Beira shouldn’t be stinky!!!

Here. I’m trying to shed some random light on the most recent IPO of Beira Group (BPPL).

By and large, it is a good IPO that came to the market in a while. Key points being:

• The company is an established long standing one with long track record, delivering profits and a seemingly good balance sheet (does not look that they have capitalized any revalued land. Well they have actually done a revaluation after 5 years which is understandable);
• As I usually say this is a productive company and not a shell company that owns some crappy businesses (best example: Adam Investments);
• I think the governance aspect is comparably better. 

Skepticism

However, I’m too skeptic due to several reasons.

•       Firstly, the company is not raising money rather it is a money out deal. I’d prefer a money in deal where the Company would be utilizing the IPO money for expansion and thereby better valuations in the long term;
•       Why is Hirdaramani’s exiting this business. Again the question is if the business outlook and prospects for the company are better someone would stay on, in a perfect world (may be Hirdaramani’s need some money for other purpose or they are having issues with other shareholders of the company);
•       I wonder if this is the right time to go to market when the market is trading at historic low multiples for the last two years. The idea here is that no company, with a proper evaluation, would consider going to market at this time unless they are desperate (due to some reason that is not going to be good for the public investors).

The bright side

I’m not completely negative. In the offering, they only issue 10% to the public. That is the bare minimum to be listed on the Diri Savi Board. The two lessons from this is that company’s current owners (except Hirdaramani’s) are greedy and don’t want to share most of it with the public. Second lesson being they are confident that the raising can be completed because if they were short a decimal point it will be a flop.

Now the pricing

Again and as I usually say, not every good company is a good investment. That said better to look at pricing (I actually don’t have time to do a valuation of this company). The comps I prefer to use are slightly different to what the IB guys have used. (But I don’t ignore them and reproduce them in the table below).

Looking at this I’m indifferent on an investment in to B P P L.  

Our (Sri Lankans') immunity to global oil shocks!

Everyone is now talking about global oil prices as it recently hit a new bottom (below USD30/barrel). A look at the global oil market (if you are trying to understand the market), will direct you to different things, such that; we hear about Brent, WTI, etc., Commodity markets/exchanges (NYMEX, ICE, etc), instruments like Spot, Futures, etc. (if you want to study these things, log on to this please). Anyway, my aim in this post is not to look at global oil markets but to give you an account on how the Sri Lankan markets work in the face of the global dynamics.

Structure and economic importance

The Ministry of Petroleum Resources Development acts as the policy making and chief accounting body for four entities; Ceylon Petroleum Corporation, Ceylon Petroleum Storage Terminals Pvt Ltd, Petroleum Resources Development Secretariat and Polipto Lanka Pvt Ltd. Sri Lanka’s annual fuel bill is c. USD 4.5 billion. (this includes both Crude Oil and Refined Products imports). To give you some context, this is about 25% of country’s total import bill and approx. 50% of the export bill. However, due to recent sharp drop in oil prices import bill has almost halved as of November 2015 and its share as a percent of total imports has dropped to 14%. (Note: Crude oil imports & Crude oil (CIF value LKR mn) for 2015 are for the 1H15, total USD value from Jan - Oct period) 

Government’s revenue from taxes on petroleum is as depicted in the below table: (it actually does not represent a major part of it’s revenue as it is claimed to be in the media and in political circles).

Sri Lanka petroleum market

Sri Lankan petroleum market is a regulated duopoly. Ceylon Petroleum Corporation (CPC) and Lanka IOC PLC (a subsidiary of Indian Oil Corporation Ltd) are the two players in this market. Apart from fuel importation and distribution in Sri Lanka these two players are also involved in the lubricants business, bunkering. Bituman and other services. (in which the competition is very different and that discussion I will reserve for another post, as my focus here is to talk about fuels).

CPC is engaged in import of Crude as well as refined products while LIOC sources refined, bulk fuel, from international markets. CPC actually imports three types of crude, namely; Light Crude Oil (has not been imported since 2014), Murban Crude Oil and Oman Export Blend. LIOC is said to possess 18% market share in the domestic fuel retail market (as per their latest published Annual Report. However, the overall market share, looking at sales quantum, is about 13%).    

CPC is struggling with some structural problems as pointed out in the Annual Report.

