JKH Initiation Report July 10 2013

Sri Lanka | Diversified Holdings Initiation of coverage
EQUITY RESEARCH 10 July 2013
John Keells Holdings PLC (JKH)

The Cautious Conglomerate
John Keells Holdings (JKH), Sri Lankas largest conglomerate, accounts for over 9.0% of the Colombo Stock Exchanges (CSE) total market capitalization. Its businesses encompass consumer food and retail (CF&R), hotels, oil bunkering and containers, property development, finance and IT services. We forecast that JKH will post a revenue CAGR of 9.0% over FY14E-FY16E, while its EBITDA margin should remain roughly stable around 13.9%. This relatively slow growth trajectory reflects managements cautious approach towards investment and expansion, and implies that JKH may face challenges in maintaining its market position in some segments. However, it is encouraging that the company is focused on generating shareholder value and unwilling to pursue growth at the expense of margins. Our DCF/SOTP valuation analysis and P/E analysis suggest a valuation range of LKR218-292, compared with the share price of LKR242 as of 9 July 2013 (see page 14 for a detailed explanation of our valuation methodology). JKHs revenue will likely grow at a 9.0% CAGR through FY16E. We expect JKHs top-line growth to be driven primarily by the leisure segment, which is primarily made up of hotels in Sri Lanka and the Maldives. Growth of 400bps in occupancy rates and a 5.2% CAGR in average room rates over FY14E-FY16E should bolster the top line. We forecast that revenue at JKHs CF&R segment, will post a 13.2% CAGR through FY16E, boosting the companys overall revenue growth. JKHs transportation business should grow in the low single digits, but continue to account for a large portion of total revenue. We estimate that the EBITDA margin will remain around 13.9%. Due to JKHs highly diversified nature, growth in one segment is often offset by weakness in other areas. We believe that its EBITDA margin will decline to 13.9% in FY14E from 14.5% in FY13, as overall expenses rise and property segment revenue (where margins can be high) continues to be volatile. JKHs real estate development efforts should boost margins in the coming years as revenues from apartments sold are recognized. However, the businesss relatively small size limits its overall impact. During FY14EFY16E, cost containment efforts in the leisure segment should broadly support margins. If JKHs upbeat plans for its supermarkets are achieved, the CF&R segment where we currently forecast an EBITDA margin of just above 6.0% may have some scope to surprise to the upside. A cash cushion and low leverage could allow for growth. Management has not demonstrated a strong interest in pursuing acquisition-driven growth, and it has been cautious in allocating capital to cultivate organic growth. JKHs strong cash (and cash equivalents) position of 15% of market capitalization and low leverage of 17% suggest that the company should be in a strong position if it elects to be more assertive. Also, the companys large land bank which accounts for 6% of our estimate of JKHs valuation may allow for some additional upside, depending on its end use (see page 18 for arenas where JKH may surprise to the upside). We establish a valuation range of LKR218-292, compared with the current share price of LKR242. JKH trades at an FY14E P/E of 16.7x, a premium to its peers. This valuation premium stems from a share liquidity premium and the perception that the company is one of the most transparent and shareholder friendly entities in Sri Lanka. That JKH is not controlled by a single shareholder (unlike many other locally listed conglomerates), also contributes to its valuation premium. In coming quarters, we will be closely tracking the performance of JKH across a number of key areas and will be updating our valuation range in future earnings updates (see page 21 for key areas). Key statistics
CSE/Bloomberg tickers Share price (9 July 2013) No. of issued shares (m) Market cap (USDm) Enterprise value (USDm) Free float (%) 52-week range (H/L) Avg. daily vol (shares,1yr) Avg. daily turnover (USD 000) JKH.N0000/JKH SL LKR242 857 1,587 1,597 88% LKR297/177 594,720 1,054
Source: CSE, Bloomberg Note: USD/LKR=128.7 (avg. for the 1 year ended 9 July 2013)
Share price movement
150%
100%
50% Jul-12 Sep-12 Nov-12 Feb-13 JKH ASPI Source: CSE, Bloomberg
Apr-13 S&P SL 20
Share price performance

3m JKH S&P SL 20 All Share Price Index
Source: CSE, Bloomberg
6m 8% 7% 4%
12m 32% 20% 22%
-2% 1% 3%
Summary financials
LKRm (year end 31 March) Revenue EBITDA Segment results Net profit Recurrent EPS ROE (%) P/E (x) 2013 85,557 12,375 10,125 11,047 13.0 13.7 19.2 2014E 96,514 13,435 10,304 12,396 14.6 13.2 16.7 2015E 105,079 14,845 11,403 13,413 15.8 13.0 15.4
Source: JKH, Amba estimates
1 A capital market development initiative by the Colombo Stock Exchange in association with Amba Research
John Keells Holdings PLC
Table of Contents
JKHs revenue to post a 9.0% CAGR over FY14E-FY16E .................................................................................................. 3
Leisure segment revenue CAGR of 7.6% over FY14E-FY16E driven by higher occupancy and rising average room rates ................ 3 Rising per capita GDP and consumption to support CF&R segments revenue CAGR of 13.2% over FY14E -FY16E ......................... 5 JKHs transportation business to grow slowly, but continue to account for a substantial share of total revenue .................................. 7 Financial services, IT and other segments to make a small contribution to top-line growth ................................................................. 8
EBITDA margin to remain roughly flat at around 13.9% during FY14E-FY16E .................................................................. 9
Cost-control efforts in the leisure segment to support JKHs margins .................................................................................................. 9 High though volatile property segment margins should support overall margins ............................................................................ 9 Some possibility for upside margin surprise from CF&R segment ...................................................................................................... 10
JKHs large cash position, low debt and land bank support balance sheet strength ......................................................... 12
Strong cash position and low gearing to allow investments ................................................................................................................ 12 JKHs large land bank may be a source of further value for JKH........................................................................................................ 12
We establish a valuation range for JKH shares of LKR218-292........................................................................................ 14

DCF/SOTP analysis yields a valuation range of LKR218-243 per share ............................................................................................ 14 P/E analysis yields a fair value range of LKR236-292 per share ........................................................................................................ 17 Where is additional potential upside? ................................................................................................................................................. 18 Direct comparison with peers may not be relevant to our valuation .................................................................................................... 18 Share price performance .................................................................................................................................................................... 19
Earnings release focus areas............................................................................................................................................. 21 Appendix 1: Company overview......................................................................................................................................... 23

JKHs key businesses ......................................................................................................................................................................... 24 Management strategy, transparency and governance ........................................................................................................................ 26 Shareholding structure ....................................................................................................................................................................... 26 Board of directors ............................................................................................................................................................................... 27
Appendix 2: Key financial data ........................................................................................................................................... 29

Summary group financials (LKRm) ..................................................................................................................................................... 29 Key ratios............................................................................................................................................................................................ 30 Segmental summary........................................................................................................................................................................... 31
Appendix 3: Industry analysis using Porters framework ................................................................................................... 33

Food and beverage manufacturing ..................................................................................................................................................... 33 Organized food retail .......................................................................................................................................................................... 34 Hotels ................................................................................................................................................................................................. 36 Oil bunkering ...................................................................................................................................................................................... 37 Container handling ............................................................................................................................................................................. 39 Property (condominium development) ................................................................................................................................................ 40
Appendix 4: SWOT analysis .............................................................................................................................................. 42 Appendix 5: Diversified sector overview ............................................................................................................................ 43 Fact Sheet .......................................................................................................................................................................... 46
Sri Lanka investment environment overview ...................................................................................................................................... 46
JKHs revenue to post a 9.0% CAGR over FY14E-FY16E

We expect JKHs revenue growth to be driven primarily by the companys leisure and consumer foods and retail (CF&R) segments. The transportation segment will remain a significant contributor to revenue, although in our view, its growth will lag that of the company as a whole (refer to Appendix 1 for a detailed discussion of JKHs revenue composition).
Leisure segment revenue CAGR of 7.6% over FY14E-FY16E driven by higher occupancy and rising average room rates
We expect the leisure segments revenue to post a CAGR of 7.6% over FY14E-FY16E, to reach approximately LKR26bn in FY16E. The segments growth should be fuelled by modestly rising occupancy levels, which we forecast will increase from a blended 67% in FY13 to 71% in FY16E. Additionally, marginal increases in average room rates (ARR), which should post a blended CAGR of 5.2% over FY14E-FY16E, would likely bolster segment growth. Industry growth in room inventory (total room inventory in Colombo is forecasted to rise by over 50% through 2015 as new hotels are opened) should serve to cap upward movement in occupancy levels and ARRs. JKHs leisure segment revenue growth driven by higher occupancy and increasing room rates
Figure [1]: Average room rates at JKHs Colombo hotels to post a 6.1% CAGR over FY14E-FY16E
70% 25,000 20,000 65% 15,000 10,000 5,000 55% FY10 FY11 FY12 FY13 FY14E FY15E FY16E Average room rate (LKR) (RHS) Occupancy rates (LHS) 0
Figure [2]: Average room rates at JKHs Sri Lankan resorts to post a 5.6% CAGR over FY14E-FY16E
75% 70% 65% 60% 55% 50% FY10 FY11 FY12 FY13 FY14E FY15E FY16E Average room rate (LKR) (RHS) Occupancy rates (LHS)
Source: JKH, Amba estimates Note: SL resorts are hotels outside Colombo
25,000 20,000 15,000 10,000 5,000 0
60%
Source: JKH, Amba estimates Note: Data excludes the upcoming business hotel
We expect the companys room inventory (excluding the upcoming business hotel JV project with Sanken see Appendix 1 for further details) in Sri Lanka to remain flat through the forecast period. Although the launch of the new business hotel will increase JKHs room inventory in Colombo by 28% in FY15E, JKH currently holds only a relatively small stake (27.8%) in the hotel, and therefore, we expect the incremental addition to revenues to be minimal. On another front, JKH recently invested in a small national air taxi service called Cinnamon Air. While JKHs minority stake will not be material to the firms overall performance , the operation will help consolidate the companys position in the leisure sector. JKH has indicated that it continues to search for attractive expansion opportunities in the leisure sector, but has been unable to uncover any that meet its investment return hurdles. Although we expect JKHs market share to decline, the companys focus only on investment efforts that will deliver returns above its required hurdle rates reflects positively on the companys desire to deliver shareholder value.

Figure [3]: JKHs room inventory in Sri Lanka to remain flat while tourist arrivals may post a 28% CAGR over FY14E-FY16E
YoY growth 60% 40% 20% 0% 2010 2011 2012 2013 2014E 2015E 2016E Annual tourist arrivals (RHS) YoY growth in JKH room inventory in Sri Lanka (LHS) YoY growth in tourist arrivals (LHS)
3,000,000 2,000,000 1,000,000 0
Source: JKH, Sri Lanka Tourism Development Authority, Amba estimates Note: Room inventory numbers are for the 12-month period ended 31 March of each year and exclude the business hotel
More broadly, Sri Lankas tourism industry faces numerous challenges that will also serve to limit JKHs growth in its leisure segment. Tourist visits to Sri Lanka, at just over 1 .0m in 2012 (up 17% YoY) substantially lag those of other countries in Southeast Asia. In 2012, the Philippines recorded 4.3m tourist arrivals (up 9% YoY), Vietnam received 6.8m arrivals (up 13% YoY) and Indonesia reported 8.0m visitors (up 11% YoY). Sri Lankas tourism infrastruc ture in terms of airports, roads and transportation, and services trails those of competitors for tourism growth. Further, minimum room rate regulations could dampen Sri Lankas international competitiveness. Perhaps most critically, Sri Lankas tourism product is at risk of pricing itself out of the market if the cost of electricity and low labor productivity (due to a shortage of skilled labor) continue to rise. On a related front, the tourism industry in the Maldives, while thriving, continues to be threatened by political instability and regulatory uncertainty. There is a risk that the government may pass legislation (such as a recent short-lived but nevertheless worrisome ban on spas) that is contrary to the interests of the leisure industry. That the tourism industry accounts for just over a quarter of the countrys economy, though, suggests that the government which is projecting an 8.1% CAGR in tourist arrivals over FY14E-FY16E will likely be more cautious in its approach. JKHs Maldives properties account for 27% of JKHs leisure segment revenues and 6% of overall group revenue and the company currently has no plans to increase its room inventory there. The likely stabilization of the investment and political environment in the Maldives should bode well for the tourism industry in the country.
Figure [4]: JKHs room inventory in the Maldives to remain flat, while tourist arrivals are expected to post an 8.1% CAGR over FY14EFY16E
YoY growth 20% 0% (20%) (40%) 2010 2011 2012 2013 2014E 2015E 2016E Annual tourist arrivals (RHS) YoY growth in JKH room inventory in Maldives (LHS) YoY growth in tourist arrivals (LHS)
1,500,000 1,000,000 500,000 0
Source: JKH, Ministry of Tourism, Arts and Culture Maldives (2012 tourism statistics), Amba estimates Note: Room inventory numbers are for the 12-month period ended 31 March of each year
Rising per capita GDP and consumption to support CF&R segments revenue CAGR of 13.2% over FY14E-FY16E
We believe JKHs CF&R segment will contribute substantially to the companys overall revenue growth. We expect the consumer foods component (comprising ice cream, carbonated soft drinks and frozen processed/convenience foods) to post a revenue CAGR of 10.3% over FY14E-FY16E, while retail (which includes the companys 51 supermarkets) records a 15.4% CAGR over the same period. Both elements of the CF&R segment are driven by overall macroeconomic growth, and, more concretely, disposable income. As shown in Figure 5, JKHs consumer foods and retail businesses both roughly track the two macroeconomic data points, with the companys growth being substantially higher than either a trend we forecast will continue over the coming years.
Figure [5]: JKHs CF&R growth to outpace macroeconomic growth

YoY growth 25% 20% 15% 10% 5% 0% 2010 2011 2012 YoY GDP per capita growth rate YoY revenue growth - Consumer foods 2013 2014E 2015E 2016E YoY disposable income growth rate YoY revenue growth - Retail
Source: World Bank, Central Bank of Sri Lanka, Amba estimates Note: CF&R segment revenues are for the 12-month period ended 31 March. GDP per capita and disposable income growth rates for 2013 are based on Central Bank of Sri Lanka and World Bank estimates
New product launches and closing consumption gap key to foods growth
We believe JKHs top-line growth in the consumer foods component will also be supported by the following. New product launches. Over the past two years, JKH launched two new ice cream flavors and a soft drink flavor, along with an expanded range of sausages. The group also relaunched its premium ice cream range. In addition, JKH also recently introduced mineral water into its product portfolio. Geographical expansion. Since launching in the Maldives over a decade ago, Elephant House JKHs ice cream brand has become the market leader. The brand was also introduced into the Middle Eastern market in FY12. Management has indicated that Elephant House may be launched in additional markets, although timing is unclear. Additional available capacity. JKH reports that it has substantial scope to increase production using current capacity simply by adding an additional shift. Currently, the companys key production facilities operate on one shift. JKH also acquired a meat processing plant in FY13 to enhance its production capacity. Closing consumption gaps. Sri Lankas per capita consumption of ice cream, at 1.7 liters/year, is well above the levels of China and the Philippines. However, consumption levels reflecting both purchasing power and consumer appetite in nearby Malaysia and Singapore are substantially higher. New product development and consumption of ice cream and soft drinks should help boost CF&R revenue growth

