Sri Lanka Weekly

DNH MARKET WATCH

DNH Financial (Pvt) Ltd. www.dnhfinancial.com +94-11-5700777

17-21 October 2011

Market Performance
This Week ASPI MPI Turnover (bn) Foreign Purchases (mn) Foreign Sales (mn) Traded Companies Market PER (X) Market Cap (LKR bn) Market Cap (US$ bn) Dividend Yield (%) Price to Book (X) 6,357 5,675 4.4 425 755 253 16.35 2,283 20.6 1.66 2.07 Prv. Week 6,550 5,878 6.8 1213 621 255 16.84 2,353 21.2 1.61 2.13 WoW% -2.9 -3.5 -35.3 -65.0 21.6 -0.8 -2.9 -3.0 -3.0 3.1 -2.8

Market Indices

In the absence of any significant news, the Sri Lanka bourse continued its downward trajectory with the ASPI and MPI losing 2.9% and 3.5%WOW to close at 6357 and 5675 respectively. With the majority of investors sitting in the wings, turnover dropped to its lowest level in recent months, falling to LKR4.4 bn (35.3%WoW) with the only notable trades recorded by John Keells Holdings, Colombo Land and HVA Foods which collectively accounted for 14% of the weeks total. Global markets meanwhile traded largely lower during the week as a result of Moodys cut of Spains credit rating to A1

from Aa2 and the rating agencys warning that it may lower Frances rating amid growing eurozone debt concerns.

Gainers & Losers (%)

SMB Leasing (W 0016) Miramar Kalamazoo Ceylinco Ins. (X) Colombo Investment Trust SMB Leasing (X) Infrastructure
32.7 -25.0 -32.4 -37.5

Serendib Land -50.0

9.4 12.8 14.3

Global Markets
14-Oct 21-Oct

Interest Rates & Currencies

WoW% -2.9 -1.7 -3.9 -1.4 -1.2 -2.6 Prime Lending Rate (Avg. Weighted) Deposit Rate (Avg. Weighted) Treasury Bill Rate (360 Days) Dollar Denominated Bond Rate LKR/US$ (Selling Rate) LKR/EURO (Selling Rate)
21-Oct

Sri Lanka - ASPI India - Sensex Pakistan - KSE 100 Taiwan Weighted Singapore - Straits Times Hong Kong - Hang Seng

6550 17083 11992 7358 2744 18502

6357 16785 11525 7255 2712 18026

9.21% 6.48% 7.34% 6.25% 111.05 154.00

Market Performance
All eyes are now however focused on Sundays EU meeting as investors wait with bated breath in the hopes of securing a much needed panacea to the regions crisis. Kicking off the 3Q2011 corporate results season, Piramal Glass released its results recording a 25% jump in revenues and 54% rise in earnings on the back of increased volume growth notwithstanding relatively higher input prices. Benefiting from the robust growth in the local economy, we expect the majority of the 3Q2011 corporate results to record double digit quality earnings growth as a result of higher volumes and improved margins. While the market PE on the local bourse has been on a declining trend, we believe that the current multiple of 16X does not fully reflect the valuations of a number of fundamentally strong stocks which are trading at multiples of below 10X. With investors having pushed up the price of lower quality companies during the 2009/2010 bull run, an opportunity to invest in companies of higher fundamental value now exists with significant upside potential of reversing relative underperformance.With trading volumes showing increasing signs of declining, we believe that the market is coming close to a consolidation point before changing course to a rerating. With the majority of 3Q2011 results yet to be released, we advise investors to take advantage of this window period to select stocks that are likely to outperform based on solid intrinsic values.

