spen-initiation of coverage

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As at 31 Dec 2012 %

Melstacorp Ltd 40%

Rubicond Enterprises 16% Aberdeen Global As ian fund 7%

Aberdeen Asia Pacific fund 4%

Aberdeen Global As ia pacific fund 7%

0

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illions

Price volume

Avg. Daily Turnover(LKR mn) 64.5

Market Capitalization (LKR bn) 49

52-week High 136.3

52-week Low 100

Price Movement

1M - LKR119 0.7%

3M - LKR 120 -0.2%

12M - LKR 113.5 5.6%Key facts

Shares outstanding (mn) 406

Free float (%) 36%

Beta 0.8

Trailing Price/Earnings (X's) 12.7

Book value per share 65

Debt to total capital 33.8%

Dividend yield 0.8%

As at 09.04.2013

AITKEN SPENC

Price vs. Volume

Source – Company Annual Report and Filings



Price LKR Volume (000’s)

Long-Term Buy

Price (09.04.13) : LKR 119.8

Target Price : LKR 132

Sector : Diversified

Travis Gomez

[email protected]

Ini

31st Mar 2012 FY09 FY10 F

Net revenue (LKR mn) 29,000 23,795 24,

YoY % 7% -18%

EBIT (LKR mn) 4,112 4,032 3,9

YoY % 13.9% -2.0% -1.

Earnings to Equity (LKR mn) 2,040 2,060 2,5

YoY % 10.8% 1.0% 23.

P/E 4.2 18.1 2

DPS 0.5 0.6

Consistent performance de

We initiate our coverage on Aitken Sp

recommendation in lieu of its investments i

economy including tourism, logistics and po

the uncertainty over the future of the firm’s i

SPEN which commands both foreign instituti

currently trading at a slight discount based

year forward revenue and earnings CAGR of

Highlights

Tourism segment to sustain SPEN

albeit at a slower pace: With the conclu

2009, accelerated growth was witness

exponential growth in foreign tourist

group’s subsidiary; Aitken Spence H

Adaraan brand of hotel chains in Sri L

positioned to capture a sizeable slice of

segment witnessed a revenue growth o

Profit before tax (PBT) growth of 31%

Future direction of the strategic seg

expiration of the firm’s Power Purc

the next 3-4 years is a cause for conc

future direction of the firm. The closure

Embilipitiya in 1QFY12 for maintena

earnings contribution from the strategi

restoration of the revenue stream from

YoY jump in the segments revenue in 9

energy sector in Sri Lanka puts the futur

in question.

Trading at a discount based on absolu

We arrive at a price target of LKR 132 represents a price appreciation potential

against the current price of LKR 119.

attractive from a price earnings (P/E)

against the market and domestic pee

estimates the share is trading at a for

forward P/BV multiple of 1.7x in FY13E

SPEN

Source – Asia Wealth Management Co. (Pvt) Ltd estimate

10

tiation of coverage

11 FY12 FY13E FY14E FY15E

29 30,192 36,164 40,822 44,268

4% 22% 20% 13% 8%

57 5,604 6,074 6,986 8,030

9% 41.6% 8.4% 15.0% 14.9%

36 3,709 3,682 3,897 4,862

1% 46.3% -0.7% 5.8% 24.8%

6.0 12.3 13.2 12.5 10.0

0.7 1.0 1.4 1.4 1.5

ivered..

ence with a Long Term Buy

growth sectors of the Sri Lankan

er distribution counterbalanced by

nvestments in the power segment.

onal and high net worth interest is

n a DCF valuation reflecting a 3-

14% and 9% respectively.

rowth in the post-war context

sion of the 30-year old civil war in

d in the Tourism segment with

rrivals. Under the purview of the

otels (AHUN) its Heritance &

anka and Maldives, SPEN is well

his growth. As a result the leisure

f 26% YoY for 9MFY13 and a

oY for the same period.

ent in question: The impending

asing Agreements (PPA’s) over

ern as it brings into question the

of its long dated 100MW plant in

ce contributed to the decline in

subsector in FY12. Despite the

the plant as evident in the 47%

FY13, changing dynamics of the

e profitability of these investments

e & relative valuation

based on a DCF valuation whichof 10% for the 12-months period

0. The counter is also relatively

erspective, trading at a discount

rs (Annexure 3). Based on our

ard P/E multiple of 13.2x and a

.

s

pril 2013



2 Asia Wealth Management Co.

36%

15%

44%

5%

Tourism

Logistics

Strategic

Services

Best Corporate Citizen 2012

National green gold award 2012

UNWTO best practices in ecotourism 2011

Best tour operators hall of fame 2012

Top 3 in STING Corporate accountability index 2012

National energy efficiency awards 2012

Location Type Capacity

Completed

Embilipitiya Thermal 100MW

Horana Thermal 24MW

Matale Thermal 24MW

Ambewela Wind 3MW

Matale Mini-hydro 2.5MW

Planned

Bangladesh Thermal 200MWn/a Bio Mass 10MW

Fig 1 – Revenue composition FY12


Fig 2- Leading the way in sustainability..

Source – Company Filings & media articles

Fig 3 - Key brands represented

Currently downsizing its fleet i

wake of low freight rates brou

about by an oversupply of shi

The group has been the local

partner for TNT express for ov

decades

Entered into a joint venture wi

group in FY12


Fig 4 – Diversified Energy Mix


(Pvt) Ltd

Company Overview

From its simple beginnings as merchants

Spence, after an illustrious tenure of over 100

is one of the most-recognized brand name

competent management team, the group has

number of key segments of the Sri Lank Logistics, power generation and inward mone

Tourism

The firm is well positioned to benefit from

island via its investment in its subsidiary;

(AHUN) and associate Browns Beach Hotel

“Heritance” is one of the most sought after

Sri Lanka. Its three resorts Kandalama, A

combined room capacity of approx. 358 roo

luxury with environmental sustainability. Its

has enabled the firm to successfully enter

currently the group operates over 550 rooms

Resorts”. The firm’s commitment towards i

unique experiences to its clients is self-e

Heritance Maha Gedera which provides an

Logistics

The logistics segment which encompasses fr

and integrated logistics services has historical

segment in terms of its contribution towards

revneu CAGR of 9% & earnings CAGR of 22

the disappointing outlook for world trade

FY12 the sector managed to post a revenu

operations of LKR 847 mn; its best perform

the firm’s successful entry into South Afr

opportunities presented at the Hambantota

growth in the coming years.

Strategic

Historically, the firm’s three oil fired therm

bulk of the segments revenue. However, wit

PPA’s of the above plants, the firm has proa

sustainable energy generation sub-segme

currently being made in bio mass and windinvestments expected in the coming years.

years of experience in the operations and ma

expects to extend its services overseas a

finalizing the contracts for the building of tw

in Bangladesh. Hence we expect the returns

the revenues and earnings of this sector in

power management segment under strategic

expect the group’s investments in Garments

but minimal contribution towards the seg

associate investment in Elpitiya Plantatio

make a minimal contribution towards the str

structural weaknesses in the plantations secto

in the

ght

ps

r 3

ith the

Initiation of coverage

and commission agents, Aitken

+ years of operations in Sri Lanka

s in Sri Lanka today. Led by a

ade successful investments into a

an economy, including Tourism,y transfer operations.

the post-war tourism boom in the

Aitken Spence Hotel Holdings

(BBH). AHUN’s signature brand

rands in the resort hotels sector in

ungalle and Tea factory with a

s, are case studies for combining

ommitment towards sustainability

into the Maldivian market and

under its flagship brand “Adaraan

nnovation and providing new and

vident in its recently rebranded

authentic ayurveda experience.

eight forwarding, Courier services

ly been the firm’s most consistent

revenue and earnings recording a

% over a five year period. Despite

and decline in freight rates, in

of LKR 4.7 bn and profit from

nce to date, mainly on account of

ica. We expect this together with

port to account for the segments

l power plants accounted for the

h the impending expiration of the

ctively decided to venture into the

t with a number of investments

power technologies, with further In addition, given the firms long

agement of power plants, the firm

d is currently in the process of

100 MW thermal power plants

from these two ventures to sustain

lieu of the reclassification of the

segment investments. Further, we

and printing to yield a consistent

ent earnings. Further, the firms

s (ELPL.N) is also expected to

tegic segments earnings owing to

.