“..Murban crude oil which gives a better yield, helping to increase the refinery margin. The Murban crude oil is only produced by Abudabi National Oil Company in Abu Dhabi and hence has a very limited supply with only 10% of the production coming to the open market in Asia. However, there is speculation that this 10% will also likely to be further reduced with the recent commissioning of a new refinery owned by ADNOC in UAE. This might have a negative impact on the procurement of Murban crude oil by CPC in future and hence will need to explore for alternative crude oils compatible with the current refinery configuration”.

Sri Lanka faced this similar problem when the US imposed sanctions on Iran as CPC’s refinery is, understandably, best suited to refine Iranian Crude.

Further the Annual Report points that “Making the situation worst, the CEB demand for fuel oil has drastically reduced with the commissioning of Norachcholai Coal Power Plant compelling CPC to look for alternative avenues to market the excess fuel oil produced at refinery. With a highly unstable demand for thermal power generation coupled with a very low demand for the local industry, the refinery is facing problems of disposing around 1,400 Metric Tons of excess fuel oil per day”. As a result, they have had to sell/export the excess at very low prices.   

The Duopoly

As I mentioned, the Retail Fuel business in Sri Lanka is a regulated duopoly. The government run CPC accounts for c.85 - 87% of the market while the balance is shared by LIOC. The table below shows the financial performance of both entities. (Please note that LIOC is a March Company while CPC is a December company. However, 2014 figures are from Jan-Dec 2014 for both and 2015 figures are for Jan – Sept 2015 for both companies, for comparison purposes. Also note that figures are in LKR millions).

To get a better understanding it is essential to look at the performance ratios which are produced below. (Keep in mind that two years of data analysis may be not enough to get a better picture).  

To get an understanding about the financial positions of the two entities I have reproduced their Balance Sheets (as at CYE14 and Sept 2015). The accompanying ratio analysis shows a comparison of them. Capital structure of CPC is not helping at all, as per the analysis.   

Operationally, CPC is understandably employing around 5,800 staff (equivalent to 50% of the staff of all the State Owned Industrial Enterprises. Statistic from Central Bank of Sri Lanka). However, LIOC only employs around 174 staff members as per there disclosures in the CSE. This converts to Revenue per Staff figure of LKR 290.65 million for LIOC and LKR 48.96 million for the counterpart, CPC. 

Similarly, CPC runs 1193 Fuel Stations island-wide. LIOC, on the other hand, operates 179 Fuel Stations.

In terms of sales, local sales of refined products are about 4.4 million metric tons. (table for total local sales and CPC sales). LIOC sells c.0.5 million MT (555,918 MT in 2014 FYE, 584,436 MT in 2015 FYE).

Finally, I’d like to come to the most interesting bit, the retail fuel prices in the local market. The chart below gives the CPC’s crude import prices over last several years. (LIOC does not import crude). As per the CBSL’s most recent Economic Weekly publication the 2015 December import price was USD41.21 per barrel. (this is not directly comparable to world market price due to many reasons. But its trajectory is not substantially different from the global movements).

Now look at the local market retail prices of different versions of fuel used by people. In the political arena, different numbers are thrown by different people but without any basis (but just with the intention of attaining political mileage out of it. Once, I can remember, one of the current government’s ministers, during the campaign, mentioned that CPC is taxed unnecessarily to fund the activities of former regime’s family). So, it is our duty to do our own research to see what is actually happening.

Why not reduce local fuel prices?

The above is a common question every one raised in the recent past, as they know the global market has collapsed. (no one ask the opposite of this question when the global market climbs up). But, that’s human nature.

The government has reported that they can’t give any further reductions as they have got to deal with a bad fiscal situation plus and they want to make up for the losses they made while prices were high.(essentially the people have had to pay for the state sector inefficiency). Inefficiencies are partly due to CPC’s financial situation and its inability to invest in its infrastructure and technology. (one reason being fuel was sold at subsidized prices when global prices were very high). On the other hand, even though the price of oil in USD terms dropped significantly, the LKR has also depreciated significantly over last year or so. Hence, the LKR value of the imports have not dropped in a similar passion.

Hence, Sri Lankan companies/individuals can’t be expected to be benefitted even if the oil prices are at historic lows in the world markets. However, may be we are being benefitted from the reduced import bill such that we might have avoided a greater crisis due to BoP problems had our import bill remained at USD4 billion levels.  

