hayleys plc (hayl)hayleys plc (hayl) 1 a capital market development initiative by the colombo stock...

Sri Lanka | Diversified Holdings EQUITY RESEARCH

Initiation of coverage 5 September 2013

Hayleys PLC (HAYL)

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A capital market development initiative by the Colombo Stock Exchange in association with Amba Research

Focus on diversity Hayleys PLC (HAYL), Sri Lanka’s largest listed manufacturing- and export-driven conglomerate, focuses primarily on value-added products. Its key business lines include purification products (activated carbon), hand protection (rubber gloves), transportation and logistics (T&L), plantations and agriculture. We expect HAYL’s revenue to grow at a CAGR of 6.0% over FY14E-FY16E and its EBIT margin to increase 222bps to 11.2% in FY16E from FY13 levels. Strong demand and improving economies of scale in purification products and T&L will be the key drivers of this margin expansion. We expect the temporary suspension of a hand protection production facility in Sri Lanka to have a relatively minor impact on revenues and margins through FY15E as it only accounts for 3% of HAYL’s revenues (see page 7 for our forecasts). HAYL’s presence in export markets (64% of total revenues are derived outside of Sri Lanka) positions the company on a global platform, whilst also exposing it to uncertainty in the light of FX volatility and raw material price fluctuations. Recently however, the depreciation of the LKR could work well for HAYL’s top-line. Our DCF/SOTP valuation and P/E analyses suggest a valuation range of LKR277-319, compared with the share price of LKR290 as of 4 September 2013.

We expect HAYL’s revenue to grow at a CAGR of 6.0% over FY14E-FY16E. The

purification segment should drive revenue growth, as increasingly stringent emission regulations in the US and China spur demand. The T&L segment will also be a source of top-line growth thanks to HAYL’s pioneer position in the domestic T&L industry. We project a 2.4% YoY growth (base-case) in revenue in the hand protection segment in FY14E (compared with 8.7% in FY13), but we expect a recovery subsequently. Some of the company’s smaller segments should also post solid revenue growth.

We forecast the EBIT margin will rise 222bps over F14E-FY16E. Margin growth

should be driven primarily by the positive impact of economies of scale resulting from recent capacity expansions, better inventory management and strong brand positioning in the purification products segment, along with exposure to high-margin operations within the T&L segment. This should help the company withstand a decline in margins through FY15E in the hand protection segment. Potential pressure to margins may arise from higher commodity prices, and/or a prolonged slowdown in key export markets.

Tight short-term liquidity and a high debt burden may pressure cash flow.

HAYL’s reliance on debt funding has pushed up the company’s debt burden. Leverage stands at 42% in 1QFY14, up from 36% in FY09, while HAYL has a current ratio of 1.1x in 1QFY14 (compared with 1.3x in FY09), with high reliance on short-term debt (approximately 69% of total debt in 1QFY14). Any additional debt funding, could put further pressure on earnings.

We establish a valuation range of LKR277-319, compared with the current share price of LKR290. HAYL currently trades at an FY14E forward P/E of 9.2x.

Since April 2011, the shares have traded at a forward P/E of between 4.0x and 32.5x. We arrived at this valuation range through scenario and sensitivity (to our risk-free rate and market risk premium) analyses of our base-case DCF/SOTP assumptions (refer to pages 18-21 for details); we also discuss in detail three scenarios, focusing on the temporary suspension of the hand protection segment factory, and have based our valuation on the base-case scenario as described on pages 6-7. We will closely monitor the performance of the key growth segments and update our valuation range in future earnings release updates.

Key statistics CSE/Bloomberg tickers

Share price (4 Sep 2013)

No. of issued shares (m)

Market cap (USDm)

Enterprise value (USDm)

Free float (%)

52-week range (H/L)

Avg. daily vol (shares,1yr)

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HAYL.N0000/HAYL SL

LKR290

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LKR325/284

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Source: CSE, Bloomberg Note: USD/LKR=128.6 (avg. for the year ended 4 September 2013

Share price movement

Source: CSE, Bloomberg

Share price performance

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HAYL -7% -2% -6%

All Share Price Index -11% 2% 7%

S&P SL 20 -12% 0% 9%


Summary financials

LKRm (year end 31 March) 2013 2014E 2015E

Revenue 74,302 80,080 83,793

EBITDA 8,543 10,684 11,568

Segment results 6,663 8,389 9,073

Net profit 1,854 2,366 2,622

Recurrent EPS 24.7 31.5 35.0

ROE (%) 9.1 10.2 10.5

P/E (x) 12.1 9.2 8.3

Source: HAYL, Amba estimates

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Hayleys PLC

Table of Contents

Hayleys (HAYL): Dimensions of a unique conglomerate ..................................................................................................... 3

Broad business diversification .............................................................................................................................................................. 3 Contemporary spin on traditional products ........................................................................................................................................... 3 Strong presence in export markets ....................................................................................................................................................... 3 Exposure to FX fluctuations .................................................................................................................................................................. 4 Margins depend on key raw material prices ......................................................................................................................................... 4 Autonomy in segmental decision making ............................................................................................................................................. 5

Dipped Products PLC factory: current situation and scenario analyses .............................................................................. 6

Revenue to grow at a 6.0% CAGR over FY14E-16E........................................................................................................... 8

Purification products segment to benefit from strong global demand ................................................................................................... 8 Transportation services and logistics to continue to contribute to group top-line through Advantis .................................................... 10 Faced with challenges, HAYL’s hand protection segment to contribute to group revenues at a 3.9% CAGR over FY14E-FY16E .... 10 Plantations will remain an important revenue contributor ................................................................................................................... 11 Agriculture segment revenues to modestly benefit from value added exports .................................................................................... 12 Emerging segments to make minor contributions to revenue growth ................................................................................................. 12

EBIT margin to increase 222bps to reach 11.2% in FY16E .............................................................................................. 14

Purification products to lead EBIT margin expansion ......................................................................................................................... 14 Transportation and logistics to continue momentum and contribute to group margin ......................................................................... 15 Hand protection’s EBIT margin to decline in FY14E, but recover thereafter ....................................................................................... 15 Agriculture and plantations segments to make modest contributions to group EBIT margin .............................................................. 16 Smaller segments have minimal impact on margin ............................................................................................................................ 17

We establish a valuation range for HAYL shares of LKR277-319 ..................................................................................... 18

DCF/SOTP analysis yields a valuation range of LKR277-319 per share ............................................................................................ 18 Our P/E analysis yields a range of LKR285-315 per share ................................................................................................................ 21 Additional sources of valuation upside ............................................................................................................................................... 22 Other challenges ................................................................................................................................................................................ 22 Relative valuation comparison ............................................................................................................................................................ 26 Share price performance .................................................................................................................................................................... 27

Earnings release focus areas ............................................................................................................................................. 28

Appendix 1: Company overview......................................................................................................................................... 29

Appendix 2: Key financial data ........................................................................................................................................... 35

Appendix 3: Industry analysis using Porter’s framework ................................................................................................... 39

Appendix 4: SWOT analysis .............................................................................................................................................. 45

Appendix 5: Diversified sector overview ............................................................................................................................ 46

Fact Sheet .......................................................................................................................................................................... 49

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Hayleys (HAYL): Dimensions of a unique conglomerate

HAYL is unlike any other Sri Lankan conglomerate for a number of reasons. The company has a more diverse range of businesses than most other domestic conglomerates and focuses on converting traditional national commodities into value-adding products for export. The company has a relatively higher presence in export markets than other conglomerates, which puts HAYL on the global map and positively exposes HAYL’s top-line growth during periods of LKR depreciation (as in the recent past). Further, we believe that HAYL’s segments have a higher degree of autonomy, relative to other conglomerates.

Broad business diversification

HAYL has a more diversified business than other Sri Lankan conglomerates – the most balanced and diversified among the top five (by market capitalization). For all other conglomerates considered, the majority (over 70%) of revenues and EBIT (over 75%) come from two to three key segments, compared with five segments for HAYL. Such diversification bodes well for HAYL and helps to mitigate risks.

Figure 1: Over 70% of HAYL’s revenue comes from five segments

Figure 2: Over 75% of HAYL’s EBIT comes from five segments

Source: HAYL, John Keells Holdings PLC, Aitken Spence PLC, CT Holdings PLC, Carsons Cumberbatch PLC

Source: HAYL, John Keells Holdings PLC, Aitken Spence PLC, CT Holdings PLC, Carsons Cumberbatch PLC

Contemporary spin on traditional products

Sri Lanka has historically been a source of valuable commodities, including tea, rubber, coconut and spices. HAYL has created businesses by leveraging the country’s natural resources and moving up the value chain to produce a range of high-value-added products. Rubber gloves, activated carbon (AC) and coir products (such as brushes for industrial and household use, coir mattresses, and mats) are some of the key products that HAYL has developed using Sri Lanka’s home-grown resources. The company has acquired substantial market share in these strategic business areas, which is an unusual example of a Sri Lankan company participating on the global stage.

Strong presence in export markets

HAYL is unique in the universe of Sri Lankan conglomerates owing to its strong presence in export markets. HAYL focuses on adding value to Sri Lanka’s natural resources and brings in foreign currency to the country. HAYL is one of the main FX earners in Sri Lanka, accounting for 3% of total national export income in 2012. About 64% of the company’s total FY13 revenue came from exports, substantially higher than that for other conglomerates, while the remaining 36% came from the domestic market.

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Traditional raw materials are converted into high-value adding products across HAYL

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Figure 3: HAYL has a greater global market presence than other Sri Lankan conglomerates

Name of conglomerate Global market presence (% of revenues) Key export markets

Hayleys PLC 63.6% Europe, Asia, US

John Keells Holdings PLC 14.5% Maldives

Aitken Spence PLC 24.6% Maldives

Carsons Cumberbatch PLC 46.5% Indonesia, Malaysia

Source: HAYL, John Keells Holdings PLC, Aitken Spence PLC, Carsons Cumberbatch PLC

The company derives more than a quarter of its total revenues from the US and the Eurozone. Asia (excluding Sri Lanka) is its second-largest export market (13% of revenues). In contrast, most of the other leading conglomerates have their foreign exposure limited to only one or two countries, as shown above.

The key implication of HAYL’s high exposure to exports is that a sharp slowdown in external markets is likely to have a more negative effect on HAYL than on the other conglomerates in Sri Lanka.

Exposure to FX fluctuations

HAYL’s high export focus means that the impact of currency fluctuations is a key factor to the company, as HAYL would be more exposed to FX fluctuations relative to its peers. That said, in recent months, the sharp depreciation of the LKR would positively contribute to the company’s top-line. A majority of the company’s input costs are denominated in LKR, with revenues denominated in foreign currencies. This means that, all else remaining equal, HAYL’s margins will tend to benefit when the LKR is weak and be squeezed when the local currency is strong.

Figure 4: A depreciating LKR has a positive impact on HAYL’s earnings

Source: HAYL, Bloomberg

Margins depend on key raw material prices

HAYL’s expense structure is driven to a large degree by commodity prices. The company relies on a number of commodities – most notably, tea, rubber and coconut – for critical inputs. Price volatility could cause uncertainty for HAYL, as margins could be squeezed if commodity prices rise and the company is unable to fully pass on this cost hike to customers. Alternately, HAYL may benefit if commodity prices decline.

In recent months however, as prices of key raw materials have fallen, HAYL would benefit from lower production costs, but could still face margin pressure as these benefits would need to be passed onto customers, due to global competitiveness. Indeed, as shown on page 24 (Figure 29), the company’s exposure to commodity prices can be both positive and negative for its margins –

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Approximately 64% exposure to exports makes HAYL’s bottom line more exposed to FX fluctuations relative to other conglomerates in Sri Lanka

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for example, between 2008 and 2012, any increase in commodity prices (tea, rubber and coconut) led to lower segmental EBIT margins, while a dip in commodity prices ensured higher segmental margins.

Autonomy in segmental decision making

We believe HAYL’s business segments are, for the most part, managed as separate entities, with each responsible for its own strategy and profitability. This is somewhat similar to what other conglomerates in Sri Lanka do, although the specific dimensions of management approaches differ from one firm to another. HAYL’s approach is unique in that the key subsidiaries within its main segments are separately listed entities (refer to Appendix 1 for details). While HAYL owns a controlling stake in each of these, they are all subject to the external oversight of minority shareholders and the stock exchange, which engenders – and requires – a relatively high degree of autonomy. Though the company has a few centralized services under corporate management, for example, strategic business development, legal and treasury, we believe that for the most part, strategy is driven at the segment level, with management held directly accountable for financial performance.

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Dipped Products PLC factory: current situation and

scenario analyses

Dipped Products PLC (CSE ticker: DIPD), which is 57.5% held by HAYL, manufactures and distributes protective gloves – including medical, household and industrial purpose gloves – and is part of the hand protection segment (which accounted for 20% of HAYL’s total FY13 revenue). See Appendix 1 for further details of the segment’s operations.

One of DIPD’s factories, Venigros Pvt Ltd, has been temporarily suspended due to villagers’ claims of water contamination in its area of location. We believe the financial impact at group level should not cause significant concern for the company, as this factory only accounts for approximately 15% of this segment’s revenue and 3% of group revenue. In our base-case scenario, we envision revenue growth of 2.4% YoY for this segment in FY14E (compared with 8.7% in FY13), and an approximate 425bps drop in the EBIT margin from previous year’s levels to 5.1% in FY14E.

Due to aforementioned reasons, production has been temporarily ceased at the Venigros plant since July 30. DIPD has been able to transfer some of its Venigros capacity to other factories in Sri Lanka, and has also outsourced orders to its third party suppliers. However, we believe the suspension will still have a negative impact on revenues and margins in FY14E.