Figure [6]: Sri Lanka's per capita consumption of ice cream lags the more developed Asian economies
Liters/yr 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Indonesia India Pakistan Philippines China Thailand Sri Lanka Malaysia Singapore
Source: Rediff.com, Ceylon Cold Stores PLC
On a macro level, Sri Lankas modern food retailing sector is attractive, with only 15% of food sold through modern outlets (i.e., large organized retail stores); the balance is bought through markets and other informal channels. The experience of other emerging markets suggests that increasing disposable income is positively correlated to modern food retail market share, as consumers search for a more convenient grocery shopping experience. JKHs food retailing operations account for approximately 57% of the CF&R segments revenue (as of FY13), and roughly 16% of the companys revenue. The companys food retail operation is the third-largest in Sri Lanka by revenue, and the second-largest in terms of total store count, as shown in Figure 7. JKH reports that its focus will be on opening relatively large stores of 7,000 saleable sq. ft; previously, the companys store sizes varied around the 3,500 -4,000 sq. ft. range.
Modern food retailing in Sri Lanka has significant growth potential
Figure [7]: Keells Super trails Cargills in total store count

No. of stores 250 200 150 100 50 0 FY11 Keells Super FY12 Arpico Supercenters Cargills FY13 45 42 47 45 51 44 194 163
211
Source: JKH, Richard Pieris & Company PLC, Cargills PLC (data as of 31 March) Note: Cargills data for FY13 are estimates
JKHs retail store expansion rate has been relatively slow, wi th store count increasing by two stores per annum over the past five years. After many years of being in operation, the companys retail arm became profitable for the first time in FY12. Now that the breakeven point for the business of around 50 stores has been achieved, JKH should begin to reap the rewards of scalability of its food retail business. However, management has also said that its policy is to launch food retail operations only in areas of the country that are at a sufficiently high level of disposable income. Indeed, a majority of the companys 51 stores (as of March 2013) are in the Colombo area, which is Sri Lankas most affluent region. JKHs conservative approach to store launches implicitly allows more aggressive

competitors most notably, Cargills to establish a strong local market position well before Keells Super outlets are launched in a particular region. On a related front, JKHs own internal investment return hurdles may stand in the way of any substantial acceleration in store openings. The company has a target return on capital employed (ROCE) of 15% for any new investment. This should be difficult for the food retail business to achieve, given that management aims to achieve a net margin of 2% which is unlikely to be consistent with the targeted high ROCE level. Capex of LKR100m required per new store may thus be a hard sell internally. Management has indicated its desire to accelerate the rate at which new stores are launched to potentially as much as 10 units per annum. However, we are less aggressive than JKH and forecast only two new store launches per annum through FY16E. JKHs own investment return hurdles may stand in the way of any substantial acceleration in store openings
JKHs transportation business to grow slowly, but continue to account for a substantial share of total revenue
The growth of JKHs transport segment will be hampered by capacity constraints. We expect overall segment revenue to increase at a CAGR of 4.5% over FY14E-FY16E, to reach LKR22.6bn in FY16E, owing primarily to growth in the oil bunkering business. JKH is active in the container business via a 42.2% stake in South Asia Gateway Terminals (SAGT), which is accounted for as an associate business.
JKHs oil bunkering business to provide a steady revenue flow

JKHs oil bunkering business imports oil and supplies bunker fuel primarily to ships calling in for transshipment at the Colombo port. Total current storage capacity for bunker fuel at the Colombo port is 35,000 metric tons (MT). The three largest industry players JKHs Lanka Marine Services (the industry leader, with a 40% market share), state-controlled Lanka Maritime Services and private company Lanka Indian Oil Company dominate the sector, although there are a number of smaller players. Growth in the oil bunkering business is hampered by oil storage capacity at the Colombo port. The government has said it hopes to increase capacity by more than twofold. The timetable of this expansion, and how additional space would be made available, has not yet been announced. In the meantime, the only real possibility for top-line growth is via an increase in the price of oil. We assume that although the Colombo ports oil bunkering services are operating at capacity, intense competition will gravitate against any efforts to substantially increase prices. Moreover, growth in regional trade, which leads to greater demand for transshipment services, should drive the oil bunkering segments revenues. However, while Sri Lanka is in a geographically strong location, it still faces stiff competition from other ports within a radius of a few hours. On another front, the port development at Hambantota a site of significant infrastructure investment in Sri Lanka may threaten the position of the Colombo port, and JKHs oil bunkering business. The 82,000 MT of oil storage capacity at the Hambantota port is currently under state control, and it may become an increasingly important factor as the ports container operations evolve. JKHs transport segment provides a steady revenue flow, although growth prospects are limited by constraints
Container business faces pressure following capacity expansion at the Colombo port
JKHs container business entails loading and unloading container vesse ls at the Colombo port. Two main operators South Asia Gateway Terminals (SAGT), in which JKH owns 42.2%, and stateowned Jaya Container Terminals (JCT) dominate the Colombo ports container capacity of 4.9m twenty-foot equivalent units (TEU). Currently, the government controls about 60% of total port capacity. JKH reports that SAGTs installed capacity of 1.3m TEU/year has been increased to 2m TEU/year thanks to the application of upgraded equipment and technology. Currently, the facility is operating at 85% capacity, and any additional increase is pending the privatization of additional area. In December 2011, China Merchant, a Hong-Kong listed Chinese state firm, entered into a publicprivate partnership (PPP) for a build-operate-transfer arrangement that added 2.5m TEU in capacity in July 2013, equivalent to an overall 50% increase in capacity. This sharp increase in total port capacity should pressure pricing as the new market entrant carves out its customer base. It will

likely also defer any additional privatization of space. Therefore, we believe SAGTs growth prospects, both at the top line as well as in terms of margins, are challenging.
Figure [8]: SAGT operating at 85% annual throughput capacity, with further increases only possible through new terminal access
TEUs 2,000,000 1,900,000 1,800,000 1,700,000 1,600,000 FY10 FY11 FY12 FY13 Volume (TEUs)
Source: SAGT, Amba estimates Note: TEU = twenty-foot equivalent units
FY14E
FY15E
FY16E
Financial services, IT and other segments to make a small contribution to top-line growth
In our view, JKHs financial services, IT and other segments (which include produce broking and warehousing, and other real estate operations) will post a combined revenue CAGR of 9.3% over FY14E-FY16E, generating revenue of LKR24.9bn in FY16E (or roughly 22% of total revenue). Some of the key issues relating to these segments include the following: Insurance: We assume that JKHs insurance operations will grow roughly in line with GDP. While there is a clear growth opportunity in Sri Lankas insurance indu stry, as disposable income rises and the outlook of consumers becomes more long term in nature, the market is also highly competitive. As a mid-tier player, Union Assurance (UAL) in which JKH holds a 96% stake is subject to pricing pressure from larger competitors. We estimate UALs book value and forecast its value generation into our SOTP valuation using a P/BV multiple (valuing UAL at a 5% premium to its 2012 P/BV). Banking: Nations Trust Bank (NTB), in which JKH holds a 29.9% stake, is a small-tier asset in a fast-growing sector that is dominated by state-controlled and some of the large private commerical banks. We forecast NTBs value generation into our SOTP using a P/BV multiple valuing NTB at a 10% premium to its FY12 P/BV (and at a premium to its peer average). Stockbroking: John Keells Stock Brokers (JKSB) accounted for only 2% of the financial services segments revenue in FY13. Overall low trading volumes, an over-broked market, weak stock market performance and declining commissions all contribute to mixed prospects for JKHs stockbroking activities. IT: JKH offers a niche product in the IT segment. We believe that the business does not appear to be a major priority; additionally, heavy competition particularly from India exerts downward pressure on pricing. We forecast top-line growth to be around 10%. Insurance, banking and IT will also contribute to the top line
EBITDA margin to remain roughly flat at around 13.9% during FY14E-FY16E

We expect JKHs EBITDA margin to be roughly flat during the forecast period as weaker segments drag down those that we believe will post EBITDA margin growth. Some of the key dynamics of this process are described below. Weaker segments drag down those that we believe will post EBITDA margin growth
Figure [9]: EBITDA margins from the property and leisure segments to drive JKH margin growth
Margin 70% 60% 50% 40% 30% 20% 10% 0% FY10 FY11 EBITDA margin (JKH) EBITDA margin (CF&R)
FY12
FY13 EBITDA margin (Leisure) EBITDA margin (Transport)
FY14E
FY15E FY16E EBITDA margin (Property) EBITDA margin (Financial Services)
Cost-control efforts in the leisure segment to support JKHs margins

We expect the leisure segments higher revenue and internal operational efficiencies to lead to a 100bps increase in the EBITDA margin to 33.3% in FY16E in the context of a firm-wide EBITDA margin of 14.5% in FY13 and 13.6% in FY16E. This relatively modest increase is still significant in light of the sectors intensifying competition and cost pressures. Broadly speaking, variable costs in the hotel sector are relatively low, and hotels hold high operating leverage. Fixed costs are driven by electricity, staff salaries and lease rentals, which together account for over 50% of total costs. While most of these costs are controllable, we expect staff costs (which represent the single-largest expense to JKHs leisure segment) to increase rapidly, as competition for qualified personnel mounts. Additionally, the Sri Lankan government has held discussions on implementing an across-the-board wage hike for the countrys tourism industry. However no firm proposals have yet been made on this front. Competition, escalating costs (led by rising labor costs) could pressure leisure segment margins
High though volatile property segment margins should support overall margins
Top-line growth in the property segment is derived primarily from apartment sales and ongoing property rentals. The segments EBITDA margins fluctuate sharply depending on the timing of apartment sales, which command significantly higher margins than rentals. The company receives 10-20% of revenues at the time of sale, with the balance being payable by the customer based on the proportion of project completion.

Figure [10]: Property segments EBITDA margin significantly higher than the groups
Margin 70% 60% 50% 40% 30% 20% 10% 0% FY10 FY11 FY12 FY13 FY14E FY15E FY16E JKH group EBITDA margin
Source: JKH, Asian Hotels and Properties PLC, Amba estimates
Property segment EBITDA margin
JKHs property segment accounts for a relatively small percentage of revenue, ranging from 3.4% to 6.3% over FY08-FY13. However, it accounts for a volatile and outsized contribution to profitability; for example, the property segments contribution to the companys EBIT more than doubled to 25.8% in FY11. We anticipate a solid contribution from the property segment during the th forecast period following the completion of the OnThree20 and 7 Sense residential property development projects. According to the company, approximately 80% of OnThree20s apartments had been pre-sold as of March 2013. We expect almost all of the 475 apartments to be sold by project completion in December 2014, and over 90% of its revenue to be booked through the fiscal year end 2015, bolstering margins during the period. However, visibility on future property development projects is limited. It is likely that JKH will continue to draw upon its extensive land bank (see Figure 13) for real estate development efforts; however, our ability to provide concrete financial performance forecasts is contingent upon JKHs announcements regarding its future plans. Colombos high-end residential real estate sector has witnessed strong demand over the past several years, and a large number of high-end residential real estate projects are currently in the works. This could lead to oversupply, and demand could come under pressure.
OnThree20 and 7 Sense, two of the on-going real estate development projects, will contribute to group EBITDA margins through FY16E
th
Some possibility for upside margin surprise from CF&R segment

We believe the CF&R segment will post relatively flat margins during the forecast period. According to the company, retail operations have achieved sufficient scale to break into profitability, and this is reflected in our forecasts. Two elements of the segments operations that could lead to unexpectedly strong results are provided below: Pass-through of price hikes: Management has indicated that it generally boosts prices of ice cream and soft drinks as much as two times per year, in part to pass on to consumers increases in the cost of sugar and other inputs. The relatively low level of competition in the market ice cream is a de facto oligopoly means that JKH faces little resistance to increasing prices. If demand continues to be robust, JKH could push through higher price hikes to bolster margins. Potential of private label: JKH reports that currently 4% of retail sales are generated by privatelabel goods. The company says that it hopes to boost this to 10%. Gross margins on privatelabel goods are 50% higher than gross margins for branded goods, according to JKH. If the companys efforts to increase the share of private -label goods on the shelves of its Keells supermarkets move faster than anticipated, margins could surprise on the upside. An increased mix of private label products could result in a margin surprise from CF&R

Figure [11]: CF&R segments EBITDA margins to remain flat at around 6.3% over FY14E-FY16E
Margin 12% 10% 8% 6% 4% 2% 0% FY10
Source: Amba estimates
FY11
FY12
FY13
FY14E
FY15E
FY16E
JKHs large cash position, low debt and land bank support balance sheet strength
Strong cash position and low gearing to allow investments
JKH has maintained a strong cash balance position (including cash in hand and short-term investments) over the past few years, with cash and cash equivalents making up approximately 19% of total assets, or 15% of market capitalization. The company also has been able to generate strong free cash flow balances and gearing has continuously been below 30%. This indicates that the company has remained largely a self-financed business, in relation to its local peers, with minimal support from external financial institutions. JKHs cash position also places it at a considerable advantage relative to other domestic conglomerates, which hold net debt positions.
Figure [12]: JKH has a strong net cash position relative to other local conglomerates
LKRm 20,000 10,000 0 (10,000) (20,000) (30,000) (40,000) (50,000) John Keells Holdings
Source: JKH, Bloomberg Note: All data as of FY13
Carson Cumberbatch
Aitken Spence
CT Holdings
Hayleys
Therefore, JKHs strong liquidity and the option of raising further debt financing open up opportunities for the company to venture into new projects to enhance shareholder value. However, the challenge as discussed elsewhere in this report is whether JKH will uncover projects that offer a sufficiently attractive return. The danger is that excessive caution will lead to a steady deterioration in market share in some of the companys segments.
JKHs cautious approach to investment could dampen growth opportunities
JKHs large land bank may be a source of further value for JKH
JKH owns one of the largest private land banks in Sri Lanka, including 121 acres of real estate within and out of Colombo. A significant proportion of this land is included under PPE on the group balance sheet, and has been valued as of 31 March 2013. In the figure below, we present our estimations of the dormant land bank, and these are based on our discussions with JKH and the companys reported valuations.