Will you be willing to take the risk of changing oil price. (Nowadays, quickly and rapidly changing). Of course, you answer will be most likely be a ‘yes’. In this scenario, we should be prepared to accept higher prices if world prices increase. (that may sound little harsh, isn't it).  If this wa the case, you will save in down markets and can probably be using those savings for wealth generation. Conversely, in an up market, you may see your savings affected badly. (If the up market prevails for a prolonged period it may affect you severely). But, we may be better at managing our own finances better than the governement does with all its political interferences.  

Bottomline

Retail fuel prices become one of the main topics of discussion in and around election times and most often oil prices are reduced soon after a government is elected. (happend even after the most recent election!). As goverement gets older, it is highly unlikely that they reduce oil prices. (it has not happened that way before, may be once or twice only). In contrast, tendency to increase retail prices in the face of increasing global fuel market is very highly likely, irrespective of elections. Hence, in a declining fuel market, LIOC and CPC stand to make huge profits and vice versa.

Since our market fuel prices are government decided we don’t tend to see the same variation in prices that we see in the global markets. (on a very constant and regular interval, at the extreme case on a daily basis). We are worried now as the world prices are at historical lows. But, commodity prices are very volatile and we never know when would they reverse and start increasing. (then we will be surely happy the price in the local market is fixed, well until the GoSL increase it). However, due to this mechanism we are immune to global shocks (at least in the short run) as the government partially hedge us against shocks with their regulated price.   

Re-think Impact Investing

As of late, Impact Investing (II) and Socially Responsible Investing (SRI) has drawn attention of a wider audience. The two are used interchangeably and hence become difficult to draw lines between II and SRI. Member Bodies (Global Impact Investing Network) and Policy Initiatives (The Forum for Sustainable and Responsible Investment.) have also been launched to look in to this area of investment. A survey by GIIN and J.P. Morgan in 2014 points out that about 55% of Impact Investors surveyed look for market rate of returns – like any other typical investor, not categorized under II or SRI.

To narrow it down to Impact Investing, the GIIN defines the “Impact Investments are investments made in to companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return”. The report further highlights that the Financial Inclusion is the most commonly pursued theme which actually includes investments in micro-finance, small and medium enterprise (SME) finance, and community banking.  The vast majority of Impact Investment funds that reached Sri Lanka are also predominantly towards micro-finance and SME finance, apart from concessionary funding which came from Multilateral Agencies or other Development Funding Agencies (DFIs).

From the individual II Fund Manager perspective, their expressed high-level expectations are social, economic and financial – most of the time, broadly understood as targeting double or triple bottom line. However, at a more operational level, the focus is not different to conventional investing where you focus on certain financial/performance parameters in screening, executing and monitoring deals. It all may boil down to a very concise Term Sheet which does not even give an indication on the social and economic returns that are expected of through such investments.

Interestingly, most of the recipients of II funding are themselves not interested in measuring the outcomes in the Social and Environmental parameters rather than certain key financial/performance parameters like Portfolio-at-Risk (PAR), Non Performing Advances (NPA), Loan Growth Ratio, Debt-to-Capital Ratio, etc. In one hand, those are the criteria looked at by the II Fund Managers and on the other hand, most of these funding recipients are locally listed/unlisted return maximizing companies. Hence, the platform is well set for a conventional investment to take place – in the pretext of Impact Investment. The ultimate result is simple. The II Fund Manager funds the recipients at commercial rates or expects normal market returns. Consequently, these organizations on lend their clients – who are inevitably vulnerable (socially, economically and/or financially) segments in the economy – at exorbitant rates. In some instances, the interest rates can range between 27% - 47% in an economy like Sri Lanka where Sri Lankan Government bills are issued at approx. 7% and corporate lending rates can range between 11.5% - 14.5%. Ironically, neither II Fund Managers nor their beneficiary local organizations do evaluate what type of returns their ultimate clients earn by investing the financing received.

Now this entire process raises several concerns. Firstly, it raises the question whether it is moral/humane to treat an already vulnerable group – behind the name of Impact Investing. Secondly, the practicing organizations in the economy might engage in malpractices – such as multiple lending, loan rollovers, etc with the intent of preserving PAR and NPA - due to excessive pressure exerted upon them by the II Fund Managers. Thirdly, the beneficiaries might also be pushed – as has been the case - to go for multiple loans with different organizations further amplifying the issue. In the final analysis, a disruption caused – by practices like these – to the industry may prove to be alarming as it is the only source of financing accessible to these vulnerable segments – most of the time poor women, marginalized communities, etc.

