market as it is forecasting the benchmark All Share Index (ASI) to hit
the 7,500 points level by end third quarter and 9,000 points level by
end 2011.
“While the SEC’s decision to allow stock broking companies to provide
margin facilities to clients based on their liquidity capacity is
definitely encouraging, we expect investors to now focus more
significantly on corporate fundamentals which would provide the
necessary catalyst for a sustainable rally leading to the market
re-rating comfortably above the 7500 levels during 3Q2011 and reduce the
somewhat fear-based emotional selling that has characterised certain
periods of trading over the last few weeks,” DNH said in its weekly
stock market review.
The broking firm expects a number of themes to emerge over the next few
weeks which it said will shape market trajectory; prolonged nervousness
in the global markets as they continue to capitulate to US and Eurozone
debt tensions, conversely, record performance in the Sri Lanka economy
and strong double digit corporate top line as well as bottom line growth
and improved margins, cheap PEG valuations in the majority of the
companies in our universe, and the relative unattractiveness of
alternatives such as T-Bills, fixed deposits or real estate.
“The convergence of all these factors will provide the perfect backdrop
for the Colombo bourse to comfortably breakthrough the 9000 resistance
level by year end generating a return of 25-30% from current levels. We
are not unaware however that we may encounter sporadic lumps and bumps
along the way as we climb a solid upward slope, but our conviction for
equities remains well and truly strong and justifiably so,” DNH said.
Noting that although from an absolute PE valuation yardstick, the
Colombo market at current levels may appear relatively expensive
vis-à-vis regional markets DNH said from an all important PEG basis, the
Colombo bourse can be described as not only attractive but cheap and
getting cheaper as the full impact of the current earnings cycle is
absorbed.
“At a PEG of 0.6X, we believe that the market offers considerably
attractive buying opportunities for investors seeking double digit
returns over a minimum three-four month investment horizon. For those
with an investment horizon of even greater, we believe the returns will
be considerably higher. We advise investors however to be
ultra-selective in their stock selection and focus on companies that are
fundamentally sound with a strong domestic consumption theme,” said DNH
which comes under the ERI Group.
“While some industry commentators have expressed concerns over the
prospect of an over-valuation of the market and a possible correction,
we disagree and take a markedly different view. The fear and panic that
have been rattling global investors over the US and Eurozone debt crises
is unlikely to impact the Colombo bourse as we believe that there is a
clear polarisation between the performance of the domestic bourse
vis-à-vis its global peers. Consequently, lead by domestic factors, we
believe the market will end 3Q2011 at least 8-10% higher characterised
however by sporadic periods of volatility,” DNH said.
Supported by leadership mainly from large and medium sized stocks with a
strong domestic theme, we believe that the bourse is well on course to
breaking through the psychologically important 9000 key resistance level
by year end and making the crossing at a prospective PEG of1.0X.
“We believe that the next few months will offer an attractive
opportunity for risk savvy investors to be able to proactively position
themselves to capitalise on a 25-30% rise in the market. Investors are
advised that temporary dislocations in the market cannot be discounted
and when they arrive many will question the ability of the bourse to
bounce back; but bounce back it will. With alternatives to domestic
equities becoming increasingly unattractive, we see a strong liquidity
driven impact on equity returns.
Continued low interest will make equities more attractive and cash unattractive,” DNH said.
It pointed out that although inflation has been crawling upwards in
recent months and is currently hovering at 7.0%, it still remains at
relatively benign levels and is not a concern at this stage. While
strong domestic consumption and resultant increased demand pull factors
could stoke inflationary pressures going forward, we believe that given
the increasingly cost push nature of the CPI, domestic inflation should
remain at current levels as demand pull inflationary pressures will be
comfortably offset by cost push factors, namely lower import costs a
result of lower global commodity prices.
