26th January 2016

Transcription

26th January 2016

Equity Research
Distilleries Company of Sri Lanka PLC
Initiation Coverage
Arrack has been a lifestyle alcoholic beverage in Sri Lanka over many years while
experiencing an inelastic demand from a strong habitual consumption amongst Sri Lankans.
DIST being the market leader since its inception supplying Arrack to the local market, we
expect the company to reap benefits from the expected per capita income rise backed by
inelasticity of the industry and measures taken by 2016 Budget to curtail down illicit and
illegal liquor. Excessive levies on liquor producers will also barricade small scale liquor
producers to operate in the industry while benefiting DIST.
Investment Considerations
Inelastic proxy for consumption growth: Local liquor industry has been a resilient
performer historically, despite continuous tax hikes. With expected GDP per capita income
rise and demand inelasticity, we expect liquor consumption to post modest 1.7% CAGR in
medium term while mitigating the risk of possible consumption downturn based on price
hikes. We believe that illicit/illegal liquor consumption to be cut down on tight regulatory
measures while big players will benefit on increased volumes. Accordingly, DIST being the
leading Arrack producer could leverage on inelastic consumption growth of Arrack and
record strong performance in bottom-line.
DIST, undisputed market leadership: With 67% market share, we estimate to increase its
market share to historical averages (70% by FY18) while Sri Lanka's alcohol consumption
and 'budget 2016' to regulate the industry will augur well with DIST in regaining its lost
market share. Proved business acumen of the owner/chairman of the group will contribute to
be a key factor in group maintaining its market leadership.
'DCSL Arrack', strong brand name attached to local consumers: DCSL has been able to
make a strong foothold in local households through its strong brand name 'DCSL Arrack',
giving competitive advantage for DIST to stand above the competition.
Budget 2016 trending positive for DIST: We believe that Budget 2016 will generate
positive results for DIST in medium to long run while making the industry more concentrated
with few large players. We also expect illicit and illegal liquor consumption to be reduced
noticeably upon effective implementation of budget proposals, giving a market advantage for
DIST.
Strong balance sheet and low gearing to allow for investments: The Group is fairly low
geared and hence can conveniently leverage up for prospective investment opportunities.
BUY
Share Details
Bloomberg Ticker
CSE Sector
GICS Sector
Market Cap (LKR Mn)
Issued Quantity (Mn)
30-day avg T/O (LKR Mn)
Beta (6 months)
DIST SL
Beverage, Food & Tobacco
Consumer Staples
64,800
300
12.71
1.02
Investment Fundamentals
LKR Bn
12MTrail.
Revenue
30.8
Net Profit
6.9
S/H's Equity
64.8
Total Assets
91.9
ROA (%)
7
ROE (%)
11
2016(F)
31.8
5.5
69.5
97.9
6
8
8.90
1.06
2.18
1.50
Price Behavior
330
310
290
270
250
230
210
190
170
150
26-Jan-15
26-Apr-15
26-Jul-15
Business Nature
Recommendation Guidance, Important Disclosures and Analyst Certification: Page 25
26-Oct-15
26-Jan-16
ASI movement (adjusted to DIST base price)
Other businesses: We expect Telco and plantation sectors to drag down DIST's ROEs while
DIST's other diversify businesses to grow in line with GDP growth of the country.
26 January 16
2018(F)
35.3
8.4
83.4
112.8
7
11
Price Multiples
Earnings per share (trailing 12m)
Salient Sections of the Report
Inelastic proxy for consumption growth (pg.2)|DIST, undisputed market leadership (pg.4)|
DCSL Arrack, a strong brand name (pg.6)|Budget 2016 trending positive (pg.7)| Strong
balance sheet (pg.9)| Telco & Plantation (pg.10)| SEPN, a sweetener on DIST's value (pg.12)|
Valuation (pg.13)|Sensitivity (pg.15)| Earnings risk comment (pg.15)|Appendices (pg.16 )
2017(F)
33.8
7.9
76.2
105.2
8
11
PE (X)
PBV (X)
Price to Sales (X)
Divdend Yield (%)
SPEN, a sweetener on DIST's value: DIST has an associate investment in Aitken Spence PLC,
a blue chip conglomerate owning one of largest locally owned hotel chains having high
profitability. SPEN contributes 23% to DIST valuation.
We assume a cost of equity of 14.34% for our valuation which is a 6% premium on 3 year
treasury bond rate(GOSL), taking into consideration the equity market risk. Accordingly, We
have valued the counter using SOTP approach and derived the value of a share at LKR 291.30.
At the current value, counter is trading at a discount to our valuation. We give a Buy
recommendation for DIST.
LKR 264.80
LKR 216.00
35%
Medium
(refer page 22 for recommendation)
DIST Share Price
Valuation
LKR 291.30
LOLC SEC Valuation
12M Tgt Price (excl.dividend)
Share Price
Upside/(Downside)
Risk Level
LKR
Leveraging on inelastic consumption growth
Per Share Details as at 30.09.2015 (LKR)
Net Asset Value per share
Sales per share (trailing 12m)
Dividend Per Share (trailing 12m)
24.27
209.51
99.29
3.25
Distilleries Company of Sri Lanka PLC the leading hard liquor
producers in Sri Lanka.It produces different types of Arrack
products and imports other types of liquor products. It also
has other diversified businesses in various industries.
Shareholder Details
Milford Exports Ceylon Lt
Lanka Milk Foods Cwe Ltd
Yaseen Muzaffar Ali
Shareholders below 5%
41%
13%
7%
33%
Source:CSE, Bloomberg, LOSEC Research
Analyst (s)
Gayan Rajakaruna
+94 117 880837
gayanraj@lolcsecurities.com
Initiation Coverage: Distilleries Company of Sri Lanka PLC | 26 January 16
Inelastic proxy for consumption growth
Arrack is a lifestyle
product with consistant
demand
Arrack consumption to
lag economic growth
3.8 litres per capita
Arrack consumption by
2018
Distilled alcoholic beverages have become a lifestyle product amongst the male population of the Island nation since
1505 from western colonisation. Today, alcohol industry has become a matured and profitable industry due to
consistent demand for alcoholic beverages. The beverage segment of DIST which accounts for 66% of group's topline
and approx. 86% of the bottom-line as at FY15 dominates the market since its inception and supplies high quality
alcoholic products, predominantly Arrack to local consumers.
In the last decade, Sri Lanka's Arrack consumption has seen a modest growth of 1.4%. This could be largely due to the
increased penetration of illicit & illegal liquor products to the society and disproportionate growth of taxes compared
with disposable income rise.
We estimate recorded Arrack consumption for next 3 years to be inline with 1.7% CAGR by considering expected per
capita income growth (avg.12%), potential shift from cheaper liquor to legal products on rise of disposable income
and curtailing the availability of illicit liquor through tight regulatory controls. Accordingly, we estimate a 3.8 litres
per capita Arrack consumption by 2018 and it could reach to 4 litres by 2020. There is a positive correlation between
GDP per capita income growth with arrack consumption pattern, however the correlation can be affected from a mix
shift from local arrack products to foreign hard/soft liquor products when income rises and lifestyle getting improved
accordingly.
Graph 01: Arrack consumption maintains a modest growth
of 1.4%-1.7%
Lr (Mn)
90
80
70
Graph 02: Correlation of per capita income growth and
arrack consumption is positive
20%
USD
6,000
15%
5,000
10%
4,000
5%
3,000
0%
2,000
-5%
1,000
35%
30%
25%
60
50
40
30
20
10
-
-10%
2005 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
(F) (F) (F)
Arrack consumption (lr)
YoY Growth
Average
20%
15%
10%
5%
0%
2010
2011
2012
Per capita income (USD)
GDP per capita YoY growth
Source:Excise Department, WHO, LOLC SEC Estimates
2013
-5%
2015 2016 2017
(F)
(F)
(F)
Arrack consumption YoY growth
2014
Source:Excise Department, WHO, LOLC SEC Estimates, Dept. of Statistics
Industry outlook is positive for big players
Based on WHO, Sri Lanka's unrecorded alcohol (illicit) consumption is ~40%. By considering a declining trend of
number of offences recorded under Excise Dept/NATA, we believe that illicit liquor trade carried out by small
Illicit liquor consumption
manufactures have been gradually declined over the years. Recorded alcohol consumption of the country is relatively
accounts ~40% of total
higher than several neighbouring countries and the avg. of South Asia and South-East Asia and also greatly tilted
consumption
towards to hard liquor (85%) over soft liquor. We expect DIST will benefit from this positive outlook in regaining its
lost market share during last three years.
Table 01: Sri Lankans prefer spirits over beer and wine
Country
Sri Lanka
Maldives
Nepal
India
Myanmar
Thailand
South Asia Avg
South-East Asia
World
* This is based on 2010 data
Total per Recorded per
capita
capita
alcohol con. alcohol con.
