jkh initiation report july 10 2013

7/28/2019 JKH Initiation Report July 10 2013

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Sri Lanka | Diversified Holdings EQUITY RESEARCH

Initiation of coverage 10 July 2013

John Keells Holdings PLC (JKH)

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

The Cautious ConglomerateJohn Keells Holdings (JKH), Sri Lankas largest conglomerate, accounts forover 9.0% of the Colombo Stock Exchanges (CSE) total market capitalization.Its businesses encompass consumer food and retail (CF&R), hotels, oilbunkering and containers, property development, finance and IT services. Weforecast that JKH will post a revenue CAGR of 9.0% over FY14E-FY16E, whileits EBITDA margin should remain roughly stable around 13.9%. This relativelyslow growth trajectory reflects managements cautious approach towardsinvestment and expansion, and implies that JKH may face challenges inmaintaining its market position in some segments. However, it is encouragingthat the company is focused on generating shareholder value and unwilling topursue growth at the expense of margins. Our DCF/SOTP valuation analysisand P/E analysis suggest a valuation range of LKR218-292, compared with theshare price of LKR242 as of 9 July 2013 (see page 14 for a detailed explanationof our valuation methodology).

JKHs revenue will likely grow at a 9.0% CAGR through FY16E. We expect JKHstop-line growth to be driven primarily by the leisure segment, which is primarily madeup of hotels in Sri Lanka and the Maldives. Growth of 400bps in occupancy rates anda 5.2% CAGR in average room rates over FY14E-FY16E should bolster the top line.We forecast that revenue at JKHs CF&R segment, will post a 13.2% CAGR throughFY16E, boosting the companys overall revenue growth. JKHs transportationbusiness should grow in the low single digits, but continue to account for a largeportion of total revenue.

We estimate that the EBITDA margin will remain around 13.9%. Due to JKHshighly diversified nature, growth in one segment is often offset by weakness in otherareas. We believe that its EBITDA margin will decline to 13.9% in FY14E from 14.5%in FY13, as overall expenses rise and property segment revenue (where margins canbe high) continues to be volatile. JKHs real estate development efforts should boost

margins in the coming years as revenues from apartments sold are recognized.However, the businesss relatively small size limits its overall impact. During FY14E-FY16E, cost containment efforts in the leisure segment should broadly supportmargins. IfJKHs upbeat plans for its supermarkets are achieved, the CF&R segment

where we currently forecast an EBITDA margin of just above 6.0% may havesome scope to surprise to the upside.

A cash cushion and low leverage could allow for growth. Management has notdemonstrated a strong interest in pursuing acquisition-driven growth, and it has beencautious in allocating capital to cultivate organic growth. JKHs strong cash (and cashequivalents) position of 15% of market capitalization and low leverage of 17%suggest that the company should be in a strong position if it elects to be moreassertive. Also, the companys large land bank which accounts for 6% of ourestimate of JKHs valuation may allow for some additional upside, depending on itsend use (see page 18 for arenas where JKH may surprise to the upside).

We establish a valuation range of LKR218-292, compared with the currentshare price of LKR242. JKH trades at an FY14E P/E of 16.7x, a premium to itspeers. This valuation premium stems from a share liquidity premium and theperception that the company is one of the most transparent and shareholder friendlyentities in Sri Lanka. That JKH is not controlled by a single shareholder (unlike manyother locally listed conglomerates), also contributes to its valuation premium. Incoming quarters, we will be closely tracking the performance of JKH across a numberof key areas and will be updating our valuation range in future earnings updates (seepage 21 for key areas).

Key statisticsCSE/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)

JKH.N0000/JKH SL

LKR242

857

1,587

1,597

88%

LKR297/177

594,720

1,054

Source: CSE, BloombergNote: USD/LKR=128.7 (avg. for the 1 year ended 9 July2013)

Share price movement

Source: CSE, Bloomberg

Share price performance

3m 6m 12m

JKH -2% 8% 32%

S&P SL 20 1% 7% 20%

All Share Price Index 3% 4% 22%

Source: CSE, Bloomberg

Summary financials

LKRm (year end31 March) 2013 2014E 2015E

Revenue 85,557 96,514 105,079

EBITDA 12,375 13,435 14,845

Segment results 10,125 10,304 11,403

Net profit 11,047 12,396 13,413

Recurrent EPS 13.0 14.6 15.8

ROE (%) 13.7 13.2 13.0

P/E (x) 19.2 16.7 15.4

Source: JKH, Amba estimates

50%

100%

150%

Jul-12 Sep-12 Nov-12 Feb-13 Apr-13JKH ASPI S&P SL 20


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John Keells Holdings PLC

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Table of Contents

JKHs revenue to post a 9.0% CAGR over FY14E-FY16E .................................................................................................. 3

Leisure segment revenue CAGR of 7.6% over FY14E-FY16E driven by higher occupancy and rising average room rates ................ 3

Rising per capita GDP and consumption to support CF&R segments revenue CAGR of 13.2% over FY14E-FY16E ......................... 5

JKHs transportation business to grow slowly, but continue to account for a substantial share of total revenue .................................. 7

Financial services, IT and other segments to make a small contribution to top-line growth ................................................................. 8

EBITDA margin to remain roughly flat at around 13.9% during FY14E-FY16E .................................................................. 9

Cost-control efforts in the leisure segment to support JKHs margins .................................................................................................. 9

High though volatile property segment margins should support overall margins ............................................................................ 9

Some possibility for upside margin surprise from CF&R segment ...................................................................................................... 10

JKHs large cash position, low debt and land bank support balance sheet strength ......................................................... 12

Strong cash position and low gearing to allow investments ................................................................................................................ 12

JKHs large land bank may be a source of further value for JKH........................................................................................................ 12

We establish a valuation range for JKH shares of LKR218-292 ........................................................................................ 14DCF/SOTP analysis yields a valuation range of LKR218-243 per share ............................................................................................ 14

P/E analysis yields a fair value range of LKR236-292 per share ........................................................................................................ 17

Where is additional potential upside? ................................................................................................................................................. 18

Direct comparison with peers may not be relevant to our valuation .................................................................................................... 18

Share price performance .................................................................................................................................................................... 19

Earnings release focus areas ............................................................................................................................................. 21

Appendix 1: Company overview......................................................................................................................................... 23

JKHs key businesses......................................................................................................................................................................... 24

Management strategy, transparency and governance ........................................................................................................................ 26

Shareholding structure ....................................................................................................................................................................... 26

Board of directors ............................................................................................................................................................................... 27

Appendix 2: Key financial data ........................................................................................................................................... 29

Summary group financials (LKRm) ..................................................................................................................................................... 29

Key ratios............................................................................................................................................................................................ 30

Segmental summary ........................................................................................................................................................................... 31

Appendix 3: Industry analysis using Porters framework ................................................................................................... 33

Food and beverage manufacturing ..................................................................................................................................................... 33

Organized food retail .......................................................................................................................................................................... 34

Hotels ................................................................................................................................................................................................. 36

Oil bunkering ...................................................................................................................................................................................... 37

Container handling ............................................................................................................................................................................. 39Property (condominium development) ................................................................................................................................................ 40

Appendix 4: SWOT analysis .............................................................................................................................................. 42

Appendix 5: Diversified sector overview ............................................................................................................................ 43

Fact Sheet .......................................................................................................................................................................... 46

Sri Lanka investment environment overview ...................................................................................................................................... 46


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JKHs revenue to post a 9.0% CAGR over FY14E-FY16E

We expect JKHs revenue growth to be driven primarily by the companys leisure and consumerfoods and retail (CF&R) segments. The transportation segment will remain a significant contributorto revenue, although in our view, its growth will lag that of the company as a whole (refer to

Appendix 1 for a detailed discussion of JKHs revenue composition).

Leisure segment revenue CAGR of 7.6% over FY14E-FY16E driven by

higher occupancy and rising average room rates

We expect the leisure segments revenue to post a CAGR of 7.6% over FY14E-FY16E, to reachapproximately LKR26bn in FY16E. The segments growth should be fuelled by modestly risingoccupancy levels, which we forecast will increase from a blended 67% in FY13 to 71% in FY16E.

Additionally, marginal increases in average room rates (ARR), which should post a blended CAGRof 5.2% over FY14E-FY16E, would likely bolster segment growth. Industry growth in roominventory (total room inventory in Colombo is forecasted to rise by over 50% through 2015 as newhotels are opened) should serve to cap upward movement in occupancy levels and ARRs.

