CT Holdings PLC (CTHR)

Sri Lanka | Diversified Holdings EQUITY RESEARCH

Initiation of coverage 5 September 2013

CT Holdings PLC (CTHR)

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

Cashing in on consumption growth CT Holdings (CTHR) is the fourth-largest Sri Lankan diversified company by market capitalization. The company holds controlling interests in Cargills (CSE ticker: CARG, CTHR’s 70%-owned food retail company), the country’s largest chain of supermarkets, as well as in several companies in the food processing, restaurant, real estate, entertainment and financial services sectors. We expect CTHR’s revenues from continuing operations to post an 11.1% CAGR over FY14E-FY16E and net margin to expand 40bps to 2.3% by FY16E. Rising disposable income should continue to boost consumer demand and benefit Sri Lanka’s modern food retail market, driving CTHR’s retail and wholesale distribution segment (84% of revenue in FY13) at an 8.8% CAGR over FY14E-FY16E. We expect margins to benefit from higher food sales and economies of scale in food processing. However, high finance costs resulting from CTHR’s recent spate of acquisitions may pressure earnings. We arrive at a valuation range of LKR126-153 for CTHR, compared with the current share price of LKR140, as at 4 September 2013.

Sri Lanka’s organized food retail penetration grew to 15% in 2012 from 10% in 2004. This growth was supported by rising disposable income (12.6% CAGR over

2010-2012) and a slowly increasing preference for shopping at modern retail outlets. However, penetration remains lower than regional peers’, implying growth potential.

We expect CTHR’s revenues to post an 11.1% CAGR over FY14E-FY16E. CTHR’s

food retail and wholesale distribution segment will be the key driver of growth, with revenue rising at an 8.8% CAGR over the forecast period, driven mainly by macro-level growth and an aggressive store expansion strategy. Total store count is up 55% since 2009 and we forecast a 22% increase from FY13 to FY16E. We believe the food processing segment (12% of revenue), which produces a range of items such as ice cream, yoghurt and soft alcoholic beverages, will grow at a 22.6% CAGR.

Net profit margin should widen 40bps to 2.3% in FY16E. Margin growth should be

supported by a 47bps margin expansion in the retail and wholesale distribution segment to 1.6% in FY16E. Net margin in the food processing segment should expand by 127bps to 3.8% in FY16E, driven by the economies of scale gained from the recent capacity expansions in the segment. Margin expansion may be tempered by growing operating costs as a result of the rise in electricity and fuel expenses. Additionally, increased finance and depreciation expenses could also negatively impact the margin.

High debt level may weigh on profitability due to higher finance costs. Over the

past three years, management has carried out several acquisitions and other expansion activities, mostly funded by debt – which climbed to LKR15.8bn in 1QFY14, up 150% from FY10. Due to this increase in debt, CTHR’s gearing levels increased to 42% in 1QFY14 from 30% in FY10 and should drive the increase in its interest expense over FY14E-FY16E, and thereby possibly restrict any significant profit growth in the short term. However, we expect these investments to pay off starting from FY14E.

We arrive at a valuation range of LKR126-153, compared with the current share price of LKR140. We have used DCF/SOTP valuation and P/E analyses to establish

this valuation range. CTHR shares currently trade at an FY14E P/E of 23.9x, within its three-year historical forward P/E range of 17.3x-41.2x. Our bull-case scenario analysis assumes better-than-expected performances in the retail segment. Conversely, our bear-case scenario takes into account a possible slowdown in consumption due to sluggish consumer sentiment (see page 21 for risks to our valuation range).

Key statistics CSE/Bloomberg tickers

Share price (4 Sept 2013)

No. of issued shares (m)

Market cap (USDm)

Enterprise value (USDm)

Free float (%)

52-week range (H/L)

Avg. daily vol (shares,1yr)

Avg. daily turnover (USD

‘000)

CTHR.N0000/CTHR SL

LKR140

183

193

338

39%

LKR170/120

17,500

19

Source: CSE, Bloomberg Note: USD/LKR=128.6 (avg. for the 1 year ended 4 September 2013)

Share price movement

Source: CSE, Bloomberg

Share price performance

3m 6m 12m

CTHR -3% 8% 7%

All Share Price Index -11% 2% 7%

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


Summary financials

LKR m (year end 31 March) 2013 2014E 2015E

Revenue 56,050 63,319 70,385

EBITDA 6,337 4,738 5,216

Net profit 1,084 1,061 1,508

Recurrent EPS 6.31 5.85 6.56

ROE (%) 6.5 4.7 6.5

P/E (x) 22.1 23.9 21.3

Source: CTHR, Amba estimates

Note: Revenue and net profit figures exclude discontinued operations

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140%

Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13

CTHR ASPI S&P SL 20

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Table of Contents

Favorable consumer indicators to drive growth of food retail segments ............................................................................. 3

Disposable income and consumption rising steadily ............................................................................................................................ 3 Potential risks to the food retail sector .................................................................................................................................................. 7

We forecast CTHR’s revenue to post an 11.1% CAGR through FY16E ............................................................................. 9

Growth in the food retail market to drive retail and wholesale distribution, and food processing revenue ............................................ 9 Food processing revenue to grow at a 22.6% CAGR through FY16E .................................................................................................. 9 Restaurant revenues to rise at a CAGR of 22.6% through FY16E ..................................................................................................... 10

Net profit margin to improve 40bps to 2.3% in FY16E from 1.9% in FY13 ........................................................................ 12

Rise in finance costs may weigh on short-term profit potential ........................................................................................................... 12 Retail and wholesale distribution margins to widen 47bps supported by retail volume growth ........................................................... 12 Food processing margins to widen 127bps, driven by recent investments in capacity expansion and new products......................... 13 Restaurant margins to expand 49bps fuelled by growing consumer demand in the local restaurant sector ....................................... 13 Real estate margin to contract to 3.0% in FY16E, as new developments weigh on margin ............................................................... 13

High debt levels may lower earnings growth ..................................................................................................................... 14

Land bank may add to upside potential .............................................................................................................................................. 15 Trajectory of banking efforts evolving ................................................................................................................................................. 16

We establish a valuation range of LKR126-153 for CTHR ................................................................................................ 18

DCF/SOTP analysis returns a valuation range of LKR126-153 per share .......................................................................................... 18 P/E analysis yields a valuation range of LKR127-140 per share ........................................................................................................ 20 Sources for additional potential upside/downside ............................................................................................................................... 21 We have not factored in relative valuation in our price range ............................................................................................................. 21 Share price performance .................................................................................................................................................................... 22

Earnings release focus areas ............................................................................................................................................. 24

Appendix 1: Company overview......................................................................................................................................... 25

CTHR’s key businesses ..................................................................................................................................................................... 26 Management strategy, transparency and governance ........................................................................................................................ 27 Shareholding structure ....................................................................................................................................................................... 28 Board of directors ............................................................................................................................................................................... 29

Appendix 2: Key financial data ........................................................................................................................................... 31

Summary group financials (LKRm) ..................................................................................................................................................... 31 Key ratios............................................................................................................................................................................................ 32 Segmental summary ........................................................................................................................................................................... 33

Appendix 3: Industry analysis using Porter’s framework ................................................................................................... 35

Organized food retail .......................................................................................................................................................................... 35 Food and beverage manufacturing ..................................................................................................................................................... 36

Appendix 4: SWOT analysis .............................................................................................................................................. 39

Appendix 5: Diversified sector overview ............................................................................................................................ 40

Fact Sheet .......................................................................................................................................................................... 43

Sri Lanka investment environment overview ...................................................................................................................................... 43

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Favorable consumer indicators to drive growth of food

retail segments

Supported by encouraging macro trends, the Sri Lankan food retail market is growing, mainly driven by the improving retail infrastructure and an expanding, increasingly selective consumer base looking for convenience.

Disposable income and consumption rising steadily

We believe Sri Lanka’s favorable macroeconomic environment, in terms of continuing GDP growth and the consequent increase in disposable income, is driving growth in the food retail sector, as reflected in rising consumer demand. This bodes well for CTHR’s retail and wholesale distribution and food processing segments, which we expect to benefit from increased consumer appetite for food and beverage products. As illustrated in Figure 1, we expect revenue growth in these two segments to outperform both macroeconomic data points.

Figure 1: Growth in CTHR’s food retail and processing segments to outpace macroeconomic growth

Source: World Bank, Central Bank of Sri Lanka (CBSL), Amba estimates

The food, beverages and tobacco industry’s contribution to GDP grew to 8.1% in 2012 from 7.9% in 2007. Further, expenditure on food, beverages and tobacco recorded a 16.6% CAGR over the period to LKR610.9bn in 2012. Both measures highlight the growth in local consumption in the recent past.

