Monday, September 26, 2011

Corporate earnings post strong growth

Corporate earnings for the recently concluded June 2011 quarter indicate a levelling of the post-war boom witnessed in the comparable quarter a year ago.

Nonetheless, corporate earnings have maintained its strong growth trajectory, recording a Year-on-Year (Y-o-Y) increase of 35.7% in June 2011.

Our analysis of 229 counters (ie: 86% of listed entities) based on attributable profits, signal that corporate earnings growth continues to be strong in the milieu of low interest rates, normalising inflation and steady GDP growth.

Banks, Finance and Insurance continued be the main contributor to profit (26%), followed by the Diversified sector (19%) and the Food, Beverage and Tobacco sector (14%).

The Hotels and Travels sector witnessed a notable increase (2%) in its contribution to profit from last year when the contribution was 0.15%.

However, the Health Services and Plantations sectors which were top contributors to total earnings in Q2 2010 however failed to do so this quarter.

The Plantations sector recorded losses amounting to Rs 709mn, attributable to wage hikes and unfavourable weather patterns. With the exception of the Plantations sector, Footwear and Textiles was the only sector over the quarter to record losses.

Relative to Q2 2010, losses from this sector increased (-0.74% Y-o-Y to total market cf. -0.27% Y-o-Y in Q2 2010) markedly in Q2 2011.

While we concede that global macro conditions remain a risk, our outlook for Sri Lankan equities remains positive given the country’s current macro-conditions and steady drive towards post-war growth.

In our analysis, we have assumed a ‘top-down’ approach, analyzing average sector growth trends over the past four years and adjusting our earnings forecasts in light of the recent macro-economic developments in the Sri-Lankan economy.

In the interest of presenting realistic and sustainable future earnings potential, we have excluded from our base for forecasting exceptional capital gains since Q2 2010.

Based on our earnings forecasts for FY2011/12, we estimate the market to trade on a forward PE in the range of 14x-16x through March 2012.

Although this indicates a higher market PER relative to regional peers - particularly within frontier markets - we believe that in the post-war context, the Colombo bourse has strong medium to long-term potential amidst the increased political stability, the streamlined regulatory framework and consistent foreign exchange policy.

We continue to see value in the market given the strong future earnings potential of corporates particularly amid the positive macro-economic fundamentals within the country.

We believe that the market PE will rationalize in the quarters ahead and advise accumulating a portfolio of selected stocks which will generate value in the medium term.

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