Figure [13]: JKHs dormant land bank estimated at LKR11.6bn
Acreage 6.73 1.22 3.06 1.06 3.77 44.37 14.64 25.15 8.43 6.50 6.31 Value per acre (LKRm) 1,140 229 667 80 28 15 25 3 2 23 23 Current value (LKRm) 7,669 280 2,042 85 106 668 361 70 18 149 144 11,591
Location Slave Island Complex, Colombo 2 Ferguson Road, Colombo 15 Vauxhall Street, Colombo 2 Trincomalee Ja-Ela Nilaveli Trincomalee Wirawila Wakare Ahungalla Ahungalla
In our financial model, we value JKHs land bank at its market value, as reported by JKH. The land bank accounts for roughly 6% of our forecast SOTP valuation.
We establish a valuation range for JKH shares of LKR218292

We establish a 12-month valuation range based on our current earnings outlook for JKH shares of LKR218-292 per share, compared with the current share price of LKR242 as of 9 July 2013. We arrive at our valuation range applying sensitivity analysis to a DCF/SOTP valuation methodology, and a P/E-based relative valuation approach. For the sake of comparison, we also assess JKHs valuation levels relative to a group of peers. For factors that will provide an upside/downside to this stated valuation range, please refer to page 18 of the report.
Figure [14]: Valuation range analysis provides a range of LKR218-292 per share (current share price LKR242)
218 DCF/SOTP
242 243
236 P/E analysis
292
177 52-week range
297
0 150
Source: Amba estimates, JKH, Bloomberg
190
230
270
310
DCF/SOTP analysis yields a valuation range of LKR218-243 per share

In valuing JKH shares, we applied a combined DCF/SOTP approach. Our base-case assumption of a risk-free rate of 9.5% and a market risk premium of 5.0% yields a value per share of LKR229; adjusting these assumptions (to allow for a risk-free rate range of 8.5-10.5% and a market risk premium range of 4.0-6.0%) implies a valuation range of LKR218-243. Other elements of our valuation approach include the following: For the transport (oil bunkering only), leisure, property, CF&R and financial services (stockbroking only) segments, we conducted a DCF analysis, with explicit forecasts through FY16E, and a six-year fade period thereafter. Where segment revenues are earned in USD (particularly leisure and transport), we have used a conservative 1.5% YoY LKR depreciation rate for our forecast period. We value JKHs minority stake in SAGT (which handles containers at the Colombo port) by using Gordons dividend growth model. To assess the value of JKHs insurance operations, we applied a target P/BV valuation approach, based on comparables. We have valued UAL at 2.8x (a 5% premium to its year-end 2012 P/BV), and at a premium to its peers, as it has historically traded at high multiples relative to its peers. We value JKHs 29.9% stake in NTB using a target P/BV valuation approach, based on comparables. We have valued NTB at 1.4x (a 10% premium to its year-end 2012 P/BV) and at a premium to its peer group, as it has historically traded at a premium to its peers. Our base-case assumptions include a risk-free rate of 9.5% and a market risk premium of 5.0%

For the IT segment, we applied an EV/sales valuation metric as we were unable to conduct a DCF analysis due to insufficient disclosure regarding the segments performance. Also, we value JKHs land bank on a standalone basis, based on the companys valuation of market value applied to the dormant land bank and our discussions with the company (refer to Figure 13 for additional details on how we value the companys land bank). JKHs current capital structure comprises 17% debt and 83% equity. We have assumed a balanced 50/50 target capital structure across all segments and a terminal growth rate of 3%. We assume a 50/50 target capital structure
The following tables reflect our DCF/SOTP assumptions for the companys key segments. For each segment we have estimated the following: EBIT and FCF figures throughout the explicit and fade periods. Terminal value at FY22E, calculated by applying a terminal growth rate to unleveraged FCF as of FY22E.
Finally, we arrived at our segmental EV by discounting the unleveraged FCF values over the explicit and fade periods at the segmental WACC. Assumptions for each segment are presented in the figures below.
Figure [15]: Amba DCF/SOTP assumptions schedule:
Transportation WACC assumptions Target capital structure Cost of equity Cost of debt Terminal growth rate Effective tax rate WACC Leisure WACC assumptions Target capital structure Cost of equity Cost of debt Terminal growth rate Effective tax rate WACC Property WACC assumptions Target capital structure Cost of equity Cost of debt Terminal growth rate Effective tax rate WACC Consumer food and retail WACC assumptions Target capital structure Cost of equity Cost of debt Terminal growth rate Effective tax rate WACC
50/50 14.0% 10.0% 3.0% 15.0% 11.3%
EBIT total FCF Terminal value (undiscounted) Equity valuation of SAGT EV (incl. SAGT)
FY14E 988 1,232 15,253 21,526 33,147
50/50 14.8% 10.0% 3.0% 15.0% 11.6%
EBIT total FCF Terminal value (undiscounted) EV
FY14E 5,301 1,735 104,063 66,051
50/50 14.5% 10.0% 3.0% 15.0% 11.5%
FY14E 2,428 4,668 29,398 23,786
50/50 14.0% 10.0% 3.0% 15.0% 11.3%
FY14E 1,074 148 53,835 30,371
Financial services WACC assumptions for JKSB Target capital structure Cost of equity Cost of debt Terminal growth rate Effective tax rate WACC IT segment valued on an EV/Sales basis Revenue EV/Sales peer average EV Others WACC assumptions Target capital structure Cost of equity Cost of debt Terminal growth rate Effective tax rate WACC
50/50 14.5% 10.0% 3.0% 15.0% 11.5% 50/50 FY14E 7,478 2.00 14,957
EBIT total (JKSB only) FCF (JKSB only) Terminal value (undiscounted for JKSB only) UAL P/BV NTB P/BV EV (incl. UAL and NTB)
FY14E 18 25 180 13,302 4,675 18,134
50/50 15.0% 10.0% 3.0% 15.0% 11.8%
FY14E (75) (705) 2,378 562
Source: Amba estimates Note: All figures are in LKRm unless otherwise stated. SAGT=South Asia Gateway Terminals,JKSB = John Keells Stockbrokers; UAL = Union Assurance PLC, NTB = Nations Trust Bank PLC
The following table shows the contribution of each segment to our base-case value per share.
Figure [16]: Contribution by segment to JKHs value per share (including land bank)
Equity value (LKRm) 33,147 66,051 23,786 30,371 18,134 15,518 29,724 (20,004) (11,366) 11,591 196,951 LKR per share 38.6 77.0 27.7 35.4 21.1 18.1 34.6 (23.3) (13.2) 13.5 229.4 Contribution mix 17% 34% 12% 15% 9% 8% 15% -10% -6% 6%
Transportation Leisure Property CF&R Financial services Information technology & others Cash and cash equivalents Debt Minority interests Land bank Total
Source: Amba estimates
However, if we assume a lower market risk premium of 4.0%, then the SOTP value would be LKR243 per share; correspondingly, if the market risk premium increases to 6.0%, the SOTP value would be LKR218 per share.
Figure [17]: Sensitivity analysis schedule

Risk-free rate 9.5% 243 236 229 223 218
Market risk premium
4.0% 4.5% 5.0% 5.5% 6.0%
8.5% 258 250 243 236 230
9.0% 250 243 236 230 224
10.0% 236 229 223 218 212
10.5% 229 223 218 212 207
Source: Amba estimates Note: Our base-case assumptions are a risk free rate of 9.5% and a market risk premium of 5.0%
P/E analysis yields a fair value range of LKR236-292 per share

JKHs 12-month forward P/E has ranged from 13.0x to 30.2x since April 2010. The shares 12month historical forward P/E averaged 19.2x during this period. The stock currently trades at 16.7x its 12-month forward EPS (based on our forecasts), a 13% discount to its historical average.
Figure [18]: JKH forward P/E band chart
LKR 425 375 325 275 225 175 125 75
Apr-12
Apr-10
Apr-11
10x
Source: JKH, Bloomberg
15x
20x
25x
30x
Market price per share
In determining a P/E valuation range and a share price range, we apply two scenarios: Conservative scenario: Here we assume that JKH will trade at a forward multiple of 16.3x, a 15% discount to its recent historical average. As growth slows, JKHs shares may trade at a lower multiple. During FY09-FY13, the companys revenue posted a CAGR of 15.4%, and EBITDA a CAGR of 13.3%, compared with our FY14E-FY16E forecasts of a CAGR of 9.0% in revenue and a CAGR of 6.7% in EBITDA. We applied a forward P/E of 16.3x to our FY14E diluted EPS estimate of LKR14.5 to arrive at a fair value of LKR236 per share. Optimistic scenario: Under this scenario, investors place a higher premium on managements approach particularly in contrast to the less-disciplined investment strategies of some other domestic conglomerates. This focus on generating shareholder value rather than persuing lowreturn growth is rewarded by investors with a valuation that is a 5% premium to the recent historical average. This premium is also on account of the highly anticipated Glennie Street mega development project implying a 20.2x P/E multiple. Applied to our forecast of FY14E diluted EPS, this leads to a share price level of LKR292 per share.
JKH currently trades at 16.7x its 12-month forward EPS; we forecast a conservative scenario with a 15% discount to the recent historical average, and an optimistic scenario with a 5% premium to the recent historical average
Apr-13
Where is additional potential upside?

Our modeling of JKHs financial performance has been intentionally conservative in some respects. We have not factored in the following possible sources of valuation upside: Property/Leisure: The anticipated USD640m mixed-use development project on the 12.5-acre plot at Glennie Street, could boost JKHs share price. Although JKH remains silent on plans for this property, it is speculated to include a hotel, apartments and a shopping mall. Oil bunkering: If Lanka Marine Services is able to secure additional bunker fuel storage capacity, this would add to top- and bottom-line growth. Land bank: We estimate that JKHs land bank is worth approximately LKR11.6bn (see Figure 13), equivalent to 6% of the per share value we ascribe to the stock in our DCF/SOTP valuation. This value could rise sharply depending on the manner in which the land is used. Container handling: With one terminal already awarded under a PPP with China Merchants Holdings, there are two other terminals with a cumulative container handling capacity of 5m TEU. If SAGT is able to secure some part of this new capacity, it would add to bottom-line growth. CF&R: JKH reports that the food retail business has reached the required economies of scale to become profitable. The company forecasts a rapid rate of growth for the segment via more store openings; we apply a more conservative approach, suggesting that there may be more scope for top-line and margin growth than we forecast. Additional valuation upside is possible from the real estate development segment
There is also some scope for negative surprises that could pressure our valuation range. There could be delays to JKHs property development projects, and rapidly growing supply of high -end apartments could outstrip demand, forcing JKH to cut prices. Weakness in tourist arrivals, and an excess of new room inventory could hurt ARR growth and occupancy rates. Additionally, there is some risk that the companys food retail operations disappoint, and continue to pressure overall company margins. Further, capacity constraint issues in the transport segment could also threaten share performance.
Direct comparison with peers may not be relevant to our valuation

Figure 19 presents JKHs valuation metrics relative to its peers. JKH trades at a premium to the average of its peers based on P/E valuation metrics. The shares are trading at an FY14E P/E of 16.7x, at a 23% premium to its peer group average.

Figure [19]: JKH trades at a premium on most measures to most comparables
P/E Company name John Keells Holdings PLC Domestic peers Aitken Spence PLC Hemas Holdings PLC Hayleys PLC Richard Pieris & Co. PLC CT Holdings PLC International peers Astra International Indonesia Vingroup Inc.- Vietnam ITC Limited India Larsen & Toubro Ltd. India Cheung Kong Holdings China Hutchison Whampoa China Genting Group Malaysia Sime Darby Berhad Malaysia Siam Cement - Thailand Mean Median High Low 16.8x 46.9x 28.0x 23.0x 4.7x 5.0x 15.4x 15.1x 13.8x 22.2x 18.2x 46.9x 4.7x 15.8x 35.2x 28.2x 17.0x 8.6x 13.2x 17.7x 14.1x 22.4x 18.0x 16.4x 35.2x 5.6x 13.2x 10.6x 31.9x 16.1x 8.8x 12.5x 16.5x 17.1x 15.3x 14.6x 14.0x 31.9x 6.7x 11.6x 11.7x 30.6x 16.1x 7.9x 11.1x 14.5x 15.9x 13.0x 13.5x 12.3x 30.6x 6.9x 10.4x NA 25.8x 14.0x 7.4x 9.7x 13.3x 14.5x 11.0x 12.0x 11.0x 25.8x 6.3x NM NM 17.9% 10.8% NM 13.6% NM NM NM 12.5% 12.0% 17.9% 7.9% 1.3% -9.2% 2.3% -18.9% 2.4% 2.0% 7.4% 1.6% 2.4% -2.4% 1.5% 7.4% -18.9% 0.5% NA NA NA NA NA NA NA NA -1.0% 0.9% 5.1% -15.9% 26.0x 19.5x 41.8x 15.4x 39.5x 13.1x 11.6x 26.0x 5.6x 23.5x 14.9x 8.4x 12.1x 6.7x 19.9x 13.4x 9.8x NA 6.9x NA 11.0x 9.0x NA 6.3x NA 13.3% 7.9% NM 5.9% NM -1.8% -0.6% -13.8% 4.6% -12.8% 5.1% 4.4% 0.9% NA -15.9% 2011 21.6x 2012 17.9x 2013 19.2x 2014E 16.7x 2015E 15.4x EPS CAGR FY14E-FY15E 10.3% FCF yield 2012 6.3% 2013 4.5%
Source: JKH, Bloomberg, Amba estimates Note: JKH multiples are based on Amba estimates. Peer multiples are Bloomberg estimates. FY13 P/E multiples for all international peers (except for ITC Limited and Larsen & Toubro Ltd.) are Bloomberg estimates, and not actuals
Selecting an adequate peer group for a conglomerate is challenging. No potential peer has an identical slate of business segments. But while the companies in the figure above are imperfect at best points of comparison, we have included this data to provide some measure of comparison with other regional conglomerates.
Share price performance

JKH shares closed at LKR242 on 9 July 2013, LKR58 higher than twelve months earlier, for an appreciation of 32%, compared to a 20% increase in the S&P SL 20 and a 22% jump in the All Share Price Index (ASPI) over the same period.

