Value thesis more pronounced in Lankan equities; yet polarised risks make 2019 challenging

Thursday, 17 January 2019 00:05 -     - {{hitsCtrl.values.hits}}


  • Asia Securities’ 2019 Equity Market Outlook Report picks winners for the new year


Asia Securities Research expects the Sri Lankan stock market to offer pockets of opportunities for investors, in the year ahead, despite expectations that 2019 will in general be a challenging year for equities. The leading stock brokerage firm is recommending that clients take positions in stocks with specific growth opportunities in the current environment.

The Colombo Stock Exchange’s All Share Price Index (ASPI) currently trades at 8.5x trailing price-to-earnings (P/E) multiple, down from 10.1x at the beginning of 2018. Furthermore, the ASPI is trading at a 20% discount to the overall MSCI Emerging Markets (EM) index, which is the largest discount seen in the last five years. 

As widely understood, the local idiosyncratic risks (largely political and to some extent macroeconomic) led to Rs. 9.6 b (approx. $ 50 m) of foreign fund outflows from the stock market compared to Rs. 28.5 b in inflows in 2017 resulting in the dip in valuations. 

EM equities too saw a challenging 2018 as a stronger US economy, rising US rates, and the resulting weakening EM currencies leading to foreign funds exiting the EM asset class. However, the outlook for EMs has improved and is expected to mark a catch-up rally buoyed by an improving macro picture, strengthening currency and lower oil prices with the caveat of easing US-China trade tensions.

However, it is likely that Sri Lanka will not see a significant benefit from this trend in the short run, as the local conditions will keep foreign investors on the sidelines; 1) delayed budget reading that creates uncertainty about fiscal measures, 2) debt maturities of $ 5.9 b exacerbated by credit rating downgrade and the resultant pick up in refinance costs, and 3) uneasy alliance between the president and the UNF government, raising concerns on continuing policy divergence, are the largest residual risks factored in by investors. 

In addition, given the current high interest rate environment, the local high net worth and retail investors may favour the fixed income asset class and take a wait-and-see approach toward equities. Overall, these developments will drive soft momentum in 1H CY19.

However, from a macro standpoint, several catalysts could lead to better investor confidence in 2H CY19; 1) re-engaging with funding partners such as the IMF and making progress on other funding lines currently in the pipeline 2) managing the $ 1.5 b sovereign bond repayments in January and April, and 3) presenting the budget with streamlined fiscal policy, while continuing the reforms agenda, are key data points eagerly watched by investors. 

In addition, several tailwinds supporting growth momentum can lead to an improved outlook on SL; 1) pickup in agriculture and the related household income, translating to better consumer demand, 2) continued low oil prices and better hydro power generation leading to an improved current account balance, and 3) lower currency depreciation strengthening reserves.

Of the 12 sectors covered by Asia Securities, three are rated positive, with a neutral view on the rest. Banks are expected to see an improvement in earnings with the high impairments seen in 2018 falling away, while the telecommunication sector is expecting a tailwind for voice demand through the reduction of the telco levy. 

The consumer segment (FMCG and retail) currently experiencing muted growth should see its earnings recover in 2H CY18. In the manufacturing sector, export-oriented companies will see better results with the lower nominal LKR rates, while Non-Bank Finance sector and Leisure will remain under pressure in 2019, according to Asia Securities.

The top picks selected by Asia Securities Research in 2H CY18 returned 0.8%, outperforming the broader ASPI (-2.1%) and the S&P SL 20 (-7.0%) on a total return basis. The portfolio for 2019 is comprised of seven stocks selected based on specific value drivers, backed by the Asia Securities’ bottom-up views on each stock.