Sri Lanka – Equity Strategy

March 2021

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Economic outlook
• We expect economic growth to improve to 5.0% in 2021 (coming off from a low base in 2020) and 4.0% in 2022. We expect a
gradual improvement in private consumption to support growth. Vaccination rollout and a gradual resumption of economic activities
should anchor our growth expectations for 2021 and beyond. Public investments are likely to be low due to debt refinancing
challenges.

• We expect current account deficit to rise in 2021 to 3.1% of GDP. Rising crude oil prices and the gradual recovery in economic
activities will push the import bill higher. In 2020, savings from the fuel bill amounted to USD 1.4 billion, largely benefiting from low
oil prices. In 2020, the average CIF price of fuel imports (by the Ceylon Petroleum Corporation) stood at USD 44/barrel vs. USD 69 in
2019. Crude oil prices are expected to hover around USD 60 in 2021, coupled with higher country risk premiums + a possible steep
rupee depreciation might add a steep pressure on the current account balance. The government is gradually relaxing import controls
on intermediary and investment goods which could further add pressure. However, we expect increased merchandise exports and
higher tourism receipts to cushion the blow to a certain extent. In Jan 2021, gross official reserves dropped to USD 4.8 billion and if
inflows continued to be slow and low might be a concern for LKR fundamentals. The CBSL emerged as a net fx seller during last two
months with the currency seeing increased pressure (USD 23 and 72 million net fx sales in Dec and Jan).

• We expect a higher fiscal deficit in 2021. Government’s fiscal deficit target for 2021 is at 7.9% (as indicated in the Budget 2021)
however, given the challenges in the revenue collection front, likely LKR depreciation and a resultant increase in debt servicing cost,
there could be upside pressure on the fiscal deficit.

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Economic Outlook
• Policy outlook to be continued: We expect the accommodative monetary policy stance to continue to a greater part of 2021 due to
limited fiscal leeway. We expect inflation to remain subdued due to the current output gap and don’t expect an excess demand
situation.

• Political outlook is stable. The present government has secured a two-third majority and we expect a greater political stability and
policy coherence, as a result.

Macroeconomic forecasts

2019 2020 2021

Real GDP growth % 2.3 -4.2 5.0

Current account deficit % 2.2 2.8 3.1

Fiscal deficit % 6.8 9.8 10.0

CPI (% annual average) 4.8 4.7 5.5

USD-LKR (end period) 181.63 186.40 210.00

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USD-LKR evolution since 2002

Source: Bloomberg

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Equity Themes in 2021
• SL equities have risen by 8% YTD, aided by higher liquidity on low market rates and better than expected earnings recovery.

• We are bullish on F&B, manufacturing and construction sector themes supported by growth resumption and inward focused
government’s policy priorities. Asset quality pressure is likely to increase in the banking sector once moratoriums come off in March
2021. Large banks have adequately provided for a possible asset quality shock, however small banks remain underprovided. We might
see negative earnings surprise on underprovided small banking stocks if the business recovery gets delayed post moratorium. We also
prefer net exporter stocks amidst a greater likelihood of a steep currency fall.

• Please refer to page 17 for BRS’s top recommendations.

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ASPI vs Regional Indices - YTD

Source: Bloomberg

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 80.0
100.0
120.0
140.0
160.0
180.0
200.0
31-Dec-20

Materials
01-Jan-21
02-Jan-21
03-Jan-21

Abbreviations
04-Jan-21

Diversified Financials
05-Jan-21
06-Jan-21
07-Jan-21
08-Jan-21
09-Jan-21

DF
10-Jan-21

MAT
11-Jan-21
12-Jan-21
13-Jan-21
14-Jan-21
15-Jan-21

Banks
16-Jan-21
17-Jan-21
18-Jan-21

Capital Goods
19-Jan-21
20-Jan-21
YTD Index moving sectors

21-Jan-21

MAT

CG
BNK
22-Jan-21
23-Jan-21
24-Jan-21

DF
25-Jan-21
26-Jan-21
27-Jan-21

CG
28-Jan-21
29-Jan-21
30-Jan-21
BNK

31-Jan-21
01-Feb-21
02-Feb-21
Food, Beverage & Tobacco
03-Feb-21
FBT

04-Feb-21
05-Feb-21
FBT

06-Feb-21
07-Feb-21
08-Feb-21
09-Feb-21
10-Feb-21
11-Feb-21
12-Feb-21
13-Feb-21
14-Feb-21
15-Feb-21
16-Feb-21
17-Feb-21
18-Feb-21
19-Feb-21
20-Feb-21
21-Feb-21
22-Feb-21
23-Feb-21
Source: CSE

24-Feb-21
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Sector wise outlook
Banking – Selectively positive
The sector in general, witnessed the pressures stemming from deterioration of asset quality and weakened Net Interest Margin (NIM) due to distressed
business activities and monetary policy easing. The banking sector credit growth remained below par due to COVID-19 outbreak disrupting business
activities. However, we believe majority of the banks have made adequate provisions for likely asset quality pressure whilst low interest rate environment
and a pickup in economic activities are likely to generate demand for credit.

