Sri Lanka Stock Picks

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Thursday, February 18, 2010

SRI LANKA - PLANTATION SECTOR REPORT

Investment Summary

Sri Lankan tea prices at record high levels: Sri Lankan tea prices marked a strong recovery from 2QFY10 onwards where it touched the highest ever prices in mid September which was recorded at LKR456 per kg (up 70% YTD). The upswing was mainly attributable to the global supply shortage created by the production deficit in Kenya, India and Sri Lanka due to unfavourable weather conditions. Furthermore, strong demand from the Middle East for Sri Lankan low grown teas and rising demand lead by slowly reviving global economy also strengthened the price increase. Going forward we expect the tea prices to stabilise at current levels and ease by mid 2010 with the production recovering globally. We forecast the prices to remain at LKR360 in 2009 and to reach LKR 389 (up by 8%) in 2010E.

Natural rubber prices on the rise: Local rubber sector suffered severely since FY08 owing to the global economic downturn where synthetic rubber was preferred by the buyers due to lower cost. Natural rubber prices have now started picking up on the back of rising fuel prices which will make synthetic rubber more expensive. Sri Lankan rubber prices which were at the lowest in December 2008 (LKR120 per kg) have now reached LKR350 per kg. We believe the upward price trend would sustain with the rising crude oil prices (now closer to USD80 per barrel) which would further strengthen the demand for natural rubber. Therefore we forecast the rubber prices to be at LKR211 per kg for 2009 and grow by a sharp 30% YoY to LKR274 per kg in 2010E.

Sector profitability to recover: The sector was poised to mark strong earnings in FY10E owing to high commodity prices. But the growth was hindered by the estate labour wage hike which increased the cost of production by a near 20% with effect from April 2009. However we believe the +70% rise in tea and three-fold rise in rubber prices would be able to wither the negative effects of the cost of production to a certain

extent. With tea prices stabilising at current levels and rising rubber prices which would be sustainable in the long run, we forecast the sector to record a strong earnings during the coming quarters.

Our key recommendations would be Malwatta (MAL), Kegalle (KGAL), Kotagala (KOTA) and Namunukula (NAMU) mainly on the back of strong earnings potential (where most of the companies have recorded results above expectations) coupled with strategies to strengthen the bottom line through aggressive cost management policies.