Figure 2: Expenditure on food, beverages and tobacco posted a 16.6% CAGR over 2007-2012

Source: Department of Census and Statistics

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YoY GDP per capita growth rateYoY disposable income growth rateYoY revenue growth - retail and wholesale distribution (LHS)YoY revenue growth - food processing (LHS)

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Growing macro trends should benefit the Sri Lankan food retail market

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Overall consumption levels in the country continued to rise in 2012, although at a slower rate than in 2011. Private consumption, in particular, grew 15.5% YoY in 2012, compared with 25.1% in 2011. Food, beverages and tobacco constitute the largest consumption expenditure sector, rising 27.7% YoY in 2011 and subsequently 7.7% in 2012. This sector contributed 37.6% of total private consumption expenditure (PCE) in 2012, down from 40.4% in 2011, as rising income levels reduced the share of spending on essential items such as food, while that on non-food items increased 20.7% YoY in 2012, compared with 23.4% in 2011. However, CARG’s most recent annual report cites research from the Nielsen Company which shows that the share of expenditure on food, while expenditure on beverages, laundry and household products, amongst others, has dropped.

Figure 3: Private consumption levels continued to rise in 2012; spending on food, beverages and tobacco increased 7.7% YoY

Figure 4: Spending on food, beverages and tobacco as a percentage of household expenditure declined slightly in 2012 compared with that in 2010

Source: CBSL

Source: Department of Census and Statistics

Overall food retail market growing, along with the preference for

modern food retail outlets

Traditional trade outlets, such as local grocers, outdoor markets and roadside stalls, continue to hold the majority share (85%) of the Sri Lankan food retail market, particularly in rural areas. However, CARG’s aggressive outlet expansion plan is targeting regional cities in an attempt to expose these areas to modern retail outlets. Organized retail (i.e., supermarkets) is accreting market share, albeit slowly, by operating a low-margin, high-volume model, and entices customers with a larger range of products (some at prices lower than what traditional stores can offer) and a more comfortable shopping environment.

At a macro level, Sri Lanka’s modern food retailing sector is attractive, with only 15% of food sold through modern outlets in 2012, compared with 10% in 2004, according to data from Nielsen – the rest is bought through traditional grocery stores (which carry a limited range of staples and convenience goods) and outdoor markets (which offer fresh produce). This segment should, therefore, benefit from the growing propensity for shopping at modern trade outlets. The experience in other emerging markets suggests that increasing disposable income is positively correlated with modern food retail market share, as consumers demand greater choice and search for a more convenient grocery shopping experience.

CARG is well positioned to capture the growing demand for

organized food retail

CARG’s chain of supermarkets currently enjoys a market share of about 40-45% in the local organized food retail sector and slightly less than 7% of the estimated total grocery spend,

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Private consumption expenditure (LHS)

Expenditure on food, beverages and tobacco (LHS)

Expenditure on food, beverages and tobacco - YoY growth (RHS)

37.6% 42.3% 37.6%

62.4% 57.7% 62.4%

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The current low level of penetration of modern retail outlets leaves room for upside in the sector

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according to management. The rapid growth of its store network should help the retailer position itself to capture an increase in shopping at supermarkets, with the increasing presence of CARG’s own-brand goods strengthening its position further.

CTHR’s retail and wholesale distribution activities account for approximately 84% of its total revenue from continuous operations (as of FY13), while retail operations alone contribute 79%. The company’s food retail operation is the largest amongst private supermarket retailers in Sri Lanka by both revenue and total store count, as shown in Figure 5.

Here, we examine three main factors that contribute to CTHR’s competitive edge in the organized food retail space.

Extensive retail network. Through CARG, CTHR’s main retail strategy is to reach as many

regional areas in the country as possible, where no private supermarket chains have ventured yet. Just over 50% of Sri Lanka’s total fast-moving consumer goods (FMCG) market is in rural areas, according to a Nielsen report, and these regions are generally underserved by modern-format retailers.

CARG launched an ambitious expansion program in December 2009 to open 100 new outlets by FY14, a 74% increase in its store count, which stood at 136 as of March 2009. The company remains on track to achieve this target – net additions were 75 new outlets between March 2009 and March 2013, including 29 in FY13 alone. As of June 2013, the company had 219 outlets in all 25 districts of the island. CARG is far more aggressive in its expansion plans than its competitors Keells Super and Arpico, which had net openings of only four and minus one stores, respectively, in FY13 and seven and six over FY09-FY13. This allows CARG to enjoy the first-mover advantage and establish a strong local market position before its competitors enter a particular region. Keells Super and Arpico focus more on opening larger stores in cities with higher levels of disposable income.

Figure 5: CARG leads Keells Super and Arpico in total store count

Source: CTHR, Ceylon Cold Stores PLC, Richard Pieris and Company PLC

Efficient supply chain. CARG has built direct relationships with farmers from whom the

supermarket retailer buys agricultural and dairy produce, which it distributes to its retail outlets. By directly sourcing from the farmers in a typical produce supply chain, the company is able to sell the products at highly competitive prices in its supermarkets, which is a key feature of its marketing strategy. As part of its strategy of buying produce directly from farmers, CARG ensures a price 20% above the farmers’ production cost, thereby firmly securing the supply of goods, according to the company’s management. Due to the efficiency of its supply chain and its efforts to minimize post-harvest wastage, the supermarket chain is typically able to price its products lower than modern trade competitors. This has made CARG popular with price-conscious customers, who want to keep their food expenses low. Figure 6 compares the prices of a few common goods across supermarkets in Colombo. In this sample – which is admittedly limited – CARG offers the lowest prices for most of the goods, though not all, in our sample list.

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CARG is the leader in the local modern food retail market due to its wide-reaching outlet network, a well-organized supply chain and its growing presence in the private-label space

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Figure 6: Price comparison of key food items across supermarket retailers

Item (in LKR) Cargills Keells Arpico

Rice (samba) 60 70 70

Rice (red) 45 60 60

Wheat flour 124 127 125

Big onions 216 197 165

Potatoes 155 123 165

Lentils 139 149 141

Sugar (white) 98 103 97

Coconuts 45 45 42

Chicken breast 640 857 678

Fish 1,079 1,005 881

Source: Amba, based on prices gathered from all three retailers

Note: Prices are as of 26 August 2013 per kg of each item, except coconut prices which are per nut

Growth of private-label goods. Demand for private-label products is rising due to improved

quality and expanded product variety, and these products are popular with both retailers and customers, who are looking to save money. A Nielsen report showed that sales of private-label goods, on average, grew 16% YoY in eight Asian countries in 2011. Customers benefit from the generally lower prices of these products, while retailers such as CARG enjoy higher margins, often as much as 25% more than those on comparable branded goods. Since private-label goods often have lower marketing costs, supermarket retailers are able to offer such items at a lower price than similar branded products. Management stated that CARG typically prices its private-label products lower than the category leader. For CARG, private-label goods constitute 3-4% of revenue, compared with 4% for Keells and 2% for Arpico.

A brief comparison of certain key ratios across the top three retailers in the country is shown in Figure 7. CARG’s lower revenue per store can be attributed to the fact that most of its newer stores are being opened in less populated, lower income towns, whilst Arpico and Keells continue to focus on higher income areas. Further, Keells and Arpico tend to have stores that are larger in size, contributing to higher revenue per store figures. Keells supermarkets are currently focusing on opening stores of 7,000 sq. ft. and Arpico’s stores are 10,000-60,000 sq. ft. in size. CARG’s stores, on the other hand, are in the 2,000-5,000 sq. ft. range, with expansion plans now focusing on the smaller-sized Cargills Express stores, particularly in sub-urban towns.

Figure 7: CARG’s FY13 revenue is 2.8x higher than its closest local peer Arpico, but revenue per store is the lowest in the group

Revenue (LKRm) Revenue growth (YoY) Revenue/store (LKRm)

Retailer FY11 FY12 FY13 FY11 FY12 FY13 FY11 FY12 FY13

Cargills 31,493 39,205 44,258 3.1% 24.5% 12.9% 193 202 210

Arpico Supercentres 10,926 14,027 15,703 20.8% 28.4% 12.0% 260 312 357

Keells Super 10,258 11,918 14,025 12.7% 16.2% 17.7% 228 254 275

Source: CTHR, Ceylon Cold Stores PLC and Richard Pieris and Company PLC

Figure 8: CARG’s margins are lower than Arpico’s, ROA is higher compared to Keells

Operating margin ROA

Retailer FY11 FY12 FY13 FY11 FY12 FY13

Cargills 3.5% 4.3% 3.8% 4.5% 4.6% 6.8%

Arpico Supercentres 7.6% 10.6% 6.1% NA NA NA

Keells Super 0.2% 0.7% -1.3% -2.5% 0.4% -5.0%

Source: CTHR, Ceylon Cold Stores PLC and Richard Pieris and Company PLC

CARG’s absolute revenue is far higher than peers’, but revenue per store trails the peer group due to smaller store sizes

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Low penetration of modern food retail highlights growth potential

An analysis of the sales contribution from modern store formats to total grocery sales across several regional peers reveals that penetration levels in a country generally go hand in hand with per capita GDP levels. This trend suggests that as Sri Lanka’s GDP per capita rises, supermarket retailers have an opportunity to increase their presence and share of total food retail sales.

