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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 Conglomerate John Keells Holdings (JKH), Sri Lanka’s largest conglomerate, accounts for over 9.0% of the Colombo Stock Exchange’s (CSE) total market capitalization. Its businesses encompass consumer food and retail (CF&R), hotels, oil bunkering and containers, property development, finance and IT services. We forecast that JKH will post a revenue CAGR of 9.0% over FY14E-FY16E, while its EBITDA margin should remain roughly stable around 13.9%. This relatively slow growth trajectory reflects management’s cautious approach towards investment and expansion, and implies that JKH may face challenges in maintaining its market position in some segments. However, it is encouraging that the company is focused on generating shareholder value and unwilling to pursue growth at the expense of margins. Our DCF/SOTP valuation analysis and P/E analysis suggest a valuation range of LKR218-292, compared with the share price of LKR242 as of 9 July 2013 (see page 14 for a detailed explanation of our valuation methodology).

JKH’s revenue will likely grow at a 9.0% CAGR through FY16E. We expect JKH’s

top-line growth to be driven primarily by the leisure segment, which is primarily made up of hotels in Sri Lanka and the Maldives. Growth of 400bps in occupancy rates and a 5.2% CAGR in average room rates over FY14E-FY16E should bolster the top line. We forecast that revenue at JKH’s CF&R segment, will post a 13.2% CAGR through FY16E, boosting the company’s overall revenue growth. JKH’s transportation business should grow in the low single digits, but continue to account for a large portion of total revenue.

We estimate that the EBITDA margin will remain around 13.9%. Due to JKH’s

highly diversified nature, growth in one segment is often offset by weakness in other areas. 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 can be high) continues to be volatile. JKH’s real estate development efforts should boost margins in the coming years as revenues from apartments sold are recognized. However, the business’s relatively small size limits its overall impact. During FY14E-FY16E, cost containment efforts in the leisure segment should broadly support margins. If JKH’s upbeat plans for its supermarkets are achieved, the CF&R segment – where we currently forecast an EBITDA margin of just above 6.0% – may have some scope to surprise to the upside.

A cash cushion and low leverage could allow for growth. Management has not

demonstrated a strong interest in pursuing acquisition-driven growth, and it has been cautious in allocating capital to cultivate organic growth. JKH’s strong cash (and cash equivalents) 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 more assertive. Also, the company’s large land bank – which accounts for 6% of our estimate of JKH’s valuation – may allow for some additional upside, depending on its end use (see page 18 for arenas where JKH may surprise to the upside).

We establish a valuation range of LKR218-292, compared with the current share price of LKR242. JKH trades at an FY14E P/E of 16.7x, a premium to its

peers. This valuation premium stems from a share liquidity premium and the perception that the company is one of the most transparent and shareholder friendly entities in Sri Lanka. That JKH is not controlled by a single shareholder (unlike many other locally listed conglomerates), also contributes to its valuation premium. In coming quarters, we will be closely tracking the performance of JKH across a number of key areas and will be updating our valuation range in future earnings updates (see page 21 for key areas).

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)

JKH.N0000/JKH SL

LKR242

857

1,587

1,597

88%

LKR297/177

594,720

1,054

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

JKH -2% 8% 32%

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 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

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150%

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

John Keells Holdings PLC

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Table of Contents

JKH’s 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 segment’s revenue CAGR of 13.2% over FY14E-FY16E ......................... 5 JKH’s 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 JKH’s margins .................................................................................................. 9 High – though volatile – property segment margins should support overall margins ............................................................................ 9 Some possibility for upside margin surprise from CF&R segment ...................................................................................................... 10

JKH’s large cash position, low debt and land bank support balance sheet strength ......................................................... 12

Strong cash position and low gearing to allow investments ................................................................................................................ 12 JKH’s large land bank may be a source of further value for JKH........................................................................................................ 12

We establish a valuation range for JKH shares of LKR218-292 ........................................................................................ 14

DCF/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

JKH’s 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 Porter’s framework ................................................................................................... 33

Food and beverage manufacturing ..................................................................................................................................................... 33 Organized food retail .......................................................................................................................................................................... 34 Hotels ................................................................................................................................................................................................. 36 Oil bunkering ...................................................................................................................................................................................... 37 Container handling ............................................................................................................................................................................. 39 Property (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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JKH’s revenue to post a 9.0% CAGR over FY14E-FY16E

We expect JKH’s revenue growth to be driven primarily by the company’s leisure and consumer foods and retail (CF&R) segments. The transportation segment will remain a significant contributor to 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 JKH’s 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 segment’s revenue to post a CAGR of 7.6% over FY14E-FY16E, to reach approximately LKR26bn in FY16E. The segment’s growth should be fuelled by modestly rising occupancy 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 CAGR of 5.2% over FY14E-FY16E, would likely bolster segment growth. Industry growth in room inventory (total room inventory in Colombo is forecasted to rise by over 50% through 2015 as new hotels are opened) should serve to cap upward movement in occupancy levels and ARRs.

Figure [1]: Average room rates at JKH’s Colombo hotels to post a 6.1% CAGR over FY14E-FY16E

Figure [2]: Average room rates at JKH’s Sri Lankan resorts to post a 5.6% CAGR over FY14E-FY16E

Source: JKH, Amba estimates Note: Data excludes the upcoming business hotel

Source: JKH, Amba estimates Note: SL resorts are hotels outside Colombo

We expect the company’s room inventory (excluding the upcoming business hotel JV project with Sanken – 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 JKH’s room inventory in Colombo by 28% 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 JKH’s minority stake will not be material to the firm’s overall performance, the operation will help consolidate the company’s position in the leisure sector.

JKH has indicated that it continues to search for attractive expansion opportunities in the leisure sector, but has been unable to uncover any that meet its investment return hurdles. Although we expect JKH’s market share to decline, the company’s focus only on investment efforts that will deliver returns above its required hurdle rates reflects positively on the company’s desire to deliver shareholder value.

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JKH’s leisure segment revenue growth driven by higher occupancy and increasing room rates


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Figure [3]: JKH’s 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 estimates Note: Room inventory numbers are for the 12-month period ended 31 March of each year and exclude the business hotel

More broadly, Sri Lanka’s tourism industry faces numerous challenges that will also serve to limit JKH’s 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 Indonesia reported 8.0m visitors (up 11% YoY). Sri Lanka’s tourism infrastructure – in terms of airports, roads and transportation, and services – trails those of competitors for tourism growth. Further, minimum room rate regulations could dampen Sri Lanka’s international competitiveness. Perhaps most critically, Sri Lanka’s tourism product is at risk of pricing itself out of the market if the cost of electricity 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 threatened by political instability and regulatory uncertainty. There is a risk that the government may pass legislation (such as a recent short-lived but nevertheless worrisome ban on spas) that is contrary to the interests of the leisure industry. That the tourism industry accounts for just over a quarter of the country’s economy, though, suggests that the government – which is projecting an 8.1% CAGR in tourist arrivals over FY14E-FY16E – will likely be more cautious in its approach.

JKH’s Maldives properties account for 27% of JKH’s leisure segment revenues and 6% of overall group 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 for the tourism industry in the country.