Looking beyond the reported numbers While the majority of economic indicators point to a strong acceleration in the domestic economy, we attempted to defy the skeptics and look beyond the reported numbers and test out the figures once and for all. With the Sri Lankan economy growing at an amazing 8.3%, it was highly important for us to determine the extent of the trickle down effect on the masses, especially the middle income class that accounts for the majority of the population and whose consumer patterns will largely fuel future economic growth and shape its trajectory. A Random walk down Colombo We started our journey with the dine-outs. Restaurants are generally a good proxy of consumer spending and a reasonably reliable indicator of economic momentum in the country. Having stopped by several of Colombos restaurants, both fine dining and low to mid end quick service establishments, we were not surprised by our findings. Most restaurants were full, notably fine dining areas. What was interesting to note was that up to 75-90% of guests at city five star restaurants were locals indicating that disposable incomes were rising with domestic consumers clearly not in a hurry to tie up their purse strings against the backdrop of international recessionary pressures and a slowdown in global consumption.

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Market Performance (Cont...)

Checking in to hotels It is definitely encouraging to note that tourist arrivals to Sri Lanka is growing at strong double digit rates, notwithstanding a slowdown in the global travel industry and tourists becoming more value conscious with their tourist dollars. While foreign tourists have traditionally been responsible for high hotel occupancy levels, a recent development has been the increasing take up of hotel rooms by local guests, a trend that clearly reveals a specific rise in the disposable income of selected consumer segments. While this is not uncommon in the case of resort hotels which normally experience a flurry of local guests during the weekends, this appears to be a new phenomenon for the city hotels whose live-in guests have traditionally being wholly foreign visitors. Time to indulge in some luxury? While there are no prizes for guessing that vehicle sales in the country has been on the rise, indicative again of rising disposable incomes, what is interesting to note is that the majority of the increase appears to have stemmed from a rise in the luxury vehicle segment. Sales of mid end cars are rising but premium makes appear to be surging even faster. While spending on luxury goods generally reflects rising disposable incomes, most importantly however it indicates the extent of confidence in the economy, as demand for luxury goods are the first items to be affected during an economic downturn.

New Registration of Motor Vehicles

6000 5000 4000 3000 2000 1000 0

Motor Cars

Dual Purpose Vehicles

Source- DNH Research/ CBSL

The reverse generally holds true in the case of an upturn where luxury goods consumption will tend to rise ahead of the consumption of normal goods. In the case of the Sri Lankan consumer, demand for luxury brands appears to be accelerating to hitherto unseen levels indicating a firm rise in the feel good factor of domestic consumers. Is this irrational exuberance? We think not. We believe that this is the genuine beginning of a new economic cycle fueled by an expanding high spending middle class. While we certainly contend with the fact that not everyone will benefit equally from the economic upswing with income disparities widening in some segments. However, we firmly believe that the trickle down process has now begun with a strong contagion effect likely on other parts of the country sooner than later.

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Market Performance (Cont...)

Outbound not just inbound tourism is on the rise While inbound tourist traffic has clearly seen a prolific rise, outbound tourism appears to be enjoying similar growth. While we do agree that this is partly due to a general decline in the price of holiday packages, the volume of traffic nevertheless indicates that domestic consumers do have pockets deep enough to indulge in an overseas leisure experience and we expect this trend to only increase going forward. Housing approvals on the rise Notwithstanding Sri Lankas relatively high real estate and rental prices, demand for housing appears to be increasing at a significant rate. In fact, we believe that the majority of apartment complexes are enjoying close to full occupancy while significant demand is already apparent for off plan properties. With demand for quality housing outstripping supply, we expect real estate prices to gradually trend upwards commensurate with a rise in disposable incomes.

So should we buy Sri Lankan Equities? While we are justifiably convinced that the economic upturn is indeed trickling down to the masses, the question remains should we buy Sri Lankan equities? While local investors appear to be concerned over the prospect of only pedestrian returns in the stock market, we believe that such concerns may be warranted if and if only their investment style is one of a short term speculative nature. However, we believe that for those whose investment horizon is beyond the immediate term can expect to enjoy a supernormal return once the 3Q2011 results are fully factored in. Consequently, we advise investors to maintain a healthy investment horizon focusing on high quality cash rich companies with strong balance sheets that have underperformed during periods of market over-exuberance and which have the upside potential to re-rate to their intrinsic values. We expect the bourse to test the 6500 psychological resistance level next week fueled by solid corporate results from the majority of companies in our universe shrugging off the nervousness in the global markets. With local equities currently offering investors the opportunity to buy strong future growth and profits at a discounted price, we re-iterate the need to select stocks that have a business model which is largely domestically focused.

