

EBIT 14.6% 15.0% 10.2% 10.2% 10.2% 10.2%

Strategic investments 2011 2012 2013 2014E 2015E 2016E

Revenue 10,723 14,581 17,908 15,105 15,258 15,452

EBITDA 2,028 2,190 1,664 1,431 1,454 1,480

EBIT 961 1,768 1,324 1,086 1,092 1,100

YoY growth

Revenue -9.4% 36.0% 22.8% -15.7% 1.0% 1.3%

EBITDA -2.9% 8.0% -24.0% -14.0% 1.6% 1.8%

EBIT -33.9% 84.0% -25.1% -18.0% 0.6% 0.8%

Margins

EBITDA 21.4% 16.6% 10.2% 10.5% 10.7% 10.8%

EBIT 9.0% 12.1% 7.4% 8.0% 8.0% 8.0%

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Services 2011 2012 2013 2014E 2015E 2016E

Revenue 1,487 482 537 599 667 743

EBITDA 924 221 220 251 274 301

EBIT 792 154 148 178 199 221

YoY growth

Revenue -15.5% -67.6% 11.4% 11.4% 11.4% 11.4%

EBITDA -1.4% -76.1% -0.6% 14.0% 9.5% 9.6%

EBIT 1.2% -80.6% -3.5% 20.0% 11.4% 11.4%

Margins

EBITDA 62.2% 45.8% 40.9% 41.9% 41.2% 40.5%

EBIT 53.2% 31.9% 27.6% 29.8% 29.8% 29.8%


FX rates (LKR/USD): Y/E 31 March 2013 = 129.59

Y/E 31 March 2012 = 112.64

Y/E 31March 2011 = 112.12

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Appendix 3: Industry analysis using Porter’s framework

Porter’s analysis – named after its creator, Harvard Business School professor, Michael Porter – is an analytical tool used for industry and competitive analysis. To assess overall industry attractiveness, the tool uses seven elements: barriers to entry, barriers to exit, rivalry among competitors, power of buyers, power of suppliers, availability of substitutes and government action. Based on a range of specific analytical points for each element, the industry and/or company subject to analysis are rated on a spectrum of highly unattractive to highly attractive. Each rating is then used to arrive at an overall industry rating. Below, we briefly present some key points of the seven elements for the key industry in which SPEN operates.

Hotels

Conclusion: the industry should remain mildly attractive through 2016

The Sri-Lankan government’s target to increase tourist arrivals in the country by approximately 150% by 2016 to 2.5m highlights its plans to make Sri Lanka a prime tourist destination over the medium term. According to the Sri Lanka Tourism Development Authority’s (SLTDA) statistics and forecasts, the country will require additional room inventory to meet the anticipated increase in tourist arrivals. This substantial potential demand is likely to attract new entrants to this highly competitive industry. Switching costs for customers is low and will remain low as the number of industry participants increases.

However, the industry may be threatened by its overdependence on destination management companies (DMC, which are local firms offering services to help attract and bring in tourists to Sri Lanka) and a labor shortage. Furthermore, regulations relating to the proposed wage hike and minimum room rates could dampen industry growth.

Threat of new entrants – moderate

Customer brand loyalty is low, as are switching costs, as customers can easily get distracted when choosing a holiday destination, which makes it easier to create a niche in this industry. The high capital requirements for property development and periodical refurbishments may be less of a challenge for international hospitality companies, as they may have better access to funding than domestic firms. Larger hotel chains, as well as international brands entering Sri Lanka’s hotel sector (including Shangri-La, Hyatt and Sheraton), should enjoy economies of scale.

Barriers to exit – moderate

The one-time exit cost may be considered moderate. As Sri Lanka is poised to become a major tourist hub over the medium term, any hotel wishing to dispose of its operations could be taken over by a larger competitor/firm that would view this as an attractive opportunity to consolidate/diversify.