DIPD’s share price has seen some volatility (down 15% since 25 July 2013, while the market overall has declined 5%). While HAYL’s share price has fluctuated (ranging between LKR286 and LKR305), the overall decline since July 25

th has been just 4%. We believe that this resilience is

mainly due to the stock’s low liquidity.

Figure 5: HAYL’s share price has remained resilient throughout the Venigros factory suspension


Scenario analysis

We have analyzed scenarios based on three possible outcomes of the Venigros factory suspension, and have factored the issue into our DCF/SOTP and P/E-based valuations. Below, we present our scenarios (please see pages 18-21 for details on the impact of these scenarios to our valuation range).

Scenario 1- Base-case: Factory operations suspended temporarily, 40% of capacity transferred to other plants/outsourced/bought-in from foreign suppliers by end of FY14E (reaching 100% by the end of FY15E), relocation plans commence.

Under this scenario, we assume that the factory operations will remain suspended temporarily. There would be some level of revenue disruption, while capacity is transferred to other

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Venigros factory operations suspension not anticipated to have a major financial impact on the group

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plants/outsourced/purchased to meet orders through FY15E. We expect the segment’s revenue growth to decelerate with 2.4% YoY growth forecast in FY14E (compared with 8.7% YoY in FY13).

We expect the FY14E segmental EBIT margin to decline to 5.1% (compared with 9.4% in FY13) on account of the capacity transfer costs, a decline in economies of scale and an increase in operational expenses during this period. Our revenue and margin estimates also account for a modest loss of reputation resulting from the aforementioned events.

We also assume that HAYL will commence its factory relocation program as soon as a suitable location is approved by the authorities, and we expect this to be completed by FY16E. We have factored into our valuation an estimated cost of relocation and have spread this over the next two to three years. Relocation costs are assumed to include costs of the factory suspension, transfer of staff and equipment, and set-up costs at the new location.

Scenario 2: Factory allowed to continue operations at existing location, while relocation plans commence.

Under this scenario, the factory is allowed to continue operations at its current location in Weliweriya, while relocation plans are underway. We anticipate minimal disruptions to operations under this scenario.

Here, we assume minimal revenue disruption (only from the months of suspension). We expect revenue growth to be 1.0% above base-case levels in FY14E (up 3.4% YoY) as HAYL will be allowed to continue at its present location and will not face any short-term disruptions resulting from the transfer of capacity to other locations (as in the base-case scenario). We expect minimal reputational damage to the brand and company.

Segment EBIT margin is expected to be 6.6% (150bps higher than base-case levels) in FY14E, as no incremental operational expenses will occur from capacity transfer plans (as in the base case). Throughout the remainder of the explicit forecast period, we expect segment margin to be 50bps higher than base-case levels on account of continued economies of scale and minimal reputational damage.

Scenario 3: Factory operations on a prolonged suspension, 25% of capacity transfer by end of FY14E (100% being reached by FY16E), relocation plans commence.

Under this scenario, 25% of capacity transfers will be possible by FY14E, with full capacity transferred by end-FY16E. We believe this could have a negative impact on customer orders.

We assume that revenues through FY15E will be at around 80-85% of base-case levels as the Weliweriya plant accounts for approximately 15% of the hand protection segment’s revenue.

We assume the segment EBIT margin will be 150-250bps lower than base-case levels through FY16E on account of lost economies of scale. Upon commencement of the new factory, possibly by the end of FY16E, we expect the margin to be at the base-case level.

Figure 6: Scenario analysis and its impact on the hand protection segment as well as HAYL’s top and bottom lines

Scenario 1* Scenario 2* Scenario 3*

FY13 FY14E FY15E FY16E FY14E FY15E FY16E FY14E FY15E FY16E

Hand protection segment

Revenue 14,675 15,032 15,585 16,467 15,179 15,965 17,107 11,274 12,468 14,820

Revenue growth 8.7% 2.4% 3.7% 5.7% 3.4% 5.2% 7.2% -23.2% 10.6% 18.9%

EBIT 1,373 769 935 1,021 1,004 1,038 1,146 295 561 697

EBIT margin 9.4% 5.1% 6.0% 6.2% 6.6% 6.5% 6.7% 2.6% 4.5% 4.7%

HAYL group

Revenue 74,302 80,080 83,793 88,485 80,226 84,173 89,126 76,322 80,676 86,838

Revenue growth 12.9% 7.8% 4.6% 5.6% 8.0% 4.9% 5.9% 2.7% 5.7% 7.6%

EBIT 6,663 8,389 9,073 9,899 8,624 9,176 10,024 7,914 8,699 9,574

EBIT margin 9.0% 10.5% 10.8% 11.2% 10.7% 10.9% 11.2% 10.4% 10.8% 11.0%


*Note: the financial impacts of the scenario analyses reflected in the figure, are based on Amba estimates

Base-case scenario to result in a 2.4% YoY growth in segmental revenue in FY14E, with an approximate 425bps decline in EBIT margin from FY13 levels

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Revenue to grow at a 6.0% CAGR over FY14E-16E

We expect HAYL’s revenue growth to be driven by the fast-growing purification products and transportation and logistics segments. We believe the hand protection segment, which is facing a temporary suspension of one of its factories in Sri Lanka, can recover by the end of FY15E. In addition, plantations and agriculture will be important contributors to revenue.

Figure 7: Five key segments to drive HAYL’s revenue growth over FY14E-16E

YoY revenue growth FY11 FY12 FY13 FY14E FY15E FY16E

HAYL 42.2% 21.4% 12.9% 7.8% 4.6% 5.6%

Purification products 25.3% 34.5% 16.0% 9.7% 8.6% 7.4%

Transportation and logistics 35.3% 82.6% 31.2% 8.4% 8.5% 9.0%

Hand protection 24.8% 15.4% 8.7% 2.4% 3.7% 5.7%

Agriculture 27.3% 3.4% -3.3% 1.8% 2.0% 2.2%

Plantations 90.5% 69.8% 13.1% 13.5% 0.1% 4.6%


Purification products segment to benefit from strong global

demand

Haycarb PLC (CSE ticker: HAYC) focuses primarily on the manufacture of coconut-shell-derived activated carbon (AC), the purest form of AC (with very little focus on coal-derived AC production), and has a total production capacity of 30,000 metric tons (MT). HAYC accounts for a 17% share of the global coconut-shell-derived AC market, which we estimate at approximately 200,000 MT.

We expect HAYC, a quoted subsidiary (in which HAYL holds a 68% stake), to post an 8.5% revenue CAGR over FY14E-FY16E.

US and China are the key customers

According to HAYC’s FY12 annual report, the global AC market was worth USD1.8bn in 2011 and will reach USD3.0bn by 2016, at a CAGR of 11.0% through 2016. Powdered and granular AC will account for a significant proportion of this industry growth (compared to AC pellets). HAYC produces AC in powder, granular and pellet forms, which are key growth areas in the global industry. HAYL’s AC segment operates globally, with 35% of turnover generated from Asia and 31% from the US.

Figure 8: North America and China to lead AC volume growth, with a 12.0-15.0% anticipated CAGR through 2015

Source: Haycarb PLC

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HAYC’s FY12 annual report states that demand for AC in the US is expected to rise 12-15% per annum through 2014 to approximately 600,000-800,000 MT, driven by tighter regulatory requirements from the Environmental Protection Agency’s (EPA) Mercury and Air Toxic Standards (MATS). This is in relation to the reduction of mercury (and other metal and acid gas) emissions from oil and coal-fired industrial plants. This ruling came into effect in April 2012, with the compliance deadline set for April 2015. According to Roskill Information Services (an independent UK-based international metals and minerals research company), AC injection systems (which use AC as the key material input) are favored as the leading technology-based system for the control of mercury emissions. AC has unique properties of adsorption (the binding of molecules or particles from a gas, liquid or dissolved solid to a surface) as a purification agent, with a single gram of AC making available a surface area of approximately 1,200 sq. m. for adsorption.

In China, demand for AC may grow as much as 12% annually through 2015, driven by continued strong macroeconomic growth, according to the HAYC FY12 annual report (after growing 13.5% in 2012). This would make China the second-largest AC market in the world (just behind the US, and accounting for 20% of global demand). This growth is expected to stem from increasingly environment-friendly policies in China. Several of the most polluted cities in the world are in China, and recent regulatory changes – such as more stringent emission control limits for industries and carbon tax laws – should spur demand for AC and thereby, for HAYC products.

Water purification remains amongst the most common end-use

application

AC can be used in a wide range of applications – namely water purification, air treatment and gold extraction.

Figure 9: AC has a wide range of end-use applications

Applications Uses

Environmental applications Environmental spill cleanup, groundwater remediation, drinking water filtration, wastewater treatment,

air purification

Gas purification Used for the purification of compressed air and gas in the chemical industry

Storage of fuel Gas can be stored in AC – it can be stored in a low-mass, lower-pressure and low-volume environment

Gold extraction Activated carbon is used to absorb gold cyanide complexes in the processing of gold

Agriculture Detoxification of soil by removing pesticides, fertilizers or herbicides and water purification treatments

Medicinal applications As treatment for poisonings and indigestion

Source: Songshan Activated Carbon Factory

In the context of end-use applications, HAYC’s markets for water purification (49% of FY13 revenues) and air treatment (20%) are primarily based in the US and Europe. Demand for water purification treatments is likely to continue to grow, as this is one of the most common uses of activated carbon (in purification treatments). Additionally, in the US, the EPA’s Stage 2 Disinfectants and Disinfection Byproducts Rules, which propose more stringent water purification standards, are expected to drive demand in the country through 2017, according to Freedonia Group, an industry market research firm. Further, we expect all these regulations to push up the demand for AC globally.

Future revenue growth opportunities may arise thanks to anticipated industrial expansion in Russia and India, which could lead to greater demand for water and air purification programs.

HAYC on an expansion drive to ride the growth wave

In response to the anticipated growth in the global demand for AC, HAYC has been steadily expanding its manufacturing capacity. The company has added 5,000 MTs of capacity in recent years, and the total capacity now stands at 30,000 MTs. HAYC, which remains the leading producer and exporter of coconut-shell-derived AC (17% global market share as of March 2013), is now shifting its focus to untapped value-added (niche) market segments within its key markets (such as Japan and the US) and to Southeast Asia (China) and emerging European economies.

Tighter emission control and environmental protection standards across the US and China to drive demand for AC

Capacity expansions in Sri Lanka, Indonesia and Thailand put HAYC in a competitive position

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We expect volume growth to continue as a result of the company’s recent efforts to increase capacity, namely:

The 100% acquisition of Shizuka Co., an AC manufacturer in Thailand, in September 2012 through HAYC’s JV Carbokarn Company Ltd

The incorporation of Haycarb Value Added Products Pvt Ltd in Sri Lanka (as a fully owned subsidiary of HAYC) to manufacture and export value-added AC products

The JV with Palu Mitra Company to build a greenfield AC plant in Indonesia in January 2013

HAYC is also planning expansions within its export markets in Asia, in countries such as Indonesia, Thailand, Vietnam and Malaysia, and is targeting to increase its export presence in West Africa and South America for gold extraction. As per HAYC’s FY12 annual report, the overall demand for AC in Central and South America is projected to increase at a 7.0% CAGR through 2015, while AC demand from Australia is expected to grow at a 10.0% CAGR over the period, thanks to strength in gold mining. HAYL has a presence in Australia (7% of HAYC’s FY13 revenues), and this growth could create a platform for HAYC to consolidate its position in this market.

Transportation services and logistics to continue to contribute to

group top-line through Advantis

HAYL has a well-established local presence in international freight forwarding, integrated logistics services, and other marine and terminals & engineering services. We expect the segment to post an 8.6% revenue CAGR over FY14E-FY16E, with revenues reaching LKR14.5bn in FY16E. Growth is driven mainly by the segment’s well-integrated network, as well as its long-standing partnerships with some of the world’s largest shipping lines.

Further revenue growth potential can be expected on account of the anticipated LKR depreciation in the long term, economic growth in Sri Lanka and the recently announced “free-port” concept (a free port is a special customs area with relaxed or no customs regulations or controls for transshipment) at the Colombo and Hambantota ports. In addition, the launch of the Colombo International Container Terminal (CICT) at the Colombo South Harbor (which can handle Triple E-class ships that carry up to 18,000 twenty-foot equivalent units), along with the new seven-year development plan unveiled by the Sri Lanka Ports Authority (to position Sri Lanka as a global logistics hub taking advantage of its strategic location) should drive revenues over our forecast period. We also expect the oil and gas exploration projects in the Mannar and Cauvery basins (in which HAYL expects to get additional business in the next phase of drilling) to provide further revenue growth potential within this segment.

In the short term, these positive revenue drivers may be impacted by an overall slowdown in the global shipping industry, due to a slowdown in worldwide economic activity.

Faced with challenges, HAYL’s hand protection segment to

contribute to group revenues at a 3.9% CAGR over FY14E-FY16E

Dipped Products PLC (CSE ticker: DIPD) is HAYL’s main subsidiary (HAYL holds a 57.5% stake). DIPD manufactures and distributes protective gloves for medical, industrial and household (general purpose) applications. Industry consensus suggests that global demand for rubber gloves is set to grow 8-10% YoY over the next few years.

Based on the recent stream of events that have unfolded at one of DIPD’s manufacturing plants, located in Weliweriya, Sri Lanka, we assume the base-case scenario (as discussed on pages 6-7) to materialize. Based on these estimates, we expect the hand protection segment’s revenues to grow at a 3.9% CAGR over FY14E-FY16E, taking all concerned factors into account and driven by a rise in demand for industrial gloves and by the non-cyclical demand for medical gloves.

HAYL is primarily focused on the non-medical (household and industrial) glove segment, where it holds an estimated 5% of global market share. Changes to the regulatory framework and concerns over worker safety and welfare in Asian countries are expected to increase the demand for non-medical gloves and strengthen DIPD’s (and consequently HAYL’s) position. This is likely to increase sales in the Asia/Africa segment, which accounts for 15% of DIPD’s total FY13 revenue, and help the company meet its long-term target of doubling its market share, driven in part by capacity expansion.