3.7 lr
2.2 lr
1.2 lr
0.7 lr
2.2 lr
0.2 lr
4.4 lr
2.2 lr
0.7 lr
0.1 lr
7.1 lr
6.4 lr
2.1 lr
1.0 lr
2.5 lr
1.8 lr
6.2 lr
4.7 lr
Beer
Wine
Spirits
13%
29%
48%
7%
83%
27%
33%
40%
35%
0%
29%
1%
0%
6%
0%
5%
15%
8%
85%
41%
51%
93%
12%
73%
45%
42%
50%
Source:WHO
2 | LOLC Securities Limited
Inelastic proxy for consumption growth (cont…)
Demand inelasticity to augur well with DIST's revenue growth
Demand inelasticity to
keep sales volume stable
despite price increases
Historically, alcohol industry has seen a demand inelasticity, despite increasing retail prices followed by regular
excise duty increases. We expect that our estimate on modest Arrack consumption growth to be further backed by
price inelasticity which was witnessed previously while enabling DIST to pass down incremental taxes without
significantly deteriorating sales volume. We expect any possible volume decline due to unbearable taxes in coming
years to be off set by positive measures introduced by budget 2016 which will enable DIST to regain lost volumes in
the recent past.
We derived the existing 'net' and 'gross' selling price per Arrack litre based on historical revenue and production
quantity of the company subjected to duties. Net selling price per litre is estimated with 3% CAGR for FY16-18
considering the existing net price, past average growth, expected rise of inflation and premium added over peers
(currently LKR 10-20 per bottle). With 2016 budget proposal, topline tax on net selling prices estimated to be
increased to avg. 250% from current average level of 202% and we believe that impact of this increase to be reflected
by beginning of FY16/17.
Graph 03: Avg. price of 1 lr of Arrack to be LKR 1606 by 2017
Graph 04: People consume Arrack despite price increases
LKR per lr
Lr (Mn)
90
1,800
1,600
85
1,400
1,200
Price increases has seen minimal
impact on consumption
80
1,000
800
75
600
70
400
200
65
2009
2010
2011
2012
2013
2014 2015/162016/172017/18
(F)
(F)
(F)
Weighted avg. excise duty per arrack lr
Weighted avg. selling price per arrack lr (incl. taxes)
Weighted avg. selling price per arrck lr (excl. taxes)
Source:Excise Department, LOLC SEC Estimates
60
648
676
LKR
846
959 1,058 1,250 1,332 1,575 1,606
per lr
(F)
(F)
(F)
Arrack consumption(lr)
Linear (Arrack consumption(lr))
DIST caters to 71% of
DIST plays a crucial role while catering to 71% of total Arrack consumption in 2014. After making LKR 6bn
total Arrack consumpion investment in FY15, now it is fully equipped with modern blending and bottling plant to facilitate a greater capacity.
DIST, Undisputed market leadership
DIST dominates with
avg.75% market share
DIST has been operating as the market leader in Sri Lankan hard liquor industry amidst intense competition from
other licensed liquor manufactures and the continuous influx of illicit liquor to the market. Based on the annual hard
liquor production, DIST has been able to maintain an average 75% market share since 2006. However during last
three years, market share of DIST has seen a dip from 76% to 67% and could be largely due to significant infusion of
cheaply priced illegal liquor to the market by certain licenced manufacturers and consumers opting for lower priced
products despite the difference in quality. Such manufacturers have been capable of pricing their products at a
discount to the market price through cost savings gained on evading excise and import duties.
Graph 05: DIST has a dominant market share on production
Proof Lr (Mn)
60
55
50
45
40
35
30
25
20
15
10
5
0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
(F) (F) (F)
Graph 06: Hard liquor market share of top 3 players in 2014
85%
11%
80%
14%
8%
75%
70%
65%
60%
67%
55%
50%
IDL
Total production excl. DIST - Proof lr
DIST
Rockland
Other
DIST production - Proof lr
Disproportionate taxes
on alcohol beverages
compared with income
growth
Though Sri Lanka's recorded Arrack consumption is less volatile historically, there is a drop in last two years which
seems to be due to increasing illicit liquor (unrecorded liquor) in the market and price sensitive customers shifting to
such liquor in based on disproportionate retail price increases in parallel to their income growth. However we believe
that total hard liquor consumption including both recorded and unrecorded consumption to be remained with a
modest growth of 1% - 2% range due to demand inelasticity for alcoholic beverages.
DIST's share on recorded Arrack consumption has registered a drop from 81% to 71% as a result of the drop in
recorded Arrack consumption and consumers shifting from DCSL Arrack to other local Arrack brands who have
significantly under-priced their products by dodging excise duties and channelling them to retail liquor shops run by
same manufactures.
Graph 08: Gvt. imposes more taxes on liquor than peoples'
income growth
Graph 07: DIST's market share on Arrack consumption
Proof Lr (Mn)
60
90%
85%
50
30%
25%
80%
40
30
75%
20%
70%
15%
65%
20
60%
10
55%
0
50%
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
(F)
(F)
(F)
10%
5%
0%
2010
2011
2012
2013
2014 2015 (F) 2016 (F) 2017 (F)
DIST arrack sales - proof lt
Total arrack consumption - proof lr
Per capita income YoY growth
Excise duty per lr YoY growth
DIST share on consumption
Average
Avg. per capita income growth
Avg. per capita excise duty growth
* Arrack consumption given in bulk litres has been converted to proof litres
DIST, Undisputed market leadership (cont…)
DIST's and its subsidiary Periceyl Ltd. liquor products are mainly classified as Special Arrack, Coconut & Processed
Arrack, Molasses Arrack and locally made foreign liquor. In Special Arrack segment, DIST has 82% market share in
2014 while Coconut & Processed Arrack segment secured 47% market share in 2014.
Graph 09: Special Arrack accounts for over 85% of total production volume
Proof Lr (Mn)
45
93%
92%
40
91%
90%
35
89%
30
88%
87%
25
86%
85%
20
84%
15
83%
2007
2008
2009
2010
2011
2012
Special Arrack
Coconut & Processed Arrack
Country Made Foreign Liquor
% Special Arrack on total production
2013
2014
Molasses Arrack
Market share forecast of DIST
Gvt. to support on
curtailing illicit/illegal
liquor
DIST's market share to
reach 70% by FY18
Competetive advantage
on its leadership
In terms of hard liquor consumption, the industry has seen a modest growth of 1.4% since 2005 due to the stagnant
consumers' purchasing power on liquor led by disproportionate excise duty increase. During last 3 years, hard liquor
industry saw a decline in recorded production and consumption largely due to populating illegal and illicit liquor
significantly. There could also be a slight impact from substitution effect of beer, deteriorating hard liquor
consumption. However, we believe that steadfast loyalty towards liquor consumption along with Gvt. support on
curtailing down illicit/illegal liquor will enable DIST to compete in the legitimate alcoholic beverage business with
more equal term.
We estimate that DIST will be able to regain lost sales volume during next three years based on tightened government
policies to regulate liquor industry which will lead to deteriorate small players' share in the industry and to
concentrate it with few large players (refer page 07). Further small manufactures will lose pricing advantage created
on untaxed/low-taxed ethanol and liquor, enabling DIST's products to be more price competitive and thereby
increasing sales volumes. Thus we estimate DIST's market share to reach 70% by FY18 from 67% recorded in FY15.
Specially company's leadership; Mr. Harry Jayawardena has shown a strong business acumen over the years to
maintain the market leadership in the highly profitable industry, even during the adverse environments.
"DCSL Arrack" a strong brand name attached to Sri Lankan consumers
DCSL amongst most
valuable brands
We believe that strong brand name of Distilleries which has been built over last couple of decades is the greatest
strength of the company for its continued success. DCSL has been able to make a strong foothold in Sri Lankan
households through its strong brand name "DCSL Arrack" while its unique taste and affordable "kick-per-buck" have
made an inerasable image amongst Sri Lankan consumers. Proving its brand strength, DCSL has been honoured
within top fifteen most valuable brands (Brand value - LKR 9602 Mn) and one of the most valued corporate entities of
the country.
Diagram 01: DCDL has a strong brand image and diverse portfolio of Arrack products
Source:DIST Annual Report 2015
DIST has a regulatory
advantage
National Authority on Tobacco & Alcoholic (NATA) Act prohibits advertising and promoting alcoholic brands which
has created a platform for DIST to stay resilient amidst hefty competition since peers also can not promote their
brands or products through any form of media while DIST has already been maintaining well established and reputed
brand name over the years. This will naturally be an entry barrier for new comers as well preventing them to
promote their products. Accordingly, this regulatory barrier will essentially create a competitive edge for DIST over
its peers to dominate the industry.