Figure [1]: Average room rates at JKHs Colombo hotels to post a

6.1% CAGR over FY14E-FY16E

Figure [2]: Average room rates at JKHs Sri Lankan reso rts

post a 5.6% CAGR over FY14E-FY16E

Source: JKH, Amba estimatesNote: Data excludes the upcoming business hotel

Source: JKH, Amba estimatesNote: SL resorts are hotels outside Colombo

We expect the companys room inventory (excluding the upcoming business hotel JV project withSanken see Appendix 1 for further details) in Sri Lanka to remain flat through the forecast period.

Although the launch of the new business hotel will increase JKHs room inventory in Colombo by28% in FY15E, JKH currently holds only a relatively small stake (27.8%) in the hotel, and therefore,we expect the incremental addition to revenues to be minimal.

On another front, JKH recently invested in a small national air taxi service called Cinnamon Air.While JKHs minority stake will not be material to the firms overall performance , the operation willhelp consolidate the companys position in the leisure sector.

JKH has indicated that it continues to search for attractive expansion opportunities in the leisuresector, but has been unable to uncover any that meet its investment return hurdles. Although weexpect JKHs market share to decline, the companys focus only on investment efforts that willdeliver returns above its required hurdle rates reflects positively on the companys desire to delivershareholder value.

0

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10,000

15,000

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55%

60%

65%

70%

FY10 FY11 FY12 FY13 FY14E FY15E FY16E

Occupancy rates (LHS) Average room rate (LKR) (RHS)

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25,000

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55%

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70%

75%


Occupancy rates (LHS) Average room rate (LKR) (RHS

JKHs leisure segmentrevenue growth driven byhigher occupancy andincreasing room rates


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Figure [3]: JKHs room inventory in Sri Lanka to remain flat while tourist arrivals may post a 28% CAGR over FY14E-FY16E

Source: JKH, Sri Lanka Tourism Development Authority, Amba estimatesNote: Room inventory numbers are for the 12-month period ended 31 March of each year and exclude the business hotel

More broadly, Sri Lankas tourism industry faces numerous challenges that will also serve to limitJKHs growth in its leisure segment. Tourist visits to Sri Lanka, at just over 1.0m in 2012 (up 17%YoY) 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 Indonesiareported 8.0m visitors (up 11% YoY). Sri Lankas tourism infrastructure in terms of airports, roadsand transportation, and services trails those of competitors for tourism growth. Further, minimumroom rate regulations could dampen Sri Lankas international competitiveness. Perhaps mostcritically, Sri Lankas tourism product is at risk of pricing itself out of the market if the cost ofelectricity and low labor productivity (due to a shortage of skilled labor) continue to rise.

On a related front, the tourism industry in the Maldives, while thriving, continues to be threatenedby political instability and regulatory uncertainty. There is a risk that the government may passlegislation (such as a recent short-lived but nevertheless worrisome ban on spas) that is contrary tothe interests of the leisure industry. That the tourism industry accounts for just over a quarter of thecountrys economy, though, suggests that the government which is projecting an 8.1% CAGR intourist arrivals over FY14E-FY16E will likely be more cautious in its approach.

JKHs Maldives properties account for 27% of JKHs leisure segment revenues and 6% of overallgroup revenue and the company currently has no plans to increase its room inventory there. The

likely stabilization of the investment and political environment in the Maldives should bode well forthe tourism industry in the country.

Figure [4]: JKHs room inventory in the Maldives to remain flat, while tourist arrivals are expected to post an 8.1% CAGR over FY14E-FY16E

Source: JKH, Ministry of Tourism, Arts and Culture Maldives (2012 tourism statistics), Amba estimatesNote: Room inventory numbers are for the 12-month period ended 31 March of each year

0

1,000,000

2,000,000

3,000,000

0%

20%

40%

60%

2010 2011 2012 2013 2014E 2015E 2016E

YoY growth

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

YoY growth in JKH room inventory in Sri Lanka (LHS)

0

500,000

1,000,000

1,500,000

(40%)

(20%)

0%

20%

2010 2011 2012 2013 2014E 2015E 2016E

YoY growth

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

YoY growth in JKH room inventory in Maldives (LHS)


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Rising per capita GDP and consumption to support CF&R segments

revenue CAGR of 13.2% over FY14E-FY16E

We believe JKHs CF&R segment will contribute substantially to the companys overall revenuegrowth. We expect the consumer foods component (comprising ice cream, carbonated soft drinksand frozen processed/convenience foods) to post a revenue CAGR of 10.3% over FY14E-FY16E,while retail (which includes the companys 51 supermarkets) records a 15.4% CAGR over the sameperiod.

Both elements of the CF&R segment are driven by overall macroeconomic growth, and, moreconcretely, disposable income. As shown in Figure 5, JKHs consumer foods and retail businessesboth roughly track the two macroeconomic data points, with the companys growth beingsubstantially higher than either a trend we forecast will continue over the coming years.

Figure [5]: JKHs CF&R growth to outpace macroeconomic growth

Source: World Bank, Central Bank of Sri Lanka, Amba estimatesNote: CF&R segment revenues are for the 12-month period ended 31 March. GDP per capita and disposable income growth rates for 2013 are based on Central Bank ofSri Lanka and World Bank estimates

New product launches and closing consumption gap key to foods growth

We believe JKHs top-line growth in the consumer foods component will also be supported by the

following.

New product launches. Over the past two years, JKH launched two new ice cream flavors anda soft drink flavor, along with an expanded range of sausages. The group also relaunched itspremium ice cream range. In addition, JKH also recently introduced mineral water into itsproduct portfolio.

Geographical expansion. Since launching in the Maldives over a decade ago, Elephant HouseJKHs ice cream brand has become the market leader. The brand was also introduced intothe Middle Eastern market in FY12. Management has indicated that Elephant House may belaunched in additional markets, although timing is unclear.

Additional available capacity. JKH reports that it has substantial scope to increase productionusing current capacity simply by adding an additional shift. Currently, the companys keyproduction facilities operate on one shift. JKH also acquired a meat processing plant in FY13to enhance its production capacity.

Closing consumption gaps.Sri Lankas per capita consumption of ice cream, at 1.7 liters/year,is well above the levels of China and the Philippines. However, consumption levels reflectingboth purchasing power and consumer appetite in nearby Malaysia and Singapore aresubstantially higher.

0%

5%

10%

15%

20%

25%

2010 2011 2012 2013 2014E 2015E 2016E

YoY GDP per capita growth rate YoY disposable income growth rate

YoY revenue growth - Consumer foods YoY revenue growth - Retail

oY growth

New product development andconsumption of ice cream andsoft drinks should help boostCF&R revenue growth


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Figure [6]: Sri Lanka's per capita consumption of ice cream lags the more developed Asian economies

Source: Rediff.com, Ceylon Cold Stores PLC

On a macro level, Sri Lankas modern food retailing sector is attractive, with only 15% of food soldthrough modern outlets (i.e., large organized retail stores); the balance is bought through markets

and other informal channels. The experience of other emerging markets suggests that increasingdisposable income is positively correlated to modern food retail market share, as consumerssearch for a more convenient grocery shopping experience.

JKHs food retailing operations accountfor approximately 57% of the CF&R segments revenue (asof FY13), and roughly 16% of the companys revenue. The companys food retail operation is thethird-largest in Sri Lanka by revenue, and the second-largest in terms of total store count, as shownin Figure 7. JKH reports that its focus will be on opening relatively large stores of 7,000 saleable sq.ft; previously, the companys store sizes varied around the 3,500-4,000 sq. ft. range.

Figure [7]: Keells Super trails Cargills in total store count

Source: JKH, Richard Pieris & Company PLC, Cargills PLC (data as of 31 March)

Note: Cargills data for FY13 are estimates

JKHs retail store expansion rate has been relatively slow, with store count increasing by two storesper annum over the past five years. After many years of being in operation, the companys retailarm became profitable for the first time in FY12. Now that the breakeven point for the business ofaround 50 stores has been achieved, JKH should begin to reap the rewards of scalability of itsfood retail business.

However, management has also said that its policy is to launch food retail operations only in areasof the country that are at a sufficiently high level of disposable income. Indeed, a majority of thecompanys 51 stores (as of March 2013) are in the Colombo area, which is Sri Lankas mostaffluent region. JKHs conservative approach to store launches implicitly allows more aggressive

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Indonesia India Pakistan Philippines China Thailand Sri Lanka Malaysia Singapore

Liters/yr

45 47 5142 45 44

163

194211

0

50

100

150

200

250

FY11 FY12 FY13

No. of stores

Keells Super Arpico Supercenters Cargills

Modern food retailing in SrLanka has significant growth

potential


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competitors most notably, Cargills to establish a strong local market position well before KeellsSuper outlets are launched in a particular region.

