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Vone Acuty 2015
Vone Acuty 2015
Research Analyst
Samalka Athuraliya |
(+94) 112 206 254
samalka@acuitystockbrokers.com
ACUITY STOCKBROKERS RESEARCH | SRI LANKA EQUITIES
Investment Summary
Vallibel One Diversified
Four-Year Performance: VONE vs. ASPI Top 10 Shareholders (as at 30th June 2015)
35 7500 Mr. K D D Perera 63.48%
Employees Provident Fund 9.35%
28 6000 Vallibel Investments (Private) Limited 8.46%
Vallibel Leisure (Private) Limited 8.46%
21 4500
Price Rs.
ASPI Level
VONE ASPI
Vallibel One
Table 0f Contents
Investment Overview | 4
Segment Review
Valuation
Summary Financials | 20
Investment Overview
RCL and LFIN to Determine VONE’s Performance
The 6th largest Diversified company by market fuel and electricity costs.
capitalization, Vallibel One’s (VONE) business operations
span the country’s Construction, Banks & Finance, Tiles & Sanitary Ware Supported by Cost Efficiencies
Plantations and Healthcare & FMCG industries. While the and Lower Fuel Costs
majority of total revenue is generated through the Group’s 8,000
growth segments such as Tiles, Sanitary Ware and Banks &
Finance, VONE has also diversified into industries such as 6,000
LKR Mn
Plantation (4.98% of total revenue), and Consumer, 4,000
Lifestyle & Healthcare (13.62%). We believe that due to
2,000
industry dynamics in Construction and Financial Services,
Royal Ceramics PLC (RCL) and L B Finance (LFIN) will 0
continue to remain the dominant contributors to the 2012 2013 2014 2015 2016E
Group’s consolidated topline.
Gross Profit EBIT
VONE’s EBIT Margins Improve ~600bps to 17.37% in Source: VONE Annual Reports, Acuity Estimates
30,000 30%
FY 2014/15). Following the rationalization of its dealer
20,000 20% network meanwhile, we expect RCL’s EBIT margins to
10,000 10% stabilize at ~22.0%, thereafter.
0 0%
2011 2012 2013 2014 2015 VONE’s medium-term prospects are also likely to be driven
Revenue EBIT Margin by LFIN’s growth potential in the Mortgage Lending and
Source: VONE Annual Reports
Vehicle Leasing segments. Despite LFIN’s heavy Gold loan
We believe strong revenue growth and stable margins will book, high competition from banks in the leasing segment
drive RCL’s value in the short term. We forecast RCL and the possible interest rate hike in H2’15, we remain
revenue growing at a 3-year CAGR of 14.73% positive on the company’s prospects due to its increased
(LKR 21.30Bn in FY 2016/17E) fuelled by growth in the focus on untapped markets such as mortgage lending.
construction industry and expansion in RCL’s export Through mortgage lending, LFIN targets a thus far over-
markets. Based on our estimate for a sustainable GDP looked customer base due to their high risk profile. We
growth rate of 6.80% in 2016-17E, we expect construction believe growth prospects in the mortgage lending market
activity in the country to be boosted by: (1) prospects in are high due to: (1) higher demand for housing on the back
the formerly war-stricken North/East; (2) increasing of rising population; and (2) significant growth in personal
demand for housing to cater to a rising population over the housing loans in the recent past (loans disbursed for
next decade; and (3) the disparity between strong housing has grown at a compounded growth rate of 4.66%
economic growth and weak per capita tile consumption in per quarter from March 2013-March 2015). Our positive
Sri Lanka. Furthermore, while we concede that an increase outlook on LFIN is further strengthened by the fact that
in interest rates is likely in H2’15, we see rates remaining the company continues to focus on high interest earning
broadly stable and believe that RCL should benefit from assets such as Pawning, Lease financing, Housing and SME
this stability as it should help spur personal housing lending.
construction. In addition to growth in Construction
activity, we also expect topline growth at RCL to stem from Lease Financing and Housing are Among the High
its strong market position in the domestic industry and Interest Earning Assets
LFIN's Focus is on the High Interest Earning Assets
expansion in its export markets.