Table 02:Most valuable brands of food & beverage sector in Sri Lanka
Company
NEST
CARG
LION
DCSL
CCS
HARI
KFP
BFL
LMF
CONV
Rank Brand Value
(USD Mns)
7
8
10
13
22
50
54
63
66
72
139
122
114
67
35
8
6
5
5
4
Brand
Rating
AAAA
AAAAAAA+
BB
BBB
ASource: Brand Finance
Budget 2016 trending positive for DIST
*Minimum excise duty of LKR 250 mn per month
16 out of 20 licenced
arrack producers pay
below LKR 250 mn per
month
Budget 2016 has proposed to impose a minimum excise duty of LKR 250 mn per month (LKR 3 Bn/year) from liquor
manufactures which will adversely affect small manufactures while benefiting big players like DIST. In 2014, DIST
accounted 66% out of total duties of LKR 52.55 bn paid for hard liquor while 11% came from small manufacturers
whose contribution were less than LKR 3 Bn per year. However, assuming that what is declared by them holds true,
most of the small players are likely to be wiped out from the industry upon implementation and 11% to be even out
amongst top few players.
However reality may deviate from the estimates as there is a considerable volume of illegal supply which are not
taxed/disclosed and thus paying below this threshold eroding Gvt revenue though they have the capacity pay proper
tax amount. Upon effective implementation, a policy of this nature will enable such illegal players to pay more taxes
in the future and thereby preventing them to price liquor products way below the market rate. However as per
various sources, there is a court case pending against this and may not come to effect in short term. But current Gvt is
considered to be aggressive on revenue collection and thus we believe this policy to be gradually effective with some
amendments and eventually leaving the industry more concentrated with big players.
Graph 10: Small liquor producers account only 11% of total
duty payment
Graph 11: Small manufactures with 11% market share pay
below LKR 250 mn
11%
11%
DIST+Periceyl
9%
14%
66%
International Dist.
Top 3 contributors
Rockland
Contributors<LKR
250mn
Other
89%
Source:Excise Department
Source:Excise Department
*Single annual licence fee of LKR 50 mn
Small liquor producers
have to increase price to
absorb incremental cost
It was proposed to impose a flat annual license fee of LKR 150 mn for liquor manufacturers irrespective of volume
could adversely affect the small companies who do not have a strong scale of production volume. However as per
"Excise Ordinance Notification No.983", this fee has been brought down to LKR 50 mn per annum. We believe that
new fee is more affordable for medium size and big firms while small liquor manufacturers to find ways absorb this
incremental cost.
*Foolproof sticker - positive for DIST upon effective execution
Foolproof sticker to
curtail illicit liquor
As per budget proposal 2016, every tax paid liquor bottle must be labelled with a fool-proof sticker enabling a visual
identification for the excise officers in identifying the tax paid liquor bottles. The decision is favourable to DIST, but
while unregulated liquor being curtailed down, we believe that the execution should be effective and free from
systematic loopholes to get rewards.
Budget 2016 trending positive for DIST (cont…)
*Annual manufacturing license fee of LKR 150 mn for each distillery
Gvt proposed to increase the annual manufacturing license fee for each distillery owned by the manufacturer to LKR
150 mn through 'budget 2016'. Subsequently, as per "Excise Notification No.983", it has been reduced to LKR 100 mn.
However, this is not effective yet and as per Excise Department and "Daily Mirror on 26.12.2015" and few other
publications indicated that the Gvt. is to withdraw this decision due to the plea made by liquor producers based on
Proposed license fee for
each distillery may not be possible collapse of many liquor manufacturing companies if this was implemented. Accordingly, it is likely that this
will not be effective and thus we have not factored the negative impact to our valuation.
implemented
If this becomes effective, DIST may have to pay LKR 300 mn for two distilleries. We believe that DIST and other
players will accordingly increase price to pass cost to consumers.
*Income tax rate to be reduced from 40% to 37.5%
2.5% decline in corporate With the introduction of 30% corporate tax rate and 25% of surtax for liquor industry, the total effective income tax
will be estimated as 37.5%. This will be a 2.5% drop from the existing rate of 40% enabling DIST to have a positive
tax
impact on its bottom-line. However it remains high compared to other industries which is 15%-30%.
*Increased custom and excise duties on foreign liquor, beer and imported ethanol
Gvt has increased the total tax burden (mainly on custom import duty) of imported foreign liquor from LKR 1850/lr
to LKR 2500/lr while adding further 70% as excise levy. This will make foreign liquor further costly and consumers
will tend to shift to country made foreign liquor or Arrack supporting local producers like DIST to gain market share.
On a negative note, company has to incur an additional cost due to increased import duties on ethanol (from LKR
300/lr to LKR 400/lr), since 50% of ethanol required for DIST's production is imported while the rest is produced
DIST's cost of production
locally. Production cost will be further affected due to Rupee depreciation as ethanol cost accounts to 40% of cost of
will increase
production. Thus we estimate that cost of production of one proof lr of Arrack to record a 4% CAGR over next three
years from the current weighted avg. cost of LKR 303 in order to absorb expected cost increase.
*Imposing higher percentage of excise duties on beer over hard liquor
Percentage growth of excise duties imposed on strong and mild beer based on 'October and November 2015 price
Beer to take a greater hit revisions' are considerably above those on hard liquor. Thus beer manufactures will be pushed to increase prices at a
from budget 2016
higher percentage compared to liquor manufactures to reflect the revised taxes, which could negate beer demand
and substitution effect on hard liquor.
Graph 12: Excise duty growth % of beer is greater than Arrack
45%
40%
Excise duty % growth
35%
30%
25%
20%
15%
10%
5%
0%
Nov-14
Arrack
Foreign liquor
Oct-15
Nov-15
Mild beer-alcohol vol.<5%
Strong beer-alcohol vol.>5%
Source: Excise Department, Parliament Gazettes
Strong balance sheet and low gearing to allow for investments
DIST maintains strong
cash base and low
gearing
DIST has been able to generate strong free cash flow balances and gearing has continued to be below 23% over last
three years which will open up further avenues for raising debt to venture into new projects. We don't expect any
significant debt financing in years ahead since a LKR 6 Bn investment for a blending and bottling plant has been
already made and expect DIST to maintain the same low level of gearing for next three years. Its cash balance
(combined with cash in hand and short-term investments) by FY15 is LKR 6.5 bn which is significant compared to
most of the Sri Lankan corporates. Thus DIST has appeared to be a self-financed business during previous years while
indicating its capability of internal capital formation for capital investments.
Graph 13: DIST has a low gearing ratio and sound asset base
LKR Mn
120,000
110,000
Gearings ratio are below
25% and declining
Graph 14: Low gearing over listed peers
180%
30%
100,000
90,000
25%
80,000
70,000
20%
60,000
50,000
15%
40,000
30,000
10%
20,000
10,000
5%
-
160%
140%
120%
100%
80%
60%
40%
20%
0%
0%
2010
2010 2011 2012 2013 2014 2015 2016 2017 2018
(F)
(F)
(F)
Cash and cash equivalents
Total Assets
2011
2012
DIST
Gearing
2013
LION
Source: Bloomberg, LOLC SEC Estimates
2014
2015
BREW
Source:DIST Annual Report, Bloomberg
Out of the largest companies in terms of asset base (excluding bank, finance & insurance sector), DIST has been
amongst the top ten listed companies.
Graph 15: Total asset value comparison
240
220
200
180
160
140
120
100
80
60
40
20
0
JKH
CARS
BUKI
VONE
SLTL
DIAL
DIST
HAYL
SHL
BREW
LION
Source:DIST Annual Report, Bloomberg
Telecommunication and Plantation sectors, dragging DIST's ROEs
DIST's full owned subsidiary "Lankabell Private Ltd." mainly operates in fixed telephony and broadband segments of
the country which are intensely competitive and dominated by two telecom giants SLTL and DIAL. It has been
pioneering CDMA technology in local market with 25% market share in fixed lines and has recently introduced its 4G
LTE network on a bandwidth of 25 MHz in the 2.3 GHz spectrum which is the most sought after brand in the Asian
region.
Lanka Bell's fixed
telephony market share is Lanka Bell's fixed telephony (CDMA) segment has seen a continuous decline of its market (subscriber base) over the
deteriorating
past three years due to consistent market growth of SLTL through its economies of scale and rapid growth of mobile
telephony usage over fixed lines in Sri Lankan households . Thus we believe that fixed line segment of Lanka Bell will
continue to see pressure on performance.
Graph 16: Lanka Bell's CDMA market share is dropping
70%
Graph 17: Fixed broadband market is growing
3,000,000
60%
2,500,000
50%
2,000,000
40%
1,500,000
30%
1,000,000
20%
Fixed broadband
subscribers growing by
19% CAGR
500,000
10%
-
0%
2012
SLTL
2013
DIAL
2014
Lanka Bell
Source:SLTL & DIAL annual reports, TRCSL, LOLC SEC Estimates
2009
Fixed
2010
2011
Mobile
2012
2013
2014
YoY Growth
Source:SLTL & DIAL annual reports, TRCSL, LOLC SEC Estimates
Lanka Bell could see a potential in its data business through 4G LTE network as the country has seen a rapid growth
of internet usage over the years. Proving market's growth potential, fixed broadband subscribers have increased at
Lanka Bell has potential 19% CAGR since 2010. However, Lanka Bell has a uphill task of capturing a strong market share to make a recovery
in growing data business from loss territory as other two leading players, DIAL and SLTL aggressively operate to increase their share of data
market.