Figure 9: Regional comparison of modern food retail penetration levels and GDP per capita show room for growth in the local market

Source: World Bank, JP Morgan, PricewaterhouseCoopers

Potential risks to the food retail sector

While the local organized food retail industry is enjoying a period of revenue growth, the following factors highlight potential downside risks that may affect this momentum.

Regulatory changes could affect supermarket operators’ revenue and profitability levels. The 12% value-added tax (VAT) imposed in January 2013 on all retail and wholesale operators with quarterly revenues of more than LKR500m is likely to moderate revenue and, therefore, margin growth, as not all of the extra cost can be passed on to consumers.

Supermarket chains’ margins are typically thin, with their main focus being on high sales volumes over high margins. There is, therefore, constant pressure on operating costs, which is compounded by the recent hikes in fuel and electricity costs.

The table below compares CARG’s operating and net margins with those of a sample of its global peers, and shows that while CARG’s operating margin has historically been in line or slightly below the peer average, its net margin trails that of the peer group, possibly highlighting the negative margin impact of its increased debt level.

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Risks to the local food retail sector include regulation changes, continued pressure on margins and a lack of qualified personnel

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Figure 10: Comparison of global peers highlights low margin levels in the food retail sector

Operating margin Net margin

Retailer Country 2011 2012 2013 2011 2012 2013

Cargills Sri Lanka 3.5% 4.4% 3.7% 1.8% 1.8% 0.8%

Tesco UK 5.8% 5.9% 3.9% 4.4% 4.4% 0.2%

Walmart USA 6.1% 5.9% 5.9% 3.9% 3.5% 3.6%

Carrefour France 2.9% 2.8% 2.9% 0.5% 1.6% 1.3%

Metro Germany 3.6% 2.5% 2.1% 1.0% 0.0% 0.1%

Aeon Co Japan 3.8% 4.2% 3.8% 6.7% 6.5% 6.9%

Al-Meera Consumer Goods Qatar 3.0% 3.8% NA 6.6% 7.0% NA

Dairy Farm Singapore 5.6% 4.7% 5.1% 5.3% 4.6% 4.8%

Sumber Alfaria Trijaya Indonesia 2.3% 2.2% 2.4% 2.0% 2.1% 1.9%

Midi Utama Indonesia Indonesia 2.9% 2.6% NA 1.2% 1.2% NA

Philippine Seven Corp. Philippines 5.1% 5.3% NA 3.5% 3.6% NA

Mean 4.1% 4.0% 3.7% 3.5% 3.4% 2.7%

Median 3.7% 4.0% 3.8% 3.7% 3.6% 1.9%

High 6.1% 5.9% 5.9% 6.7% 7.0% 6.9%

Low 2.3% 2.2% 2.1% 0.5% 0.0% 0.1%

Source: CARG, Bloomberg

Several Sri Lankan industries, from tourism to plantations, are experiencing a severe dearth of qualified personnel, and the food retail sector is no exception. The lack of suitable personnel, especially managers and other higher-level executives, together with high employee turnover, makes managing and training human resources crucial for CARG’s expansion plans.

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We forecast CTHR’s revenue to post an 11.1% CAGR

through FY16E

We expect CTHR’s revenue growth to be fuelled primarily by its retail and wholesale distribution segment, supported by the food processing segment. The restaurants segment should also continue to contribute positively to group revenue, as will the real estate and entertainment segments, albeit to a much lesser extent.

Growth in the food retail market to drive retail and wholesale

distribution, and food processing revenue

We forecast retail and wholesale distribution revenue to grow at a CAGR of 8.8% over FY14E-FY16E to reach approximately LKR60.5bn. This segment is CTHR’s largest top-line contributor and consists largely (94%) of CARG’s food retail operations.

The food processing segment, which produces FMCG items such as ice creams and yoghurt as well as beer, and accounted for 12% of CTHR’s continuing revenues in FY13, is forecast to grow at a 22.6% CAGR through FY16E to reach LKR11.9bn. Growth in both segments should come mainly from the positive macroeconomic factors discussed above, in addition to CARG’s continually expanding retail and distribution footprint.

Figure 11: Revenue growth in the retail and food processing segments


Food processing revenue to grow at a 22.6% CAGR through FY16E

The local food retail sector has seen a marked increase in lifestyle and impulse purchases over the past few years, spurred by a corresponding rise in disposable income. Through its food processing segment, and its sizeable portfolio of own brands of popular consumer goods, CTHR is in a prime position to take advantage of this trend.

We expect the following factors to further support CTHR’s revenue growth in this segment.

New product launches. In FY13, CTHR’s 59.5%-owned listed subsidiary Kotmale (CSE ticker:

LAMB) expanded its line of cheese products by introducing cheese wedges and launched a new range of yoghurts in 1QFY14. A new range of one liter UHT milk cartons and a chocolate malt food drink were also launched in the year. CTHR is also capitalizing on the growing demand for more healthy and natural products with a new line of natural juices. Further, CARG signed a deal with Carlton & United Brewers (CUB) to brew and distribute its Foster’s brand of beer in Sri Lanka, which is scheduled to enter the local market in 3QFY14E.

Capacity expansion. Over the past three years, CTHR has invested significantly in expanding

capacity in its food processing operations, anticipating a rise in demand for these products. The

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We expect CTHR’s revenue to benefit from growing food retail sales in Sri Lanka

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company is bolstering its top selling item by adding production and storage capacity to its dairy ice cream operations, in addition to its pasteurized milk and yoghurt plants, which should be commissioned by 3QFY14E. Sri Lanka’s per capita consumption of ice cream, at 1.7 liters/year, is well above the levels in China and the Philippines. However, consumption levels – reflecting both purchasing power and consumer appetite – in nearby Malaysia and Singapore are substantially higher.

In the brewery segment, CTHR plans a substantial capacity increase to 600,000 hectoliters (htl) per annum from 50,000 htl at the time of the acquisition of the business in FY12; capacity is presently at 300,000htl. Demand for alcohol is poised to benefit from growth in disposable income and the rise in tourist arrivals to the country, evidenced by the 22.5% YoY growth in the malt liquor production industry in FY12, as per the CARG 2012 annual report.

Geographical expansion. Processed meat revenue continued to increase in FY13, although the

product line experienced some margin pressure as well, and CTHR is keen to explore new markets for export. Additionally, the company should also see further growth in this product category coming from the pickup in the local and Maldivian hospitality sectors.

Restaurant revenues to rise at a CAGR of 22.6% through FY16E

We expect revenue in the restaurant segment, which accounted for 3% of CTHR’s continuing revenues in FY13, to grow at a 22.6% CAGR over FY14E-FY16E. This is as a result of more people eating out – the CBSL reports a 50% YoY growth in PCE in the hotel, cafe and restaurant segment in 2012. In addition, CTHR’s revenue in the segment has been recently boosted by higher prices points at KFC. The local restaurant industry is likely to benefit from growing tourist arrivals, with the government forecasting a 28.0% CAGR in tourist arrivals over 2014E-2016E.

Figure 12: Private consumption expenditure (PCE) on restaurant visits posted an 18.0% CAGR over 2009-2012

Source: CBSL

CTHR, through its 70%-owned subsidiary Cargills Food Processors (Private) Limited operates the franchise for the KFC chain of fast-food restaurants. The company has already opened 23 KFC outlets, including 5 in FY13, mainly in Colombo and its suburbs. The recently launched outlets in regional cities have performed above the company’s expectations, with consumers in these areas showing a higher propensity to dine out than in the past. CTHR has plans to add two or three more outlets in FY14, with several more in the pipeline, according to the company.

KFC’s strength in the local quick-service sector is its ability to innovate and “localize” its food menus to make them more appealing to the local palette. The launch of KFC’s home delivery service in FY12 should also help boost revenue in the segment, as increasingly busy households opt to bring home the dining out experience.

Through CARG, the company has also signed a deal to become the exclusive franchise in Sri Lanka for global restaurant chain TGI Friday’s. The first restaurant is scheduled to open at the end

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The restaurant segment will be driven by the growing KFC chain and the opening of the first TGI Friday’s restaurant in 2013

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of 2013 in Fort, the heart of Sri Lanka’s business district, but no further expansion plans beyond the opening of the first restaurant are currently available. We forecast that CTHR will open one new TGI Friday’s restaurant a year through FY16E.

