DNH Financial gives optimistic view on Bourse

DNH Financial Ltd., is taking an optimistic view on the prospects of the Colombo stock market providing some valuable advice to investors. Here are excerpts from a recent report published by ERI Group's DNH Financial’s Research Team.

Could Sri Lanka currently be the world’s most attractive emerging market (EM)? We definitely believe so. On the back of its strong macroeconomic outlook, a stable political environment, the sharp uptrend in domestic consumption, heightened foreign investor confidence, robust double digit corporate EPS growth and relatively low PEG vis-à-vis other EMs, we believe that Sri Lanka is in an enviable position to capture the world’s top EM position.

Recent weeks were a period replete with positive surprises; 7X oversubscription of the SL sovereign bond issue which says a considerable lot about the strength of FII confidence in the economy, upgrades by global ratings agencies re-affirming the robustness and sustainability of economic growth, double digit surge in tourist arrivals notwithstanding the slowdown in the global travel industry and most importantly, the release of strong 2Q2011/1Q2012 corporate results kicking in a new cycle of earnings growth.

Given the confluence of these factors we expect the Colombo bourse to comfortably break through the key resistance level of 7000 shrugging off any nervousness in the global markets.

Watch out for Healthy Top line growth

With the 2Q2011/1Q2012 corporate results season kicking in, we expect the majority of companies to record healthy top line growth on the back of robust macro-economic conditions and an uptrend in the domestic consumption cycle. This combined with improved margins will enable the bulk of the companies in our investment universe to achieve strong double digit 1Q2012 earnings growth. Nonetheless, we advise investors to be wary of those that may record unusually sharp earnings growth without a corresponding increase in top line revenues as this could indicate a one-off event or extra-ordinary item that could boost earnings.

Consequently, we emphasise the need to select companies that will report sustainable earnings growth with top line revenues leading EPS growth.

Market remains attractive on a PEG basis

It is highly important that we use the most appropriate valuation techniques when determining the relative worth or attractiveness of any emerging market and Sri Lanka is by no means an exception. For those investors who still believe that the Sri Lankan market is overvalued based on valuation yardsticks like market PE alone will be in for a pleasant surprise.

The current earnings cycle will deliver higher than expected growth that should drive down valuations notably that of PE while increasing the attractiveness of the market’s PEG which is now significantly lower than the majority of the world’s leading emerging markets.

Sri Lanka World’s Top EM?

In an environment of heightened global risk, we consider it extremely important for market operators and the government to enhance the visibility of the country’s economic and corporate performance to an international investor base.

With most Emerging Market (EM) investors still seeking supernormal returns, we believe that with the right amount of investor awareness, Sri Lanka can indeed attract a sizeable amount of FII interest. With the developed markets still battered by recessionary woes, combined with earnings slowdowns forecast for most EMs, Sri Lanka is in an enviable position to capitalise on foreign fund flows seeking investment opportunities given the prospect of a fast growing economy, a stable political environment, a robust domestic consumption cycle and strong double digit EPS growth. This in our opinion makes Sri Lanka arguably the world’s top EM.



Domestic factors will determine Market Trajectory

With external factors less likely to affect market trajectory, internal factors will continue to provide the necessary impetus for a market rerating. In this respect, we re-iterate the fact that strong domestic economics will provide the necessary backdrop for corporates to achieve sustainable EPS growth. Consequently, we advise investors to seek companies that have a business model mainly focused on domestic demand and consumption.

Buying in a Falling Market

With most investors having panicked during the past couple of weeks as the market recorded relative losses, we viewed the decline as a strong buying opportunity. In this respect our bull points were as follows;

• Confidence in the Sri Lankan economy is at an all time high. The country’s recent sovereign bond issue was oversubscribed 7X in a period of global uncertainty which says a considerable lot about the strength of FII confidence in the SL economy

• Domestic macro-economic and corporate performance will come in at near record highs against the backdrop of a stable political environment

• Valuation multiples such as PEG appear highly attractive leading to a market rerating

• Lack of alternative investment opportunities in other asset classes/or geographies that could generate returns comparable to Sri Lankan equities

Market to break through 7000 key resistance level

While we believe that the domestic bourse has largely bottomed out at current levels, we nevertheless accentuate the fact that it would be highly unrealistic to expect it to re-rate to former peaks as we expect the market to be far less speculative than previous periods.

Consequently, we expect the bourse to achieve moderate growth in the medium term and view the current market conditions as an opportunity for investors to gradually re-enter the market as stock prices now more realistically reflect corporate fundamentals and fair values. In this respect, we re-iterate the need to build positions in quality companies with strong business models, sustainable earnings growth and defensive attributes.

Notwithstanding the general nervousness in the global markets, we expect the bourse to break through the key resistance level of 7000 in the near term fueled by healthy 2Q2011/1Q2012 corporate results and positive investor sentiment. Although further volatility in the market, characterised by a series of rallies and pullbacks, cannot be ruled out, we believe that a carefully selected portfolio of fundamentally strong stocks will provide superior investment returns in the medium to longer-term.

In this respect, we advise investors to,

• Avoid trading on media headlines

• Select investments carefully, focus on investment, not speculation, while however being conscious of market dynamics

• Seek alpha rather than beta

• Carefully observe liquidity flows between sectors and stocks as these are an excellent indicator of market direction and sentiment

• Diversify risk in a focused and informed manner

• Focus on a company’s future earnings; the past is only a guide

• Select the right stocks, back them for the medium to longer term, and the market should take care of itself