Transportation and logistics to support top-line growth; present challenges in the hand protection segment to have minimal overall impact

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Further, increasing health awareness, particularly in the emerging economies of Southeast Asia and Latin America, is expected to boost the demand for medical gloves. To support this, HAYL has invested significantly in its medical glove facility in Thailand in recent years. The company has also planned capacity expansion projects over the next two years, but has not disclosed any details. Overall, HAYL’s focus is now shifting to non-traditional markets such as Eastern Europe, China, India, Japan and Africa.

Plantations will remain an important revenue contributor

We expect the plantations sector (12% of FY13 group revenue), which primarily consists of tea production, to post a 6.0% revenue CAGR for FY14E-FY16E. This has been one of HAYL’s traditional and longstanding product lines (accounting for 4.5% of Sri Lanka’s total tea production in 2012).

Tea is a critical export, accounting for 16% of total exports from Sri Lanka in 2012. The Central Bank of Sri Lanka expects tea exports to increase by approximately 35% from 2012 levels to USD1.9bn by 2016. Approximately 10% of Sri Lanka’s population is employed in the tea industry.

Figure 10: Almost all of Sri Lanka’s national tea production is exported

Source: Central Bank of Sri Lanka

Note: 2012 figures are provisional

HAYL’s revenue from this segment has shown solid growth, with a CAGR of 54.1% over FY11-FY13. We forecast growth to slow down due to a number of challenges facing the industry, such as the over-reliance on struggling tea small-holders (in developing countries, small holdings are small farms or land extents supporting a single family), who account for 70% of Sri Lanka’s total tea production; volatility in weather conditions; labor shortages; rising wages and the slowdown in key export markets.

280

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340

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

kg (m)

Total tea production in Sri Lanka Total tea exports from Sri Lanka

Plantations segment to remain an important contributor to the top-line despite several industry challenges

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Figure 11: Labor rates in the tea industry have been rising steadily

Figure 12: Revenues have increased in line with cost increases

Source: Central Bank of Sri Lanka Note: 2012 figures are provisional

Source: Central Bank of Sri Lanka Note: 2012 figures are provisional

Approximately 25% of the plantations segment’s revenues come from direct exports through its 100%-owned subsidiary Mabroc Teas Pvt Ltd. This tea-exporting (bulk and retail) arm of HAYL serves more than 50 locations worldwide, with approximately 140 stock-keeping units (SKUs). We believe that this segment could benefit from additional revenue growth if HAYL increases its exposure to value-added teas.

Agriculture segment revenues to modestly benefit from value

added exports

We believe that the agriculture segment will remain a noteworthy contributor to group revenues, although growth will be low – at a 2.0% revenue CAGR over FY14E-FY16E. The agriculture sector in the country is dominated by rice cultivation and accounts for approximately 10% of Sri Lanka’s GDP; in 2012, it provided employment to approximately 31% of the workforce. This segment’s performance is directly linked to the domestic agricultural sector, as HAYL provides products and services (fertilizers, machinery and value-added products such as vegetable seeds) to farmers in Sri Lanka. The segment’s value added fruit and vegetable export business also shows positive growth potential.

While yields from the agriculture industry in Sri Lanka have been declining (with negative growth experienced in this segment in FY13, largely due to unfavorable weather conditions), the segment could see further revenue upside on account of the anticipated mechanization in the rice cultivation industry and an increase in revenues from agri-exports. The Department of Agriculture in Sri Lanka has plans to further mechanize the Sri Lankan agriculture industry, primarily to increase production efficiencies and provide more employment opportunities in agro-related companies. This would bode well for HAYL as it is one of the key providers of agricultural inputs and equipment in Sri Lanka.

On the downside, risks to revenue forecasts could come from delays in the receipt of subsidies in the agriculture sector, which could lower revenues.

Emerging segments to make minor contributions to revenue growth

We expect the leisure and aviation segment (3% of FY13 revenue) to grow at a 14.2% CAGR over FY14E-FY16E. This segment is a relatively new venture for the HAYL group. There is scope for growth in the segment, as the government is focused on increasing the flow of tourists to Sri Lanka. We believe the recently completed refurbishments to the Kingsbury city hotel will contribute to revenue growth. In addition, the company has recently announced more projects in Wadduwa (located on the western coast of Sri Lanka) and Trincomalee (located on the eastern coast). Although details are not yet available, we expect these developments to contribute to HAYL’s top-line growth.

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Agriculture and other smaller segments to make recognizable contributions to group revenues

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Construction materials (3% of FY13 revenue) is forecast to grow at a CAGR of 6.5% over FY14E-FY16E, with revenue reaching LKR3.0bn in FY16E. Growth is expected on the back of the ongoing construction boom in Sri Lanka, with numerous hotel and condominium projects underway.

The textile segment accounted for approximately 8% of revenue in FY13. This segment’s revenues declined at a 4.0% CAGR over FY12-FY13 because of internal operational inefficiencies (refer Appendix 1 for details). Management has invested in a turnaround plan over the past two years and expects positive results in FY14E. We expect a 2.8% CAGR over FY14E-FY16E, as this segment recovers gradually over the forecast period.

The remaining segments (fiber, consumer products, power and energy, and industry inputs) accounted for approximately 16% of FY13 revenues and combined are forecast to grow at a 6.0% revenue CAGR over FY14E-FY16E.

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EBIT margin to increase 222bps to reach 11.2% in FY16E

We expect EBIT margin growth to mainly come from the purification products and transportation and logistics segments – with the hand protection, agriculture and plantations segments making modest contributions to group margin.

Figure 13: Key segments to contribute to EBIT margin growth at HAYL


Purification products to lead EBIT margin expansion

We expect strong revenue growth in this segment on the back of capacity expansions (and the resulting economies of scale), coupled with HAYC’s strong positioning in the global market (it holds a 17% global market share), to drive a 157bps increase in EBIT margin over FY14E-FY16E to 14.8% in FY16E. We believe HAYC’s well-established client relationships and brand reputation allow the company to manage volatility in raw material prices better than its competition. In addition, HAYC’s inventory management strategy (of holding three to four months’ stock at any given time) could also boost margins. In FY13, the purification products segment’s EBIT margin came in 426bps higher than that of HAYL as a whole.

Figure 14: Purification products and transportation and logistics segments to drive margin growth


0%

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FY11 FY12 FY13 FY14E FY15E FY16E

EBIT margin

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Agriculture Plantations HAYL

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HAYL group EBIT margin Purification products segment EBIT margin Transportation and logistics segment EBIT margin

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Key possible threats facing HAYC are competition from other global producers and scarcity of raw materials. Domestic competition comes from industry players such as Jacobi Carbon and Bieco Link, with international competitors being mainly in Thailand and the Philippines. In addition, higher minimum wages and electricity tariffs in Sri Lanka could hurt this segment’s profitability.

Approximately 50% of HAYL’s AC production capacity is based in Sri Lanka, for which HAYC imports half of its raw material (coconut shell charcoal) from India, with the rest being sourced locally. The remaining production capacity is split equally between the company’s Indonesian and Thailand plants, for which raw material is obtained from domestic producers in those countries. Unfavorable weather patterns could negatively impact the availability of raw materials – coconut shells in particular, which account for the majority of HAYC’s total input. Government policy decisions have also boosted the prices of coconut shells locally, and any further price increase could hurt margins.

Besides hedging against commodity price fluctuations, HAYC’s strategy is also to build up a three- to four-months’ stock of inventory, so that the company is better able to manage any sudden price increase caused by supply shortages. We expect longstanding relationships with end-customers to enable HAYC to pass through some of the industry-wide cost increases.

Figure 15: Volatility in coconut prices could impact the purification products segment’s margin



Transportation and logistics to continue momentum and contribute

to group margin

We expect the transportation and logistics segment to continue its momentum and post a 285bps increase in EBIT margin through FY16E, with EBIT reaching LKR1.7bn in FY16E (17% of HAYL’s total EBIT). This is driven by the solid mix of operations, with greater exposure to higher-margin businesses (such as shipping agencies, a 100% margin operation). The downside risks to margins would be high dependency on agency businesses. However, while not impossible, this risk is unlikely, given the longstanding relationship between HAYL and its principals.

Hand protection’s EBIT margin to decline in FY14E, but recover

thereafter

Referring to our base-case scenario (as discussed on pages 6-7), we expect the EBIT margin from this segment to take a hit in the current fiscal year, and fall to 5.1% in FY14E (compared with 9.4% in FY13). However, we expect all capacity transfers to be complete by end-FY15E, allowing DIPD to revert to normal operational levels by April 2015.

In recent times, DIPD saw increased price volatility, as glove prices are directly linked to global rubber prices. However, industry sources suggest that rubber prices may decline in the coming years, as supply outstrips demand. Another contributing factor to the anticipated decline in rubber

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HAYC’s brand reputation and inventory management strategy to strengthen segment EBIT margins; transportation and logistics to bring in solid margin growth

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prices is the general slowdown in the global economy, which could lead to a fall in the demand for rubber-based products (such as tires; vehicle sales account for more than 55% of natural rubber consumption globally). DIPD has also introduced lean manufacturing processes in its factories, which could benefit margins.

Figure 16: Anticipated decline in rubber prices could push up margins in the hand protection segment



In addition, higher minimum wages in the rubber industry and a hike in electricity tariffs in Sri Lanka could hurt the segment’s profitability. Increased competition from suppliers in China and Malaysia – which account for 60% of the total global production of rubber gloves – could also put pressure on margin growth.

Agriculture and plantations segments to make modest contributions

to group EBIT margin

Despite a combined 93bps decline in EBIT margin through FY16E, we expect the agriculture and plantations segments to modestly contribute to group margin.

We forecast that EBIT margin in the agriculture segment will increase by 52bps to reach 10.8% in FY16E, while plantations segment EBIT margin will reduce by 212bps to reach 10.6% in FY16E. This modest contribution is on the back of the increasing pressures faced by these two industries in Sri Lanka (as discussed earlier).

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2006 2007 2008 2009 2010 2011 2012

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Smaller segments have minimal impact on margin

Figure 17: HAYL’s smaller segments (by revenue) yield higher margins, albeit negligible at the group level

Segment FY11 FY12 FY13 FY14E FY15E FY16E

Fiber -2.7% 0.6% 6.7% 5.6% 6.0% 5.9%

Textiles -10.4% -14.1% -4.5% -3.8% -3.5% -3.0%

Construction materials 4.2% 7.9% 16.7% 11.8% 12.0% 12.0%

Consumer products 6.2% 6.5% 5.8% 5.9% 6.0% 6.3%

Industry inputs 1.5% 12.5% 13.6% 11.4% 12.5% 12.8%

Power and energy 51.5% 38.0% 64.1% 65.1% 59.5% 61.0%

Leisure and aviation 68.4% 38.4% 55.2% 47.6% 50.0% 50.5%


As shown above, segments that make small contributions to group revenues individually earn relatively high segmental operating margins (EBIT). For example, the leisure segment accounts for just 3% of group revenues but yielded an EBIT margin of 55% (FY13). The power and energy segment contributes less than 1% to HAYL’s revenue but had an EBIT margin of 64% in FY13. We expect this trend to continue.

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We establish a valuation range for HAYL shares of LKR277-

319

We estimate a 12-month valuation range of LKR277-319 per share, compared with the current share price of LKR290 as of 4 September 2013. This range has been derived using scenario and sensitivity analyses with discounted cash flow/sum of the parts (DCF/SOTP) valuation techniques, along with a P/E- based relative valuation approach (using our estimates of forward FY14E EPS). We also assess HAYL’s valuation levels relative to a set of domestic and foreign conglomerates as peers (see page 22 for additional factors that, in our view, could drive the share price).

Figure 18: Valuation range analysis provides a range of LKR277-319 per share (current share price: LKR290)

Source: HAYL, Amba estimates, Bloomberg

DCF/SOTP analysis yields a valuation range of LKR277-319 per share

We have applied a combined DCF/SOTP methodology in arriving at our valuation range for HAYL’s shares. Our base-case assumptions include a risk-free rate of 9.5% and a market risk premium of 5.0%, and yield a value per share of LKR297. By adjusting these assumptions based on various scenarios (see pages 6-7) and conducting sensitivity analyses, we arrive at a valuation range of LKR277-319, compared with HAYL’s current share price of LKR290.

Key elements of our base-case valuation approach include the following:

A DCF valuation for all the segments includes explicit forecasts through FY16E and a six-year fade period thereafter.

HAYL’s current capital structure consists of 41% debt and 59% equity. We have assumed a target capital structure of 50/50 for all segments and a terminal growth rate in the range of 0.5-2.5%.

Figure 19 reflects our DCF/SOTP assumptions for the company’s key segments. For each segment, we have estimated:

EBIT and FCF throughout the explicit and fade periods

Terminal value at FY22E, calculated by applying a terminal growth rate to unleveraged FCF as of FY22E

284

285

280

277

325

315

319

319 290

0

1

270 290 310 330

52-weekrange

P/E analysis(scenarioanalysis)

DCF/SOTP(scenarioanalysis)

DCF/SOTP(sensitivityanalysis)

Our base-case assumptions include a risk-free rate of 9.5% and a market risk premium of 5.0%. We have assumed a 50/50 capital structure

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Finally, we arrived at our segmental EV by discounting the unleveraged FCF values over the explicit and fade periods at the segmental WACC.