3 Asia Wealth Management Co. (Pvt) Ltd

Governance metric* SPEN Peers

No of board members 11 9

No of independent directors 5 5

Board members who own shares 3 5% of independent directors 45% 56%

% of board members who own share 27% 56%

Tenure of board members(Years) 6.7 4.1

Services

Aitken Spence has also managed to tap-in to the inward remittances which are a

vital source of foreign exchange for the economy via a joint venture with

MMBL Money transfer (Pvt) Ltd, the principal agent for Western Union in

Sri Lanka. The opening up of the North & East post war also provides

opportunities for domestic growth with approx. 300 new agents being added in

urban and semi-urban parts of Sri Lanka in 2011/12. The elevator services

segment also falls under the purview of the group’s services segment with the

group being principal agent for OTIS Elevators in Sri Lanka. We expect a

healthy contribution from this sub-segment due to the post-war construction

boom.

Fig 5 – Corporate Governance snapshot

*Based on latest available data

Source – Bloomberg

Group structure






-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

FY09 FY10 FY11 FY12 FY13E FY14E FY15E

LKR (mn)

13% CAGR

7% CAGR

0

20

40

60

80

100

120

Beginningof

social unrest

MaldivianPM

resigns

MaldivianPM

arrested

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

Industry Overview

Sri Lanka: Explosion in tourist arrivals with a 3 year CAGR of

30% recorded since ending of the conflict: The tourism sector in Sri

Lanka has been the focus of much analysis and discussion subsequent

to the ending of the three decade long civil war in 2009 which

triggered a boom in tourist arrivals. The government has incorporated

this potential source of foreign exchange into its development agenda

dubbed “5 hubs plus tourism” with an ambitious target of 2.5mn

tourist arrivals by 2016E. However, given the persistence of

comparatively high average room rates (ARR) and poor infrastructure,

legitimate questions are being raised with regard to the sustainability

of the tourism sector. We believe that the development agenda for this

sector must be assessed in the context of positioning the economy’s

natural and built resources to suit the needs of the prospective clientele

in an environmentally sustainable manner. This has been the core

strength of the group’s investment in Aitken Spence Hotels (AHUN)

which has never wavered in its commitment towards developing

sustainable tourism both domestically and abroad.

Maldives: Remains a popular destination despite heightened

political risk: Maldives recorded a 3% YoY growth in tourist arrivals

for 2012 due to the volatile situation that prevailed in the archipelagoat the beginning of the year. AHUN has a comparative advantage

relative to competitor hotel chains with more than 75% of its revenue

from the Maldives operations which enjoy comparatively higher

margins.

Relatively overpricedgiven

current tourist mix which

could adversely impact

futureoccu anc rates

Demand drivers

Tourist

arrivals

ARR rates

Exchange

rate

Arrivals for 2012 have met

government expected target

of 1mntourists asper

overnment data

Government policy to limit

forex mkt intervention

would make SL a relatively

attractive tourist destination

Supply drivers

New

entrants

Operating

expense

Regulatory

regime

The improved security

situation in the island has

attracted greater foreign

investments to the sector

Rising fuel, energy and raw

material costs due to

shocks to internal and

external factors

An increased awareness for

the need for eco-friendly

sustainable growth in the

industr

Source – Asia Wealth Management Co. (Pvt) Ltd estimates

Tourism

SPEN tourism segment revenue

While earnings of the tourism sector is unlikely to keep pace with the exuberance surrounding the prospects for the sector,we believe that the depressed exchange rate and the governments investment in physical infrastructure which encompasses

roads, highways, ports and airports and a greater awareness of the environmental impact could ensure the viability of the

sector in the long term.

Outlook for the segment

LKR (mn)

Thousands per month

Source – Sri Lanka tourism board


Fig 6 – Maldives tourist arrivals; sustained despite

political risks

Fig 7 - Sri Lanka tourist spending





-

1,000

2,000

3,000

4,000

5,000

6,000


LKR (mn)

13% CAGR

1% CAGR

60

62

64

66

68

7 0

7 2

7 4

7 6

7 8

2004 2005 2006 2007 2008 2009 2010 2011 2012

Sri La nka 's Score W orl d avera ge

# 1 4 8

# 8 9

#113

#113

0

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1000

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1-Apr-11 1-Jul-11 1-Oct-11 1-Jan-12 1-Apr-12 1-Jul-12 1-Oct-12 1-Jan-13

0

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150

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2011 2012

Strategic location in a fast growing region: Sri Lanka has beenconferred with a significant geographical advantage with the potential

to become a transshipment hub to fast growing markets such as India. At

present the Colombo port accounts for 15% of all transshipment cargo

with over 80% of the trade originating from India. Considering the

strong trade relations that develop between countries of close proximity,

Sri Lanka has the potential to become a trade gateway to the fast

growing Indian economy. The potential mutual benefits of such a

relationship that have been observed amongst other economies in the

region such as China & Hong Kong, has led the government to identify

the maritime sector as one of the key areas of development under its

“hub concept”. To this end significant investments have been made at

developing the Hambantota port as well as expanding the capacity at the

Colombo port by TEU’s 2.4 mn per annum. This coupled with

efficiency improvements at the Colombo port as indicated by the

improvement in the trade freedom score, Sri Lanka is expected to play a

noteworthy role in the freight forwarding & transshipment sectors.

Short-to medium term outlook for shipping remains bleak : As per

the latest IMF forecasts for the region, despite the more positive growth

outlook expected for the Asian region (6.7% real GDP growth for Asia

in 2012 vs. 3.3% for the world), the significant linkages that persist

between Asia & developed markets has resulted in a slowdown in

shipping activities. Clarkson which prepares the Clarksea index; aleading indicator of shipping activity expects a 0.49% contraction in

throughput for Asia in 2012. This has been reflected to a certain extent in

the YoY decline in the container volumes at the Colombo port for 2012.

(Fig 10). The slowdown has been further aggravated by an oversupply

of shipping capacity which has led to significant declines in freight

rates as indicated by the Baltic freight index. This also prompted a

number of large shipping lines such as Maersk and CKYH to cut their

respective capacities leading to a reduction in transshipment traffic.

Logistics


SPEN logistics segment revenue


While the significant cuts in capacity is expected to improve freight rates in the short term, the search for greater economies

of scale by shipping lines could prompt freight rates to reach steady state, albeit at a lower rate in the long term

Fig 8 - Efficiency improvements at Colombo port

Trade freedom score

Source – Economic freedom index


Fig 9 - Signs of slower activity..

Monthly ship traffic

Fig 10 - Baltic freight index


Index

Demand drivers

World

Trade

Carrier

capacity

Airfreight

rates

According to Economist

Intelligence Unit,W orld

tradeis expected to avg

6.5% till FY15E

Preference for ultra-large

container carriers with

higher capacities

Threat from airfreight likely

to remain low due to

comparatively high fuel

costs

Supply drivers

Freight

rates

Port

efficiency

Skilled

labour

Balticfreight index

expected to remain at a

depressed level due to

oversu l of shi ca acit

Capacity expansion and

cutting red tape would

improve the overall

attractiveness of Ports

SL’s shipping industry

currently faces a shortage of

skilled labour, likely to limit

ca acit ex ans ion





-

5,000

10,000

15,000

20,000

25,000

30,000


LKR (mn)

-8% CAGR

19% CAGR

Installed capacity (Mw) 2010 2011 % ChangeHydro 1,383 1,401 1%Thermal -Oil 1,390 1,407 1%NCRE 45 50 11%

Flat tariff LKR/kw 2012 2013 % change

Mini-hydro 13.04 16.7 28%

Wind 19.43 20.62 6%Biomass (dendro) 20.7 25.09 21%Municipal waste 22.02 26.1 19%

53%

47%

1%

Hydro Thermal -oil & Coal NCRE

40%

59%

1%

2010 2011

Recognition of environmental issues driving energy sector

dynamics: The heightened activity in the tourism sector has placed

environmental needs at the forefront of the government’s development

agenda. In addition to increasing the forest cover, the government has

committed itself to meeting 15% and 20% of the country’s energy

requirements by Non-Conventional Renewable Energy (NCRE)

sources by 2015 and 2020 respectively. To this end the government

has a number of generous proposals in its budget proposals for 2013 in

order to attract greater private investments towards the energy sector.

Contemporaneously, the government has explicitly stated in its budget

proposal for 2013 that oil based power strategies are to be

discouraged in the future. This has ramifications for the private

investors in oil based power ventures who contribute to the nationalgrid and may face lower tariff rates in the future.

Limiting factors: large initial outlays and long gestation periods:

While such generous concessions has resulted in an increase in private

investments in renewable energy, NCRE’s still account for less than

1% of total power generated in 2011. This is primarily due to the

significant cost outlay in terms of machinery which has to be

imported. A typical 5MW Biomass power plant requires an initial

outflow of approx.LKR 1.2 bn – 1.5bn. Further while most NCRE

projects remains attractive from an IRR point of view with returns on

investments in NCRE averaging approx. 11% for Sri Lanka, mostinvestors are dissuaded by the long payback periods of such ventures

which can be as much as 15+ years. In lieu of this the government has

further extended its concessions granted to the NCRE sub-segment in

its budget proposal for 2013 in the form of tariff concessions for the

importation of machinery.