Pawning
Despite our bullish view on RCL’s prospects, we remain Lease Finance
slightly cautious on the back of the possible removal of
Residential Housing
CESS on Tile imports, which could change industry
dynamics. Nevertheless, we remain confident that RCL’s SME Lending
margins will improve over the next two years due to
0% 3% 6% 9% 12% 15%
strong revenue growth, good cost containment and low Average Interest Rates
Source: CBSL
Investment Overview
VONE Rated a BUY on SOTP Valuation
Moreover, we also expect LFIN’s loan book growth to be Our value for RCL is based on a DCF valuation and we
supported by: (1) growth in three-wheeler leasing due to derive a value of LKR 19.10 per share, which represents a
lower fuel prices; (2) increase in small car sales due to 41.85% contribution to VONE’s total equity value. Backed
changes in tax regulation; and (3) potential in the Small by strong growth prospects and above industry-average
and Medium Enterprises (SME) segment. Our positive performance, we believe LFIN should continue to trade
outlook for the company is also backed by LFIN’s better- above its sector average of 1.84x PBV, and therefore,
than-peer diversification of its loan book combined with assign a target multiple of 1.92x (2016E). We thus derive a
its better than industry-average performance in Net value of LKR 18.04 per share for LFIN, which contributes
Interest Margins and Cost to Income Ratios. While we are 39.52% to total equity value. For Delmege meanwhile, we
bullish on LFIN and believe that the Group has robust assign a target multiple of 11.12x PER (2016E), as we
short-medium term prospects, we remain slightly cautious believe a discount to the Diversified sector PER of 15.89x
regarding its higher-than-peer Gold loan exposure (~1/5th is warranted for this private diversified conglomerate. On
of its total lending portfolio), which we percieve as a this basis, we derive a per share value of LKR 2.31 for
significant risk for the company. Delmege and believe that this is justified given the
expected turnaround in the business. Our target multiple
Although earnings volatility has defined much of the recent of 0.42x PBV (2016E) for HOPL is based on our view that
performance in the Consumer, Lifestyle and Healthcare VONE’s Plantations segment is currently fairly valued at
segments, we expect the signs of recovery seen in Q1’15 to 0.40x (2016E). Our target multiple compares with a peer-
continue into the remainder of the year. Recent mean of 0.58x and is at the lower end of HOPL’s historical
restructuring efforts, lower fuel/electricity costs and the PBV range of 0.39-1.70x. We note that a turnaround in the
likely increase in private consumption levels are expected Plantations sector should however, lead to a re-rating and
to improve performance in FY 2015/16E. We note though boost HOPL’s value in VONE. For our valuation of VONE
that VONE’s Plantation segment is likely to continue associates meanwhile, we have used a Justified PBV for
weighing on Group margins due to several challenges in Sampath Bank and the market value of assets for Fortress
the industry. Over-reliance on the Middle-Eastern markets Resorts and Waskaduwa Beach Resort. Based on this, we
and the ongoing geo-political unrest in these markets, derive a per share value of LKR 5.18 for Sampath Bank and
coupled with low global commodity prices and domestic LKR 0.45 for the Leisure associates. We do not assign a
industry concerns such as higher wages are likely to value to the Group’s Greener Water project, (despite
dampen overall industry prospects. Despite these necessary approvals being obtained), as its feasibility and
challenges however, we remain positive on HOPL’s previously disclosed concept is currently being re-
medium-term prospects as it focuses on: (1) investing in evaluated. Based on these assumptions therefore, we
replanting and upgrading its factories; and (2) crop assign a BUY rating on VONE and expect a total return of
diversification including Palm Oil. 26.0% on a 12M horizon (dividend yield of 2.2%).
Driven by the strong short-medium term growth prospects VONE Valued Using a SOTP Valuation Method
in VONE’s subsidiaries and associates, we see a 26.0% Valuation Multiple Value Per Share
Segment
upside on the stock and recommend a 12M BUY. Based on Method (x) (LKR Mn) Value
our SOTP valuation methodology, we have valued each of Royal Ceramics DCF - 20,752.2 19.10
VONE’s business segments and derive a target price of LKR L B Finance PBV 1.92 19,599.8 18.04
28.5, which with an average historical dividend yield of Delmege Diversified PER 11.12 2,504.7 2.31
Horana Plantations PBV 0.42 607.5 0.56
2.2% translates to a total return of 26.0%.
Sampath Bank Justified PBV - 5,631.7 5.18
The Fortress Resorts Market Value - 253.1 0.23
Rated BUY with a Total Return of 26.0% Waskaduwa Beach Resort Market Value - 240.5 0.22
30.0 Target Price of LKR 28.5 Yields an Equity Value 49,589.4 45.64
25.0
Upside of 23.7% on Current Price Adjustments (18,676.3) (17.19)
Stock Price LKR
Price 28.45
20.0
Source: Acuity Estimates
15.0
Our BUY recommendation on VONE is further supported
10.0
by a PER based relative valuation. VONE currently trades
5.0 at 8.83x PER, compared to its peer-average of 14.36x, a
0.0 significant discount of 38.52%. Backed by VONE’s strong
Mar-12 Mar-13 Mar-14 Mar-15 Sep-15 12M TP
earnings potential and price upside though, we believe this
Source: Bloomberg, Acuity Estimates
discount is unwarranted compared to its historic discount
of 21.79% and should thus trade at a higher multiple.