Figure 19: Amba DCF/SOTP assumptions schedule

Purification products

WACC assumptions

FY14E

Target capital structure 50/50 EBIT total 1,510

Cost of equity 15.3% FCF 710

Cost of debt 13.0% Terminal value (undiscounted) 15,150

Terminal growth rate 2.5%

Effective tax rate 28.0% EV 11,079

WACC 12.3%

Transportation and logistics

WACC assumptions

FY14E






WACC 12.2%

Hand protection

WACC assumptions

FY14E

Target capital structure 50/50 EBIT total 769





WACC 12.8%

Agriculture

WACC assumptions

FY14E

Target capital structure 50/50 EBIT total 785





WACC 12.1%

Plantations

WACC assumptions FY14E



Cost of debt 13.0% Terminal value 3,974



WACC 12.1%

50/50

Source: Amba estimates Note: All figures are in LKRm unless otherwise stated.

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Figure 20 below presents the segmental contributions to our value per share.

Figure 20: Contribution by segment to HAYL’s value per share

Segment Equity value (LKRm) Value per share

Fiber 1,400 18.7

Hand protection 8,234 109.8

Purification products 11,079 147.7

Textiles 722 9.6

Construction materials 899 12.0

Agriculture 4,227 56.4

Plantations 3,124 41.7

Transportation and logistics 8,380 111.7

Consumer products 1,646 22.0

Power and energy 4,575 61.0

Industry inputs 1,285 17.1

Leisure and aviation 7,597 101.3

Investments and services (365) (4.9)

Cash and equivalents 3,690 49.2

ST Investments 1,726 23.0

Debt (24,306) (324.1)

Minority Interests (11,606) (154.7)

22,308 297.4

Source: Amba estimates

We have arrived at our range by looking at different scenarios along with a sensitivity analysis (based on changes to our risk-free rate and market risk premium).

We have adjusted our base-case assumptions to allow for a risk-free rate range of 9.0-10.0% and a market risk premium range of 4.5-5.5%. If we assume a lower market risk premium of 4.5%, then the SOTP value would be LKR319 per share. Correspondingly, if the market risk premium increases to 5.5%, the SOTP value would be LKR277 per share.

Figure 21: Sensitivity analysis schedule

Risk-free rate

9.0% 9.3% 9.5% 9.8% 10.0%

Market risk

premium

4.5% 340 330 319 310 300

4.8% 328 318 308 299 289

5.0% 317 307 297 288 279

5.3% 306 296 287 278 269

5.5% 295 286 277 268 259

Source: Amba estimates Note: Our base-case assumptions are a risk free rate of 9.5% and a market risk premium of 5.0%

Based on the scenario analysis in relation to the DIPD factory suspension (as discussed on pages 6-7 – refer Figure 6), which assume changes to our base-case estimates, we establish a valuation range of LKR280-319.

Scenario analysis incorporating possible outcomes resulting from the DIPD factory suspension and our sensitivity analysis give a price range of LKR277-319

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Our P/E analysis yields a range of LKR285-315 per share

HAYL’s 12-month forward P/E has ranged from 4.0x to 32.5x since September 2010. Our normalized 12-month historical forward P/E average stands at 9.5x. The share currently trades at 9.2x its 12-month forward EPS (based on Amba forecasts) – a 3% discount to its normalized 12-month historical average.

Figure 22: HAYL has traded at a P/E of between 4.0x and 32.5x over the past three years


In determining a P/E valuation range and a share price range, we apply two scenarios:

Optimistic scenario: In this scenario, we assign a 5% premium to our normalized 12-month historical average by assuming stronger-than-forecast growth in the purification products segment and the outcome of scenario 2 in the hand protection segment. This, together with increased investments in the high-margin leisure segment and better-than-expected growth in the construction materials segment (due to the anticipated construction boom), which we have conservatively forecast to grow at 5-8% through FY16E is also expected to contribute to a potential share price upside. We also factor in a higher LKR depreciation, which could increase top- and bottom-line growth, as HAYL has more than 60% of its presence in export markets. This implies a forward P/E multiple of 10.0x. Applied to our forecast of FY14E diluted EPS, this leads to a share price level of LKR315 per share.

Conservative scenario: This takes into account the potential value erosion to shareholders from slower growth in the purification products segment and scenario 3 (discussed on page 7) in relation to the DIPD products factory suspension. We have assigned a 5% discount to out normalized 12-month historical average to arrive at a forward P/E multiple of 9.0x. Applying this to our FY14E forward diluted EPS estimate of LKR31.5, we arrive at a fair value of LKR285.

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HAYL shares currently trade at 9.2x its 12-month forward EPS; we forecast an optimistic scenario with a 5% premium to the normalized 12-month historical average, and a conservative scenario with a 5% discount to the normalized 12-month historical average

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Additional sources of valuation upside

Here are a few possible sources of valuation upside that we have not factored into our modeling of HAYL’s financial performance:

Leisure: HAYL ventured into the leisure industry in FY11 and is still in the early stages of developing the segment. On the back of the company’s investment in the Amaya Group of resorts and The Kingsbury hotel in Colombo, this segment could be one of the key focus areas for the group in the future. Although the segment yields a high EBIT margin (an average of 63% over FY11-FY13), its contribution to group revenues, at just 3%, is still minor. Any additional significant investment by HAYL in the sector could help improve HAYL’s top and bottom line growth, although putting short-term pressure on ROA.

Activated carbon: The Minamata Convention on Mercury, an anticipated new global mercury control treaty focused on measures undertaken to reduce airborne mercury emissions, is expected to be signed in Japan in October 2013. Once this comes into effect, the outlined proposals are set to be adopted by 2020 (by the 140 UN member countries involved in the treaty). This should increase the demand for AC for air purification in the countries bound by the treaty in the medium to long term.

Transportation and logistics: The opening of the CICT terminal in the first week of August 2013, together with the “free port” concept at Colombo and Hambantota, should bring in greater traffic at both these ports.

Oil and gas: Through Hayleys Advantis, its main subsidiary in the transportation and logistics segment, HAYL provides support services for oil and gas exploration activities in the Mannar basin (north west of Sri Lanka). Hayleys Energy Services, the energy arm of Hayleys Advantis, recently won competitive bids to secure eight major support service contracts for the second phase of exploratory drilling in Mannar. If substantial hydrocarbon reserves are found there, Hayley Advantis could be well positioned to be a key beneficiary.

Construction materials: HAYL ventured into the construction sector with the acquisition of the Alumex Group in FY11. The construction materials segment currently accounts for approximately 3% of group revenues. A construction boom in Sri Lanka, or an otherwise substantial increase in real estate development activity, could benefit the segment.

Other challenges

In addition to the company’s unique characteristics, HAYL faces a couple of key challenges that pose some risks.

High levels of debt and low liquidity

HAYL appears to be reliant on short-term debt, with its short-term-to-total debt ratio being approximately 70% since FY09 (and short-term debt accounting for around 29% of total capital employed in 1QFY14). This has put pressure on the company’s liquidity position, which has declined in recent years – in 1QFY14, the current ratio came in at 1.1x (well below management’s target of 1.5-2.0x) compared with 1.3x in FY09. HAYL’s gearing ratio has also increased to 42% in 1QFY14 from 36% in FY09.

Additional sources of valuation upside is possible from the leisure, transportation and logistics and construction materials segments

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HAYL has been funding recent acquisitions and expansions using debt, as no new ordinary shares have been issued to raise capital since FY08. Most recently, in June 2013, HAYL sold a three-year LKR2bn debenture that was to be put towards restructuring the company's balance sheet and strengthening liquidity, by extending the maturing of borrowed funds due end-March 2014.

Figure 25: 70% of HAYL’s debt is due within one year

Debt category Within 1 year Between 1 and 5 years After 5 years

Short-term borrowings 16,308 - -

Long-term loans 1,560 4,595 398

Debentures - 2,040 -

Finance lease obligations 25 47 591

Total 17,893 6,682 989

Source: HAYL Note: All figures in LKRm

HAYL has one of the highest debt burdens (in absolute terms, as well as relative to its peers, coming in second behind Carson Cumberbatch PLC) in the Sri Lankan conglomerate universe, as shown below.

Figure 26: HAYL’s net debt is one of the highest among Sri Lanka’s leading conglomerates


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Hayleys PLC Carson Cumberbatch CT Holdings Aitken Spence John Keells HoldingsPLC

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Figure 23: In the past, over 75% of HAYL’s total debt consists of short term funding

Figure 24: Gearing has steadily risen over the past three years

Source: HAYL Source: HAYL

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The constrained liquidity position could also put pressure on the company’s profits (due to the high interest burden and short-term repayment obligations). This can be seen through HAYL’s interest cover (EBIT/interest expense) which fell to 2.2x in FY13 from 4.4x in FY10.

Recent returns show a positive growth trajectory, although lower than

peers

Based on our calculations, HAYL’s ROA has averaged 2.4% over the past five years, compared with a peer average (top four domestic conglomerates by market capitalization) of 5.8%. Similarly, its ROE has averaged 7.0%, compared with a peer average of 12.8%. However, it is noteworthy to mention that over the past three years, HAYL’s ratios have seen an upward growth trajectory, with ROA increasing by 125bps since FY11, to reach 2.6% in FY13 and ROE increasing by 464bps since FY11, to reach 9.1% in FY13.

Figure 27: HAYL’s ROA averaged 2.4% over FY09-FY13 Figure 28: HAYL’s ROE averaged 7.0% over FY09-FY13

Source: HAYL, John Keells Holdings PLC, Aitken Spence PLC, Carsons Cumberbatch PLC, CT Holdings PLC

Source: HAYL, John Keells Holdings PLC, Aitken Spence PLC, Carsons Cumberbatch PLC, CT Holdings PLC

We believe this could be attributed to the larger asset base at HAYL (relative to its peers) resulting from recent acquisitions, refurbishments and revaluations that have taken place. We also believe that HAYL’s greater exposure to volatility in commodity prices and FX fluctuations is pressuring operating margins.

Figure 29: Recent commodity price increases have resulted in EBIT margin pressure for HAYL

Source: HAYL, Central Bank of Sri Lanka

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HAYL JKH SPEN CARS CTHR

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Critically though, the company’s main segments (purification products, hand protection, agriculture, plantations, and transportation and logistics) have consistently generated ROAs higher than the group average.

Figure 30: Purification products, hand protection, agriculture, plantations, and transportation and logistics drive group ROA


Note: Other segments include fiber, construction materials, textiles, consumer products, industry inputs, power and energy, leisure and aviation and investments and services

HAYL’s group ROA has been pulled down by smaller segments such as textiles (which has been loss-making since FY11), power and energy (which has generated highly volatile ROA values), leisure and aviation, fiber, as well as investments and services.

As noted previously, HAYL is more diversified than other conglomerates in Sri Lanka. Although this approach smoothens earnings volatility, we believe the company’s large number of highly distinct subsidiaries dilutes HAYL’s management time and focus. Therefore, we believe HAYL should rationalize the investment portfolio to optimize shareholder value.

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Purification products Agriculture & plantations Other segments

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Relative valuation comparison

Figure 31 presents HAYL’s valuation metrics relative to its peers. HAYL trades at a discount to the average of its peers based on P/E valuation metrics. The shares trade at an FY14E P/E of 9.2x –at a 26% discount to its peer group average.

Figure 31: Relative valuation table

Company name

P/E EPS CAGR FCF yield

2011 2012 2013 2014E 2015E FY14E-FY15E 2012 2013

Hayleys PLC 41.8x 26.0x 12.1x 9.2x 8.3x 18.9% -9.8% 8.9%

Domestic peers

John Keells Holdings PLC 21.6x 17.9x 17.2x 16.0x 12.9x 7.3% 6.3% 4.5%

Aitken Spence PLC 26.0x 13.1x 14.9x 12.3x 10.4x 16.9% -1.8% 5.1%

Hemas Holdings PLC 19.5x 11.6x 8.4x 7.4x 6.2x 20.4% -0.6% 4.4%

Richard Pieris & Co. PLC 15.4x 5.6x 6.7x 6.9x 6.2x NM 4.6% NA

CT Holdings PLC 39.5x 23.5x 19.9x NA NA NM -12.8% -15.9%

International peers

Astra International – Indonesia 16.8x 15.8x 12.2x 10.7x 9.4x NM 1.3% 0.5%

Vingroup Inc.- Vietnam 46.9x 35.2x 6.0x 8.0x NA NM -9.2% NA

ITC Limited – India 28.0x 28.2x 31.9x 26.6x 22.5x 17.4% 2.3% NA

Larsen & Toubro Ltd. – India 23.0x 17.0x 16.1x 12.4x 10.9x -12.1% -18.9% NA

Cheung Kong Holdings – China 4.7x 8.6x 9.4x 8.5x 8.1x NM 2.4% NA

Hutchison Whampoa – China 5.0x 13.2x 13.3x 11.7x 10.7x 11.6% 2.0% NA

Genting Group – Malaysia 15.4x 17.7x 17.0x 14.0x 12.9x NM 7.4% NA

Sime Darby Berhad – Malaysia 15.1x 14.1x 15.9x 14.6x 13.7x NM 1.6% NA

Siam Cement - Thailand 13.8x 22.4x 13.4x 11.6x 10.1x NM 2.4% NA

Mean 20.8x 17.4x 14.5x 12.4x 11.2x 10.2% -0.9% -0.3%

Median 18.2x 16.4x 14.2x 11.7x 10.6x 14.3% 1.8% 4.4%

High 46.9x 35.2x 31.9x 26.6x 22.5x 20.4% 7.4% 5.1%

Low 4.7x 5.6x 6.0x 6.9x 6.2x -12.1% -18.9% -15.9%

Source: HAYL, Bloomberg, Amba estimates Note: HAYL 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. However, 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.

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27


Share price performance

HAYL shares closed at LKR290 on 4 September 2013, LKR20 lower than twelve months earlier, indicating a reduction of 6%, compared with a 7% rise in the All Share Price Index (ASPI) and a 9% increase in the S&P SL 20 over the same period.

Figure 32: Share price performance graph


As shown in the figure below, HAYL has lagged both the main CSE indices over the past three years.

