Blue chips and fundamentally-sound stocks key contributors to Bourse’s recent revival

The rebound in the Colombo stock market between late July and end September has largely been emphatic though a few sceptics continue to write it off as being not genuine or link it to play on junk and speculative stocks.

Some well-versed and qualified finance industry professionals too have succumbed to this notion, which some experts opined had checkmated sustenance of the recent revival. This apart, some uncertainty on interest rate scenario, spike in inflation and quick profit taking weakened overall investor sentiments. Some brokers, however, based on fundamentals and attractive valuations, suggest there remains a host of buying opportunities. This recommendation is largely on blue chips and fundamentally-sound second tier stocks.

The Daily FT has tracked the performance of top 30 stocks by market capitalisation, the price change on a year-to-date basis as of end June (when market was depressed) and end September (peak of recent revival) as well as compiled the list of double digit contributors to the benchmark All Share Index’s gain. This analysis confirms the larger rebound has been fuelled by the top tier stocks whilst fundamentally-sound companies too have benefitted from the retail-driven revival with sharp gains, reversals or their dip reduced. Between the last week of June and that of September, the ASI had gained by 22% and market capitalisation by Rs. 417 billion. The most emphatic development is the Rs. 10 billion increase in net foreign inflow between mid-July and last week.

For comments from – DNH Financial, Asia Wealth, Softlogic Stockbrokers, and CT Smith and table of double digit ASI movers - See page 2

Below are some observations from four brokers – DNH Financial, Asia Wealth, Softlogic Stockbrokers, and CT Smith.

DNH Financial in its weekly report opined that despite the last few days’ profit taking, the Sri Lanka Bourse is still up 19% for the past three months in dollar terms and is the best performing market in Asia during the period even though the market is down 4% and 20% respectively on a MTD and YTD basis.

In terms of relative valuations, although trading at a higher multiple than Pakistan, at its current PE of 11.9X ($ terms), the Sri Lanka Bourse appears attractively valued when compared to other Asian markets such as India, which is currently trading at 16.0X, or Taiwan and Japan, which are trading 24.6X and 22.2X respectively.

“We expect the market to trade sideways over the coming week pending the release of 3Q2012 corporate results. As such we advise investors to be appropriately positioned to take advantage of the likelihood of a moderate rerating in the market once the heavy weight stocks announce their results,” DNH said.

While the market’s rise last month is mainly attributable to retail buying rather than significant institutional or foreign interest, DNH still views market conditions as a healthy entry point for investors to cherry pick quality stocks on weakness and keeping in mind an investment horizon over the medium to longer term.

Although Balance of Payments pressures are likely to continue on the back of high oil prices and inflationary conditions may persist, Sri Lanka’s economic story still appears to be intact and will provide the necessary comfort to investors justifying the current market PE.

While anecdotal evidence suggests that investors generally do not tend to concentrate significantly on fundamentals during a bull run phase, the current lull in the market should be viewed as chance for investors to do their homework and seek out companies that will generate firm top line growth with robust cash flows and benefit from the strong domestic consumption cycle.

“Given that intrinsic values are more stable than extrinsic values (which are largely affected by external factors), we advise investors to look beyond the absolute price of a stock to its fundamental value which will ultimately determine its true worth, remembering that price deviations from value can occur only short term,” DNH added.

Asia Wealth Management said the growth prospects for the Sri Lankan economy remain strong compared with the region and are attractively valued on a P/E basis. This is further reiterated by the Central Bank’s decision to tighten monetary policy via open market operations in order to reduce inflation to more acceptable levels. This is evident in the net foreign inflow of around Rs. 1.1 billion recorded last week.

Commenting on the Bourse’s performance last week, Asia said activities at the Colombo Bourse remained muted for a second week as retail investors showed reluctance to respond to the policy directives enacted by the SEC in order to maintain the positive momentum that was witnessed since mid August.

This is evident in the low turnovers and volumes that would have been recorded over the course of the week, in the absence of large transactions on certain blue chip counters such as John Keells Holdings and Colombo Dockyard.

“This may possibly be due to fear instilled in the minds of minority shareholders over potential conflicts of interest that may arise as a result of the reversal of certain SEC policy measures as highlighted in the media, particularly with regard to the reversal of the policy with respect to trade restrictions imposed on directors and employees of licensed stockbrokers. Although the SEC maybe justified in its actions, policy decisions made in a haphazard and non-transparent manner raises risks for all parties concerned,” Asia said.

Softlogic Stockbrokers said following the 1,000 point bull run in September, the Bourse has taken a breather, with profit taking and margin calls dragging down the index close to +350 points. Amidst the slip in the index, most banking sector counters have lost ground with price depreciations to almost 15%.

“The plunge in banking counters has forced us to re-look at the banking sector, which could be identified as one of the cheapest sectors in the market with the capacity of a strong growth potential. We advise our investors to aggressively re-enter the banking sector as most counters trade below 10X PER on 2012E earnings. It is also pointed out that we are biased towards the larger banks amidst caps placed on credit growth,” Softlogic said.

CT Smith Stockbrokers in its monthly report said the Colombo Bourse rose 15% in September recording the highest MoM gain since September 2010. The average daily turnover rose to Rs. 1.67 billion as against Rs. 635 million in August.

“The indices were largely driven by a retail rally, which began end August and peaked in September, amidst declining interest rates. Since the sharp rise in prices during the month resulted in seemingly higher valuations across the board, a near term correction seems likely. Nevertheless foreign funds picked up fundamentally-strong counters which also witnessed sharp price increased during the month,” CT Smith said.