Figure [20]: JKH outperforms the S&P SL 20 and drives the ASPI
Index values 7,500 6,500 5,500 4,500 3,500 2,500 Share price (LKR) 300 275 250 225 200 175 150 6/10/2013
5/10/2011
7/10/2010
3/10/2012
8/10/2012
12/10/2010
ASPI
10/10/2011
S&P SL 20
JKH
As shown in the figure below, JKH has outperformed the indices over a range of recent time periods.
Figure [21]: JKH vs. key indices

3m JKH S&P SL 20 ASPI
6m 8% 7% 4%
1 year 32% 20% 22%
1/10/2013
2 year 15% -7% -13%
3 year 59% 33% 33%
-2% 1% 3%
Earnings release focus areas

What follows is a checklist of items that investors should track in the next and subsequent quarterly earnings release. We will be closely tracking the performance of JKH across these key areas and will be revising our forecasts and updating our valuation range in earnings update notes. Please refer to the company profile for the context of these questions.
For the firm as a whole:

1. Has there been an increase in debt levels to support expansion? The judicious use of leverage would be a positive signal. JKH is underleveraged, and an increase in debt would be a move toward a more efficient capital structure.
CF&R segment food manufacturing

1. 2. 3. Is JKH adding a shift at production facilities to increase production capacity? Focus on changes in market share for JKHs soft drinks and ice cream products. Has JKH been able to pass on price hikes of inputs to consumers?
CF&R segment retailing

1. 2. How many stores has JKH opened during the period? Focus on the margins of the food retailing business. The company stated that it had achieved the required scale to become profitable, so any weakness that does not stem from one-off causes should be a source of concern.
Leisure segment
1. How have actual tourist arrivals compared to government projections? For 2013, the Sri Lankan government is targeting 1.2m tourist arrivals, compared with just over 1.0m arrivals in 2012. What have been the occupancy rates at star-class hotels? One source of concern in recent months has been declining occupancy at higher-end hotels despite rising tourist arrivals. What is the trend in minimum average room rates? Focus on any update on the JV with Sanken (business hotel).
2. 3. 4.
Transportation segment oil bunkering

1. Have there been any measures to increase storage capacity for bunker fuel at the Colombo Port, and is any further privatization of capacity planned? This could increase JKHs current 40% market share through LMS. Are there plans to privatize oil bunkering facilities at Hambantota? The countrys other major port boasts of significantly more oil bunkering capacity than the Colombo port, and its development is a government priority.
2.
Transportation segment container handling

1. 2. Has SAGT taken any measures to increase capacity? Current capacity stands at 2m TEU. Has there been any shift in the volume mix between the domestic and transshipment businesses? The company indicated that it anticipates a gradual shift from the current 20/80 (domestic/transshipment) ratio to 15/85 once the new container terminal comes on stream this year. This could lead to lower margins. Has JKHs stake in SAGT changed (from the 42.2% it currently controls)? Has there been any change in the dividend payout rate to JKH by SAGT (from the current level of nearly 100%)?
3. 4.

5. Any strong movement in the LKR would impact the business, as customers are billed in USD.
Property segment
1. Focus on any update on the 7th Sense project (Gregorys Road) and the proposed new mixed use development project (Glennie Street, at the site of the JKH headquarters). The latter in particular is highly anticipated by the market but has not been factored into our current projections due to lack of visibility on the development.
Financial services segment

1. 2. 3. Any update on the Central Bank of Sri Lanka rule which was subsequently put on hold that would require JKH to sell down its stake in NTB to 15% (from the current 29.9%)? Has there been any change in UALs market share in the life insurance business? As of FY12 (December 2012), its market share stood at 13%. Has there been any movement on government regulations regarding the life insurance industry, with focus on the following? Separation of the life and non-life businesses by 2015 Possible listing of life and non-life businesses by 2016 Extension of the minimum capital requirement (for new entrants) to existing firms for each line of business (life and non-life)
Appendix 1: Company overview

John Keells Holdings (JKH) is the largest publicly traded company on the Colombo Stock Exchange (CSE), with a market capitalization of LKR207bn (USD1.6bn) as of 9 July 2013. JKHs FY13 net profit was the highest ever recorded by a publicly traded company in Sri Lanka. Established in the early 1870s, JKH has evolved over time, having entered and exited various businesses as management strategies and economic climates changed. The company currently operates in six segments: consumer food and retail (CF&R), leisure, transportation, property development, financial services, information technology and a handful of other small businesses. The CF&R, leisure, and transport segments are the largest contributors to the companys top and bottom lines, together bringing in approximately 76% of revenue and over 70% of EBITDA in FY13. Amongst Sri Lankas large conglomerates, JKH is unusual in that a single large shareholder does not control a majority stake. This has bolstered the companys reputation for relatively high levels of transparency and strong corporate governance. It has also helped boost the share liquidity of the stock, which has an average daily trading volume of approximately 595,000 shares, or an average annual daily turnover of approximately USD1m (July 10 2012 to July 9 2013). Also, JKH is the only Sri Lankan company to have a global depository receipt (GDR) issue (Bloomberg ticker: KEEL LX), which is traded on the Luxembourg Stock Exchange.
Figure [22]: CF&R, leisure and transport segments generate approximately 76% of JKH revenues in FY13
LKRm 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 FY09 CF&R Property Others
Source: JKH Note: Individual segmental revenues are inclusive of inter-segmental revenue
Figure [23]: Leisure, property and CF&R remain the largest annual EBITDA contributors
LKRm 12,000 10,000 8,000 6,000 4,000 2,000 0
FY10
FY11
FY12
FY13
Leisure Financial services
Transport IT
FY09 FY10 FY11 CF&R Leisure Financial services Property Others

Source: JKH
FY12 FY13 Transport IT
JKH recorded LKR85.6bn in revenue for FY13, with a CAGR of 15.4% over FY09-FY13. The group generated EBITDA of LKR12.4bn in FY13, representing a 13.3% CAGR over FY09-FY13.

Figure [24]: JKH revenue grew at a 15.4% CAGR over FY09FY13
LKRm 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 FY08 FY09 Revenues (LHS)
Source: JKH
Figure [25]: JKH EBITDA grew at a 13.3% CAGR over FY09-FY13
YoY growth 30% 25% 20% 15% 10% 5% 0% (5%) FY10 FY11 FY12 YoY growth (RHS)
LKRm 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 FY09 FY10 FY11 FY12
YoY growth 60% 40% 20% 0% (20%) (40%) FY13 EBITDA (LHS) YoY growth (RHS)
Source: JKH
JKHs key businesses

The CF&R segment the largest contributor to JKHs top line (29% of FY13 revenues) engages in manufacturing beverages (carbonated soft drinks), frozen confectionary (ice cream) and convenience foods. It also operates a chain of sup ermarkets. The segments activities are as follows: Ice cream and soft drinks JKHs Ceylon Cold Stores (CCS) subsidiary produces soft drinks and ice cream under the Elephant House brand name, which is the market leader in Sri Lanka, with a market share of just over 50%. Elephant House has also been the market leader in the Maldives over the past decade and expanded into Kuwait in FY12. The consumer foods business yields much higher margins than the retail segment, with gross margins of over 30% (more than tenfold the margins reported by the retail segment). Frozen processed/convenience foods The companys Keells Food Products (KFP) subsidiary manufactures and sells processed meat products (under the Keells, Krest and Elephant House brands) locally. The subsidiarys products are also sold in the Maldives, India and the UAE. Retail JayKay Marketing Services (JMS) owns and operates the Keells Super chain of supermarkets, with 51 outlets island-wide (as of March 2013). This includes 45 Keells Super and 6 Super K outlets. The Keells Super chain is the second-largest food retailer in Sri Lanka, in terms of number of stores (behind Cargills, which operated an estimated 211 stores as of March 2013). JMS recently changed its strategy to focus on larger store formats (approximately 7,000 sq. ft compared with initial store sizes of 3,500-4,000 sq. ft) and K-Zone malls. Retail net margins are low, at around 1-2%.
JKHs leisure segment (24% of FY13 group revenues) includes a range of hotels and resorts (under the Cinnamon and Chaaya brands) in Sri Lanka and the Maldives, as well as the companys destination management arm. Colombo city hotels Cinnamon Grand and Cinnamon Lakeside are the two five-star hotels located in Colombo, accounting for approximately 35% of five-star room inventory in the capital. Blended occupancy rates at JKH city hotels average between 65% and 70%, with room rates of USD130-140 per day. Sri Lankan resorts This division comprises eight hotels (all located outside of Colombo) and holds a market share of around 11% of room inventory in Sri Lanka (excluding Colombo). Occupancy rates average around 60%. This segment has average room rates of USD95-110 per day. Maldivian resorts Comprising three hotels in the Maldives, this part of the business posts occupancy rates of over 80%, driven primarily by tourist arrivals from China and Europe. As

the country is a popular tourist destination, the resorts are able to command higher average room rates of over USD300 per day. Destination management and tour operations JKH operates services in Sri Lanka and India through its wholly owned subsidiaries Walkers Tours and Whittall Boustead (in Sri Lanka) and Serene Holidays (in India). Walkers Tours is one of the leading destination management companies in Sri Lanka. The leisure segment relies heavily on these operators to draw tourists to the groups hotels. Development project - JKH is participating in the development of a three-star 240-room select service business hotel in Colombo city through a joint venture with Sanken Lanka, a local developer. JKH currently holds a 27.8% associate stake in the project, which is scheduled to open in August 2014, and will also manage the hotel.
The companys transportation segment (23% of FY13 group revenues) focuses on oil bunkering and container handling services. Oil bunkering Lanka Marine Services (LMS), JKHs oil bunkering subsidiary, imports oil and supplies different grades of bunker fuel to vessels calling in at the Colombo port. A majority of these vessels are container ships, docking in for transshipment (which is the shipment of goods or containers to an intermediate destination, from where it is then taken onto its final destination). While there are 10 licensed bunker operators at the Colombo port, the business is dominated by three operators: LMS, Lanka Maritime Services and Lanka Indian Oil Company. LMS is the market leader, with a market share of more than 40%. Container handling JKH holds a 42.2% associate stake in South Asia Gateway Terminals (SAGT), Sri Lankas only privately owned container handling operator at the Colombo port. SAGT derives its revenue primarily through the loading and unloading of container vessels that arrive at the Colombo port for transshipment. It also handles domestic containers, although this accounts for approximately 20% of throughput volumes. Revenue from domestic operations came in at approximately USD110-115 per box, while for transshipments, it was much more competitive at USD20-25 per box. SAGT, which has a market share of 40% (in terms of volumes), faces stiff competition from its only rival Jaya Container Terminals (JCT), a stateowned operator.
The property segment is a small contributor to total JKH revenue (4% in FY13), but generates high margins. It focuses on developing and selling apartment units, as well as managing shopping malls. Within this segment, JKH owns a large private land bank (approximately 120 acres) across Sri Lanka in prime locations. The segments portfolio comprises the following: Rental properties Through its Asian Hotels and Properties PLC (AHPL) subsidiary, JKH owns and manages the following: Crescat Boulevard an upmarket shopping mall, located in central Colombo. Two K-Zone malls (Moratuwa and Ja-Ela) The latest mall in Ja-Ela is a 140,000 sq. ft complex that recently commenced operations. Almost 90% of the malls gross leasable area (which is approximately 98,000 sq. ft) has already been rented out.
Development properties OnThree20 This is a 475-apartment condominium project scheduled for completion by December 2014. The company reports that 80% of the units had already been sold as of March 2013. 7th Sense This is a 65-unit premium apartment complex project, located in a prestigious area in the south of Colombo city and scheduled for completion by April 2015. JKH is pricing the 2,000 sq. ft units at a super-premium level, and reports that one-third of the units have been reserved. Mixed-use development project We do not factor into our valuation a long-rumored mixed-use development project on the premises of JKHs 12.5-acre Glennie Street property (which currently houses the company headquarters) in Colombo city. The development would reportedly include hundreds of hotel rooms, a shopping complex, a commercial complex and serviced apartments. Due to the lack of available details and the

highly prospective (and speculative) nature of the development, this project is not reflected on our financial model. The financial services (10% of FY13 revenues) segment comprises insurance, banking and stockbroking services. Insurance - JKH owns a subsidiary stake in Union Assurance PLC (UAL), one of Sri Lankas leading insurance companies (offering both life and non-life insurance products). UAL is the fourth-largest life insurance provider in Sri Lanka, with a market share of approximately 13% (as of December 2012). Banking and stockbroking services JKH also holds a 29.9% interest in Nations Trust Bank (NTB), a small-tier commercial and retail bank. Regulatory requirements could require JKH to sell its stake down to 15%, although JKH management indicated that the situation is in flux. JKH also has a 90% stake in John Keells Stock Brokers (JKSB), through which it offers share broking services.
JKHs information technology segment (8% of FY13 revenues) offers IT, software, office automation and BPO/KPO services. JKH is also the authorized dealer for Samsung mobile phones in Sri Lanka.
Management strategy, transparency and governance

JKH has a number of financial targets that it strives to achieve on a segment basis, including annual EBIT growth of over 20%, diluted EPS growth of more than 20%, an ROCE of 15% and an ROE of 18%. Further, JKH seeks to maintain group gearing levels below 25%. In practice, these investment return hurdles often appear to act more as barriers to investment. JKH is steadily losing market share in a number of segments, in part due to a reluctance to invest in developing different businesses. Maintaining a strong investment discipline and focusing on returns, rather than market share, is laudable. However, it may over time threaten to erode the companys position in a number of arenas. JKH enjoys a strong reputation amongst capital market participants as being one of the most transparent and accessible companies traded on the CSE. This is reflected in part in the relatively high proportion of the company held by international investors and the comparatively high level of liquidity of its shares. However, while disclosure may be adequate by local standards, there are still some areas in which it could improve to move towards international standards. Some possible areas of improvement include the following. The companys quarterly disclosure levels regarding capex, working capital, depreciation and other granular details on a segment level are uneven, and an analyst seeking to value the company must frequently make broad and tenuous assumptions regarding JKHs historical (and forecast) performance on a range of factors. Expanding disclosure in quarterly announcements would be a significant improvement. We believe that JKH should produce investor presentations, listing the companys overall strategy and business approach and make these available on its website. This would help potential investors to better understand company performance and direction.
Shareholding structure
International investors hold over 65% of JKHs shares and institutional investors (both domestic and international) hold over 70% overall. Management controls 5% of the company. Unlike many other traded conglomerates, a single shareholder does not control a majority stake in the company.

Figure [27]: Total local individual shareholders account for less than 30% of total shareholding
Mgmt and connected parties 5% Other domestic investors 28% Retail investors 23% Institutional investors 72%
Figure [26]: JKH's domestic investor base is approximately 33%

Mgmt and connected parties 5%
International investors 67%
Source: JKH, as of March 2013
Source: JKH, as of March 2013
The top five shareholders as of March 2013 are presented below.