On a related front, JKHs own internal investment return hurdles may stand in the way of anysubstantial acceleration in store openings. The company has a target return on capital employed(ROCE) of 15% for any new investment. This should be difficult for the food retail business toachieve, given that management aims to achieve a net margin of 2% which is unlikely to beconsistent with the targeted high ROCE level. Capex of LKR100m required per new store may thus

be a hard sell internally. Management has indicated its desire to accelerate the rate at which newstores are launched to potentially as much as 10 units per annum. However, we are lessaggressive than JKH and forecast only two new store launches per annum through FY16E.

JKHs transportation business to grow slowly, but continue to

account for a substantial share of total revenue

The growth of JKHs transport segment will be hampered by capacity constraints. We expectoverall segment revenue to increase at a CAGR of 4.5% over FY14E-FY16E, to reach LKR22.6bnin FY16E, owing primarily to growth in the oil bunkering business. JKH is active in the containerbusiness via a 42.2% stake in South Asia Gateway Terminals (SAGT), which is accounted for asan associate business.

JKHs oil bunkering business to provide a steady revenue flow

JKHs oil bunkering business imports oil and supplies bunker fuel primarily to ships calling in fortransshipment at the Colombo port. Total current storage capacity for bunker fuel at the Colomboport is 35,000 metric tons (MT). The three largest industry players JKHs Lanka Marine Services(the industry leader, with a 40% market share), state-controlled Lanka Maritime Services andprivate company Lanka Indian Oil Company dominate the sector, although there are a number ofsmaller players.

Growth in the oil bunkering business is hampered by oil storage capacity at the Colombo port. Thegovernment has said it hopes to increase capacity by more than twofold. The timetable of thisexpansion, and how additional space would be made available, has not yet been announced. In themeantime, the only real possibility for top-line growth is via an increase in the price of oil. Weassume that although the Colombo ports oil bunkering services are operating at capacity, intensecompetition will gravitate against any efforts to substantially increase prices.

Moreover, growth in regional trade, which leads to greater demand for transshipment services,

should drive the oil bunkering segments revenues. However, while Sri Lanka is in a geographicallystrong location, it still faces stiff competition from other ports within a radius of a few hours.

On another front, the port development at Hambantota a site of significant infrastructureinvestment in Sri Lankamay threaten the position of the Colombo port, and JKHs oil bunkeringbusiness. The 82,000 MT of oil storage capacity at the Hambantota port is currently under statecontrol, and it may become an increasingly important factor as the ports container operationsevolve.

Container business faces pressure following capacity expansion at the

Colombo port

JKHs container business entails loading and unloading container vessels at the Colombo port. Twomain operators South Asia Gateway Terminals (SAGT), in which JKH owns 42.2%, and state-owned Jaya Container Terminals (JCT) dominate the Colombo ports container capacity of 4.9mtwenty-foot equivalent units (TEU). Currently, the government controls about 60% of total portcapacity.

JKH reports that SAGTs installed capacity of 1.3m TEU/year has been increased to 2m TEU/yearthanks to the application of upgraded equipment and technology. Currently, the facility is operatingat 85% capacity, and any additional increase is pending the privatization of additional area. InDecember 2011, China Merchant, a Hong-Kong listed Chinese state firm, entered into a public-private partnership (PPP) for a build-operate-transfer arrangement that added 2.5m TEU incapacity in July 2013, equivalent to an overall 50% increase in capacity. This sharp increase in totalport capacity should pressure pricing as the new market entrant carves out its customer base. It will

JKHs own investment returnhurdles may stand in the wayof any substantial accelerationin store openings

JKHs transport segmentprovides a steady revenueflow, although growth

prospects are limited byconstraints


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likely also defer any additional privatization of space. Therefore, we believe SAGTs growthprospects, both at the top line as well as in terms of margins, are challenging.

Figure [8]: SAGT operating at 85% annual throughput capacity, with further increases only possible through new terminal access

Source: SAGT, Amba estimatesNote: TEU = twenty-foot equivalent units

Financial services, IT and other segments to make a small

contribution to top-line growth

In our view, JKHs financial services, IT and other segments (which include produce broking andwarehousing, and other real estate operations) will post a combined revenue CAGR of 9.3% overFY14E-FY16E, generating revenue of LKR24.9bn in FY16E (or roughly 22% of total revenue).Some of the key issues relating to these segments include the following:

Insurance:We assume that JKHs insurance operations will grow roughly in line with GDP.While there is a clear growth opportunity in Sri Lankas insurance industry, as disposableincome rises and the outlook of consumers becomes more long term in nature, the market isalso highly competitive. As a mid-tier player, Union Assurance (UAL) in which JKH holds a96% stake is subject to pricing pressure from larger competitors. We estimate UALs bookvalue and forecast its value generation into our SOTP valuation using a P/BV multiple (valuing

UAL at a 5% premium to its 2012 P/BV).

Banking: Nations Trust Bank (NTB), in which JKH holds a 29.9% stake, is a small-tier asset ina fast-growing sector that is dominated by state-controlled and some of the large privatecommerical banks. We forecast NTBs value generation into our SOTP using a P/BV multiplevaluing NTB at a 10% premium to its FY12 P/BV (and at a premium to its peer average).

Stockbroking: John Keells Stock Brokers (JKSB) accounted for only 2% of the financialservices segments revenue in FY13. Overall low trading volumes, an over-broked market,weak stock market performance and declining commissions all contribute to mixed prospectsfor JKHs stockbroking activities.

IT: JKH offers a niche product in the IT segment. We believe that the business does notappear to be a major priority; additionally, heavy competition particularly from India exertsdownward pressure on pricing. We forecast top-line growth to be around 10%.

1,600,000

1,700,000

1,800,000

1,900,000

2,000,000


TEUs

Volume (TEUs)

Insurance, banking and IT willalso contribute to the top line


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EBITDA margin to remain roughly flat at around 13.9%

during FY14E-FY16E

We expect JKHs EBITDA margin to be roughly flat during the forecast period as weaker segmentsdrag down those that we believe will post EBITDA margin growth. Some of the key dynamics of thisprocess are described below.

Figure [9]: EBITDA margins from the property and leisure segments to drive JKH margin growth


Cost-control efforts in the leisure segment to support JKHs margins

We expect the leisure segments higher revenue and internal operational efficiencies to lead to a100bps increase in the EBITDA margin to 33.3% in FY16E in the context of a firm-wide EBITDAmargin of 14.5% in FY13 and 13.6% in FY16E. This relatively modest increase is still significant inlight ofthe sectors intensifying competition and cost pressures.

Broadly speaking, variable costs in the hotel sector are relatively low, and hotels hold highoperating leverage. Fixed costs are driven by electricity, staff salaries and lease rentals, whichtogether account for over 50% of total costs. While most of these costs are controllable, we expect

staff costs (which represent the single-largest expense to JKHs leisure segment) to increaserapidly, as competition for qualified personnel mounts. Additionally, the Sri Lankan government hasheld discussions on implementing an across-the-board wage hike for the countrys tourism industry.However no firm proposals have yet been made on this front.

Highthough volatileproperty segment margins should support

overall margins

Top-line growth in the property segment is derived primarily from apartment sales and ongoingproperty rentals. The segments EBITDA margins fluctuate sharply depending on the timing ofapartment sales, which command significantly higher margins than rentals. The company receives10-20% of revenues at the time of sale, with the balance being payable by the customer based onthe proportion of project completion.

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70%


Margin

EBITDA margin (JKH) EBITDA margin (Leisure) EBITDA margin (Property)EBITDA margin (CF&R) EBITDA margin (Transport) EBITDA margin (Financial Services)

Weaker segments drag downthose that we believe will postEBITDA margin growth

Competition, escalating costs(led by rising labor costs) could

pressure leisure segment

margins


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Figure [10]: Property segments EBITDA margin significantly higher than the groups

Source: JKH, Asian Hotels and Properties PLC, Amba estimates

JKHs property segment accounts for a relatively small percentage of revenue, ranging from 3.4%to 6.3% over FY08-FY13. However, it accounts for a volatile and outsized contribution toprofitability; for example, the property segments contribution to the companys EBIT more thandoubled to 25.8% in FY11. We anticipate a solid contribution from the property segment during theforecast period following the completion of the OnThree20 and 7

thSense residential property

development projects. According to the company, approximately 80% of OnThree20s apartmentshad been pre-sold as of March 2013. We expect almost all of the 475 apartments to be sold byproject completion in December 2014, and over 90% of its revenue to be booked through the fiscalyear end 2015, bolstering margins during the period.