Strategic – Power Generation (Largest sub-segment)

Demand drivers

Consumer

demand

Industry

demand

Govt

policy

IncreasingGDPper Capita

strongly correlates with

future energy demand by

households

Government policypromoting energy intensive

sectors such as sugar, steel

etc could bolster demand.

Consistency in the policy to

reduce oil dependence would

ensure sustained demand for

renewable ener sources

Supply drivers

Input costs

Cost of

Machinery

Tariff rates

Fuel prices expected to remain

high while input costs for

renewable may also rise due to

competition amongst suppliers

Tax exemptions grantedcomes as a welcome relief

to producers though LKR

depreciation will play a role

Tariffs rates for renewable

energy maybe maintained at

the current attractive levels

in the short run.


SPEN Strategic segment revenue


While the government has invested in non-renewable energy solutions such as Coal power in order to meet short term energy

requirements, in the medium to long term there is a clear signal on the part of the government to shift its energy mix in favour of

NCRE’s in order to achieve its objective of reducing the economy’s oil dependency.

Fig 11 - -Attractive tariff rates

Source – PUBSL

Fig 12 - Increased focus on NCRE’s..

Source – CEB statistical digest 2011

Fig 13 - ..But energy mix remains unchanged

Source – CEB statistical digest 2011





With the Central Bank achieving its USD 6bn target for inward remittances for the economy in 2012, the heightened focus

by the government would positively impact the inward money transfer sector in the short to medium term. However, we

caution that structural shifts in the composition of migrant workers and domestic macroeconomic factors must be

accounted for when determining the long term prospects of the sector.

0

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200

300

400

500

600

700

FY12 FY13E FY14E FY15 E

7% CAGR

LKR (mn)

33%

54%

67%

46%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2005 2006 2007 2008 2009

Un sk il le d S ki ll ed

5% 6% 7.8%

0%

10%

20%

30%

40%

50%

60%

70%

2007 2008 2009 2010 2011

Middle East South East asia

26.128.8

22.7

15.2

8.9

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

0.5

0

5

10

15

20

25

30

35

1990/91 1995/96 2002/03 2006/07 2009/10

Poverty headcount % of population Gin i Coeff icient

An integral part of the economic landscape – With close to 1/4th of the

domestic population employed abroad and with private remittances

accounting for over 50% of total exports, the government has correctly

identified the vital role played by inward remittances in earning foreign

exchange in order to meet the economy’s external obligations. To this end a

number of proposals have been brought forth via the government budget

proposal for 2013 in order to encourage foreign workers to use formal

channels of inward money transfers. While this fact coupled with a decline in

the share of Sri Lankan workers living illegally has led to an exponential growth

in remittance growth over the past 5 years, we identify two developing trends

which would impact the long term sustainability of this stable source of foreign

income.

Decline in poverty-led migration – Research by Hettige & Mayer reveal

that the key driver of migration particularly among unskilled and semi-skilled

female workers in Sri Lanka is due to poverty related factors. This has also

resulted in a high concentration of Sri Lankan workers in the Middle East

region. While political risk and safety standards too acts as a deterrent to

migration into the region we believe that the decline in poverty levels in the

island as indicated by official data could result in a slowdown in the growth

rate of annual departures for foreign employment in the long term.

Alongside initiatives to encourage greater inward money transfers, the

government through vocational training and other programs has made an

attempt to increase the skill level of migrant workers in order to enable them

to take up more lucrative jobs further up the value chain. Data published by

the Bureau of foreign employment reveals that the share of skilled male

workers has trended upwards although the reverse can be observed for female

workers. A 33% increase in the number of departures of professional

workers during the 1H2012 was also reported by the Central bank. The

implications of this on inward remittances have been studied by Amjad

(1989) whose studies revealed that the propensity to save is higher amongst

skilled & semi-skilled workers compared with unskilled workers. However

his research also revealed that the incidence of inward remittances was

lower amongst professional workers in comparison to other categories of

employment. Hence we believe that growth in the share of skilled & semi-

skilled workers would be a key indicator of the prospects of the inward

remittances industry.

Services – Money Transfer (Largest Sub-segment)

Demand drivers

Economic

growth

Political

risk

Consumer

awareness

Weaker than expected growth

in Middle-Eastern economies

could result in a slowdown in

remittance rowth

Political uncertainty in the

Middle East could disrupt

money transfers

Greater awareness of the

safety offered by

transferring money through

le al channels

Supply drivers

Governme

nt policy

Setup

costs

Forex

policy

Government promotion

efforts to encourage

migration through formal

channels

Costs involved in setting up

branches in

underdeveloped provinces

Government policy to

simplify procedures for

remittance transactions

SPEN Services segment revenue



Fig 15 - Limited impact on job composition

Female departures by job mix

Source – SLBFE

Source – SLBFE

Fig 16 - High exposure to the middle East

% of total foreign employment

Fig 14 - Towards more equitable growth

%Score

Source – CBSL





100

105

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115

120

125

130

135

140

8-Dec-11 8-Jan-12 8-Feb-12 8-Mar-12 8-Apr-12 8-May-12 8-Jun-12 8-Jul-12 8-Aug-12 8-Sep-12 8-Oct-12 8-Nov-12

1HFY13 results reveal

earnings up 35% YoY

Slowdown in container

shipment volumes at

Colombo port

Hotel association

satisfied with govt

2013budget

proposals

Fitch reaffirms SPEN's rating

at AA with negative outlook

SPEN reports highest e ver

PBT of L KR5.5 bn for

FY12, recognising sale of

stake of Colombo South

terminal stake to CMHI

Firm increases its

equity investment in

CINEC to 40%AHUN hotels recognised as

the most energy e fficient

Large transaction of

SPEN's stock which

accounts for 16.4% of

total equity3QFY12 results

released

SPEN enters best tour

operatorshall of fame

SPEN reports 13% growth

in PAT for 1QFY13

SPEN plans to

sell 30% stake of

port project to

China Merchants

Holdings

0

5

10

15

20

25

30

35

40

45

Revenue* COGS** GP Net operating

expenses

EBIT Finance

expense

Finance

inome***

PBT tax expense PAT Minority

ineterst

Net income

47% 18% 18% 16%

Shift in capital

structure towards

the sector average

has resulted in a

lower interest bill

High fuel costs

and exchange

rate volatility

resulting in a

30% YoY cost

escalation

100%12%

36%

15%

44%

5%

Revenue mixPAT mix

48%

13%

19%

20%

Adminex pense:

51% of all

employees

deployed in the

toursim sector

53%

2% 2% 2%4%

29%

Ta x expense

expected to rise

with tax revisions in

maldives and

expiration of tax

shields for power

sector

Financial snapshot – FY12

LKR (mn)

*Revenue net of tax

**COGS = Raw materials & consumables + other operating expenses (direct) + Change in direct inventories

***Includes share of associate company profits

Source - Company Filings

Event timeline (Dec 2011 – Dec 2012)

Price (LKR)

Source – Asia Wealth Management Co. (Pvt) Ltd





LKR mn 3QFY13 3QFY12 % Change 9MFY13 9MFY12 % Change

Revenue 9,206 8,124 13% 27,764 21,323 30%

Revenue tax (132) (120) 10% (386) (346) 12%

Net revenue 9,074 8,004 13% 27,378 20,978 31%

Cost of sales* (5,290) (4,710) 12% (16,671) (12,059) 38%

Gross profit 3,784 3,294 15% 10,707 8,919 20%

Other operating income (52) 53 -200% 18 152 -88%

Employee benefits expense (1,041) (917) 14% (2,918) (2,543) 15%

Depreciation and amortisation (354) (101) 250% (1,031) (855) 21%

Indirect operating expenses (1,133) (980) 16% (3,343) (2,916) 15%

Profit from operations 1,203 1,349 -11% 3,435 2,757 25%

Finance income 197 105 88% 590 326 81%

Finance expenses (388) (183) 112% (1,026) (488) 110%

Net finance expense (191) (78) 144% (436) (161) 170%

Profits from associates 62 21 193% 150 65 132%

Profit before tax 1,075 1,292 -17% 3,149 2,660 18%

Income tax expenses (168) (214) -21% (506) (451) 12%

Profit for the period 907 1,078 -16% 2,643 2,209 20%

Minority interest (205) (305) -33% (569) (542) 5%

Earnings to equityholders 702 773 -9% 2,074 1,667 24%

34% 33%

44% 50%

20%15%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

9MFY12 9MFY13

Tou rism S trate g ic Lo gist ics S ervice s

LKR mn 3QFY13 3QFY12 % Change 9MFY13 9MFY12 % Change

Tourism 834 893 -7% 1,801 1,370 31%

Logistics 102 169 -40% 423 628 -33%

Strategic (62) 162 -138% 794 547 45%

Services 44 28 54% 130 116 12%

Total 918 1,252 -27% 3,149 2,660 18%

51% 57%

21%

25%

24%13%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

9MFY12 9MFY13

Tourism Strategic Logistics Services

LKR mn 3QFY13 3QFY12 Change 9MFY13 9MFY12 % Change

Tourism 3,438 2,835 21% 9,320 7,393 26%

Logistics 1,542 1,362 13% 4,383 4,356 1%

Strategic 4,303 3,971 8% 14,223 9,672 47%

Services 132 112 18% 385 356 8%

Total 9,415 8,281 14% 28,312 21,778 30%

Quarterly financial performance

Source: Company Annual Reports & Filings

*Cost of sales = Raw materials & consumables + other operating expenses (direct) + Change in direct inventories