Name of shareholder Janus Overseas Fund Mr. S.E. Captain Broga Hill Investment Ltd Paints and General Industries Ltd* Deutsche Bank AG - London
Source: JKH *Note: Paints and General Industries is majority owned by Mr. S.E.Captain
Description US-based asset management company Domestic high net worth investor SPV of Khazanah Nasional Berhard, Malaysias sovereign wealth fund Paint manufacturer in Sri Lanka Nominee holder for international shareholders
Stake 10.1% 9.6% 8.7% 5.7% 3.8%
Board of directors
As of March 2013, JKHs board comprised nine directors. Their details are provided below.
Name of Director Mr. Susantha Ratnayake Mr. Ajit Gunewardene Mr. Ronnie Pieris Mr. Franklyn Amarasinghe Dr. Indrajit Coomaraswamy Mr. Tarun Das Mr. Ashroff Omar Mr. Ranjit Gunasekara Ms. Sithie Tiruchelvam
Source: JKH
Description Chairman and CEO. Has held dual positions since 2006. A 35-year veteran of JKH. Deputy chairman. Member of the board for over 20 years, and has been with JKH for more than 30 years. Director of a number of companies within the JKH group. Group finance director. Appointed to the JKH board in 2003. Senior independent non-executive director. Appointed to the board in 1999. A lawyer and a consultant in HRrelated issues. Independent non-executive director. Appointed to the JKH board in 2011. Former Central Bank official who has also worked in other government finance positions. Independent non-executive director. A three-decade veteran of the Confederation of Indian Industry (CII). Independent non-executive director and CEO of Brandix Lanka Ltd., a leading operator in the Sri Lankan apparel sector. Independent non-executive director. Was appointed to the board in 2011. Former banker and CFO of National Development Bank in Sri Lanka. Independent non-executive director. Board member since 2007. Corporate and labor lawyer.
Figure [28]: JKH Corporate Holding Structure

Lanka Marine Services (99.4%) - oil bunkering Transportation South Asia Gateway Terminals (SAGT) (42.2%) - container handling John Keells Hotels PLC (80.3%) - Sri Lankan and Maldivian Resorts Trans Asia Hotels PLC (82.7%) - Cinnamon Lakeside Leisure Asian Hotels and Properties PLC (78.6%) - Cinnamon Grand Keells Hotel Management Services Ltd (100%)
Asian Hotels and Properties PLC (property development) (78.6%) - Crescat Boulevard (mall and apartments), the Emperor and Monarch (apartments) Property John Keells Residential Properties (Pvt) Ltd. (100%) OnThree20 (apartments) John Keells Properties Ja-ela (Pvt) Ltd. (100%) - K-Zone mall Ceylon Cold Stores PLC (81.4%) - Elephant House branded ice-cream and soft drinks CF&R Keells Food Products PLC (89.7%) - frozen/processed John Keells Holdings PLC JayKay Marketing Services (Pvt) Ltd. (81.4%) - Keells Super retail outlets Union Assurance PLC (95.7%) Financial Services Nations Trust Bank PLC (29.9%) John Keells Stock Brokers (Pvt) Ltd. (90.0%)
John Keells Computer Services (Pvt) Ltd. (100%)
IT Services
InfoMate (Pvt) Ltd. (100%)
John Keells Office Automation (Pvt) Ltd. (100%)
John Keells BPO Solutions Lanka (Pvt) Ltd. (100%)
Other
Source: JKH, subsidiaries
Appendix 2: Key financial data

Summary group financials (LKRm)
INCOME STATEMENT (For the year ended 31 March) Revenue EBITDA Total segmental results Interest expense Associate/JV income/(expense) Earnings before tax (EBT) Net profit 60,500 6,587 4,887 (796) 2,641 10,161 7,980 77,690 10,241 8,378 (1,416) 2,765 11,407 8,880 85,557 12,375 10,125 (1,081) 3,369 13,765 11,047 96,514 13,435 10,304 (1,179) 3,267 16,642 12,396 105,079 14,845 11,403 (1,228) 3,362 17,837 13,413 110,876 15,051 11,507 (1,203) 3,691 18,345 14,893 2011 2012 2013 2014E 2015E 2016E
BALANCE SHEET (As at 31 March) Current assets Cash and cash equivalents Short-term investments Accounts receivable Inventories Total current assets Non-current assets Property, plant and equipment Leasehold property Investments in associates/JVs Total non-current assets Total assets Current liabilities Short-term debt Accounts payable Income tax payable Total current liabilities Non-current liabilities Long-term debt Post-retirement benefit obligation Total non-current liabilities Equity Common share capital Retained profit Minority interest Total equity Total liabilities and equity
2011
2012
2013
2014E
2015E
2016E
2,113 16,952 8,982 3,153 34,198
4,267 24,847 11,347 4,350 47,746
3,555 26,586 12,775 3,999 50,018
4,590 26,586 8,854 4,818 47,951
5,144 26,586 9,606 5,293 49,732
5,658 26,586 9,536 5,751 50,634
28,628 9,512 14,692 76,596 110,794
34,290 10,278 15,654 86,712 134,458
49,273 9,514 15,724 109,100 159,118
52,088 9,049 16,331 121,047 168,998
55,297 8,607 17,068 131,543 181,275
59,176 8,178 17,971 141,913 192,548
6,334 11,114 792 19,494
7,833 14,875 823 24,468
8,259 14,608 981 25,499
7,110 15,442 981 25,184
7,146 16,258 981 26,036
6,551 16,080 981 25,263
8,275 1,216 23,552
12,221 1,372 29,788
11,858 1,385 32,434
12,104 1,385 32,680
12,814 1,385 33,390
13,619 1,385 34,195
24,612 25,296 7,642 67,748 110,794
25,111 33,001 8,863 80,201 134,458
26,480 42,704 11,366 101,185 159,118
26,480 51,382 12,637 111,133 168,998
26,480 60,770 13,964 121,849 181,275
26,480 71,195 14,780 133,090 192,548

CASH FLOW STATEMENT (For the year ended 31 March) Operating activities Net cash flow from operating activities Investing activities Purchase of PPE and intangible assets Dividends received from associates/JVs Net cash flow from investing activities Financing activities Debt issuance/(repayment) Common share issuance/(repurchase) Interest paid Dividends paid to common shareholders Net cash flow from financing activities Net increase/(decrease) in cash and cash equivalents (5,371) 1,289 (796) (2,488) (6,791) (2,758) 1,747 499 (1,416) (2,314) 496 7,970 221 1,370 (1,081) (2,982) (1,320) (2,950) (903) (1,179) (3,719) (7,071) 1,035 746 (1,228) (4,024) (5,833) 554 210 (1,203) (4,468) (6,276) 514 (5,093) NA (4,469) (5,522) NA (9,003) (5,237) NA (16,354) (5,471) 2,661 (11,811) (6,201) 2,625 (10,577) (7,011) 2,789 (10,222) 8,501 16,476 14,723 19,917 16,964 17,013 2011 2012 2013 2014E 2015E 2016E
Note: In this case Interest paid in the Cash Flow Statement is equal to the interest expense on the Income Statement
Key ratios
2011 Growth Revenue growth (%) EBITDA growth (%) EBT growth (%) Net profit growth (%) Recurrent diluted EPS growth (%) Margins EBITDA margin (%) EBT margin (%) Net profit margin (%) ROCE (%) ROE (%) Liquidity and efficiency Current ratio (x) Total asset turnover (x) Gearing and cash Flow Debt/Capital (%) Interest cover (x) Free cash flow (FCF) yield (%) Net debt/FCF (x) Valuation P/E (x) P/BV (x) EV/Sales (x) EV/EBITDA (x) EV/FCF (x) Dividend yield (%) Dividend cover (x) 21.6 3.0 3.0 27.5 53.1 1.1 4.3 17.9 2.4 2.2 16.9 15.8 1.5 3.5 19.2 2.3 2.5 17.1 22.3 1.4 3.7 16.7 2.1 2.2 15.4 14.7 1.8 3.2 15.4 1.9 2.0 14.0 19.7 2.0 3.2 13.9 1.8 1.9 13.8 21.2 1.8 3.9 17.7 6.1 1.9 (1.3) 20.0 5.9 6.3 (0.8) 16.6 9.4 4.5 (1.1) 14.7 8.7 6.9 (0.8) 14.1 9.3 5.1 (1.1) 13.2 9.6 4.8 (1.2) 1.8 0.5 2.0 0.6 2.0 0.5 1.9 0.6 1.9 0.6 2.0 0.6 10.9 16.8 13.2 2.7 14.5 13.2 14.7 11.4 6.0 13.5 14.5 16.1 12.9 4.8 13.7 13.9 17.2 12.8 8.2 13.2 14.1 17.0 12.8 8.4 13.0 13.6 16.5 13.4 7.8 13.2 26.1 32.5 55.4 53.4 49.5 28.4 55.5 12.3 11.3 (16.7) 10.1 20.8 20.7 24.4 22.8 12.8 8.6 20.9 12.2 12.4 8.9 10.5 7.2 8.2 8.2 5.5 1.4 2.8 11.0 11.0 2012 2013 2014E 2015E 2016E

PER SHARE DATA Recurrent basic EPS (LKR) Recurrent diluted EPS (LKR) Common dividend per share (LKR) Book value per share (BVPS) Net operating cash flow per share Net cash flow per share
2011 12.8 12.6 3.0 94.8 13.4 (4.4)
2012 10.6 10.5 3.0 84.2 19.5 9.4
2013 13.0 12.9 3.5 104.6 17.2 (3.4)
2014E 14.6 14.5 4.6 115.0 23.2 1.2
2015E 15.8 15.7 4.9 126.0 19.8 0.6
2016E 17.5 17.4 4.5 138.2 19.9 0.6
Segmental summary
(For the year ended 31 March)
Transportation Revenue EBITDA EBIT YoY growth Revenue EBITDA EBIT Margins EBITDA EBIT Leisure Revenue EBITDA EBIT YoY growth Revenue EBITDA EBIT Margins EBITDA EBIT Property Revenue EBITDA EBIT YoY growth Revenue EBITDA EBIT Margins EBITDA EBIT 61.8% 61.4% 51.4% 51.2% 50.8% 50.3% 42.8% 42.5% 40.2% 39.9% 38.4% 38.0% 53.9% 309.3% 318.3% 61.8% 34.5% 34.8% -14.7% -15.7% -16.1% 66.1% 40.1% 40.3% 20.6% 13.0% 13.1% -34.3% -37.1% -37.3% 27.4% 18.6% 2011 2,494 1,542 1,531 30.3% 22.5% 2012 4,033 2,074 2,063 32.3% 23.8% 2013 3,441 1,748 1,730 31.3% 23.6% 2014E 5,715 2,449 2,428 33.0% 25.0% 2015E 6,889 2,766 2,745 33.3% 25.5% 2016E 4,529 1,740 1,721 20.1% 48.5% 73.0% 26.5% 39.9% 52.9% 18.3% 26.2% 25.3% 8.4% 5.0% 7.7% 7.5% 13.5% 13.5% 6.8% 7.7% 9.0% 7.0% 6.0% 2011 13,810 3,782 2,570 4.8% 4.2% 2012 17,469 5,291 3,930 5.4% 4.9% 2013 20,672 6,680 4,923 5.0% 4.8% 2014E 22,415 7,012 5,301 5.0% 4.8% 2015E 24,092 7,962 6,016 5.2% 5.0% 2016E 25,724 8,572 6,558 41.4% 164.8% 243.7% 40.2% -4.0% -0.7% 5.1% 19.1% 22.3% 4.5% -3.2% 1.6% 4.5% 4.5% 4.5% 4.5% 9.1% 9.4% 2011 13,426 939 801 2012 18,816 901 795 2013 19,784 1,074 972 2014E 20,683 1,039 988 2015E 21,623 1,086 1,033 2016E 22,606 1,184 1,130

Consumer food and retail Revenue EBITDA EBIT YoY growth Revenue EBITDA EBIT Margins EBITDA EBIT Financial Services Revenue EBITDA EBIT YoY growth Revenue EBITDA EBIT Margins EBITDA EBIT
Source: JKH, Amba estimates Note: Segmental EBIT has been calculated after incorporating eliminations/adjustments and using Amba estimates for segmental overheads FX rates (LKR/USD): Y/E 31 March 2013 = 129.59 Y/E 31 March 2012 = 112.64 Y/E 31 March 2011 = 112.12
2011 18,358 1,123 683 15.9% 40.3% 62.8% 6.1% 3.7% 2011 6,484 1,009 707 23.2% 42.1% 62.3% 15.6% 10.9%
2012 22,047 1,876 1,318 20.1% 67.0% 92.9% 8.5% 6.0% 2012 8,015 1,375 1,051 23.6% 36.2% 48.8% 17.2% 13.1%
2013 24,423 1,427 758 10.8% -23.9% -42.5% 5.8% 3.1% 2013 8,701 902 566 8.6% -34.4% -46.1% 10.4% 6.5%
2014E 28,297 1,899 1,074 15.9% 33.1% 41.7% 6.7% 3.8% 2014E 9,949 964 775 14.3% 9.1% 41.3% 9.7% 7.8%
2015E 31,650 1,957 1,083 11.9% 3.0% 0.9% 6.2% 3.4% 2015E 10,432 1,003 813 4.9% 4.0% 4.9% 9.6% 7.8%
2016E 35,386 2,138 1,207 11.8% 9.3% 11.4% 6.0% 3.4% 2016E 11,121 1,399 1,207 6.6% 39.5% 48.5% 12.6% 10.9%
Appendix 3: Industry analysis using Porters framework

Porters analysis named after its creator, Harvard Business School professor, Michael Porter is an analytical tool used for industry and competitive analysis. To assess overall industry attractiveness, the tool uses seven elements: barriers to entry, barriers to exit, rivalry among competitors, power of buyers, power of suppliers, availability of substitutes and government action. Based on a range of specific analytical points for each element, the industry and/or company subject to analysis are rated on a spectrum of highly unattractive to highly attractive. Each rating is then used to arrive at an overall industry rating. Below, we briefly present some key points of the seven elements for the key industries in which JKH operates.
Food and beverage manufacturing

Conclusion: The industry should remain attractive through 2016. Sri Lankas food and beverage manufacturing industry comprises branded F&B manufacturers, such as Keells, Cargills, Nestle and Unilever. The customer base includes distributors, comprising large organized retailers, small local grocery stores/retailers and markets across Sri Lanka. The sector should hold substantial opportunities for firms to increase volumes and revenues. The industry will likely continue to be competitive, with key players constantly focusing on maintaining brand equity through innovation and product differentiation. Positive industry dynamics, such as rising per capita GDP, a growing middle-class population, strong brand awareness and the governments efforts to promote the domestic F&B sector, are expected to stimulate industry demand. The industrys attractiveness also means that there is the threat of new entrants. The strong market positions of incumbent producers in the sector, and the economies of scale and lower costs of production they enjoy relative to both smaller local competitors as well as international F&B companies contemplating entering the Sri Lankan market, somewhat diminish this risk, however.
Threat of new entrants moderate.