Rivalry among competitors – moderate to high

At present, there are many local and international hotel operators (e.g., JKH, Aitken Spence, Jetwing, Taj Hotels, Hilton and others) in Sri Lanka. The industry is poised for growth, as the government is targeting a significant increase in tourist arrivals over the next few years, which creates a need for additional room inventory in the country. Each hotel operator also competes on a different niche (based on star class, services offered, quality of customer service, etc.) and all these factors collectively create an evenly balanced platform, allowing all competitors to benefit from the potential industry growth.

Bargaining power of buyers – high

Tourists and holiday-makers are generally highly price sensitive; they seek value for money, even if it is at a star-class hotel. Visitors to Sri Lanka have a range of options to choose from, and switching costs for buyers is low. Furthermore, the strategic importance of the product/service offering is low, as holidays are a luxury (non-essential) expense borne by individuals, depending on their levels of disposable income.

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Bargaining power of suppliers – high

There are two key suppliers to the hotel industry: DMCs and employees. There are a few well-established DMCs in Sri Lanka, such as Walkers Tours, Aitken Spence Travels and Jetwing Travels, and roughly over 60% of inbound travels are secured through these intermediaries. There are few alternatives for hotels to using the services of DMCs, other than for hotels to launch their own destination management efforts. Occupancy levels at hotels depend largely on the relationship between the hotel and the DMC. Some of the large established local hotel chains already have DMCs that operate as their sole agents. Even so, the DMC’s services are strategically important to the hoteliers, which make switching costs high. This leaves DMCs in a strong position to negotiate their rates with hotels.

There is also a severe shortage of skilled labor in the industry, and there is no substitute to hiring employees, as a personalized service is critical to the success of the hotel sector. Therefore, employees in the sector generally enjoy strong bargaining power, which reduces industry attractiveness.

Threat of substitutes – high

Holidays offer customers leisure, entertainment and relaxation. Therefore, there are several substitutes, particularly tourist destinations in other regions that can compete for a share of the customer’s wallet, particularly other regional tourist destinations. Brand loyalty is limited and the customers can easily change their minds. There may also not be a significant price differential; therefore, switching costs are low.

Government action – moderate

While the government is investing to promote Sri Lanka’s image as a global tourist hub, industry players believe that the government could do more to put the country on the tourism world map. On the positive side, the tax on foreign leases of land for business ventures is down to approximately 10%, which could drive foreign investment into Sri Lanka. However, the country is still in the process of developing the infrastructure required to support the anticipated 2.5m tourists in 2016. The tourism sector remains highly regulated, which could be counter-productive to industry growth. Higher minimum average room rates, while increasing hotel sector revenues, could reduce Sri Lanka’s regional and international competitiveness. Higher electricity tariffs and the proposed wage hike in the tourism sector could also hurt industry attractiveness.

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Appendix 4: SWOT analysis

Strengths Weaknesses

Strong brand recognition

Experienced management team

Long-standing representation and partnership with many reputed global brands ( OTIS, Tui, Western Union Money Transfer, Singapore Airlines, Qatar Airways, TNT, etc.)

Strong focus on delivering shareholder value

Uncertainty in the power sector

Inadequate disclosure of segmental performace breakdown

Opportunities Threats

Strong anticipated growth in tourist visits

Rising GDP/capita and disposable income in Sri Lanka

Foreign investments through JVs, partnership agreements, etc.

Increased diversification into international markets

Continued challenges in the Sri Lankan power sector

Domestic infrastructure not up to international standards

Proposed legislation (for example, on minimum room rates and tourism industry wages), which could negatively affect the growth of the tourism segment

Rupee appreciation could affect sectors that earn revenues in USD

Risk of political instability and social unrest

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Appendix 5: Diversified sector overview

As of 9 July 2013, the diversified sector accounted for 22% of the CSE’s total market capitalization of USD17.6bn. It is the second-largest sector on the stock market, after financial services.