Plantation sector
Plantation sector of DIST entails Balangoda Plantations PLC (BALA), a subsidiary with 43.23% ownership and
Madulsima Plantations PLC (MADU), an associate business with 45.9% holding. BALA recorded a loss of LKR 95 mn
by FY15 and LKR 310 Mn loss has already been incurred for 9MFY16, signalling a possible performance decline in
Negative outlook of
years ahead. MADU also follows a similar loss making pattern while deteriorating the contribution from associate
plantation industry
businesses to the Group. With the down turn of global tea prices and increase in cost of production on wage increases
curtails growth prospects of plantation sector workers, we expect plantation sector to generate negative earnings and thus affecting DIST's
bottom-line in FY16,17 and 18.
Telecommunication and Plantation sectors, dragging DIST's ROEs
Graph 19: Tea export price decline and cost of production
increase make losses for plantation companies
Graph 18: BALA and MADU has incurred losses
LKR Mn
300
20%
30%
15%
200
20%
10%
100
10%
5%
2010
2011
2012
2013
2014
0%
2015 (9M)
-5%
(100)
0%
2009
2010
2011
2012
2013
2014
2015
-10%
-10%
(200)
-20%
-15%
(300)
-20%
-30%
YoY Growth of tea export price (LHS)
YoY Growth of cost of production (LHS)
Margin per kg (RHS)
(400)
BALA
MADU
Source:BALA & MADU Annual Reports, Bloomberg
Source: CBSL Annual Report, LOLC SEC Estimates
Diversified sector will reduce dependency on Arrack business
Diversifed segment to
grow with GDP growth
Diversified business segment of the Group has been yielding positive earnings for last four years with a 33% CAGR of
PBT. Its contribution to the total revenue is 18% and 6% to Group's earnings. Group's restructuring program to
consolidate subsidiaries and associates under Melstacrop has seem to be paid off well in terms of improved financial
performance and enhancing the contribution from non-alcoholic sector while reducing the Group's dependency on
liquor business.
Diversified segments contains variety of businesses under 19 subsidiaries while Insurance (Continental Insurance),
Financial Services (Melta Regal), Leisure (Herittance Negambo) and power generation (Bogo Power) being the key
contributors of the segmental performance. This segment is highly diversified, we expect the segmental performance
to improve in par with the economic growth (GDP) potential of the country.
Graph 20: Diversified segment to grow inline with expected GDP growth
LKR Mn
4,500
14%
13%
4,000
11%
3,500
12%
11%
11%
12%
10%
3,000
9%
8%
2,500
2,000
1,500
12%
6%
6%
5%
4%
1,000
2%
500
-
0%
2010
2011
2012
Diversified revenue
2013
2014
GDP growth
2015
2016(F)
2017(F)
2018(F)
% of segment contribution to revenue
Source:DIST annual reports, LOLC SEC Estimates
Aitken Spence PLC - A sweetener on DIST's value
DIST has invested in Aitken Spence (SPEN) as an associate business owning 43.07% of this blue chip diversified
conglomerate with main exposure to tourism through Aitken Spence Hotel Holdings PLC (AHUN). With post war
tourism boom in Sri Lanka along with tourism growth in Asian region, SPEN has been able to generate 9% average
SPEN is one of the largest
annual earnings growth during last five years mainly through its high profitable hotel business. Currently, its tourism
blue chip conglomerate
segment account for 75% of its net earnings and rest is derived from various businesses in power, logistic and
services industries.
Graph 21: SPEN's tourism segment has superior profitability
Graph 22: Earnings composition of SPEN's business
segments
14
10%
12
2%
10
13%
8
6
4
75%
2
AHUN
CONN
AHUN
AHPL
CONN
JKHL
AHPL
JKHL
SHOT
Tourism
SHOT
Maritime & Logistics
Strategic investments
Source: Bloomberg
AHUN's room inventory
will increase from 2141
to total of 3145
Services
Source: SPEN's Annual Report 2015
We expect SPEN to post a 20% average earnings growth in next three years for equity holders which will be largely
driven by the growing number of tourist arrivals inline with ongoing capacity expansion of its tourism segment,
despite political turmoil of Maldives resulting to see a earnings decline in last two quarters. AHUN's room capacity
will increase from 2141 to total of 3145 by 46% by 2018 and we estimate 75% earnings contribution derived from
tourism segment for next three years.
Graph 23: Tourism segment of SPEN to grow with industry
growth in Sri Lanka & Maldives
LKR Mn
2,500
50%
45%
2,000
40%
35%
1,500
30%
25%
1,000
Graph 24: AHUN's room inventory to reach 3145 rooms by
2018 and continue to be the second largest hotelier
# of rooms
3500
3145 rooms by 2018
3000
2500
2000
20%
15%
500
1500
10%
5%
0
0%
2010
2011
2012
2013
2014
2015(E)
Earnings
YoY Tourist arrival growth in Sri Lanka
YoY tourist arrival growth in Asia & Pacific
Source: SLTB, Ministry of Tourism Maldives
SPEN 's growth to
continue, adding value
to DIST
1000
500
0
AHUN
CONN
AHPL & JKHL
CHOT
SHOT
Source: Company annual reports, LOLC SEC Estimates
DIST carries SPEN its book at LKR 7.45 Bn. We expect SPEN to generate superior earnings as a diversified holding
backed by tourism growth potential in the region and expected GDP growth in Sri Lanka and thereby add significant
value to DIST in years ahead.
Valuation
We have used the 'Sum of the Parts' (SOTP) approach in deriving the valuation for DIST. Accordingly we estimate
total valuation for the company at LKR 87.37 billion. We assume a cost of equity of 14% which is 6% premium to 3
year Sri Lanka Govt Treasury Bond Yield. A risk premium of 6% has been taken considering the equity market risk in
CSE. We have taken a mid-term growth (4-6 years) of 3% and a free cash flow terminal growth (>6 years) of 1% of
valuing beverage segment. Accordingly, we value the share at LKR 291.30 which is a 35% discount to the current
price of the share. At the current share price, DIST is trading at forward PE of 8.2X and a forward PBV of 0.9X.
Sensitivity of valuation for Terminal Growth and Cost of Equity is indicated below and sensitivity of key assumptions
are evaluated separately in proceeding section.
Table 03: Valuation Sensitivity Matrix
Terminal
Growth
Rate
Share price in LKR
0.5%
0.8%
1.0%
1.3%
1.5%
12%
241
281
320
359
398
13%
234
269
304
340
375
Cost of Equity
14%
227
259
291
324
356
15%
221
250
280
309
339
16%
216
243
270
297
324
Source:CSE, Bloomberg, LOLC SEC Estimates
Table 04: SOTP Valuation of DIST
Segment
Equity value (LKR Mn)
Beverages
Plantation
Telecommunication
Diversified
Associate Investments: SPEN
MADU
Investments on financial assets
Cash
Group's debt (adjusted for NCI)
48,754
521
4,684
5,612
20,238
667
17,654
2,048
(12,810)
Total Equity Value of DIST
87,369
Value per Share (LKR)
163
2
16
19
67
2
59
7
(43)
291
Source:LOLC SEC Estimates
Table 05: Peer Comparison
Name
Distilleries Co Of Sri Lanka (Sri Lanka)
Lion Brewery Ceylon Plc (Sri Lanka)
Ceylon Beverage Holdings Plc (Sri Lanka)
Radico Khaitan Ltd (India)
Hite Jinro Co Ltd (South Korea)
Takara Holdings Inc (Japan)
Luzhou Laojiao Co Ltd-A (China)
Thai Beverage Pcl (Thailand)
Market Cap (USD Mn)
PE (x)
PBV (X)
450
300
110
220
1608
1552
4476
11667
9.43
26.68
18.52
30.04
55.08
26.40
30.74
15.65
1.03
4.86
3.54
5.79
1.46
1.30
2.92
3.87
Dividend
Yield %
1.50
0.74
1.06
0.72
3.62
1.31
3.81
3.72
ROE %
11.17
19.65
20.68
21.80
2.59
5.11
9.51
26.17
Source:CSE, Bloomberg, LOLC SEC Research
13| LOLC Securities Limited
Valuation (cont…)
In valuing DIST, we applied Sum of the Parts (SOTP) analysis approach based on several valuation techniques in
valuing respective segments of SOTP model which is illustrated in Table 04.
Beverage segment
We have valued the beverage segment by applying the Residual Income method, applying a 14.34% required rate of
return which comprised with 8.34% risk free rate and a market risk premium of 6%. We have estimated a 3%
medium term residual income growth (4 -6 years) of the beverage segment by applying a discount to the expected
per capita income growth and considering stable profit making ability inherited in the hard liquor industry. 1%
terminal growth rate has been applied by considering the flat growth rate of arrack consumption in valuing the
beverage segment. Accordingly, we valued the segment at LKR 48,754 Mn while generating a LKR 163 per share.