There are a few large established F&B manufacturers in Sri Lanka who mostly produce their own label/branded products in large quantities and enjoy economies of scale and other cost advantages. Differentiation occurs through product variations (flavors, package sizes, etc.) and branding. Customer (retailer) brand loyalty is high in the case of smaller retail customers, they may be compelled to stock these large local brands to attract customers, and in the case of larger organized retail customers such as Keells and Cargills, they would give preference to their own manufactured brands within the product ranges that they offer (e.g., ice-creams and soft drinks). Even though raw materials are easily available, a new entrant would have to incur high initial capital expenditure to set up a manufacturing facility, or else import goods for sale but would be forced to sell at relatively higher prices as a result. Further, establishing a distribution network would be difficult as a majority of the large locally established F&B manufacturers have their own retail distribution networks, or have tied up with other large organized and smaller local retailers to sell their products.
Barriers to exit moderate.

Although firms in the industry use specialized processes to automate their manufacturing, potential buyers are ready to take over should they choose to exit. However, a large F&B manufacturing firm should consider the impact to its business before making such a decision as there is a high level of strategic interrelationship with its retail lines of business, and an exit could have a significant oneoff impact on the organization.
Rivalry amongst competitors - moderate.

A few large firms (Keells, Cargills and Nestle) dominate the F&B manufacturing industry in Sri Lanka. With anticipated increases in per capita GDP and consumer demands for a more convenient lifestyle, the demand for branded, high-quality F&B products should increase. High levels of product and brand differentiation enable existing players to compete on a distinct basis effectively and seek opportunities to increase volumes and market share. Innovation is critical in this industry to maintain brand equity and keep customers engaged. Existing firms may also have

the option of enhancing capacity easily without the need for additional fixed costs (by simply adding on another shift at an existing factory).
Bargaining power of buyers high.

This analysis has been broken down to include both types of buyers: Large organized retail buyers : high bargaining power There are a few large organized retailers (including the manufacturers own distribution networks) in Sri Lanka, which account for 15% of retail trade in the country e.g., Keells Super, Cargills, Arpico, Laugfs and Sathosa. Although they account for a smaller proportion of the customer base, they can be considered more important than the smaller retail buyers as they have more extensive distribution networks, and will therefore account for a large volume of sales to the F&B manufacturer. Buyer switching cost is low (with the exception of retailers stocking own-branded products) as these organized retailers are aware of their importance to the manufacturers. As retail margins are generally low, around 2-3%, and since they purchase in bulk, these buyers should be able to squeeze the manufacturers margins, indicating higher bargaining power. Small local retail buyers: low bargaining power Small local retailers (buyers) account for 85% of the customer base for the large F&B manufacturers. However, they have lower bargaining power because they buy in small quantities from the few large firms producing these locally branded, high-quality products (that are trusted and preferred by the local end consumer). Brand differentiation is high, which makes switching costs high, as these small local retailers may be required to stock certain brands to meet demands from their customer base. Further, these small retailers do not have much room for margin improvement as the large F&B manufacturers are in a more dominant position and will try to squeeze the margins of the smaller retailers.
Bargaining power of suppliers low.

There are a large number of small local suppliers and a few international suppliers providing basic commodity ingredients (such as sugar and meat) to F&B manufacturers. Even though raw materials comprise over 80% of the manufacturers total production costs, which implies that the suppliers are a critical contributor to the F&B manufacturing industry, bargaining power of the suppliers is low as they provide undifferentiated products. This makes customer switching costs low, as these items can be obtained easily from anywhere. Suppliers are also much smaller in size and scale compared to the large F&B manufacturers, which places them in a weaker bargaining position.
Threat of substitutes moderate.

Substitutes are available in the form of other local brands and some internationally branded items as well. However, customer switching costs may be high smaller local substitute brands may not be well recognized and international brands may be too expensive for the end consumer, which would result in unsold inventories for retail distributors (who would consequently opt not to stock such brands). Therefore, existing branded F&B manufacturers would only be exposed to substitute brands from their direct local competitors.
Government action favorable.

The strategic plan of the Export Development Board (a state organization dealing with the promotion and development of exports) for 2011-2015 has identified the F&B industry as one of the seven key priority sectors, with plans to grow export earnings from this sector to USD1bn by 2015 (from approximately USD284m in 2012, including tobacco exports). Therefore, there are several incentives, such as VAT exemptions on machinery and equipment and zero tax concessions on processed foods, provided to firms operating in this industry, which increases industry attractiveness.
Organized food retail

Conclusion: The industry should remain neutral through 2016. The organized food retail sector in Sri Lanka is dominated by a few large firms. The industry is highly competitive and still in its growth phase, with opportunities for revenue growth resulting from rising disposable income in Sri Lanka. Customers can choose whether or not to go to a retail store,

as most products sold are day-to-day FMCG items, for which substitutes are freely available in open-air markets or other small grocery stores. Moreover, consumers have very little brand loyalty. However, if large retail chains expand their distribution networks, manage the impact of new regulations and retain their customer base, they can generate margin growth.
Threat of new entrants low.

Potential new entrants to Sri Lankas food retail industry may be attract ed by low product differentiation, low customer brand loyalty, high price elasticity and, therefore, low switching costs, which make it easier to penetrate the industry and attract new customers through lower prices. However, the threat of new entrants is reduced by economies of scale enjoyed by larger, wellestablished retail chains that already have extensive distribution networks in place. High initial capital expenditure is also required (approximately LKR100m for a saleable area of 7,000 sq. ft.) to set up operations and find a suitable prime location. Further, recent regulations imposing a 12% VAT charge on retailers with a turnover of above LKR500m (approximately USD4m) per quarter could also discourage new entrants, as retail sector net margins are already low at 2-3%.

The one-time exit cost may be considered moderate. Retail outlets in Sri Lanka are either owned by a company or obtained on a long-term lease. Therefore, disposing of these outlets may not be a major problem as company-owned properties are in prime locations, which are largely sought after, and any lease agreements may be terminated/revised.
Rivalry among competitors high.

Although there are several smaller private retailers across the island, the organized retail industry consists of three main private sector FMCG retail chains Keells, Cargills and Arpico (accounting for approximately 15% of retail trade in Sri Lanka). The industry is in its growth stage, to be driven by an expected 7.2% CAGR in per capita income over FY14E-FY16E, according to World Bank estimates. Provided that economic growth trends as projected, existing firms can benefit from incremental increases in market share through market development (opening more stores in new locations) over the medium term, as rising GDP could see more customers visiting larger retail outlets regularly. However, significantly low levels of differentiation could increase price competition and yield low margins.

The industry is home to a large number of consumers who remain extremely price conscious, despite rising GDP and the desire for a more comfortable lifestyle. They are not willing to pay significantly higher prices for products that are readily available elsewhere at a considerably lower price. The generic nature of FMCG products and the highly elastic nature of demand means there are several substitutes available and customer switching cost is extremely low, as they can easily opt not to visit a large retailer for weekly FMCG requirements. Further, based on statistics from the Central Bank of Sri Lanka (CBSL), at the end of 2011, over 40% of the average monthly household spend was on key FMCG products. This is a significant proportion of the buyers income, which would further increase price sensitivity.

Large retailers manufacture some of their own products. Other products come from small fragmented suppliers or larger established manufacturers. However, regardless of the size or scale of the external supplier, extensive distribution networks established by organized retailers make external suppliers fully dependent on organized retailers for business. Switching costs of large retailers are low due to the generic nature of the products, which makes them easily available. Even with branded products, suppliers are largely dependent on retailers for business, and even if large retailers choose not to stock particular brands, it would not have a significant impact on top lines, since customers are flexible and can easily choose another brand to meet their immediate needs. Cost of sales is the highest contributor to a retailers cost structure and since retailers face increasing margin pressure from high direct and fixed costs and their inability to increase prices, there is a constant need for cost control. Further, retailers purchase in bulk from external suppliers, accounting for a large proportion of suppliers revenues, which again lowers the bargaining power of supplier firms.

Threat of substitutes high.
The substitute to retail supermarket shopping is purchasing provisions from small local grocery stores or open-air markets. Customer switching costs are extremely low as the availability of small local vendors being widespread across Sri Lanka. Further, these small retailers maintain close relationships with customers; therefore, organized retailers are unable to command strong brand loyalty.
Government action moderate.

Most large retailers have been able to absorb the 12% VAT charge together with their suppliers, which means customers will not face any significant price increases. There is also a recent proposal to ban foreign investments for retail trade to protect domestic investors, although further details on this regulation are not yet available. The government reserves the right to make any tax and policy amendments in most areas, without having to give any prior notice to businesses. This creates uncertainty for the industry and the impact depends on how quick the businesses are in responding to such changes.
Hotels
Conclusion: The industry should remain mildly attractive through 2016. The Sri-Lankan governments target to increase tourist arrivals in the country by approximately 150% by 2016 to 2.5m highlights its plans to make Sri Lanka a prime tourist destination over the medium term. According to the Sri Lanka Tourism Development Authoritys (SLTDA) statistics and forecasts, the country will require additional room inventory to meet the anticipated increase in tourist arrivals. This substantial potential demand is likely to attract new entrants to this highly competitive industry. Switching costs for customers is low and will remain low as the number of industry participants increases. However, the industry may be threatened by its overdependence on destination management companies (DMC, which are local firms offering services to help attract and bring in tourists to Sri Lanka) and a labor shortage. Furthermore, regulations relating to the proposed wage hike and minimum room rates could dampen industry growth.

Customer brand loyalty is low, as are switching costs, as customers can easily get distracted when choosing a holiday destination, which makes it easier to create a niche in this industry. The high capital requirements for property development and periodical refurbishments may be less of a challenge for international hospitality companies, as they may have better access to funding than domestic firms. Larger hotel chains, as well as international brands entering Sri Lankas hotel sector (including Shangri-La, Hyatt and Sheraton), should enjoy economies of scale.

The one-time exit cost may be considered moderate. As Sri Lanka is poised to become a major tourist hub over the medium term, any hotel wishing to dispose of its operations could be taken over by a larger competitor/firm that would view this as an attractive opportunity to consolidate/diversify.
Rivalry among competitors moderate to high.

At present, there are many local and international hotel operators (e.g., JKH, Aitken Spence, Jetwing, Taj Hotels, Hilton and others) in Sri Lanka. The industry is poised for growth, as the government is targeting a significant increase in tourist arrivals over the next few years, which creates a need for additional room inventory in the country. Each hotel operator also competes on a different niche (based on star class, services offered, quality of customer service, etc.) and all these factors collectively create an evenly balanced platform, allowing all competitors to benefit from the potential industry growth.

Tourists and holiday-makers are generally highly price sensitive; they seek value for money, even if it is at a star-class hotel. Visitors to Sri Lanka have a range of options to choose from, and switching costs for buyers is low. Furthermore, the strategic importance of the product/service

offering is low, as holidays are a luxury (non-essential) expense borne by individuals, depending on their levels of disposable income.
Bargaining power of suppliers high.

There are two key suppliers to the hotel industry: DMCs and employees. There are a few wellestablished DMCs in Sri Lanka, such as Walkers Tours, Aitken Spence Travels and Jetwing Travels, and roughly over 60% of inbound travels are secured through these intermediaries. There are few alternatives for hotels to using the services of DMCs, other than for hotels to launch their own destination management efforts. Occupancy levels at hotels depend largely on the relationship between the hotel and the DMC. Some of the large established local hotel chains already have DMCs that operate as their sole agents. Even so, the DMCs services are strategically important to the hoteliers, which make switching costs high. This leaves DMCs in a strong position to negotiate their rates with hotels. There is also a severe shortage of skilled labor in the industry, and there is no substitute to hiring employees, as a personalized service is critical to the success of the hotel sector. Therefore, employees in the sector generally enjoy strong bargaining power, which reduces industry attractiveness.
Threat of substitutes high.

Holidays offer customers leisure, entertainment and relaxation. Therefore, there are several substitutes, particularly tourist destinations in other regions that can compete for a share of the customers wallet, particularly other regional tourist destinations. Brand loyalty is limited and the customers can easily change their minds. There may also not be a significant price differential; therefore, switching costs are low.

While the government is investing to promote Sri Lankas image as a global tourist hub, industry players believe that the government could do more to put the country on the tourism world map. On the positive side, the tax on foreign leases of land for business ventures is down to approximately 10%, which could drive foreign investment into Sri Lanka. However, the country is still in the process of developing the infrastructure required to support the anticipated 2.5m tourists in 2016. The tourism sector remains highly regulated, which could be counter-productive to industry growth. Higher minimum average room rates, while increasing hotel sector revenues, could reduce Sri Lankas regional and international competitiveness. Higher electricity tariffs and the proposed wage hike in the tourism sector could also hurt industry attractiveness.
Oil bunkering
Conclusion: The industry should remain mildly attractive through 2016. The oil bunkering industry distributes imported oil as bunker fuel to ships docking at the Colombo port, where a majority of these vessels come in for transshipments (the shipment of goods or containers to an intermediate destination, from where it is taken to its final destination). The industry is dominated by three large operators in Colombo, while the oil bunkering facilities at the Hambantota port, which commenced operations in late-2012, is to remain under state control over the medium term and, hence, has been excluded from our analysis. Expansion projects at the Colombo port would lead to more intense competition, as firms fight to increase market share. Due to capacity constraints, which make the industry unattractive to new entrants, the existing key players in the industry have opportunities to increase revenues and margins moderately purely through internal and operational efficiencies, as capacity constraints are a medium-term problem within the industry. Competition is based on the speed and quality of service offerings and not so much on price and product offerings, as all firms offer an undifferentiated product. Furthermore, increased privatization of bunkering operations in Sri Lanka should be considered if overall efficiencies of the bunkering industry are to improve.
Threat of new entrants low.

Even if new firms were to enter the industry, they would face heavy pressure from existing players, who are well-established and benefit from economies of scale. Furthermore, product differentiation levels are low, as all bunker operators store and provide the main grades of fuel oil IFO 180cst, IFO 380cst (the two most popular intermediate fuel oils) and MGO (Marine gas oil). Although

bunker fuel is an essential commodity product and brand loyalty is not important (thus, customer switching costs are low), a new entrant would require access to a share of the bunker storage capacity. However, currently, there is limited installed storage capacity for a new entrant to penetrate the market.
Barriers to exit low.