Figure [30]: Top five sectors on the CSE by market capitalization

Sector name

Market cap

(USDbn)

% of total CSE

market cap Two largest companies

Banks, finance and insurance 3.9 22% Commercial Bank of Ceylon PLC

Hatton National Bank PLC

Diversified 3.8 22% John Keells Holdings PLC

Carsons Cumberbatch PLC

Beverage, food and tobacco 3.6 21% Ceylon Tobacco Company PLC

Nestle Lanka PLC

Hotels and travels 1.1 7% Asian Hotels & Properties PLC

Aitken Spence Hotel Holdings PLC

Telecommunication 1.1 6% Sri Lanka Telecom PLC

Dialog Axiata PLC

Source: CSE Note: Data as of 9 July 2013

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There are 18 listed diversified companies trading on the CSE, 13 of which are listed on the Main Board, and 5 are listed on the Diri Savi Board. We have listed the top 10 companies in the diversified sector based on market capitalization as of 9 July 2013, along with a brief description of their main businesses.

Figure 31: Details of conglomerates listed on the Main Board of the CSE

Company name Bloomberg/CSE tickers

Market cap

(USDm)

Free float

(%) Top three businesses by revenue contribution

John Keells Holdings PLC JKH SL/ JKH.N0000 1,587 88.4% Consumer food (manufacturing) and retail

Tourism (hotels, destination management)

Transportation (oil bunkering, container handling)

Carsons Cumberbatch PLC CARS SL/ CARS.N0000 632 23.8% Oil palm plantations (palm oil, palm kernel, fresh fruit)

Oils and fats (refined oils, cooking oil, specialty fats)

Beverages (breweries)

Aitken Spence PLC SPEN SL/ SPEN.N0000 384 40.1% Power generation

Tourism (hotels, destination management)

Logistics (freight forwarding, courier services,

integrated logistics, maritime transport)

CT Holdings PLC CTHR SL/ CTHR.N0000 202 38.7% Retail and wholesale Distribution (FMCG)

Ceramics and tiles (manufacturing and distribution)*

Food processing (consumer foods)

Hayleys PLC HAYL SL/ HAYL.N0000 175 40.0% Hand protection (rubber gloves)

Transportation and logistics (warehousing and

distribution, freight, chartering and port operations)

Purification products (carbon granular, fines, powders

and pellets)

Vallibel One PLC VONE SL/ VONE.N0000 146 19.4% Finance (banking)

Apparel

Tiles

Hemas Holdings PLC HEMS SL/ HHL.N0000 133 28.3% Healthcare (pharmaceuticals, diagnostic and surgical

services, hospitals)

FMCG

Power generation

Richard Pieris & Co. PLC RICH SL/ RICH.N0000 103 45.0% Retail

Plantations (tea, rubber, palm oil)

Plastics (water tanks and pumps, foam mattresses,

bulbs, molded plastics)

Expolanka Holdings PLC EXPO SL/ EXPO.N0000 102 26.9% Freight and logistics (air and sea freight, logistics,

warehousing)

International trading and manufacturing (agricultural,

paper, plastic, metal pharmaceutical products)

Investments and services (airline general sales agent,

business process outsourcing, education,

investments, corporate services)

Finlays Colombo PLC JFIN SL/ JFIN.N0000 74 3.5% Tea exports

Services (environmental services, insurance

brokering, marine cargo surveying, airline general

sales agent)

Logistics (tea warehousing, temperature-controlled

logistics, air freight)

Source: CSE, Bloomberg, Company annual reports

Note: Market capitalization and free float data as of 9 July 2013. Revenue contribution based on FY13 data.

*CT Holdings PLC disposed their stake in Lanka Wall Tiles during May 2013

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The shareholding structures of the conglomerates listed above are shown in Figure 32. Four companies have significant international shareholding, and management hold large stakes in four issuers.