Figure [4]: JKH’s 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 estimates Note: Room inventory numbers are for the 12-month period ended 31 March of each year

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

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500,000

1,000,000

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(40%)

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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 segment’s

revenue CAGR of 13.2% over FY14E-FY16E

We believe JKH’s CF&R segment will contribute substantially to the company’s overall revenue growth. We expect the consumer foods component (comprising ice cream, carbonated soft drinks and frozen processed/convenience foods) to post a revenue CAGR of 10.3% over FY14E-FY16E, while retail (which includes the company’s 51 supermarkets) records a 15.4% CAGR over the same period.

Both elements of the CF&R segment are driven by overall macroeconomic growth, and, more concretely, disposable income. As shown in Figure 5, JKH’s consumer foods and retail businesses both roughly track the two macroeconomic data points, with the company’s growth being substantially higher than either – a trend we forecast will continue over the coming years.

Figure [5]: JKH’s CF&R growth to outpace macroeconomic growth

Source: World Bank, Central Bank of Sri Lanka, Amba estimates Note: 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 of Sri Lanka and World Bank estimates

New product launches and closing consumption gap key to foods growth

We believe JKH’s 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 and

a soft drink flavor, along with an expanded range of sausages. The group also relaunched its premium ice cream range. In addition, JKH also recently introduced mineral water into its product portfolio.

Geographical expansion. Since launching in the Maldives over a decade ago, Elephant House

– JKH’s ice cream brand – has become the market leader. The brand was also introduced into the Middle Eastern market in FY12. Management has indicated that Elephant House may be launched in additional markets, although timing is unclear.

Additional available capacity. JKH reports that it has substantial scope to increase production

using current capacity simply by adding an additional shift. Currently, the company’s key production facilities operate on one shift. JKH also acquired a meat processing plant in FY13 to enhance its production capacity.

Closing consumption gaps. Sri Lanka’s per capita consumption of ice cream, at 1.7 liters/year,

is well above the levels of China and the Philippines. However, consumption levels – reflecting both purchasing power and consumer appetite – in nearby Malaysia and Singapore are substantially higher.

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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

YoY growth

New product development and consumption of ice cream and soft drinks should help boost CF&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 Lanka’s modern food retailing sector is attractive, with only 15% of food sold through 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 increasing disposable income is positively correlated to modern food retail market share, as consumers search for a more convenient grocery shopping experience.

JKH’s food retailing operations account for approximately 57% of the CF&R segment’s revenue (as of FY13), and roughly 16% of the company’s revenue. The company’s food retail operation is the third-largest in Sri Lanka by revenue, and the second-largest in terms of total store count, as shown in Figure 7. JKH reports that its focus will be on opening relatively large stores of 7,000 saleable sq. ft; previously, the company’s 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

JKH’s retail store expansion rate has been relatively slow, with store count increasing by two stores per annum over the past five years. After many years of being in operation, the company’s retail arm became profitable for the first time in FY12. Now that the breakeven point for the business – of around 50 stores – has been achieved, JKH should begin to reap the rewards of scalability of its food retail business.

However, management has also said that its policy is to launch food retail operations only in areas of the country that are at a sufficiently high level of disposable income. Indeed, a majority of the company’s 51 stores (as of March 2013) are in the Colombo area, which is Sri Lanka’s most affluent region. JKH’s conservative approach to store launches implicitly allows more aggressive

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Modern food retailing in Sri Lanka has significant growth potential


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

On a related front, JKH’s own internal investment return hurdles may stand in the way of any substantial 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 to achieve, given that management aims to achieve a net margin of 2% – which is unlikely to be consistent 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 new stores are launched to potentially as much as 10 units per annum. However, we are less aggressive than JKH and forecast only two new store launches per annum through FY16E.

JKH’s transportation business to grow slowly, but continue to

account for a substantial share of total revenue

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

JKH’s oil bunkering business to provide a steady revenue flow

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

Growth in the oil bunkering business is hampered by oil storage capacity at the Colombo port. The government has said it hopes to increase capacity by more than twofold. The timetable of this expansion, and how additional space would be made available, has not yet been announced. In the meantime, the only real possibility for top-line growth is via an increase in the price of oil. We assume that although the Colombo port’s oil bunkering services are operating at capacity, intense competition 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 segment’s revenues. However, while Sri Lanka is in a geographically strong 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 infrastructure investment in Sri Lanka – may threaten the position of the Colombo port, and JKH’s oil bunkering business. The 82,000 MT of oil storage capacity at the Hambantota port is currently under state control, and it may become an increasingly important factor as the port’s container operations evolve.

Container business faces pressure following capacity expansion at the

Colombo port

JKH’s container business entails loading and unloading container vessels at the Colombo port. Two main operators – South Asia Gateway Terminals (SAGT), in which JKH owns 42.2%, and state-owned Jaya Container Terminals (JCT) – dominate the Colombo port’s container capacity of 4.9m twenty-foot equivalent units (TEU). Currently, the government controls about 60% of total port capacity.

JKH reports that SAGT’s installed capacity of 1.3m TEU/year has been increased to 2m TEU/year thanks to the application of upgraded equipment and technology. Currently, the facility is operating at 85% capacity, and any additional increase is pending the privatization of additional area. In December 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 in capacity in July 2013, equivalent to an overall 50% increase in capacity. This sharp increase in total port capacity should pressure pricing as the new market entrant carves out its customer base. It will

JKH’s own investment return hurdles may stand in the way of any substantial acceleration in store openings

JKH’s transport segment provides a steady revenue flow, although growth prospects are limited by constraints


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likely also defer any additional privatization of space. Therefore, we believe SAGT’s growth prospects, 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 estimates Note: TEU = twenty-foot equivalent units

Financial services, IT and other segments to make a small

contribution to top-line growth

In our view, JKH’s financial services, IT and other segments (which include produce broking and warehousing, and other real estate operations) will post a combined revenue CAGR of 9.3% over FY14E-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 JKH’s insurance operations will grow roughly in line with GDP.

While there is a clear growth opportunity in Sri Lanka’s insurance industry, as disposable income rises and the outlook of consumers becomes more long term in nature, the market is also highly competitive. As a mid-tier player, Union Assurance (UAL) – in which JKH holds a 96% stake – is subject to pricing pressure from larger competitors. We estimate UAL’s book value 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 in a fast-growing sector that is dominated by state-controlled and some of the large private commerical banks. We forecast NTB’s value generation into our SOTP using a P/BV multiple valuing 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 financial services segment’s revenue in FY13. Overall low trading volumes, an over-broked market, weak stock market performance and declining commissions all contribute to mixed prospects for JKH’s stockbroking activities.

IT: JKH offers a niche product in the IT segment. We believe that the business does not appear to be a major priority; additionally, heavy competition – particularly from India – exerts downward pressure on pricing. We forecast top-line growth to be around 10%.

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Insurance, banking and IT will also contribute to the top line


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EBITDA margin to remain roughly flat at around 13.9%

during FY14E-FY16E

We expect JKH’s EBITDA margin to be roughly flat during the forecast period as weaker segments drag down those that we believe will post EBITDA margin growth. Some of the key dynamics of this process 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 JKH’s margins

We expect the leisure segment’s higher revenue and internal operational efficiencies to lead to a 100bps increase in the EBITDA margin to 33.3% in FY16E – in the context of a firm-wide EBITDA margin of 14.5% in FY13 and 13.6% in FY16E. This relatively modest increase is still significant in light of the sector’s intensifying competition and cost pressures.