Diversified Financials – Negative

Since the sector is heavily depending on loans given to micro and small businesses along with leasing, effects of COVID-19 coupled with import restrictions
curtailing vehicle registrations had an adverse impact on the operations of finance companies. Despite the ease off curfews and gradual recovery of
business activities, finance companies will continue to witness pressures until a significant improvement in macroeconomic conditions along with the
removal of import restrictions on motor vehicles. Therefore, we remain cautious on the sector as the likelihood of the removal of motor vehicle import
restrictions is lower.

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Sector wise outlook
Insurance – Positive on Life Insurance

Life insurance industry witnessed a robust growth in Gross Written Premium (GWP) in 2020 following the increased awareness on insurance policies amidst
elevated risk of health concerns. Given that the sector is largely underpenetrated as a percentage of Sri Lanka’s Gross Domestic Product (GDP) in
comparison with regional countries, we believe the sector has ample room to grow in terms of policies and GWP. However, sector is likely to see near term
earnings pressure due to double whammy effect of increased change in contract liabilities and lower investment income stemming from the lower interest
rate environment. We believe, the growth in GWP is likely to outweigh the effects of lower interest rate, resulting an expansion in the sector earnings.

Government of Sri Lanka (GoSL) imposed restrictions on vehicle importations hindering new vehicle registrations which impacted the general insurance
topline growth as the sector heavily depends on the mandatory motor vehicle insurance. Since import restrictions are likely to continue in 2021, general
insurance GWP is likely to remain flat. In 2020, sector benefitted from the less claims made by the policy holders due to less accidents as the public isolated
themselves amidst COVID-19 outbreak. However, we do not expect the general insurance sector to enjoy similar benefits as the country gradually coming
into normalization leading up to higher claims in comparison to 2020.

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Sector wise outlook
Food, Beverage and Tobacco – Positive

Plantations – Negative. Oil palm plantations remain an exception

The plantation sector received a boost with improved commodity prices in 2020. The industry believes that tea prices will sustain at current levels towards
mid-2021. Resumption of industrial activities, especially tyre production will further increase the demand for natural rubber and drive for better prices.
Global palm oil prices which have reached a near 10 year high and is expected to climb further according to industry reports. Recently passed increase of
the minimum wage of plantation workers could however be a key risk. Given the commodity market outlook, companies with exposure to oil palm and
rubber will witness a lessened impact from the wage hike in the coming quarters.

Poultry – Positive.

Demand for Chicken is expected to increase as a comparatively cheaper source of protein and pick up of tourism sector could be a boost to the industry. The
performance of Poultry sector will face some restrictions with import ban on maize. With an improved maize output expected for the coming year, some of
the margin pressure faced by poultry players could be lessened. The proposed tax incentives being enacted and government’s stance on relaxing the import
ban/ allowing a suitable alternative would be key factors to drive the poultry sector in 2021.

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Sector wise outlook
Food, Beverage and Tobacco – Positive
Consumer Goods & Retail – Positive

Consumer Goods & Retail sector is on the recovery path from the pandemic induced setback. The gradual recovery will take place as the income levels improve and
tourism industry revives. With the vaccine coming into the picture footfalls would improve towards the latter half of the year. Further localized lockdowns remain a risk
for the industry under the new normal. However, the industry is now better positioned with strengthened online channels and distribution networks. Ban on PET
bottles if materialized could also have significant impact on the sector.

Tobacco - Negative

The only local cigarette manufacturer CTC has received a tax breather since December 2019, after being imposed with back-to-back hikes since 2016 (+85%). The last
hike in December was offset by the reduction in VAT (15% to 8%) and removal of NBT. The budget 2021 proposed to impose a single Special Goods and Service Tax
(percentage unknown) in place of the various goods and service taxes and levies (which amount to 77% or gross revenue) presently. However, with the re-emergence of
the second round of Covid, most plans are yet to be implemented.