KFC faces competition in the local market from other international fast food chains such as McDonalds, Pizza Hut and Dominoes, as well as competitors like stand-alone restaurants and smaller, informal wayside food stalls. While it still enjoys a considerable level of popularity amongst diners, KFC’s high price point relative to some of these smaller establishments, may negatively affect diner footfall.

Real estate and entertainment segments to make modest revenue

contributions

Real estate

We expect CTHR’s real estate segment to post low growth – with a CAGR of 3.8% over FY14E-FY16E. The segment makes up 1% of total revenue and consists primarily of CTHR’s listed subsidiary, CT Land Development PLC (CSE ticker: CTLD), and CT Properties, among other smaller companies. CTLD’s business activities comprise mainly the ownership and operation of Majestic City, one of the more popular shopping malls in the country. CT Properties is the property development arm of the segment and was responsible for the construction of the 100-unit Empire apartment complex, a leading residential condominium project completed in 2009. The company is now nearing the completion of its CT Gardens project, a residential township with 180 building plots, and has recently signed a preliminary JV agreement for the construction of GS Towers, a 260-unit luxury condominium project in Kotahena, a busy business and residential area 3km from the center of Colombo, at a reported cost of USD52m.

We believe CTHR is likely to use its considerable land bank for future development projects and have factored in the value of such investment properties in arriving at our valuation range (refer page 16 for further details).

The increasing level of economic activity in Sri Lanka and the inflow of expatriates into the country should also present CTHR with more opportunities to cater to the resultant growth in demand for premium office space and high-end apartments. However, several other property development companies are also competing for a share of this expected demand hike – an estimated 3,000 new high-end apartments and condominiums should enter the real estate market by 2018, possibly resulting in a supply glut, although the development of these projects will be phased out over the period.

Entertainment

We forecast entertainment revenues to grow at a CAGR of 6.4% through FY16E to reach LKR189m, although it will still account for only less than 1% of FY16E group revenues. We believe that this segment will benefit from the rising demand for leisure and entertainment activities from increasingly affluent middle-class consumers with growing disposable incomes. The segment operates several cinemas in Colombo and other main cities. Sri Lanka’s Central Bank Annual Report for 2012 stated that there was a 13% growth in leisure and entertainment spending over 2010-2012, further supporting the company’s decision to invest and overhaul its existing cinemas in FY11.

The real estate segment should benefit from CTHR’s extensive land bank; the entertainment segment stands to gain from the growing expenditure on leisure activities

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Net profit margin to improve 40bps to 2.3% in FY16E from

1.9% in FY13

We expect CTHR’s net profit margin from continuing operations to improve 40bps over the forecast period, as volume growth in key segments should offset losses in the real estate segment. Three key factors affecting CTHR’s margin are set out below.

Operating costs. This mainly consists of electricity and fuel expenses. Management stated that

electricity costs constitute 2-3% of CTHR’s revenue and the company is a large consumer of electricity, due mainly to CARG’s high electricity requirements for its supermarket chain and its capital-intensive food processing factories.

Finance costs. CTHR’s recent significant capex spend has led to a spike in its finance costs, as

detailed further below.

Depreciation. Higher depreciation charges are also the result of CTHR’s investment activities over

the past three years.

Rise in finance costs may weigh on short-term profit potential

As a result of CTHR taking on additional debt to finance its recent expansion plans, finance costs rose 113% YoY in FY13 and are likely to remain high until the company pays down its debt. CTHR’s management is reported to have said that the company will reduce its debt over the next two years. This rise in the company’s finance expenses, which accounts for 46% of EBIT in FY13, could weight down on CTHR’s profitability levels until debt levels are reduced.

Figure 13: Net profit margins from the retail, food processing and restaurant segments to drive CTHR margin growth

Source: CTHR

Retail and wholesale distribution margins to widen 47bps supported

by retail volume growth

We expect the retail and wholesale distribution segment’s net profit margin to expand 47bps in FY16E to 1.6% from 1.1% in FY13. This growth is likely to result from CTHR’s aggressive outlet expansion strategy driving retail revenue growth. Although this margin expansion appears modest, we believe it is noteworthy, as margins in the food retail sector are typically low (refer to Figure 10 for a peer comparison of margins), with the focus being on selling high volumes. In addition, the segment contributes 49% of the group’s net income, and, as such, even a slight expansion in the segment’s margin would boost overall net income.

Two factors tempering the segment’s margin expansion are rising electricity and fuel costs and, to a lesser extent, the imposition of the VAT from January 2013. Although CTHR does not disclose

-40%

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0%

20%

40%

2010 2011 2012 2013 2014E 2015E 2016E

Margin

Retail & wholesale distribution Real estate Food processing Restaurants Entertainment CTHR

CTHR’s margin should be driven by its retail and food processing segments, although margin growth may be tempered by rising operating costs

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13


the exact breakdown between its fixed and variable operating costs, we expect the recent fuel and electricity price hikes to drive up the cost of logistics and the operating cost of supermarkets, especially larger outlets, thereby restricting significant margin growth in the upcoming quarters. We believe the introduction of the VAT will also weigh on profitability of the segment, although CARG states that the impact from the tax has been mitigated to some extent.

Food processing margins to widen 127bps, driven by recent

investments in capacity expansion and new products

We forecast an expansion in CTHR’s food processing margins to 3.8% in FY16E from 2.5% in FY13, as investments in soft alcohol and the underperforming confectionary businesses weigh down on margin expansion in the short term. CTHR has invested LKR1.5bn to expand the capacity for dairy goods and LKR2-2.5bn to increase the production capacity for its soft alcohol range. Although such significant capex may limit margin expansion in the short term, we expect the dairy business to remain profitable and the brewery to turn around from FY15E. Furthermore, the launch of the Kist biscuits line in FY12 in an already competitive market is still below the company’s expected level of performance. We expect this product line to break even in FY15E, as improved distribution and marketing strategies raise the level of consumer awareness of the biscuit range.

The increase in electricity costs and VAT impact may temper margin growth in this capital-intensive segment, although CTHR does not disclose to what extent. There could, however, be some scope for upside margin surprise from potential price increases, particularly for ice creams, CTHR’s best-selling product. The relatively low competition in the market – ice cream is a de facto oligopoly – means that CTHR faces little resistance to increasing prices. If demand remains robust, CTHR could push through higher price hikes to bolster margins. With regard to the soft alcohol business, further rises in excise duties on alcohol would pressure margins in the segment; excise duties were increased twice during FY13 and most recently in August 2013.

Restaurant margins to expand 49bps fuelled by growing consumer

demand in the local restaurant sector

We forecast the restaurant segment’s net profit margin to expand to 9.5% in FY16E from 9.0% in FY13, driven by the increasing consumer expenditure on dining out in hotels, cafes and restaurants, as well as increasing prices. In addition, the opening of the first TGI Friday’s restaurant should also boost margins slightly as we expect the restaurant to return higher margins compared with KFC. However, rising operating costs and input prices will continue to pressure margins in the segment. Relief in the form of increasing prices is also limited if the restaurants are to remain competitively priced and due to the already high price points charged.

Real estate margin to contract to 3.0% in FY16E, as new

developments weigh on margin

Margins in the real estate segment tend to be very volatile, and are affected by construction costs and the timing of apartment sales, which command significantly higher margins than rentals. We forecast a contraction in the segment’s net margin to 3.0% in FY16E from 43.8% in FY13, mainly affected by the construction costs of the GS Towers project. The development is slated for completion in 2018; however, we currently have no visibility on the projected revenue inflows and the timings of such.

The food processing segment should see its margin rise by 127bps due to its recent capacity expansions coming online and the growth in consumption levels

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High debt levels may lower earnings growth

High level of gearing and lack of cash generation could restrict

investment opportunities in the near term

Over the past three years, following the end of the 30-year civil war in Sri Lanka, CTHR has invested significantly in new business ventures, such as in the real estate segment, and in capacity enhancement of existing product lines. CARG alone is reported to have made more than LKR12bn in post-war investments, about 7.4x its FY13 net profit. Most of these investments have been funded through debt and, as a result, CTHR’s net debt increased to LKR14.6bn in 1QFY14 from LKR5.8bn in FY10. The company’s gearing level came in at 42% as at 1QFY14, compared with 30% in FY10.

In addition, CTHR’s free cash flow (FCF) generation has not been encouraging, with negative FCF reported every year since 2008, with the exception of 2010, resulting in a group FCF yield of negative 10% on average for the past three years.

We believe that CTHR’s divestment of its holding in Lanka Ceramic PLC for LKR2.9bn in May 2013 may provide a source of funds for debt repayment. CTHR has paid an interim dividend of LKR5 per share in June 2013 using part of the proceeds from the divestment.