Broadly speaking, variable costs in the hotel sector are relatively low, and hotels hold high operating leverage. Fixed costs are driven by electricity, staff salaries and lease rentals, which together 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 JKH’s leisure segment) to increase rapidly, as competition for qualified personnel mounts. Additionally, the Sri Lankan government has held discussions on implementing an across-the-board wage hike for the country’s tourism industry. However no firm proposals have yet been made on this front.

High – though volatile – property segment margins should support

overall margins

Top-line growth in the property segment is derived primarily from apartment sales and ongoing property rentals. The segment’s EBITDA margins fluctuate sharply depending on the timing of apartment sales, which command significantly higher margins than rentals. The company receives 10-20% of revenues at the time of sale, with the balance being payable by the customer based on the proportion of project completion.

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Margin

EBITDA margin (JKH) EBITDA margin (Leisure) EBITDA margin (Property)

EBITDA margin (CF&R) EBITDA margin (Transport) EBITDA margin (Financial Services)

Weaker segments drag down those that we believe will post EBITDA margin growth

Competition, escalating costs (led by rising labor costs) could pressure leisure segment margins


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Figure [10]: Property segment’s EBITDA margin significantly higher than the group’s

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

JKH’s 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 to profitability; for example, the property segment’s contribution to the company’s EBIT more than doubled to 25.8% in FY11. We anticipate a solid contribution from the property segment during the forecast period following the completion of the OnThree20 and 7

th Sense residential property

development projects. According to the company, approximately 80% of OnThree20’s apartments had been pre-sold as of March 2013. We expect almost all of the 475 apartments to be sold by project completion in December 2014, and over 90% of its revenue to be booked through the fiscal year end 2015, bolstering margins during the period.

However, visibility on future property development projects is limited. It is likely that JKH will continue 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 JKH’s announcements regarding its future plans.

Colombo’s high-end residential real estate sector has witnessed strong demand over the past several years, and a large number of high-end residential real estate projects are currently in the works. This could lead to oversupply, and demand could come under pressure.

Some possibility for upside margin surprise from CF&R segment

We 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 segment’s operations that could lead to unexpectedly strong results are provided below:

Pass-through of price hikes: Management has indicated that it generally boosts prices of ice

cream and soft drinks as much as two times per year, in part to pass on to consumers increases in the cost of sugar and other inputs. The relatively low level of competition in the market – ice cream is a de facto oligopoly – means that JKH faces little resistance to increasing prices. If demand continues to be robust, JKH could push through higher price hikes to 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 the company’s efforts to increase the share of private-label goods on the shelves of its Keells supermarkets move faster than anticipated, margins could surprise on the upside.

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JKH group EBITDA margin Property segment EBITDA margin

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Sense, two of the on-going real estate development projects, will contribute to group EBITDA margins through FY16E

An increased mix of private label products could result in a margin surprise from CF&R


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

Source: Amba estimates

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JKH’s 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 approximately 19% of total assets, or 15% of market capitalization. The company also has been able to generate strong free cash flow balances and gearing has continuously been below 30%. This indicates that the company has remained largely a self-financed business, in relation to its local peers, with minimal support from external financial institutions. JKH’s cash position also places it at a considerable 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, Bloomberg Note: All data as of FY13

Therefore, JKH’s strong liquidity and the option of raising further debt financing open up opportunities 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 steady deterioration in market share in some of the company’s segments.

JKH’s 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 estate within and out of Colombo. A significant proportion of this land is included under PPE on the group balance sheet, and has been valued as of 31 March 2013. In the figure below, we present our estimations of the dormant land bank, and these are based on our discussions with JKH and the company’s 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

JKH’s cautious approach to investment could dampen growth opportunities


13


Figure [13]: JKH’s dormant land bank estimated at LKR11.6bn

Location Acreage

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 JKH’s land bank at its market value, as reported by JKH. The land bank accounts for roughly 6% of our forecast SOTP valuation.


14


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 of LKR218-292 per share, compared with the current share price of LKR242 as of 9 July 2013. We arrive 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 JKH’s valuation levels relative to a group of peers. For factors that will provide an upside/downside to this stated 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 share

In valuing JKH shares, we applied a combined DCF/SOTP approach. Our base-case assumption of a 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 risk premium 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 through FY16E, and a six-year fade period thereafter.

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

We value JKH’s minority stake in SAGT (which handles containers at the Colombo port) by using Gordon’s dividend growth model.

To assess the value of JKH’s insurance operations, we applied a target P/BV valuation approach, based on comparables. We have valued UAL at 2.8x (a 5% premium to its year-end 2012 P/BV), and at a premium to its peers, as it has historically traded at high multiples relative to its peers.

We value JKH’s 29.9% stake in NTB using a target P/BV valuation approach, based on comparables. We have valued NTB at 1.4x (a 10% premium to its year-end 2012 P/BV) and at a 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 assumptions include a risk-free rate of 9.5% and a market risk premium of 5.0%


15


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

Also, we value JKH’s land bank on a standalone basis, based on the company’s valuation of market value applied to the dormant land bank and our discussions with the company (refer to Figure 13 for additional details on how we value the company’s land bank).

JKH’s current capital structure comprises 17% debt and 83% equity. We have assumed a balanced 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 company’s key segments. For each segment 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 as of FY22E.

Finally, we arrived at our segmental EV by discounting the unleveraged FCF values over the explicit 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

WACC assumptions

FY14E

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 assumptions

FY14E






WACC 11.5%

Consumer food and retail

WACC assumptions

FY14E


Cost of equity 14.0% FCF 148




WACC 11.3%

We assume a 50/50 target capital structure


16


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

50/50

IT segment – valued on an EV/Sales basis

FY14E

Revenue 7,478

EV/Sales – peer average 2.00

EV 14,957

Others

WACC assumptions

FY14E

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 estimates Note: 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 JKH’s 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 be LKR243 per share; correspondingly, if the market risk premium increases to 6.0%, the SOTP value would be LKR218 per share.


17


Figure [17]: Sensitivity analysis schedule

Risk-free rate

8.5% 9.0% 9.5% 10.0% 10.5%

Market risk

premium

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 estimates Note: 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

JKH’s 12-month forward P/E has ranged from 13.0x to 30.2x since April 2010. The share’s 12-month historical forward P/E averaged 19.2x during this period. The stock currently trades at 16.7x its 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, a 15% discount to its recent historical average. As growth slows, JKH’s shares may trade at a lower multiple. During FY09-FY13, the company’s revenue posted a CAGR of 15.4%, and EBITDA 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 FY14E diluted 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 management’s approach – particularly in contrast to the less-disciplined investment strategies of some other domestic 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 recent historical average. This premium is also on account of the highly anticipated Glennie Street mega development project implying a 20.2x P/E multiple. Applied to our forecast of FY14E diluted EPS, this leads to a share price level of LKR292 per share.

75

125

175

225

275

325

375

425

Ap

r-10

Ap

r-11

Ap

r-12

Ap

r-13

LKR

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

JKH currently trades at 16.7x its 12-month forward EPS; we forecast a conservative scenario with a 15% discount to the recent historical average, and an optimistic scenario with a 5% premium to the recent historical average


18


Where is additional potential upside?