Sector revenue

Revenue Mix


Sector PBT


PBT Mix





% of total assets

LKR mn

25%

36%

31%

59%

44%57%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


Tourism Logistics Strategic Services

% of total revenue

31%41%

61% 41%

0%

10%

20%

30%

40%

50%60%

70%

80%

90%

100%

FY06 FY07 FY08 FY09 FY10 FY11 FY12

Tourism Logistics Strategic Services

0

5

10

15

20

25

30

35

40

45

50

FY07 FY08 FY09 FY10 FY11 FY12 FY13E FY14E FY15E

9% CAGR

14% CAGR

Financial analysis

Tourism- Improved security situation bolsters domestic sector investments

In light of the improved security situation in the country which had led to a

boom in tourist arrivals, the firm’s chain of hotels under the Heritance brand

proved to be a popular choice for tourists with the group’s tourism segment

recording a 21% YoY rise in revenue in 3QFY13. The firm is well geared to

meet the expected boom in tourism and is expected to continue to account for a

significant share of group revenue and earnings.

Logistics- Outlook bleak for short to medium term due to low freight rates

The integrated logistics solutions offered by SPEN in Sri Lanka continued to

outperform relative to a sample of global peers due to its exposure to high

growth segments in Sri Lanka as well as South Africa with revenue CAGR of

14% YoY over a 6-year period. It has managed to maintain an EBIT margin

averaging 15.4% over the period which is above the global peer average of

9%. The firm is currently planning on consolidating its operations given the

weaker short to medium term outlook brought about by slowing global trade

and high fuel costs.

Strategic- Future of power plants: Earnings growth potential in question

The power generation segment is the largest sub-segment within the firm’s

strategic investments which accounted for 59% of group revenue and 45% of

group EBIT in FY09. Since then investments have been channeled towards the

tourism sector with tourism sector accounting for 47% of group EBIT by FY12.

Uncertainty surrounds the future of the firm’s investments in its aging power

plants Namely; Matale & Horana oil fired power plants with a capacity of

24MW each and Embilipitiya with a capacity of 100MW. The sector has

historically made a stable contribution towards EBIT margin which has ranged between 15%-17% over 6 years. The aging plants have also put the reliability

of its plants in jeopardy which saw the closure of its 100MW Ace Power Plant

during the first quarter of FY12 which resulted in the firm incurring penalties

due to a breach of the PPA. However, the management has reiterated that it

remains confident that it will be successful in renewing its existing contracts

with the CEB and is determined that power generation remain one of the

group’s core sub-segment investments and has expressed interest in investing in

the energy-hungry South Asian region. An investment in this sector would

entail a significant future CAPEX expenditure with a long payback period.

Services- strong growth prospects ahead

Performance of the service segment was also sustained with the group recording

an 18% YoY revenue growth in 3QFY13 and revenue CAGR of 7% over a 5

year period. The firm’s exposure to inward money transfer services through its

partnership with Western Union enjoys high gross and operating profit margins

and is expected to benefit from the expected increases in private remittances.


Fig 18 - -Revenue mix


Fig 19 - Total assets mix: Tilt towards leisure..


Fig 17 - Revenue performance over time





ROIC (%)

Fig 22 – Consistent returns

ROIC (%)

23%

28%

25%

0%

5%

10%

15%

20%

25%

30%

-

1,000

2,0003,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

FY08 FY09 FY10 FY11 FY12 FY13E FY14E FY15E

NOP LA T A djuste d EBITA mar gin

0%

5%

10%

15%

20%

25%

FY08 FY09 FY10 FY11 FY12

Tour ism* Logis tics Strateg ic Services

Fig 23 - ROIC*, Capital employed & EBIT

margin** : Uneven growth

0%

5%

10%

15%

20%

25%

30%


WACC

ROIC

0%

5%

10%

15%

20%

25%

0 5 10 15 20 25

Tourism

Strategic

Services

Logistics

58%

18%

58%

6%

24%

Extraordinary items bolster earnings in FY12

While the Gross profit margin witnessed a slight dip in FY12 from 50.3% to

47.2% from the previous year, both the Profit before tax and net profit margins

witnessed a noteworthy increase. This was partly on account of the firm’s

subsidiary: Aitken Spence Shipping’s decision to divest itself of its investment

in the widely discussed Colombo South Container Terminal citing escalating

costs. This was accomplished through the sale of its 30% stake in the venture

to its partner China Merchants Holdings. This resulted in an extraordinary

gain of LKR 655 mn being recorded in FY12. This resulted in the firm

recording its highest ever profit before tax of LKR 5.5 bn and a 46% jump in

earnings to shareholders in FY12.

NOPLAT: Consistent performance

Given the presence of intermittent extraordinary items which makes

comparisons across time difficult, a more prudent indicator of firm performance

is the Net Operating Profit/Loss After Tax (NOPLAT) advocated by

McKinsey which considers only the earnings from core operations. Our

estimates reveal a consecutive increase in NOPAT over the past five years with

a 5 year CAGR of 11%. We expect the trend in NOPLAT growth to be

consistent with a growth in NOPLAT CAGR of 9% over our forecast period.

ROIC: Value creation

Based on the core operations of the firm, we estimate that the firm has managed

to maintain a high return on invested capital (ROIC) over a 5 year historical

period. The firm recorded a ROIC of 24% in FY12 which is over and above the

current discount rate (WACC) of 14%. Hence while we expect margin

expansion to be more modest over our forecast period, we believe that the

earnings potential of existing investments is likely to remain strong.

CAPEX: Reinvestment needs concentrated in tourism & logistics segment

It is clear from fig 22 that Return on Invested Capital (ROIC) has been unequal

across segments across segments and over time. While our measure of ROIC

maybe potentially understating returns as average sector assets are used as a

proxy for invested capital (With the exception of the tourism sector where

AHUN’s ROIC is used as a proxy), nevertheless it is clear that returns on

strategic segment investments has been on a declining trend as the firm’s

investments in its long-dated furnace-oil powered plants reaches the maturity

stage. However, this together with the tourism segment accounts for 82% of the

group’s total assets. Therefore in order for the group to maintain a high earnings

growth rate which in the past has recorded a 26% growth on a CAGR basis

over a 4 year historical period, we expect the group’s capital expenditure in thestrategic and the tourism segment to be maintained at an elevated level.

Fig 20 – NOPLAT: Consistent contribution

from core operations

LKR (mn.)


Fig 21 –ROIC: value creation over time

(%)


*Based on AHUN’s ROIC


Capital employed (LKR bn)

Based on FY12 figures

*ROIC = Sector EBIT *(1- effective tax rate)/ Sector average total assets

**EBIT margin by sector is indicated within their respective bubbles

Source: Asia Wealth management Co. (Pvt) Ltd





Column1 FY09 FY10 FY11 FY12 FY13E FY14E FY15E

ROE 14% 11% 13% 16% 14% 13% 15%

Tax Burden 60% 61% 66% 68% 66% 65% 65%

Interest Burden 83% 83% 96% 97% 92% 86% 94%

EBIT margin 14% 17% 16% 18% 17% 17% 18%

Asset turnover 0.87 0.65 0.65 0.68 0.69 0.73 0.75

Equity Multiplier 2.33 2.06 1.92 1.95 2.02 1.91 1.80

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.91.0

5%

7%

9%

11%

13%

15%

17%

FY09 FY10 FY11 FY12 FY1 3E FY14 E FY15 E

A ss et tu rn ov er (X ) R OE( %)

Fig 24 – Efficiency Vs. profitability

Fig 25 - Tax bill expected to trend

upwards

Fig 26 –Financial leverage close to peer

average

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%


G & S taxes in Maldives

comes into effect

Expiration of

Matale & Horana

PPA's *

Expiration of

100MW

embilipitiya PPA

38%

29%

34%

15%

20%

25%

30%

35%

40%

45%

5 0%


Optimal capitalstructure

Peer Average

DuPont analysis

Asset Turnover

Asset turnover is a measure of how efficiently firm’s resources are being

utilized. The firm has historically maintained a high level of reinvestment with

an average reinvestment rate (Capital expenditure plus working capital

requirements) averaging 45% over the past five years. Capital expenditure has

particularly been focused on the tourism sector with the sector assets accounting

for 41% of total assets in FY12. As a result of this asset turnover has

historically been on a downward trend. In anticipation of future investments

in the sustainable energy sector and further investments in the tourism sector,

we expect only a relatively modest improvement in asset turnover from 0.68x in

FY12 to 0.75x by FY15E.