We have estimated already paid total super gain tax liability and factored in FY16 earnings which has resulted a
considerable drop in net earnings estimated for FY16. Effective corporate tax of 37.5% has been applied in
forecasting net earnings of the beverage segment.
Plantation
Balangoda Plantation (BALA) is largely in to tea plantation and therefore we valued the segment based on PBV
multiple method by considering the sector average PBV derived from selected set of counters which are
predominantly into tea plantation. We valued Madulsima Plantations (MADU-associate business) in the same manner
adjusting it for Melstacrop's stake.
Telecommunication
For telecommunication segment, we have applied EV/EBITDA multiple method discounted to the average EV/EBITDA
of two listed players (SLT & DIAL). We used a 20% discount to the average EV/EBITDA considering Lanka Bell's
market share drop, loss making scenario over last three years and SLT & DIAL dominance in local data business.
Diversified
Diversified segment of DIST has been into many business segments and Melstacrop Limited operates as the holding
entity of these widespread businesses. We believe that this business segment has similar characteristics of holdings
companies listed under diversified sector of CSE. Accordingly we valued the segment based on PE multiple method
considering sector average PE. We adjusted the derived equity value for DIST's effective ownership of Browns Beach
Hotel.
Investments on financial assets
Short term and long term financial assets are valued on the estimated market value as at December 31, 2015.
Associates: SPEN
In valuing SPEN, We used market multiple method and applied an average of weighted average 'Hotel' and
'Diversified' sectors PE and PBV multiples for its trailing 12M earnings for common equity holders and for the current
book value. We expect a 75% to 25% earnings mix from both hotel and diversified segments and weighted sector
multiples accordingly. In deriving weighted hotel sector multiples, we selected only leading hoteliers who hold hotel
chains locally and overseas. We adjusted the DIST's ownership of 43.07% for the average value derived from both
multiples and derived the value of DIST's stake of SPEN as LKR 20,238 Mn.
Summarized Sensitivity of Assumptions
Graph 25: GDP per capita growth sensitivity: Medium
Graph 26: Currency sensitivity on beverage seg.: Medium
LKR
LKR
296
298
296
294
292
290
288
286
284
282
280
278
294
+2%
292
+1.5%
290
-2%
-1.5%
288
286
284
282
-1%
-1%
0
1%
Change of GDP per capita income growth forecast
0
USD:LKR forecast
Graph 27: Corporate tax sensitivity on beverage seg.: Medium
LKR
1%
Graph 28: Tourist arrivals sensitivity on SPEN: Medium
LKR
296
294
+1%
292
-1%
290
288
286
284
-1%
0
1%
Change of corporate tax on liquor forecast
298
296
294
292
290
288
286
284
282
280
278
+2%
-2%
-1%
0
1%
Change of average tourist arrival growth rate forecast
Earnings Risk Comment
Sri Lankan liquor industry is exposed to considerable regulatory risk due to regular import and excise duty hikes to
increase Gvt's tax revenues. As a result, licensed liquor manufactures are often compelled to increase selling prices
by passing incremental costs to consumers to maintain their margins. To a certain extent consumers will not be
price sensitive due to drinking necessity, however when price rises become greatly disproportionate to disposable
income growth, price sensitive consumers tend to shift to low priced soft and illicit liquor products.
Currently, industry has an entry barrier from regulation. If Gvt. decided to liberalize the industry, it will lead the
industry to be more competitive and deteriorating market share of the existing players. Further, inline with
country's growth if Gvt removed hefty taxes and import restrictions enforced on foreign liquor enabling Sri Lankans
to consume high quality foreign liquor, DIST as the market leader will face a significant risk of losing its market
share.
As a national initiative if the Gvt enforces restrictions on liquor supply to the market or a complete halt of liquor
production and consumption due to rising health implications and religious/social pressure for such closure, DIST
as the largest player will certainly plunge to liquidating position. But tobacco and liquor industry being the second
highest contributor to the Gvt. revenue makes it a highly unlikely enforcement.
Longer term demographic and lifestyle changes could also affect future earnings of DIST as liquor is highly
correlated with social & cultural acceptance . Over the years, Sri Lankan elderly and female population have been
growing over young males lowering demand for hard liquor. Elderly people do not tend to consume liquor on for
better health while females would not consume liquor on cultural norms. Some religions have stricter principles on
liquor consumption which will essentially create a risk of deteriorating demand when their population is growing at
a higher rate. However, we foresee these demographic changes as more long term driven and somewhat distant
from medium term impact. As part of lifestyle changes, a considerable increase in soft liquor (beer and wine)
consumption is also witnessed in the recent past along with rise of disposable income, creating a substitution effect
on hard liquor. We believe that the DIST's market share to be protected from this shift due to demand inelasticity
and brand loyalty towards 'DCSL Arrack'.
In summary, We don't see a much risk of losing a substantial market share of DIST in short to medium term, despite
regular Gvt. tax hikes which will be soften by consumption inelasticity. Therefore with expected modest growth of
the liquor industry, we are confident that DIST will not run into significant risks in medium term.
Appendices
Table 06: Return comparison
DIST
%
3 months
6 months
YTD
1 year
ASI Index
-21.45
-23.19
-12.20
-6.49
-10.67
-12.95
-8.22
-13.51
S&P SL 20
Index
-13.82
-18.98
-9.02
-19.48
LION
-14.29
-13.04
-14.29
-12.20
Source:CSE, Bloomberg
Graph 29: Share Price Movement
Volume
4,000,000
Volume
SMAVG (50)
Highest Price at 11.05.2015: LKR 310.20
3 Year Lowest Price as at 05.04.2013: LKR 160
350
Price
SMAVG (100)
300
3,000,000
250
2,000,000
200
1,000,000
150
-
Rs
5,000,000
100
100.00
75.00
50.00
25.00
0.00
1/26/13
RSI (14)
7/26/13
1/26/14
7/26/14
1/26/15
7/26/15
1/26/16
Graph 30: PE Chart
Graph 31: PBV Chart
14.0
1.6
12.0
1.4
10.0
1.2
8.0
1.0
6.0
0.8
4.0
1/26/13
7/26/13
1/26/14
PE ratio
7/26/14
Highest
1/26/15
Average
7/26/15
1/26/16
0.6
01/26/13
07/26/13
01/26/14
PBV ratio
Lowest
07/26/14
Highest
01/26/15
Average
Graph 32: Price per Sales
07/26/15
01/26/16
Lowest
Graph 33: Dividend Yield
3.5
2.1
1.9
3.0
1.7
1.5
2.5
1.3
2.0
1.1
0.9
1.5
1.0
1/26/13
0.7
7/26/13
1/26/14
7/26/14
Price to Sales ratio
Highest
1/26/15
Average
7/26/15
1/26/16
0.5
1/26/13
7/26/13
1/26/14
DIST dividend yield
Lowest
7/26/14
Highest
1/26/15
Graph 34: CSE PE Chart
1.8
1.8
1.7
1.7
1.6
1.6
1.5
1.5
1.4
1/26/13
15.0
14.0
13.0
12.0
11.0
10.0
9.0
07/26/13
ASI PE ratio
1/26/16
Lowest
Graph 35: CSE PBV Chart
16.0
8.0
01/26/13
7/26/15
Average
01/26/14
07/26/14
Highest
01/26/15
Average
07/26/15
01/26/16
7/26/13
ASI PBV ratio
1/26/14
7/26/14
Highest
1/26/15
Average
7/26/15
1/26/16
Lowest
Lowest
Table 07: Financial Summary Forecast
Figures in LKR Mn (31st March)
Income Statement
FY 13
FY 14
FY 15
FY 16 (E)
FY 17 (F)
FY 18 (F)
65,790
28,766
(15,898)
12,869
(6,190)
7,059
1,292
8,084
(2,826)
5,140
63,186
28,983
(15,219)
13,764
(6,084)
7,680
1,440
9,494
(3,263)
6,122
66,765
28,693
(16,234)
12,459
(5,568)
7,302
1,391
9,728
(3,254)
6,553
77,387
31,841
(16,966)
14,876
(6,160)
9,054
1,506
11,272
(3,662)
5,485
94,918
33,838
(18,159)
15,678
(6,599)
9,452
1,752
11,750
(3,749)
7,907
99,504
35,257
(19,167)
16,090
(6,947)
9,553
2,236
12,232
(3,748)
8,386
4,843
1,601
6,140
21,469
57,078
78,547
1,276
21,771
23,047
2,787
25,834
300
47,678
52,713
78,547
3,924
4,017
4,436
21,755
61,987
83,742
941
22,719
23,660
2,489
26,148
300
53,336
57,593
83,742
6,505
3,300
4,984
23,791
68,898
92,689
1,210
22,368
23,577
4,287
27,865
300
