• EDI system for cabinet nod
• First step towards short selling
• Agribusiness pinpoints urgent reforms
• Rising crime: Singer to take guard
• Justin Meegoda calls for more assistance from DFIs
• Mind Your Business
• The flavour getting sweeter
• News

EDI system for cabinet nod

By Dinali Goonewardene

A proposal to facilitate EDI between the Customs Department, Ports Authority, Shipping Agents and freight forwarding departments of airlines was first mooted four years ago. It was expected to cut down bottlenecks at the port and reduce human intervention at the customs. The US $ 2.7 mn project took three years to obtain cabinet approval before falling by the wayside.

A private company, Sri Lanka Electronic Data Interchange Network Pvt Ltd (SLEDIN) was set up to implement the project with CINTEC playing an advisory role. The company's shareholders included the Sri Lanka Ports Authority, Customs Department, Sri Lanka Telecom, Export Development Board and the Ceylon Association of Shipping Agents. However the company was subsequently told by the Finance Ministry to desist from its efforts. SLEDIN's shareholders are now in a quandary as they face the prospect of losing out if the company closes down.

The EDI system which will enable the systems of different government organisations to interact without changing individual systems is vital to Sri Lanka. However analysts question whether an EDI system is outdated in an era in which the internet has taken over.

First step towards short selling

By Chanakya Dissanayake

Short selling gained its notorious fame after Malaysian President Mahathir Mohamad "naked short selling" a criminal offence punishable by death to save the Malaysian Stock Exchange from an agonising death caused by speculatvie naked trading. 

Short selling is a speculative practice where market players enter into contracts to buy or sell shares at pre-determined prices, without actually holding the shares. 

The type of short selling that is likely to be introduced to Colombo is short selling coupled with lending and borrowing. This will enable long term investors to lend the shares to their brokers, who in return will lend the shares to interested parties to short sell. SEC feels that this is a safer method of introducing short selling, rather than permitting naked short selling. 

Brokers will enter into contracts with both the lender and the borrower, to ensure the terms and conditions of repayment and time period. Both the lender and the broker will earn a fee from the transaction and the borrower will provide collateral against the borrowed stock. The contract can also include dividends and bonuses to be held in favour of the actual owner of shares.

This move is to facilitate more liquidity to the Colombo market, which is identified as a particularly illiquid market. Only 50% of all issued shares are lodged in the Central Depository System of the CSE and of these only 30 companies trade on a daily basis. However to introduce short selling the Central Depository System will have to be upgraded. 

Stockbrokers had a positive sentiment on short selling being introduced to the bearish Colombo bourse. Senior Fund Manager Namal, Probodha Sama-rasekera said, " The main problem will be the illiquidity of the Colombo market. 

What will happen if you short sell and could not buy the shares in the market? Initially it is better to start with the most liquid shares and later proceed to other companies".

Agribusiness pinpoints urgent reforms

Authority for agro-policy making is fragmented among many government and provincial authorities, responsible for agriculture, livestock and natural resources. As a reform measure an apex advisory council for agro-industry development is suggested. This body would comprise of main government ministries and agencies involved in agriculture. The main goal would be to identify and resolve constraints to agro development at national level.

The research has also pointed out the limited private sector consultation in policy planning. This has reduced the effectiveness of government initiatives and has increased investor uncertainty. Another constraint identified is the high import duty for packaging material. This has hindered the development of products suited for the world market. 

It is also proposed to abolish the import licence for wheat and corn. The present import licence functions as a non tariff barrier, limiting the competition in food and feed manufacturing industries. Currently government has the monopoly on wheat imports and the Prima mill has been enjoying the wheat milling monopoly for two decades.

From an export perspective it is proposed to reduce the minimum employment and investment criteria for BOI incentives for agro industries in difficult regions.

NAC was established last month as the successor to USAID funded Agro Enterprise Project (AGENT). Currently it is assisting high value horticulture projects in Kandy with the aid of GTZ. 

Rising crime: Singer to take guard

Singer's "Homeguard" system comprises of; Magnetic contact detector, passive infra-red detector, wireless siren and a auto dialler to call help through a telephone line. 

The " Autoguard" system designed for vehicles include, shock sensors and anti hi-jack features.