We believe this being a sin industry; will continue to be regular bait for successive governments with periodic tax hikes inevitable. The local manufacturer has taken a
steep price hike in recent times which has impacted volumes over the years. However, the recovery and sustainability in volumes have been impressive for CTC. The
National Authority on Tobacco and Alcohol Act has on several occasions proposed the single stick ban of cigarettes within the country. If implemented CTC would have
an impact, as 90%-95% is single stick sales.

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Sector wise outlook
Capital Goods – Positive
Conglomerates – Positive

Counters with higher exposure to leisure segments will likely experience near term earnings pressure amidst COVID-19 whilst opening the borders for tourism ought to
ease off the pressures gradually. However, we believe diversification effects stemming from positive sectors will help conglomerates sustaining in the near term leading
up to medium to long term. HAYL with the exposure to activated carbon, glove manufacturing and other export-oriented industries is likely to outperform the other
conglomerates whilst closely followed by SUN due to positive outlook on healthcare, local pharma manufacturing, dairy and palm oil in 2021.

Tile Industry – Positive

The import restriction has turned the fortunes of local tile manufacturers during the 1H FY21 operating at full capacity. Accumulated stocks were sold during the period
with local manufacturers only able to cater to 50% of local demand. With the import restriction to continue for another six months (minimum) the local tile
manufacturers are expected to run at full capacity. LWL (+100%) and RCL (+25%) are looking at further expansion in capacity, expected by mid-2022. The depreciating
Rupee we believe will further pressure import prices, opening opportunities for local manufactures to partly cater to the existing big importers at competitive prices.
This we believe will be an opportunity for local manufacturers in the medium term, who suffered due to cheaper imports flooding the market. Given the governments
pro local stance, we believe new players will enter the market within 2-3 years. However, we believe existing players will have an edge over new entrants. Low interest
rates and heightening activity in the construction sector will give an added boost to the sector. Exports will be keenly looked at given the opportunities arising from the
US/China trade disharmony. Volatility in LPG prices will continue to be an impediment on production cost. However, believe LPG prices will remain stable in the near
term.

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Sector wise outlook
Consumer Durables and Apparel – Neutral
The apparel sector is likely to witness a better growth in 2021 as the vaccine should restore consumer confidence and ease the tension of going into brick-and-mortar
stores. Online retailing is at an all-time high and has been growing for many strategic brands which will increase orders. The depreciation in the Sri Lankan Rupee should
benefit these companies as they earn mostly in US Dollars thereby margins may show an improvement compared to previous years.

The ban on Chinese cotton from the Xinjiang province is beneficial for competitors such as Sri Lanka as brands are moving away from this region in search of new and
potential long-term strategic clients which can bring in a higher volume of orders. However, the USA and EU have been affected greatly due to Covid-19, which may
worsen even further this year and can lead to a fall in purchasing of clothing items. Furthermore, cotton prices are likely to increase in 2021 which can hinder margins
for apparel sector firms. A successful rollout of the vaccine will improve consumer sentiment and be pivotal to the performance of the apparel sector.

Consumer Services – Negative

The sector turned red with significant losses made due to the closure of borders for tourism amidst COVID-19 global pandemic. GoSL reopened borders for tourism on
21st January spurring hopes of recovery for the sector. However, we believe tourist arrivals will remain significantly low due to the concerns of virus infection. Therefore,
city hotels will continue to see earnings pressure as the sector is highly levered with higher administration, maintenance, and finance cost amidst SLFRS - 16 effect
whereas, resorts are likely record better results in comparison (albeit weaker performance in the past) as both locals and foreigners are scheduled to travel outside of
Colombo.

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Sector wise outlook
Materials Sector – Positive
Export Oriented – A hedge against a possible LKR depreciation
HAYC – One of the leading activated carbon manufacturers in the world benefitted from increased demand on its segments of gold extraction and face masks leading to
higher margins. Given the untapped potential in the global market share, HAYC is planning on adding capacity whilst focusing on improvising and producing value-
added products.
DIPD– Glove manufacturing entity with the presence of plantations will continue to benefit from the significant demand generated under the COVID-19 environment.
The company has publicly announced the construction of a plant adding more capacity to match the excess demand.

Agricultural and Chemicals - Positive

Favorable policies proposed by the GoSL under Budget 2021 coupled with the increased agricultural activities have supported counters such as CIC and AGST gaining
more demand on the fertilizer segment. Given the strong stance taken by the GoSL, agricultural activities are ought to witness a boom amidst the promotion of local
producers. Therefore, we believe, agricultural produce and fertilizers will continue to experience strong demand whilst concerns of LKR depreciation on raw material
imports which might be passed into customers.

