Expolanka Holdings IPO: Subscribe says CT Smith Stockbrokers

Expolanka Holdings, initially a local family-based exporter of fresh produce, was established in 1978 and has evolved into a recognised Group with interests mainly in transportation, international trading, manufacturing and strategic investment sectors.

The Group is a leading player in the transportation sector, with an expansive network that has extended to the Asian, Middle Eastern and Sub-Saharan regions. Expolanka’s experience, expertise and reliability have resulted in the Group being amongst the preferred logistics suppliers for global apparel brands and regional expansion over the years has been a combination of entering new, high-growth markets to better service existing long-term clients as well as capture new clientele.

The international trading sector, which is inclusive of the export and import agricultural products and the export of value added and bulk tea, is the Group’s second largest sector. Expolanka has plans for backward integration in the segment, whilst also aggressively venturing into value added and branded exports for fresh produce and tea.

With growth thus expected to be primarily driven by the transportation and international trading sectors and in particular by the freight forwarding and tea sub-segments, we expect Expolanka to post recurring net profits of Rs. 1,778 m for FY12E (up 53% YoY) and Rs. 2,437 m in FY13E (up 37% YoY).

At the IPO price of Rs. 14, Expolanka trades at PER multiples of 15.1X FY12E and 11.2X FY13E, offering strong recurring EPS Growth of 42% in FY12E and 35% FY13E, whilst also providing attractive ROEs of 28% in FY12E and 27% in FY13E. The Group also has a comparatively attractive PEG ratio of 0.4X in FY12E. Thus, with high growth expectations, strong regional presence, a recognised brand name and capable management team, we expect Expolanka to outperform the market in the medium to longer term. We thus recommend, SUBSCRIBE.

Introduction to Expolanka Holdings

Expolanka Holdings, initially a family-based company established in Sri Lanka as an exporter of fresh produce in 1978, has evolved into a recognised local Group with interests mainly in transportation, international trading, manufacturing and strategic investment sectors.

The Group is a respected local business with a strong franchise, experienced management team, and is a leading player in the transportation sector (primarily consisting of freight forwarding and airline GSA operations), with an expansive network that has extended to the Asian, Middle Eastern and Sub-Saharan regions.

Expolanka’s experience, expertise and reliability have resulted in the Group being amongst the preferred logistics suppliers for global apparel brands such as Marks & Spencer, Victoria’s Secret, Tommy Hilfiger and Diesel. Regional expansion over the years has been a combination of entering new, high-growth markets to better service existing long-term clients as well as capture new clientele.

The transportation segment is consequently the Group’s main source of earnings, accounting for approximately 53% of revenue and 72% of PAT during 1-3Q11. The international trading sector (inclusive of commodity trading) continues to play an important role in the Group, whilst the strategic investments sector, inclusive of BPO and tertiary education businesses have been successful ventures into potentially high growth industries in the future. Further, synergies pre-empted by the transportation sector has been a successful platform for the Group to explore new markets for existing and new products.

Given a recovering global economy led by emerging economies, coupled with bright expectations for an economic renaissance in post-conflict Sri Lanka, Expolanka has correspondingly re-aligned its operations to achieve the most effective and efficient use of Group resources.

Two sub-par performing Group companies, namely Denshun Industries (which had exposure to the local garments industry) and Expo Aviation (which operated a domestic air passenger service and was also a private carrier of international cargo) were divested in 2010, whilst management has also indicated aggressive plans to strengthen its presence in existing sectors and venture into new high growth sectors both locally and regionally.

Increasing Group presence in the local and regional transport and logistics sector and increasing production capacity of export items are thus a few of the planned strategies.

Initial Public Offering

With a view to strengthen the Group’s identity as an independent professionally run conglomerate and raise funds to further Group investments, Expolanka will make an offer for subscription for 172 m ordinary voting shares (8.8% of the Group subsequent to the IPO) at a price of Rs. 14 per share, to be listed on the Main Board of the Colombo Stock Exchange (CSE) under the ‘Diversified Holdings’ sector. The IPO will raise approximately Rs. 2,408 m, mainly to retire debt, enhance working capital and expand local warehouse capacity.

