Market turnover needs to revive to previous levels

Monday, 14 October 2013 00:10 - - {{hitsCtrl.values.hits}}

By First Capital Equities Despite a healthy economic backdrop and firm corporate fundamentals, turnover levels for the Sri Lankan equity market have been anything but inspiring in 2013 (on an YTD basis) with the turnover ratio declining from 9.8% in 2012 to 7.1% in 2013YTD.

We attribute the low volumes to the following factors:

High interest rates that prevailed during most part of the year have drained liquidity away from the bourse. As evident in the chart, the correlation between the 12 month bill rate and market turnover levels appear strong and we expect turnover levels to pick up once interest rates decline further.
Plethora of debenture offerings valued at approximately Rs. 40 b so far this year has reduced the appeal for domestic equities.
With foreign participation accounting for on average of 40% of market turnover over the last couple of years, volatility in global markets across all asset classes have dented flows into the Sri Lanka bourse this year
Relatively low institutional participation both by the EPF and mutual funds have contributed towards lower turnover levels in 2013 compared to previous years
Sluggish sentiment and risk aversion by corporates. Most corporates appear to invest surplus funds in money markets rather than equities.

A suitable panacea n More institutional participation required. We believe that the bourse has largely bottomed out at current levels presenting an attractive opportunity for long term investors such as the EPF to enter the market on a selective basis. Despite global liquidity constraints, long term foreign institutional investors appear to be utilising the current market conditions as an entry point to cherry pick blue-chip stocks notwithstanding their exposure to possibility of currency risk.

Domestic investors may need to incorporate fundamentals more significantly into their investment decision process in order to cherry pick high growth stocks trading at attractive valuations thereby leading to more equity market participation and consequently higher market trading activity. While most investors would argue that the bourse has certainly not delivered during the year, selected blue-chip stocks have however generated returns well above that of alternative investments such as T-bills and debenture offerings.

Market trajectory We expect the equity markets to gap up during the next couple of weeks with a break to the upside from the relatively sideways flag that we have been experiencing over the last couple of weeks. 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. 3Q2013/2Q2014 corporate results trickling in With the 3Q2013/2Q2014 corporate results now trickling in, we expect the ASPI to gradually change course over the next few weeks from its current sideways movement to a broader range bound upper trajectory supported by leadership mainly from fundamentally strong bellwether companies. We advise investors to be brave and take the leap by carefully selecting sectors and stocks that would benefit fully from the domestic growth story. We recommend an asset allocation strategy focusing on key sectors such as Banking & Finance, banking, Diversified and Hotels which we believe would outperform the market.

While we expect 3Q2013/2Q2014 earnings growth to be modestly higher than 2Q2013/1Q2014, we also expect the quality of earnings to improve during the quarter with greater contribution from core operations spearheading the earnings drive while non-core activities are likely to play second fiddle.
Consolidated margins are likely to improve on a QoQ basis on the back of core growth in operations which may smoothen out relatively lower other income generation.
We expect consolidated earnings to grow by 10-15% fuelled by an improvement in margins in the banking sector, higher volume growth from the diversified, F&B and hotel sectors and a recovery in margins in the manufacturing sector.