Tax burden

The tax burden is expected to rise in the future due to the expiration of tax

shields in FY13E and FY15E enjoyed by the firm’s investment in thermal

power plants. Further tax revisions in Maldives which accounts for bulk of the

leisure segment’s revenue would further raise its tax burden. This would be

offset to a certain extent by future investments in mini hydro and other

sustainable energy ventures which have in the past enjoyed tax exemptions.

Hence although the government has expressed its commitment to encourage

more sustainable energy ventures in the country, given the budgetary constraints

facing the Ceylon Electricity Board (CEB), we expect such tax concessions to

be maintained at the current rates. Further, given that the tourism sector would

continue to account for the bulk of the firm’s revenue, we project that the

effective tax margin will rise from 14% in FY12 to 18% by FY15E.

Equity multiplier

The equity multiplier measures the proportion of debt financing as a proportion

of the firm’s assets. The firm recorded a debt-to-capital ratio of 33.8% in FY12,

down from a high of 48% in FY08. Our estimates reveal that the optimal capital

structure for the firm based on the cost of capital approach is approx. 30%,

while the peer average of the diversified sector is 25%. We expect the debt-to-

capital ratio to be maintained close to the current level of 33.9% in FY13E

declining to 28.3% in FY15E.


A DuPont analysis quantifies our expectations for the firm in terms of number of key metrics. This mirrors our

future outlook for the sector and the firm


ROE (%) Asset turnover (X’s)

Effective tax rate (%)


Debt-to-capital ratio (%)






-

1,000

2,000

3,000

4,000

5,000

6,000

0

5

10

15

20

25

30

35

40

45

FY07 FY08 FY09 FY10 FY11 FY12

Invested capital excluding goodwill Total funds invested

Funds Invested (LKR bn) YoY change (LKR mn)

Fig 27 – Shift in preference towards

inorganic growth

Future Outlook

As per company announcements and management disclosures, we believe that

the following sectors would experience the most dynamic changes over our

forecast period .

Tourism: Capacity expansion and new investments expected to continue:

32 new water Villas in the groups Maldivian properties, a 200 room four

stared hotel by the groups associate BBH as well as the re-launching of

Kalutara Ramada resort as “The Sands” are some of the capacity expansion

ventures completed over the year by the group’s subsidiary AHUN.

Uncertainty surrounded the group’s project in Ahungalla to build 55 luxury

Villas as part of a joint venture with the Sixth Sense Group with the firm

recently announcing the termination of the agreement due to delays caused by

changes that took place in the top management of the foreign counterpart.

Strategic: Significant overhaul expected as firm’s energy mix realigns to new

dynamics.

The group, in the event of a non-renewal of the existing PPA agreements may

seek to rebalance its exposure away from oil-fired energy generation and shift

towards more sustainable power solutions in the domestic economy. The firm is

however building on its long expertise in managing oil-fired energy solutions

and is in the process of securing contracts for 2, 100MW power plants in

Bangladesh as per disclosures in the firm’s 2012 annual report. Further, the

management remains confident that it would be successful in renewing its

existing PPA’s while diversifying its operations within the power sub-segment.

Given its successful venture into the bio mass, wind power and other renewable

energy ventures as well as the attractive tariff rates on offer, the management

has expressed its interest in increasing its exposure in this sector with projects

such as a 10MW waste-to-energy project and greenfield projects such as

Solar and wind power under consideration. The strategic sector currently

accounts for 41% of the group assets, and hence any changes in this sector’s

composition would have significant implications for the firm’s profitability and

value.

Logistics: Likely to turn to inorganic growth

With the maturing of the group’s logistics segment we believe that the firm’s

strategy will be to consolidate its position in this segment. In the spirit of the

joint venture the group entered into with CINEC Maritime Campus in FY12,

we believe that the majority of growth in this segment would come from

inorganic growth.

Services: A more focused approach

A more focused approach is being adopted for the services segment and has

prompted the group led to the decision to reclassify the group’s Plant O&M

activity from the Services segment to the strategic segment. While no specific

ventures have been discussed by the management, we expect the group to make

adequate investments in this segment to take advantage of the opportunities in

the money transfer sub segment through the widening of the firms branch

network.






Key inputs

Model two-stage FCFF

High growth period 5 years

Weighted average beta 0.8

Weighted pre tax cost of debt 8%

Weighted cost of equity 16%

Marginal tax rate 13.8%

Debt-to-capital ratio 27%

Weighted WACC 14%

Terminal EBIT growth rate 4%

Fig 29 – Model assumptions

Fig 30 – Sector assumptions*

Sector Tourism Logistics Strategic Services

Revenue growth 6% 1% 15% 7%

EBIT margin 22% 10% 13% 31%EBIT growth -5% 5% 0% 7%

Reinvestment rate 41% 47% 0% 39%

Sector Beta 0.9 0.6 0.5 0.2

Revenue weight 31% 11% 57% 1%

Fig 31 – Sensitivity analysis

132 12% 13% 14% 15% 16%

2% 151 133 121 105 933.0% 160 139 127 108 96

4% 170 147 132 112 99

5.0% 186 157 141 118 103

6% 205 170 150 124 107

WACC

G r o w t h r a t e

Fig 32 – Price assimilation*

SPEN

LKR 127 136 127 136 127 136

P/E 13.9 14.9 13.2 14.2 10.6 11.4P/BV 1.8 2.0 1.6 1.8 1.4 1.6

FY15EFY13E FY14E

Fig 28 – DCF valuation

LKR mn

Enterprise Value* 67,405

Market value of Debt 17,793

Minority interest 4,959

Cash & Equivalents 7,054

Value of equity 53,683

Number of shares (mn's) 406

Intrinsic value per share 132

Current price 119.8

Upside/downside potential 10%

Valuation

We conclude our survey of SPEN with a discounted cash flow (DCF) model

which has been complimented by a relative valuation approach.

DCF Valuation

A two stage free cash flow to firm (FCFF) method with a five year explicit

growth phase has been used to take into account the accelerated growth

expected in the post war context. While a sum of parts (SOTP) valuation is

considered a more suitable valuation tool for a conglomerate, in the absence of

segment details on working capital, cash positions and contributions from sub-

segments, we believe that a group level valuation is more suitable to our

purposes. Applying a discount factor of 14% based on current market returns

yields a discounted value for equity of LKR 53.7 bn. This implies a per share

intrinsic value of LKR 132. Based on the current price of LKR 119.80 this

implies a price appreciation potential of 10%.

Revenue CAGR higher than historical growth: As highlighted in our sector

analysis we believe that the Strategic and Services segment will grow at a faster

pace over our forecast period while the revenue contribution from the Tourism

segment will be sustained albeit at a more measured growth pace. This

would result in group revenue CAGR of 14% over a three-year time horizon.

EBIT margins preserved: Based on our explicit forecasts for the sector we

believe that EBIT margins will average 17.3% over FY13E-FY15E which is

lower than FY12’s margin due to the absence of any extraordinary items. We

justify a sustainable EBIT growth rate of 4% for the firm which is a blended

average of the firm’s segment weighted average of sustainable growth given the

firm’s exposure to high growth sectors of the economy.

Reinvestment Rate: As highlighted in the financial analysis, a significantchunk of the group’s capex expenditure is directed towards the tourism and

strategic segment. Given that this sector is likely to be an area of focus for the

management we maintain a reinvestment rate (Net CAPEX plus net working

capital requirement) of 92% in FY13E. We expect a slowdown in the Tourism

segment’s returns over time with the tourism sector entering a more

normalized pace of growth which would also result in a lower reinvestment rate

to the historical average of approx. 40% by the end of our explicit period.

Finally assuming that ROIC reverts to its historical ROIC of 22% and a

sustainable EBIT growth rate of 4% we compute the reinvestment rate as 18%.