Figure 33: HAYL vs. key indices

3m 6m 1 year 2 year 3 year

HAYL -7% -2% -6% -26% -13%

ASPI -11% 2% 7% -18% -2%

S&P SL 20 -12% 0% 9% -10% -1%


2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

200

250

300

350

400

450

Aug-10 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13

Share price (LKR)

HAYL ASPI S&P SL20

Index values

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28


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 closely track HAYL’s performance across these key areas and revise our forecasts and update 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 any increase in debt levels?

2. Has the company indicated any intention to either make new acquisitions or sell existing assets?

Hand protection

3. What is the outcome and status of the temporary shut-down of the Venigros factory?

4. Are the stated expansion plans on track?

5. Is HAYL increasing its presence in the medical gloves (particularly the higher-margin surgical gloves) segment? Demand in this segment tends to be less cyclical in nature, and therefore provides a measure of stability in revenue flows.

Purification products

6. How has overall purification performance been in the US and in China? These are among the largest growth markets, and any slowdown in demand from these markets could impact the segment’s revenues.

7. How is demand for gold expected to change? Gold extraction is a key and fast-growing use of AC. A deceleration in global demand for gold would reduce demand for AC from mining companies.

8. Has there been a significant change in coconut production that could impact the prices of raw materials? HAYL primarily uses coconut-shell-derived charcoal to manufacture AC.

9. Are the stated expansion plans on track? Have any new acquisitions/investments been made? What are the capacity impacts of these investments?

Transportation and logistics

10. How has the trajectory of the global macroeconomic environment shifted, and how might this impact the segment’s growth and margins?

Plantations and agriculture

11. How have weather conditions affected crop yields?

12. Have there been any fluctuations in tea and rubber prices?

13. Have there been any significant changes in the operating and regulatory environment of the Sri Lankan agriculture sector? HAYL’s agriculture segment is directly correlated with the performance of the Sri Lankan agriculture industry.

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Appendix 1: Company overview

Hayleys PLC (HAYL) is one of Sri Lanka’s largest and most diversified conglomerates. The company has a market capitalization of LKR21.8bn (USD163m) as of 4 September 2013.

HAYL was established in 1878 as Chas P. Hayley, and was later incorporated as Hayleys Ltd in 1952. HAYL’s portfolio includes eight segments: global markets and manufacturing (which includes hand protection, purification products, textiles, fiber and construction materials), agriculture and plantations, transportation and logistics (T&L), consumer products, leisure and aviation, power and energy, industry inputs, and investment and services.

In 2012, HAYL accounted for 3% of Sri Lanka’s total national export income. The company also generated 5% of total national tea production and 2% of total national rubber production.

Figure 34: Hand protection, purification products, plantations, T&L and agriculture generate over 70% of HAYL revenues

Figure 35: Hand protection, purification products, plantations, T&L and agriculture bring in over 70% of EBIT

Source: HAYL

Note: Segmental revenues include inter-segmental revenues

"Other" includes power and energy, industry inputs, leisure and aviation, and investments and services

Source: HAYL

Note: Segmental EBIT include non-segment adjustments

"Other" includes power and energy, industry inputs, leisure and aviation and investments and services

HAYL recorded LKR74.3bn (USD573m) in revenue for FY13 (year-end 31 March 2013), with a CAGR of 19.1% over FY09-FY13. The company generated EBIT of LKR6.7bn (USD51m) in FY13, representing a 19.6% CAGR over FY09-FY13.

Figure 36: HAYL revenue grew at a 19% CAGR over FY09-FY13 Figure 37: HAYL EBIT grew at a 20% CAGR over FY09-FY13

Source: HAYL Source: HAYL

-

10,000

20,000

30,000

40,000

50,000

60,000

70,000


LKRm

Fiber Hand protectionPurification products TextilesConstruction materials AgriculturePlantations Transportation and logistics

(1,000)

1,000

3,000

5,000

7,000

9,000


LKRm

Fibre Hand protectionPurification products TextilesConstruction materials AgriculturePlantations Transportation and logisticsConsumer products Other

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

0

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YoY growth

LKRm

Revenues (LHS) YoY growth (RHS)

(40%)

(20%)

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EBIT (LHS) YoY growth (RHS)

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30


HAYL’s key businesses

The global markets and manufacturing segment contributed 51% to total revenue and 40% of

EBIT in FY13. It includes the hand protection, purification products, textiles, fiber and construction materials sub-segments:

Hand protection - This is the largest contributor to this segment (accounting for 20% of HAYL’s total FY13 revenue), and holds a 5% share of the global industrial and general purpose rubber glove market. Dipped Products PLC (CSE ticker: DIPD), which is 57.5% held by HAYL, is one of the world’s leading manufacturers and distributors of protective gloves, including medical, household and industrial purpose gloves. As of 31 March 2013, DIPD generated 46% of its revenue from US and European markets, and has a presence in a total of 70 countries globally.

Purification products - This sub-segment, which contributed 13% to HAYL’s revenue in FY13, is involved in the production of activated carbon (AC). AC is a form of processed carbon that has substantial adsorption properties. Adsorption is the binding of molecules or particles from a gas, liquid or dissolved solid to a surface; a single gram of AC making available a surface area of approximately 1,200 sq. m– and is used as a purification agent for water, air treatment and gold extraction. The sub-segment consists of Haycarb PLC (CSE ticker is HAYC; 68% stake held by HAYL), which is the largest manufacturer of coconut shell-derived AC worldwide, accounting for 17% of global production. HAYC has five manufacturing operations in Sri Lanka, Indonesia and Thailand, and is supported by a global marketing and distribution network. HAYC has an annual manufacturing capacity of 30,000 MT, with 99% of its sales derived from exports. It also offers a range of value-added services such as AC regeneration and environmental engineering solutions.

Textiles - This sub-segment contributed 8% to total revenue in FY13, and has an annual capacity exceeding 12,000 MT of single jersey, interlock, rib, pique, fleece, polar fleece, pointelle fabric and flat knits. Hayleys MGT Knitting Mills PLC (CSE ticker MGT), an 83% owned subsidiary of HAYL, provides supplies for the manufacture of a range of international brands including M&S, Decathlon, NEXT, Intimissimi, George, Nike and Tesco. In FY11, MGT reported losses of approximately USD7m (compared with a net profit of around USD3m in the previous year), and this was attributed to the significant provisioning for inventory and receivables. Since then, the company has invested heavily in restructuring the business (reducing its losses to USD3.5m in FY13) and says that it expects the sub-segment to return to profitability during FY14E.

Fiber - This sub-segment accounted for 7% of HAYL’s top line in FY13. Its product range is made up of coir (a natural fiber extracted from coconut husk and used in products such as floor mats, ropes, twine and brushes), industrial and household brush ware, twisted fiber, bedding and cushioning, as well as horticultural and erosion control products such as geo textiles, stitch blankets, coir pots, poles, weed control mats and coir fiber pith.

Construction materials - Contributing 3% to total revenue in FY13, the construction materials sub-segment manufactures aluminum extrusions for the domestic construction industry (aluminum extrusions are objects created using aluminum alloy, which have a defined cross-sectional profile and can be used for a wide range of purposes, e.g., profiles for tracks, frames, rails and mullions). The Alumex Group (an unquoted subsidiary in which HAYL owns a 60% stake) has a market share of 52% in Sri Lanka. Its product portfolio offers extrusions in over 700 designs and covers a broad spectrum of products.

The agriculture and plantations segment contributed 22% to total revenue in FY13, and consists

of two regional plantations, which together manage 44 tea and rubber estates.

Plantations – This sub-segment contributed 12% to total revenue in FY13, and consists of two regional plantation companies: Kelani Valley Plantations PLC and Talawakelle Tea Estates PLC. The segment has a total extent of 19,500 hectares in plantation lands, and employs over 25,000 people. This segment also includes Mabroc Teas (Pvt) Ltd, a tea export company (acquired in FY12) that supplies a range of value-added teas to over 50 countries.

Agriculture – The agriculture sub-segment, which contributed 10% to total revenue in FY13, offers a wide range of agricultural inputs and value-added products for both domestic and global markets. Its domestic services include the manufacture and sale of fertilizer and other agricultural products, including vegetable seeds. The company also sells agricultural

Hayleys PLC

31


machinery. It is also becoming a significant domestic producer of tissue culture plantlets, which are used to produce clones of plants. Although this segment’s performance is mainly in the domestic agricultural sector, high value added agri export products form an important part of the portfolio. HAYL exports value-added food and horticulture products to global markets which contribute over 20% to segment revenues, accounting for 47% of the country’s vegetable and fruit exports. The sector's value added fruit and vegetable export business uses the out- grower farmer system for the produce that is exported in the forms of pickles and slices to food supply chains such as Burger King and McDonalds. HAYL also has a presence in Bangladesh.

Also, the government's continued interest to develop the domestic dairy industry will provide opportunities for the sector's animal health division which currently provides medicaments and nutritional supplements to the livestock farmers in the country.

The transportation and logistics segment contributed 15% to group revenue in FY13. It is led by

Hayleys Advantis, which has been a shipping and freight forwarding agency for over 50 years. This segment also offers integrated end-to-end logistics solutions, and is a market leader in the provision of third-party logistics services. Hayleys Advantis provides support services to the domestic oil and gas industry, and also provides a range of marine services, including vessel agency and onshore or offshore support. Further, the segment’s terminals and engineering operation offers inland container depot operations, and the conversion of containers for temporary accommodation.

The consumer products segment contributed 6% to total revenue in FY13. This segment consists

of Hayleys Lightcraft and Hayleys Café Pixel Showrooms. It markets globally branded products and services, such as photo imaging consumer lighting (lighting solutions to meet indoor or outdoor requirements), healthcare, homecare and FMCG products that are offered by the lighting and imaging divisions (which are the sole distributors of products from Procter & Gamble, Philips Lighting, Fujifilm and Blue Cross Pharmaceuticals).

The leisure and aviation segment contributed 3% to total revenue in FY13. HAYL controls a 51%

stake in the newly refurbished Kingsbury hotel in Colombo, a 65% stake in Amaya Leisure PLC (a Sri Lankan chain of hotels and resorts) and recently increased to 94% its holding in Eastern Hotels Pvt. Ltd, which controls a hotel on the eastern coast of Sri Lanka. HAYL’s acquisition of Amaya Leisure PLC brought the addition of six local properties to the company’s hotel portfolio. Hayleys Aviation represents a number of international airlines as their general sales agent (GSA) in Sri Lanka and the Maldives and offers flight supervision at the Colombo International Airport. Hayleys Tours provides a range of destination management services (such as handling transport, accommodation and excursions).

The industry inputs/power and energy segment contributed to 1% of total revenue (FY13). The

industry inputs sub-segment is involved in the supply of industrial raw materials to Sri Lankan manufacturers, including the supply of dyes and chemicals to the textile industry. The segment also supplies and supports diesel power generating units, electronic systems and medical imaging equipment. The power and energy sub-segment mainly engages in renewable energy generation as well as supplying to the national electricity grid from its wind, hydro and biomass-based power plants.

Investments and services is the investment arm of HAYL (contributed a negligible 0.01% to total

FY13 revenues) and includes a business process outsourcing (BPO) company that provides in-house services as well as services to external customers (primarily in Sri Lanka).

Management strategy, transparency and governance

HAYL has a number of financial targets that it strives to achieve, including profitability targets such as a group ROCE of more than 20% (compared to current levels of 12.4% in FY13, based on our calculations) and an EBITDA/assets ratio of more than 10% (this ratio stood at 11% at the end of FY13). Further, HAYL seeks to maintain liquidity with a current ratio between 1.5x and 2.0x (this has ranged from between 1.0x to 1.3x over the past five years) and a debt/EBITDA ratio below 3.0x (our calculated ratio for FY13 is 2.8x). Further, HAYL hopes to maintain its gearing ratio between 35-40% (gearing levels for FY13 were at 41.2%) and an external credit rating of AA (current rating of AA- by RAM Ratings Lanka).

Hayleys PLC

32


HAYL continues to capture additional export market share, and is now expanding into emerging markets, which the company believes offer significant growth potential. The company has also more recently entered sectors of the Sri Lankan economy that it believes are poised to post strong growth, such as leisure and construction materials. Management also says it will focus on controlling stakes in both equity and/or management.

In terms of transparency, disclosure is adequate by local standards, however HAYL could improve in certain aspects to move towards international standards. Some possible areas of improvement include the following:

The company’s quarterly disclosure levels – regarding capex, working capital, depreciation and other factors on a segment level – are uneven. An analyst seeking to value the company must frequently make broad and tenuous assumptions regarding HAYL’s historical (and forecast) performance on a range of factors. Expanding disclosure in quarterly announcements would be a significant improvement.

Similarly, many details on segment performance, such as hotel occupancy rates, production volumes for carbon and gloves and details about its transportation and logistics segments are disclosed only annually (or not disclosed at all). Forecasting quarterly results and drilling down to achieve a greater level of granularity on industry and business trends and trajectories is challenging given the complex nature of the business and the lack of adequate segmental disclosure.

Shareholding structure

Management and connected parties hold 48% of HAYL’s shares and other domestic investors hold another 48%, with international investors holding the balance 4%. Further, Mr. K.D.D Perera, the current deputy chairman, holds a 45.4% stake in HAYL.

Figure 38: International investors have only a 4% shareholding Figure 39: Management and connected parties account for

48% of total shareholding

Source: HAYL, as of March 2013 Source: HAYL, as of March 2013

Mgmt and connected

parties 48%

Other domestic investors

48%

International investors

4%

Mgmt and connected

parties 48%

Other retail investors

36%

Institutional investors

16%

Hayleys PLC

33


The top five shareholders as of March 2013 are presented below.