The situation can be simply conceptualized with the help of a hypothetical example. Let’s say one helps – financially- a Needy in the street. Obviously, the helper would not ask the Needy to pay back interest as well as see him succeed in life as a result of him helping the Needy. But, the helper has achieved something that is not financially measurable -but measurable in other qualitative terms. For instance, the helper may have supported the Needy with his next meal for the day, funded part of the Needy’s medical bills, or could be anything or if not helper will at least have the inner self-satisfaction that he/she helped someone - without actually knowing how the Needy made use of his/her money.

However, in contrast now think of conceptualizing the so-called Impact Investors, who tries to help some vulnerable group while expecting them to pay market rates on the money, and also expect them to enjoy the social and economic upgrades as a result of their funds, wherein the investor enjoys the qualitative outcomes/returns -like the helper did in the example above.

However, it should be understood that the suggestion is not to provide funding free of charge like the helper did in the above hypothetical example but to provide funding at rates/returns that are not commercial or exorbitant given the segment served. The justification for giving up on commercial rates/returns would be that the Impact Investors are enjoying the other non-quantitative outcomes as a result of their funding being used without a burden by the recipient.  The resultant returns would thereby be the quantitative plus the qualitative elements. As the ultimate recipients graduate to small and medium scale – when they are able to pay higher returns - progressively higher rates/returns may be applied by the II community. 

 

Or else, it looks that it is not humane or moral to exploit vulnerable segments in any market under the appearance of Impact Investing. Or accept to compromise on the financial and qualitative returns. Isn’t that what Impact Investing should be or else why do we need alternative terminology to identify Investing.

Greetings for 2016

We just bid farewell to an eventful 2015 and looking forward to even more thrilling year, 2016. Here’s my very best wishes to all of the readers, from around the world, for a fantastic 2016. I would also like to thank every one of you for your continuous patronage shown towards LanakanMarkets over 2015 and I do hope to see same (or even more) level of support and interaction in this year.

Year in review: 2015

Colombo Stock Exchange (CSE)

CSE ended the year down 5.54% (All Share Index – ASI) and with a double digit dip in the S&P SL20 Index of 11.33%. Following corporate/other actions were noticed:

• Three Equity IPOs were concluded: (namely completion of Arpico Insurance PLC (AINS.N0000) listing, Singha Hospitals PLC (SINH.N0000) and lastly People’s Insurance PLC of which the listing yet be completed as of my writing). The three offers raised a combined c.LKR 1.08 billion (c. USD 7.5 million) from the public. SINH performed poorly as an IPO. It only jumped 12% at the debut and closed the year down 16%. In contrast, AINS was trading up 36% when it reached its highest price during the year and ended the year up 20%. People’s Insurance will debut in 2016 and it is likely to see a significant pop at the debut. (it is the only IPO which got oversubscribed in the first day after about 3 – 4 years);
• After about a 4 year break, another Closed-End Fund was listed on the CSE, namely Candor Opportunities Fund (COF.U0000) which raised c.LKR504 million (c. USD 3.5 million). On the inauguration it recorded an 8% hype though not sustained with volumes. Closed the year 5% below offer price;
• The public corporate bond market remained active as more and more companies tapped the market. A total of c. LKR83.5 billion (c.USD 579.61 million) was raised by 23 corporates. Interestingly, 84% of that was raised by Bank and Finance Sector companies while the balance was raised by Non-Bank corporates. In another event, the debentures that had been earlier issued by Urban Development Authority matured in October. Due to a conflict of interest issue, the Securities and Exchange Commission of Sri Lanka (SEC) suspended temporarily a debenture offering of EAP Broadcasting Company Limited;
• One of the Credit Rating Agencies, Lanka Rating Agency (formerly, RAM Ratings Lanka Ltd) were suspended by the SEC due to non-compliance. On the Sri Lankan Credit Ratings Industry I wrote several posts in this blog which you can search here: they were themed, Learn from the Past, Prevention is always better and lastly Now What; 
• CSE also adopted GICS towards the end of the year and will be parallel run until it is fully adopted in place of old classification; 
• The government, in its recent budget, removed the Share Transaction Levy (STL) whereby stocks trading on CSE will be 0.30% cheaper from 1 January 2016;
• Market PE was 17.98x, PBV 1.99x and Dividend Yield 2.18% by the end of the year; and
• S&P SL20 rebalancing took place in December, as usual.