Prior to the IPO during December 2010, the major shareholders of Expolanka sold down approximately 317.6 m shares (17.8% of the Group pre-IPO) at Rs. 6 per share.

Transportation sector: Growth engine of the Group

Introduction

The transportation sector is Expolanka’s foremost business segment and consists mainly of freight forwarding, logistics management, airlines representation and exposure to the local hospitality industry, handling both inbound and outbound tourists.

Whilst offering traditional freight forwarding and logistics services across all regions, the segment also offers specialised services for the apparel industry and pioneering concepts like ‘Garments on Hangers,’ as well as the local perishable logistics market, which is complementary to the Group’s second largest international trading segment. As indicated before, success in this sector has been due to exceptional service standards, customised service offering to clients and reliability which has transpired to the Group being the preferred logistics partner for many well-known global brands.

Whilst Expolanka’s initial foray into the freight forwarding and logistics segment was via Expolanka Freight (set up in 1982), current regional offices are mostly under 100% owned Expolanka International. This core Group segment specialises in air and sea international trade, and has now expanded its reach to the Asian, Middle Eastern and Sub-Saharan regions, with exposure to 11 countries spread across 39 cities.

With years of experience and expertise, Expolanka has thus emerged as a leading player in the high growth South Asian region, with a notable presence in Sri Lanka, India and Bangladesh, where the Group has a total of 21 offices, 15 of which are spread across India.

Expolanka’s airline representation segment has also grown in significance since its foray into the sector in 1994. The Group is now the General Sales Agent for 13 airlines, primarily in the cargo space, spread across four countries, namely, Sri Lanka, India, Bangladesh and the United Arab Emirate. Expolanka’s venture into the hospitality industry in 1994, though initially to cater to the travel requirements of the Group through Classic Travels has now expanded to inbound (via Classic Vacations) and destination management (via Luxe Asia), the last of which handles inbound tourists with strategic partnerships in Sri Lanka, India and the Maldives.

Industry analysis and expectations

Given Expolanka’s International presence, in high growth frontier/emerging markets in the South Asian, East Asian and Middle East and North African region, the level and growth in international trade in these markets is a core driver for earnings.

Trade comprising India, Sri Lanka, Bangladesh and Pakistan amounted to US$ 523 b in 2010, rising at a five-year CAGR of 18%, driven primarily by India and Bangladesh. With future growth also expected to be driven by these countries, demand for logistical services are expected to increase in line as these services are facilitators of international trade, which would in turn be beneficial for Expolanka’s operations.

Although growth prospects in existing regions are attractive, competition on multiple fronts is also considerable. Expolanka competes with multinationals such as DHL, DB Shenker and Kuehne and Nagel, regional players such as Dart and Scanwell and local players such as Continental in India and Freightlinks in Sri Lanka. However the Group’s longstanding customer relationships and the ability to be more flexible in dealing with customer requirements than large process driven multinationals has been an enduring competitive advantage for the company.

Locally, Sri Lanka’s strategic location on the global sea trade routes combined with the capacity expansion at the Colombo Port and the new port at Hambantota (South of Sri Lanka) is a boon to its external trade sector, which should translate to higher earnings from Expolanka’s local operations. Recent Budget proposals to reduce anti-competitive practices at the port should also be an advantage to the company.

The Group has thus indicated plans to establish offices in the south of Sri Lanka to take advantage of the impending increase in business, whilst also increasing capacity at an existing warehouse which is in close proximity to a rail network.

World tourism is also on the rebound from the downturn witnessed subsequent to the global financial crisis. According to the World Tourism Organization (UNWTO), world tourist arrivals rose 7% YoY to 935 m arrivals in 2010 and are expected to grow 4-5% YoY for 2011E, with emerging destinations leading the growth.

