JKH mega rights issue to settle debt, new investments

Efforts by John Keells Holdings (JKH), Sri Lanka’s biggest listed conglomerate, to raise nearly Rs 13 billion from a rights issue – a move that has triggered speculation as much as widespread buying interest – is aimed at repaying some of its debt from a recent spate of investments.

It would also be for the group’s medium-term capital expenditure requirements expected to be in the range of Rs.10-15 billion, with likely investments in the proposed Colombo South Harbour, a foray into the hotel sector in India, and possible further investments in BPO operations, brokers CT Smith Stockbrokers Ltd said.

In a report analysing JKH’s strategy to raise Rs 12.9 billion for debt repayment/investment through a rights issue of 1:5 at Rs.140 per share, the report said the group plans to have 20 hotels under the brands "Cinnamon" and 'Chaaya' in the medium term, with at least half located outside Sri Lanka.

The rights issue is the single largest public capital raising exercise at the Colombo Stock Exchange which is to be followed by a Scrip Issue of 1 for 7, on the enhanced capital.

The report said JKH recently embarked on an expansion drive investing approximately Rs.12 billion on bolstering JKH’s leisure portfolio in the Maldives, re-branding and refurbishment of its hotel chain, entering into a BPO joint venture, and increasing its stake in SAGT – the container terminal at the Colombo Port.

“Currently trading on PE multiples of 28.0x FY07F and 17.5x FY08F, the share offers significant upside potential given sustained above average earnings growth in the medium to long-term, amidst speculation of take over interest,” the report recommended.
The broking firm said it expects JKH to report 12% YoY growth in its FY07F net profit to Rs.3.4 billion, with the renewed threat of violence in the country having a significant short to medium-term impact on the Sri Lankan segment of JKH’s key tourism sector.

“However, we estimate group earnings to rise sharply by 76% YoY to Rs.6.0 billion in FY08F, backed by increased profit contributions from property and its Maldivian resorts as well as robust growth in the transportation sector,” it said.

While the debt reduction – from the new inflow of funds -- will reduce the company’s gearing in the short term, more importantly it will facilitate the undertaking of more debt to fund its future capital expenditure requirements.

The report also referred frequent reports of buying interest in the company, saying amidst the lack of a controlling shareholder, which entices take over interest, “we believe that at current valuations, the highly liquid stock is likely to outperform the market and most peers.”

JKH’s key transportation sector (contributing 94% of consolidated 2Q07 NP) reported a 55% YoY increase in its 2Q07 earnings, resulting in its 1H07 sector profits rising to Rs.1,297million (+32% YoY). This was a strong regaining of growth momentum, with profit margins rebounding to a record high 25% after slipping to 17% in the previous quarter. “We believe that the sector growth is likely to have been driven by the 26.25% owned (increased to 33.75% subsequent to end of 2Q07) associate South Asia Gateway Terminals (SAGT). Despite SAGT handling an increasing number of lower margin transshipment traffic, compared to higher margin domestic throughput, its likely higher capacity utilization has enabled the 1.4 million TEU container terminal to report impressive earnings growth.”

JKH’s fully owned bunkering service provider, Lanka Marine Services is also likely to have posted strong growth. However, its margins are expected to come under pressure with the advent of more competition. The company recently reduced its prices, likely in anticipation of increased competition in the segment. LMS adopts a premium pricing strategy, levering on its virtual monopoly position, and the company’s profitability has increased around six fold since its acquisition by JKH in August 2002 from the government, the report said.

Maldives outshines Sri Lanka
JKH’s leisure sector reported a net profit of Rs.57 million in 2Q07, compared to a loss of Rs.3 million in the tsunami affected 2Q06 and a post tax profit of Rs.305 million in pre-tsunami 2Q05. While the group’s properties in the Maldives contributed strongly (sector profits were up 764%YoY to Rs.97 million in 1H07), despite high interest costs on recent debt (total sector interest costs increased 838% YoY to Rs.123 million in 2Q07), JKH’s Sri Lankan hotels – both resorts and city, under-performed.

JKH’s Food & Beverage sector reported only modest growth in earnings, with its contribution to group earnings remaining negligible and below potential. Flagship Ceylon Cold Stores’ (CCS) 2Q07 profits declined 37% YoY to Rs.21million, its lowest quarterly profit since 4Q05. However, its 1H07 profits were still up 45% YoY to Rs.91million. The decline in earnings for 2Q07 was mainly the result of a disappointing performance in the Food & Beverage segment (Ice Cream and Carbonated Soft Drinks) while its super marketing operations reported reduced losses. Meanwhile, processed meat products market leader Keells Food Products (KFP) witnessed a strong turnaround while posting a NP of Rs.14 million in 2Q07, compared to a loss of Rs.22 million in 2Q06. “The relatively disappointing performance of the ice cream and carbonated soft drinks sector was partly due to higher raw material costs (notably sugar, which could not be fully passed on to end consumers),” the report said.

Leisure sector
JKH is the largest leisure related corporate in the country and is the single largest operator of hotel rooms - it controls Asian Hotels and Properties which gives it ownership of around 40% of the five star hotel rooms in the capital - and it is also the leading inbound tour operator in Sri Lanka. JKH has in excess of 2,100 hotel rooms comprising around 850 five star category rooms in Colombo, close to 760 resort hotel rooms in Sri Lanka and 530 in the Maldives (inclusive of the brand new 100 room 'upmarket' Maldivian Resort, Alidhoo Coral Garden Resort & Spa expected to be added to the portfolio by April 2007).

The group’s total investment in the Maldives over the last 12 months is approximately Rs.6 billion. JKH, in conjunction with the establishment of KHL, is also re-branding its hotel chain under a new branding strategy. However, the ongoing uncertainty surrounding the ceasefire agreement in Sri Lanka has already resulted in the company delaying some of the investments required for the 'repositioning' exercise, the report said.

Food & Beverage
Amidst stiff competition, CCS re-launched supermarket operations and plans to expand its supermarket presence to 50 outlets by 2007 (from the curent 25), in its bid to gain economies of scale in this low margin, but fast growing business. Although the organised retailing and supermarket concepts are still in their infancy stages in Sri Lanka, rapidly changing lifestyles (e.g. increasing working wives, higher incomes, increased value of time and convenience etc) are making the 'one-stop shop' increasingly attractive, especially amongst the urban middle and upper class, the report said.