Figure [32]: Shareholding structure – by investor type and geographical location

Investor type Geographical location

Management Other retail Institutional Management Other domestic International

John Keells Holdings PLC 5.0% 23.3% 71.7% 5.0% 28.4% 66.6%

Carson Cumberbatch PLC 0.3% 3.9% 95.9% 0.3% 81.7% 18.0%

Aitken Spence PLC 1.9% 7.5% 90.7% 1.9% 52.8% 45.3%

CT Holdings PLC* 19.5% 21.2% 59.3% 19.5% 66.5% 14.0%

Hayleys PLC 48.5% 36.0% 15.6% 48.5% 48.0% 3.5%

Vallibel One PLC* 63.3% 8.0% 28.7% 63.3% 36.0% 0.7%

Hemas Holdings PLC 4.0% 6.1% 89.9% 4.0% 89.2% 6.8%

Richard Pieris & Company PLC 0.4% 15.9% 83.8% 0.4% 40.1% 59.5%

Expolanka Holdings PLC 72.8% 10.7% 16.6% 72.8% 23.2% 4.1%

Finlays Colombo PLC* 0.0% 1.6% 98.4% 0.0% 2.5% 97.5%

Source: Company annual reports *Note: Data as of FY12 (31st March 2012). For Finlays PLC, the FY12 data is as of 31st December 2012

Below are key financial statistics for these conglomerates.

Figure [33]: Key financial data

Company name Revenue EBIT Net income EBIT margin (%) Net income margin (%)

John Keells Holdings PLC 661 55 94 8.3% 14.3%

Carson Cumberbatch PLC 588 84 35 14.2% 6.0%

Aitken Spence PLC 283 43 25 15.0% 8.9%

CT Holdings PLC 527 34 9 6.5% 1.7%

Hayleys PLC 572 51 14 9.0% 2.5%

Vallibel One PLC 254 39 11 15.3% 4.3%

Hemas Holdings PLC 202 19 13 9.3% 6.4%

Richard Pieris & Co. PLC 268 29 15 10.7% 5.5%

Expolanka Holdings PLC 387 15 8 3.8% 2.1%

Finlays Colombo PLC 40 2 3 6.1% 7.2%

Source: Bloomberg Note: All data as of FY13, except for Finlays Colombo PLC (data as of December 2012). All figures are in USDm, unless stated otherwise

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Appendix 6: Sri Lanka power sector overview

The following is a brief overview on the Sri Lankan power sector, based mainly on information and data from the CEB and the Public Utilities Commission of Sri Lanka (PUCSL).

Sri Lanka generates electricity from thermal (oil and coal), hydropower and other renewable sources. The generation mix varies depending on weather patterns. In 1H12, thermal, hydropower and other renewable sources accounted for 78%, 18% and 4% of total power generated in Sri Lanka, respectively. We used the figures from the June 2012 PUCSL report since it was more comprehensive than the latest release.

The CEB, the state-run power producer and distributor, controls approximately 66% of the country’s generating capacity. The private sector, consisting of a few independent thermal power producers (IPPs) and a host of small renewable energy power producers (SPP), accounts for the rest.

Significant private-sector participation in the country’s power sector started with the connection of the privately owned Lakdhanavi (22.5MW) thermal power plant to the national grid in 1996. This was followed by the connection of another 10 privately owned thermal power plants to the grid. The owners of these plants are generally referred to as IPPs. SPEN is a noteworthy IPP – its three thermal power plants have a combined installed power generating capacity of 148MW, accounting for about 18% of the country’s total IPP capacity and 5% of the total installed generating capacity as at June 2012.

The CEB buys power from IPPs as per the terms of the PPAs it has signed with each individual producer. The CEB then transmits this power to end-consumers and bills them. The price at which the CEB bills the customers must be approved by the PUCSL, the state electricity regulator. The CEB has been making losses for many years, because it has been selling power for less than its generation/buying costs (see Figure 37 for generation/buying costs). In a bid to reverse this situation, the CEB increased electricity prices by about 60% (approved by the PUCSL) in April 2013.

The higher tariff has been met with a great deal of public displeasure, and there is now close scrutiny of the associated costs, including the PPAs. Many sector experts are of the opinion that the PPAs are inequitable. Therefore, the PUCSL has refused the CEB the license to renew any PPAs that expire. Currently, two of SPEN’s power plants are inactive, as their PPAs have expired.