September 2015 Page 5
ACUITY STOCKBROKERS RESEARCH | SRI LANKA EQUITIES
Vallibel One Diversified
Domestic Construction Sector Prospects & Global Prospects for the Tiles and Sanitary Ware segments are
Tile Demand to Drive Revenue | closely associated with the country’s building construction,
which is primarily driven by economic growth. Historic
In FY 2014/2015, Vallibel One (VONE) generated 37.23% data suggests a strong positive correlation (r) between
of its revenue through its subsidiary, RCL, which primarily GDP growth and the Construction sector (r=0.98),
focuses on the manufacture of walltiles/floortiles (Tiles implying that the Tiles and Sanitary Ware industries are
segment), and bathware (Sanitary Ware). The cumulative closely tied to overall GDP and construction industry
EBIT contribution from the Tiles and Sanitary Ware growth.
segments to the Group amounted to LKR 3.25Bn in
FY 2014/2015 or 41.80% of total Group EBIT. As depicted Tiles Industry Closely Tied to Economic Growth
in the flow chart below, following RCL’s acquisition of 250 Construction Activity Picks
We believe medium-term growth prospects for the fraction of the demand, a 100000 units per annum is
country’s construction industry stem primarily from the required to fill the housing gap2. Additionally, driven by
fact that: (1) there is wide variation in construction the need for convenience and flexible living, KPMG expects
industry growth rates at the provincial level; (2) disparity 3800 units to be added to the market by condominium
between demand and supply in the housing industry; and developers. Although the household size in Sri Lanka has
(3) Sri Lanka has one of the lowest per-capita tile declined from 5 persons per household in 1980 to 4 in
consumption levels in the region. Despite the overall 2010, the average household size (sq ft) has not declined
uptick in Sri Lanka’s post-war construction activity, much over the years, implying that demand for space per person
of this growth has stemmed from the Central Province has increased.
(CP). Construction in the CP grew at a CAGR of 85.18%
between 2010-2012, compared to 25.56% in the East and Disparity between Per Capita Tile Consumption and
36.75% in the North. However, growth prospects for the Economic Growth to Drive Domestic Sales
North/East regions appear robust and have in fact 10.0
outperformed growth in the Central Province (GDP growth 8.0
8.0 7.3
CAGR 2010-2012: CP-14.97% vs. North-19.10% & East- 6.0
6.0 5.0
26.85%). We thus believe growth potential for
4.0 3.3 2.8
construction activity in the North-East provinces remains
1.4
strong, particularly due to demand stemming from 2.0 0.8
resettlements and building rehabilitation. In addition to 0.0
domestic housing and village reconstuction however, we China Vietnam Indonesia Sri Lanka
Source: ICCTAS (2013), World Bank, Acuity Research
expect the resurrection of projects such as the Achchuveli Per capita tile consumption (sq.m) Per capita GDP growth (%)
Industrial Complex in Jaffna, to also drive construction Source: ICCTAS (2013), World Bank, Company Data
activity in the region. We also believe the rehabilitation of Sri Lanka’s low per-capita tile consumption coupled with
the railway network, road development and continuous its robust GDP growth potential also highlights strong
progress in rural electrification should also benefit tourism medium-term revenue streams for RCL. Given the
in the North/East, further supporting demand for disparity between GDP growth and per capita tile
construction-related products. Consequently, we believe consumption, and our assumption of a sustainable
that the North/East of the country is yet to achieve the economic growth rate for Sri Lanka of 6.80% for 2016-
peak of its development, which in our view should further 17E, we believe that the country is yet to uncover the
support construction activity. We thus believe that RCL, growth potential of its tile industry. Sri Lanka’s per capita
with its islandwide franchise and strong market position, GDP growth in 2013 was 7.25%1 Y-o-Y, slightly below that
would be able to leverage on this potential. of China, which recorded 7.70% Y-o-Y growth, but
significantly above that of Indonesia (5.60% Y-o-Y) and
Construction Activity Backed by Higher Demand for Vietnam (5.50% Y-o-Y)3. Despite the higher-than-peer GDP
Housing growth rate recorded by Sri Lanka however, the country’s
100000 Housing Units Per per capita tile consumption was considerably lower than
7.5 Annum Required to Meet Replacement that of its regional peers who reported slower economic
Demand of 1.5mn Units by Housing growth. Sri Lanka’s per capita tile consumption in 2013
Housing Units (Mn)
period, commercial banks’ loans and advances to the With the Rocell Pty acquisition therefore, RCL is positioned
construction industry increased at a quarterly to capture on this demand and provide diversification to
compounded growth rate of 4.42% (Mar‘13-Mar’15). The RCL Group’s existing exports to several of the top tile
proportion of loans and advances used for construction importing countries (USA, France and the UAE).
also increased to 17.10% in March 2015 from 14.40% two
years prior. The US Remains Top Importer (160Mn Square Meters)
of Global Tile Exports
Low Interest Rate Environment Leads to Higher
150
Construction Activity in the Country
Sq.m (Mn)
16% 500,000 100
Avg. Quarterly AWPR (%)
In addition to higher activity in the domestic construction Tiles and Sanitary Ware Revenues to Grow 21.28%
industry, we also anticipate revenue growth to stem from Y-o-Y to LKR 19.62Bn in FY 2015/16E
RCL’s increased focus on export markets. Currently, RCL
24,000 160%
generates ~7.00% of its revenue from exports. Over the Source: Infotile (2013)
years, however, RCL has faced several challenges in its
12,000 80%
tiles entering the export market (domestic cost of
production is relatively higher), combined with slow 6,000 40%
demand due to weak global economic conditions.
