Attractive valuation, policy changes may stabilise Bourse: Asia

Asia Wealth Management believes attractive valuations coupled with policy changes could stabilise the year  to date 20% negative Colombo stock market as foreigners seize opportunities.

It said activities in the market last week were led by foreign investors while local institutional investors stayed sidelined.

At the same time a significant absence of local retail investors was witnessed due to lost confidence over the market and soaked liquidity due to lower portfolio values and limited availability of broker credit.

However, long prevailed sentiments over the accumulation of fundamental stocks by foreign investors extended to this week, realising a significant foreign inflow.

The week saw foreign purchases amounting to Rs. 823.8 million, whilst foreign sales amounted to Rs. 459 million, resulting in a net inflow Rs. 364.8 million.

“We witnessed a number of crossing transactions taking place on John Keells Holdings, Ceylon Tobacco, Sampath Bank, and Hatton National Bank. These transactions shed light on the future prospects of the Bourse, despite volatility over policy reforms and interest rates,” Asia said.

Total turnover for the week amounted to Rs. 1.8 billion out of which 34% was realised via block trades on aforementioned counters and total volume of shares traded for the week was 83.7 million. Furthermore, PCH Holdings, Dialog Axiata, Free Lanka Capital Holdings, John Keells Holdings, Panasian Power and Blue Diamonds (non-voting) topped the list in terms of volume during the week.

Market capitalisation stood at Rs. 1,856 billion, a dip of -1.5% WoW. The YTD performance was down 20.1%. Asia also said the ASI showed faint signs of stabilising within a low turnover framework towards the end of the week.

This partly indicates relative valuation of the market reaching attractive levels compared to regional peers. Colombo bourse is currently trading at a market P/E of 11.4 times which is 28.5% discount to India which is trading at 14.7 times.

“In this backdrop, coupled with the fact that South Asian economies tend to share fairly similar composition of economic risks and comparative advantages, we expect foreign involvement in Colombo bourse to increase keeping in line with regional trends,” Asia said.

Foreign share in Sri Lanka’s stock market turnover has remained in the range of 25% to 30% within the past three years, which is at present 10%-15%, well below the historical average. It further illustrates that relatively lower foreign participation in the market is likely to correct in the medium term.

The sectors to keep an eye on would be diversified, hotels and travels, banking and finance and healthcare, considering the interest shown by investors and the relative advantages the sectors share within the present global and domestic economic conditions.

Furthermore, the decision taken by the Central Bank of Sri Lanka to allow free transfer of funds from NRFC accounts will make capital flows into Sri Lanka more receptive towards country’s interest rate. This would make regional interest rates more comparable with that of Sri Lanka given that now there are no external factors to consider for the creditors other than the prospective yield in deciding the optimum destination within the region.

Hence, Sri Lanka is now in a position to benefit from her comparatively higher interest rates, which was earlier dampened by nonmarket regulations of flow of funds through NRFC accounts. The move will increase the effectiveness of interest rates as a tool to attract more foreign capital into the economy and hence, would assist to stabilise the rupee value against internationally traded currencies.

“It is likely to increase capital availability of private sector and in turn would possibly drive down interest rates in the medium term. The Government may take further steps to increase the threshold limit applicable for foreigners when investing in Government securities from the current level of 12.5 per cent with the aim of attracting more foreign inflows to the economy. The overall impact of these developments on future of Sri Lanka’s equity trade may prove to be constructive given that they may assist to wither off any undue pressure on the Bourse if external situation of the economy turns further negative,” Asia Wealth Management said.

With both buyers and sellers largely sitting in the wings, as we head further into the third quarter, DNH Financial expects market activity to remain relatively restrained in the near term.

“However we expect momentum to gather steam in the medium to longer term with a break to the upside from the relatively sideways flag that we have been experiencing so far. Consequently, we view the current market environment as an opportunity for investors to clean their books, re-align their portfolios and reposition themselves with a flight to quality,” it said.

DNH Financial also advises investors to break away from the herd, maintain a healthy investment horizon and focus on companies that will deliver quality earnings despite high interest rates.

“We further advise investors against seeking speculative positions but focusing on quality companies that will generate double digit returns over a reasonable investment horizon,” the broker said.

Given the twin impact of the rise in oil prices and high interest rates, it advises investors to carefully analyse the cost and capital structure of companies before considering investment avoiding those that may have high energy costs (and are unable to successfully pass on price increases to consumers) and are overly leveraged as such companies may experience margin erosion both at the operating and net level.

“We reiterate the need to consequently focus on cash rich companies that will benefit fully from the domestic consumption cycle,” DNH Financial said.