Price Assimilation

Based on a 52-week historical price movement, SPEN’s stock has been

observed to reach a maximum of LKR 135 over a 52-week time horizon. The

52-week historical price movement implies a price volatility of 6% against a

mean price of LKR 117. This implies a price deviation of LKR 7.06 with the

share expected to reach a price of LKR 127 against the current price of LKR

119.8 in the event of an upward swing with the current price assumed as the

mean.


*The average of estimates for the forecast period



Explanatory note

*The depicted price range is based on the following criteria;

The lower bound is based on an upward growth of 6% based on a 12-month standard deviation of

the stock against the 52-week mean.

The upper bound is the maximum closing price of the stock recorded over the same 12-month

period


*Computed based on Two stage FCFF model with 5 year

explicit period






7.6

12.7

5.1

0

2

4

6

8

10

12

14

Assets in Place Growth assets Trailing P/E

60%

40% 100%

P/E (x’s)

Fig 34 – P/E disaggregation

60

70

80

90

100

110

120

130

140

150

Fig 33 – P/E movementP/E analysis

An analysis of the price movements of SPEN (Fig 33) indicates that it is

currently trading at multiples between 13x and 15x, close to the 52-week

average P/E of 12.8x after having reached a high of LKR 135 (With a PE of

15x) during the 52-week period. This implies a price ranging from a low of

LKR 123 to a high of LKR 142. Using Damodaran’s methodology (Fig 34) of

P/E disaggregation, 60% of the 12-m trailing P/E of SPEN’s value may be

justified by assets in place with the remainder is accounted for by growth

prospects.

Relative valuation

Given the diversity in terms of the operations of local firms classified under the

diversified sector, it is difficult to draw an intuitive conclusion based on relative

multiples. However, it is clear that SPEN is trading at a discount relative to both

the sector and the Market in terms of the P/E and P/BV multiple. The relatively

lower multiples registered by the firm maybe as a result of the uncertainty

surrounding the future of the firms investments in the power generation sub-

segment. Based on our earnings forecasts the implied forward P/E’s of SPEN

for the years FY13E and FY14E to stand at 12.5x and 11.6x respectively.



13x

12x

14x

15x

Price (LKR)





SPEN.N FY12 FY13E FY14E FY15EPrice(LKR) 118 118 118 118

EPS 9.1 9.1 9.6 12.0

P/E 12.3 13.2 12.5 10.0

BVPS 61.4 69.1 77.3 87.8

P/BV 1.8 1.7 1.5 1.3

ROE 16% 14% 13% 15%

SPEN trailing P/E 12.7

SPEN trailing P/BV 1.8

SPEN ROE 14%

Market P/E 11.9

Market P/BV 1.6

Market ROE 13%

Sector P/E 15.5

Sector P/BV 1.8

Sector ROE 12% 80 100 120 140 160 180

FCF to firm

Current P/E

Price assimiltation

52-week High/Low

Current Price Intrinsic Price

-

50

100

150P/E

PBVROE

ASI Aitken Spence

-

50

100

150P/E

PBVROE

Hotels &Travels Aitken Spence

Fig 35 – Relative value analysis Fig 36 – Football field analysis

Fig 38 – ASI Vs. SPEN Fig 39 – Diversified Vs. SPEN

80

85

90

95

100

105

110115

120

125

Hotels &Travels AitkenSpence ASI

Priceindex

Fig 37 – 52-week price movement

Valuation Dashboard

Price (LKR)

Source – Asia Wealth Management Co. (Pvt) Ltd estimates Source – Asia Wealth Management Co. (Pvt) Ltd estimates

Source – Asia Wealth Management Co. (Pvt) Ltd research

Source – Asia Wealth Management Co. (Pvt) Ltd research





4,479

6,545

8,560

10,050

0

2,000

4,000

6,000

8,000

10,000

12,000

2009 2010 2011 2012

2009 2010 2011 2012

17%

Tourist arrivals (mn's)

Fig 40 – 15% depreciation of LKR in 2012

bolsters foreign interest

0

1

2

3

4

5

6

7

8

9

0

5

10

15

20

25

1 -Jan-0 7 1 -Jan-0 8 1 -Jan-09 1 -Jan-1 0 1-Jan-1 1 1 -Jan-1 2

EBIT Cover

1-Year treasury Bond

Yield(%) (X's)

Fig 41 – Comparatively lower exposure

Fig 42 – Growing interest of private sector

60%

40%

P ub li c P ri vate

57%

43%

2010 2011

Risks to our recommendation

In this section we address risks related to both the group’s earnings and risk to

our recommendation in terms of the expected stock performance and the target

price.

Exchange rate risk

The government’s decision to move away from a fixed exchange rate regime to

a managed exchange rate regime in early 2012 most acutely affects the

tourism and logistics sector. A depreciating LKR would be beneficial to the

tourism and logistics sector which would make the firms overseas operations

more profitable in Rupee terms and its domestic operations more competitive.

However other risks such as low occupancy due to high average room rates in

the case of tourism sector and low freight rates in the case of the logistics sector

may be overriding risks which could dampen revenue & earnings growth.

Further the firm may have to reassess the profitability of its future investments

in the sustainable energy segment particularly with respect to investments in bio

mass, wind and solar power where the machinery would have to be wholly

imported and account for a substantial portion for the initial outlay.

Interest rate risk

While the firm is relatively less exposed to burgeoning finance costs due to the

deleveraging which has been taking place since 2009, the significant volatility

experienced in domestic interest rates ensures that interest rate risk remains a

significant concern for the firm.

Competition risk

The firm’s operations which encompass tourism, logistics and power generation

have been identified as areas of high growth which have experienced significantearnings growth in the past 3 years. The encouragement by the government in

these key areas as part of its “5 hubs + tourism” development plan has

resulted in an increase in competition from both government and private sector

participants. In the case of tourism, the entry of new players both from within

and without challenges traditional hotel services players such as AHUN to

continuously innovate in order to maintain its competitive edge. The logistics

sector is also attracting significant competition due to investments made by the

government and the private sector in increasing port capacity and the

completion of the new port in the South of Sri Lanka. With respect to power

generation, the attractive tax concessions in the renewable energy sector have

attracted a myriad of private sector investments particularly in mini hydro and

bio mass ventures.

Source – Sri Lanka tourist board


Source – CEB electricity digest 2011





Pla nt type The rma l Mini Hydro Wind Bio Ma ss

Capacity (kWh) 125,000 2,500 3,000 600

Plant efficiency* 95% 70% 30% 85%

Tariff rates(Kwh)** 13.00 16.70 21.22 25.09

Average revenue ( LKR mn) 13,523 256 167 112

Fig 43 – Discontinuation of thermal powerinvestments poses significant revenue risk

Fig 44– Cost escalation could put margins under

pressure

Hotels tariff structure (HP 3) Current Proposed % change

Fixed Charge (LKR/month) 3,000 3,000 0%

Demand charge (LKR/KVA) 750 1000 33%

Fuel adjustment charge (%) 15 15 0%

Peak (LKR/KWh) 16.4 23 40%

Off peak (LKR/KWh) 8.85 9 2%

Day (LKR/KWh) 12.6 14 11%

Fig 45 – Increasing exposure to tourism could

drag up the group’s risk

Unlevered beta* EBIT Contribution**

Tourism 0.9 48%

Logistics 0.6 7%

Services 0.2 42%

Strategic** 0.5 3%

SPEN 0.6 100%

Business specific risk

Non-renewal of PPA’s

The PPA’s between Ace power (Pvt) Ltd and the Ceylon electricity board

(CEB) are set to expire in 2015/16. The management has also expressed its

intention of venturing into the sustainable energy sector through an investment

in mini hydro and wind power which currently enjoys attractive rates for

electricity generation. However given the pressure on the Ceylon Electricity

Board (CEB) to curb its operating losses, we expect a downward revision in

PPA rates. However if the firm is successful in renewing its PPA’s a

reassessment of our intrinsic value and hence recommendation could take place

given the significant contribution made by these investments to the sector in the

past.

Risk of input cost escalation

Escalations in prices of utilities including electricity, fuel and water continues to

remain a challenge for most sectors of the economy. SPEN is no exception with

regard to its leisure sector investments where heightened competition is

expected to further aggravate the prevailing situation. Our analysis of the

proposed electricity tariff revisions for 2013 leads us to conclude that the

negative impact on the tourism sector is particularly acute. As discussed in the

section on tourism, the high operating leverage associated with hotel services

increase the sensitivity of hotels to such changing cost dynamics. However, the

proactive measures undertaken by the group to promote a more sustainable form

of tourism has improved its operating efficiency. Further, the impact on cost

would be comparatively limited due to the firm’s high exposure to the Maldives

market. Cost factors would also dominate the top line growth of the freight

forwarding sector particularly with regard to air freight. While the government’s

rationale behind promoting Non conventional renewable energy (NCRE’s) is an

attempt to reduce the economy’s exposure to high fuel costs, industry analysts

point out that the lack of a systematic approach towards pricing and

licensing could threaten the viability of this sub sector due to cost escalations.