However, due to high growth potential within this space, 0 0%
2012 2013 2014 2015 2016E 2017E
RCL has continued to increase focus on its exports and
recently invested in developing the market in Australia Revenue YoY Growth
through Rocell (Pty) Limited. Demand for tiles in Company
Source: Australia
Data
Source: VONE Annual Reports, Acuity Research
has been on the rise for multiple reasons including the In light of: (1) robust GDP prospects; (2) potential in the
higher durability and lower carbon footprint (ie: tiles in domestic construction sector; and (3) growth in RCL’s
place of timber flooring) of floor-tiles. export markets, we forecast revenue growth of 21.28%
Y-o-Y to LKR 19.62Bn for FY 2015/2016E. Given the
Benefits of Tiles vs. Alternative Flooring likelihood of a possible interest rate hike in H2’15 and its
Higher Durability implications however, we estimate revenue growth in
Increasing Awareness on Environmental Concerns FY 2016/17E should moderate to 8.53% Y-o-Y. Our
Low Post-Installation Maintenance
estimates further assume that the volatility in revenue
Thinner and Lighter Tiles Save on Transportation Costs and Renovation Costs
growth in 2012-2015 (due to inorganic expansion), should
Less Constraints for Tiles Cf. Timber (In Wet Areas)
not continue in the near-term.
Source: Acuity Research
Cost Efficiencies & Lower Energy Costs Prop Gross Profit Margins to Stabilize at ~41.50% in FY
Margins | 2016/17E Following a Dip in FY 2013/14
RCL, like much of the rest of the tiling industry is facing the 9,000 50%
challenge of obtaining consistent and high quality raw 7,500 47%
material due to a lack of streamlining in the mining and
Margin (%)
LKR (Mn)
6,000
quarrying industries. We note that this has led to weaker 44%
4,500
production yields and thus resulted in an increase in the 41%
cost of production. This in turn has also resulted in local 3,000
1,500 38%
tile manufacturers such as RCL being unable to compete
with the low priced and poor quality imports, resulting in 0 35%
pressure on margins. In 2014 however, with stricter 2012 2013 2014 2015 2016E 2017E
regulation being implemented by the local
Source: Annualauthorities, the
Reports, Acuity Research
Gross Profit Gross Margin
supply issue was for the most part resolved. Consequently, Source: VONE Annual Reports, Acuity Research
VONE’s Tiles and Sanitary Ware segments collectively
reported a gross profit of LKR 6.42Bn in FY 2014/15 The Group also faced additional challenges relating to its
(margin of 39.71%, up ~220bps Y-o-Y). The improvement dealer network, which led to lower-than-expected margin
in margins was also driven by lower energy costs (which improvement in FY 2014/2015. We anticipate improved
account for ~40% of RCL’s cost base), combined with Group results in FY 2015/2016E following the
continued focus on cost efficiency improvements. For rationalization of its dealer network. Largely owing to
instance, RCL’s subsidiary, Lanka Tiles reported that the savings achieved through better cost management (RCL
company was able to reduce its total energy costs by expects to save ~LKR 200Mn in FY 2015/2016E), we
19.0% in FY 2014/2015, owing to the reduction in LP Gas forecast EBIT to grow at a 4-year CAGR of 31.65% to
prices. Given RCL Group’s significant production capacity, LKR 4.16Bn in FY2015/2016E,Source: yielding a margin of
Annual Reports, Acuity Research
we believe that it would be in a better position to negotiate 21.19% (vs. margin of 20.10% in FY 2014/2015).
the price of its raw materials, thus allowing it to largely Thereafter, we expect margins to stabilize at ~22.0%.
contain its costs in the short-medium term.
RCL EBIT to Grow at a 4-Year CAGR of 31.65% Amid
Following the CERA acquisition in May 2013, RCL’s gross Stringent Cost Management
margin declined from 47.80% in 2012 to 37.48% in 2014
(down 10 percentage points), weighed down by cost 5,000 35%
inefficiencies at CERA. Post-consolidation (2015) however,
CERA reported a ~220bps Y-o-Y improvement in 4,000 30%
Margin (%)
LKR (Mn)
Risk Analysis of Domestic Tiles Industry | considering that: (1) exports only account for ~7.0% of
total revenue for RCL; and (2) the devaluation over the
The main challenges currently faced by the local tiling month is limited to ~4.0%. However, a further
industry include: (1) the inadequately governed imported devaluation in the LKR and continued expansion in RCL’s
tile market; (2) the lack of streamlining in the mining and export markets should support its performance in the
quarrying sector; (3) the possibility of margin erosion due future.
to high price sensitivity for tiles; and (4) the perception
that wall tiles are a luxury item. Lenient anti-dumping laws and countervailing duty
legislation also impacts the local tile manufacturing
Low Quality, Cheap Imports Account for 60.0% of Total industry as imported products are marketed at a lower
Market Share in July 2015 price than domestic selling prices. The local tiling industry
is primarily affected by cheap Chinese tiles (which account
for 70.0% import dumping) due to the lack of anti-
dumping levies by the GoSL. As a result of the increased
RCL, 34% threat of imports, RCL has faced significant pressure on its
margins over the years. In order to mitigate the impact of
these lower quality, cheaper imports, RCL currently splits
Imports, 60% its sales in terms of its distribution network. As such, RCL’s
products are made available to the end customers through
the Group’s 140+ direct dealer network (which markets
Mack Tiles,
Source: Company Data (2015) smaller sized, lower margin tiles which compete with
6%
imports) or its 95 own showrooms and franchised outlets
Source: Company Data (2015)
(markets mainly larger sized, higher margin tiles). The lack
One of the primary challenges to the local tile of streamlining in the mining and quarrying sector also
manufacturing industry is the threat of cheap imports negatively affects the domestic tiles industry, and the RCL
from India, China and Indonesia. During April-July 2015, Group has continuously lobbied for better regulation in the
imports accounted for 60.0% of Sri Lanka’s tile industry mining sector in order to achieve higher yields.