Given the Central Bank’s increasingly accommodative monetary policy, we
expect interest rates to continue to remain at current levels
notwithstanding the Bank of Ceylon (BOC)’s recent decision to cut loan
interests from 12% to 9% which although could have the ability to
trigger similar action from other commercial banks, is unlikely to
result in an industry wide reduction in rates as we believe that the
majority of banks will face increasingly downward pressure on margins if
rates are actually reduced.
Meanwhile, despite the ‘safe haven’ appeal that cash instruments offer,
an important point to note is that taking into consideration the
current low interest rate environment, investors who maintain savings in
the form of fixed deposits are now generating negative real returns
given current inflation levels.
The scenario does not change significantly in the case of those
currently invested in T-bills either, as the real rate of return on
T-Bills was a mere 25 bps in July 2011. Consequently given DNH’s
expectations of a 25-30% rise in the bourse by year end, the opportunity
of not investing in the Colombo bourse could be painfully high for
those investors sitting in cash, the broking firm argued.
“Considering the unattractiveness of either fixed deposits or T-bills
in real terms, we therefore recommend a shift to high yielding equities
which is likely to generate significantly higher returns. In this
respect, we re-iterate the need to however adopt a rigorous stock
selection strategy to identify fundamentally solid stocks that will
outperform and generate above market risk adjusted gains,” it said.
DNH also said it is remains overweight on the Manufacturing, Banking,
Diversified and F&B sectors which it opined have a strong domestic
focus and will benefit fully from rapidly rising local consumption. “We
are also bullish on the Hotel sector which has performed surprisingly
well notwithstanding increasing global recessionary pressures,” it
added.
Focusing on corporate results released so far, DNH said companies have
definitely exceeded market expectations with average consolidated EPS
growth of 30-35%.
“While we are certainly pleased that the majority of companies have
recorded both healthy top as well as bottom line growth and improved
margins, we advise investors to be somewhat wary of those that have
reported unusually sharp earnings growth without a corresponding
increase in top line revenues. This could mirror a non-recurring event
such as an unusual or infrequent item (included as part of ‘Other
Income’), which is unlikely to recur going forward or an extra-ordinary
item. Consequently, we emphasise the need to select companies that are
likely to report sustainable earnings growth going forward with top line
revenues LEADING EPS growth,” DNH said.
With regard to the economy, DNH said having grown by an impressive 8.0%
in 2010, GDP growth during the 2Q2011 is expected to remain strong
notwithstanding the turmoil in the global markets. This is high by any
standard. Growth will be broad-based across all sectors, most notably
from the Industrial, Services and Hotel sectors and will be fuelled by
strong domestic consumption at all levels as a result of a rise in
consumer disposable income and corporate profitability. While export
growth could tail off slightly as a result of a modest dip in demand
from international buyers, we do not see any significant impact on the
Balance of Payments as we expect tourist arrivals to continue to remain
high while expatriate remittances will continue lend support to
household spending.
Having enjoyed welcome gains from the real estate sector during last
couple of years as a result of the end of the war, we see little to
encourage investors to re- enter the market this year as we believe that
much of the ‘easy’ gains in the sector has already been realised.
Considerable value increase has pushed yields down to 5-6% levels,
which, when considered against risk free T-Bill rates, do not appear
overly attractive and certainly compares unfavourably when juxtaposed
against equities. In the medium to longer term however, we expect the
real estate sector to benefit from the ongoing domestic economic
expansion which we believe will result in a re-rating of the real estate
market.
Strong opportunity for foreign fund managers and unconstrained local fund managers
Given the expectation of continued nervousness in the global markets
during 4Q2011, we expect most international fund managers to square
their books ahead of the new year. The dislocations in the global
markets will consequently offer significant opportunity for global asset
managers to invest these surplus funds in markets such as Sri Lanka
which is currently at the top of economic performance.
“We believe that local fund managers meanwhile whom are unconstrained
in their mandate will also be able to generate significantly positive
alpha by exploiting market opportunities using an active portfolio
management approach in their stock selection thereby outperforming those
that are linked to indexes,” DNH said.
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