However, visibility on future property development projects is limited. It is likely that JKH willcontinue to draw upon its extensive land bank (see Figure 13) for real estate development efforts;however, our ability to provide concrete financial performance forecasts is contingent upon JKHsannouncements regarding its future plans.

Colombos high-end residential real estate sector has witnessed strong demand over the pastseveral years, and a large number of high-end residential real estate projects are currently in theworks. This could lead to oversupply, and demand could come under pressure.

Some possibility for upside margin surprise from CF&R segmentWe believe the CF&R segment will post relatively flat margins during the forecast period.

According to the company, retail operations have achieved sufficient scale to break into profitability,and this is reflected in our forecasts. Two elements of the segments operations that could lead tounexpectedly strong results are provided below:

Pass-through of price hikes: Management has indicated that it generally boosts prices of icecream and soft drinks as much as two times per year, in part to pass on to consumersincreases in the cost of sugar and other inputs. The relatively low level of competition in themarket ice cream is a de facto oligopoly means that JKH faces little resistance toincreasing prices. If demand continues to be robust, JKH could push through higher price hikesto bolster margins.

Potential of private label: JKH reports that currently 4% of retail sales are generated by private-label goods. The company says that it hopes to boost this to 10%. Gross margins on private-

label goods are 50% higher than gross margins for branded goods, according to JKH. If thecompanys efforts to increase the share of private-label goods on the shelves of its Keellssupermarkets move faster than anticipated, margins could surprise on the upside.

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Margin

JKH group EBITDA margin Property segment EBITDA margin

OnThree20 and 7 Sense, twoof the on-going real estatedevelopment projects, willcontribute to group EBITDAmargins through FY16E

An increased mix of privatelabel products could result in amargin surprise from CF&R


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Figure [11]: CF&R segments EBITDA margins to remain flat at around 6.3% over FY14E-FY16E

Source: Amba estimates

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JKHs large cash position, low debt and land bank support

balance sheet strength

Strong cash position and low gearing to allow investments

JKH has maintained a strong cash balance position (including cash in hand and short-term

investments) over the past few years, with cash and cash equivalents making up approximately19% of total assets, or 15% of market capitalization. The company also has been able to generatestrong free cash flow balances and gearing has continuously been below 30%. This indicates thatthe company has remained largely a self-financed business, in relation to its local peers, withminimal support from external financial institutions. JKHs cash position also places it at aconsiderable advantage relative to other domestic conglomerates, which hold net debt positions.

Figure [12]: JKH has a strong net cash position relative to other local conglomerates

Source: JKH, BloombergNote: All data as of FY13

Therefore, JKHs strong liquidity and the option of raising further debt financing open upopportunities for the company to venture into new projects to enhance shareholder value. However,the challenge as discussed elsewhere in this report is whether JKH will uncover projects that

offer a sufficiently attractive return. The danger is that excessive caution will lead to a steadydeterioration in market share in some of the companys segments.

JKHs large land bank may be a source of further value for JKH

JKH owns one of the largest private land banks in Sri Lanka, including 121 acres of real estatewithin and out of Colombo. A significant proportion of this land is included under PPE on the groupbalance sheet, and has been valued as of 31 March 2013. In the figure below, we present ourestimations of the dormant land bank, and these are based on our discussions with JKH and thecompanys reported valuations.

(50,000)

(40,000)

(30,000)

(20,000)

(10,000)

0

10,000

20,000

John Keells Holdings Carson Cumberbatch Aitken Spence CT Holdings Hayleys

LKRm

JKHs cautious approach toinvestment could dampengrowth opportunities


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Figure [13]: JKHs dormant land bank estimated at LKR11.6bn

LocationAcreage

Value per acre

(LKRm)

Current value

(LKRm)

Slave Island Complex, Colombo 2 6.73 1,140 7,669

Ferguson Road, Colombo 15 1.22 229 280

Vauxhall Street, Colombo 2 3.06 667 2,042

Trincomalee 1.06 80 85

Ja-Ela 3.77 28 106

Nilaveli 44.37 15 668

Trincomalee 14.64 25 361

Wirawila 25.15 3 70

Wakare 8.43 2 18

Ahungalla 6.50 23 149

Ahungalla 6.31 23 144

11,591


In our financial model, we value JKHs land bank at its market value, as reported by JKH. The landbank accounts for roughly 6% of our forecast SOTP valuation.


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We establish a valuation range for JKH shares of LKR218-

292

We establish a 12-month valuation range based on our current earnings outlook for JKH shares ofLKR218-292 per share, compared with the current share price of LKR242 as of 9 July 2013. Wearrive at our valuation range applying sensitivity analysis to a DCF/SOTP valuation methodology,and a P/E-based relative valuation approach. For the sake of comparison, we also assess JKHsvaluation levels relative to a group of peers. For factors that will provide an upside/downside to thisstated valuation range, please refer to page 18 of the report.

Figure [14]: Valuation range analysis provides a range of LKR218-292 per share (current share price LKR242)

Source: Amba estimates, JKH, Bloomberg

DCF/SOTP analysis yields a valuation range of LKR218-243 per shareIn valuing JKH shares, we applied a combined DCF/SOTP approach. Our base-case assumption ofa risk-free rate of 9.5% and a market risk premium of 5.0% yields a value per share of LKR229;adjusting these assumptions (to allow for a risk-free rate range of 8.5-10.5% and a market riskpremium range of 4.0-6.0%) implies a valuation range of LKR218-243.

Other elements of our valuation approach include the following:

For the transport (oil bunkering only), leisure, property, CF&R and financial services(stockbroking only) segments, we conducted a DCF analysis, with explicit forecasts throughFY16E, and a six-year fade period thereafter.

Where segment revenues are earned in USD (particularly leisure and transport), we have useda conservative 1.5% YoY LKR depreciation rate for our forecast period.

We value JKHs minority stake in SAGT (which handles containers at the Colombo port) by

using Gordons dividend growth model.

To assess the value of JKHs insurance operations, we applied a target P/BV valuationapproach, based on comparables. We have valued UAL at 2.8x (a 5% premium to its year-end2012 P/BV), and at a premium to its peers, as it has historically traded at high multiples relativeto its peers.

We value JKHs 29.9% stake in NTB using a target P/BV valuation approach, based oncomparables. We have valued NTB at 1.4x (a 10% premium to its year-end 2012 P/BV) and ata premium to its peer group, as it has historically traded at a premium to its peers.

177

236

218

297

292

243

242

0

1

150 190 230 270 310

52-week range

P/E analysis

DCF/SOTP

Our base-case assumptionsinclude a risk-free rate of 9.5%and a market risk premium of5.0%


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For the IT segment, we applied an EV/sales valuation metric as we were unable to conduct aDCF analysis due to insufficient disclosure regarding the segments performance.

Also, we value JKHs land bank on a standalone basis, based on the companys valuation ofmarket value applied to the dormant land bank and our discussions with the company (refer toFigure 13 for additional details on how we value the companys land bank).

JKHs current capital structure comprises 17% debt and 83% equity. We have assumed abalanced 50/50 target capital structure across all segments and a terminal growth rate of 3%.

The following tables reflect our DCF/SOTP assumptions for the companys key segments. For eachsegment we have estimated the following:

EBIT and FCF figures throughout the explicit and fade periods.

Terminal value at FY22E, calculated by applying a terminal growth rate to unleveraged FCF asof FY22E.

Finally, we arrived at our segmental EV by discounting the unleveraged FCF values over theexplicit and fade periods at the segmental WACC.

Assumptions for each segment are presented in the figures below.

Figure [15]: Amba DCF/SOTP assumptions schedule:

Transportation

WACC assumptions FY14E

Target capital structure 50/50 EBIT total 988

Cost of equity 14.0% FCF 1,232

Cost of debt 10.0% Terminal value (undiscounted) 15,253

Terminal growth rate 3.0% Equity valuation of SAGT 21,526

Effective tax rate 15.0% EV (incl. SAGT) 33,147

WACC 11.3%

Leisure


Target capital structure 50/50 EBIT total 5,301



Terminal growth rate 3.0%

Effective tax rate 15.0% EV 66,051

WACC 11.6%

Property







WACC 11.5%

Consumer food and retail



Cost of equity 14.0% FCF 148




WACC 11.3%

We assume a 50/50 targetcapital structure


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Financial services

WACC assumptions for JKSB FY14E

Target capital structure 50/50 EBIT total (JKSB only) 18

Cost of equity 14.5% FCF (JKSB only) 25

Cost of debt 10.0% Terminal value (undiscounted for JKSB only) 180

Terminal growth rate 3.0% UAL P/BV 13,302

Effective tax rate 15.0% NTB P/BV 4,675

WACC 11.5% EV (incl. UAL and NTB) 18,134

IT segment valued on an EV/Sales basis

FY14E

Revenue 7,478

EV/Sales peer average 2.00

EV 14,957

Others


Target capital structure 50/50 EBIT total (75)

Cost of equity 15.0% FCF (705)



Effective tax rate 15.0% EV 562

WACC 11.8%

Source: Amba estimatesNote: All figures are in LKRm unless otherwise stated. SAGT=South Asia Gateway Terminals,JKSB = John Keells Stockbrokers; UAL = Union Assurance PLC, NTB =Nations Trust Bank PLC

The following table shows the contribution of each segment to our base-case value per share.