(by volume), suggesting that the domestic tiles industry is
currently threatened by higher volumes of cheaper, low Lanka Walltiles (LWL) also faces the issue of lower
quality imported tiles. This is in comparison to imports demand for wall tiles, on the back of a perceived notion in
accounting for ~35.0% of the tiles industry in 2009/10 Sri Lanka that wall tiles are a ‘luxury item’6. This is
and 52.0% in 2014/15. Imports are cheaper due to its poor reflected in the split in sales between wall and floor tiles in
quality coupled with the lower cost of production (foreign the industry. Approximately 80.0% of the local tiles
manufacturers use lower cost fuels such as coal and industry consists of floor tiles, while the remaining 20.0%
Liquified Natural Gas). The GoSL however, has imposed a is accounted for by wall tiles. As a result, most customers
CESS of 35.0% on imported tiles as a protectionist replace wall tiles with floor tiles. Due to the lack of demand
measure for the domestic tile manufacturing market. for wall tiles, and a stock pile-up in the recent months,
Although industry stakeholders believe this CESS should Lanka Walltiles (LWL) has decided to convert 25.0% of its
be maintained in order to protect the domestic market, plant capacity to produce floor tiles this year7. In an effort
there is a possibility that this could be removed entirely, to overcome this misconception however, LWL has
which could in turn negatively affect the local invested in a marketing campaign to stimulate demand for
manufacturing industry. Further, we believe that despite wall tiles in the country. Although the additional marketing
its 34.0% market share in the industry, RCL faces the issue campaigns should support future sales of wall tiles, it is
of margin erosion due to the high price sensitivity of tiles expected to weigh down on Group EBIT growth in FY
in the industry. As such, we note that the removal of the 2015/2016E, and therefore could limit margin
CESS on imports could lead to a loss of market share for improvement in the short term.
RCL due to pressure on margins.
Note 1 – Calculated Using the Base Year as 2002
We note however that the devaluation of the LKR over the Note 2 – KPMG – Vertical Living Beyond 2020
recent weeks should benefit RCL in terms of: (1) higher Note 3 –www.worldbank.org
Note 4 – www.imf.org
export revenue; and (2) a price hike in imported tiles Note 5 –Infotile
narrowing the gap between domestic and imported tile Note 6 – Lanka Walltiles Annual Report 2015
prices. We believe the benefit is currently negligible Note 7 – The Sunday Times, August ’15, Some 25% in Lanka Walltiles Capacity
to be Converted to Floor Tiles
Macro Variables Determine Changes in Financial In line with the Central Bank projection of private sector
Segment Product Portfolio | credit growth in 2015E of ~ 15.50%, we expect credit
appetite to improve on the back of political and economic
In addition to RCL, VONE also holds a 51.0% shareholding stability (growth in H1’15 amounted to 15.03% Y-o-Y).
(effective holding of 64.29%) in LFIN, a Licensed Finance Although some upside pressure on interest rates is likely
Company (LFC), which provides financial solutions for given the current depreciation pressure on the LKR, we
corporates, small and medium enterprises (SMEs) and still anticipate growth in private sector credit in 2016E.
individuals. In FY 2014/15, VONE earned 33.71% of Group
revenue and 50.0% of Group EBIT from LFIN. LFCs and LFCs Play a Bigger Role in Private Sector Credit in Q1
Specialised Leasing Companies (SLCs) account for 7.0% of 2015
Sri Lanka’s financial system, and by the end of 2014 the 100% 30%
20% 6%
VONE Enjoys Effective Holding of 64.29% in LFIN
0% 0%
Q4 13 Q1 14 Q2 14 Q3 14 Q4 14 Q1 15
CB LFC
LSB LFC Credit to Pvt. Sector
CB Credit to Pvt. Sector
Source: CBSL
15% SDF Window Therefore, we believe that the low private sector credit to
Rationalized
Credit-Guarantee on GDP levels imply space for growth and that the increasing
10%
Pawning Loans share of private sector credit that domestic LFC’s provide
5% imply strong growth potential for key players such as
LFIN.