Arrivals to Sri Lanka also witnessed a sharp upturn following the end of the conflict in May 2009, whilst an increase in local outbound travel was also witnessed. Total passenger traffic of 4.4 m passengers was recorded at the Bandaranaike International Airport (BIA), and is expected to increase in coming periods. The Government of Sri Lanka has set an ambitious target of attracting 2.5 m visitors to the island by 2016, whilst also doubling Per Capita GDP. Tourism in Sri Lanka is thus expected to boom in coming years, whilst increasing disposable income is likely to increase outbound travel, which will benefit Expolanka’s travel sector.

The overall sector has contributed approximately 53% to Group revenue and 72% to PAT. Freight operations in India and Bangladesh collectively contributed 25% to 1-3Q11 group PBT. We expect strong revenue growth in the freight forwarding sub-segment on account of high trade growth in existing countries and ventures into new high growth regions, whilst we also expect margins to remain stable.

On account of a recovery in tourism in Sri Lanka and increase in outbound travel, we expect revenue and margins in the travel sub-segment to increase in coming years. We thus expect the overall transport sector to be a core contributor to Group bottom line, and estimate approximately 88% of FY12E PAT (Rs. 1,783 m) and 83% of FY13E PAT (Rs. 2,321 m) to comprise of contributions from transportation.

International trading sector: Origins

Introduction

Exporting fresh produce was the initial venture of Expolanka, and this sector has expanded over the years and now deals in the export of other agricultural produce such as value added tea and import of agricultural commodities such as lentils, dates, dried fish, etc. Main export markets include the Middle East, Europe and Africa.

Under the perishables and value added products sub-sector Expolanka (Pvt) Ltd. is the leading exporter of fresh and desiccated coconut in Sri Lanka, where they control approximately 30% of the market of the former. Further, the company now manufactures and exports value added fruit products (i.e. dried fruits, fruit juices, fruit chunks in juice) and ethnic dry foods.

Expolanka Commodities, which is the main company in the commodity trading sub-sector, was established in 1980 to import and trade agricultural commodities such as dates, onions, red split lentils, dried fish, etc., and export spices and ethnic foods in consumer packs. The company is the third largest importer of red lentils and fourth largest importer of sugar into Sri Lanka, and also has its own factory to split and polish lentils, with a capacity of 200 MT a day. Further, the company also diversified into the import and marketing of cement under its ‘Expo Cement’ brand.

Expolanka has further diversified into the tea industry, where the Group exports bulk black and green tea as well as specialty and value added tea products under the brand ‘t-sips,’ to a range of 34 countries including the Middle East, Russia, Canada, Australia and Malaysia. The company is amongst the top 10 tea exporters in Sri Lanka.

Industry analysis and expectations

Sri Lanka’s agricultural exports amounted to US$ 2 b in 2010 (up 21% YoY) of which tea exports were US$ 1.3 b (up 16% YoY). Expolanka plans for the segment include backward integration where the Group will grow its own produce to mitigate supply volatility, and is also moving aggressively into branded exports, with fruits to be marketed under the new ‘Mo Fruit’ brand. Whilst working capital was a constraints in the past, Expolanka is likely to partially utilise IPO funds for the above said expansion plans. Further, a recent reduction in customs duty on imported agricultural products has also helped margins.

Coconut exports may be affected in the short term however, due to a decline in local production, which has resulted in a rise in local prices. Local coconut production was 2.3 b nuts in 2010 (declined at a 7% 5-year CAGR, amplified by a 19% YoY drop in 2010), whilst exports was 247 m nuts (declined at an 8% five-year CAGR). The Government though, is taking steps to address the dearth in production, and we expect margins from Expolanka’s coconut export business to improve in the future once supply and prices stabilise.

Though plagued by labour issues, Sri Lanka is among the main tea producers in the world with the ability to command premium prices due to superior quality. Total production rose 14% YoY to 329 m kg in 2010, though this is off a low base as production fell 9% YoY in 2009 due to adverse weather. Export volumes were 313 m kg (up 8% YoY) in 2010. Adverse weather conditions in beginning 2011 may once again hamper production in the short term, though we nonetheless expect overall production and export volumes to increase in the next few years.