CBSL policy

With the change in the political scene beginning in January, the Central Bank of Sri Lanka (CBSL) governor quit his job and a new Governor wasappointed. Before Long, in March 2015, the new Governor got himself entangled in a Bond Scam which I personally did not expect to see under a government which came to power pledging to bring in Good Governance and eradicate corruption. But, as usual things did not happen the way we wanted. I also wrote about my expectations in this post.

In terms of Monetary Policy, several decisions were implemented as pointed out below:

• In March, the Standing Deposit Facility rate of 5%, which was instituted under previous Governor, was removed by the CBSL;
• In April, the CBSL Policy Rates were reduced by 50 bps, a very unexpected move by the CBSL at the time, thereby bringing the SDFR and SLFR to 6.00% and 7.50% respectively; and
• Most recently, in December, the Statutory Reserve Ratio (SRR) was increased by 150 bps to 7.50%. This increase would affect the Banking Sector profitability, albeit not significantly.

There was no clear guidance from the CBSL in regards to the ongoing Consolidation of Financial Sector initiative that they carried out through 2014. The last communique in this connection was issued in 31 December 2014 and afterwards there was no any indication from the CBSL whether it was called off or still in operation. I would have expected them to come out and provide clear guidance to those companies which were forced by CBSL to merge. However, in the recent Budget of the Government they mentioned that companies are welcome to merge voluntarily.

Treasuries performance

Both primary and secondary market treasury rates moved up shifting the yield curve upward. The Primary bill rates increased significantly as reflected in the below table:

In the secondary market, the rates showed a similar fashion increase as evidenced by below table:

The yield curve signified a positive curve and an upward shift, though not a parallel shift. 

As reflected by the yield spread, it looks like that the investors are expecting interest rates to increase. The yield spread has increased to 3.93, a 1.58 increase compared to the beginning of the year 2015. 

LKR trajectory

2015 was not a good year for Sri Lanka Rupee (LKR). LKR showed significant depreciation against the US Dollar (USD) and Japanese Yen (JPY), 8.47% and 7.49% against USD and JPY respectively. A marginal depreciation of 3.71% against Sterling Pound (GBP) was witnessed while a 2.06% appreciation against Euro observed.

In terms of USD borrowings, Lanka borrowed closed to USD 7.5 billion via Sri Lanka Development Bonds (SLDBs), International Sovereign Bonds and Reserve Bank of India (RBI) Currency Swap Agreement. (Please note that this does not include other forms of borrowings by the government). The table below shows the issuances in chronological order:

The table shows each instrument’s tenure, amount raised and the interest rate. One noteworthy thing about the RBI Currency Swap facilities is that CBSL was not as transparent as it was with regard to SLDBs and International Sovereign Bonds of Government of Sri Lanka. Hence, it was quite tricky to find out exact periods on which they were utilized. However, from available information I assume that the first tranche of USD400 million was availed in April and the other USD1,100 million was made use in August. Going by the mechanics and as I posted in my articlehere, I also assume that the CBSL extended these facilities in August and December. (every three month tenure, purely my assumption). As of end of November 2015, the official gross reserves position stood at USD 7.3 billion compared to USD 8.8 billion by end of November 2014. 

My initiatives

Personally, I also took some initiatives to broad base the readership and to enhance my own excitement to blog more and more. Hence, as determined inthe beginning of 2015 I kept posting at a faster pace. Additionally, I have the LankanMarkets email which is active where you can directly send your feedback. [lankanmarkets@gmail.com]. Moreover, I have added social media widgets using which you can comment, share, and follow your favorite/interesting posts. The search button will allow you to search for anything that you want. The most popular posts are also organized for your quick access.

Final thoughts

As I always mention I do welcome your valuable comments/thoughts/ideas, either good/bad as it will help develop the blogging experience, for me for sure and hopefully for you as readers. Further, should you want any particular topic be discussed please do let me know as I’ll be happy to do that. In addition, should you need any research sent directly to you, I will also try to get that done beginning from this year. 

Anyway, I will try to outperform the last year with more posts in 2016.

Thank you again.   

Why a Hutch; when no rabbits inside!

I was interested in anarticle that discussed about an acquisition in the Sri Lankan Telco Industry. The story was interesting to me in several ways. Firstly, I have a small holding of Sri Lanka Telecom PLC (SLTL.N000) shares and hence this is of importance to me as a shareholder. Secondly, the story talks about an acquisition and some valuation numbers for the target company (Hutchison TelecommunicationsLanka (Private) Limited) and thirdly there is underlying politics to all this.