Greater Colombo Housing Approvals Index

130.0 120.0 110.0 100.0 90.0 80.0 70.0 60.0 50.0 40.0

Source- DNH Research/ CBSL

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Corporate News
Kicking off the corporate results season, Piramal Glass released its 3Q2011 results recording a 25% jump in revenues and 54% rise in earnings on the back of increased volume growth notwithstanding higher input prices during the period. Benefiting from the robust growth in the local economy, we expect the majority of the 3Q2011 corporate results releases to follow a similar trend of higher volume growth driving double digit earnings growth. In this respect, we advise investors to focus on companies with largely monopolistic attributes and brand loyalty within sectors and sub-sectors that are both growth and resilient and will be direct beneficiaries of the domestic economic upturn.

by strong macroeconomic fundamentals and a continued expansion in both the private and government sectors. With real GDP growth forecast at between 8-9% in the coming years, bank credit should grow faster enabling commercial banks to report robust interest income which will be reflected in strong earnings growth for most banks. Firm capital structures and sound leverage ratios will provide a solid foundation for growth while consumer, commercial and government related lending activities will drive sector earnings as private consumption continues to rise.

Global Outlook
Unites States On the back of the twin impact of strong 3Q2011 corporate profits combined with expectations of positive announcements from the EU summit, US equities posted its third straight week of gains with the S&P 500 up 1.1% for the week. While recent market gains have pushed the S&P 500 to the top of its trading range between 1,230 and 1,250, investors are likely to increasingly watch developments in Europe before allowing company earnings to push stocks higher. Given that US equities are currently trading at a multiple of 10-11X on 2012 earnings, the critical question is whether to selectively buy fundamentally strong stocks that are attractively valued or continue to remain on the sidelines in expectation of a bottoming out. With US equities having traditionally traded on a PE of 13-14X during a recession, current trading multiples appear increasingly

Economic News
Bank credit growth slows in July 2011 Bank credit rose by 34.1% to LKR 1.78 trillion as of Aug 2011 compared to 33.9% recorded as at July. Credit issued by domestic banks grew by 35.9% to LKR1.59 trillion while foreign banks accounted for LKR181.8 bn (+19.7%). Meanwhile, new loans generated during the first 8 months of the year recorded LKR260 bn with a significant proportion of this made to the government reflecting the heightened economic activity in the country. In Sri Lanka, credit growth is not only procyclical, but tends to grow faster than GDP during expansions and more slowly during recessions. While credit growth could see an easing off during the 4th quarter, we expect momentum to resume in 2012 underpinned

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Global Outlook
attractive for certain counters. Notwithstanding market valuations, it may take more than an attractive PE to lure investors into equities with strong positive signals from the EU Summit likely to be a deciding factor. Eurozone Eurozone equities traded with a downward bias as investors sat in the wings ahead of the EU meeting on Sunday where talks are to be held by the regions policymakers on how to contain the ongoing debt crisis. The Eurostoxx 50 consequently declined by 1.3% during the week led mainly by declines in the DAX and FTSE 100. Notwithstanding the prospect of a possible positive outcome at the EU meetings, Germany and France still appear to be at relative disagreement on how to scale up the European Financial Stability Facility and how to cut Greek debt. Europes economic rollercoaster ride meanwhile continued during the week with Moodys downgrading Spains credit rating by two notches to A1 from Aa2 followed by downgrades by S&P and Fitch. In addition, Moodys has also warned France that by backing the European rescue fund, its own credit rating could be at risk. While a positive trajectory for the markets could eventuate following Sundays EU summit announcements, the medium to longer term outlook remains merky given the highly complicated structure of the euro zone and the difficulty in swift implementation of any decisions reached.

