Is CSE a blood bath or a gold mine?

By Ravi Abeysuriya

One cannot help but wonder whether the peace dividend has resulted in, the market being overpriced or is CSE a “bubble” waiting to burst. In the long-run, no stock market can sustain the kind of returns that CSE provided over the past two years.

It is worth noting that the Sri Lankan market PE multiple has now come down to around 19 times. Fortunately, timely action by the SEC prevented a blood bath, similar to that of Bangladesh here.  In comparison with MSCI Emerging Market Index of 13 times which consists of countries such as India, China, and Brazil, or with the PE multiple of frontier markets - the category to which Sri Lanka belongs to - is only about 10 times, Sri Lanka PE multiple stands out at 19 times.

Hence one can argue our market is still relatively overvalued.

In the medium to long term, I see CSE will be a “Gold Mine” as Sri Lanka will sustain a high economic growth and companies will continue to report robust results and have growth in earnings, gradually bringing down our valuations to more realistic levels.  Some of the key drivers are:

We are hoping to double the country’s per capita income to 4,000 USD by 2016; this requires maintaining GDP growth rates of around 8 percent over the years ahead.

A shift of wealth from West to the East is already underway – Like Hong Kong to China, Sri Lanka will become the gateway to India, an economy with 1.3 trillion dollar GDP and a market with over 1 billion people and one of the world’s second fastest growing economy.

Being located in a strategically advantageous location, Sri Lanka has potential to become a maritime, aviation, energy, knowledge and a commercial hub in the region and to integrate the domestic economy to the international markets.

We see similarities with our present economy and those economies of South Korea, Singapore and Hong Kong 25 to 40 years ago. Sri Lanka’s GDP per capita was 50 per cent higher than South Korea’s in 1950, while today, it is 75 per cent lower. Sri Lanka can emulate the growth of Asian Tigers.

Other countries that have recovered from prolonged civil wars such as Peru and Angola have experienced strong economic growth once peace dawned.

Since we were able to generate a growth rate of around 6% even during the war, Sri Lanka has the potential to generate close to double digit growth rates.

Investments in infrastructure, tourism and agriculture will create an increase in household income and spending in the war affected north & the east region.

This could lead to a growth of around 13% in the region, thus adding 1 to 2 percent per annum to GDP of Sri Lanka.

Currently we have only 255 companies listed on the CSE. We would witness lots of companies and even government owned undertakings making use of the CSE to raise long-term funds through corporate debt and equities for expansion.

There is a lot of potential to increase the investor base. A greater proportion of our savers will consider the CSE as a medium to build their savings instead of putting their money in savings accounts, given the low returns. We currently have only about 35,000 CDS account holders i.e. less than 1% of our population, actively trading in the CSE.

There would be more M&A activities for Sri Lankan firms overseas and vice versa and the money required would be raised as debt or equity through the CSE.

Of course, CSE has a few problems, similar to any other capital market. As a result reforms and developments are needed to take CSE to the next level.

What is required is we promote investor confidence, ethical practices that instill public trust in the market, and market intermediaries serve the best interest of clients, and robust regulatory standards that protect investors and advocate fair play.  

The need of the hour is the visionary leadership, to build our market. Some of the policy changes we would see soon are:

Stipulating minimum public float as a continuous listing requirement for companies listed in main board CSE to have more liquidity

Amending the SEC Act to provide for civil sanctions such as punitive penalties and disgorgement on offenders such as those who artificially manipulate the market prices

Facilitate the growth of Institutional investor base such as the Unit Trust Industry and encourage more trading of debt through CSE

Encourage full service brokers so that investors are able to diversify across all five asset classes and allow brokers to sweep credit balances to money market accounts and offer built-in cash management features

Paperless transactions and electronic confirmations, with CSE Board lot size being changed to one share and elimination of Odd Lot Board in the near future.

Fortunately, the size of the CSE has made it possible for few local high net worth investors and institutional investors to support the market at current levels without a major correction.

In the absence of these investors the CSE, the Gold Mine could easily turn into a bloodbath.

The lack of professionalism and objective fundamental research is one of the key criticisms of CSE. Most investors in CSE still trade on the peace dividend and the favorable macroeconomic conditions and not on company fundamentals.

Heraymila Securities strongly believe investors in the CSE should be diligent and make use of objective fundamental research on companies to pick companies that are fundamentally strong.  

Good fundamental research will help them identify companies that will limit losses in the event of a market correction, while still helping them to make money in the short run.

This article is based on the speech made by Ravi Abeysuriya CFA and Heraymila Securities Chief Executive Officer at the LBR LBO CFO Forum on Tuesday.