Rotten story

In fact, this acquisition story is not a new thing to the market. It has been floating around for quite some time. This story suggests that Hutch was on the lookout for a sale in Sri Lanka. This article gives more color to the industry’s rumors to the possible consolidations. As per this article it looked like the acquisition of Hutch by SLT was imminent. Likewise, I can give many examples of this nature and the fact is none of these contemplated acquisitions have taken place as of my writing.

Presidential attention

Interestingly, this is not the first time that country’s presidential attention, albeit in different presage, was driven to this story as per the above article. In 2014, the then president also interfered in this matter as this article suggests. Further, this latter story from 2014 points out to the fact that there were disagreements on the value of the acquisition target. At the time, SLT has offered to buy Hutch USD132 million (c. LKR17.1 billion at LKR/USD of 130) whereas Dialog had offered USD78 million (c. LKR10.14 billion) as per the article.

The Telco Industry in Sri Lanka

Well, let’s quickly look at the Sri Lankan Telco Industry. Telco industry in Sri Lanka is regulated by the Telecommunications Regulatory Commission of Sri Lanka (TRC) and there are currently 6 operators offering Landline, Mobile, Data, Enterprise, TV, etc services. See the below table for a brief analysis:

Clearly, these things suggest that the Lankan Telco Industry is now in a saturated situation and I attribute to it an Oligopolistic market structure (well, except that fact that they can’t set prices and earn abnormal profits as a result of regulation). The 3 firm concentration ratio as per my calculations (based on subscriber base) is about 82%. To give it a different flavor I looked at the Herfindahl-Hirschman Index – HHI value for the Lankan Telco Industry and based on my calculations I arrived at an index value of 2,588 which suggests that it is a highly concentrated industry.

Refer below chart from Central Bank of Sri Lanka annual report.

Value vs Price

With that brief discussion I move on to value the target. No, I can’t do it. Why? I don’t have any revenue or cash flow figure to do a valuation model. Hutch is not a listed entity in Sri Lanka and hence no information is publicly available except what I gathered so far. I can only make some approximations by looking at the other players and their performance.

Also based on the available information, I think I should be able to do some sort of pricing of the target. That should be better than nothing, I suppose!

The new deal value is mentioned in that above article as being USD130 – 135 million (c. LKR19.17 billion using LKR/USD 142). Which is equivalent to a Price to Subscriber ratio of c.LKR9,585. More than Dialog’s Price to Subscriber ratio and a 33.75% discount to that of SLT itself.

As with my approximations please look at the above table. Accordingly, based on mobile revenue and mobile subscriber base, I arrive at LKR6,020.49 and LKR6,120.00 of Revenue per Subscriber for Dialog and SLTL respectively. Quite contrast to that, the same figure for Airtel is LKR4,939.09. I think this is explained by Dialog’s and SLTL’s market leading positions, product offerings, etc. If I try to approximate the revenue figure for Airtel using an average of Dialog and SLTL Revenue per Subscriber figure, I arrive at a LKR10.926 billion whereas it’s actual is LKR8.89 billion. Hence, I reject leaders’ ratio as an approximation figure for Hutch and Etisalat. (May be for Etisalat it may be ok to use and average of all three: Dialog, SLTL and Airtel. However, Etisalat is not the focus in this post, hence I don’t bother too much about it). I, therefore, utilize Airtel’s ratio to approximate the sales figure for Hutch and arrive at a LKR9.878 billion as their topline. (I’m sure Hutch must also be operating at a loss like Airtel and Lanka Bell). The proposed payment consideration is at an implied Price to Sales multiple of 1.94x which compares with the same of 1.33x for both Dialog and SLTL. (Actually a premium of 45%). Or to look at it from another angle. Hutch should be at least making LKR14.4 billion or more to justify paying that much to acquire it by SLTL.

Figures in LKR '000s except ratios which are times.

As per the blow chart, as per my approximations (I accept that my approximations may be wrong!) I derive a Price/Sales based price of LKR13.15 billion for Hutch. Similarly, applying the SLTL and Dialog Price/Subscriber ratios I derive a pricing range of LKR28.94 billion to LKR18.86 billion.