Asia Asian equities closed the week on a neutral note ahead of the Eurozones crucial meeting on Sunday aimed at finding a solution to Europes debt crisis. Consequently, the Asia Pacific index closed marginally lower to end the week down 0.9%. Stocks suffered on Thursday in the run-up to the weekends scheduled EU summit as a barrage of conflicting headlines pointed to discord between key parties and delays in announcing a plan. Meanwhile China announced during the week that it would allow four of its local governments to begin issuing their own debt widely seen as a boost for the Chinese banking sector and the broader economy especially after Beijing released lower than expected 3Q2011 economic growth figures which showed Chinese GDP growth slowing down to 9.1% compared to market expectations of 9.2% and higher. The figures may stoke concerns that a slowdown in orders from the U.S. and Europe could be denting Chinese growth while stubbornly high inflationary figures could also pose a challenge.

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DNH TOP 30
Company CSE CODE Share Price (LKR)
Sri Lanka Telecom Lanka ORIX Leasing AHOT Properties Dialog Axiata Softlogic Holdings Colombo Fort Land & Buildings Aitken Spence John Keells Holdings Commercial Bank Hemas Holdings Hayleys Hatton National Bank Distilleries Richard Pieris Eden Hotel Lanka Nawaloka Hospitals Kotagala Plantations Asiri Hospitals DIMO Kegalle Plantations Royal Ceramics Lanka WallTile Ceylon Glass Laugfs Gas VallibelOne National Development Bank DFCC Bank Sampath Bank Ceylon Leather Ceylon Grain Elevators Expolanka Holdings SLTL LOLC AHPL DIAL SHL CFLB SPEN JKH COMB HHL HAYL HNB DIST RICH EDEN NHL KOTA ASIR DIMO KGAL RCL LWL GLAS LGL VONE NDB DFCC SAMP CLPL GRAN EXPO 50.80 84.80 85.90 8.00 19.20 53.70 126.50 195.00 108.00 35.00 367.10 187.70 162.80 10.00 39.90 4.00 80.50 9.00 1240.00 115.20 134.30 107.00 8.00 40.00 25.10 128.50 117.00 203.50 77.00 102.00 11.00

Valuation Guide
Net Profit (LKR mn)

2008
7,367 1055 623 -2879 3 717 3069 4965 4268 719 803 3219 3430 -305 311 -109 171 198 103 177 206 437 -261 229 N/A 1605 1360 1414 -24

2009
778 2,385 689 -12208 -38 50 2987 5552 4304 935 2609 4352 2136 712 498 97 323 318 278 376 711 766 -61 528 N/A 2085 1713 2098 36

2010
3,943 7,367 2148 5047 N/A 556 3428 9063 5524 1355 1216 4464 8308 2141 101 1071 668 262 2122 883 1374 909 579 1003 N/A 2150 7137 3303 107 475 1547

-53
N/A

134 518

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DNH TOP 30
EPS (LKR mn) EPS Growth (%) PE (X)

Valuation Guide
Price to Growth (X) Dividend Yield (%) Shares in issue (mn)

Market Cap (LKR bn)

2008

2009

2010

2009

2010

2008

2009

2010

2010

SLTL LOLC AHPL DIAL SHL CFLB SPEN JKH COMB HHL HAYL HNB DIST RICH EDEN NHL KOTA ASIR DIMO KGAL RCL LWL GLAS LGL VONE NDB DFCC SAMP CLPL GRAN EXPO

4.08 2.22 1.41 -0.35 0.00 3.98 7.56 5.91 11.19 1.40 10.71 9.00 11.43 -0.16 5.89 -0.08 5.34 0.22 11.60 7.08 1.86 8.00 -0.27 0.59 N/A 9.77 5.13 9.05 -0.96 -0.88 N/A

0.43 5.02 1.56 -1.50 -0.05 0.28 7.36 6.61 11.28 1.83 34.79 12.17 7.12 0.37 9.43 0.07 10.09 0.36 31.32 15.04 6.42 14.03 -0.06 1.36 N/A 12.70 6.46 13.42 1.44 2.23 0.26