Figure [16]: Contribution by segment to JKHs value per share (including land bank)

Equity value (LKRm) LKR per share Contribution mix

Transportation 33,147 38.6 17%Leisure 66,051 77.0 34%

Property 23,786 27.7 12%

CF&R 30,371 35.4 15%

Financial services 18,134 21.1 9%

Information technology & others 15,518 18.1 8%

Cash and cash equivalents 29,724 34.6 15%

Debt (20,004) (23.3) -10%

Minority interests (11,366) (13.2) -6%

Land bank 11,591 13.5 6%

Total 196,951 229.4

Source: Amba estimates

However, if we assume a lower market risk premium of 4.0%, then the SOTP value would beLKR243 per share; correspondingly, if the market risk premium increases to 6.0%, the SOTP valuewould be LKR218 per share.


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Figure [17]: Sensitivity analysis schedule

Risk-free rate

8.5% 9.0% 9.5% 10.0% 10.5%

Marketriskpremium

4.0% 258 250 243 236 229

4.5% 250 243 236 229 223

5.0% 243 236 229 223 218

5.5% 236 230 223 218 212

6.0% 230 224 218 212 207

Source: Amba estimatesNote: Our base-case assumptions are a risk free rate of 9.5% and a market risk premium of 5.0%

P/E analysis yields a fair value range of LKR236-292 per share

JKHs 12-month forward P/E has ranged from 13.0x to 30.2x since April 2010. The shares 12-month historical forward P/E averaged 19.2x during this period. The stock currently trades at 16.7xits 12-month forward EPS (based on our forecasts), a 13% discount to its historical average.

Figure [18]: JKH forward P/E band chart

Source: JKH, Bloomberg

In determining a P/E valuation range and a share price range, we apply two scenarios:

Conservative scenario: Here we assume that JKH will trade at a forward multiple of 16.3x, a15% discount to its recent historical average. As growth slows, JKHs shares may trade at alower multiple. During FY09-FY13, the companys revenue posted a CAGR of 15.4%, andEBITDA a CAGR of 13.3%, compared with our FY14E-FY16E forecasts of a CAGR of 9.0% in

revenue and a CAGR of 6.7% in EBITDA. We applied a forward P/E of 16.3x to our FY14Ediluted EPS estimate of LKR14.5 to arrive at a fair value of LKR236 per share.

Optimistic scenario: Under this scenario, investors place a higher premium on managementsapproach particularly in contrast to the less-disciplined investment strategies of some otherdomestic conglomerates. This focus on generating shareholder value rather than persuing low-return growth is rewarded by investors with a valuation that is a 5% premium to the recenthistorical average. This premium is also on account of the highly anticipated Glennie Streetmega development project implying a 20.2x P/E multiple. Applied to our forecast of FY14Ediluted EPS, this leads to a share price level of LKR292 per share.

75

125

175

225

275

325

375

425

Apr-10

Apr-11

Apr-12

Apr-13

LKR

10x 15x 20x 25x 30x Market price per share

JKH currently trades at 16.7xits 12-month forward EPS; we

forecast a conservativescenario with a 15% discountto the recent historical average,and an optimistic scenario witha 5% premium to the recenthistorical average


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Where is additional potential upside?

Our modeling of JKHs financial performance has been intentionally conservative in some respects.We have not factored in the following possible sources of valuation upside:

Property/Leisure: The anticipated USD640m mixed-use development project on the 12.5-acreplot at Glennie Street, could boost JKHs share price. Although JKH remains silent on plans forthis property, it is speculated to include a hotel, apartments and a shopping mall.

Oil bunkering: If Lanka Marine Services is able to secure additional bunker fuel storagecapacity, this would add to top- and bottom-line growth.

Land bank: We estimate that JKHs land bank is worth approximately LKR11.6bn (seeFigure 13), equivalent to 6% of the per share value we ascribe to the stock in our DCF/SOTPvaluation. This value could rise sharply depending on the manner in which the land is used.

Container handling: With one terminal already awarded under a PPP with China MerchantsHoldings, there are two other terminals with a cumulative container handling capacity of 5mTEU. If SAGT is able to secure some part of this new capacity, it would add to bottom-linegrowth.

CF&R: JKH reports that the food retail business has reached the required economies of scaleto become profitable. The company forecasts a rapid rate of growth for the segment via morestore openings; we apply a more conservative approach, suggesting that there may be morescope for top-line and margin growth than we forecast.

There is also some scope for negative surprises that could pressure our valuation range. Therecould be delays to JKHs property development projects, and rapidly growing supply of high -endapartments could outstrip demand, forcing JKH to cut prices. Weakness in tourist arrivals, and anexcess of new room inventory could hurt ARR growth and occupancy rates. Additionally, there issome risk that the companys food retail operations disappoint, and continue to pressure overallcompany margins. Further, capacity constraint issues in the transport segment could also threatenshare performance.

Direct comparison with peers may not be relevant to our valuation

Figure 19 presents JKHs valuation metrics relative to its peers. JKH trades at a premium to theaverage of its peers based on P/E valuation metrics. The shares are trading at an FY14E P/E of16.7x, at a 23% premium to its peer group average.

Additional valuation upside ispossible from the real estatedevelopment segment


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Figure [19]: JKH trades at a premium on most measures to most comparables

Company name

P/E EPS CAGR FCF yield

2011 2012 2013 2014E 2015E FY14E-FY15E 2012 2013

John Keells Holdings PLC 21.6x 17.9x 19.2x 16.7x 15.4x 10.3% 6.3% 4.5%

Domestic peers

Aitken Spence PLC 26.0x 13.1x 14.9x 13.4x 11.0x 13.3% -1.8% 5.1%

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 14.0x 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 22.2x 18.0x 14.6x 13.5x 12.0x 12.5% -2.4% -1.0%

Median 18.2x 16.4x 14.0x 12.3x 11.0x 12.0% 1.5% 0.9%

High 46.9x 35.2x 31.9x 30.6x 25.8x 17.9% 7.4% 5.1%

Low 4.7x 5.6x 6.7x 6.9x 6.3x 7.9% -18.9% -15.9%

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

Selecting an adequate peer group for a conglomerate is challenging. No potential peer has anidentical slate of business segments. But while the companies in the figure above are imperfect atbest points of comparison, we have included this data to provide some measure of comparisonwith other regional conglomerates.

Share price performance

JKH shares closed at LKR242 on 9 July 2013, LKR58 higher than twelve months earlier, for anappreciation of 32%, compared to a 20% increase in the S&P SL 20 and a 22% jump in the AllShare Price Index (ASPI) over the same period.


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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 be closely tracking the performance of JKH across these keyareas and will be revising our forecasts and updating our valuation range in earnings update notes.Please refer to the company profile for the context of these questions.

For the firm as a whole:

1. Has there been an increase in debt levels to support expansion? The judicious use of leveragewould be a positive signal. JKH is underleveraged, and an increase in debt would be a movetoward a more efficient capital structure.

CF&R segmentfood manufacturing

1. Is JKH adding a shift at production facilities to increase production capacity?

2. Focus on changes in market share forJKHs soft drinks and ice cream products.

3. Has JKH been able to pass on price hikes of inputs to consumers?

CF&R segmentretailing

1. How many stores has JKH opened during the period?

2. Focus on the margins of the food retailing business. The company stated that it had achievedthe required scale to become profitable, so any weakness that does not stem from one-offcauses should be a source of concern.

Leisure segment

1. How have actual tourist arrivals compared to government projections? For 2013, the SriLankan government is targeting 1.2m tourist arrivals, compared with just over 1.0m arrivals in2012.

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

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

4. Focus on any update on the JV with Sanken (business hotel).

Transportation segmentoil bunkering

1. Have there been any measures to increase storage capacity for bunker fuel at the ColomboPort, and is any further privatization of capacity planned? This could increase JKHs current40% market share through LMS.