A spokesperson for Singer said that even though the equipment is currently being imported, if the local demand is strong the company will begin to locally assemble the security equipment. Singer will be using its wide distribution network to make the security equipment available on a national scale. M.M Organisation is also expected to join Singer in bringing the vehicle security system islandwide.

Justin Meegoda calls for more assistance from DFIs

"The primary mission of the Development Banks is to lend a hand to local businesses. 

"Today they are giving billions to multi national companies, but we cannot even get a line of credit to our profitable leasing portfolio. We are servicing the needs of the rural entrepreneur and this is the type of assistance we get", said Meegoda who used to be an Assistant General Manager in the country's leading Development Bank before forming the Vanik.

Meegoda explained the current situation at Vanik to media last Wednesday. 

"It is true that we are going through difficulties. We are not hiding the facts, but at the same time, we are going through a complete restructuring and concentrating on our profit making ventures", he said. 

The media conference was in the aftermath of an injunction order issued by the Colombo District Court preventing any sale of assets by Vanik. 

"The court order was issued on the application of few debenture holders who raised worries about the Vanik's ability to redeem the debentures.

Vanik claims that it had not defaulted on a single interest payment and would have no difficulty in redeeming the Rs. 400 million debenture in 2003 as it falls due, if they were given a chance to continue with its restructuring. 

The debenture is secured by guarantees of People's Bank and USAID. USAID has issued a letter to the Trustee of the debenture, HSBC, stating the continued validity of the guarantee. Meegoda appealed to the highest authorities to protect the entrepreneul spirit and assist businesses that are going through hard times without resorting to foreclosing. 

"We are the only company that had faith in the Colombo market after 1994. Vanik has invested more than Rs 500 mn in the plantation sector. It is true that we had made judgmental errors. 

"But we can turn Vanik around with its profitable subsidiaries. All we are asking is for a breather," said Meegoda.

Vanik was formed in early 1990's by a group of professionals, whose pioneering initiatives included the introduction of redeemable debenture to the Colombo market. It rode the bull market in 1992-93 and became one of the most successful merchant banks in Sri Lanka. 

Vanik faced a liquidity crisis that was caused by a run on deposits, after it suffered losses from its investments in a declining market.

Mind Your Business

Bankers' dilemma

Some trade unions in the sector, especially those in the banks are perturbed by the comments of the former sporting hero that he alone is in charge of the banks while claiming the good professor handles only international finances. They have sought hurried clarifications but have been told to await the lady's return from her European tour...

Letting the gas off

Clothes fight

Both malls have been refurbished at enormous cost but one has now pushed up its prices aiming to cater mostly to a tourist market. 

The other meanwhile continues a policy of bargains for locals. There are two others in the fray, including one that is open throughout the day but the real good news for consumers is that two more will make their appearances in the city... 

Interest rates killing the economy

There is an expectation that interest rates would rise further. The market expectation of further increases in interest rates is also shown in a number of other decisions including the depression in the share market.

A year ago interest rates on three month treasury bills were only 11. 5% per annum. One-year treasury bills yielded a return of only 12. 5% per annum. The sharp rise in Treasury bill rates is more striking if we compare interest rates over a shorter period. Take for instance the last two months for comparison. Compared to the current one-year rate of 19. 37%, it was only 15. 3% just 2 months ago at the end of September. This sharp increase in interest rates by as much as 7. 5 percentage points for one year TBs in the last two months will undoubtedly lead to higher commercial banking interest rate. Sharp increases in lending rates could have a very serious impact on investment.

The rise in Treasury bill rates is in turn pulling up all other interest rates. The prime lending rate of commercial banks, which is the rate at which banks lend to their best customers, rose to nearly 21%.

Other lending rates are likely to be 5 to 6 percentage points higher. So the average borrower is likely to have to pay over 25% per annum.

The sharp increase in interest rates in so short a time is particularly harsh on borrowers who have already borrowed, as they would have not expected to bear this additional high cost on their borrowing when they embarked on their projects. New investors would no doubt be discouraged by the higher costs of borrowing. This is particularly so with respect to projects that have a long gestation period as their debt burden would rise heavily during the period when their industry has not commenced production. Only those investments that are assured of very high returns on their investment in the short run are likely to be able to borrow at these high rates of interest. Small entrepreneurs too would be particularly badly affected by the steep rise in prices, as they have little bargaining power with their banks.