Figure 14: CTHR’s net debt position is higher compared with peers’

Source: CTHR, respective company financial reports

Note: Figures are as of June 2013

Figure 15: CTHR’s net debt progression (FY10-1QFY14)

Source: CTHR

(20,000)

(10,000)

0

CT Holdings PLC Ceylon Cold Stores PLC Richard Pieris & Co. PLC Hemas Holdings PLC Nestle Lanka PLC

LKRm

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60%

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Net debt Gearing

Short term investment opportunities may be curbed by current debt position

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High debt levels could restrict CTHR’s ability to make further acquisitions or additional large investments until some part of this is paid down and the liquidity position improves.

In Figure 16, we have highlighted a few of the larger acquisitions CTHR has been involved in over the past three years. Management noted that these transactions were carried out mainly to benefit from the economies of scale and compete more closely with multinational food retailers, which account for around 70% of all branded food sales in supermarkets in Sri Lanka.

CTHR’s investment activities include enhancing its ice cream factory, improving the Kist jam and cordial plant and expanding its meat processing plant. Further, as mentioned previously, CTHR also expanded its dairy, brewery and confectionery businesses, including the acquisitions of Kotmale Holdings, McCallum Breweries and Diana Biscuits, detailed in Figure 16.

Figure 16: CTHR has expanded its business lines through acquisitions in the past few years

Year Target Description Transaction amount Comment

2010 Kotmale Holdings PLC Produces dairy products LKR922m Acquired a stake of 74%. This has now increased to 90.65

2010 Diana Biscuits Manufacturers (Private) Limited Manufactures and distributes biscuits

LKR350m Acquired the company's production plant

2010 Ceykor Aluminium Industries Limited Manufactures aluminum extrusions for the local market

LKR105m Acquired a 62% stake. Renamed as Swisstek Aluminium Limited in 2011

2011 McCallum Breweries (Ceylon) Limited, McCallum Brewing Company (Private) Limited and Three Coins Company (Private) Limited

Produces the Three Coins brand of beer

LKR1,425m

Source: CTHR, ft.lk, island.lk

During FY13, CARG has also finalized an agreement to establish a dairy hub in the northern part of Sri Lanka in order to further consolidate its dairy operations. Financial details for the project have not yet been disclosed.

Land bank may add to upside potential

CTHR’s entire real estate portfolio consists of about 130 acres of land in and out of Colombo as of March 2012; the two properties listed under Cargills (Ceylon) PLC in Figure 17 were detailed in CARG’s FY13 annual report. We believe that some of these properties could be used for future development projects and be a sizeable source of further value. In Figure 17, we have highlighted these specific sites and arrived at a valuation based on current market prices.

We believe that CTHR’s valuable land bank could be a noteworthy source of upside potential

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Figure 17: We estimate CTHR’s investment property land bank at LKR8.0bn

Land area (Acres) Value per acre

(LKRm) Current value

(LKRm)

C T Holdings PLC

Kandy 1.06 185 197

Nuwara Eliya 0.38 235 88

Negombo 0.57 192 109

Bandarawela 2.80 172 240

Cargills (Ceylon) PLC

Colombo 1 0.88 1,447 638

Colombo 2 0.51 690 177

Boralesgamuwa 2.50 290 725

Vauxhall Street - Colombo 2 1.50 1,271 1,906

Braybrooke Place - Colombo 2 0.49 1,047 511

C T Properties Lakeside (Private) Limited

Boralesgamuwa 43.00 52 2,236

C T Properties G S (Private) Limited

Kotahena - Colombo 13 1.23 400 490

Dawason Office Complex (Private) Limited

Colombo 2 0.59 1,115 655

Total 7,971


In our sum-of-the-parts (SOTP) valuation of CTHR, the land bank accounts for 32% of our estimated equity value for the company.

Trajectory of banking efforts evolving

CTHR and CARG are the joint sponsors of Cargills Agriculture and Commercial Bank (CACB), which will have a capital base of LKR5bn and is awaiting final approval from the CBSL to commence operations. CACB will operate as a commercial bank and offer a full range of conventional services such as corporate and project finance. We believe that the bank may have a particular focus on the microfinance space and cater to micro, small and medium enterprises (MSMEs), especially in the agricultural and agro-based sectors.

CACB was granted provisional approval by the CBSL in September 2011 and was originally scheduled to commence operations in July 2012, but this was pushed back several times due to delays in obtaining final approval.

The bank has a perceptible advantage in building out its branch network, as it will be able to use CARG’s extensive store footprint and set up small branches within these supermarkets. This should allow CACB to benefit from the low cost of setting up new branches and establish a presence in regional cities, where most farmers and other agricultural workers, the bank’s apparent target market, live.

CTHR and CARG each hold a 15% stake in CACB, each acquired for LKR660m, while two foreign investors – the International Finance Corporation (IFC) and DEG (a subsidiary of German state development bank KfW) – own 10% each. The IFC, the private sector investment arm of the World Bank, is expected to provide a USD7.0m senior loan to support CACB’s debt funding requirements, in addition to making a USD3.8m equity investment (equivalent to 44m shares of CACB’s initial share capital). In July 2013, the Employees’ Provident Fund (EPF), Sri Lanka’s state-controlled pension fund, invested a reported LKR550m to acquire a 10% holding in CACB, including a director board seat, according to the local Daily Mirror journal.

As more detailed and confirmed plans for the bank have not yet been formally announced, we have taken a conservative view and not factored this in our estimates. Furthermore, since CTHR’s

Visibility on the impact of the new banking venture is currently limited; CACB is awaiting final approval from the CBSL

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holding in CACB is only 15%, the bank would be accounted for only as an associate and, as such, its impact on CTHR’s operations may be limited.

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We establish a valuation range of LKR126-153 for CTHR

We arrive at a valuation range of LKR126-153 for CTHR, compared with the current share price of LKR140 as of 4 September 2013. We have arrived at this valuation range using scenario analysis with the discounted cash flow (DCF)/SOTP valuation technique and a P/E-based valuation approach. For comparison, we have also assessed CTHR’s valuation levels relative to a group of peers.

Figure 18: Valuation range analysis provides a range of LKR126-153 per share (current share price: LKR140)

Source: Amba estimates, CTHR, Bloomberg

DCF/SOTP analysis returns a valuation range of LKR126-153 per share

We have used a combined DCF/SOTP method to arrive at our valuation range for CTHR. We used base-case assumptions of a risk-free rate of 9.5% and a market risk premium of 5.0%, yielding a value of LKR135 per share.

The assumptions we have made for each segment are presented below. Other elements of our valuation approach include the following:

We conducted a DCF analysis for all five segments, with explicit forecasts over FY14E-FY16E, followed by a fade period up to FY22E.

We value CTHR's investment property portfolio (see Figure 17) based on our assumption that these properties may be used for future development projects and provide future upside to CTHR's valuation. We have valued these properties based on average market land prices for the areas they are located in.

We assume a target capital structure of 50/50 for all segments, compared with CTHR's current capital structure of 62% equity and 38% debt.

The following tables reflect 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.

We arrive at our segmental enterprise value (EV) by discounting the unleveraged FCF values over the explicit and fade periods at the segmental WACC.

127

126

120 170

140

153 140

0

1

50 100 150 200

52-Week Range

P/E analysis

DCF

Our base case assumes a risk-free rate of 9.5% and a market risk premium of 5.0%

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Figure 19: Amba DCF/SOTP assumptions schedule

Retail and wholesale distribution and food processing

WACC assumptions

FY14E

Target capital structure 50/50 EBIT total 2,408

Cost of equity 14.5% FCF 831

Cost of debt 13.0% Terminal value (undiscounted) 49,855

Terminal growth rate 3.0%

Effective tax rate 28.0% EV 32,688

WACC 11.4%

Restaurants

WACC assumptions

FY14E

Target capital structure 50/50 EBIT total 295





WACC 12.1%

Real estate

WACC assumptions

FY14E






WACC 12.2%

Entertainment

WACC assumptions

FY14E



Cost of debt 13.0% Terminal value (undiscounted) 161


Effective tax rate 28.0% EV 116

WACC 12.1%

Source: Amba estimates

Figure 20 lists the segmental and other contributions to our base-case value per share.

Figure 20: Segmental and land bank contribution to CTHR’s value per share

Equity value (LKRm) LKR per share Contribution mix

Retail and wholesale distribution, and FMCG 34,413 178.5 132%

Real estate 1,679 9.2 7%

Restaurants 1,633 8.9 7%

Entertainment 116 0.6 0%

Cash and cash equivalents 850 4.6 3%

Short-term investments 343 1.9 1%

Debt (15,806) -86.3 -64%

Minority interests (4,715) -25.8 -19%

Dormant land bank 7,971 43.5 32%

Total 24,759 135.2 100%

Source: Amba estimates

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We have also constructed bull- and bear-case scenarios to supplement our base-case DCF valuation, mainly based on our projections for CARG’s store openings and performance, since this is CTHR’s largest top-line contributor. The key distinguishing factors of these are as follows:

Bull case: Here we assume that CARG will open 27, 20 and 13 stores annually over FY14E -FY16E. This is in comparison to 22, 14 and 10 openings for the period in our base case. In this scenario, we assume that the retail segment will perform above our expectations, supporting the accelerated pace of store openings. This scenario would yield a share price of LKR153.