60,704
64,824
92,689
5,789
3,652
5,195
23,638
74,271
97,909
1,261
22,690
23,951
4,465
28,416
300
65,373
69,493
97,909
6,815
3,892
5,575
25,284
79,897
105,181
1,353
22,945
24,298
4,660
28,958
300
72,103
76,223
105,181
7,803
4,055
5,884
26,744
86,050
112,795
1,428
23,130
24,558
4,875
29,433
300
79,241
83,361
112,795
Net Income
Depreciation & Amortization
Changes in Non-Cash Capital
Cash From Operations
5,140
1,700
(832)
5,054
6,122
1,540
(2,666)
4,823
6,553
1,575
(1,598)
4,693
5,485
1,990
(511)
6,964
7,907
2,168
(528)
9,547
8,386
2,330
(397)
10,318
Capital Expenditures
Increase in Investments
Cash From Investing Activities
(2,594)
(270)
(3,154)
(4,812)
(1,636)
(7,251)
(10,271)
(3,851)
(4,000)
575
(4,931)
(4,000)
(2,043)
(7,794)
(4,000)
(2,247)
(8,483)
Dividends Paid
Change in Long Term Borrowings
Cash from Financing Activities
Net Changes in Cash
(891)
(686)
(1,486)
414
(898)
(965)
(1,800)
-4,229
(975)
1,086
154
996
(816)
178
(316)
1,716
(1,176)
195
(726)
1,026
(1,248)
215
(848)
988
Gross Revenue
Net Revenue
Cost of Revenue
Gross Profit
Operating Expenses
Operating Income
Share of profit of equity accounted invt
Pretax Income
Income Tax Expense
Net Profit att. to shareholders
Balance Sheet
Cash & Near Cash Items
Accounts & Notes Receivable
Inventories
Total Current Assets
Total Long-Term Assets
Total Assets
Accounts Payable
Other Short-Term Liabilities
Total Current Liabilities
Total Long-Term Liabilities
Total Liabilities
Share Capital
Retained Earnings & Other Equity
Total Equity
Total Liabilities & Equity
Cash Flow Statement
Table 08: Forecast Ratios
FY 13
FY 14
FY 15
FY 16 (E)
FY 17 (F)
FY 18 (F)
45%
18%
11%
7%
17.13
3.00
47%
21%
11%
7%
20.41
3.25
43%
23%
11%
7%
21.84
3.25
47%
17%
8%
6%
18.28
2.72
46%
23%
11%
8%
26.36
3.92
46%
24%
11%
7%
27.95
4.16
23%
4.3
1.6
0.9
25%
6.3
1.6
1.2
23%
10.5
1.5
1.3
22%
9.2
1.5
0.9
20%
8.1
1.5
0.8
19%
7.1
1.4
0.8
0.9
0.7
0.4
160
0.9
0.7
0.3
179
1.0
0.8
0.3
203
1.0
0.8
0.3
219
1.0
0.8
0.3
241
1.1
0.8
0.3
265
Growth Ratios
Revenue Growth YOY%
Earnings growth YOY%
Total Assets YOY%
Total Debt YOY%
7%
-7%
7%
-10%
1%
19%
7%
20%
-1%
7%
11%
3%
11%
-16%
6%
4%
6%
44%
7%
3%
4%
6%
7%
3%
Investment Ratios
PE Ratio (X)
Price to Book Value (X)
Dividend Yield (%)
9.72
1.04
1.80%
9.95
1.14
1.60%
11.01
1.18
1.35%
11.81
0.99
1.26%
8.20
0.89
1.82%
7.73
0.81
1.93%
Profitability Ratios
GP Margin (%)
NP Margin (%)
ROE (%)
ROA (%)
Earnings per share (LKR)
Dividend per Share (LKR)
Credit Ratios
Total Debt/Equity Ratio (%)
Interest Coverage (X)
Total Assets/Equity (X)
Net Debt/EBIT (X)
Liquidity Ratios
Current Ratio (X)
Quick Ratio (X)
Asset Turnover Ratio (X)
Net Asset Value per share (LKR)
Company
Distilleries Company of Sri Lanka PLC (DIST) is the market leader in the beverage industry with avg. 75% volume
market share of domestic hard liquor market while also maintaining a diversified portfolio of other business
operations. In its beverage business category, the company distils, manufactures and distributes liquor products for
the local market. Other business operations entail plantation, telecommunication, insurance and other financial
services, power generation, logistics, textiles, business process outsourcing (BPO) services, media and tourism. DIST
operates under state-of-the-art fully automated bottling plants and pot and patent distillation units located in four
strategic regions in Seeduwa, Kandy, Kalutara and Badulla and an island wide distribution network consisting of a
large fleet of vehicles coupled with massive warehouse facilities.
DIST is currently headed by Mr. Harry Jayawardena who is a prominent business personnel in Sri Lanka. DIST is one
of the largest cap counters in the Colombo Stock Exchange (CSE) with the market capitalisation of LKR 68700 Mn
(USD 474 Mn) and it is the only listed player operating in the hard liquor manufacturing sector.
History of DIST
Excise Department of Ceylon which was initially created in 1913 as the enforcement authority to distribute and sell
liquor products in Sri Lanka branched out into the distillation and manufacture of liquor products. The State
Distilleries Corporation which was incorporated in 1974 took over this venture while the Excise Department
realigned its operation as a monitory body. Under a government policy decision made in 1989, the State Distilleries
Corporation was converted into a limited liability company. Subsequently, the transfer of ownership took place at CSE
in 1992 enabling the company to stand out as a private entity. After this privatisation, the company saw a significant
turnaround in terms of production volumes, process efficiencies and superior financial performance while making
DIST to become the largest distiller in the country.
Financial Snapshot
Graph 36: DIST's net revenue breakdown
Graph 37: DIST's PBT breakdown
LKR Mn
25,000
LKR Mn
12,000
250%
10,000
200%
40%
35%
30%
20,000
25%
8,000
150%
20%
15,000
15%
10%
10,000
5%
0%
5,000
6,000
100%
4,000
50%
2,000
-5%
-10%
-
-15%
2010
2011
Beverages
Telecommunication
YoY growth
2012
2013
2014
2015
Plantation
Diversified
Source: Annual Reports, Bloomberg
0%
2010
2011
2012
2013
2014
2015
(2,000)
-50%
Associates profit
Telecommunication
Beverages
Diversified
Plantation
YoY growth
Source: Annual Reports, Bloomberg
Beverage segment represents the majority of Group's revenue and profitability while registering 66% and 86% contribution by FY15
respectively. Revenue generated from the beverage segment has seen a considerable growth from 2010 to 2013 and then seen a slightly drop in
during last two years mainly due to decreasing volumes and shrinking market share as a result of excessive taxes and large influx of cheaper
liquor to the market.
However, the segment has been able to increase their PBT during last three years due to operational efficiencies and the streamlined cost
structure. Despite of 10% and 12% revenue contribution from plantation and teleco segments, both have incurred losses during FY15.
Diversified segment has managed to yield average 7% contribution to Group's PBT over last four years while associate businesses were able to
generate positive earnings for the Group with 35% CAGR over last five years. DIST has been operating as a crucial contributor to Gvt. revenue
while paying LKR 41 bn to the state by way of taxes.
DIST Business Segments
DIST's core business entails distilation and distribution of beverage products including sevral varieties of coconut
based arrack, locally manufactured foreign liquor and imported foreign liquor varieities. Over the years, DIST has also
succesfully diversified in to other industires such as telecommunicarion, plantation, telecommunication, financial
services, textile, IT and leisure.
Beverage segment
This segment accounts 66% of Group's revenue and 86% of profit before tax as of FY15 and currently operates under
three sub segements.
Cocunut and processed arrack: DIST offers cocunut arrack and special arrack brands such as Old Arrack, White
Label Arrack, Blue Lable Arrack, Double Distilled Arrack, Extra Special, Pure Cocunut Arrack, etc. Sri Lankan cocunut
arrack is believed to be one of the purest, naturally derived alcoholic bevereges in the world distilled through a
natural fermentation process.
Locally manufactured foreign liquor: This segment is largerly managed by Periceyl (Pvt) Ltd, a joint venture
between DIST and France-based Pernod Ricard in 1996. Periceyl manufactures and distributes locally manufactured
foreign liquor and Arrack via DCSLs extensive distributor network. Periceyl’s flagship brands include Galerie
Napoleon French Brandy, Franklin Brandy, Black Opal Arrack - the unique premium arrack, and Flinton Gin, Balmora
Rum, Petroff Vodka and House of Tilbury Whisky .
Imported foreign brands: Periceyl also distributes the world renowned range of wines and spirits, which are owned
by Group Pernod Ricard France, such as Royal Salute, Chivas Regal, The Glenlivet, Ballantines whiskies, Martell
Cognac, Absolut Vodka, Beefeater Gin, Havana Club Rum, Jacob’s Creek, Long Mountain , Montana wines and G.H.
Mumm and Perrier Jouet champagnes.