The rising costs of finance would be on top of the escalation in prices of imported raw materials owing to the depreciating currency. The Rupee had depreciated to about Rs 82 for a US Dollar, compared to Rs 72 per US Dollar a year ago. This 14% depreciation is much higher than has been witnessed in recent years. In 1999, the Rupee depreciated by only 6%. It depreciated by 9. 6% in 1998.

The root cause for the rising interest rates is the widening fiscal deficit requiring the government to borrowing heavily. These borrowing are not only raising interest rates but also reducing the amount of funds available for the private sector. This starving of funds is indeed unfortunate at a time when our industries are doing well and enjoying an export boom of sorts. At the very time when industries should expand their investments and take advantage of the global conditions, they may have to contract. It is therefore vital for the government to find a different way by which to finance the deficit. That way is through foreign borrowing.

The specific conditions, which have required the huge government borrowing and the performance of the economy, justify such foreign borrowing. The difficulty may however be the lack of credibility in the government. The government has made no effort to reduce other wasteful expenditures; no signals of serious thinking on economic issues have emerged and above all shown evidence of poor governance. These factors may seriously impair the government's capacity to borrow, particularly from the international organisations. Even commercial borrowing may be justified in the current circumstances.

It is vitally important that the government finds ways and means of bridging the deficit without raising interest rates to levels, which hurt industries and kill them through exorbitant interest costs. 

It would be a pity at a time when export industry is faring so well, if interest rates mete out a crippling blow.

The flavour getting sweeter

Investment summary

Negative sentiment, a result of the wage increases, was one reason for the sell-off in the sector. In June 2000,we had advised investors to hold back on the sector until further assessment of the sector as a whole had been done. However, after taking a detailed look at the sector 's cost of production (COP),the net sales av rage (NSA)and margins, we believe that this is an excellent time to get into the plantations sector.

Our analysis of the tea sector prompts us to forecast stagnant real COP, a 13%pa increase in real NSA and, hence, a 3%increase in margins in the long term. We believe that tea margins will be on an uptrend for the next couple of years.

We expect rubber prices to stabilise at current levels over the short term and then start picking up over the medium-to-long term, due to a revival in world demand as well as an increase in local consumption. Further, we expect the palm oil industry to pick up from its low levels and help companies which have diversified into this commodity.

Our top buys are Maskeliya Plantations, Watawala Plantations, Kelani Valley Plantations and Balangoda Plantations. Maskeliya benefits from its pure tea exposure by capitalising on the hightea prices. Watawala has hedged itself against low commodity prices, by diversifying into three different commodities. Kelani Valley has the advantage of having high exposure to both rubber and tea, and hence being able to ride on the back of either industry.Balangoda, by virtue of its consistently high production volumes and low COP, is able to maintain profits even with relatively low NSAs.

Conglomerates 'exposure to the plantations sector will help boost their profits. The company that benefits the most from plantations is Richard Pieris followed by John Keells Holdings, Hayleys and Aitken Spence. Conglomerates are a way out for investors who are seeking exposure to plantations only through stocks with large market caps and high liquidity.

Shortage in world supply pushing up prices

We believee that tea prices are on the rise and that they will continue to be on an uptrend for the next couple of years. There are several reasons for this view, the main one being the shortage of tea supply in Kenya, one of the largest tea-producing countries in the world and also one of Sri Lanka 's main competitors. 

Kenya experienced a crippling drought in 1998,which led to the uptrend in tea prices in 1999.Recently, Kenya again experienced a severe drought, one of the worst to have hit the country in the last century.

While this is undoubtedly a very unfortunate development for Kenya, it has given a much-needed boost to demand for Sri Lankan tea. As a result, Sri Lankan tea prices are on the uptrend.

More plantations being listed on the CSE

The privatisation of Sri Lankan plantations began in 1992, but the sector did not get listed on the market until 1995.Currently,16 of the 22 plantations companies are listed on the Colombo Stock Exchange (CSE), up from 12 companies in 1998;we expect the all of them to list soon.