Installed power generation capacity of 3,277MW

Sri Lanka has a total installed power generating capacity of 3,277MW (as of June 2012, according to the PUCSL) from 145 power plants.

Figure [34]: Power plants by producer and source Figure [35]: Installed power generation capacity mix – thermal

accounts for 51%

Producer No.

CEB – thermal 7

CEB – hydro 17

CEB – wind 1

IPPs – thermal 11

Small power producers (SPPs) – renewable 109

Total 145

Source: PUCSL, June 2012 Source: PUCSL, June 2012

CEB Hydro 41%

CEB Thermal -

Oil 16%

CEB Thermal -

Coal 9%

IPP Thermal

26%

SPP Renewable

8%

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The maximum electricity demand in Sri Lanka is about 2,150MW per day, according to CEB System Control records. The reserve margin (excess capacity over peak demand) is 30-35%. The country requires a significant reserve margin, as weather plays an important role in power generation from hydro and other renewable sources (49% of installed capacity).

All grid-connected power plants sell their power to the CEB and Lanka Electricity Company (LECO, a government-owned private company that distributes electricity in the Western Province), which deliver power to consumers via transmission networks.

Demand for electricity to grow at a peak rate of 6.6% YoY up to 2025

As per the CEB’s Long-Term Generation Expansion Plan (2011-2025), the country’s electricity demand is likely to increase at a peak rate of 6.6% YoY up to 2025. At this rate, peak demand is likely to be approximately 2,292MW in 2013 and 2,776MW by 2016. Currently, the reserve margin at peak demand, excluding capacity from non-conventional renewable energy (NCRE) sources, is about 30%.

If a reserve margin of 30% (excluding NCRE) is to be maintained, installed capacity will have to increase by approximately 670MW, or about 223MW on average per year over 2013-2016.

CEB projects in the pipeline to add 1,220MW of capacity by 2016

If the three major projects in the CEB’s pipeline are commissioned on schedule, the requirement of 670MW of additional capacity will be met with relative ease.

Figure [36]: CEB projects in the pipeline to add 1,220MW of generating capacity

Project Planned capacity (MW) Status Target completion year

Norochcholai coal power plant (Phase II and III) 600 Under construction 2014

Uma Oya hydro power plant 120 Under construction 2015

Trincomalee coal power plant 500 Under construction 2016

Source: CEB

The CEB will, in fact, have about 550MW of excess installed capacity by 2016, which it could use to replace the purchases it makes from the costlier IPPs (refer to Figure 37 for the cost breakdown). It costs the CEB LKR16.99 to generate a kilo watt hour (kWh) of thermal power compared with the LKR21.79/kWh it has to pay to IPPs on average. As a result, the CEB runs a loss, as it subsidizes both IPPs and consumers.

Figure [37]: Power generation cost to the CEB

Plant Average unit cost to the CEB (LKR/kWh)

All hydro 4.65

All CEB thermal 16.99

All IPP thermal 21.79

NCRE 13.77

All plants (average) 16.72

Source: PUCSL, June 2012

Role of IPPs in Sri Lanka’s power sector

IPPs are important players in the country’s power sector. They have helped the CEB meet the shortfall in generation capacity, especially during drought seasons when hydropower plant reservoirs are running low.

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Figure [38]: Power generation mix – IPPs have increased their share from 15% to 43% over 2000-11

Source: CEB

IPPs’ contribution to the generation mix dropped to 43% in 2011 from 45% in 2010 due to the commissioning of Phase I of the CEB’s Norochcholai coal power plant in 2011. We expect the contribution to decline further once the three major projects in the CEB’s pipeline (see Figure 36) are operational.

IPPs provide power to the grid through the CEB

The CEB purchases power from IPPs as per the PPAs it has signed with each of them and transmits it to end-consumers.

The power purchase tariff structure includes two key components: a capacity charge and an energy charge.