Our modeling of JKH’s 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-acre plot at Glennie Street, could boost JKH’s share price. Although JKH remains silent on plans for this 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 storage capacity, this would add to top- and bottom-line growth.

Land bank: We estimate that JKH’s land bank is worth approximately LKR11.6bn (see Figure 13), equivalent to 6% of the per share value we ascribe to the stock in our DCF/SOTP valuation. 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 Merchants Holdings, there are two other terminals with a cumulative container handling capacity of 5m TEU. If SAGT is able to secure some part of this new capacity, it would add to bottom-line growth.

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

There is also some scope for negative surprises that could pressure our valuation range. There could be delays to JKH’s property development projects, and rapidly growing supply of high-end apartments could outstrip demand, forcing JKH to cut prices. Weakness in tourist arrivals, and an excess of new room inventory could hurt ARR growth and occupancy rates. Additionally, there is some risk that the company’s food retail operations disappoint, and continue to pressure overall company margins. Further, capacity constraint issues in the transport segment could also threaten share performance.

Direct comparison with peers may not be relevant to our valuation

Figure 19 presents JKH’s valuation metrics relative to its peers. JKH trades at a premium to the average of its peers based on P/E valuation metrics. The shares are trading at an FY14E P/E of 16.7x, at a 23% premium to its peer group average.

Additional valuation upside is possible from the real estate development segment


19


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 estimates Note: JKH 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. But while the companies in the figure above 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

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


20


Figure [20]: JKH outperforms the S&P SL 20 and drives the ASPI


As shown in the figure below, JKH has outperformed the indices over a range of recent time periods.

Figure [21]: JKH vs. key indices

3m 6m 1 year 2 year 3 year

JKH -2% 8% 32% 15% 59%

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

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


150175200225250275300

2,500

3,500

4,500

5,500

6,500

7,500

7/1

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010

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8/1

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1/1

0/2

013

6/1

0/2

013

Share price (LKR) Index values

ASPI S&P SL 20 JKH


21


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 key areas 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 leverage would be a positive signal. JKH is underleveraged, and an increase in debt would be a move toward a more efficient capital structure.

CF&R segment – food manufacturing

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

2. Focus on changes in market share for JKH’s soft drinks and ice cream products.

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

CF&R segment – retailing

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 achieved the required scale to become profitable, so any weakness that does not stem from one-off causes should be a source of concern.

Leisure segment

1. 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 1.0m arrivals in 2012.

2. 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.

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

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

Transportation segment – oil bunkering

1. Have there been any measures to increase storage capacity for bunker fuel at the Colombo Port, and is any further privatization of capacity planned? This could increase JKH’s current 40% market share through LMS.

2. Are there plans to privatize oil bunkering facilities at Hambantota? The country’s other major port boasts of significantly more oil bunkering capacity than the Colombo port, and its development is a government priority.

Transportation segment – container 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 transshipment businesses? 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 this year. This could lead to lower margins.

3. Has JKH’s 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 level of nearly 100%)?


22


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 (Gregory’s Road) and the proposed new mixed-use development project (Glennie Street, at the site of the JKH headquarters). The latter in particular is highly anticipated by the market but has not been factored into our current projections 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 – that would require JKH to sell down its stake in NTB to 15% (from the current 29.9%)?

2. Has there been any change in UAL’s 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 insurance industry, 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)


23


Appendix 1: Company overview

John Keells Holdings (JKH) is the largest publicly traded company on the Colombo Stock Exchange (CSE), with a market capitalization of LKR207bn (USD1.6bn) as of 9 July 2013. JKH’s FY13 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 various businesses as management strategies and economic climates changed. The company currently operates in six segments: consumer food and retail (CF&R), leisure, transportation, property development, financial services, information technology and a handful of other small businesses. The CF&R, leisure, and transport segments are the largest contributors to the company’s top and bottom lines, together bringing in approximately 76% of revenue and over 70% of EBITDA in FY13.

Amongst Sri Lanka’s large conglomerates, JKH is unusual in that a single large shareholder does not control a majority stake. This has bolstered the company’s reputation for relatively high levels of transparency and strong corporate governance. It has also helped boost the share liquidity of the stock, which has an average daily trading volume of approximately 595,000 shares, or an average annual daily turnover of approximately USD1m (July 10 2012 to July 9 2013). Also, JKH is the only Sri 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 generate approximately 76% of JKH revenues in FY13

Figure [23]: Leisure, property and CF&R remain the largest annual 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 group generated 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


24


JKH’s key businesses

The CF&R segment – the largest contributor to JKH’s top line (29% of FY13 revenues) – engages

in manufacturing beverages (carbonated soft drinks), frozen confectionary (ice cream) and convenience foods. It also operates a chain of supermarkets. The segment’s activities are as follows:

Ice cream and soft drinks – JKH’s Ceylon Cold Stores (CCS) subsidiary produces soft drinks and 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 the Maldives over the past decade and expanded into Kuwait in FY12. The consumer foods business 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 foods – The company’s Keells Food Products (KFP) subsidiary manufactures and sells processed meat products (under the Keells, Krest and Elephant House brands) locally. The subsidiary’s products are also sold in the Maldives, India and the UAE.

Retail – JayKay Marketing Services (JMS) owns and operates the Keells Super chain of supermarkets, with 51 outlets island-wide (as of March 2013). This includes 45 Keells Super and 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 of March 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-Zone malls. Retail net margins are low, at around 1-2%.

JKH’s 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 company’s destination management arm.

Colombo city hotels – Cinnamon Grand and Cinnamon Lakeside are the two five-star hotels located in Colombo, accounting for approximately 35% of five-star room inventory in the capital. 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) and holds 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 USD95-110 per day.

Maldivian resorts – Comprising three hotels in the Maldives, this part of the business posts occupancy 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-FY13

Source: JKH Source: JKH

(5%)

0%

5%

10%

15%

20%

25%

30%

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000


YoY growth

LKRm

Revenues (LHS) YoY growth (RHS)

(40%)

(20%)

0%

20%

40%

60%

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000


YoY growth LKRm

EBITDA (LHS) YoY growth (RHS)


25


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

Destination management and tour operations – JKH operates services in Sri Lanka and India through its wholly owned subsidiaries Walkers Tours and Whittall Boustead (in Sri Lanka) and Serene Holidays (in India). Walkers Tours is one of the leading destination management companies in Sri Lanka. The leisure segment relies heavily on these operators to draw tourists to the group’s hotels.

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

The company’s transportation segment (23% of FY13 group revenues) focuses on oil bunkering

and container handling services.

Oil bunkering – Lanka Marine Services (LMS), JKH’s oil bunkering subsidiary, imports oil and supplies different grades of bunker fuel to vessels calling in at the Colombo port. A majority of these vessels are container ships, docking in for transshipment (which is the shipment of goods or containers to an intermediate destination, from where it is then taken onto its final destination).