Name of shareholder Description Stake

Mr. K.D.D. Perera* HAYL’s deputy chairman, entrepreneur and domestic high net worth

investor 40.9%

Trustees of the D.S.Jayasundera Trust Created by the late Mr. Lal Jayasundera (former chairman/CEO of HAYL), it

now benefits several charities, with his wife being the primary beneficiary 11.6%

Trustees of the Hayleys PLC - Employees Share

Trust

Trust set up by a special resolution adopted at an EGM in 1998

9.1%

SBL/Mr. K.D.D. Perera* Ownership through a custodian account at Seylan Bank PLC by Mr. K.D.D.

Perera (HAYL’s deputy chairman and key shareholder) 4.5%

Lanka ORIX Leasing Company PLC A leading local licensed finance company 3.3%

Source: HAYL

*Note: Vallibel One PLC (CSE ticker, VONE) owns 2.9% of HAYL. Mr. K.D.D. Perera has a 63.2% stake in VONE.

Board of directors

As of March 2013, HAYL’s board comprised 12 directors. Their details are provided below.

Name of Director Description

Mr. Mohan Pandithage Chairman and chief executive. Has been at Hayleys PLC for over 40 years.

Mr. Dammika Perera Deputy chairman. Appointed to the board in 2008. Secretary to the Ministry of Transport. Well-known investor

and entrepreneur with over 24 years’ experience.

Mr. Rizvi Zaheed Executive director. Responsible for the agriculture segment and appointed to the board in 2004.

Mr. Nimal Perera Non-executive director, appointed to the board in July 2009. Over 30 years’ experience and serves as managing

director or director in several other companies.

Mr. Sarath Ganegoda Executive director. Responsible for the strategic business development unit and the consumer segment and

appointed to the board in September 2009.

Mr. Rajitha Kariyawasan Executive director. Responsible for the purification segment and appointed to the board in June 2010.

Dr. Harsha Cabral Independent non-executive director. Appointed to the board in February 2011. President’s Counsel with 25 years’

experience in the field of company law. Serves as director in several other companies

Dr. Mahesha Ranasoma Executive director. Appointed to the board in April 2011 and been the managing director of Dipped Products PLC since then. He is also a director of Kelani Valley Plantations PLC, Talawakelle Tea Estates PLC and Mabroc Teas.

Mr. Mangala Goonatilleke Independent non-executive director, appointed to the board in June 2011. Finance professional with over 25 years of post-qualification experience. Currently holds directorship in several other companies.

Mr. Ranil Pathirana Independent/non-executive director, appointed to the board in June 2011. Holds directorship in several other companies.

Mr. Lalin Samarawickrama Executive director, appointed to the board in June 2011. Internationally qualified hotelier and member of the Institute of Hospitality, UK (formerly HCIMA). He is also a director of several other companies.

Mr. Ruwan Waidyaratne Appointed as an executive director of the Hayleys PLC board in April 2013 and has overall responsibility of the transportation segment.

Source: HAYL

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34


Figure 40: HAYL corporate holding structure

Source: HAYL

Note: % holding is the absolute holding (not the effective holding)

Hayleys Advantis Group (95%)

Hayleys PLC

Global Markets and Manufacturing

Agriculture and Plantations

Transportation and Logistics

Consumer Products

Leisure and Aviation Amaya Leisure PLC (65%)

Hunas Falls PLC (66%)

The Kingsbury PLC (51%)

Hayleys Consumer Products Ltd (99%)

Nirmalapura Wind Power (Pvt) Ltd. (51%)

Hayleys Industrial Solutions Pvt Ltd (100%)

Purification Products

Hand Protection

Textiles

Fiber

Construction Materials

Kelani Valley Plantations (71%)

Hayleys Agro Holdings (97%)

Talawekelle Tea Estates (75%)

Haycarb Group (68%)

Dipped Products Group (57%)

Hayleys MGMT Knitting Mills PLC (83%)

Hayleys Fiber PLC (65%)

Alumex Pvt Ltd (60%)

Power and Energy

Hayleys PLC

35


Appendix 2: Key financial data

INCOME STATEMENT 2011 2012 2013 2014E 2015E 2016E

(For the year ended 31st March)

Revenue 54,225 65,807 74,302 80,080 83,793 88,485

EBITDA 4,121 5,707 8,543 10,684 11,568 12,499

EBIT 2,836 4,115 6,663 8,389 9,073 9,899

Interest expense (1,013) (2,138) (3,069) (2,792) (3,050) (3,084)

Associate/JV income/(expense) 51 4 0 (3) 10 11

Earnings before Tax (EBT) 2,041 2,561 5,025 6,775 7,076 7,736

Net profit 686 1,038 1,854 2,366 2,622 2,866

BALANCE SHEET 2011 2012 2013 2014E 2015E 2016E

(As at 31st March)

Current assets

Cash and cash equivalents 2,866 2,670 3,124 3,585 4,350 4,513

Short term investments 522 625 1,232 1,726 1,726 1,726

Accounts receivable 11,655 13,866 15,288 17,002 18,074 19,467

Inventories 8,472 10,398 10,366 11,061 11,759 12,609

Total current assets 23,766 27,887 30,293 33,722 36,256 38,662

Non-current assets

Property, plant and equipment 25,366 30,822 37,206 38,871 40,063 41,357

Intangible Assets 3,369 5,164 5,359 5,267 5,162 5,059

Investments in associates/JVs 643 306 269 274 280 285

Total non-current assets 30,132 37,986 44,666 46,238 47,330 48,526

Total Assets 53,898 65,873 74,959 79,960 83,587 87,188

Current liabilities

Short term debt 12,151 16,517 17,892 16,068 16,642 16,642

Accounts payable 8,043 9,666 10,960 11,695 12,433 13,273

Income tax payable 399 298 571 647 647 647

Total current liabilities 20,692 26,626 29,513 28,538 29,850 30,690

Non-current liabilities

Long term debt 4,541 5,212 5,671 7,050 6,453 5,956

Postretirement benefit obligation 3,335 3,921 4,285 4,435 4,435 4,435

Total non-current liabilities 9,467 10,798 11,775 14,854 13,457 12,160

Equity

Common share capital 1,575 1,575 1,575 1,575 1,575 1,575

Retained profit 7,005 9,692 11,011 12,209 14,437 16,873

Minority interest 8,481 10,077 11,196 12,818 14,301 15,924

Total equity 23,739 28,449 33,671 36,568 40,280 44,339

Total Liabilities and Equity 53,898 65,873 74,959 79,960 83,587 87,188

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CASH FLOW STATEMENT 2011 2012 2013 2014E 2015E 2016E

(For the year ended 31st March)

Operating activities

Net cash flow from operating activities 2,413 2,472 7,315 6,029 8,669 9,043

Investing activities

Purchase of PPE and intangible assets (2,922) (5,129) (5,320) (3,784) (3,687) (3,893)

Net cash flow from investing activities (4,660) (5,113) (4,683) (2,480) (2,649) (2,988)

Financing activities

Debt issuance/(repayment) 2,205 593 (15) 1,225 (23) (497)

Common share issuance/(repurchase) - (50) - - - -

Interest paid (1,210) (1,477) (2,678) (2,850) (3,050) (3,084)

Dividends paid to common shareholders (150) (300) (300) (355) (393) (430)

Dividends paid to minority interests - (389) (784) (921) (989) (1,082)

Net cash flow from financing activities 751 (1,663) (3,975) (1,363) (5,255) (5,893)

Net increase/(decrease) in cash and cash equivalents

(1,496) (4,303) (1,343) 2,186 765 163

KEY RATIOS 2011 2012 2013 2014E 2015E 2016E

Growth

Revenue growth (%) 42.2% 21.4% 12.9% 7.8% 4.6% 5.6%

EBITDA growth (%) 21.3% 18.9% 26.7% 7.0% 3.2% 5.6%

EBT growth (%) -16.1% 38.5% 49.7% 25.1% 8.3% 8.0%

Net profit growth (%) -28.1% 45.1% 61.9% 25.9% 8.2% 9.1%

Recurrent diluted EPS growth (%) -38.0% 25.5% 96.2% 34.8% 4.4% 9.3%

Margins

EBITDA margin (%) 7.6% 8.7% 11.5% 13.3% 13.8% 14.1%

EBIT margin (%) 5.2% 6.3% 9.0% 10.5% 10.8% 11.2%

Net profit margin (%) 1.3% 1.6% 2.5% 3.0% 3.1% 3.2%

ROCE (%) 7.6% 9.1% 12.4% 14.3% 14.7% 15.2%

ROE (%) 4.5% 6.2% 9.1% 10.2% 10.5% 10.5%

Liquidity and Efficiency

Current Ratio (x) 1.1 1.0 1.0 1.2 1.2 1.3

Total Asset Turnover (x) 1.0 1.0 1.0 1.0 1.0 1.0

Gearing and Cash Flow

Debt/Capital (%) 41.3% 43.3% 41.2% 38.7% 36.4% 33.8%

Interest Cover (x) 2.8 1.9 2.2 3.0 3.0 3.2

Free cash flow (FCF) yield (%) -1.8% -9.8% 8.9% 10.3% 22.9% 23.7%

Net debt/FCF (x) (26.1) (6.9) 9.6 7.9 3.4 3.2

Valuation

P/E (x) 41.8 26.0 12.1 9.2 8.3 7.6

P/BV (x) 1.9 1.5 1.0 0.9 0.8 0.8

EV/Sales (x) 1.0 0.9 0.7 0.7 0.6 0.6

EV/EBITDA (x) 12.6 9.9 6.3 5.0 4.6 4.3

EV/FCF (x) (101.9) (21.4) 27.2 23.8 10.7 10.4

Hayleys PLC

37


PER SHARE DATA 2011 2012 2013 2014E 2015E 2016E

Reported diluted EPS (LKR) 9.0 13.8 24.7 31.5 35.0 38.2

Common dividend per share (LKR) 4.0 4.0 4.5 4.7 5.2 5.7

Book value per share (BVPS) 203.4 245.0 299.7 316.7 346.4 378.9

Net operating cash flow per share 32.2 33.0 97.5 80.4 115.6 120.6

Net cash flow per share (20.0) (57.4) (17.9) 29.2 10.2 2.2

Group and segmental summary

GM&M - Purification Products 2011 2012 2013 2014E 2015E 2016E

Revenue 6,326 8,509 9,869 10,823 11,749 12,622

EBITDA 738 929 1,494 1,745 1,954 2,137

EBIT 643 811 1,306 1,510 1,704 1,868

YoY growth

Revenue 25.3% 34.5% 16.0% 9.7% 8.6% 7.4%

EBITDA -7.0% 25.8% 60.8% 16.8% 12.0% 9.4%

EBIT -7.7% 26.2% 60.9% 15.7% 12.8% 9.6%

Margins

EBITDA 11.7% 10.9% 15.1% 16.1% 16.6% 16.9%

EBIT 10.2% 9.5% 13.2% 14.0% 14.5% 14.8%

GM&M - Hand Protection 2011 2012 2013 2014E 2015E 2016E

Revenue 11,700 13,499 14,675 15,032 15,585 16,467

EBITDA 740 1,253 1,810 1,183 1,403 1,515

EBIT 455 884 1,373 769 935 1,021

YoY growth

Revenue 24.8% 15.4% 8.7% 2.4% 3.7% 5.7%

EBITDA -20.5% 69.2% 44.5% -34.6% 18.6% 8.0%

EBIT -45.5% 94.3% 55.4% -44.0% 21.6% 9.2%

Margins

EBITDA 6.3% 9.3% 12.3% 7.9% 9.0% 9.2%

EBIT 3.9% 6.5% 9.4% 5.1% 6.0% 6.2%

Transportation and Logistics 2011 2012 2013 2014E 2015E 2016E

Revenue 4,735 8,644 11,343 12,294 13,339 14,540

EBITDA 644 679 1,085 1,426 1,801 2,036

EBIT 558 592 981 1,229 1,467 1,672

YoY growth

Revenue 35.3% 82.6% 31.2% 8.4% 8.5% 9.0%

EBITDA 11.2% 5.4% 59.9% 31.4% 26.3% 13.0%

EBIT 18.1% 6.1% 65.6% 25.3% 19.4% 14.0%

Margins

EBITDA 13.6% 7.8% 9.6% 11.6% 13.5% 14.0%

EBIT 11.8% 6.9% 8.6% 10.0% 11.0% 11.5%

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Agriculture 2011 2012 2013 2014E 2015E 2016E

Revenue 7,407 7,656 7,402 7,538 7,689 7,858

EBITDA 797 1,307 873 861 884 927

EBIT 721 1,216 761 785 807 849

YoY growth

Revenue 27.3% 3.4% -3.3% 1.8% 2.0% 2.2%

EBITDA 32.0% 64.0% -33.2% -1.4% 2.7% 4.9%

EBIT 34.5% 68.7% -37.4% 3.2% 2.8% 5.1%

Margins

EBITDA 10.8% 17.1% 11.8% 11.4% 11.5% 11.8%

EBIT 9.7% 15.9% 10.3% 10.4% 10.5% 10.8%

Plantations 2011 2012 2013 2014E 2015E 2016E

Revenue 4,662 7,917 8,952 10,163 10,177 10,648

EBITDA 863 800 1,323 1,303 1,323 1,406

EBIT 632 628 1,139 1,039 1,058 1,129

YoY growth

Revenue 90.5% 69.8% 13.1% 13.5% 0.1% 4.6%

EBITDA 447.6% -7.3% 65.4% -1.5% 1.5% 6.2%

EBIT 3836.7% -0.8% 81.4% -8.7% 1.9% 6.6%

Margins

EBITDA 18.5% 10.1% 14.8% 12.8% 13.0% 13.2%

EBIT 13.6% 7.9% 12.7% 10.2% 10.4% 10.6%


Note: GM&M (Global Markets and Manufacturing)

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

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Appendix 3: Industry analysis using Porter’s framework

Porter’s 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 HAYL operates.