0%
Jun'13 Sep'13 Dec'13 Mar'14 Jun'14 Sep'14 Dec'14 Mar'15
Source: CBSL
Source: CBSL
In an effort to benefit from changing macro variables, LFIN LKR 2.41Bn, growing at a 3-year CAGR of 130.09% over
continuously makes strategic changes to its product FY 2012/13-2014/15, supported by the low and stable
portfolio. Currently, LFIN’s focus on Loans and Receivables interest rate regime combined with LFIN’s aggressive
is driven by growth potential in the Mortgage Loans marketing campaigns. Through its Mortgage Loans
segment. LFIN’s lending portfolio includes, Gold loans, segment, LFIN intends to offer small ticket mortgage
vehicle loans and mortgage loans (ie: categorized as loans facilities to customer segments overlooked by banks and
and receivables) along with Lease Rentals Receivables and without access to formal banking channels. Following the
Stock out on Hire. Lease Rentals and Stock out on Hire end of the internal conflict in Sri Lanka, the country
accounted for 59.81% of LFINs lending portfolio, while experienced a boom in its Construction industry. Although
Loans and Receivables accounted for 40.19%. construction or the purchase of a home is considered a
significant investment for an individual, over 90.0% 9 of the
LFIN’s Loan Book to Continue Upward Trajectory Amid Sri Lankan property market has been debt-free, while re-
Growth in Loans and Leases mortgaging homes is almost non-existent10. As of 2011, Sri
70,000
Lanka’s mortgage market accounted for 2.4% of GDP
compared with ~40.0% in Singapore10.
56,000
LKR Mn
0 30%
2012 2013 2014 2015 2016E 2017E
15%
Loans and Receivables Lease Rentals and Stock out on Hire
0%
Source: VONE Annual Reports, Acuity Estimates
-15%
targets customers overlooked by banks due to their high Additionally, motor car sales accounted for ~13.0% of
risk profile. We therefore, estimate a 39.09% Y-o-Y growth total new registrations at the end of June 2015, increasing
in gross mortgage loans in LFINs lending portfolio, thus from a mere 9.0% at the end of 2014. Meanwhile, the
implying an increase in the composition of mortgage loans proposal to remove a depreciation table and the revision
as a percentage of total gross loans to 12.48% in of excise taxes in January 2015 has effectively led to a price
FY 2015/16E (from 10.34% in FY 2014/15). hike of hybrid vehicles. Despite the increase in prices and a
decline in fuel prices therefore, new hybrid / electric
Change in Tax Regulation and Lower Fuel Prices vehicle sales between January and July increased a
Determine Growth in Leasing | significant 184.96% Y-o-Y in 2015, which we believe
should benefit LFIN in the current financial year, due to its
Despite increased competition within the Leasing space, increased focus on hybrid vehicles. However, given that:
we expect LFIN to continue focusing on its core business of (1) a near-term increase in fuel prices is unlikely; (2) the
leasing as well as loans for vehicle purchases. Within the increase in import duty leading to higher prices of
Lease Rentals Receivables and Stock-out-on-Hire segment, hybrid/electric vehicles; and (3) the likelihood of an
LFIN is currently shifting all its hire purchase facilities to increase in interest rates and a further depreciation of the
leasing mainly due to the exemption of finance leases from LKR, it is unlikely that LFIN would continue to benefit from
VAT (mandated by the Budget 2015). This is due to the an increase in new registrations of hybrid/electric
lack of distinction between Hire Purchase and Finance vehicles. However, we expect demand for small cars to
Leasing following the change in tax regulation. In our view, remain relatively steady as low fuel costs should help
growth in LFIN’s Leasing segment is expected to be offset some of the negative pressure stemming from a
boosted by: (1) the strong rise in demand for small weaker LKR.
vehicles (<1000 cc) and dual purpose vans due to reduced
import duties; (2) growth in the three wheeler leasing Lower Fuel Prices Drive New Registrations for Three
market following fuel price reductions; and (3) favourable Wheelers in 2015
macro factors leading to growth in microleasing. Three Wheeler Registrations Increase a
New Registrations (Jan - Apr)
LKR/Litre
30,000 140
20,000 120
100%
10,000 100
80% Motor Car
0 80
Sales in H1'15
60% Beats 2014 2013 2014 2015
Full Year Sales
40% New Three Wheeler Registrations LP 92 Avg. Price
Source: Mid-Year
Source: Mid-Year Report
Report 2015
2015 (Ministry
(Ministry of
of Finance),
Finance), Ceypetco
Ceypetco
20%
segment remaining a growth driver for the company. Within the backdrop of both: 1) LFIN’s increased focus on
LFIN’s low delinquecy rates are attributable to three- the Loans & Receivables (particularly Mortgages) segment;
wheelers being used for income generating purposes and 2) its continued potential in the Leasing segment
(e.g. travelling & goods transportation) and due to lower therefore, we estimate LFIN’s total net loan book growing
fuel prices significantly improving the customers’ 11.87% Y-o-Y to LKR 63.02Bn in FY 2015/16E. Growth
disposable income. Therefore, we believe LFIN’s growth in should be supported by both, (1) Loans and Receivables
the net lease rentals portfolio will be primarily aided by its (+14.76% Y-o-Y); and (2) Lease Rentals and Stock out on
continued focus on the three-wheeler leasing service Hire (+9.93% Y-o-Y). Moreover, from a comparative
under Micro Leasing. We expect this, combined with perspective, we believe LFIN’s lending portfolio is more
higher demand for small cars to drive LFIN’s full year diversified relative to its peers, providing the Group with a
leasing portfolio growth further (Q4 2014/15 net lease strong competitive advantage. As of the end of FY 2014/15
rentals grew 11.23% Y-o-Y and 19.27% Y-o-Y in Q1 for instance, LFIN’s gross Leases and Hire Purchases
2015/16). accounted for 66.62% of the total lending portfolio while
Loans and Receivables accounted for 33.38%. Peers such
Three wheeler leasing is a constituent of LFIN’s micro as CFIN and PLC by contrast recorded 95.50% and 77.39%
leasing service, which primarily focuses on small-scale of Leases and Hire Purchases during the same period,
businesses and self-employed individuals (i.e. low-middle while LOFC’s lending portfolio primarily consisted of
level income earners) with sufficient income levels to Loans and Receivables (77.41%). We thus believe that
repay a loan. In addition to the leasing of three wheelers, CFIN, PLC and LOFC’s higher risk exposure to a single asset
LFIN’s microleasing services also cater to motor bike class (relative to LFIN’s more diverse product portfolio),
leasing. We believe: (1) the increasing disposable income provides LFIN with a strong competitive advantage and
levels in Sri Lanka fuelled by lower fuel and electricity should help further support topline growth.