2. Are there plans to privatize oil bunkering facilities at Hambantota? The countrys other majorport boasts of significantly more oil bunkering capacity than the Colombo port, and itsdevelopment is a government priority.

Transportation segmentcontainer handling

1. Has SAGT taken any measures to increase capacity? Current capacity stands at 2m TEU.

2. Has there been any shift in the volume mix between the domestic and transshipmentbusinesses? The company indicated that it anticipates a gradual shift from the current 20/80(domestic/transshipment) ratio to 15/85 once the new container terminal comes on stream thisyear. This could lead to lower margins.

3. Has JKHs stake in SAGT changed (from the 42.2% it currently controls)?

4. Has there been any change in the dividend payout rate to JKH by SAGT (from the current levelof nearly 100%)?


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5. Any strong movement in the LKR would impact the business, as customers are billed in USD.

Property segment

1. Focus on any update on the 7th Sense project (Gregorys Road) and the proposed new mixed-use development project (Glennie Street, at the site of the JKH headquarters). The latter inparticular is highly anticipated by the market but has not been factored into our currentprojections due to lack of visibility on the development.

Financial services segment

1. Any update on the Central Bank of Sri Lanka rule which was subsequently put on hold thatwould require JKH to sell down its stake in NTB to 15% (from the current 29.9%)?

2. Has there been any change in UALs market share in the life insurance business? As of FY12(December 2012), its market share stood at 13%.

3. Has there been any movement on government regulations regarding the life insuranceindustry, with focus on the following?

Separation of the life and non-life businesses by 2015

Possible listing of life and non-life businesses by 2016

Extension of the minimum capital requirement (for new entrants) to existing firms for each

line of business (life and non-life)


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Appendix 1: Company overview

John Keells Holdings (JKH) is the largest publicly traded company on the Colombo StockExchange (CSE), with a market capitalization of LKR207bn (USD1.6bn) as of 9 July 2013. JKHsFY13 net profit was the highest ever recorded by a publicly traded company in Sri Lanka.

Established in the early 1870s, JKH has evolved over time, having entered and exited variousbusinesses as management strategies and economic climates changed. The company currentlyoperates in six segments: consumer food and retail (CF&R), leisure, transportation, propertydevelopment, financial services, information technology and a handful of other small businesses.The CF&R, leisure, and transport segments are the largest contributors to the companys top andbottom lines, together bringing in approximately 76% of revenue and over 70% of EBITDA in FY13.

Amongst Sri Lankas large conglomerates, JKH is unusual in that a single large shareholder doesnot control a majority stake. This has bolstered the companys reputation for relatively high levels oftransparency and strong corporate governance. It has also helped boost the share liquidity of thestock, which has an average daily trading volume of approximately 595,000 shares, or an averageannual daily turnover of approximately USD1m (July 10 2012 to July 9 2013). Also, JKH is the onlySri Lankan company to have a global depository receipt (GDR) issue (Bloomberg ticker: KEEL LX),which is traded on the Luxembourg Stock Exchange.

Figure [22]: CF&R, leisure and transport segments generateapproximately 76% of JKH revenues in FY13

Figure [23]: Leisure, property and CF&R remain the largestannual EBITDA contributors

Source: JKH

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

Source: JKH

JKH recorded LKR85.6bn in revenue for FY13, with a CAGR of 15.4% over FY09-FY13. The groupgenerated EBITDA of LKR12.4bn in FY13, representing a 13.3% CAGR over FY09-FY13.

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

FY09 FY10 FY11 FY12 FY13

LKRm

CF&R Leisure TransportProperty Financial services ITOthers

0

2,000

4,000

6,000

8,000

10,000

12,000


LKRm

CF&R Leisure Transport

Financial services Property IT

Others


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JKHs key businesses

The CF&R segmentthe largest contributor to JKHs top line (29% of FY13 revenues) engages

in manufacturing beverages (carbonated soft drinks), frozen confectionary (ice cream) andconvenience foods. It also operates a chain of supermarkets. The segments activities are asfollows:

Ice cream and soft drinks JKHs Ceylon Cold Stores (CCS) subsidiary produces soft drinksand ice cream under the Elephant House brand name, which is the market leader in Sri Lanka,with a market share of just over 50%. Elephant House has also been the market leader in theMaldives over the past decade and expanded into Kuwait in FY12. The consumer foodsbusiness yields much higher margins than the retail segment, with gross margins of over 30%(more than tenfold the margins reported by the retail segment).

Frozen processed/convenience foodsThe companys Keells Food Products (KFP) subsidiarymanufactures and sells processed meat products (under the Keells, Krest and Elephant Housebrands) locally. The subsidiarys products are also sold in the Maldives, India and the UAE.

Retail JayKay Marketing Services (JMS) owns and operates the Keells Super chain ofsupermarkets, with 51 outlets island-wide (as of March 2013). This includes 45 Keells Superand 6 Super K outlets. The Keells Super chain is the second-largest food retailer in Sri Lanka,in terms of number of stores (behind Cargills, which operated an estimated 211 stores as ofMarch 2013). JMS recently changed its strategy to focus on larger store formats(approximately 7,000 sq. ft compared with initial store sizes of 3,500-4,000 sq. ft) and K-Zonemalls. Retail net margins are low, at around 1-2%.

JKHs leisure segment (24% of FY13 group revenues) includes a range of hotels and resorts(under the Cinnamon and Chaaya brands) in Sri Lanka and the Maldives, as well as the companysdestination management arm.

Colombo city hotels Cinnamon Grand and Cinnamon Lakeside are the two five-star hotelslocated in Colombo, accounting for approximately 35% of five-star room inventory in thecapital. Blended occupancy rates at JKH city hotels average between 65% and 70%, with

room rates of USD130-140 per day.

Sri Lankan resorts This division comprises eight hotels (all located outside of Colombo) andholds a market share of around 11% of room inventory in Sri Lanka (excluding Colombo).Occupancy rates average around 60%. This segment has average room rates of USD95-110per day.

Maldivian resorts Comprising three hotels in the Maldives, this part of the business postsoccupancy rates of over 80%, driven primarily by tourist arrivals from China and Europe. As

Figure [24]: JKH revenue grew at a 15.4% CAGR over FY09-FY13

Figure [25]: JKH EBITDA grew at a 13.3% CAGR over FY09-FY

Source: JKH Source: JKH

(5%)

0%

5%

10%

15%

20%

25%

30%

0

10,000

20,000

30,000

40,000

50,00060,000

70,000

80,000


YoYgrowth

LKRm

Revenues (LHS) YoY growth (RHS)

(40

(20

0%

20%

40%

60%

0

2,000

4,000

6,000

8,00010,000

12,000

14,000


YoY growLKRm

EBITDA (LHS) YoY growth (RHS)


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the country is a popular tourist destination, the resorts are able to command higher averageroom rates of over USD300 per day.

Destination management and tour operations JKH operates services in Sri Lanka and Indiathrough its wholly owned subsidiaries Walkers Tours and Whittall Boustead (in Sri Lanka) andSerene Holidays (in India). Walkers Tours is one of the leading destination managementcompanies in Sri Lanka. The leisure segment relies heavily on these operators to draw touriststo the groups hotels.

Development project - JKH is participating in the development of a three-star 240-room selectservice business hotel in Colombo city through a joint venture with Sanken Lanka, a localdeveloper. JKH currently holds a 27.8% associate stake in the project, which is scheduled toopen in August 2014, and will also manage the hotel.

The companys transportation segment (23% of FY13 group revenues) focuses on oil bunkeringand container handling services.

Oil bunkeringLanka Marine Services (LMS), JKHs oil bunkering subsidiary, imports oil andsupplies different grades of bunker fuel to vessels calling in at the Colombo port. A majority ofthese vessels are container ships, docking in for transshipment (which is the shipment ofgoods or containers to an intermediate destination, from where it is then taken onto its finaldestination).

While there are 10 licensed bunker operators at the Colombo port, the business is dominatedby three operators: LMS, Lanka Maritime Services and Lanka Indian Oil Company. LMS is the

market leader, with a market share of more than 40%.

Container handling JKH holds a 42.2% associate stake in South Asia Gateway Terminals(SAGT), Sri Lankas only privately owned container handling operator at the Colombo port.SAGT derives its revenue primarily through the loading and unloading of container vessels thatarrive at the Colombo port for transshipment. It also handles domestic containers, although thisaccounts for approximately 20% of throughput volumes. Revenue from domestic operationscame in at approximately USD110-115 per box, while for transshipments, it was much morecompetitive at USD20-25 per box. SAGT, which has a market share of 40% (in terms ofvolumes), faces stiff competition from its only rival Jaya Container Terminals (JCT), a state-owned operator.