While there are 10 licensed bunker operators at the Colombo port, the business is dominated by 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 Lanka’s only privately owned container handling operator at the Colombo port. SAGT derives its revenue primarily through the loading and unloading of container vessels that arrive at the Colombo port for transshipment. It also handles domestic containers, although this accounts for approximately 20% of throughput volumes. Revenue from domestic operations came in at approximately USD110-115 per box, while for transshipments, it was much more competitive at USD20-25 per box. SAGT, which has a market share of 40% (in terms of volumes), 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 high

margins. 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 segment’s 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. ft complex that recently commenced operations. Almost 90% of the mall’s gross leasable area (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 by December 2014. The company reports that 80% of the units had already been sold as of March 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 is pricing the 2,000 sq. ft units at a super-premium level, and reports that one-third of the units have been reserved.

Mixed-use development project – We do not factor into our valuation a long-rumored mixed-use development project on the premises of JKH’s 12.5-acre Glennie Street property (which currently houses the company headquarters) in Colombo city. The development would reportedly include hundreds of hotel rooms, a shopping complex, a commercial complex and serviced apartments. Due to the lack of available details and the


26


highly prospective (and speculative) nature of the development, this project is not reflected on 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 Lanka’s leading insurance companies (offering both life and non-life insurance products). UAL is the fourth-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 to sell 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 share broking services.

JKH’s 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 phones in 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 an ROE 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 invest in developing different businesses. Maintaining a strong investment discipline and focusing on returns, rather than market share, is laudable. However, it may over time threaten to erode the company’s position in a number of arenas.

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

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

The company’s quarterly disclosure levels – regarding capex, working capital, depreciation and other granular details on a segment level – are uneven, and an analyst seeking to value the company must frequently make broad and tenuous assumptions regarding JKH’s historical (and forecast) performance on a range of factors. Expanding disclosure in quarterly announcements would be a significant improvement.

We believe that JKH should produce investor presentations, listing the company’s overall strategy and business approach and make these available on its website. This would help potential investors to better understand company performance and direction.

Shareholding structure

International investors hold over 65% of JKH’s shares and institutional investors (both domestic and international) hold over 70% overall. Management controls 5% of the company. Unlike many other 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 less

than 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, Malaysia’s 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, JKH’s 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. Director

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 apparel

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 and connected

parties 5%

Other domestic investors

28% International

investors 67%

Mgmt and connected

parties 5%

Retail investors

23%

Institutional investors

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%) - container handling

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-Zone mall

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%)


Transportation

Leisure

Property

Financial Services

CF&R

IT Services

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

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

Ceylon Cold Stores PLC (81.4%) - Elephant House branded 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%) - Cinnamon Grand

Trans Asia Hotels PLC (82.7%) - Cinnamon Lakeside

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

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 96,514 105,079 110,876

EBITDA 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

Current liabilities

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 liabilities

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


Operating activities

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

Investing activities

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 activities

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 2016E

Growth

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

Liquidity and efficiency

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)

Valuation

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 13.8

EV/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%

EBIT 62.8% 92.9% -42.5% 41.7% 0.9% 11.4%

Margins

EBITDA 6.1% 8.5% 5.8% 6.7% 6.2% 6.0%

EBIT 3.7% 6.0% 3.1% 3.8% 3.4% 3.4%

Financial Services 2011 2012 2013 2014E 2015E 2016E

Revenue 6,484 8,015 8,701 9,949 10,432 11,121

EBITDA 1,009 1,375 902 964 1,003 1,399

EBIT 707 1,051 566 775 813 1,207

YoY growth

Revenue 23.2% 23.6% 8.6% 14.3% 4.9% 6.6%

EBITDA 42.1% 36.2% -34.4% 9.1% 4.0% 39.5%

EBIT 62.3% 48.8% -46.1% 41.3% 4.9% 48.5%

Margins

EBITDA 15.6% 17.2% 10.4% 9.7% 9.6% 12.6%

EBIT 10.9% 13.1% 6.5% 7.8% 7.8% 10.9%


Note: Segmental EBIT has been calculated after incorporating eliminations/adjustments and using Amba estimates for segmental overheads

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

Y/E 31 March 2012 = 112.64

Y/E 31 March 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 industries in which JKH operates.

Food and beverage manufacturing

Conclusion: The industry should remain attractive through 2016.

Sri Lanka’s food and beverage manufacturing industry comprises branded F&B manufacturers, such as Keells, Cargill’s, Nestle and Unilever. The customer base includes distributors, comprising large organized retailers, small local grocery stores/retailers and markets across Sri Lanka.

The sector should hold substantial opportunities for firms to increase volumes and revenues. The industry will likely continue to be competitive, with key players constantly focusing on maintaining brand equity through innovation and product differentiation. Positive industry dynamics, such as rising per capita GDP, a growing middle-class population, strong brand awareness and the government’s efforts to promote the domestic F&B sector, are expected to stimulate industry demand.

The industry’s attractiveness also means that there is the threat of new entrants. The strong market positions of incumbent producers in the sector, and the economies of scale and lower costs of production they enjoy relative to both smaller local competitors as well as international F&B companies contemplating entering the Sri Lankan market, somewhat diminish this risk, however.

Threat of new entrants – moderate.

There are a few large established F&B manufacturers in Sri Lanka who mostly produce their own label/branded products in large quantities and enjoy economies of scale and other cost advantages. Differentiation occurs through product variations (flavors, package sizes, etc.) and branding. Customer (retailer) brand loyalty is high – in the case of smaller retail customers, they may be compelled to stock these large local brands to attract customers, and in the case of larger organized retail customers such as Keells and Cargills, they would give preference to their own manufactured brands within the product ranges that they offer (e.g., ice-creams and soft drinks). Even though raw materials are easily available, a new entrant would have to incur high initial capital expenditure to set up a manufacturing facility, or else import goods for sale – but would be forced to sell at relatively higher prices as a result. Further, establishing a distribution network would be difficult as a majority of the large locally established F&B manufacturers have their own retail distribution networks, or have tied up with other large organized and smaller local retailers to sell their products.

Barriers to exit– moderate.

Although firms in the industry use specialized processes to automate their manufacturing, potential buyers are ready to take over should they choose to exit. However, a large F&B manufacturing firm should consider the impact to its business before making such a decision as there is a high level of strategic interrelationship with its retail lines of business, and an exit could have a significant one-off impact on the organization.

Rivalry amongst competitors - moderate.

A few large firms (Keells, Cargills and Nestle) dominate the F&B manufacturing industry in Sri Lanka. With anticipated increases in per capita GDP and consumer demands for a more convenient lifestyle, the demand for branded, high-quality F&B products should increase. High levels of product and brand differentiation enable existing players to compete on a distinct basis effectively and seek opportunities to increase volumes and market share. Innovation is critical in this industry to maintain brand equity and keep customers engaged. Existing firms may also have


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the option of enhancing capacity easily without the need for additional fixed costs (by simply adding on another shift at an existing factory).

Bargaining power of buyers – high.

This analysis has been broken down to include both types of buyers:

Large organized retail buyers: high bargaining power – There are a few large organized retailers (including the manufacturers’ own distribution networks) in Sri Lanka, which account for 15% of retail trade in the country – e.g., Keells Super, Cargills, Arpico, Laugfs and Sathosa. Although they account for a smaller proportion of the customer base, they can be considered more important than the smaller retail buyers as they have more extensive distribution networks, and will therefore account for a large volume of sales to the F&B manufacturer. Buyer switching cost is low (with the exception of retailers stocking own-branded products) as these organized retailers are aware of their importance to the manufacturers. As retail margins are generally low, around 2-3%, and since they purchase in bulk, these buyers should be able to squeeze the manufacturers’ margins, indicating higher bargaining power.