Bear case: Conversely, if the retail segment does not meet expectations due to sluggish consumption levels, CARG may decide to slow down its store network expansion plans and open only 19, 10 and 9 stores annually over the explicit forecast period, resulting in a share price of LKR126.

P/E analysis yields a valuation range of LKR127-140 per share

CTHR’s 12-month forward P/E has ranged between 17.3x and 41.2x since September 2010, and the share has traded at a 12-month average forward P/E of 22.8x. The share currently trades at 23.9x its 12-month forward EPS (based on Amba forecasts), 10% below its historical average.

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

Optimistic scenario: In this scenario, we expect shares to trade at a 24.0x forward multiple, based on our FY14E EPS estimate, implying a 5% premium to the share's historical average. This valuation outlook may arise from several favorable factors, such as better-than-expected growth in the food retail business driven by improving consumer demand and an increase in the proportion of shopping done at supermarkets. We applied the 24.0x forward P/E to our FY14E EPS estimate of LKR5.85 to arrive at a value of LKR140 per share.

Conservative scenario: Here, investors may place a discount on the CTHR share due to sluggish consumption levels affecting the performance of the retail and food processing segments. By assigning a 5% discount to its 12-month forward P/E, implying a 21.7x multiple applied to FY14E EPS, we arrive at a share price of LKR127.

Figure 21: CTHR forward P/E band chart

Source: CTHR, Bloomberg

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300

Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13

LKR

15x 21x 28x 34x 40x MPS

Our optimistic scenario assumes a 5% premium to account for a higher-than-expected rise in consumer demand, while we apply a 5% discount in our conservative scenario to adjust for low growth in consumption levels

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Sources for additional potential upside/downside

Listed below are some possible sources of valuation upside that we have not factored into our modeling of CTHR's financial performance:

Retail and food processing: As the food retail segment continues to grow, revenues (and possibly margins) could grow faster than our forecasts. Since CTHR's retail and wholesale distribution and food processing segments account for 95% of revenue and 64% of net profit attributable to the equity owners of the company, a better-than-expected performance could have a disproportionately large impact on overall margins.

Investments: CTHR plans to launch Cargills Agriculture and Commercial Bank (CACB) and is currently awaiting final approval from the CBSL. While details of the bank's start-up and operation plans are limited, CTHR is likely to take advantage of CARG’s extensive outlet network to expand its own network by setting up bank branches inside each retail store at low cost. This new venture could very well be a source of upside potential for the CTHR share.

Real estate: CTHR has signed a preliminary JV agreement for the construction of a luxury condominium complex in the heart of Colombo. The project should be completed in 2018, and should bring in additional revenue and profit for CTHR. Additionally, the company may also start new development projects using some of its potential investment property land bank in Colombo and regional cities (refer to Figure 17 for more details on CTHR’s dormant land).

Restaurants: The company plans to open its first TGI Friday’s restaurant in 3QFY14E, which should add to top-line growth in the segment, although we do not have any indication as to what sort of revenue inflow is expected from the restaurant annually. We have accounted for the opening of one new TGI Friday’s restaurant per year in our explicit forecast period until FY16E. We have made this conservative assumption as there is no visibility on its potential expansion plans yet, leaving room for potential upside for this segment.

Entertainment: CTHR plans to open a new shopping mall in Jaffna in 3QFY14E, including three new cinema screens, which should add to top-line growth in the entertainment segment.

However, there are risks to our valuation that could result in some downside to our estimates for CTHR. Retail operations may post only sluggish growth, which could impact our forecasts considerably, since this is by far the largest segmental component of revenue. The food processing segment may remain affected by the currently loss-making brewery and biscuit businesses for longer than we expect. In addition, ongoing increases in electricity and fuel costs may affect both these segments more than expected, with the retail operations additionally hit by the VAT, although CARG states that the impact from the tax on its operations are minimal. The real estate segment may also underperform as a result of delays or weak demand for current development projects brought on by stiff competition from new condominiums and other high-end residential schemes.

We have not factored in relative valuation in our price range

Figure 22 compares CTHR’s valuation metrics relative to its peers’. The share is trading at an FY14E P/E of 23.9x, at a premium to its peer average of 19.5x.

Owing diversified companies’ range of activities, choosing an appropriate group of peers is challenging. Therefore, we have included a list of companies that, though imperfect, provides some measure of comparison for CTHR with other regional conglomerates.

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Figure 22: CTHR trades at a discount to its peer group on most measures

Company name

P/E EPS CAGR FCF yield

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

CT Holdings PLC 29.3x 28.3x 22.2x 23.9x 21.3x 2.0% 12.7% -15.9%

Domestic peers

Ceylon Cold Stores PLC 81.2x 3.8x 6.7x NA NA NA 3.0% 3.2%

Richard Pieris & Co. PLC 15.4x 5.6x 6.7x 6.9x 6.3x 7.6% 4.6% 4.2%

Hemas Holdings PLC 19.5x 11.6x 8.4x 8.5x 7.1x 20.4% -0.6% 5.6%

Nestle Lanka PLC 17.9x 28.8x 38.4x 33.2x NA NA 2.7% NA

International peers

Sumber Alfaria Trijaya Tbk PT 37.6x 40.5x 37.5x 29.4x 22.8x 29.0% -0.2% NA

Midi Utama Indonesia Tbk PT 38.7x 50.6x 45.9x NA NA NA -2.1% NA

Philippine Seven Corp. 25.2x 78.6x 91.8x NA NA NA 0.0% NA

Mean 35.1x 23.5x 23.9x 19.5x 12.1x 19.0% 1.1% 4.3%

Median 28.5x 20.2x 22.9x 18.9x 7.1x 20.4% 0.0% 4.2%

High 81.2x 50.6x 45.9x 33.2x 22.8x 29.0% 4.6% 5.6%

Low 15.4x 3.8x 6.7x 6.9x 6.3x 7.6% -2.1% 3.2%

Source: CTHR, Bloomberg, Amba estimates Note: CTHR multiples are based on Amba estimates. Peer multiples are Bloomberg estimates. FY13 P/E multiples for Nestle Lanka PLC and all international peers are Bloomberg estimates and not actuals

Share price performance

CTHR shares closed at LKR140 on 4 September 2013, having appreciated by 7% YoY (LKR10) from the same time last year, compared with a 9% increase in the S&P SL 20 and a 7% jump in the All Share Price Index (ASPI) over the period.

Figure 23: Share price performance graph


Figure 24 shows that CTHR has outperformed the local indices within the last year, while only underperforming the S&P SL20 index in the one year period comparison.

2,000

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Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13

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CTHR ASPI S&P SL 20

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Figure 24: CTHR vs key indices

3 months 6 months 1 year 2 years 3 years

CTHR -3% 8% 7% 0% -16%

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

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


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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 CTHR’s performance across these key areas and revise our forecasts and update our valuation range in earnings update notes.

For the group as a whole:

1. Have debt levels further increased to fund expansion-related activities? Such an increase could weigh down on profitability due to the associated rise in finance costs.

2. Have any additional details on CACB emerged, specifically with regard to the opening date?

Retail and wholesale distribution segment

1. How many Cargills stores were opened during the period?

2. How have margins in the segment performed? What effect has VAT had on these margins?

Food processing segment

1. Has there been any indication on how ice creams sales have progressed in the period, since this is its highest-selling product group in the segment.

2. Have further capacity expansion plans been made for any product group?

3. Focus on the performance of beer and biscuits – have they started generating profits?

Restaurants segment

1. How many KFC outlets have been opened in the period?

2. Has the TGI Friday’s restaurant commenced operations? Have any expansion plans for the restaurant been detailed?

Entertainment segment

1. Have the cinemas in the Jaffna mall been opened and how have they performed in the period?

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Appendix 1: Company overview

CT Holdings PLC (CTHR) is the fourth-largest conglomerate listed on the Colombo Stock Exchange (CSE) by market cap – which stood at LKR26bn (USD193m) as at 4 September 2013 with a free float of 38.7%.

CTHR began operations as Ceylon Theatres Limited in 1928, with an initial focus on the Sri Lankan entertainment industry. The company grew and changed through numerous acquisitions and strategy evolutions. Today, its business activities are divided into five main segments: retail and wholesale distribution, food processing, restaurants, real estate and entertainment. The retail and wholesale distribution and food processing segments are the most significant contributors to CTHR’s top line and profit, bringing in 95% of revenue and 64% of net profit from continuing operations in FY13 (these two segments record lower margins than the company’s other segments). This discrepancy between contribution to revenue and net profit arises due to the retail and wholesale distribution segment’s lower net profit contribution – 58% in FY13 compared with 84% of revenue. The restaurants segment is the third-largest contributor to revenue (3% in FY13), but accounts for 16% of net profit.