This is of particular concern for Dendro and bio mass power generation where

limited supply of raw materials (Primarily Gliricidia) could result in significant

price appreciations which could threaten the viability of the entire industry in

the absence of appropriate regulation.

Lack of diversification

The firm has experienced increasing exposure to the tourism sector over time

and now accounts for close to 36% of the firm’s revenue and 41% of firm assets

in FY12. This has transformed this diversified firm into more of a leisure

sector bet. This entails that SPEN will be overexposed to the risks specific to

the leisure sector, including the threat of new entrants, uncompetitive ARR’s,

high operating leverage etc. This has implications for the discount factor for the

group as the tourism sector has a relatively higher risk exposure as measured

by the beta (Fig 45). However, moving forward we expect the strategic segment

to account for a higher proportion of revenue and earnings over our forecast

period which would mitigate this risk to a certain extent.

*Based on research done on average efficiency of plants

**Based on power sector tariffs applicable for 2012-2013

Source - Asia Wealth management co. (Pvt) Ltd estimates

Source – CEB






Valuation risk

Modeling risk

Complex organization structure is an inherent weakness in most conglomerates

and SPEN is no exception. While we have not applied any arbitrary adjustment

to the discount factor to take into account the complex operations structure

given the firm’s commitment to move towards a more intuitive organization

structure for its core operations, the possibility of understating the earnings

potential of a firm is an ever present possibility. The lack of information

pertaining to the firm’s investments in subsectors such as printing, garments,

elevator services may not be fully captured in our intrinsic value. However

given that these investments account for only a small portion of total revenue &

earnings we believe that the possibility of a significant understatement of the

firm’s value is unlikely. A further issue relates to the groups significant land

bank categorized as freehold property which as at FY12 was valued at approx.

LKR7 bn. However, as this embodies both genuine freehold property as well as

land utilized for current operations or earmarked for future investments,

disaggregating freehold property proves to be a challenge. Hence we have opted

for the prudent choice and not included the value of freehold property in our cash flow valuation.





Profitability ratios FY09 FY10 FY11 FY12 FY13E FY14E FY15E

Revenue growth 6.5% -17.5% 4.0% 22.0% 19.9% 12.9% 8.4%

GP Margin 36.8% 48.4% 50.3% 47.2% 40.0% 41.1% 42.0%

EBIT Margin 14.2% 16.9% 16.0% 18.6% 16.8% 17.1% 18.1%

PBT margin 11.7% 14.1% 15.4% 18.1% 15.4% 14.8% 17.0%

NP Margin 7.0% 8.7% 10.3% 12.3% 10.2% 9.5% 11.0%

Liquidity ratios

Current ratios 1.3 1.3 1.4 1.3 1.6 2.1 2.5

Quick ratio 1.2 1.2 1.3 1.2 1.4 1.9 2.3

Efficiency ratios

Interest cover 3.7 4.1 5.4 8.1 4.4 4.5 6.9

Inventory Cycle (days) 25.8 39.8 44.5 38.8 33.5 34.2 33.3

Receivable Cycle (days) 75.0 85.7 70.1 79.3 110.6 123.0 121.5

Payables Cycle (days) 76.6 120.6 120.2 120.2 120.5 110.8 101.3

Cash conversion cycle (days) 24.2 5.0 (5.5) (2.1) 23.6 46.4 53.5

Gearing ratios

Debt to equity ratio 60.1% 48.5% 41.4% 51.1% 51.4% 39.3% 39.5%

Debt to capital ratio 37.6% 32.7% 29.3% 33.8% 33.9% 28.2% 28.3%

Investor ratios

ROE(%) 14.1% 11.5% 12.6% 16.1% 13.9% 13.1% 14.5%ROA(%) 12.5% 11.2% 10.5% 12.9% 12.0% 13.2% 14.3%

Pre tax ROIC 18.7% 16.4% 15.5% 19.7% 19.1% 19.6% 20.1%

After-tax ROIC 16.9% 14.6% 13.9% 17.0% 16.0% 16.1% 16.5%

Capital turnover 1.5 1.0 1.0 1.1 1.2 1.2 1.2

Asset turnover(X) 0.9 0.6 0.6 0.7 0.7 0.7 0.7

Equity Multiplier(X) 2.0 2.0 1.8 1.8 1.9 1.8 1.7

EPS 5.0 5.1 6.2 9.1 9.1 9.6 12.0

DPS 0.6 0.7 1.0 1.4 1.4 1.5 1.8

Annexure


Annexure 1: Quick performance review





LKR. mn FY09 FY10 FY11 FY12 FY13E FY14E FY15ERevenue 29,308 24,169 25,144 30,670 36,771 41,506 45,011

Revenue tax (307) (374) (415) (479) (607) (685) (743)

Net revenue 29,000 23,795 24,729 30,192 36,164 40,822 44,268

Cost of sales (18,315) (12,271) (12,281) (15,939) (21,698) (24,031) (25,675)

Gross Profit 10,685 11,524 12,448 14,253 14,466 16,791 18,593

Employee benefits expense (2,217) (2,624) (3,055) (3,580) (2,775) (3,241) (3,579)

Other operating expenses -Indirect (3,456) (3,345) (3,596) (3,989) (3,978) (4,899) (5,312)

Other operating income(expense) 391 150 254 698 241 289 347

EBITDA 5,403 5,705 6,051 7,382 7,953 8,941 10,049

Depreciation (1,260) (1,582) (2,002) (1,711) (1,802) (1,878) (1,943) Amortization & Impairment (31) (90) (93) (66) (76) (76) (76)

Profit from operations (EBIT) 4,112 4,032 3,957 5,604 6,074 6,986 8,030

Finance income 419 289 495 489 780 584 633

Finance expenses (1,125) (987) (731) (694) (1,369) (1,547) (1,169)

Net finance expense (706) (698) (236) (205) (589) (963) (536)

Associate company profits (9) 19 95 64 81 13 37

Profit before tax 3,397 3,353 3,816 5,463 5,566 6,036 7,530

Income tax expense (328) (366) (387) (753) (891) (1,086) (1,355)

Profit for the year 3,069 2,987 3,428 4,711 4,676 4,949 6,175

Minority interest (1,029) (927) (892) (1,001) (994) (1,052) (1,313)Earnings to equityholders 2,040 2,060 2,536 3,709 3,682 3,897 4,862

Income statement

Annexure 2: Financial Statements






LKR. mn

Non-current assets FY09 FY10 FY11 FY12 FY13E FY14E FY15E

Property, plant & equipment 22,636 23,329 18,525 22,531 23,480 24,281 24,855

Leasehold properties 1,505 1,468 1,359 2,549 2,545 2,540 2,536

Intangible assets 109 154 204 603 603 603 603

Investments 1,187 1,280 3,426 3,470 3,470 3,470 3,470

Finance lease receivables 2,232 1,920 1,280 427 0

Deferred tax assets 74 57 138 210 140 47 0

Other non-current assets 56 56 37 12 0

Non-Current Assets 25,510 26,288 25,940 31,337 31,554 31,379 31,463

Current Assets

Inventories 1,284 1,394 1,608 1,783 2,194 2,305 2,383

Trade and other receivables 5,834 5,344 4,159 8,956 12,961 14,555 14,911

Finance lease receivables due within one year 604 684 0 0 0

Amounts due from associates 161 125 23 6 4 1 0

Current investments 5 5 305 242 242 242 242

Deposits and prepayments 533 490 547 756 1,912 1,266 1,293

Current tax receivable 57 158 122 158 105 35 0

Short term deposits 2,020 2,752 5,059 4,355 3,493 3,684 8,043

Cash & cash equivalents 828 825 736 2,177 3,882 3,224 5,362

Total current assets 10,721 11,093 13,169 19,117 24,794 25,311 32,234

Assets classified as held for sale 149 162 181 149 149 149 149

Total Assets 36,381 37,543 39,290 50,604 56,497 56,840 63,846

Equity and Liabilities

Stated capital 2,135 2,135 2,135 2,135 2,135 2,135 2,135

Reserves 7,228 9,317 11,123 12,544 12,544 12,544 12,544

Retained earnings 7,715 7,442 7,959 10,250 13,364 16,697 20,962

Equity attributable to equityholders 17,078 18,894 21,217 24,929 28,042 31,375 35,640