Cement – Positive
Benefitting from the import restrictions coupled with a low interest rate environment driving residential construction, TKYO has announced its capacity expansion
project indicating the potential demand for Cement. We believe TKYO will generate impressive earnings in 2021 with the resumption of construction activities as
outlined in the Budget 2021 coupled with the use of housing loans within a low interest rate environment.

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Sector wise outlook
Telecommunication - Positive
The sector includes DIAL and SLTL with intense competition between the counters to gain market share. The sector is benefitting from the current practice
of working from home whilst social distancing measures led to the increased usage of social media to stay connected with families, relatives, friends etc.
Therefore, we believe the sector will continue to gain from the higher usage of data under the current context. Furthermore, digitalization initiatives taken
by the corporations will be beneficial for the sector whilst concerns of heavy competition and the impact of the depreciation of LKR will continue to persist.

Transportation - Positive
The COVID-19 outbreak has swept the freight industry by storm, with freight rates escalating to new highs during the pandemic. Uncertainty in port
operations and airline availability globally has led to freight rates increasing three to four folds within a short span in time. EXPO.SL 1H FY21 exceptional
performance was aided by catering to the emergency need for PPE (Personal Protective Equipment), chartering standalone flights.

We believe higher freight rates will aid the 2H FY21E performance with core business volumes returning to pre-Covid levels by 3Q FY21. As vaccine
distribution gets underway, we believe the hype in the freight industry to grow in the near term, albeit expecting a gradual decline in freight rates towards
the end of 2021.

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Sector wise outlook
Utilities – Positive

Sri Lanka continues to face challenges in catering to growing electricity demand, due to the vacuum in larger-scale projects. The present government
intends on expediting large projects with the approval given for a 300MW LNG plant in Kerawalapitiya followed by a 120MW wind power plant which was
commissioned in Mannar recently, moving towards increasing the use of cleaner energy to 70% by 2023. We believe many large-scale projects; LNG, wind
and solar will be commissioned during the next three years in catering to the large infrastructure drive, as emergency power is expected to cost the CEB
LKR 436bn between 2021-2023.

Listed power companies exposed to hydropower will benefit from higher avoided cost tariffs due to the alternative use of fuels. However, expired PPA plants
will be renegotiated at lower rates. Rainfall will continue to be a deciding factor on overall performance. We believe listed power entities are moving into
other renewable energy sources viz wind and solar which has gained in demand. Diversification into other renewable energy sources have made listed
power entities prospective investments in the medium term. VPEL.SL – remains a good dividend play enjoying higher tariffs for Denewaka Ganga and
Kiriwaneliya plants until 2025 and 2026 respectively.

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BRS Top Picks
Stock CMP TP Upside DPS Total return Forward EPS PER (x) NAVS P/B (x) DY Thesis

We expect the gradual recovery in consumption, incremental contribution

CCS 635.25 923.00 45.3% 15.00 47.7% 30.51 20.8 166.20 3.8 2.4% from new stores and positive mix change in the manufacturing segment (higher
margin impulse products) to drive earnings growth

RCL 235.00 396.00 68.5% 14.00 74.5% 42.87 5.5 253.8 0.9 6.0% Will continue to benefit from the import restrictions. After restrictions are lifted
imports and local manufactureres will compete at a level playing field.
TILE 174.25 316.00 81.3% 16.15 90.6% 36.77 4.7 166.8 1.0 9.3%
Imports wont be as cheap as before due to the depreciating rupee and expected
higher duties. Construction activity expected to pick up. Low interest enviornment
LWL 177.25 346.00 95.2% 13.60 102.9% 39.33 4.5 235.39 0.8 7.7% to boost the overall sector.

A good dividend play until the remaining two plants PPA ends in 2026 and 2027
VPEL 7.20 8.30 15.3% 1.00 29.2% 0.69 10.4 3.55 2.0 13.9% respectively.

COMB 84.50 100.00 18.3% 6.50 26.0% 17.95 4.7 140.88 0.6 7.7%

SAMP 150.50 190.00 26.2% 8.25 31.7% 31.53 4.8 323 0.5 5.5%
Strong liquidity, capital and asset quality buffers to support the expansion in loan
book. Improvement in credit sentiment with vaccine rollout amidst revival of
HNB 127.00 160.00 26.0% 8.00 32.3% 28.50 4.5 326.3 0.4 6.3% economic activities.

HNB(X) 99.90 130.00 30.1% 8.00 38.1% 28.50 3.5 326.3 0.3 8.0%

Source: BRS Research

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Bartleet Religare Securities (Pvt) Ltd

Email: research@bartleetreligare.com

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