In May 2013, CTHR sold off its 80.4% stake in Lanka Ceramic PLC for LKR2.9bn. Lanka Ceramic and its listed subsidiaries, Lanka Walltiles PLC and Lanka Floortiles PLC, previously made up CTHR’s ceramics and tiles segment, which was the second-largest contributor to the company’s top-line (12% in FY13) and net profit (21%) after the retail and wholesale distribution segment. As a result of this transaction, CTHR also disposed of its interests in its plantations and packaging segments, which together contributed 6% to group revenues and 6% to net profit in FY13.

Figure 25: Retail and wholesale distribution and food processing contribute 95% of FY13 revenue

Figure 26: Retail and wholesale distribution and food processing segments account for 64% of net profit

Source: CTHR Source: CTHR

CTHR posted revenue from continuing operations of LKR56.1bn for FY13, at a CAGR of 15.2% over FY10-FY13. The company generated net profit at a 27.5% CAGR over FY10-FY13 to reach LKR1.1bn in FY13.

0

20,000

40,000

60,000


LKRm

Entertainment Restaurants

Food processing Real estate

Retail & wholesale distribution

(400)

200

800

1,400

FY08 FY09 FY10 FY11 FY12 FY13

LKRm

Entertainment Restaurants

Food processing Real estate

Retail & wholesale distribution

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CTHR’s key businesses

The group’s retail and wholesale distribution segment is the largest contributor to revenue (84%

of revenue and 49% of net profit in FY13) and mainly consists of the activities of subsidiary Cargills, in which CTHR holds a 70.0% stake.

Retail – CTHR subsidiary Cargills (CSE ticker: CARG) operates the largest private supermarket chain in Sri Lanka. As at end-March 2013, the company operated 211 stores across all 25 districts of the country, far ahead of its rivals Keells Super (51 outlets) and Arpico (44 outlets). In terms of revenue, its LKR44.3bn is 3.2x larger than Keells Super and 2.8x larger than Arpico. The company states that it holds about 45% of the modern food trade market. The chain’s outlets have two formats: Cargills Food City supermarkets, which have a floor space of 3,000-5,000 sq. ft and therefore carry a wider range of stock keeping units (SKUs), and Cargills Food City Express outlets, which are convenience stores with an average floor space of 2,000 sq. ft.

In August 2013, CARG submitted a proposed restructuring of its retail operations that would see its entire retail business carried out by a wholly-owned subsidiary, Cargills Food Company (Private) Limited. CARG would then function only as an investment holding company for the other segments within the group.

Wholesale distribution – Cargills’ distribution and marketing company Millers Limited holds the agency rights for a variety of international brands, including Kodak, Kraft and Cadbury. Additionally, the company has an extensive distribution and logistics network, and distributes these brands as well as the company’s own brands to CARG outlets and other supermarkets and food retail stores.

The food processing segment (12% of revenue and 15% of net profit in FY13) manufactures a

range of FMCG products, under a number of popular household brand names. The segment’s portfolio of product offerings has expanded significantly in recent years and competes with international competitors such as Nestle. The main brands under this segment are as follows:

Magic/Heavenly ice cream – Cargills stated that it is the largest dairy ice cream player in the country and through its 70.0% owned subsidiary Cargills Quality Dairies produces a range of ice creams, milk and milk shakes.

Kotmale – Kotmale Holdings PLC (CSE ticker: LAMB) is a local manufacturer and distributor of dairy products. CTHR holds a 59.5% stake in the company. The brand has been in the market for about 30 years. It produces a variety of dairy products including cheeses, ice creams, ultra-high temperature (UHT) milk, yoghurt, fresh cream and ghee.

Kist – This brand’s product portfolio includes a range of jams, sauces, cordials, fruit-based nectars and, more recently, and juices.

Kist Biscuits – Following the acquisition of Diana Biscuits Manufactures (Private) Limited in 2010, Cargills Quality Confectioneries manufactures, distributes and markets biscuits and

Figure 27: Revenue grew at a 15.2% CAGR over FY10-FY13 Figure 28: Net profit grew at a 27.5% CAGR over FY10-FY13

Source: CTHR Source: CTHR

0%

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10%

15%

20%

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confectionaries. The segment has yet to perform up to management expectations amid a highly competitive local biscuit market.

Supremo/Finest/Goldi/Sams – CARG manufactures several types of processed meats under these brand names, ranging from mass-market products to a premium deli range. The company also exports processed foods and meats to India, the Middle East and the Maldives.

Three Coins/Sando/Irish Dark/Grand Blonde – The acquisition of McCallum Brewery Limited in 2011 signaled Cargills’ entry into the local beer market. The company’s brewery operations produce a range of premium as well as mass-market beers.

CTHR’s restaurants segment (3% of revenue and 16% of net profit in FY13) consists of the

Kentucky Fried Chicken (KFC) chain of restaurants. The company has indicated that it is looking to expand its operations in this segment and, to that end, in September 2012 signed a development agreement to open the first TGI Friday’s restaurant in the country. The first outlet of this international restaurant chain is scheduled to open at the end of 2013.

KFC – Cargills holds the franchise for KFC, the largest international fast food chain in Sri Lanka, which currently has 23 outlets, mostly in Colombo and its suburbs. The restaurant is one of the most popular chains in the country and the company plans to continue to open new outlets in regional cities in response to initial encouraging demand in these areas, as well as expanding in Colombo and its suburbs.

The group’s real estate segment (1% of FY13 revenue and 19% of net profit) comprises CTHR’s

listed subsidiary, CT Land Development PLC (CSE ticker: CTLD), in which CTHR holds 51.9%, as well as several other smaller property companies. The main activities in the segment are the management of a shopping mall and property development projects.

CT Land Development (CTLD) – The company owns and is responsible for the management of the Majestic City shopping mall in Colombo. Revenue from CTLD made up 81% of total segment revenue in FY13.

Property development – CTHR’s real estate projects are carried out by its property arm CT Properties Limited, an unquoted subsidiary in which CTHR holds an 86.1% stake.

Empire – This is a 100-unit residential apartment complex in central Colombo that was completed in 2009. All units of the complex have been sold.

CT Gardens – This is a township development project developed in Piliyandala, a populated suburb around 20km south of Colombo, and this consists of 180 building plots with 12 different house designs. The plots can also be sold off only as land.

GS Towers – This 240-unit apartment complex is currently being developed by CT Properties on a 1.25-acre site in Kotahena, 3km from the commercial center of Colombo. In FY13, the company signed a JV agreement with Edmonton Private Limited, based in Singapore, for the construction of the complex. Currently, the project is in the design stage, and the company estimates it to cost USD52m.

Through its private subsidiary Ceylon Theatres (Private) Limited – in which CTHR holds a 76.0% stake – the entertainment segment (less than 1% of FY13 revenue and net profit) manages

CTHR’s cinemas, which includes four screens at the Majestic City shopping mall in Colombo, including the first 3D screen in the country. The segment also includes its other movie theatres – Regal Colombo, Regal Negombo and Regal Kandy. The company plans to develop three new screens at an upcoming shopping mall in Jaffna, in the northern part of Sri Lanka.

Management strategy, transparency and governance

Over the past three years, CTHR has made numerous acquisitions and investments into new sectors, frequently expanding its range of business lines and expanding its product portfolios within segments. The group has sold some businesses in order to fund what it believes are higher-return investment opportunities. Management notes that, broadly speaking, the company’s strategy is to invest in sectors that will grow with the economy as a whole, with the current focus being on the food retail and processing, restaurants, real estate, entertainment and financial segments. This is highlighted by the May 2013 divestment of its listed company Lanka Ceramics PLC (CSE ticker: CERA) and its subsidiaries, which contributed 18% of group revenue and 29% of net profit in FY13.

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However, CTHR typically does not release many details on its business strategy and investment plans. We believe improved articulation regarding the company’s business strategy and a higher level of segmental financial disclosure could help investors better understand the company.

We believe CTHR’s disclosure can be improved in the following areas.

The company does not disclose EBITDA/EBIT composition and working capital details on a segment basis. Investors could better understand the company's profitability of the company if this information was available.

There is very little, if any, performance-related information disclosed on a group or segment basis. For example, the Cargills store count is not disclosed on a quarterly basis, while store sales space data are not published at all. As a result, forecasting segmental and quarterly results is particularly challenging, and requires analysts to make a number of sweeping assumptions to do so.

Annual reports could be published in a more timely manner. It would be more relevant and helpful to investors and analysts if the company’s annual reports are released sooner after the end of its financial year.