The property segment is a small contributor to total JKH revenue (4% in FY13), but generates highmargins. It focuses on developing and selling apartment units, as well as managing shopping malls.Within this segment, JKH owns a large private land bank (approximately 120 acres) across Sri

Lanka in prime locations. The segments portfolio comprises the following: Rental properties Through its Asian Hotels and Properties PLC (AHPL) subsidiary, JKH

owns and manages the following:

Crescat Boulevard an upmarket shopping mall, located in central Colombo.

Two K-Zone malls (Moratuwa and Ja-Ela) The latest mall in Ja-Ela is a 140,000 sq. ftcomplex that recently commenced operations. Almost 90% of the malls gross leasablearea (which is approximately 98,000 sq. ft) has already been rented out.

Development properties

OnThree20 This is a 475-apartment condominium project scheduled for completion byDecember 2014. The company reports that 80% of the units had already been sold as ofMarch 2013.

7th Sense This is a 65-unit premium apartment complex project, located in a prestigious

area in the south of Colombo city and scheduled for completion by April 2015. JKH ispricing the 2,000 sq. ft units at a super-premium level, and reports that one-third of theunits have been reserved.

Mixed-use development project We do not factor into our valuation a long-rumoredmixed-use development project on the premises of JKHs 12.5-acre Glennie Streetproperty (which currently houses the company headquarters) in Colombo city. Thedevelopment would reportedly include hundreds of hotel rooms, a shopping complex, acommercial complex and serviced apartments. Due to the lack of available details and the


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highly prospective (and speculative) nature of the development, this project is not reflectedon our financial model.

The financial services (10% of FY13 revenues) segment comprises insurance, banking and

stockbroking services.

Insurance - JKH owns a subsidiary stake in Union Assurance PLC (UAL), one of Sri Lankasleading insurance companies (offering both life and non-life insurance products). UAL is thefourth-largest life insurance provider in Sri Lanka, with a market share of approximately 13%

(as of December 2012).

Banking and stockbroking services JKH also holds a 29.9% interest in Nations Trust Bank(NTB), a small-tier commercial and retail bank. Regulatory requirements could require JKH tosell its stake down to 15%, although JKH management indicated that the situation is in flux.JKH also has a 90% stake in John Keells Stock Brokers (JKSB), through which it offers sharebroking services.

JKHs information technology segment (8% of FY13 revenues) offers IT, software, office

automation and BPO/KPO services. JKH is also the authorized dealer for Samsung mobile phonesin Sri Lanka.

Management strategy, transparency and governance

JKH has a number of financial targets that it strives to achieve on a segment basis, including

annual EBIT growth of over 20%, diluted EPS growth of more than 20%, an ROCE of 15% and anROE of 18%. Further, JKH seeks to maintain group gearing levels below 25%.

In practice, these investment return hurdles often appear to act more as barriers to investment.JKH is steadily losing market share in a number of segments, in part due to a reluctance to investin developing different businesses. Maintaining a strong investment discipline and focusing onreturns, rather than market share, is laudable. However, it may over time threaten to erode thecompanys position in a number of arenas.

JKH enjoys a strong reputation amongst capital market participants as being one of the mosttransparent and accessible companies traded on the CSE. This is reflected in part in the relativelyhigh proportion of the company held by international investors and the comparatively high level ofliquidity of its shares.

However, while disclosure may be adequate by local standards, there are still some areas in whichit could improve to move towards international standards. Some possible areas of improvement

include the following.

The companys quarterly disclosure levels regarding capex, working capital, depreciation andother granular details on a segment level are uneven, and an analyst seeking to value thecompany must frequently make broad and tenuous assumptions regarding JKHs historical(and forecast) performance on a range of factors. Expanding disclosure in quarterlyannouncements would be a significant improvement.

We believe that JKH should produce investor presentations, listing the companys overallstrategy and business approach and make these available on its website. This would helppotential investors to better understand company performance and direction.

Shareholding structure

International investors hold over 65% of JKHs shares and institutional investors (both domestic

and international) hold over 70% overall. Management controls 5% of the company. Unlike manyother traded conglomerates, a single shareholder does not control a majority stake in the company.


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Figure [26]: JKH's domestic investor base is approximately 33%Figure [27]: Total local individual shareholders account for lessthan 30% of total shareholding

Source: JKH, as of March 2013 Source: JKH, as of March 2013

The top five shareholders as of March 2013 are presented below.

Name of shareholder Description Stake

Janus Overseas Fund US-based asset management company 10.1%

Mr. S.E. Captain Domestic high net worth investor 9.6%

Broga Hill Investment Ltd SPV of Khazanah Nasional Berhard, Malaysias sovereign wealth fund 8.7%

Paints and General Industries Ltd* Paint manufacturer in Sri Lanka 5.7%

Deutsche Bank AG - London Nominee holder for international shareholders 3.8%

Source: JKH

*Note: Paints and General Industries is majority owned by Mr. S.E.Captain

Board of directors

As of March 2013, JKHs board comprised nine directors. Their details are provided below.

Name of Director Description

Mr. Susantha Ratnayake Chairman and CEO. Has held dual positions since 2006. A 35-year veteran of JKH.

Mr. Ajit Gunewardene Deputy chairman. Member of the board for over 20 years, and has been with JKH for more than 30 years. Direct

of a number of companies within the JKH group.

Mr. Ronnie Pieris Group finance director. Appointed to the JKH board in 2003.

Mr. Franklyn Amarasinghe Senior independent non-executive director. Appointed to the board in 1999. A lawyer and a consultant in HR-

related issues.

Dr. Indrajit Coomaraswamy Independent non-executive director. Appointed to the JKH board in 2011. Former Central Bank official who has

also worked in other government finance positions.

Mr. Tarun Das Independent non-executive director. A three-decade veteran of the Confederation of Indian Industry (CII).

Mr. Ashroff Omar Independent non-executive director and CEO of Brandix Lanka Ltd., a leading operator in the Sri Lankan appare

sector.

Mr. Ranjit Gunasekara Independent non-executive director. Was appointed to the board in 2011. Former banker and CFO of National

Development Bank in Sri Lanka.

Ms. Sithie Tiruchelvam Independent non-executive director. Board member since 2007. Corporate and labor lawyer.

Source: JKH

Mgmt andconnected

parties5%

Otherdomesticinvestors

28%International

investors67%

Mgmt andconnected

parties5%

Retailinvestors

23%

Institutionalinvestors

72%


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Figure [28]: JKH Corporate Holding Structure

Source: JKH, subsidiaries

Lanka Marine Services (99.4%) - oil bunkering

South Asia Gateway Terminals (SAGT) (42.2%) - containerhandling

John Keells Residential Properties (Pvt) Ltd. (100%)OnThree20 (apartments)

Asian Hotels and Properties PLC (property development)(78.6%) - Crescat Boulevard (mall and apartments), the

Emperor and Monarch (apartments)

John Keells Properties Ja-ela (Pvt) Ltd. (100%) - K-Zonemall

John Keells Computer Services (Pvt) Ltd. (100%)

InfoMate (Pvt) Ltd. (100%)

John Keells Office Automation (Pvt) Ltd. (100%)

John Keells BPO Solutions Lanka (Pvt) Ltd. (100%)

John KeellsHoldings PLC

Transportation

Leisure

Property

FinancialServices

CF&R

IT Services

Keells Food Products PLC (89.7%) - frozen/processed

JayKay Marketing Services (Pvt) Ltd. (81.4%) - KeellsSuper retail outlets

Ceylon Cold Stores PLC (81.4%) - Elephant Housebranded ice-cream and soft drinks

John Keells Stock Brokers (Pvt) Ltd. (90.0%)

Union Assurance PLC (95.7%)

Nations Trust Bank PLC (29.9%)

Asian Hotels and Properties PLC (78.6%) - CinnamonGrand

Trans Asia Hotels PLC (82.7%) - Cinnamon Lakeside

John Keells Hotels PLC (80.3%) - Sri Lankan and MaldivianResorts

Keells Hotel Management Services Ltd (100%)

Other


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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 60,500 77,690 85,557 96,514 105,079 110,876EBITDA 6,587 10,241 12,375 13,435 14,845 15,051

Total segmental results 4,887 8,378 10,125 10,304 11,403 11,507

Interest expense (796) (1,416) (1,081) (1,179) (1,228) (1,203)