Diversified Businesses
DIST's diversified business have been restructured under Melstacorp Limited which holds 19 direct and indirect
subsudiries and 2 associated companies. This has enabled Distilleries Company to more focus on the beverage
segment whilst Melstacorp to provide greater focus on diversified businesses and investments.
Plantations: This segment mainly engeges in cultivation and processing tea and rubber via Balangoda Plantation
PLC(BALA), an entity of which DIST has an effective ownership of approx. 58%. Plantation segement accounts for
10% of DIST's net revenue in FY15. It has 23 Estates is over 13,000 hectares comprising of Sri Lanka’s most fertile tea
and rubber Estates.
Telecommunication: This segment accounts for 12% of DIST's net revenue in FY15 and operates in the fixed
telecommunication and broadbrand sectors via its subsidiary Lanka Bell. Lanka Bell is the second largest fixed line
operator in Sri Lanka with a subscriber base in excess of 1.2 million. Lanka Bell has 62 own branch offices islandwide
along with the customer reach through over 600 retail outlets around the country.
Other diversified businesses (excluding associate companies): DIST's other diversified businesses mainly
engages in insurance (Continental Insurance), financial services (Melsta Regal Finance), auto mobile servicing and
logistics (Melsta Logistics), textile (Texpro), BPO and KPO services (BellVantage) , leisure (Browns Beach Hotel PLC)
and media (Splendor media) industries. Divesified segment accounts 18% of DIST's net revenue in FY15.
Associate companies: The Group's two associate investments include 43.07% ownership of Aitken Spence PLC
(SPEN) which is a leading diversified conglomarate in Sri Lanka and 45.9% stake of Madulsima Plantations PLC which
is mainly in to tea cultivation and processing. SEPN is amongst the largest cap counters in CSE with a capilisation of
LKR 35.9 Bn and predominatly does businesses in hotel and tourisum industries locally and overseas.
DIST Shareholding Distribution (as at 30. 09.2015)
Shareholder
No. of shares
% Stake
124,470,500
Milford Exports (Ceylon) (Pvt) Limited
37,961,500
Lanka Milk Foods (CWE) Limited
22,418,512
Mr. Muzaffar Ali Yaseen
13,050,000
Commercial Bank of Ceylon PLC/L.E.M.Yaseen
8,650,732
Melstacorp Limited
4,400,000
HSBC International Nominees Ltd- Morgan Stanley And Co INTL P
4,230,100
HSBC INTL NOM LTD – SSBT – Wasatch Frontier Emerging Small COU
4,000,000
Commercial Bank of Ceylon PLC/M.A.Yaseen
3,713,286
Caceis Bank Luxembourg S/A Barca Global Master Fund LP
3,695,560
Lahugala Plantation (Private) Limited
2,847,500
Mrs. Shantha Marie Chrysostom
2,800,000
Northern Trust CO S/A National Westminister Bank PLC as Trust C/O Standard Chartered
Bank
2,628,568
BNYM SA/NV – Blackrock Frontiers Investment Trust PLC
2,622,188
Citigroup Global Market Limited Agency Trading Prop Securi
2,456,000
Mrs. Lorraine Estelle Marlene Yaseen
2,208,189
BNYM SA/NV – Consilium Frontier Equity Fund L.P.
2,114,200
7 Stassen Exports Limited
2,044,036
HSBC INTL Nominees Ltd-SSBT-Frank Russel Investment Company
1,882,833
Mr. Don Hasitha Stassen Jayawardena
1,839,153
HSBC International NOM Ltd- MSCO-Route One Fund 1, L.P.
49,967,143
Other
300,000,000
Total
Graph 38: Shareholder structure 1 (as at 31.03.2015)
41.5%
12.7%
7.5%
4.4%
2.9%
1.5%
1.4%
1.3%
1.2%
1.2%
0.9%
0.9%
0.9%
0.9%
0.8%
0.7%
0.7%
0.7%
0.6%
0.6%
16.7%
100.0%
Graph 39: Shareholder structure 2 (as at 31.03.2015)
Individuals
19%
Non-Resident
23%
Institutions
81%
Resident
77%
Source: Annual Report FY14/15
Corporate governance structure
As one of the most respected Sri Lankan entities, DIST is managed by a skilled and experienced Director Board while
33% of Directors being functioned as Independent Non Executive Director (NEDs). There are three Executive
Directors and one Non-Independent Non-Executive Director representing the Board. DISTs Group operations are
subjected to regulations of various governing bodies including Excise Department, NATA, CBSL , TRCSL, IBSL, CSE &
SEC, Central Environmental Authority, etc.
However, DIST is significantly dependant on its influential Chairman/Managing Director Mr. Harry Jayawardena
while his family operates as a controlling shareholder of the company with an effective ownership of 52.1%.
Company's dependence on an individual in driving the business could have a negative impact in good corporate
governance while company could run in to a significant risk at the absence of his contribution.
Graph 40: Composition of EDs and NEDs
Non Independent
NEDs
17%
EDs
50%
Independent
NEDs
33%
Key Management (Source: Company Annual Report 2014/15)
Name of Director
Mr. D. H. S.
Jayawardena
Chairman / Managing
Director
Profile
Mr. Harry Jayawardena is one the most successful and prominent business magnates in Sri
Lanka. He was elected Chairman of the DCSL Group in 2006 after serving as its Managing
Director for almost two decades. He heads many successful ventures in diversified fields of
business. He is the founder Director and the present Chairman / Managing Director of the
Stassen Group of Companies. He is a former Director of Hatton National Bank PLC. and
former Chairman of Ceylon Petroleum Corporation and SriLankan Airlines. Mr.
Jayawardena is the Honorary Consul for Denmark and was the only Sri Lankan honoured
with the prestigious “Knight’s Cross of Dannebrog’ by Her Majesty, Queen Margrethe II of
Denmark, for his significant contribution to the Danish arts, sciences and business life. He
has also been awarded the title, “Deshamanya” in recognition of his services to the
Motherland, since November 2005.
Mr. C. R. Jansz
Executive Director
Mr. C. R. Jansz has many years of experience in Logistics and in Documentation, Insurance,
Banking and Finance relating to international trade. He is the Chairman of DFCC Bank PLC
and DFCC Vardhana Bank. He serves on the Board of Melstacorp Limited, Balangoda
Plantations PLC., Lanka Bell Limited and several other companies of the Distilleries Group.
He is also a Director of Lanka Milk Foods (CWE) PLC. and its subsidiaries.
Mr. N. de S. Deva Aditya Mr. Niranjan Deva Aditya, is an aeronautical engineer, scientist and economist, is a
Independent NonConservative Member of the European Parliament elected from the SE England. He is the
Executive Director
Vice President of the Development Committee; ECR Coordinator and Conservative
Spokesman for Overseas’ Development and Co-operation.
Capt. K. J. Kahanda
(Retd.)
Executive Director
Captain Kahanda joined the Company in 1993 as Regional Manager (Central Region) and
was appointed a Director in December 2006. Being a former officer of the Sri Lanka Army,
he spearheaded the re-organisation of the operations of the Central Region since
privatisation. He specialises in logistics, distribution and security matters, and is also a
Director of G4S Security Services (Pvt) Ltd. and Pelwatte Distilleries (Pvt) Ltd., a subsidiary
of the Group.
Dr. Naomal Balasuriya Dr. Naomal Balasuriya, a medical doctor turned-entrepreneur is internationally sought
Independent Nonafter as a life changing motivational speaker. His professional expertise ranges from
Executive Director
medicine, military, management, marketing, mentoring to motivational speaking. He holds
both the Master of Business Administration (MBA) and CIM (UK) qualifications.
Mr. D. Hasitha S.
Jayawardena
Non-Independent NonExecutive Director
Mr. Hasitha Jayawardena holds a Bachelor’s Degree in Business Administration BBA (Hons)
from the University of Kent in the United Kingdom. Mr. Jayawardena joined Stassen Group
in February 2013.
Liquor industry in Sri Lanka
The Sri Lankan coconut arrack is believed to be one of the purest, naturally derived alcoholic beverages in the world
distilled through a natural fermentation process. In ancient times, toddy extracted from coconut trees was a very
popular beverage amongst Sri Lankans. After Britain took possession of what is now Sri Lanka (then Ceylon) in 1802
Arrack became popular as a alcoholic beverage and was named as "Ceylon Arrack". Ceylon arrack was produced from
‘toddy’, fermented juice of the coconut palm, extracted by cutting the flowers from the tree and hanging a bucket
below the cut to gather the free-flowing sap. Local alcohol industry currently consists of recorded hard liquor and soft
liquor along with illicit liquor production. Further toddy production through Coconut, Palmyrah and Kithul tree can
also be seen in Sri Lanka. Despite the availability of different types of arrack categories, Special Arrack is more
preferred among the consumers due to the affordable "kick-per-buck".
During the recent years there have been a number of changes implemented with regard to alcohol policies in Sri
Lanka which were more at a disadvantage to the liquor industry. Further Sri Lanka's demographic differences such as
region, culture and societal perception on drinking play a major role in shaping the direction of local liquor industry.