Minority interest 4,553 4,566 4,161 4,680 5,066 5,460 6,062

Total Equity 21,631 23,461 25,378 29,609 33,108 36,835 41,703

Non-Current Liabilities

Interest-bearing liabilities 6,241 5,157 4,144 5,743 6,703 7,499 8,519

Deferred tax liabilities 198 278 253 429 286 95 0

Employee benefits 238 295 336 388 442 509 590

Non-Current Liabilities 6,677 5,730 4,733 6,559 7,431 8,103 9,109

Current Liabilities

Trade and other payables 3,909 4,191 3,912 6,583 7,738 6,848 7,410

Provisions 458 491 327 109 -

Interest-bearing liabilities within 1 year 1,866 1,541 1,718 2,135 2,271 2,541 2,886

Amounts due to associates 1 3 - 14 9 3 -

Current tax payable 135 147 180 287 120 40 0

Interim Dividend - - - - - - -

Other financial liabilities 58 58 58 58

Other current liabilities 136 150 180 358 187 101 58

Short term bank borrowings 2,162 2,470 2,912 4,867 5,434 2,303 2,681

Current Liabilities 8,072 8,352 9,179 14,435 15,957 11,902 13,035

Total Equity and Liabilities 36,381 37,543 39,290 50,604 56,497 56,840 63,846

Balance sheet






Market Cap (LKR mn.) P/E Fwd P/E* P/BV Dvd Yield ROE (%) Debt-to-capital (%)

48,760 12.7 13.2 1.8 1.2 15 33.8

211,825 13.3 12.2 2.8 1.2 16 20.0

21,900 14.2 N/A 1.1 1.4 8 46.2

13,293 12.6 11.3 1.5 1.8 13 17.8

14,016 9.9 8.1 1.2 1.8 14 24.6

Median 12.7 11.8 1.5 1.4 13.5 24.6

Average 12.5 11.2 1.7 1.5 13.2 28.5

Annexure 3: Peer comparison

*Based on Bloomberg peer averages






Important Disclosures

Equity Rating Definition

Buy – The stock is expected to deliver an absolute return greater than or equal to 15% within a 12-month time horizon

Long-term buy – The stock is expected to deliver an absolute return less than 15% but greater than or equal to 5% within a 12-

month time horizon. However, we maintain a positive outlook for the stock based on the underlying fundamentals and the future

growth prospects of the firm.

Hold – The stock is expected to deliver an absolute return less than 15% but greater than -5% within a 12-month time horizon.

Sell – The stock is expected to deliver an absolute return less than or equal to -5% within a 12-month time horizon.

Disclaimer

The report has been prepared by Asia Wealth Management Co (Private) Limited. The information and opinions contained herein

has been compiled or arrived at based upon information obtained from sources believed to be reliable and in good faith. Such

information has not been independently verified and no guaranty, representation or warranty, express or implied is made as to its

accuracy, completeness or correctness, reliability or suitability. All such information and opinions are subject to change without

notice. This document is for information purposes only, descriptions of any company or companies or their securities mentioned

herein are not intended to be complete and this document is not, and should not be construed as, an offer, or solicitation of an

offer, to buy or sell any securities or other financial instruments. In no event will Asia Wealth Management Co (Private) Limited

be liable for any loss or damage including without limitation, indirect or consequential loss or damage, or any loss or damage

whatsoever arising out of, or in connection with the use of this report and any reliance you place on such information is therefore

strictly at your own risk.

Asia Wealth Management Co (Private) Limited may, to the extent permissible by applicable law or regulation, use the above

material, conclusions, research or analysis in which they are based before the material is disseminated to their customers. Not all

customers will receive the material at the same time. Asia Wealth Management Co (Private) Limited, their respective directors,

officers, representatives, employees, related persons and/or Asia Wealth Management Co (Private) Limited, may have a long or

short position in any of the securities or other financial instruments mentioned or issuers described herein at any time and may

make a purchase and/or sale, or offer to make a purchase and/or sale of any such securities or other financial instruments from

time to time in the open market or otherwise, in each case either as principal or agent. Asia Wealth Management Co (Private)

Limited may make markets in securities or other financial instruments described in this publication, in securities of issuers

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ResearchManager - Research

BalakrishnanNirmalan (94-11)[email protected]

Corporates

han Silva (94-11)5320251Yogini Yogarasa (94-11)5320361

Salesnstitutional Sales

abriMarikar (94-11) 5320224 077 3-576868 sabri@asia

NiroshanWijayakoon (94-11) 5320208 0777-713645 niroshan@NiyazAboobucker (94-11) 5320213 0777-727352 niyaz@asi

ManjulaKumarasinghe (94-11) 5320211 0777 -874310 manjula@

ChelakaHapugoda (94-11)5320240 0777 -256740 chelaka@a

ChamindaMahanama (94-11) 5320223 0777 -556582 mahanama

HiranBibile (94-11) 5320238 0777 -352032 hiran@asia

NiroshanRathnam (94-11) 5320242 0773 -717515 ratnam@as

eevanHett igoda (94-11) 5320220 0773 -691251 eevan@as

arajFouz (94-11) 5320210 0773 -810159 faraj@asiaMiflalFarook (94-11) 5320247 0772-253730 miflal@asi

BranchesCSE Floor CSE,01-04, World Trade Centre, Colombo

Kurunegala Union Assurance Building, No.6,1stFloor,R

Matara E.H.Cooray Building, Mezzanine Floor, No:Matara

Galle Peoples Leasing Building,2nd Floor,No.118

Negombo Asia Asset Finance, 171/1, Station Road, Ne

Moratuwa Asia Asset Finance, No.18, New De Zoysa

Panadura Asian Alliance Building, 293, Galle Road, P

Kandy 132 2/7, Hill City Complex,D. S .Senanayake Street, Kandy.

Ampara Bandula Cinema Shopping complex, No-10Ampara.

Service CentersKiribathgoda Level 2-6,Udeshi City Shopping complex, No 94,Mak

Hambantota Hambanthota Chamber of Commerce, ThangalleRoad,

affna 62/20, First Floor, Stanley Road, Jaffna

AS

Assistant Manager - Research

AmaliPerera (94-11)[email protected]

Economy

DhanushaPathirana (94-11)5320254Travis Gomez (94-11)5320254

Statistician

Nuwan Pradeep (94-11)5320257

Retail Sales

capital.lk ShiyamSubaulla (94-11)532021

asiacapital.lk Pr iyanthaHingurage (94-11)532021 acapital.lk SubeethPerera (94-11)532022

siacapital.lk NelukaRodrigo (94-11)532021

siacapital.lk GaganiJayawardhana (94-11)532023

@asiacapital.lk ShamalPerera (94-11)532021

capital.lk NuwanEranga (94-11)532024

iacapital.lk RomeshPriyadarshana (94-11)532022

iacapital.lk RukshanLiyanage (94-11)532023

capital.lk NathashaMunasinghe (94-11)532023 acapital.lk IreshaFernando (94-11)532023

SharikaRathnayake (94-11)532020

1. ThusharaAdhikari (011)-573512M G Suranjana (011)-576353

ajapilla Rd, Kurunagala. AsankaSamarakoon (037)-562884GayanNishsanka (037)-564271

:24, AnagarikaDarmapala Mw, SumedaJayawardena (041)-567752LalindaLiyanapathirana (041)-567752MaheshaMadurangi (041) -562072

,Matara Road,Galle RuchiraHasantha (091)-562999

gombo. UthpalaKarunatilake (031)-567688

d, Moratuwa.CharithPerera (011)-523866

anadura RanganathWijetunga (038)-567040AsankaChaminda (038)-567040

NilupulHettiarachchi (081)-562850

RadhikaHettiarachchi (081)-562557TharinduPriyankara (081) -562557

3,D S Senanayaka Street, Ravi De Mel (063)-567907

NalakaDhanushka (063)-567907

ola Rd,Kiribathgoda DanushkaBoteju (011)-5634803KasunNavoda

,Hambantota. SherminRanasinghe (047)-5679240SamithEdirisinghe

GratianNirmalan (021)-5671800S.Puviraj (021)-5671801

IA WEALTH MANAGEMENT CO.(PVT) LTD21-01 west tower,

World trade centre,Echelon square,

Colombo 01, Sri Lanka


8 0773-502016 [email protected]

7 0773-502015 [email protected] 7 0714-042683 [email protected]




6 0777368012 [email protected] 8 0772548795 [email protected]


1 0777-569266 [email protected] 2 0777359012 [email protected]

9 0777567994 [email protected]

2 0773-688202 [email protected] 9 0773-954994


5 0773-687307 [email protected] 6 0778-628798 [email protected] 7 [email protected] 8 0773-687027 [email protected]


3 [email protected]


0 0777410164 [email protected]

7 0773692242 [email protected] 7 0777282586 [email protected] 1 0772-681995 [email protected]


0716-270527 [email protected]

0777681866 [email protected] 0775-486869 [email protected]

0777-567933 [email protected] 0775-096969 [email protected]

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