2.18 15.50 4.85 0.62 N/A 3.09 8.44 10.79 14.48 2.65 16.21 12.49 27.69 1.11 1.91 0.76 20.88 0.29 239.06 35.32 12.40 16.65 0.61 2.59 N/A 13.09 26.92 21.13 4.28 7.92 0.87

-89% 126% 11% 324% N/A -93% -3% 12% 1% 30% 225% 35% -38% -333% 60% -189% 89% 61% 170% 112% 245% 75% -77% 131% N/A 30% 26% 48% -250% 355% N/A

407% 209% 212% -141% N/A 1012% 15% 63% 28% 45% -53% 3% 289% 201% -80% 1004% 107% -18% 663% 135% 93% 19% -1049% 90% N/A 3% 317% 57% 197% 255% 228%

12.4 38.2 61.1 N/A N/A 13.5 16.7 33.0 9.7 24.9 34.3 20.8 14.2 N/A 6.8 N/A 15.1 40.4 106.9 16.3 72.2 13.4 N/A 67.6 N/A 13.1 22.8 22.5 N/A N/A N/A

117.8 16.9 55.2 N/A N/A 193.3 17.2 29.5 9.6 19.2 10.6 15.4 22.9 27.2 4.2 58.1 8.0 25.2 39.6 7.7 20.9 7.6 N/A 29.3 N/A 10.1 18.1 15.2 53.5 45.7 41.5

23.3 5.5 17.7 12.9 N/A 17.4 15.0 18.1 7.5 13.2 22.6 15.0 5.9 9.0 20.9 5.3 3.9 30.5 5.2 3.3 10.8 6.4 13.1 15.4 N/A 9.8 4.3 9.6 18.0 12.9 13

0.06 0.03 0.08 -0.09 N/A 0.02 1.01 0.29 0.26 0.29 -0.42 5.84 0.02 0.05 -0.26 0.01 0.04 -1.73 0.01 0.02 0.12 0.34 -0.01 0.17 N/A 3.15 0.01 0.17 0.09 0.05 0.06

1.2% N/A 1.2% 2.5% 0.0% 0.2% 0.8% 1.2% 2.7% 2.1% 1.1% 2.5% 0.3% 2.7% N/A 0.8% 12.4% 1.1% 4.9% 3.0% 1.9% 1.9% 3.8% 0.0% N/A 5.1% 8.5% 2.2% N/A 1.0% 1.1%

1,805 475 443 8,144 779 180 406 840 765 512 75 358 300 1,937 53 1,410 32 889 9 25 111 55 950 387 1,087 164 265 156 25 60 1,955

91.7 40.3 38.0 65.2 15.0 9.7 51.4 163.8 82.6 17.9 27.5 67.1 48.8 19.4 2.1 5.6 2.6 8.0 11.0 2.9 14.9 5.8 7.6 15.5 27.3 21.1 31.0 31.8 1.9 6.1 21.5

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Key Economic Indicators

2003 2004 2005 2006 2007 2008 2009 2010

Nominal GDP (LKR bn) % YoY Nominal GDP (US$ bn) % YoY Real GDP Growth (%) GDP per Capita (US$) % YoY Population (mn) % YoY Inflation (%) M2 (LKR BN) % YoY Average Oil Prices (US$ / barrel) % YoY Exports (US$ bn) % YoY Imports (US$ bn) % YoY Trade Balance (US$ bn) % YoY Current Account Balance (US$ bn) % YoY Balance of Payments (US$ bn) % YoY Budget Deficit (US$ bn) % YoY Budget Deficit as % of GDP Exchange Rate (LKR/US$)

1,822 15 19 14 5.9 981 13 19.3 2 6.3 581 14 28.1 15 5.1 9 6.7 10 (1.5) 7 (0.1) -65 0.5 67 (1.4) -1 (7.3) 96.5