Rubber gloves manufacturing

Conclusion: The industry should remain attractive through 2018.

Sri Lanka’s rubber gloves industry contributed 21% of the country’s total rubber product exports (which in turn accounted for 12% of total industrial exports) in 2012. The industry comprises local players (for example Dipped Products and Glovetex (Pvt) Ltd), and multinational companies (for example, Ansell Limited and Top Glove). Industry players produce a range of natural and synthetic latex-based domestic, industrial and medical gloves.

The industry should be attractive over the coming years thanks to an increased focus on health and safety practices in the workplace, and increasing concerns over hygiene. The relationships established players in the industry have cultivated with important stakeholders – such as customers, raw material suppliers and distribution networks – along with a high level of product differentiation, are likely to discourage new producers from entering the industry. Furthermore, the dearth of substitute products and the importance of the product to buyers are factors that will tend to reduce the threat from substitute products. The industry’s attractive growth prospects, together with the close relationships established with customers, should encourage competition in the industry.

However, the industry faces threats from large buyers, who contribute to a relatively high proportion of producers’ revenue. Despite established relationships, customers may be attracted to cheaper products, particularly during periods of escalating costs and macroeconomic uncertainty. Therefore, it is becoming even more important that firms in the industry establish relationships with customers who are brand loyal and quality focused. Furthermore, players face a threat from rubber and synthetic raw material suppliers due to the shortage of natural rubber in the industry, driven by the low productivity of plantations and the variety of uses for natural rubber. This threat too could be mitigated by establishing close relationships with suppliers.

Threat of new entrants – low.

Rubber gloves manufacturers produce a wide range of gloves based on the varying needs of customers. This could range from electrical insulation gloves to medical gloves to household gloves. In order for new entrants to be profitable, they would need to achieve similar product differentiation. Gloves are essential as they provide a high level of protection in most industrial sectors. Therefore, customers would be relatively loyal to brands that provide high quality. This is particularly evident in the production of highly specialized industrial gloves, but less evident in the medical gloves market, which is more commoditized, and customers are generally more price sensitive. Therefore, it would be important that new entrants provide the same assurance of quality in order to establish their market presence, over brand loyalty for existing players’ products. Further, as OEMs depend on B2B customer orders, they do not have much bargaining power with customers, and have to establish relationships to understand customer requirements and cater to their needs. In such cases, established relationships with customers may deter new entrants, as the customers (buyers) may prefer the long-standing suppliers. The industry also requires a high level of capital investment for production plants, which will discourage new entrants. Also, the expected scarcity of raw materials due to declining crop fertility could make it difficult for new entrants to source cheap raw materials due to existing players’ established relationships with suppliers.

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Barriers to exit – moderate.

The industry requires specialized assets to produce rubber gloves. Therefore, disposing of these would be a challenge. Furthermore, if plantation companies that produce rubber such as Kelani Valley Plantations (a subsidiary of Hayleys PLC) provide raw material for rubber gloves producers such as Dipped Products (also a subsidiary of Hayleys PLC), exiting the industry would be a challenge as the integrated supplier’s revenues could drop significantly owing to the exit of the rubber gloves manufacturer.

Rivalry amongst competitors - moderate.

The industry is moderately fragmented with international players, including Top Glove and Ansell, and local companies, including Dipped Products, Hands International and Lalan Group. Furthermore, the demand for rubber gloves is growing. Malaysian Industrial Development Finance

Berhad, a Malaysia-based investment research company, expects the global industry to experience growth of 8-10% YoY over the next five years, driven by emerging markets such as India and China, which are striving to achieve higher healthcare standards. This will provide existing firms the opportunity to expand into untapped emerging markets, and make the industry more competitive. Also, competitors produce a variety of products for a range of consumers (with the possibility of hundreds of product variants) and invest continually in R&D. This is likely to differentiate them from other players in the industry.

Bargaining power of buyers – moderate to high.

There are a moderate number of buyers in the industry. These are mainly industrial companies, which are large in size and therefore have a strong bargaining power. Furthermore, they are likely to purchase in bulk and therefore account for a moderate proportion of a player’s revenue. Rubber glove producers have experienced a trend of customers choosing cheaper, lower-quality competitor products in times of economic downturn or rising costs. Buyers of medical gloves (commodity product) may have a low switching cost and could switch to other producers if they are offered better price value. However, in the industrial gloves (value-added) market, buyers would choose quality over price. Further, the high level of differentiation and low availability of substitute products would reduce the buyers’ power. Some manufacturers may have even differentiated to produce specialized products for customers’ specific needs. Also, the buyers being predominantly large industrial players providing value-added products would be profitable and have a higher resistance against price increases.

Bargaining power of suppliers – high.

Suppliers have a substantial bargaining power, although the industry is largely fragmented. Synthetic or raw rubber is an essential resource for the manufacture of rubber gloves, accounting for over 50% of total costs. Therefore, even a marginal increase in the price of supplies can have a significant impact on the cost of production. Suppliers’ bargaining power is further strengthened by the low availability of substitutes for synthetic and raw rubber. The possible scarcity of rubber as a raw material (the Sri Lanka Rubber Research Institute reported that rubber was cultivated on 214,000 hectares in 1970s but stood at just 121,000 hectares in 2012, due to plantations being converted into more profitable ventures, such as palm oil), resulting from adverse weather conditions and labor shortages in the plantations sector, has reduced the productivity of the plantations. This translates to lower yields, and therefore increases suppliers’ bargaining power.

Threat of substitutes – low.

There are no substitutes for rubber gloves. Furthermore, health and safety regulations and growing concerns for hygiene make rubber gloves an important form of hand protection. Customers also maintain strong relationships with producers and have a moderate level of brand loyalty. This will reduce the threat of consumers switching away from using rubber gloves.

Government action – moderate.

Rubber and rubber products are the third largest export earners to Sri Lanka, amounting to USD1.09bn in 2012. The Sri Lankan government is targeting to increase rubber-based exports to USD4bn by 2022, through significant investments in replantation and plantation expansions to

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increase capacity. Additional government support is anticipated for research and development projects.

Activated carbon (AC) manufacturing

Conclusion: The industry should remain attractive through 2016.

AC is a form of processed carbon, which has unique properties of adsorption (the binding of molecules or particles from a gas, liquid or dissolved solid to a surface), making it popular as a purification agent, primarily in water and air treatment. To put into context, a single gram of AC makes available a surface area of approximately 1,200 square meters for the adsorption of impurities. The key end-use applications for AC include water purification, air treatment and gold extraction. AC can be produced using a range of raw materials, including wood, coconut shells, charcoal and coal. The key players in the industry in Sri Lanka – Haycarb PLC, Jacobi Carbon and Bieco Link Carbons (Pvt) Ltd – mainly produce AC using coconut shells, and are largely export oriented.

The industry should remain attractive on the back of strong growth (at a global CAGR of approximately 11% from 2011-2016, according to the Hayleys PLC annual report), driven by the Environmental Protection Agency's (EPA) new Mercury and Air Toxics Standards (MATS) in the US to improve coal-fired power plants. These new mercury removal standards require the usage of AC injection systems, which in large industrial facilities can consume up to 2m pounds of AC in a year. Further, developments in emerging economies, such as in India and China, will increase pressure from the governments of these nations, as well as other international institutions to sustainably manage water infrastructure. Furthermore, the close relationships with customers and the growing importance of AC as a purification agent will increase the AC producers’ positioning over buyers. Industry growth and product differentiation is likely to reduce industry rivalry. At present, the industry consists of a few players and will not have an influx of new players due to the already established relationships with stakeholders among existing players, and the level of expertise and technology advancement required. Furthermore, there are few substitutes for this product due to the unique properties it provides; this will reduce the threat from substitutes.

However, the industry faces the threat of increasing pressure from suppliers, driven by the scarcity of raw materials and the importance placed on the supplies. This threat could be mitigated with the continuing investment in R&D that will result in the effective use of other substitute raw materials, such as peat and charcoal at a cheaper cost. This will lead to a growth in the local industry, which would gain the support of the Sri Lankan government in the future.


AC comes in different forms such as granular, pellets, powder, liquefied and gas-based. Therefore, new entrants would also need to produce different forms of AC in order be competitive. The industry players generally have strong relationships with their customers in order to understand and cater to their varying needs. Existing players would have established relationships with other stakeholders such as suppliers and distributors, which would give them access to cheaper raw materials and enable them to offer products at shorter lead times. Therefore new players would be faced with the challenge of establishing similar relationships. They would also face a challenge due to scarcity of raw materials. In 2006, the Supreme Court of Sri Lanka, following a Fundamental Rights application (a petition filed with the Supreme Court claiming infringement of fundamental rights) by Haycarb PLC, the largest AC manufacturer in Sri Lanka, successfully prevented Jacobi Carbons (JC), a Swedish entrant with investments in Sri Lanka, from increasing manufacturing capacity using local supplies due to the scarcity of coconut shells. This legal action resulted from JC having been granted approval by the Board of Investments in Sri Lanka to manufacture AC at volumes over and above specified limits, thereby putting a strain on raw materials. It is likely that new players could also face similar restrictions. Although AC can be produced using a variety of substitute material, this may change the quality of the end product and also increase the cost of production. Furthermore, since the product is primarily for purification purposes, there are certifications that producers would need to obtain, such as the National Sanitation Foundation (NSF) certification for product compliance. This will lead to an increase in costs for new players. Costs would also increase due to the initial capital investments and the need to continually invest in R&D and technology advancements, which would deter new entrants.

Barriers to exit – moderate.

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Due to specialized industry expertise required, finding a buyer (to exit operations) would likely be difficult. Further, the joint ventures (JV)/relationships AC producers maintain with other companies would discourage the producers from exiting the industry, as an exit could strategically impact operations of the JV party. It is unlikely that entrants will exit the industry due to its high growth potential.

Rivalry amongst competitors - moderate.

Intensity of competition is moderate as this is a niche industry with only a few competitors. Demand for water and sewage treatment is expected to grow in Sri Lanka due to the expansion of the hospitality sector and emerging opportunities in the country’s North and East. Overseas, demand for AC in the US is forecasted (according to Freedonia Group, an industry market research firm) to post an 11% CAGR through 2017, and demand in Asia is expected to post a CAGR of 9% over 2013-2017. Growth in the US is driven by the EPA’s MATS, requiring the upgrade of coal-fired power plants of utilities and industrial manufacturers. Growth in Asia is stemming from industrialization, leading to an increase in pressure from both the international community and respective governments to reduce pollution levels. This growth will reduce competition, as all the firms will have greater opportunities to increase their foothold in existing markets and venture into untapped markets. There is a moderate level of product differentiation, through the different forms of AC. Further, competitor strategies could be different, based on the technology or raw material used and also varies based on the end-use applications served. This differentiation is likely to reduce competition.

Bargaining power of buyers – moderate.

AC has over 65 end uses ranging from nuclear protection clothing to cigarette filters, and from gold mining to pharmaceuticals. Buyers’ purchasing decisions are mainly driven by brand and price; therefore, buyers will switch to competitor products based on their value offering. These factors will increase buyers’ bargaining power. However, buyers would place a significant importance on the product, due to increasing compliance regulations stemming from the application of the EPA’s MATS in the US. In emerging economies of China and India, pressure from local governments to manage water infrastructure is also likely to increase the products’ importance. Furthermore, AC is an essential purification agent, which will improve the quality of the buyers’ end product/service (mostly purification-related products and services), thereby increasing its strategic importance within the buying industry. Buyers maintain close relationships with producers and may not immediately cancel partnerships as cancellations could have a strategic impact on one or both businesses. Further, since buyers are large industrial companies who produce value-added products, they would be more profitable and may be able to bear the costs of price increases to a certain level.


Suppliers to the AC industry in Sri Lanka are coconut shell suppliers and charcoal suppliers. The AC industry requires a large quantity of raw material; the raw material (charcoal)-to-output (AC) ratio is 3:1. There are a large number of local smallholder plantation suppliers and the industry also depends to some extent on foreign suppliers to cover shortfalls. Further, these supplies comprise approximately 57% of total production costs of AC and therefore could have a significant impact on the producers’ profitability. Over 70% of coconut produced in Sri Lanka is utilized for domestic and other uses, which means that the AC industry gets supplies from the remainder (30%). This means that the suppliers are not heavily dependent on the AC industry. While these raw materials have other substitutes, such as wood, these will have an impact on the quality of the AC. Further, using substitutes such as coal could lead to an increase in production costs.


There are few substitutes for AC, such as distillation and reverse osmosis for water purification. However, the production costs of these are higher as they are slower processes requiring electricity. Furthermore, customers have a moderate level of brand loyalty and have long-term relationships with producers. This would reduce the threat from substitute products.


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This is a niche industry; therefore, the government does not have specific incentive programs for players. However, coconut cultivation is an important part of the country’s agriculture industry (9% of agriculture industry in 2012) and the government supports this by increasing the subsidies provided for replanting and new entrants. This will increase the raw material supplies available for players. In addition, the government could get involved (as discussed above) to protect domestic operators.

Tea manufacturing

Conclusion: The industry should remain mildly attractive through 2016.

According to the Central Bank of Sri Lanka (CBSL), Sri Lanka accounted for 8% of the world’s tea production and 17% of global tea exports in 2011. Tea contributed approximately 10% of the GDP (2012) and accounted for 14% of Sri Lanka’s USD10bn export market in 2012. Moreover, 70% of tea producers in Sri Lanka are smallholders (small holdings are small farms or land extents supporting a single family) and the remainder comprise regional plantation companies (including Hayleys subsidiary Kelani Valley Plantations PLC). Key tea buyers are Sri Lankan-based global tea distributors, such as Unilever, Jaferjee Brothers and Akbar Brothers Ltd.

The sector should remain mildly attractive thanks to global demand for the product, and the fact that there are few real substitutes for tea. Furthermore, potential new entrants are likely to be dissuaded from entering the industry owing to high capital costs, existing close relationships between stakeholders and labor scarcity.