Majority of Sri Lankans are Buddhists and they take a pledge to prevent alcohol consumption, even though Buddhism
does not impose such a religious rule. However there is about 9% Muslim population who are strictly prohibited from
alcohol consumption. Further, Sri Lankan women usually do not consume hard or soft liquor as they perceive it as an
unacceptable social habit while greatly discouraging their husbands, fathers and sons from consuming alcohol.
According to Excise department, 24 licensed liquor manufacturers operates in Sri Lanka where 13 players
manufacture Molasses Arrack, 12 produce coconut and processed arrack and 17 players produce special arrack.
There are 3 malt beer manufacturers and 2 wine manufacturers operating in the soft liquor industry.
Distilleries Company of Sri Lanka (DIST) is the only listed hard liquor manufacturer and Ceylon Beverage Holdings
and Lion Brewery Ceylon are the listed players in soft liquor industry.
Table 09: Financial performance comparison of listed companies operating in alcohol industry
Price(LKR Market Cap
Y/E Net NAV(LKR per
ROE%
ROA%
Counter
per Share)
DIST
LION
BREW
229.00
551.00
800.00
(LKR Mn) Profit(LKRMn)
68,700
44,080
16,790
6,553
1,330
659
PER
PBV
Dividend
Yield %
10.0
36.1
22.3
1.1
5.0
3.8
1.4
0.6
1.1
Share)
203
99
188
11.4
17.9
17.8
7.5
5.3
2.6
Source: Bloomberg
Table 10: Selected "beverage, food and tobacco" sector
indicators
Indicator
Graph 41: Comparison of alcohol consumption
Value
PER
PBV
Dividend Yield
17.12
14.35
2.49%
Toddy
Source: LOLC SEC Estimates
Graph 42: Alcohol consumption as a % of population
Soft liquor
34%
Hard liquor
66%
Consumers
20
40
2014
Non concumers
Source: NATA
60
2013
80
100
2012
120
140
Lr Millions
Source: Excise Department
*Company overview, DIST shareholding distribution, Composition of Eds and NEDs, Key management, History, SWOT analysis, Industry analysis are taken from the extracts of websites, Annual reports, Bloomberg and LOSEC
research materials.
SWOT Analysis
Strengths
Market leader in the hard liquor industry in Sri Lanka with a history of over 100 years.
Mr. Harry Jayawardena, a influential and prominent business personnel backing DIST as Managing Director
Strong brand image along with strong distribution network
Strong balance sheet and low gearing allowing DIST's for investments
Weaknesses
Company is significantly dependant on Mr.Jayawardena's direction of driving the business
Telecom and plantation sectors erode Group's profitability
Company still awaits compensation from the Gvt takeover of its Sri Lankan insurance stake and Pelwatte Sugar
Industries stake
Opportunities
Price inelasticity of demand for alcohol products
Increase per capita income and growth of tourist arrivals leading to a higher demand for alcohol
Unfavourable implication from budget 2016 for small liquor manufacturers will deteriorate their market share and
support big players to capture it
Threats
Continuous increase in selling prices due to regular increases of taxes making liquor products expensive for consumers
Cultural, religious and social pressure on curtailing alcohol consumption
Inefficiencies in executing rules and regulations related to curbing illicit and illegal liquor
Rupee depreciation leading to increase ethanol cost
Industry Analysis
Bargaining power of suppliers
Company collects toddy from local toddy suppliers and pay a fair rate if suppliers meet required quality standard.
Currently there is no scarcity of toddy and hence we see toddy suppliers bargaining power as "Low". Companies
import ethanol mostly while big players like DIST produces sugar based ethanol locally to cover part of their
requirement and use it for blending. Currently, global ethanol alcohol prices are experiencing a price drop, and thus
liquor manufactures can obtain a cheap supply. Hence bargaining power of ethanol suppliers could be considered as
"Low".
Bargaining power of customers
Buyers are seen as price takers in the industry as sellers set the price of products passing price hikes as a result of
excise duties changes to buyers. Consumers tend to buy liquor products amidst increased prices, however after some
point when prices become unaffordable they become price-sensitive and shift to illicit and illegal products at a
cheaper rate. Thus we view bargaining power of customers as "Medium".
Threat of substitutes
Substitutes for the industry can be in the form of alcoholic and non alcoholic beverages such as beers, wine, soft
drinks and fizzy drinks. There has been witnessing a significant threat from beer as beer consumption is growing at a
rapid phase over arrack consumption. But we believe that most of the beer consumers tend to drink hard liquor as
well while mitigating the substitution effect. Threat of substitutes of the industry could be considered "Medium".
Threat of new entrants
Alcohol Industry is highly regulated and obtaining manufacturing licences are very difficult and costly. Gvt also
maintains tight controls on not issuing new licences. However threat from new entrants is significant in the illicit
segment of the industry where illegal institutional and individual brewers enter and exit the market frequently. Thus
we view threat of new entrants as "High" for alcohol industry.
Existing Rivalry
Rivalry among industry players are High since the market is crowed with 24 licenced companies. In addition there is
a significant competition from beer companies like LION. Competition from illicit manufactures are also intense as
they are capable of offering products significantly below normal prices.
Recommendation Guidance
BUY – expected return > 10% in excess of benchmark return
SELL – expected return less than benchmark return
HOLD – expected return between 0% and 10% in excess of benchmark return
Investment Horizon: 3 years
12 months target price (12M Tgt Price) is based on the expected capital appreciation of the share excluding dividend.
Benchmark Interest Rate: Average Weighted Fixed Deposit Rate (AWFDR) published by Central Bank of Sri Lanka.
Risk Level Evaluation
High: Maximum price volatility to be up or down more than 50% monthly
Medium: Maximum price volatility to be up or down between 25% - 50% monthly.
Low: Maximum price volatility to be up or down less than 25% monthly.
Risk Level is calculated taking the historical standard deviation measures.
Financial Glossary
EPS = Earnings per Share
ROA = Return on Assets (adjusted net profit/average total assets)
ROE = Return on Equity (adjusted net profit/average total equity)
CAGR = Compound Annual Growth Rate ((End Value/Start Value) ^ (1/number of years) -1)
GP= Gross Profit
EBITDA= Earnings before interest, tax, depreciation and amortization
PBT= Profit before tax
PAT= Profit after tax
NP= Net Profit
PBV= Price to book value ratio
PE= Price to earnings ratio
Analyst certification: The Analyst(s) who is/are responsible for compiling or co-compiling this research and whose names appear as the analyst(s) of the research certify that the views
expressed in this research accurately reflect the personal view of the analyst(s) about the subject securities and issuers and/or other subject matter as appropriate and has taken
reasonable care to achieve and maintain independence and objectivity in making any recommendations. No part of the compensation received by the analyst(s) was, is or will be
directly or indirectly related to specific inclusion of specific recommendation or views in this research. On a general basis analyst’s performance appraisal may be influenced by quality of
the content and efficacy of the research. The analyst(s) who is/are responsible for compiling or co-compiling this research and whose names appear as the analyst(s) receive
compensation based on overall revenues of LOLC Securities Limited and its holding company (Lanka ORIX Company PLC – LOLC Group), which may include brokerage revenue from
transactions involved with the securities mentioned in this research.
General Disclaimer: LOLC Securities Limited is a company incorporated in Sri Lanka and licensed by the Securities and Exchange Commission of Sri Lanka to operate as a
stockbroker/stock dealer in Sri Lanka. LOLC Securities Limited is a trading member of Colombo Stock Exchange. This research is based on information from sources that LOLC
Securities Limited believes to be reliable. Whilst reasonable care has been taken to ensure accuracy of the information presented in the research, LOLC Securities Limited does not
give a guarantee on the accuracy of the information presented in the paper nor will take the responsibility on investment decisions taken based on the information provided by the
research and hence LOLC Securities Limited nor its employees accepts any liability whatsoever for any loss arising from investments decisions taken using the information provided in
this paper. The reader also should note this paper does not give recommendations to any particular category of investors and investor should consult investment advisors for further
clarifications regarding risks involved in investing in equity market. Investing in securities has inherent risks with no guaranteed return and price may be subjected to significant
volatilities. No part of this report should be considered as a solicitation to buy or sell any security or product or to engage in or refrain from engaging in any transaction. LOLC Securities
Limited or its employees may or may not hold positions in the securities discussed in the research and the information provided in the research should not be construed as a buy or sell
instruction for any securities mentioned in the research, Unless otherwise specifically mentioned. This research is intended for general use for clients of LOLC Securities Limited and
must not be copied in whole or in part or distributed to any third party for commercial use without permission from LOLC Securities Limited. If the reader is not the intended recipient
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professionals may provide oral or written market commentaries or trading strategies to our clients which reflect opinions which are contrary to the opinions expressed in this research
which may be influenced by different circumstances.
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26th January 2016

Transcription

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