The capacity charge is a fixed charge and includes funds to repay loans, a profit component, and a fixed operation and maintenance charge. The CEB has to pay this capacity charge, irrespective of whether it buys power from an IPP or not.

The energy charge includes a portion for variable operations and maintenance costs, and a pass-through fuel cost.

0%

20%

40%

60%

80%

100%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Private CEB

Aitken Spence PLC

39


Fact Sheet

Sri Lanka investment environment overview

Sri Lanka’s economy has been on an upward trajectory since the end of the three-decade civil war in May 2009. Sri Lanka currently boasts South Asia’s highest GDP growth, conducive fiscal and monetary policy, and favorable socio-economic conditions, which together create an attractive investment destination.

Figure [1]: Sri Lanka's GDP projected to increase at a 7% CAGR 2012-2016E

Figure [2]: GDP per capita to increase 33% by 2016E

Source: Central Bank of Sri Lanka, Department of Census and Statistics Source: Central Bank of Economic and Social Statistics of Sri Lanka 2012, Road Map 2013 - Central Bank of Sri Lanka

Figure [3]: Annual core inflation post-war has averaged 6.7%, government targeting mid-single digit levels in the medium term

Figure [4]: CBSL expects the rupee to stabilize around LKR125 per USD in the medium term

Source: Department of Census and Statistics, Central Bank of Sri Lanka Source: Bloomberg

Figure [5]: Fiscal deficit target of 5.2% of GDP for 2014E Figure [6]: Debt-to-GDP to fall to 71% by 2015E

Source: Central Bank of Sri Lanka Source: Central Bank of Sri Lanka

6.8 6.0

3.5

8.0 8.2

6.4

7.5 8.0 8.3 8.5

0123456789

2007

2008

2009

2010

2011

2012

2013E

2014E

2015E

2016E

%

0

1,000

2,000

3,000

4,000

5,000

2005

2006

2007

2008

2009

2010

2011

2012

2016

E

USD

8.5

7.7

13.6

7.0 7.0 6.9 5.8

0

2

4

6

8

10

12

14

16

2006 2007 2008 2009 2010 2011 2012

%

100

150

200

250

Jan/07 Apr/08 Jul/09 Oct/10 Jan/12 Apr/13

LKR/USD LKR/EUR LKR/GBP

0%

4%

8%

12%

0

200

400

600

2006

2007

2008

2009

2010

2011

2012

2013E

2014E

LKRbn

Fiscal Deficit LKR bn As a % of GDP

102 102 91 88 85 81 86 82 79 79 78 75 71

0

20

40

60

80

100

120

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

201…

201…

201…

%

Aitken Spence PLC

40


The Sri Lankan equity market offers a rare and attractive alternative to investors in an investment era impacted by economic growth worries. Backed by the country’s robust economic growth, the Sri Lankan capital market is well set to offer attractive returns to investors who are keen to be a part of this emerging market success story. There are several strong incentives for entering the Sri Lankan capital market.

Figure [7]: Post war, the ASPI has significantly outperformed global and developed market indices

Figure [8]: Post war, the ASPI has also outperformed some of the best-performing regional indices

Source: Bloomberg *Note: All figures re-based to 1 July 2009

Source: Bloomberg *Note: All figures re-based to 1 July 2009

Figure [9]: The CSE’s market capitalization has doubled since 2009

Figure [10]: The government anticipates FDI inflows to reach USD2bn in 2013, a 19% CAGR 2009-2013E

Source: Bloomberg, Central Bank of Sri Lanka Source: Ministry of Finance and Planning, Board of Investment of Sri Lanka

Figure [11]: Most sector P/Es are below market average and historical valuations

Figure [12]: Trend is similar on a P/BV value

Source: Colombo Stock Exchange Source: Colombo Stock Exchange

04080

120160200240280320360400

Jul-09 Feb-10 Oct-10 May-11 Jan-12 Aug-12 Apr-13ASPI Dow Jones FTSE 100

MSCI World DAX

0

100

200

300

400

Jun-09 Dec-09 Jul-10 Mar-11 Sep-11 Apr-12 Nov-12

ASPI Bombay (BSE 500)