2,091 15 21

2,453 17 24 18

2,939 20 28 16 7.7 1,421 15 19.9 1 10 993 21 61.1 21 6.9 10 10.2 15 (3.4) 36 (1.5) 130 0.2 -60 (2.0) 15 (7.0) 104.0

3,579 22 32 14 6.8 1,617 14 20.0 1 15.8 1,148 16 69.1 13 7.6 10 11.3 11 (3.7) 9 (1.4) -6 0.5 150 (2.2) 12 (6.9) 110.6

4,411 23 41 26 6.0 2,014 25 20.2 1 22.6 1,282 12 94.5 37 8.1 7 14.1 25 (6.0) 62 (3.9) 177 (1.4) -380 (2.9) 29 (7.0) 108.3

4,835 10 42 3 3.5 2,057 2 20.5 1 3.4 1,537 20 61.1 (35) 7.1 -12 10.2 -28 (3.1) -48 (0.2) -94 2.7 -293 (4.1) 45 (9.9) 114.9

5,602 16 50 18 8.0 2,399 17 20.7 1 5.9 1,813 18 77.5 27 8.3 17 13.5 32 (5.2) 67 (1.4) 563 0.9 -67 (3.9) -5 (7.9) 113.1

5.4 1,062 8 19.5 1 9 688 18 36.1 28 5.8 14 8.0 19 (2.2) 47 (0.6) 813 (0.2) -140 (1.5) 12 (7.5) 101.2

6.2 1,241 17 19.7 1 11 823 20 50.6 40 6.3 9 8.9 11 (2.5) 14 (0.7) 0 0.5 -350 (1.7) 11 (7.0) 100.5

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Key Economic Charts

6000 5000 4000 3000 2000 1000 0 Nominal GDP Real GDP 2003 2004 2005 2006 2007 2008 2009 2010

Nominal GDP

3000 2500 2000 1500 1000 500 0

GDP per Capita

GDP Per Capita 2003 2004 2005 2006 2007 2008 2009 2010

10 8 6 4 2 0

GDP Growth (%)

GDP Growth

21 20.5 20 19.5 19 18.5

Population (mn)
Population

2003 2004 2005 2006 2007 2008 2009 2010

2003 2004 2005 2006 2007 2008 2009 2010

9 8 7 6 5 4

Exports (US$ bn)

16 14 12 10

Imports (US$ bn)

Exports (US$ bn)

8 6 4

Imports (US$ bn)

2003 2004 2005 2006 2007 2008 2009 2010

2003 2004 2005 2006 2007 2008 2009 2010

BOP(US$ bn)
3 2 1 0 -1 -2 2003 2004 2005 2006 2007 2008 2009 2010 Balance of payment 120 115 110 105 100 95 90

Exchange Rate (LKR/USD)

LKR/US$

2003 2004 2005 2006 2007 2008 2009 2010

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Disclaimer
This Review is prepared and issued by DNH Financial (Pvt.) Ltd. (DNH) based on information in the public domain, internally developed and other sources, believed to be correct. Although all reasonable care has been taken to ensure the contents of the Review are accurate, DNH and/or its Directors, employees, are not responsible for the correctness, usefulness, reliability of same. DNH may act as a Broker in the investments which are the subject of this document or related investments and may have acted on or used the information contained in this document, or the research or analysis on which it is based, before its publication. DNH and/or its principal, their respective Directors, or Employees may also have a position or be otherwise interested in the investments referred to in this document. This is not an offer to sell or buy the investments referred to in this document. This Review may contain data which are inaccurate and unreliable. You hereby waive irrevocably any rights or remedies in law or equity you have or may have against DNH with respect to the Review and agree to indemnify and hold DNH and/or its principal, their respective directors and employees harmless to the fullest extent allowed by law regarding all matters related to your use of this Review.No part of this document may be reproduced, distributed or published in whole or in part by any means to any other person for any purpose without prior permission.DNH Financial is a fully owned subsidiary of Environmental Resources Investment PLC (ERI).

Contacts
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Sri Lanka Weekly17-21 October 2011

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