costs; (2) the GoSL’s higher focus on the Small and Medium
Enterprises (SME) sector and; (3) the expected stability LFIN Product Portfolio Seems More Diversified
following the General Elections held in August, should Compared to Peer Group
support LFIN’s loan portfolio growth even further. The 100%
Gross Loan Portfolio (%)
LFIN’s Increased Exposure to Gold Loans (Despite necessary measures to improve its product portfolio and
Lower Gold Prices) Remains a Risk Factor | mitigate the negative impact of lower prices. This is
particularly evident in LFIN’s Gold loan losses/gross Gold
Despite our overall bullish view on LFIN, we believe there loans ratio of 2.06% in FY 2014/15, which is significantly
are a number of risk factors within the segment. We lower than the 16.74% recorded in the previous year. The
highlight LFIN’s: (1) High exposure to Gold loans despite continued increase in demand for Gold loans is also
low Gold prices; (2) Increased competition from more apparent in the 20.45% Y-o-Y growth in the number of
traditional banks; and (3) The likelihood of an interest rate customers for Gold loans in FY 2014/15. We forecast gross
hike, as important risk factors. Sri Lanka’s credit to the Gold loans to grow at a modest 3-year CAGR of 5.58% over
private sector weakened during H1‘14, primarily due to FY 2014/15-2016/17E, resulting in a contribution of
lower pawning. However, following the guaranteeing of 42.04% of total gross loans in FY 2015/16E and 39.62% in
pawning by the Central Bank of Sri Lanka in June 2014 and FY 2016/17E, declining from 44.76% in the last financial
a rationalization of the SDF window, private sector credit year. Our modest growth forecast takes into account the
growth has since improved. Pawning (i.e. Gold-backed positive impact of increasing demand for Gold loans being
loans) in Sri Lanka gained particular popularity in the partially offset by the impact of a further decline in Gold
rural regions as it represents a plausible asset to use as prices. Despite the recent bearishness in global equity
collateral in order to access the country’s financial markets, investors have shown weak interest in the safe-
markets. A large portion of borrowing against Gold was by haven assets such as Gold, leading to the belief that Gold
the lower income rural and agricultural communities, and prices could continue to decline. Given LFIN’s high Gold-
as such were primarily used for consumption. loan exposure therefore, we believe a further decline in
Consequently, strong growth in demand for credit also led prices is likely to significantly increase risks to LFIN’s
to a rapid rise in economic activitiy in Sri Lanka. LFIN’s net product portfolio.
Gold loan book too grew at a 3-year CAGR of 37.23% (to
LKR 10671.74Mn) over FY 2010/11-2012/13, driven by Meanwhile, LFC’s including LFIN have also faced
the rally in Gold prices. Following the crash in Gold prices increasing competition from the banking sector offering
in 2013 however, the proportion of lending against Gold services which were traditionally only offered by finance
declined due to the lower value of gold against which companies. We identify this as a potential threat to LFIN’s
credit could be lent, combined with a decline in Loan to performance while also noting that the company’s
Value ratios. As a result, LFIN’s Gold loans contracted continued focus on high-margin products for a higher
24.97% Y-o-Y in FY 2013/14, as Gold prices declined margin customer base should help overcome the issue of
19.74% Y-o-Y. increased competition, at least in the short-term.