The main exit barrier would be disposing of bunker barges and fuel storage containers. However, this would not be difficult, as competitors are on the lookout for ways to increase market share and would likely purchase these assets.
Rivalry among competitors high.

Competition stems from local firms, as well as other regional ports. Local competition There are 10 licensed bunker operators at the Colombo port in Sri Lanka, but the market is an oligopoly, dominated by three large operators (Lanka Maritime Services Ltd [stateowned], Lanka Marine Services [LMS; a JKH subsidiary, with JKH holding a 99% stake] and Lanka IOC PLC [LIOC])controlling over 90% of the market share in Colombo. LMS is the market leader, with approximately 45% of the market share at the Colombo port. Research by Interocean Energy (Pvt) Ltd suggests that South Asias container -handling volume is expected to grow at approximately 8% through 2015; this creates opportunities for existing firms to maintain and increase their market shares. All firms provide the main fuel grades and products are largely undifferentiated. Furthermore, the current bunker fuel storage capacity in Colombo is 35,000 metric tons (MT) and is close to full capacity levels. The government plans to expand this to approximately 95,000 MT over the medium term. However, there is no confirmation yet on the progress of these plans. The recently added 85,000 MT of storage capacity at the Hambantota port will remain under government control over the medium term, until the government has repaid its outstanding loans to China. Therefore, due to the commodity nature of the product and the medium-term capacity constraints, firms will compete aggressively on service quality and will have to increase internal efficiencies to achieve higher margins. Regional competition Local oil bunkering operators also have to deal with competition from other regional ports, such as India, Singapore and Oman. While there are several other regional firms operating in the industry, all providing an undifferentiated product, Sri Lankan bunker operators would be at a disadvantage, due to the uncompetitive pricing of their bunker fuel (all of which is imported), which is significantly higher than that of Singapore, for example.
Bargaining power of buyers low.

The buyers consist of ships that dock at the port, mainly for transshipments, and as Colombo is a popular transshipment hub, re-fueling is essential. The key players in the local industry form an oligopoly and provide an essential commodity product, which reduces customer bargaining power. While the cost of switching between local bunker operators is low (product and price differentiation levels are low), the cost of switching to other regional suppliers may not be as low. While regional bunker operators may offer better prices, they have their limitations e.g., India, where the depth of waters is too low for larger vessels to navigate, or Oman and Malaysia, which are too far. There are no substitutes available for bunker fuel and the product is a critical resource for the ships to continue their standard operations. Furthermore, even though bunker fuel accounts for an estimated 25-50% of the buyers total operating cost, buyers cannot bargain on prices, as local bunker prices are linked to global oil prices.
Bargaining power of suppliers high.

Bunker fuel supplies are imported mainly from Singapore, UAE and India, and there are no direct substitutes for this product. Total annual oil demand in Sri Lanka is 4.8m MT (including bunker fuel) and the country is entirely dependent on imported fuel to meet this demand. Although the cost of oil makes up a large proportion of the costs for the bunker industry, there may be little room for the buyers to negotiate, as oil supplies are linked to the Platts Index, with freight and other premiums added on.
Threat of substitutes low.

Ships currently use high-sulfur fuel oil. Presently, there are no substitutes to bunker fuel and, hence, no substitute service providers.

At present, most of the bunkering storage capacity in Sri Lanka (at the Colombo and Hambantota ports collectively) is under state control. Additional privatization and capacity increases should be considered to develop the industry further and strengthen competitiveness. Furthermore, a proposed ports and airports development levy (a 5% tax on bunker sales) may impact Sri Lankas ability to compete efficiently with other regional markets.
Container handling
Conclusion: The industry should remain mildly attractive through 2016. We expect the container handling industry in Colombo to remain mildly attractive in the medium term driven mainly by the anticipated growth in the container handling industry in South Asia which is expected to increase by 8% on average through 2015, on the back of rising trade flows. This creates opportunities for existing firms to grow their volumes and increase revenues. Although the Colombo harbor is strategically located along the east-west trade route, and continues to be a critical transshipment hub in the region, there would be a certain degree of competition from other regional ports, as the shipping lines can decide which port to call in at for transshipment (depending on the final destination of the shipment).

The industry focuses on loading and unloading containers at the Colombo port. While there is very little service differentiation and low brand loyalty, which lowers the costs of switching to a local service provider, the cost of switching over to a new entrant will be much higher as the new player can be expected to take time to move up the experience curve. The Sri Lankan industry remains largely under government control, with 60% of the current industry capacity of 4.9m TEUs (twentyfoot equivalent units) being under state control. Capacity expansion plans are underway with the new terminal construction, but a new entrant trying to penetrate the market would first need to secure the bid to handle the new terminal. Further, the existing two main players are industry veterans, and benefit from economies of scale as throughput volumes increase. High capital expenditure would also be required to invest in the quay cranes and other heavy equipment needed to run efficient operations.

The industry uses specialized heavy equipment and machinery, such as cranes, fork-lifts, moving trucks, etc. However, if an existing player were to exit the industry, it might not be extremely difficult to transfer ownership of operations, as there is likely to be a few bidders, given the strategic regional location of the Colombo port and the industry growth prospects. Further, if all else fails, the operations could be taken over by the government, based on their own stipulated terms and conditions.
Rivalry amongst competitors - moderate.

There are two main container handlers in Colombo: South Asia Gateway Terminals (SAGT), Sri Lankas only privately owned terminal; and state-owned Jaya Container Terminals (JCT). JCT handles around 60% of container operations at the Colombo Port, and therefore, the level of competition is not very intense. Research by Interocean Energy Pvt Ltd suggests that container handling volume in South Asia is expected to grow at approximately 8% through 2015 and although the service offered is largely undifferentiated, planned capacity increases will increase competition in the medium term. The new terminal construction at the Colombo port, which is expected to add approximately 2.4m TEUs (roughly 50%) to capacity by 2014, is under a Public Private Partnership (PPP) owned 85% by China Merchants Holding and the balance by the Sri Lanka Ports Authority (SLPA) on a Build-Operate-Transfer (BOT) basis. With the opening of the terminal in July 2013, competition will likely intensify amongst the existing firms as the new player struggles to win market share.
Bargaining power of buyers moderate.

Buyers would mainly consist of the many shipping lines around the world. These vessels are dependent on the two main container handlers at the Colombo port. The only substitute to sea freight is air freight, which is too expensive and may not be practical for handling heavy containers. SAGT and JCT provide a critical, non-substitutable service to its buyers as transshipment

continues to dominate port activities, accounting for 80% of throughput volumes at present. Buyer switching costs may be high as other regional ports include India, where water depth is insufficient for larger vessels to navigate. Further, Indian ports are operating at near capacity levels and use Sri Lanka as its main transshipment hub. Other regional ports like Oman and Malaysia may be too far away. Therefore, although the choice of a port is largely at the customers discretion, they may not have very many options, which indicates low price sensitivity, and ultimately lower bargaining power.

The main supplies used in this industry would be the equipment - such as cranes, stackers, forklifts, etc. There are many international suppliers of such items, such as Mitsui, Mitsubishi, Caterpillar, etc. which offer slightly differentiated products. Despite this, the container handlers may be able to switch suppliers without too much of a problem, if industry standards are not maintained and/or they are not satisfied with the equipment quality. Therefore, supplier bargaining power is relatively low.

Shipping lines have only a few options in terms of substitutes. Air freight is an option, but is comparatively expensive. There are two main container handling operators in Colombo and apart from this; other regional ports could be used. Although the regional ports have their limitations, the choice of port by a shipping line depends largely on the final destination of the shipment, and so if deemed necessary, the customer could switch over to other regional ports.
Property (condominium development)

Conclusion: The industry should remain mildly attractive through 2016. Condominium development in Colombo is in its growth stage. A few large, well-established firms dominate the industry, reducing the threat of new entrants. Existing players compete based on product differentiation within different niches. As consumer disposable income continues to rise (the Sri Lankan government forecasts that GDP/capita will increase 41% from 2011 levels to USD4,000 by 2016), consumers demands for a m ore comfortable lifestyle, together with low substitute availability, could increase demand for luxury apartments. In addition, favorable government legislation could encourage property developers to invest further and increase the competitiveness of the industry.

A new entrant trying to penetrate the industry would face pressure from existing, well-established property developers who enjoy economies of scale and several other advantages. Although customer brand loyalty is low, product differentiation is high, making it possible for a new player to create a niche in the industry. Recent regulations reducing the current 100% tax on land/property leases by foreign individuals (for business ventures) to less than 10% could encourage new foreign developers to enter the industry. Capital requirements, although high would not create an entry barrier as condominium units are largely pre-sold; KPMG estimates a pre-construction-to-sale ratio of 50% creating a largely self-financed business model.
Barriers to exit low.

The only barrier to exit would be the disposition of unsold inventory units (apartments) and construction equipment. However, the condominium markets current growth phase and the characteristic pre-selling of many units indicate that demand is still growing and that this may not be a problem. Further, most of machines and equipment used for construction are hired out on contracts; therefore, disposing of these would not be an issue.
Rivalry amongst competitors moderate.

There are a few large, well-established real estate developers in Sri Lanka, including JKH, Trillium Residencies, CT Properties, Overseas Realty and Fairway Residencies. These firms compete by offering highly differentiated products at low, mid, high-end, prime and luxury levels, depending on size and features. Inter-firm rivalry is not particularly strong, as each firm may focus on one or more segments within the industry. At present, there is no significant oversupply of condominium units in Sri Lanka; therefore there are opportunities for existing firms to increase capacity.

Bargaining power of buyers low.
Potential home owners would constitute buyers/customers. These are affluent individuals, the ranks of whom are rising as per capita incomes increase. The relatively small number of development companies in Sri Lanka means that buyers do not have much choice. The substitute to buying a condominium unit would be to purchase a dwelling outright, or rent/lease a living space. Nevertheless, while substitutes are available, product differentiation (a condominium versus a house), along with the sunk cost involved in the down payment required to buy an apartment, makes buyer switching costs high.

Suppliers include suppliers of labor, raw materials (cement and steel), equipment, utilities (electricity and water for construction), furnishers, construction companies, contractors and architects. Most of these items are linked to commodity prices (such as cement, steel, etc.) and thus prices are largely driven by external factors. The large number of suppliers drives high price competition and reduces bargaining power. While there is a shortage of labor with the necessary skills, workers can be brought in from abroad, which reduces the scope for workers to demand higher wages. While condominium developers may maintain long-term relationships with suppliers, suppliers are heavily dependent on condominium developers for business due to their relatively smaller size and scale. Buyer switching costs, while not negligible, are relatively low, which reduces the bargaining power of suppliers.

The buyers need is a comfortable living space . The substitute to investing in a condominium would be to invest in land and construct a house or to enter into a long-term rental agreement. As such, there may be several substitutes available.
Government action favorable.

The lowering of interest rates would make it cheaper for developers to borrow money if necessary and for customers to take out mortgages. Moreover, the reduction of the current 100% tax on foreign leasing of land/property (for business ventures) to less than 10% is also supportive of the domestic real estate industry.
Appendix 4: SWOT analysis

Strengths Strong brand recognition Experienced management team Perceived as the leading blue chip company in Sri Lanka Strong focus on delivering shareholder value Large land bank Strong net cash position Low debt/equity ratio Exposure to high-growth sectors Weaknesses Excessive caution in investment in growth and acquisitions Market share deterioration in some segments Inadequate breakdown disclosure of segmental performance
Opportunities Strong anticipated growth in tourist visits Container handling capacity expansion Access to proposed increase in oil storage capacity Rising GDP/capita and disposable income in Sri Lanka Increased diversification into international markets
Threats In key industry segments, more aggressive competitors are taking market share Domestic infrastructure not up to international standards Proposed legislation (for example, on minimum room rates and tourism industry wages) could negatively affect the growth of the leisure and transport segments Rupee appreciation could affect sectors that earn revenues in USD Risk of political instability and social unrest
Appendix 5: Diversified sector overview

As of 9 July 2013, the diversified sector represented 22% of the CSEs total market capitalization of USD17.6bn. It is the second-largest sector on the stock market, close behind financial services.
Figure 28: Top five sectors on the Colombo Stock Exchange by market capitalization
Market cap (USDbn) 3.9 3.8 3.6 1.1 1.1 % of total CSE market cap 22% 22% 21% 7% 6%
Sector name Banks, finance & insurance Diversified Beverage, food & tobacco Hotels and travels Telecommunication
Source: CSE Note: Data as of 9 July 2013
Two largest companies Commercial Bank of Ceylon PLC Hatton National Bank PLC John Keells Holdings PLC Carsons Cumberbatch PLC Ceylon Tobacco Company PLC Nestle Lanka PLC Asian Hotels & Properties PLC Aitken Spence Hotel Holdings PLC Sri Lanka Telecom PLC Dialog Axiata PLC

There are 18 listed diversified companies trading on the CSE, 13 of which are listed on the main board, while 5 are listed on the Diri Savi Board. We have listed the top 10 companies in the Diversified sector based on market capitalization as of 9 July 2013, along with a brief description of their main businesses. Figure 29: Details of conglomerates listed on the main board of the CSE
Market cap (USDm) 1,587 Free float (%) Top 3 businesses by revenue contribution 88.4% Consumer food (manufacturing) & retail Tourism (hotels, destination management) Transportation (oil bunkering, container handling) 23.8% Oil palm plantations (palm oil, palm kernel, fresh fruit) Oils and fats (refined oils, cooking oil, specialty fats) Beverages (breweries) 40.1% Power generation Tourism (hotels, destination management) Logistics (freight forwarding, courier services, integrated logistics, maritime transport) 38.7% Retail and wholesale Distribution (FMCG) Ceramics & tiles (manufacturing and distribution)* Food processing (consumer foods) 40.0% Hand protection (rubber gloves) Transportation & logistics (warehousing & distribution, freight, chartering and port operations) Purification products (carbon granular, fines, powders and pellets) 19.4% Finance (banking) Apparel Tiles 28.3% Healthcare (pharmaceuticals, diagnostic and surgical services, hospitals) FMCG Power generation 45.0% Retail Plantations (tea, rubber, palm oil) Plastics (water tanks and pumps, foam mattresses, bulbs, molded plastics) 26.9% Freight & logistics (air and sea freight, logistics, warehousing) International trading and manufacturing (agricultural, paper, plastic, metal pharmaceutical products) Investments & services (airline general sales agent, business process outsourcing, education, investments, corporate services) 3.5% Tea exports Services (environmental services, insurance brokering, marine cargo surveying, airline general sales agent) Logistics (tea warehousing, temperature controlled logistics, air freight)
Company name John Keells Holdings PLC
Bloomberg/CSE tickers JKH SL/ JKH.N0000
Carsons Cumberbatch PLC
CARS SL/ CARS.N0000
632
Aitken Spence PLC
SPEN SL/ SPEN.N0000
384
CT Holdings PLC
CTHR SL/ CTHR.N0000
202
Hayleys PLC
HAYL SL/ HAYL.N0000
175
Vallibel One PLC
VONE SL/ VONE.N0000
146
Hemas Holdings PLC
HEMS SL/ HHL.N0000
133
Richard Pieris & Co. PLC
RICH SL/ RICH.N0000
103
Expolanka Holdings PLC
EXPO SL/ EXPO.N0000
102
Finlays Colombo PLC
JFIN SL/ JFIN.N0000
74
Source: CSE, Bloomberg, Company annual reports Note: Market capitalization data as of 9 July 2013. Revenue contribution and free float is based on FY13 data. *CT Holdings PLC disposed their stake in Lanka Wall Tiles during May 2013