Jakarta (JCI) Philippines (PASHR)

Thailand (SET) Hanoi (VNINDEX)

MSCI Emerging Market Index

1,092

2,211 2,214 2,168 2,351

0

500

1,000

1,500

2,000

2,500

2009 2010 2011 2012 2013 (June)

LKRbn

827 601 516

1,066

1,338

2,000

0

500

1,000

1,500

2,000

2,500

2008 2009 2010 2011 2012 2013E

USDm

0

30

60

90

120

Ba

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2010 2011 2012 Average market P/E 2010-2012

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2010 2011 2012 Average market P/BV 2010-2012

Aitken Spence PLC

41


IMPORTANT DISCLAIMER

This document has been prepared on behalf of the Colombo Stock Exchange (“CSE”) by Amba Research Lanka Private Limited (“Amba”) and is sponsored by the CSE. The views expressed in this document are those of the authors based on available and accessible information from the public domain and do not represent those of the CSE. Please note, inter alia, that with the publication of this document on the CSE website, www.cse.lk, neither Amba , as author, nor CSE (as sponsor) intend to assume and are not assuming any responsibility or liability (including under contract, common law or tort) to any party arising out of or with respect to this document. This document is not intended to, and does not form part of any contract with anyone (including a contract between author and reader/recipient) and no one shall have any right (contractual or otherwise) to enforce any claim in relation to the document either directly or indirectly.

Except as otherwise indicated, you may only view and print one copy of the document for your own personal, non-commercial use. You may not copy, store [either in hardcopy or in an electronic retrieval system] transmit, transfer, broadcast, publish, reproduce, create a derivative work from, display, distribute, sell, license, rent, lease or otherwise transfer any of the contents to any third person (including, without limitation, to others in your company or organization) whether for direct or indirect commercial or monetary gain or otherwise without the prior written permission of Amba and CSE.

This document does not contain any investment advice nor does it constitute an offer to buy, sell or hold any of the investment product(s)/asset class(es) mentioned herein. Prospective investors are required to possess sufficient knowledge when evaluating the advantages and risks inherent to such investment product(s)/asset class(es) mentioned herein and to take into consideration their circumstances and financial position when assessing the suitability of such investments.. Prior to making an investment decision, prospective investors are strongly advised to obtain independent advice from competent legal, financial, tax, accounting and other professionals. Amba and CSE shall not be held liable in any manner for any direct, indirect or consequential loss that may arise as a result of investing in the investment product(s)/asset class(es) mentioned herein. Amba and CSE expressly disclaim any fiduciary responsibility or liability for any consequences, financial or otherwise from any reliance placed on the information in this document. The investment product(s)/asset class(es) described in this document may not be eligible for sale or subscription within a particular jurisdiction or to particular categories of investors. This document is not intended for distribution to a person or, within a jurisdiction where such distribution would be restricted or illegal. It is the responsibility of any person reading this document to observe all applicable laws and regulation of the relevant jurisdiction. Neither Amba, nor CSE, shall be responsible for any error which may have occurred at the time of printing of this document. The information set out in this document is subject to change without notice.

The information contained herein has been obtained from sources believed to be reliable and Amba and CSE make no warranty, expressed or implied, as to the accuracy, timeliness, completeness or correct sequencing of the information.

This document does not purport to list all of the terms and conditions, nor to identify or define all or any of the risks that would be associated with the purchase or sale of the investment product(s)/asset class(es) described herein. Please note that any price levels, rates, simulations, illustrations, terms or conditions contained herein are indicative only, and may vary in accordance with changes in market conditions. All the information included in this document is current at the time of preparing this document and subject to change at any time. Any forecast, projection or forward looking statement made in this document embodies assumptions and predictions about future events that by their nature cannot be verified as facts. They are not necessarily indicative of future or likely performance, of investment product(s)/asset class(es), countries, markets or companies. Any past market conditions or product performances may not be representative of future market conditions or product performances.

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