Small local retail buyers: low bargaining power – Small local retailers (buyers) account for 85% of the customer base for the large F&B manufacturers. However, they have lower bargaining power because they buy in small quantities from the few large firms producing these locally branded, high-quality products (that are trusted and preferred by the local end consumer). Brand differentiation is high, which makes switching costs high, as these small local retailers may be required to stock certain brands to meet demands from their customer base. Further, these small retailers do not have much room for margin improvement as the large F&B manufacturers are in a more dominant position and will try to squeeze the margins of the smaller retailers.

Bargaining power of suppliers – low.

There are a large number of small local suppliers and a few international suppliers providing basic commodity ingredients (such as sugar and meat) to F&B manufacturers. Even though raw materials comprise over 80% of the manufacturers’ total production costs, which implies that the suppliers are a critical contributor to the F&B manufacturing industry, bargaining power of the suppliers is low as they provide undifferentiated products. This makes customer switching costs low, as these items can be obtained easily from anywhere. Suppliers are also much smaller in size and scale compared to the large F&B manufacturers, which places them in a weaker bargaining position.

Threat of substitutes – moderate.

Substitutes are available in the form of other local brands and some internationally branded items as well. However, customer switching costs may be high – smaller local substitute brands may not be well recognized and international brands may be too expensive for the end consumer, which would result in unsold inventories for retail distributors (who would consequently opt not to stock such brands). Therefore, existing branded F&B manufacturers would only be exposed to substitute brands from their direct local competitors.

Government action – favorable.

The strategic plan of the Export Development Board (a state organization dealing with the promotion and development of exports) for 2011-2015 has identified the F&B industry as one of the seven key priority sectors, with plans to grow export earnings from this sector to USD1bn by 2015 (from approximately USD284m in 2012, including tobacco exports). Therefore, there are several incentives, such as VAT exemptions on machinery and equipment and zero tax concessions on processed foods, provided to firms operating in this industry, which increases industry

attractiveness.

Organized food retail

Conclusion: The industry should remain neutral through 2016.

The organized food retail sector in Sri Lanka is dominated by a few large firms. The industry is highly competitive and still in its growth phase, with opportunities for revenue growth resulting from rising disposable income in Sri Lanka. Customers can choose whether or not to go to a retail store,


35


as most products sold are day-to-day FMCG items, for which substitutes are freely available in open-air markets or other small grocery stores. Moreover, consumers have very little brand loyalty. However, if large retail chains expand their distribution networks, manage the impact of new regulations and retain their customer base, they can generate margin growth.

Threat of new entrants – low.

Potential new entrants to Sri Lanka’s food retail industry may be attracted by low product differentiation, low customer brand loyalty, high price elasticity and, therefore, low switching costs, which make it easier to penetrate the industry and attract new customers through lower prices. However, the threat of new entrants is reduced by economies of scale enjoyed by larger, well-established retail chains that already have extensive distribution networks in place. High initial capital expenditure is also required (approximately LKR100m for a saleable area of 7,000 sq. ft.) to set up operations and find a suitable prime location. Further, recent regulations imposing a 12% VAT charge on retailers with a turnover of above LKR500m (approximately USD4m) per quarter could also discourage new entrants, as retail sector net margins are already low at 2-3%.

Barriers to exit – moderate.

The one-time exit cost may be considered moderate. Retail outlets in Sri Lanka are either owned by a company or obtained on a long-term lease. Therefore, disposing of these outlets may not be a major problem as company-owned properties are in prime locations, which are largely sought after, and any lease agreements may be terminated/revised.

Rivalry among competitors – high.

Although there are several smaller private retailers across the island, the organized retail industry consists of three main private sector FMCG retail chains – Keells, Cargills and Arpico (accounting for approximately 15% of retail trade in Sri Lanka). The industry is in its growth stage, to be driven by an expected 7.2% CAGR in per capita income over FY14E-FY16E, according to World Bank estimates. Provided that economic growth trends as projected, existing firms can benefit from incremental increases in market share through market development (opening more stores in new locations) over the medium term, as rising GDP could see more customers visiting larger retail outlets regularly. However, significantly low levels of differentiation could increase price competition and yield low margins.


The industry is home to a large number of consumers who remain extremely price conscious, despite rising GDP and the desire for a more comfortable lifestyle. They are not willing to pay significantly higher prices for products that are readily available elsewhere at a considerably lower price. The generic nature of FMCG products and the highly elastic nature of demand means there are several substitutes available and customer switching cost is extremely low, as they can easily opt not to visit a large retailer for weekly FMCG requirements. Further, based on statistics from the Central Bank of Sri Lanka (CBSL), at the end of 2011, over 40% of the average monthly household spend was on key FMCG products. This is a significant proportion of the buyer’s income, which would further increase price sensitivity.


Large retailers manufacture some of their own products. Other products come from small fragmented suppliers or larger established manufacturers. However, regardless of the size or scale of the external supplier, extensive distribution networks established by organized retailers make external suppliers fully dependent on organized retailers for business. Switching costs of large retailers are low due to the generic nature of the products, which makes them easily available. Even with branded products, suppliers are largely dependent on retailers for business, and even if large retailers choose not to stock particular brands, it would not have a significant impact on top lines, since customers are flexible and can easily choose another brand to meet their immediate needs. Cost of sales is the highest contributor to a retailer’s cost structure and since retailers face increasing margin pressure from high direct and fixed costs and their inability to increase prices, there is a constant need for cost control. Further, retailers purchase in bulk from external suppliers, accounting for a large proportion of suppliers’ revenues, which again lowers the bargaining power of supplier firms.


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Threat of substitutes – high.

The substitute to retail supermarket shopping is purchasing provisions from small local grocery stores or open-air markets. Customer switching costs are extremely low as the availability of small local vendors being widespread across Sri Lanka. Further, these small retailers maintain close relationships with customers; therefore, organized retailers are unable to command strong brand loyalty.

Government action – moderate.

Most large retailers have been able to absorb the 12% VAT charge together with their suppliers, which means customers will not face any significant price increases. There is also a recent proposal to ban foreign investments for retail trade to protect domestic investors, although further details on this regulation are not yet available. The government reserves the right to make any tax and policy amendments in most areas, without having to give any prior notice to businesses. This creates uncertainty for the industry and the impact depends on how quick the businesses are in responding to such changes.

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.


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.


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


37


offering is low, as holidays are a luxury (non-essential) expense borne by individuals, depending on their levels of disposable income.

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.


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.