With Expolanka being a leading tea exporter in the country, we expect increased bottom line contribution from the sector in the coming years, especially given the group’s aggressive venture into branded tea exports via their brand ‘t-sips’. Margins may be impacted in the short term however, as the Government has also increased cess on bulk tea exports. Further, unrest in key export markets in the Middle East and particularly in Libya and Syria may impact short term demand.

The overall sector contributed to 26% of revenue and 6% of PAT, with the bulk of results comprising of contributions from the tea sector. We expect the steady supply of fruits for exports, high demand in existing markets and higher margins from value addition to be beneficial going forward, whilst we also expect steady demand and prices for tea exports and higher margins from value added tea exports to boost bottom line in the medium term. We thus expect the sector to contribute to 10% of FY12E PAT (Rs. 216 m) and 14% of FY13E PAT (Rs. 402 m).

Manufacturing sector: Venturing into niche markets

Introduction

Expolanka diversified operations from its core sectors by venturing into the recycled paper and herbal pharmaceuticals segments with the establishment of Neptune Papers and Bio Extracts in 1993. Neptune Papers does the business of shredding and recycling waste paper, whilst also providing the service of secure shredding of documents for over 500 clients, including institutions such as banks and Government departments. The company has 19% market share of the waste paper export market in Sri Lanka, and shreds over 2.5 m kg of confidential documents per annum.

In the herbal pharmaceuticals sector Bio Extracts was established in 1993 and Expolanka Pharmaceuticals was established in 2002, of which the former is a manufacturer and exporter of Black Seed Herbal Products. Bio Extracts is currently one of the largest manufacturers of black seed oil products in the world. Expolanka Pharmaceuticals was established as the distribution arm of Bio Extracts to export the products under the ‘Baraka’ brand, and to market it locally under the ‘Nature Shoppe’ branded retail outlets.

Industry analysis and expectations

With competition limited to smaller stand-alone companies in both the recycled paper and herbal pharmaceutical segments, Expolanka seemingly has market dominance in both segments, which should transpire to earnings growth in the medium to longer term. With near-guaranteed access to raw materials for the recycled paper concern, the Group has indicated plans to explore new markets for their products. In a new product development strategy, Expolanka has also said it plans to venture into the metal trading service in the local market.

We expect the sector to turn bottom line positive in FY12E, and expect 1% PAT contributions to FY12E (Rs. 21 m) and FY13E (Rs. 29 m) respectively.

Strategic investments sector: First mover advantage

Introduction

Expolanka’s venture into the BPO industry and tertiary education was in 1999 by acquiring strategic stakes in HelloCorp (51% stake) and the Asia Pacific Institute of Information Technology Lanka (APIIT Lanka - 44% stake) respectively.

HelloCorp provides outsourced services for IT technical support, finance and accounting, back office operations and as such, providing services to clients around the globe. HelloCorp currently has a total capacity of 100 high-end BPO work-spaces in two locations in Colombo city.

APIIT Lanka is a tertiary education institute in Colombo, affiliated to APIIT Malaysia, providing degree courses in Computing and Information Technology, Business Management and Law. The institute also offers students the chance of completing the entire degree in Sri Lanka or transferring to a university in the UK or Australia after completing a period of study locally.

Industry analysis and expectations

The Government has stated intentions of transforming Sri Lanka into a knowledge based economy, with particular focus on ICT-BPO where significant growth potential and employment opportunity has been projected. Government officials have thus targeted revenues of US$ 1 b, whilst providing employment for 100,000 people by 2015E in the ICT-BPO industry. Earnings from the sector amounted to US$ 390 m in 2010 and are expected to grow 11% YoY in 2011E. The Government further granted VAT and Customs duty exemptions for IT products for the BPO industry in the recent Budget 2011.