Tea producers are likely to face moderate to high levels of competition driven by the low productivity in plantations and high investment costs. Further, increased product differentiation (through greater focus on value-added teas) could decrease this risk and increase profitability.


New entrants are likely to be discouraged by the significant investment required to acquire fertile plantation land. Furthermore, new players would need to win the loyalty and confidence of buyers in order to be profitable. The industry is also facing a severe labor scarcity, and new players would need to develop a workforce from scratch (wages account for approximately 65% of the production costs of tea). A new industry entrant would also face a fertilizer subsidy (a problem in the industry at the moment), which would make production more expensive for smallholders.

Barriers to exit – moderate to high.

Producers use a large land area to grow the tea crop; therefore, disposing of these plantations would be difficult. The industry is highly labor intensive and the closure of plantations could result in the producer incurring high redundancy and compensation costs. Furthermore, plantation companies that are involved in all areas of the supply chain (from cultivation to production, auction and export) would find it difficult to exit the industry due to the strategic importance of the product for their subsidiaries – if they were to exit, it would negatively impact subsidiaries along the lower end of the value chain.

Rivalry amongst competitors – moderate to high.

Media reports suggest that the Sri Lankan tea industry is largely fragmented, with 400,000 smallholders contributing to 70% of production and the remainder produced by 23 regional plantation companies. This large number of producers will increase the intensity of competition. Furthermore, players incur a high investment cost to obtain plantation lands and have high exit barriers, which would increase the competitiveness of industry players. Also, despite an increase in new planting of 280 hectares in 2012 (compared to an average of 13 hectares per annum over the past five years), tea production declined marginally by 0.4%, due to adverse weather conditions. This uncertainty in crop production is likely to increase the competitiveness of existing players as each firm will be under pressure to cover costs.

Further, as per CBSL statistics, 41% of the country’s tea is exported in bulk form, with a low level of differentiation. It also has a low price premium, which serves to increase the competiveness in the industry. Sri Lanka’s Treasury Secretary expects growth for the local industry to be relatively low, forecasted at 2-3% by 2020 per year. In contrast, the Economist Intelligence Unit forecasts

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substantially higher tea production growth in 2013 for China (8%) and India (4%), key competitors of Sri Lanka’s tea industry.

Bargaining power of buyers – high.

Buyers mainly relate to tea exporters. There are nearly 900 tea buyers in Sri Lanka, compared to the large number of smallholders (400,000). Buyers are mostly large exporters (such as Unilever, Akbar Brother Ltd, and Jaferjee brothers) who can play sellers off of each other in order to find the best price. Tea is sold at an auction, and despite established relationships with manufacturers and brokers, buyers can easily buy from other producers if they perceive better value for money. Each buyer purchases in bulk and therefore contributes to a significant proportion of the producers’ revenue, further strengthening their position. Furthermore, the high investment costs incurred by manufacturers is likely to increase the importance of buyers, who typically have higher margins, yet attempt to squeeze margins from the smallholders.


The key supplier in this case is the workforce. The tea industry employs 10% of the total population in Sri Lanka. The plantation sector’s trade unions could have a significant impact on the productivity and profitability of the industry as union activity can disrupt production flow. Furthermore, labor costs accounts for approximately 65% of total costs; therefore, even marginal increases could have a significant impact on the margins of producers. There are no substitutes for labor, which is an essential resource for the sector and this will increase their bargaining power. Workers are also showing an increasing trend of preferring more white collar jobs over working in the plantation sector, making them a scarce resource.


Tea is a popular, relatively low-cost health drink with benefits, such as reducing heart attacks and type 2 diabetes. It is also a popular drink in many cultures throughout the world. Therefore, it has a low number of substitutes. Furthermore, buyers, brokers and manufacturers in the industry maintain close relationships. Hence, if buyers were to switch to substitute products, they would need to make new relationships with substitute producers and find different end consumers for their product. However, producers of substitutes, such as coffee and fruit juices, also have aggressive promotions that could attract end consumers.


Tea production is of high importance to Sri Lanka’s economy and therefore the government proposed several measures in the 2013 budget to support the industry. Furthermore, tea exports came in at USD1.4bn (14% of total exports) in 2012 and the CBSL forecasts that this will increase to USD1.9bn by 2016. Supportive measures include increasing the replanting subsidy from LKR300,000 to LKR350,000 per hectare to encourage replanting amongst smallholders and a further increase in the subsidy for new plantation from LKR150,000 to LKR250,000 per hectare. However, it has been reported that smallholders do not receive this fair share of subsidies. In addition, media reports suggest that Sri Lanka’s two largest urea fertilizer importers have stopped imports because the government has allegedly not reimbursed them close to LKR16bn in subsidies. This will result in a scarcity of fertilizer and a reduction in land fertility. Furthermore, the industry is highly labor intensive and the 114% minimum wage increase over five years, compared with an increase in the price of tea of only 29% is likely to negatively impact manufacturers.

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Appendix 4: SWOT analysis

Strengths Weaknesses

Diversified portfolio with exposure to niche markets

Market leadership position in strategic business segments

Increasing focus on value addition

Important contributor to national exports

High debt burden

Short-term liquidity strain

Textile segment difficulties

ROE lower-than-domestic peers

Management time and focus diluted across several segments

Opportunities Threats

Global economic growth

Stringent pollution and purification legislation in the US and China

Medical gloves industry growth

Oil and gas exploration in the north of Sri Lanka

Rapid growth in the leisure and construction sectors

Volatility in commodity prices

Foreign exchange risk

Slowdown in key export markets

Uncertainty stemming from the recent factory suspension within the hand protection segment

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Appendix 5: Diversified sector overview

As of 4 September 2013, the diversified sector represented 19% of the CSE’s total market capitalization of USD17.9bn. It is the third-largest sector on the stock market, behind beverage, food and tobacco and financial services.

Figure 41: Top five sectors on the Colombo Stock Exchange by market capitalization

Sector name

Market cap

(USDbn)

% of total CSE

market cap Two largest companies

Beverage, food & tobacco 3.8 21% Ceylon Tobacco Company PLC

Nestle Lanka PLC

Banks, finance & insurance 3.7 21% Commercial Bank of Ceylon PLC

Hatton National Bank PLC

Diversified 3.3 19% John Keells Holdings PLC

Carsons Cumberbatch PLC

Hotels and travels 2.3 13% Asian Hotels & Properties PLC

Aitken Spence Hotel Holdings PLC

Telecommunication 1.0 6% Sri Lanka Telecom PLC

Dialog Axiata PLC

Source: CSE Note: Data as of 4 September 2013

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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 4 September 2013, along with a brief description of their main businesses.

Figure 42: Details of conglomerates listed on the CSE’s Main Board

Company name Bloomberg/CSE tickers

Market cap

(USDm)

Free float

(%) Top 3 businesses by revenue contribution

John Keells Holdings PLC JKH SL/ JKH.N0000 1,373 88.4% Consumer food (manufacturing) & retail

Tourism (hotels, destination management)

Transportation (oil bunkering, container handling)

Carsons Cumberbatch PLC CARS SL/ CARS.N0000 530 23.8% Oil palm plantations (palm oil, palm kernel, fresh fruit)

Oils and fats (refined oils, cooking oil, specialty fats)

Beverages (breweries)

Aitken Spence PLC SPEN SL/ SPEN.N0000 350 40.1% Power generation

Tourism (hotels, destination management)

Logistics (freight forwarding, courier services,

integrated logistics, maritime transport)

CT Holdings PLC CTHR SL/ CTHR.N0000 193 38.7% Retail and wholesale Distribution (FMCG)

Food processing (consumer foods)

Hayleys PLC HAYL SL/ HAYL.N0000 163 40.0% Hand protection (rubber gloves)

Transportation & logistics (warehousing & distribution,

freight, chartering and port operations)

Purification products (carbon granular, fines, powders

and pellets)

Vallibel One PLC VONE SL/ VONE.N0000 122 19.4% Finance (banking)

Apparel

Tiles

Hemas Holdings PLC HEMS SL/ HHL.N0000 112 28.3% Healthcare (pharmaceuticals, diagnostic and surgical

services, hospitals)

FMCG

Power generation

Expolanka Holdings PLC EXPO SL/ EXPO.N0000 101 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)

Richard Pieris & Co. PLC RICH SL/ RICH.N0000 91 45.6% Retail

Plantations (tea, rubber, palm oil)

Plastics (water tanks and pumps, foam mattresses,

bulbs, molded plastics)

Finlays Colombo PLC JFIN SL/ JFIN.N0000 74 2.9% Tea exports

Services (environmental services, insurance

brokering, marine cargo surveying, airline general

sales agent)

Logistics (tea warehousing, temperature controlled

logistics, air freight)

Source: CSE, Bloomberg, Company annual reports

Note: Market capitalization data as of 4 September 2013. Revenue contribution is based on FY13 data.

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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 43: Shareholding structures by investor type and geographical location

Investor type Geographical location

Management Other retail Institutional Management Other domestic International

John Keells Holdings PLC 5.0% 23.3% 71.7% 5.0% 28.4% 66.6%

Carson Cumberbatch PLC 0.3% 3.9% 95.9% 0.3% 81.7% 18.0%

Aitken Spence PLC 1.9% 7.5% 90.7% 1.9% 52.8% 45.3%

CT Holdings PLC* 19.5% 21.2% 59.3% 19.5% 66.5% 14.0%

Hayleys PLC 48.5% 36.0% 15.6% 48.5% 48.0% 3.5%

Vallibel One PLC 63.7% 8.2% 28.1% 63.7% 35.4% 0.9%

Hemas Holdings PLC 4.0% 6.1% 89.9% 4.0% 89.2% 6.8%

Expolanka Holdings PLC 72.8% 10.7% 16.6% 72.8% 23.2% 4.1%

Richard Pieris & Company PLC 0.4% 15.9% 83.8% 0.4% 40.1% 59.5%

Finlays Colombo PLC* 0.0% 1.6% 98.4% 0.0% 2.5% 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 44: Key financial data

Company Name Revenue EBIT Net income EBIT margin (%) Net income margin (%)

John Keells Holdings PLC 661 55 94 8.3% 14.3%

Carson Cumberbatch PLC 588 84 35 14.2% 6.0%

Aitken Spence PLC 283 43 25 15.0% 8.9%

CT Holdings PLC 527 34 9 6.5% 1.7%

Hayleys PLC 572 51 14 9.0% 2.5%

Vallibel One PLC 254 33 17 12.9% 6.6%

Hemas Holdings PLC 202 19 13 9.3% 6.4%

Expolanka Holdings PLC 387 15 8 3.8% 2.1%

Richard Pieris & Co. PLC 268 29 15 10.7% 5.5%

Finlays Colombo PLC 40 2 3 6.1% 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

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Fact Sheet

Sri Lanka investment environment overview

Sri Lanka’s economy has been on an upward trajectory since the end of the three-decade civil war in May 2009. Sri Lanka currently boasts South Asia’s 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

Figure 2: GDP per capita to increase 33% by 2016E

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

Figure 4: CBSL expects the rupee to stabilize in the medium term despite recent volatility

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 Figure 6: Debt-to-GDP to fall to 71% by 2015E

Source: Central Bank of Sri Lanka Source: Central Bank of Sri Lanka

6.8 6.0

3.5

8.0 8.2

6.4

7.5 8.0 8.3 8.5

0123456789

2007

2008

2009

2010

2011

2012

2013E

2014E

2015E

2016E

%

0

1,000

2,000

3,000

4,000

5,000

2005

2006

2007

2008

2009

2010

2011

2012

2016

E

USD

8.5

7.7

13.6

7.0 7.0 6.9 5.8

0

2

4

6

8

10

12

14

16

2006 2007 2008 2009 2010 2011 2012

%

100

150

200

250

Jan-07 Apr-08 Aug-09 Dec-10 Apr-12 Jul-13

LKR/USD LKR/EUR LKR/GBP

0%

4%

8%

12%

0

200

400

600

2006

2007

2008

2009

2010

2011

2012

2013E

2014E

LKRbn

Fiscal Deficit LKR bn As a % of GDP

102 102 91 88 85 81 86 82 79 79 78 75 71

0

20

40

60

80

100

120

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013E

2014E

2015E

%

Hayleys PLC

50


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 country’s 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

Figure 8: Post war, the ASPI has also outperformed some of the best-performing regional indices

Source: Bloomberg *Note: All figures re-based to 1 July 2009

Source: Bloomberg *Note: All figures re-based to 1 July 2009

Figure 9: The CSE’s market capitalization has doubled since 2009

Figure 10: The government anticipates FDI inflows to reach USD2bn in 2013, a 19% CAGR 2009-2013E

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

Figure 12: Trend is similar on a P/BV value

Source: Colombo Stock Exchange Source: Colombo Stock Exchange

0

80

160

240

320

400

Jul-09 Apr-10 Feb-11 Dec-11 Oct-12 Aug-13

ASPI Dow Jones FTSE 100

MSCI World DAX

0

100

200

300

400

Jul-09 Mar-10 Nov-10 Jul-11 Mar-12 Dec-12 Aug-13

ASPI Bombay (BSE 500)

Jakarta (JCI) Philippines (PASHR)

Thailand (SET) Hanoi (VNINDEX)

MSCI Emerging Market Index

1,092

2,211 2,214 2,168 2,351

0

500

1,000

1,500

2,000

2,500

3,000

2009 2010 2011 2012 2013(August)

LKRbn

827 601 516

1,066 1,338

2,000

0

500

1,000

1,500

2,000

2,500

2008 2009 2010 2011 2012 2013E

USDm

0

30

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120

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2010 2011 2012 Average market P/E 2010-2012

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2010 2011 2012 Average market P/BV 2010-2012

Hayleys PLC

51


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.

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