Oil bunkering


The oil bunkering industry distributes imported oil as bunker fuel to ships docking at the Colombo port, where a majority of these vessels come in for transshipments (the shipment of goods or containers to an intermediate destination, from where it is taken to its final destination). The industry is dominated by three large operators in Colombo, while the oil bunkering facilities at the Hambantota port, which commenced operations in late-2012, is to remain under state control over the medium term and, hence, has been excluded from our analysis. Expansion projects at the Colombo port would lead to more intense competition, as firms fight to increase market share. Due to capacity constraints, which make the industry unattractive to new entrants, the existing key players in the industry have opportunities to increase revenues and margins moderately purely through internal and operational efficiencies, as capacity constraints are a medium-term problem within the industry. Competition is based on the speed and quality of service offerings and not so much on price and product offerings, as all firms offer an undifferentiated product. Furthermore, increased privatization of bunkering operations in Sri Lanka should be considered if overall efficiencies of the bunkering industry are to improve.

Threat of new entrants – low.

Even if new firms were to enter the industry, they would face heavy pressure from existing players, who are well-established and benefit from economies of scale. Furthermore, product differentiation levels are low, as all bunker operators store and provide the main grades of fuel oil – IFO 180cst, IFO 380cst (the two most popular intermediate fuel oils) and MGO (Marine gas oil). Although


38


bunker fuel is an essential commodity product and brand loyalty is not important (thus, customer switching costs are low), a new entrant would require access to a share of the bunker storage capacity. However, currently, there is limited installed storage capacity for a new entrant to penetrate the market.

Barriers to exit – low.

The main exit barrier would be disposing of bunker barges and fuel storage containers. However, this would not be difficult, as competitors are on the lookout for ways to increase market share and would likely purchase these assets.

Rivalry among competitors – high.

Competition stems from local firms, as well as other regional ports.

Local competition – There are 10 licensed bunker operators at the Colombo port in Sri Lanka, but the market is an oligopoly, dominated by three large operators (Lanka Maritime Services Ltd [state-owned], Lanka Marine Services [LMS; a JKH subsidiary, with JKH holding a 99% stake] and Lanka IOC PLC [LIOC])controlling over 90% of the market share in Colombo. LMS is the market leader, with approximately 45% of the market share at the Colombo port. Research by Interocean Energy (Pvt) Ltd suggests that South Asia’s container-handling volume is expected to grow at approximately 8% through 2015; this creates opportunities for existing firms to maintain and increase their market shares. All firms provide the main fuel grades and products are largely undifferentiated. Furthermore, the current bunker fuel storage capacity in Colombo is 35,000 metric tons (MT) and is close to full capacity levels. The government plans to expand this to approximately 95,000 MT over the medium term. However, there is no confirmation yet on the progress of these plans. The recently added 85,000 MT of storage capacity at the Hambantota port will remain under government control over the medium term, until the government has repaid its outstanding loans to China. Therefore, due to the commodity nature of the product and the medium-term capacity constraints, firms will compete aggressively on service quality and will have to increase internal efficiencies to achieve higher margins.

Regional competition – Local oil bunkering operators also have to deal with competition from other regional ports, such as India, Singapore and Oman. While there are several other regional firms operating in the industry, all providing an undifferentiated product, Sri Lankan bunker operators would be at a disadvantage, due to the uncompetitive pricing of their bunker fuel (all of which is imported), which is significantly higher than that of Singapore, for example.

Bargaining power of buyers – low.

The buyers consist of ships that dock at the port, mainly for transshipments, and as Colombo is a popular transshipment hub, re-fueling is essential. The key players in the local industry form an oligopoly and provide an essential commodity product, which reduces customer bargaining power. While the cost of switching between local bunker operators is low (product and price differentiation levels are low), the cost of switching to other regional suppliers may not be as low. While regional bunker operators may offer better prices, they have their limitations – e.g., India, where the depth of waters is too low for larger vessels to navigate, or Oman and Malaysia, which are too far. There are no substitutes available for bunker fuel and the product is a critical resource for the ships to continue their standard operations. Furthermore, even though bunker fuel accounts for an estimated 25-50% of the buyer’s total operating cost, buyers cannot bargain on prices, as local bunker prices are linked to global oil prices.

Bargaining power of suppliers – high.

Bunker fuel supplies are imported mainly from Singapore, UAE and India, and there are no direct substitutes for this product. Total annual oil demand in Sri Lanka is 4.8m MT (including bunker fuel) and the country is entirely dependent on imported fuel to meet this demand. Although the cost of oil makes up a large proportion of the costs for the bunker industry, there may be little room for the buyers to negotiate, as oil supplies are linked to the Platts Index, with freight and other premiums added on.

Threat of substitutes – low.

Ships currently use high-sulfur fuel oil. Presently, there are no substitutes to bunker fuel and, hence, no substitute service providers.


39



At present, most of the bunkering storage capacity in Sri Lanka (at the Colombo and Hambantota ports collectively) is under state control. Additional privatization and capacity increases should be considered to develop the industry further and strengthen competitiveness. Furthermore, a proposed ports and airports development levy (a 5% tax on bunker sales) may impact Sri Lanka’s ability to compete efficiently with other regional markets.

Container handling


We expect the container handling industry in Colombo to remain mildly attractive in the medium term driven mainly by the anticipated growth in the container handling industry in South Asia which is expected to increase by 8% on average through 2015, on the back of rising trade flows. This creates opportunities for existing firms to grow their volumes and increase revenues. Although the Colombo harbor is strategically located along the east-west trade route, and continues to be a critical transshipment hub in the region, there would be a certain degree of competition from other regional ports, as the shipping lines can decide which port to call in at for transshipment (depending on the final destination of the shipment).


The industry focuses on loading and unloading containers at the Colombo port. While there is very little service differentiation and low brand loyalty, which lowers the costs of switching to a local service provider, the cost of switching over to a new entrant will be much higher as the new player can be expected to take time to move up the experience curve. The Sri Lankan industry remains largely under government control, with 60% of the current industry capacity of 4.9m TEUs (twenty-foot equivalent units) being under state control. Capacity expansion plans are underway with the new terminal construction, but a new entrant trying to penetrate the market would first need to secure the bid to handle the new terminal. Further, the existing two main players are industry veterans, and benefit from economies of scale as throughput volumes increase. High capital expenditure would also be required to invest in the quay cranes and other heavy equipment needed to run efficient operations.

Barriers to exit– moderate.

The industry uses specialized heavy equipment and machinery, such as cranes, fork-lifts, moving trucks, etc. However, if an existing player were to exit the industry, it might not be extremely difficult to transfer ownership of operations, as there is likely to be a few bidders, given the strategic regional location of the Colombo port and the industry growth prospects. Further, if all else fails, the operations could be taken over by the government, based on their own stipulated terms and conditions.

Rivalry amongst competitors - moderate.

There are two main container handlers in Colombo: South Asia Gateway Terminals (SAGT), Sri Lanka’s only privately owned terminal; and state-owned Jaya Container Terminals (JCT). JCT handles around 60% of container operations at the Colombo Port, and therefore, the level of competition is not very intense. Research by Interocean Energy Pvt Ltd suggests that container handling volume in South Asia is expected to grow at approximately 8% through 2015 and although the service offered is largely undifferentiated, planned capacity increases will increase competition in the medium term. The new terminal construction at the Colombo port, which is expected to add approximately 2.4m TEUs (roughly 50%) to capacity by 2014, is under a Public Private Partnership (PPP) owned 85% by China Merchants Holding and the balance by the Sri Lanka Ports Authority (SLPA) on a Build-Operate-Transfer (BOT) basis. With the opening of the terminal in July 2013, competition will likely intensify amongst the existing firms as the new player struggles to win market share.