Despite Lower Prices, LFIN’s Gold Loans Grew ~30.0% Moreover, the likelihood of an interest rate increase in
Y-o-Y in FY 2014/15 H2’15, could negatively impact LFIN’s interest spreads due
to a greater asset/liability mismatch in the context that
Growth in Loan Book Despite Decline in Prices long-term lending is on fixed rates relative to short-term
200
Value (Rebased to 100)
50
2010/11 2011/12 2012/13 2013/14 2014/15
Margin (%)
Benefits Healthcare
LKR mn
50 2%
from a Tiles
Lifestyle 20 0%
Well
Diversified (10) -2%
Portfolio Consumer (40) -4%
(70) -6%
Plantation Q1 2013/14 Q3 2013/14 Q1 2014/15 Q3 2014/15 Q1 2015/16
Source: Annual Reports
Valuation
Target Price of LKR 28.5 Yields a Total Return of 26.0%
Target Price of LKR 28.5 Based on a Sum-of-the- target multiple of 0.42x. At our assumed multiple, we
Parts Valuation | expect HOPL to contribute LKR 0.56 per share to VONE’s
target price. For our valuation of Sampath Bank PLC
We use a sum-of-the-parts (SOTP) valuation to arrive at (effective holding of 14.95%) we have used a Justified PBV
our target price for VONE and based on this methodology, and derive a value of LKR 5.18 per share; for the Group’s
we derive a target price of LKR 28.5 per share, implying Leisure associates, Waskaduwa Beach Resort PLC
total return of 26.0%. The valuation has been carried out (20.22%) and The Fortress Resorts PLC (18.02%)
using a series of metrics ranging from DCF to relative meanwhile, we have used the market value of assets as our
valuation (PBV & PER) to market based valuation (market basis and develop a per share value of LKR 0.23 and 0.22,
value of subsidiaries/associates). On this basis, RCL (Tiles respectively.
and Sanitary Ware segments) accounts for 41.85% of our
target equity value, while LFIN (Banks & Finance) Our SOTP Valuation Indicates a Target Price of LKR
generates 39.52% of the value. We assume Sampath Bank 28.5 for VONE
should contribute 11.36% to VONE’s target value.
Valuation Multiple Value Per Share
Segment
RCL and LFIN Contribute over 80% to VONE’s Equity Method (x) (LKR Mn) Value
Value Royal Ceramics DCF - 20,752.2 19.10
L B Finance PBV 1.92 19,599.8 18.04
Delmege Diversified PER 11.12 2,504.7 2.31
Delmege, Other, 2.22% Horana Plantations PBV 0.42 607.5 0.56
5.05%
Sampath Bank Justified PBV - 5,631.7 5.18
The Fortress Resorts Market Value - 253.1 0.23
Sampath
Waskaduwa Beach Resort Market Value - 240.5 0.22
Bank,
11.36% Equity Value 49,589.4 45.64
Adjustments (18,676.3) (17.19)
Price 28.45
Royal
Ceramics, Source: Acuity Estimates
41.85%
L B Finance, Despite necessary approvals being obtained earlier this
39.52% year for the project to proceed, we have refrained from
Source: Acuity Estimates
We value RCL (Tiles and Sanitary Ware) using a DCF incorporating revenue streams from Greener Waters in to
valuation, and arrive at a value per share of LKR 19.10, our VONE valuation, as the project’s feasibility and
assuming a WACC of 13.89%. Given our positive outlook previously disclosed concept are being re-evaluated
on LFIN and its better-than-peer performance, we value following changes to regulations in tax exemptions.
VONE’s Banks & Finance segment assuming a target Greener Water Ltd. (which was acquired in 2011) is the
Price/Book multiple of 1.92x and thus develop a per share leisure arm of VONE, under which investments have been
value of LKR 18.04. Our target multiple of 1.92x is above made towards hospitality projects. Its maiden investment
the sector average of 1.84x, a premium we believe is project lies on 14 acres in Negombo, and is designed as a
justified given that given that LFIN has historically traded 400 roomed five star hotel with 4 epicurean restaurants,
at a premium to its peer average. Given the volatility in banquets, a tranquil spa, exquisite suites, fitness centres
earnings, our value of LKR 2.31 per share for Delmege and a water park. Since 2011 though, VONE has faced
(5.05% of VONE’s equity value), is arrived at by several challenges pertaining to accessibility and
discounting the Diversified sector PER of 15.89x (i.e, approvals, but the project was approved this year. Since
11.12x 2016E). Despite expecting a turnaround at the project is yet to materialize and its continuity is
Delmege, we believe a discount on the sector PER is uncertain in light of changes in tax regulations, we have
warranted, given that it is a private diversified valued VONE on its existing core business and have
conglomerate. However, we note that a complete overhaul excluded this project from our estimates. Therefore, on our
at Delmege would likely boost VONE’s value further. 2016E estimates, we value VONE at LKR 28.5, yielding a
total return of 26.0% (Price Appreciation: 23.7% and
Similarly, although we note that a turnaround in the Dividend Yield: 2.2%).
Plantations sector should lead to a further boost in VONE’s
value, given the current weakness in the industry believe
HOPL is fairly valued at 0.40x PBV, and as such assign a
Valuation
Risk to Valuation on a Super Gains Tax
14
10
6
Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15
Susil Fernando
(+94) 112 206 234
susil@acuitystockbrokers.com
Chathura Siyambalapitiya
(+94) 112 206 232
chathura.s@acuitystockbrokers.com
S. Vasanthakumar
(+94) 112 206 250/251
vasantha.k@acuitystockbrokers.com
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