The shareholding structures of these listed conglomerates are shown in the table below. Four companies have significant international shareholding, and management hold large stakes in four issuers.
Figure 30: Shareholding structures by investor type and geographical location

Investor type Management John Keells Holdings PLC Carson Cumberbatch PLC Aitken Spence PLC CT Holdings PLC* Hayleys PLC Vallibel One PLC* Hemas Holdings PLC Richard Pieris & Company PLC Expolanka Holdings PLC Finlays Colombo PLC* 5.0% 0.3% 1.9% 19.5% 48.5% 63.3% 4.0% 0.4% 72.8% 0.0% Other retail 23.3% 3.9% 7.5% 21.2% 36.0% 8.0% 6.1% 15.9% 10.7% 1.6% Institutional 71.7% 95.9% 90.7% 59.3% 15.6% 28.7% 89.9% 83.8% 16.6% 98.4% Geographical location Management 5.0% 0.3% 1.9% 19.5% 48.5% 63.3% 4.0% 0.4% 72.8% 0.0% Other domestic 28.4% 81.7% 52.8% 66.5% 48.0% 36.0% 89.2% 40.1% 23.2% 2.5% International 66.6% 18.0% 45.3% 14.0% 3.5% 0.7% 6.8% 59.5% 4.1% 97.5%
Source: Company annual reports *Note: Data as of FY12 (31st March 2012). For Finlays PLC, the FY12 data is as of 31st December 2012
Below are key financial statistics for these conglomerates. Figure 31: Key financial data
Company Name John Keells Holdings PLC Carson Cumberbatch PLC Aitken Spence PLC CT Holdings PLC Hayleys PLC Vallibel One PLC Hemas Holdings PLC Richard Pieris & Co. PLC Expolanka Holdings PLC Finlays Colombo PLC Revenue 661 588 283 527 572 254 202 268 387 40 EBIT 55 84 43 34 51 39 19 29 15 2 Net income 94 35 25 9 14 11 13 15 8 3 EBIT margin (%) 8.3% 14.2% 15.0% 6.5% 9.0% 15.3% 9.3% 10.7% 3.8% 6.1% Net income margin (%) 14.3% 6.0% 8.9% 1.7% 2.5% 4.3% 6.4% 5.5% 2.1% 7.2%
Source: Bloomberg Note: All data as of FY13, except for Finlays Colombo PLC (data as of December 2012). All figures are in USDm, unless stated otherwise
Fact Sheet
Sri Lanka investment environment overview
Sri Lankas economy has been on an upward trajectory since the end of the three -decade civil war in May 2009. Sri Lanka currently boasts South Asias highest GDP growth, conducive fiscal and monetary policy, and favorable socio-economic conditions, which together create an attractive investment destination. Figure [1]: Sri Lanka's GDP projected to increase at a 7% CAGR 2012-2016E
% 9 8 7 6 5 4 3 2 1 0 8.0 6.8 6.0 3.5 2,000 1,000 2013E 2014E 2015E 2016E 2007 2008 2009 2010 2011 2012 0 2005 2006 2007 2008 2009 2010 2011 2012 2016 E Jan-12 Apr-13 LKR/GBP 79 79 78 75 71 201 201 8.2 6.4 8.0 8.3 8.5
Figure [2]: GDP per capita to increase 33% by 2016E

USD 5,000 4,000 3,000
7.5
Source: Central Bank of Sri Lanka, Department of Census and Statistics
Source: Central Bank of Economic and Social Statistics of Sri Lanka 2012, Road Map 2013 - Central Bank of Sri Lanka
Figure [3]: Annual core inflation post-war has averaged 6.7%, government targeting mid-single digit levels in the medium term
% 16 14 12 10 8.5 8 6 4 2 0 2006
Figure [4]: CBSL expects the rupee to stabilize around LKR125 per USD in the medium term
250
13.6 200 7.0 7.7 7.0 6.9 5.8 150
2007
2008
2009
2010
2011
2012
100 Jan-07
Apr-08 LKR/USD
Jul-09
Oct-10 LKR/EUR
Source: Department of Census and Statistics, Central Bank of Sri Lanka
Source: Bloomberg
Figure [5]: Fiscal deficit target of 5.2% of GDP for 2014E

LKRbn 600 400 200 0 12% 8% 4% 0%
Figure [6]: Debt-to-GDP to fall to 71% by 2015E

% 120 100 80 60 40
102 102 91 88 85 81 86 82
2013E
2012
2014E
2006
2007
2008
2009
2010
2011
20
Fiscal Deficit LKR bn

Source: Central Bank of Sri Lanka
As a % of GDP
Source: Central Bank of Sri Lanka
2012
2003
2004
2005
2006
2007
2008
2009
2010
2011
201
The Sri Lankan equity market offers a rare and attractive alternative to investors in an investment era impacted by economic growth worries. Backed by the countrys robust economic growth, the Sri Lankan capital market is well set to offer attractive returns to investors who are keen to be a part of this emerging market success story. There are several strong incentives for entering the Sri Lankan capital market. Figure [7]: Post war, the ASPI has significantly outperformed global and developed market indices
400 360 320 280 240 200 160 120 80 40 0 Jul-09 Feb-10 Oct-10 May-11 Jan-12 Aug-12 Apr-13 ASPI Dow Jones FTSE 100 MSCI World DAX
Source: Bloomberg *Note: All figures re-based to 1 July 2009
Figure [8]: Post war, the ASPI has also outperformed some of the best-performing regional indices
400 300 200 100 0 Jun-09 Dec-09 Jul-10 Mar-11 Sep-11 Apr-12 Nov-12
ASPI Jakarta (JCI) Thailand (SET) MSCI Emerging Market Index Source: Bloomberg *Note: All figures re-based to 1 July 2009 Bombay (BSE 500) Philippines (PASHR) Hanoi (VNINDEX)
Figure [9]: The CSEs market capitalization has doubled since 2009
LKRbn 2,500 2,000 1,500 1,000 500 0 2009 2010 2011 2012 2013 (June) 1,092
Figure [10]: The government anticipates FDI inflows to reach USD2bn in 2013, a 19% CAGR 2009-2013E
USDm 2,500 2,000 1,500 1,000 500 0 2008 2009 2010 2011 2012 2013E 827 601 516 1,338 1,066
2,211
2,214
2,168
2,351
2,000
Source: Bloomberg, Central Bank of Sri Lanka
Source: Ministry of Finance and Planning, Board of Investment of Sri Lanka
Figure [11]: Most sector P/Es are below market average and historical valuations
120 90 60 30 Chemicals & Pharmaceuticals Construction & Engineering Diversified Services Telecommunication Beverage, Food & Tobacco Hotels & travels Manufacturing Banks, Finance & Insurance Investment Trusts Power & Energy Land & Property Plantations Trading 0
Figure [12]: Trend is similar on a P/BV value

6 4 2 0
Construction & Engineering
Diversified
Services
2010
2011
2012
Average market P/E 2010-2012
2010
2011
2012
Average market P/BV 2010-2012
Source: Colombo Stock Exchange
Source: Colombo Stock Exchange
Telecommunication
Beverage, Food & Tobacco
Chemicals & Pharmaceuticals
Hotels & travels
Manufacturing
Plantations
Banks, Finance & Insurance
Investment Trusts
Power & Energy
Land & Property
Trading
IMPORTANT DISCLAIMER
This document has been prepared on behalf of the Colombo Stock Exchange (CSE) by Amba Research Lanka Private Limited (Amba) and is sponsored by the CSE. The views expressed in this document are those of the authors based on available and accessible information from the public domain and do not represent those of the CSE. Please note, inter alia, that with the publication of this document on the CSE website, www.cse.lk, neither Amba , as author, nor CSE (as sponsor) intend to assume and are not assuming any responsibility or liability (including under contract, common law or tort) to any party arising out of or with respect to this document. This document is not intended to, and does not form part of any contract with anyone (including a contract between author and reader/recipient) and no one shall have any right (contractual or otherwise) to enforce any claim in relation to the document either directly or indirectly. Except as otherwise indicated, you may only view and print one copy of the document for your own personal, non-commercial use. You may not copy, store [either in hardcopy or in an electronic retrieval system] transmit, transfer, broadcast, publish, reproduce, create a derivative work from, display, distribute, sell, license, rent, lease or otherwise transfer any of the contents to any third person (including, without limitation, to others in your company or organization) whether for direct or indirect commercial or monetary gain or otherwise without the prior written permission of Amba and CSE. This document does not contain any investment advice nor does it constitute an offer to buy, sell or hold any of the investment product(s)/asset class (es) mentioned herein. Prospective investors are required to possess sufficient knowledge when evaluating the advantages and risks inherent to such investment product(s)/asset class(es) mentioned herein and to take into consideration their circumstances and financial position when assessing the suitability of such investments.. Prior to making an investment decision, prospective investors are strongly advised to obtain independent advice from competent legal, financial, tax, accounting and other professionals. Amba and CSE shall not be held liable in any manner for any direct, indirect or consequential loss that may arise as a result of investing in the investment product(s)/asset class (es) mentioned herein. Amba and CSE expressly disclaim any fiduciary responsibility or liability for any consequences, financial or otherwise from any reliance placed on the information in this document. The investment product(s)/asset class (es) described in this document may not be eligible for sale or subscription within a particular jurisdiction or to particular categories of investors. This document is not intended for distribution to a person or, within a jurisdiction where such distribution would be restricted or illegal. It is the responsibility of any person reading this document to observe all applicable laws and regulation of the relevant jurisdiction. Neither Amba, nor CSE, shall be responsible for any error which may have occurred at the time of printing of this document. The information set out in this document is subject to change without notice. The information contained herein has been obtained from sources believed to be reliable and Amba and CSE make no warranty, expressed or implied, as to the accuracy, timeliness, completeness or correct sequencing of the information. This document does not purport to list all of the terms and conditions, nor to identify or define all or any of the risks that would be associated with the purchase or sale of the investment product(s)/asset class (es) described herein. Please note that any price levels, rates, simulations, illustrations, terms or conditions contained herein are indicative only, and may vary in accordance with changes in market conditions. All the information included in this document is current at the time of preparing this document and subject to change at any time. Any forecast, projection or forward looking statement made in this document embodies assumptions and predictions about future events that by their nature cannot be verified as facts. They are not necessarily indicative of future or likely performance, of investment product(s)/asset class (es), countries, markets or companies. Any past market conditions or product performances may not be representative of future market conditions or product performances.

JKH Initiation Report July 10 2013

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Sri Lanka | Diversified Holdings Initiation of coverage

EQUITY RESEARCH 10 July 2013

John Keells Holdings PLC (JKH)

Share price movement

Share price performance

12m 32% 20% 22%

Source: JKH, Amba estimates

John Keells Holdings PLC

We establish a valuation range for JKH shares of LKR218-292........................................................................................ 14

Appendix 2: Key financial data ........................................................................................................................................... 29

Appendix 3: Industry analysis using Porters framework ................................................................................................... 33

John Keells Holdings PLC

JKHs revenue to post a 9.0% CAGR over FY14E-FY16E

25,000 20,000 15,000 10,000 5,000 0

John Keells Holdings PLC

3,000,000 2,000,000 1,000,000 0

1,500,000 1,000,000 500,000 0

John Keells Holdings PLC

Figure [5]: JKHs CF&R growth to outpace macroeconomic growth

John Keells Holdings PLC

Source: Rediff.com, Ceylon Cold Stores PLC

Modern food retailing in Sri Lanka has significant growth potential

Figure [7]: Keells Super trails Cargills in total store count

John Keells Holdings PLC

JKHs oil bunkering business to provide a steady revenue flow

John Keells Holdings PLC

John Keells Holdings PLC

EBITDA margin to remain roughly flat at around 13.9% during FY14E-FY16E

FY13 EBITDA margin (Leisure) EBITDA margin (Transport)

FY15E FY16E EBITDA margin (Property) EBITDA margin (Financial Services)

Cost-control efforts in the leisure segment to support JKHs margins

John Keells Holdings PLC

Property segment EBITDA margin

Some possibility for upside margin surprise from CF&R segment

John Keells Holdings PLC

John Keells Holdings PLC

JKHs cautious approach to investment could dampen growth opportunities

John Keells Holdings PLC

John Keells Holdings PLC

We establish a valuation range for JKH shares of LKR218292

236 P/E analysis

177 52-week range

DCF/SOTP analysis yields a valuation range of LKR218-243 per share

John Keells Holdings PLC

Figure [15]: Amba DCF/SOTP assumptions schedule:

50/50 14.0% 10.0% 3.0% 15.0% 11.3%

FY14E 988 1,232 15,253 21,526 33,147

50/50 14.8% 10.0% 3.0% 15.0% 11.6%

EBIT total FCF Terminal value (undiscounted) EV

FY14E 5,301 1,735 104,063 66,051

50/50 14.5% 10.0% 3.0% 15.0% 11.5%

EBIT total FCF Terminal value (undiscounted) EV

FY14E 2,428 4,668 29,398 23,786

50/50 14.0% 10.0% 3.0% 15.0% 11.3%

EBIT total FCF Terminal value (undiscounted) EV

FY14E 1,074 148 53,835 30,371

John Keells Holdings PLC

FY14E 18 25 180 13,302 4,675 18,134

50/50 15.0% 10.0% 3.0% 15.0% 11.8%

EBIT total FCF Terminal value (undiscounted) EV

FY14E (75) (705) 2,378 562

John Keells Holdings PLC

Figure [17]: Sensitivity analysis schedule