Bargaining power of buyers – moderate.

Buyers would mainly consist of the many shipping lines around the world. These vessels are dependent on the two main container handlers at the Colombo port. The only substitute to sea freight is air freight, which is too expensive and may not be practical for handling heavy containers. SAGT and JCT provide a critical, non-substitutable service to its buyers as transshipment


40


continues to dominate port activities, accounting for 80% of throughput volumes at present. Buyer switching costs may be high as other regional ports include India, where water depth is insufficient for larger vessels to navigate. Further, Indian ports are operating at near capacity levels and use Sri Lanka as its main transshipment hub. Other regional ports like Oman and Malaysia may be too far away. Therefore, although the choice of a port is largely at the customer’s discretion, they may not have very many options, which indicates low price sensitivity, and ultimately lower bargaining power.


The main supplies used in this industry would be the equipment - such as cranes, stackers, forklifts, etc. There are many international suppliers of such items, such as Mitsui, Mitsubishi, Caterpillar, etc. which offer slightly differentiated products. Despite this, the container handlers may be able to switch suppliers without too much of a problem, if industry standards are not maintained and/or they are not satisfied with the equipment quality. Therefore, supplier bargaining power is relatively low.


Shipping lines have only a few options in terms of substitutes. Air freight is an option, but is comparatively expensive. There are two main container handling operators in Colombo and apart from this; other regional ports could be used. Although the regional ports have their limitations, the choice of port by a shipping line depends largely on the final destination of the shipment, and so if deemed necessary, the customer could switch over to other regional ports.

Property (condominium development)


Condominium development in Colombo is in its growth stage. A few large, well-established firms dominate the industry, reducing the threat of new entrants. Existing players compete based on product differentiation within different niches. As consumer disposable income continues to rise (the Sri Lankan government forecasts that GDP/capita will increase 41% from 2011 levels to USD4,000 by 2016), consumers’ demands for a more comfortable lifestyle, together with low substitute availability, could increase demand for luxury apartments. In addition, favorable government legislation could encourage property developers to invest further and increase the competitiveness of the industry.


A new entrant trying to penetrate the industry would face pressure from existing, well-established property developers who enjoy economies of scale and several other advantages. Although customer brand loyalty is low, product differentiation is high, making it possible for a new player to create a niche in the industry. Recent regulations reducing the current 100% tax on land/property leases by foreign individuals (for business ventures) to less than 10% could encourage new foreign developers to enter the industry. Capital requirements, although high would not create an entry barrier as condominium units are largely pre-sold; KPMG estimates a pre-construction-to-sale ratio of 50% – creating a largely self-financed business model.

Barriers to exit – low.

The only barrier to exit would be the disposition of unsold inventory units (apartments) and construction equipment. However, the condominium market’s current growth phase and the characteristic pre-selling of many units indicate that demand is still growing and that this may not be a problem. Further, most of machines and equipment used for construction are hired out on contracts; therefore, disposing of these would not be an issue.

Rivalry amongst competitors – moderate.

There are a few large, well-established real estate developers in Sri Lanka, including JKH, Trillium Residencies, CT Properties, Overseas Realty and Fairway Residencies. These firms compete by offering highly differentiated products at low, mid, high-end, prime and luxury levels, depending on size and features. Inter-firm rivalry is not particularly strong, as each firm may focus on one or more segments within the industry. At present, there is no significant oversupply of condominium units in Sri Lanka; therefore there are opportunities for existing firms to increase capacity.


41


Bargaining power of buyers – low.

Potential home owners would constitute buyers/customers. These are affluent individuals, the ranks of whom are rising as per capita incomes increase. The relatively small number of development companies in Sri Lanka means that buyers do not have much choice. The substitute to buying a condominium unit would be to purchase a dwelling outright, or rent/lease a living space. Nevertheless, while substitutes are available, product differentiation (a condominium versus a house), along with the sunk cost involved in the down payment required to buy an apartment, makes buyer switching costs high.


Suppliers include suppliers of labor, raw materials (cement and steel), equipment, utilities (electricity and water for construction), furnishers, construction companies, contractors and architects. Most of these items are linked to commodity prices (such as cement, steel, etc.) and thus prices are largely driven by external factors. The large number of suppliers drives high price competition and reduces bargaining power. While there is a shortage of labor with the necessary skills, workers can be brought in from abroad, which reduces the scope for workers to demand higher wages. While condominium developers may maintain long-term relationships with suppliers, suppliers are heavily dependent on condominium developers for business due to their relatively smaller size and scale. Buyer switching costs, while not negligible, are relatively low, which reduces the bargaining power of suppliers.


The buyer’s need is a comfortable living space. The substitute to investing in a condominium would be to invest in land and construct a house or to enter into a long-term rental agreement. As such, there may be several substitutes available.

Government action – favorable.

The lowering of interest rates would make it cheaper for developers to borrow money if necessary and for customers to take out mortgages. Moreover, the reduction of the current 100% tax on foreign leasing of land/property (for business ventures) to less than 10% is also supportive of the domestic real estate industry.


42


Appendix 4: SWOT analysis

Strengths Weaknesses

Strong brand recognition

Experienced management team

Perceived as the leading blue chip company in Sri Lanka

Strong focus on delivering shareholder value

Large land bank

Strong net cash position

Low debt/equity ratio

Exposure to high-growth sectors

Excessive caution in investment in growth and acquisitions

Market share deterioration in some segments

Inadequate disclosure of segmental performance breakdown

Opportunities Threats

Strong anticipated growth in tourist visits

Container handling capacity expansion

Access to proposed increase in oil storage capacity

Rising GDP/capita and disposable income in Sri Lanka

Increased diversification into international markets

In key industry segments, more aggressive competitors are taking market share

Domestic infrastructure not up to international standards

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

Rupee appreciation could affect sectors that earn revenues in USD

Risk of political instability and social unrest


43


Appendix 5: Diversified sector overview

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

Figure 28: Top five sectors on the Colombo Stock Exchange by market capitalization

Sector name

Market cap

(USDbn)

% of total CSE

market cap Two largest companies

Banks, finance & 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 & 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


44


There are 18 listed diversified companies trading on the CSE, 13 of which are listed on the main board, while 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 29: Details of conglomerates listed on the main board of the CSE

Company name Bloomberg/CSE tickers

Market cap

(USDm)

Free float

(%) Top 3 businesses by revenue contribution

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

Food processing (consumer foods)

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

Transportation & logistics (warehousing & 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 & logistics (air and sea freight, logistics,

warehousing)

International trading and manufacturing (agricultural,

paper, plastic, metal pharmaceutical products)

Investments & 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 data as of 9 July 2013. Revenue contribution and free float is based on FY13 data.

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


45


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

Figure 30: Shareholding structures 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 31: 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


46


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

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%

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2,000

3,000

4,000

5,000

2005

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14

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2006

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47


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-13

ASPI Dow Jones FTSE 100

MSCI World DAX

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100

200

300

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

ASPI Bombay (BSE 500)

Jakarta (JCI) Philippines (PASHR)

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MSCI Emerging Market Index

1,092

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

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1,000

1,500

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2009 2010 2011 2012 2013 (June)

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48


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.

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