Bottomline

Given that it is a horizontal integration strategy, my doubt is why should anyone (especially one of the dominant players already) pay Hutch market leading multiples? In fact, in this case all what SLTL would be acquiring is Hutch’s subscriber base and I don’t see any other synergies to them in this deal. Specially, given that no one is competitively bidding and the only bidder came at very low level, I think they should let Hutch voluntarily exit the market (let them bleed and die and then later lure its subscriber base at a cheaper price, simply) or offer at a cheap price now that would be worthwhile. Or else numbers should speak for themselves.      

TPP, the never seen formula for success

Recently, I came across thistweet by a well-known Professor, who, as usual, tries to argue that the recently signed Trans-Pacific Partnership (TPP) was a once in life time opportunity Sri Lanka missed. It was not the first time he voiced his dissatisfaction over this, as this earlier tweet of him says, with a link to the New York Times article. 

Well the learned Professor must be praising the TPP for its merits to countries like us in the APAC, I thought! Is that true? If yes, what is in it for us? How does it help countries like us? And how are we disadvantaged due to not being a signee to the Pact, as he claims in his tweet?

With these questions in mind, I tried to find anything in the public domain that would help answer these questions. But, it was very difficult to even find a draft of an agreement signed by any nation. But, as the New York Times article which the Professor shared says, “The pact, part of Mr. Obama’s strategy to balance China’s economic ascent, would knit together a largest-of-its-kind trading system in the Pacific”. Further, as the Office of the United States Trade Representative puts it in its website, it is another Made in America product which is aimed at “Leveling the playing field for American workers & American businesses”. As thisarticle by Koichi Hamada highlights “with the TPP, the US is catching a big fish with small bait. But the increased trade and investment flows brought about by the TPP’s ratification and implementation will benefit even the countries that must make larger sacrifices”. So, it is evident from these that this is not a Pact deliberated for the bilateral benefit of signees, rather to largely fulfill unitary requirements of one signee. (also not forgetting the fact that USA is heading to an election and that they need to give the US citizens something if they were to be in power. Further, their efforts to come out of the GFC and the subsequent recession via Fed lead measures have not really worked out and the Europe is also in really bad shape). 

The non-existent Free World

If I go to mainstream media, capital market or listen to any politician, I’m made to understand that we live in a globalized Free World where there are no barriers to trade. (or for years, from the Imperial times, they are boasting of Free Trade). Further, to facilitate such free trade or the free world, they invented apparatus like World Trade Organization, etc. If this is the case, why on earth do we need these other Trade Agreements, which I don’t even know whether override the already existing WTO or other stipulations, to benefit countries? May be this so-called Free World is non-existent and it only exist in documents. Still they are talking about Trade Liberalization and also at the same time some form of protectionism. (I know it is easier said than done!).   

Different views

I think it is worthwhile looking at different views so that we can form some sort of understanding that is not partial or biased. As I mentioned above that this agreement is not something drafted transparently, as the US Senator Bernie Sanders points out in thisarticle. Further, I also think that we should look at merits and demerits of previous Trade Pacts that countries and regions have signed before. Just because it is a very new pact and that the world is in a shaky situation, we should not just opt to this. (I don’t think that it is easy to reverse it once we penned it!). At least, if the Professor points out the great benefits that we derived from any such agreement with other nations (like SL and India Free Trade Agreement, etc), that would be greatly appreciable. I know of this article by economistMartin Feldstein, wherein he argues that trade agreements by Chile with USA have benefitted both.     

Bottomline

As I conclude the post, I have to mention that I do not personally know the Professor nor have I met him. Hence, I do not have anything personal rather than my own reactions to his thoughts. Honestly, I accept some of his thoughts on some other topics like the Appointments to Government positions which appeared in ft.lk as an article, etc. But, on the TPP I have my doubts and it may be true that I’m also one of the Sri Lankans swimming in the Pond called Sri Lanka listening to only our Mass Media such that I’m amazed why countries should go for these types of pacts, as the Professor mentioned in his Ravaya article. I hope that he may also write about the great aspects of the TPP and how it benefits us in an already (non)existent so-called Free World (which is assumed to be facilitated by apparatus like WTO, etc) where there are tariffs to protect their interest, in country, and pacts to protect their interests elsewhere. 

Thought to share this and wrap up. 

Follow the herd! Win or lose?