There are over 300 IT and BPO companies in Sri Lanka, inclusive of companies such as HSBC, WNS Global Services, Aviva, Microsoft, Motorola, Industrial & Financial Systems (IFS), Amba Research, RR Donnelley, Quattro, Virtusa, and Millennium Information Technology (MIT). Whilst having been cited to be amongst the top global outsourcing destinations, Sri Lanka’s competitive advantage is in its cost advantage coupled with lower upward wage pressure. With heavy support for the BPO industry in general however, leading listed conglomerate such as Aitken Spence (SPEN) have also indicated interest in entering the sector, whilst John Keells Holdings (JKH) and Hayleys (HAYL) already have a presence in the sector.

Given that HelloCorp is an established and recognised business that has been in the industry for over 10 years coupled with Expolanka’s intentions to expand local BPO operations, Government incentives and increased demand are thus expected to be beneficial for the company in the short to medium term. Further, HelloCorp recently secured a contract from SriLankan Airlines to handle its Global Contact Centre operations, which should boost company bottom line in coming periods. Increase in competition in the sector in the longer term however, could likely impact margins and growth going forward.

In the latter part of 2010, the Government introduced a new Higher Education Act which maintained the current free education system whilst simultaneously opening up universities to private investment and allowed foreign universities to set up locally. With incentives such as Government tax holidays being offered, a total of 15 foreign universities have indicated keen interest in coming into Sri Lanka.

Australia’s Monash University, China’s Beijing State University and India’s Bangalore-based Manifai Medical Collage are among interested parties. The potential for the market though, is significant, with a large percentage of students who pass the A-level examination not being admitted to local universities due to capacity constraints and stringent entry requirements.

APIIT is currently amongst the more recognised local bodies offering degree programs, and the company thus has a brand advantage which can be leveraged to boost Group bottom line in the short to medium term, given the fast growing market for degree programmes. The competitive space though is likely to become more saturated, which will possibly affect APIIT margins in the longer term.

The sector contributed to 1.3% of revenue and 2.0% of 1-3Q11 PAT. APIIT contributed to the bulk of profits. Going forward, we expect the overall sector to contribute to 3% PAT in FY12E (Rs. 57 m) and FY13E (Rs. 80 m) respectively.

Forecast and valuation

With growth expected to be primarily driven by the Transportation and International Trading sectors and in particular by the Freight Forwarding and Tea sub-segments, we expect Expolanka to post recurring net profits of Rs. 1,778 m for FY12E (up 53% YoY) and Rs. 2,437 m in FY13E (up 37% YoY). The forecast net profit of Rs. 1,555 m for FY11E is inclusive of non-recurring items totalling Rs. 389 m, of which Rs. 313 m was on account of a capital gain on the divestment of Expo Aviation in 2010. Although the aviation sector posted Rs. 108 m 1-3Q11 PAT, due to the volatility involved, Group management divested the entity in late 2010.

At the IPO price of Rs. 14, Expolanka thus trades at PER multiples of 15.1X FY12E and 11.2X FY13E, offering strong recurring EPS Growth of 42% in FY12E and 35% in FY13E, whilst also providing attractive ROEs of 28% in FY12E and 27% in FY13E. The Group also has a comparatively attractive PEG ratio of 0.4X in FY12E, compared to other diversified holding companies. Expolanka paid a dividend of Rs.0.12 per share, which is a payout of 17% on FY11E EPS, and we expect the payout to be broadly similar for future periods.

The Group trades at favourable valuations to most Diversified Holdings sector peers with conglomerate John Keells Holdings (JKH) currently trading at a 22.8X FY12E PER offering 30% FY12E EPS Growth, whilst Aitken Spence (SPEN) trades at 22.5X FY12E offering 20% FY12E EPS Growth, and CT Holdings (CTHR) trades at 23.2X FY12E offering 79% EPS Growth. Hemas Holdings (HHL) though, trades at 13.6X FY12E PER offering EPS Growth of 35% FY12E.

With a comparatively attractive net debt to equity ratio of 5.3%, high growth expectations, strong regional presence, a recognised brand name and capable management team, we expect Expolanka to outperform the market in the medium to longer term. We thus recommend, SUBSCRIBE.