DNH Financial says market can be beaten

DNH Financial Ltd., is confident that investors can beat the bearish market provided a portfolio is built comprising most compelling companies in the ASPI not only based on macro-economic fundamentals but closely tied to local consumption dynamics.

This assessment is contained in DNH’s weekly stock market review, excerpts of which are as follows.

A flash in the pan

Breaking the silence of what was an otherwise relatively quiet trading week, the Sri Lanka bourse gained 2.7% on Wednesday on news of a change at the market regulator. The rise nevertheless proved to be only short lived with the market succumbing to retail selling pressure during the ensuing days. Bucking the downward trend however, the IPO of People’s Leasing Company (PLC) was oversubscribed on its opening on Thursday. PLC which is a fully owned subsidiary of state banking giant People’s Bank offered 390 million shares at Rs. 18. Notwithstanding Wednesday’s ‘flash in the pan’, on a week on week basis, the ASPI and MPI remained virtually unchanged up by just 0.93% and 0.65% to end the week at 6407 and 5699. Market turnover of LKR6.5 bn (+141%WoW) was boosted by parcels of Galadari, Hayleys and HVA foods changing hands that collectively accounted for 40% of the week’s total. Reflecting a modest improvement in sentiment, gainers outpaced losers with Infrastructure Developers, Serendib Land and Kalamazoo recording a81.5%, 48.7% and 29.6% rise and offsetting declines in Beruwela Walk Inn, Huejay and Bimputh Lanka which lost 16.7%, 13.6% and 13.1% respectively. Global markets meanwhile remained jittery throughout the week following political uncertainty in Greece and the lack of any concrete details with regard to the EU bail out initiative. With both buyers and sellers largely sitting in the wings in anticipation of a market trigger, as we move deeper into 4Q2011, we expect the current earnings cycle to underpin market trajectory. While we expect market activity to be relatively restrained in the immediate term, 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 to take advantage of the market’s anticipated break to the upside. We consequently advise investors to break away from the herd, maintain a healthy investment horizon and focus on companies that will deliver quality earnings.

3Q2011 Corporate results…the story continues

While a mixed bag of corporate results were released this week, the majority of the results were largely positive with strong top line growth driving firm bottom-line growth. John Keells Holdings, a proxy to the economy reported a net profit growth of 38% to Rs. 1.75 billion for the 3Q2011 (adjusting for an extra-ordinary capital gain of Rs. 1.79 billion during 3Q2010) firmly epitomising the strength of the domestic economy. Although growth appears to have been generally broad based for the conglomerate, the transportation, leisure and consumer foods segments reported the strongest contribution.

Overall consolidated revenues are up 22% for companies that have reported their 3Q2011 corporate results so far together with a 2% improvement in operating margins on the back of a general reduction in costs and operating efficiencies. Notwithstanding lower other income generation, (which has historically been a catalyst boosting earnings growth), consolidated earnings have grown by 17% for 3Q2011 companies.

Unravelling hidden gems

We believe that the risk trade of 2009 and 2010 has now given way to a highly active stock selection approach. With the 3Q2011 corporate results release in full swing, we believe that investors with a medium to longer term investment horizon will now have the ideal opportunity to sift through the market and unravel hidden gems that have strong intrinsic values and have hitherto been relatively undiscovered.

Is it possible to beat the Market?

While many may question the viability to re-enter the market on the grounds that is has not delivered on a YTD basis, we believe this window period of consolidation is vitally important for corporate earnings to catch up especially consideration the market’s lofty valuations following the 2009/2010 bull run. The question facing many investors seeking to invest in the Sri Lanka bourse is whether the country’s 8-9% forecast GDP growth and 35-40%+ corporate EPS growth is likely to be absorbed into market dynamics and momentum. We certainly think so but would like to highlight the fact however that the market’s transition from a historically momentum based trading model to a fundamentally based investment model is unlikely to happen immediately but rather in a series of stages. Considering this phased development process, we advise investors to be highly selective in their investment decision making in order to benefit fully from the market’s transitioning.

We advise investors to build a portfolio of the most compelling companies in the ASPI not only based on macro-economic fundamentals but closely tied to local consumption dynamics. With the Sri Lanka bourse increasingly transitioning from a macro to micro driven as in the case of Brazil and China, the ability to make supernormal gains will to a large extent consequently depend on a bottom up selection process. In this respect, we are buyers of selected stocks in the banking, diversified and industrial sectors which would benefit fully out of the domestic expansion and pass our tests of top line growth prospects, margin sustainability, quality of management and valuation.

We are also buyers of the Leisure sector but on a selective basis. So is it possible to beat the market going forward? Our unequivocal answer is “Yes” provided that you have a medium to longer term investment horizon. And how to do it is by identifying and exploiting mis-pricings through a robust stock selection process targeting alpha generation.