It’s been a while since I last posted on My Views. I was attracted to a very interesting stock this time, Hayleys Fibre PLC (HEXP). HEXP is a subsidiary of diversified holdings, HayleysPLC. HEXP is an exporter of coir fibre. However, they generate approx. 15% - 20% of its revenue from the local market. They manufacture a variety of products which fall under five main categories, Erosion control, growing media, horticulture, bedding and upholstery and industrial fibre. In terms of revenue Asia (I assume Russia is also categorized under this by the company) and Europe account for about 75% of their export revenue while the balance is split between Japan and USA. (refer below Sale by region graph, Sourced from Company’s latest published Annual Report).

Company going forward

As per the latest annual report, the management intend to focus on the following in order to grow revenue and increase profitability from the business:

• -       More focus on erosion control, specifically to focus and rationalize the product portfolio and consolidate business with more emphasis on value added products (I hope it the most profitable product category and they will stop producing loss making products);
• -       Invest in new technologies (hope they will increase efficiency and also reduce operating costs);
• -       A backward integration project (this should help reduce raw material costs);
• -       Energy saving initiatives; and
• -       Aggressive marketing at the Joint Venture company level.

With this in mind it is good to look at historical performance to get an idea about how they have performed. (refer below for profitability ratios of HEXP). The performance numbers says the story that HEXP is operating in a very competitive market (globally competing) and are a price taker when it comes to sourcing raw materials.

As a result, returns on capital has been shockingly low. (refer the ROIC chart below). 

Recent explosive growth

At the beginning of this month, REXP was at LKR44.90 (6 October 2015) and as of my writing the stock appreciated rapidly to reach LKR88.40 as 97% return in less than a month. (refer the graph below).

As far as I know, there was no any significant news about the company which should trigger this type of appreciation. (as usual, may be market possesses some information which I’m not privy to).

However, I was interested to find out a reason for this. From what I understand, one reason may be the recent drastic depreciation in the Sri Lankan Rupee. Hence, technically, HEXP being an export company become price competitive in the market and their foreign currency earnings are now converted to higher LKR value. To see how this plays, I ran a correlation analysis in to HEXP’s revenue and LKR/USD to see if they are correlated. However, I was surprised to see that they show a negative .0.8240 correlation.

Alternatively, it is merely due to excessive retail participation due to some market rumour and subsequent herd behavior where everyone else jumped in to enjoy the rally.   

HEXP valuation

In order to value the shares of HEXP, I conducted a discounted cash flow valuation, as I usually do. As always, the valuation is based on assumptions made by me and I certainly do not possess expert knowledge as to how this business operate (but I think my assumption here are more generous than in any other case). However, I have used assumptions that I believe are reasonable and I would be glad to change them and see the impact on valuation if you can come up with more robust assumptions.

My cost of capital calculation is based on few parameters like beta of 1.17 (against All Share Index) for the stock which was taken from Colombo Stock Exchange, risk free rate of 9.85% (current 10 year Sri Lanka treasury bond rate in the market), Equity Risk Premium of 8.00% (my subjective judgment as I currently don’t have a scientific method to calculate, I will soon rectify this), pre-tax cost of debt of 9.50% and a tax rate of 15.31%.

On the tax rate I want to specifically mention that the company’s export earnings are only taxed at 12% concessionary rate while other earnings are taxed at normal 28% rate. Hence, I used a weighted average tax rate for cash flow calculations. Equity and debt weights of 79.59% and 20.41% were used respectively. Using these assumptions I derived a cost of capital for the firm of 16.93%.

The other assumptions are as per the below calculations.

Based on all these, I derived an equity value of c. LKR367.67 of which about 88% is coming from non-operating assets. These non-operating assets consist of Investment Property (property in Ekala that is rented), investment in joint venture company (carrying value of 50% ownership in Bonterra Lanka Ltd, which is equivalent to 50% of the net assets value of the entity) and other financial assets (investment in unquoted shares of Toyo Cushion Lanka Pvt Ltd and Rileys Pvt Ltd which are valued by them based on DCF method).

The derived value gives a per share value of LKR45.96 per share of REXP. The market price as of my writing of the share was LKR88.40 which is 92% higher than my valuation.

Bottomline

As I always say, I’m a very bad trader and every time I try to profit from this type of stock rallies, I end up buying in at the peak. So, now I tend not to join the bandwagon. But, if you are good at trading please go ahead and do it. But, if you are not, please be careful as the stock is currently heavily overvalued as per my valuation (you are welcome to argue with me on my valuation). If you are a believer in technicals, then be mindful as it is now in the overbought territory and a similar fashion drop is also all possible.