Associate/JV income/(expense) 2,641 2,765 3,369 3,267 3,362 3,691

Earnings before tax (EBT) 10,161 11,407 13,765 16,642 17,837 18,345

Net profit 7,980 8,880 11,047 12,396 13,413 14,893

BALANCE SHEET 2011 2012 2013 2014E 2015E 2016E

(As at 31 March)

Current assets

Cash and cash equivalents 2,113 4,267 3,555 4,590 5,144 5,658

Short-term investments 16,952 24,847 26,586 26,586 26,586 26,586

Accounts receivable 8,982 11,347 12,775 8,854 9,606 9,536

Inventories 3,153 4,350 3,999 4,818 5,293 5,751

Total current assets 34,198 47,746 50,018 47,951 49,732 50,634

Non-current assets

Property, plant and equipment 28,628 34,290 49,273 52,088 55,297 59,176

Leasehold property 9,512 10,278 9,514 9,049 8,607 8,178

Investments in associates/JVs 14,692 15,654 15,724 16,331 17,068 17,971

Total non-current assets 76,596 86,712 109,100 121,047 131,543 141,913

Total assets 110,794 134,458 159,118 168,998 181,275 192,548

Curren t liabil it ies

Short-term debt 6,334 7,833 8,259 7,110 7,146 6,551

Accounts payable 11,114 14,875 14,608 15,442 16,258 16,080

Income tax payable 792 823 981 981 981 981

Total current liabilities 19,494 24,468 25,499 25,184 26,036 25,263

Non-current l iabi l i t ies

Long-term debt 8,275 12,221 11,858 12,104 12,814 13,619

Post-retirement benefit obligation 1,216 1,372 1,385 1,385 1,385 1,385

Total non-current liabilities 23,552 29,788 32,434 32,680 33,390 34,195

Equity

Common share capital 24,612 25,111 26,480 26,480 26,480 26,480

Retained profit 25,296 33,001 42,704 51,382 60,770 71,195

Minority interest 7,642 8,863 11,366 12,637 13,964 14,780

Total equity 67,748 80,201 101,185 111,133 121,849 133,090

Total liabilities and equity 110,794 134,458 159,118 168,998 181,275 192,548


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


Operat ing act iv i t ies

Net cash flow from operating activities 8,501 16,476 14,723 19,917 16,964 17,013

Invest ing act iv i t ies

Purchase of PPE and intangible assets (5,093) (5,522) (5,237) (5,471) (6,201) (7,011)

Dividends received from associates/JVs NA NA NA 2,661 2,625 2,789

Net cash flow from investing activities (4,469) (9,003) (16,354) (11,811) (10,577) (10,222)

Financing act iv i t ies

Debt issuance/(repayment) (5,371) 1,747 221 (903) 746 210

Common share issuance/(repurchase) 1,289 499 1,370 - - -

Interest paid (796) (1,416) (1,081) (1,179) (1,228) (1,203)

Dividends paid to common shareholders (2,488) (2,314) (2,982) (3,719) (4,024) (4,468)

Net cash flow from financing activities (6,791) 496 (1,320) (7,071) (5,833) (6,276)

Net increase/(decrease) in cash and cash equivalents (2,758) 7,970 (2,950) 1,035 554 514

Note: In this case Interest paid in the Cash Flow Statement is equal to the interest expense on the Income Statement

Key ratios

2011 2012 2013 2014E 2015E 2016EGrowth

Revenue growth (%) 26.1 28.4 10.1 12.8 8.9 5.5

EBITDA growth (%) 32.5 55.5 20.8 8.6 10.5 1.4

EBT growth (%) 55.4 12.3 20.7 20.9 7.2 2.8

Net profit growth (%) 53.4 11.3 24.4 12.2 8.2 11.0

Recurrent diluted EPS growth (%) 49.5 (16.7) 22.8 12.4 8.2 11.0

Margins

EBITDA margin (%) 10.9 13.2 14.5 13.9 14.1 13.6

EBT margin (%) 16.8 14.7 16.1 17.2 17.0 16.5

Net profit margin (%) 13.2 11.4 12.9 12.8 12.8 13.4

ROCE (%) 2.7 6.0 4.8 8.2 8.4 7.8

ROE (%) 14.5 13.5 13.7 13.2 13.0 13.2

Liquid i ty and eff ic iency

Current ratio (x) 1.8 2.0 2.0 1.9 1.9 2.0

Total asset turnover (x) 0.5 0.6 0.5 0.6 0.6 0.6

Gearing and cash Flow

Debt/Capital (%) 17.7 20.0 16.6 14.7 14.1 13.2

Interest cover (x) 6.1 5.9 9.4 8.7 9.3 9.6

Free cash flow (FCF) yield (%) 1.9 6.3 4.5 6.9 5.1 4.8

Net debt/FCF (x) (1.3) (0.8) (1.1) (0.8) (1.1) (1.2)

Valuat ion

P/E (x) 21.6 17.9 19.2 16.7 15.4 13.9

P/BV (x) 3.0 2.4 2.3 2.1 1.9 1.8

EV/Sales (x) 3.0 2.2 2.5 2.2 2.0 1.9

EV/EBITDA (x) 27.5 16.9 17.1 15.4 14.0 13.8EV/FCF (x) 53.1 15.8 22.3 14.7 19.7 21.2

Dividend yield (%) 1.1 1.5 1.4 1.8 2.0 1.8

Dividend cover (x) 4.3 3.5 3.7 3.2 3.2 3.9


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

Recurrent basic EPS (LKR) 12.8 10.6 13.0 14.6 15.8 17.5

Recurrent diluted EPS (LKR) 12.6 10.5 12.9 14.5 15.7 17.4

Common dividend per share (LKR) 3.0 3.0 3.5 4.6 4.9 4.5

Book value per share (BVPS) 94.8 84.2 104.6 115.0 126.0 138.2

Net operating cash flow per share 13.4 19.5 17.2 23.2 19.8 19.9

Net cash flow per share (4.4) 9.4 (3.4) 1.2 0.6 0.6


Segmental summary


Transportation 2011 2012 2013 2014E 2015E 2016E

Revenue 13,426 18,816 19,784 20,683 21,623 22,606

EBITDA 939 901 1,074 1,039 1,086 1,184

EBIT 801 795 972 988 1,033 1,130

YoY growth

Revenue 41.4% 40.2% 5.1% 4.5% 4.5% 4.5%

EBITDA 164.8% -4.0% 19.1% -3.2% 4.5% 9.1%

EBIT 243.7% -0.7% 22.3% 1.6% 4.5% 9.4%

Margins

EBITDA 7.0% 4.8% 5.4% 5.0% 5.0% 5.2%

EBIT 6.0% 4.2% 4.9% 4.8% 4.8% 5.0%

Leisure 2011 2012 2013 2014E 2015E 2016E

Revenue 13,810 17,469 20,672 22,415 24,092 25,724

EBITDA 3,782 5,291 6,680 7,012 7,962 8,572

EBIT 2,570 3,930 4,923 5,301 6,016 6,558

YoY growth

Revenue 20.1% 26.5% 18.3% 8.4% 7.5% 6.8%

EBITDA 48.5% 39.9% 26.2% 5.0% 13.5% 7.7%

EBIT 73.0% 52.9% 25.3% 7.7% 13.5% 9.0%

Margins

EBITDA 27.4% 30.3% 32.3% 31.3% 33.0% 33.3%

EBIT 18.6% 22.5% 23.8% 23.6% 25.0% 25.5%

Property 2011 2012 2013 2014E 2015E 2016E

Revenue 2,494 4,033 3,441 5,715 6,889 4,529

EBITDA 1,542 2,074 1,748 2,449 2,766 1,740

EBIT 1,531 2,063 1,730 2,428 2,745 1,721

YoY growth

Revenue 53.9% 61.8% -14.7% 66.1% 20.6% -34.3%

EBITDA 309.3% 34.5% -15.7% 40.1% 13.0% -37.1%

EBIT 318.3% 34.8% -16.1% 40.3% 13.1% -37.3%

Margins

EBITDA 61.8% 51.4% 50.8% 42.8% 40.2% 38.4%

EBIT 61.4% 51.2% 50.3% 42.5% 39.9% 38.0%


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Consumer food and retail 2011 2012 2013 2014E 2015E 2016E

Revenue 18,358 22,047 24,423 28,297 31,650 35,386

EBITDA 1,123 1,876 1,427 1,899 1,957 2,138

EBIT 683 1,318 758 1,074 1,083 1,207

YoY growth

Revenue 15.9% 20.1% 10.8% 15.9% 11.9% 11.8%

EBITDA 40.3% 67.0% -23.9% 33.1% 3.0% 9.3%

E

jkh initiation report july 10 2013

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