Investor sentiment has sold down the index

The plantations index has been heavily sold down since the beginning of this year. From a peak year-to-date level of 274 on1 January 2000, it touched a low of 215 in August 2000 -a decline of almost 22%-due mainly to negative investor sentiment arising from the wage-increase issue. In comparison, the ASPI fell only 13%during the same period. We had informed investors in June 2000 to hold back on the sector until we had properly assessed the impact of the wage increase.

Tea prices began climbing in the later part of 1999 from their dismal levels of 1998. Fundamentally, the companies were recording positive profit growth during this period. 

However, on an index driven by investor sentiment and high retail exposure, the they nosedived on concerns over the wage increase.

Between late August and early October, when the ASPI sprung back to life in the run-up to the elections, it was the plantations sector that gave it the biggest boost. This uptrend followed the excellent prices recorded at the Colombo tea auctions.

Investors are in a trading sector Given the volatility of the plantations index, we would look at it as a trading sector. 

The need to recognise and react promptly to the cyclicality of the industry is evident from the past -investors have lost heavily whenever shares were purchased during peak times and when prices were just about to come off. Buying plantations stocks at these times would spell disaster because falling tea prices and EPS would topple share prices.

It is clear that a lot depends on how accurately one predicts the tea-price cycle. This cyclicality means that a sophisticated institutional investor stands to benefit more from plantations shares than a local retail investor would. However, it is the activity of the retail investors that make the sector volatile.

Exposure to the plantations through conglomerates

Investors who are nervous about the volatility demonstrated by the plantations stocks can gain exposure to the sector by buying into conglomerates. 

That would hedge them from extreme volatility due to the diversified nature of conglomerates. Conglomerates that have considerable exposure to the plantations sector will stand to benefit from the predicted uptrend in margins. When plantations companies perform poorly, conglomerates with significant exposure to plantations experience a sharp decline in profit growth. For example, the performance of conglomerates in was dragged down by plantations.

The conglomerate with the highest exposure to the plantations sector is Richard Pieris &Co, and the one with the lowest, Aitken Spence. 

In fy 99 and fy 00, the average contribution of plantations to conglomerates 'profits was 13.5%and 12.5%, respectively. We expect plantations to contribute around 15%to total profits of conglomerates in both fy 01 and fy 02.

Valuation

Report evaluates our core-cov rage companies in terms of profitability, dividend yield,EPS growth and PER. Profitability depends a lot on exposure Profitability (net profit/cultivated ha)shows the level of net profit earned by 1ha of cultivated land. It is important to note that the kind of exposure has a significant impact on this valuation. 

For example, Maskeliya and Balangoda (Rs 12,960/ha and Rs 11,663/ha,respectively)are miles ahead of Watawala and Kela-ni Valley (Rs 3,532/ha and Rs 2,064/ha,respectively). The main reason for Maskeliya leading the pack is its extremely high exposure to tea, because tea enjoys higher sales prices compared with the other commodities (and also because these figures w r taken at a time when tea prices were at high levels). This also explains the high valuation of Balangoda. Watawala and Kelani Valley, however, with their exposure to rubber and other commodities (which fetch less in sales prices)do not receive a high valuation from this technique.

Effective holdings considered for conglomerates

When calculating the conglomerates 'exposure to plantations in terms of hectarage, we have taken the effective holding of the parent conglomerate in each plantations company. In John Keells Holdings '(JKH 's)case, for example, we have taken into account the holding that RPK Management Services has in Kegalle and Maskeliya Plantations, and then considered the holding that JKH has in RPK. We have then converted this holding to hectares of exposure. The same goes for its holding in Namunukula Plantations.

It is interesting to see the difference between the conglomerates ' effective exposure to plantations and the actual cultivated area of their plantations. For example, JKH has Maskeliya, Namunukula and Kegalle under it, which have a total of over 15,000ha of tea; however,JKH has effective exposure to only around 3,700ha.

Profitability of the conglomerates mismatched

The profitability of the conglomerates has been calculated by taking their profits from the plantations sector and then dividing it by their area of exposure. 

However, due to the inconsistency of different conglomerates when reporting profit figures from different sectors, these numbers are slightly mismatched. For example, JKH reports plantations profits after tax, while Hayleys reports income before tax for its plantations business.

Continued next week

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