Shareholding structure

Sri Lanka-based investors hold the majority (86%) of CTHR’s shares, while institutional investors (both domestic and international) hold 59% overall as of March 2012 (the complete shareholder breakdown was most recently disclosed only in the company’s FY12 annual report). CTHR’s directors hold a 20% stake in the company. We estimate that individual members of the Page family, who founded and own a majority stake in the company through various holdings, hold personal stakes in CTHR amounting to almost 30% of the company, based on the top 20 shareholder list disclosed by the company. The Page family also holds a controlling interest in Odeon Holdings – the largest shareholder – bringing the family’s total holding in CTHR to around 71% as at June 2013.

Figure 29: 86% of CTHR’s investor base is domestic Figure 30: Individual investors, including directors, account for

41% of total shareholding

Source: CTHR, as of March 2012 Source: CTHR, as of March 2012

Top shareholders

The following table shows CTHR’s top five shareholders as of June 2013. The top 20 shareholders hold about 88% of the group.

CTHR directors

20%

Domestic investors

66%

International investors

14%

CTHR directors

20%

Institutional investors

59%

Individual investors

21%

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Name of shareholder Description Stake

Odeon Holdings (Ceylon) (Pvt) Ltd An investment company controlled by the Page family 41.6%

Mr. Anthony A. Page Chairman of CTHR 8.7%

Mr. Ranjit Page Managing director of CTHR 6.0%

Sir Chittampalam A Gardiner Trust A private family trust fund 5.0%

Ms. M.M. Page Director at Asiabox Consultancy Services, based in Singapore 4.3%

Source: CTHR, as of June 2013

Board of directors

As of June 2013, CTHR’s board comprised nine directors. Five directors, including the chairman and deputy chairman, are members of the Page family. The details of the board of directors are provided below.

Name of Director Description

Mr. Anthony A Page Non-executive chairman. He has been the chairman since April 2003. He has previously served on the board of

the CSE and was a council member of the Employers Federation of Ceylon.

Mr. Louis Page Non-executive deputy chairman. He has been engaged in determining policy framework for CTHR in a non-

executive capacity. He is also the chairman of Cargills (Ceylon) PLC.

Mr. Ranjit Page Managing director. He is also the deputy chairman and CEO of Cargills (Ceylon) PLC. He has over 29 years of

experience in the food retailing, food service and manufacturing sectors.

Mr. Jebba De Silva Independent non-executive director. He is an attorney-at-law and a past chairman of the Colombo Rubber

Traders’ Association.

Mr. Sunil Mendis Independent non-executive director. He is a former governor of the CBSL and was previously the chairman of

Hayleys PLC, a large Sri Lankan conglomerate.

Mr. Joseph Page Non-executive director. He is also the deputy chairman/managing director of CT Land Development PLC and a

director of CT Properties Limited. He was formerly an executive director at Millers Limited.

Mr. Priya Edirisinghe Independent non-executive director. He is a Consultant at HLB Edirisinghe & Co., Chartered Accountants and is

also the chairman of CTHR’s executive and audit committees.

Mrs. Cecilia Muttukumaru Non-executive director. She also serves as the chairperson of CT Smith Stockbrokers (Private) Limited, CT

Capital (Private) Limited and Comtrust Asset Management (Private) Limited.

Mr. R Selvaskandan Independent non-executive director. He is an attorney-at-law (Sri Lanka) and a solicitor (England and Wales

and Hong Kong). He also holds the position of chairman at CT Land Development PLC, deputy chairman at CT

Properties and is a partner at Varners, a Sri Lanka-based law firm.

Source: CTHR

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Figure 31: CTHR Corporate Holding Structure

Source: CTHR

CTHR holds stakes in three listed companies, namely Cargills (70.0%), CT Land Development (51.9%) and Kotmale Holdings (59.5%).

CT Holdings PLC

Retail and wholesale

distribution

Food processing

Restaurants

Real estate

Cargills Quality Foods Limited (70.0%)

Kotmale Holdings PLC (59.5%)

Cargills Quality Confectionery (Pvt) Limited (70.0%) - Kist Biscuits

Millers Brewery Limited (70.0%) - Three Coins/Sando/Irish Dark/Grand Blonde beer

Cargills Quality Dairies (Pvt) Limited (70.0%) - Magic/Heavenly ice cream

Cargills Food Processors (Pvt) Limited (70.0%) - KFC

Millers Limited (70.0%) - distribution

Cargills (Ceylon) PLC (70.0%) - Cargills Food City supemarkets

CT Land Development PLC (51.9%)

CT Properties Limited (86.1%)

CT Real Estate (Pvt) Limited (86.1%)

Entertainment Ceylon Theatres (Pvt) Limited (76.0%)

Cargills Agrifoods Limited (70.0%) - Kist products

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Appendix 2: Key financial data

Summary group financials (LKRm)

INCOME STATEMENT 2011 2012 2013 2014E 2015E 2016E

(For the year ended 31 March)

Revenue 47,045 59,283 68,236 63,319 70,385 76,774

Revenue - Continuing operations 38,455 48,848 56,050 63,319 70,385 76,774

Interest expense (806) (965) (2,060) (2,588) (2,743) (2,811)

Earnings before Tax (EBT) 2,894 3,160 2,961 1,633 2,094 2,494

Net profit 2,295 2,357 2,158 1,061 1,508 1,795

Net profit - Continuing operations 1,118 1,248 1,084 1,061 1,508 1,795

BALANCE SHEET 2011 2012 2013 2014E 2015E 2016E

(As at 31 March)

Current assets 842 872 1,181 1,293 1,634 1,878

Cash and cash equivalents 47 34 2,424 343 343 343

Short-term investments 4,159 4,951 4,891 3,527 4,538 5,758

Accounts receivable 5,487 7,612 8,834 4,301 5,023 6,278

Inventories 11,139 13,987 18,457 11,161 13,235 15,954

Total current assets 842 872 1,181 1,293 1,634 1,878

Non-current assets

Property, plant and equipment 19,014 23,542 28,745 22,290 23,291 24,255

Leasehold property 1,730 2,407 2,068 1,981 1,981 1,981

Investments in associates/JVs 52 75 148 156 165 178

Total non-current assets 23,824 29,326 41,868 37,413 38,423 39,400

Total assets 34,963 43,313 60,326 48,574 51,659 55,355

Current liabilities

Short-term debt 7,796 9,624 15,783 12,817 12,817 12,817

Accounts payable 6,443 8,704 9,543 7,591 8,371 9,582

Income tax payable 472 426 362 452 452 452

Total current liabilities 14,751 18,806 25,743 20,904 21,685 22,896

Non-current liabilities

Long-term debt 2,193 2,453 4,538 3,815 4,837 5,795

Post-retirement benefit obligation 702 806 1,004 351 351 351

Total non-current liabilities 3,958 4,556 7,204 5,189 6,211 7,169

Equity

Common share capital 517 3,194 3,194 3,194 3,194 3,194

Retained profit 3,638 4,272 10,628 10,900 11,875 13,035

Minority interest 7,334 7,680 9,924 4,904 5,210 5,576

Total equity 16,254 19,951 27,379 22,481 23,763 25,289

Total liabilities and equity 34,963 43,313 60,326 48,574 51,659 55,355

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


Operating activities

Net cash flow from operating activities 2,501 2,125 2,820 3,751 5,003 4,927

Investing activities

Purchase of PPE and intangible assets (3,264) (5,617) (6,487) (3,117) (2,815) (2,687)

Net cash flow from investing activities (4,844) (6,166) (7,541) (2,841) (2,715) (2,562)

Financing activities

Debt issuance/(repayment) (1,231) (598) (1,063) 178 1,022 958

Common share issuance/(repurchase) - 2,677 - - - -

Interest paid (806) (965) (2,060) (2,191) (2,743) (2,811)

Dividends paid to common shareholders (204) (287) (375) (1,035) (226) (269)

Net cash flow from financing activities 1,286 1,715 6,926 (360) (1,947) (2,122)

Net increase/(decrease) in cash and cash equivalents (1,057) (2,326) 2,205 550 342 244

Key ratios

2011 2012 2013 2014E 2015E 2016E

Growth

Revenue growth (%) 19.5% 24.6% 11.4% 10.5% 9.0% 6.9%

EBITDA growth (%) 32.6% 16.1% 10.7% -25.2% 10.1% 9.1%

EBT growth (%) 90.4% 9.2% -6.3% -44.9% 28.3% 19.1%

Net profit growth (%) 246.4% 11.6% -13.2% -2.1% 42.1% 19.1%

Margins

EBITDA margin (%) 10.5% 9.7% 9.3% 7.5% 7.4% 7.4%

EBT margin (%) 6.2% 5.3% 4.3% 2.6% 3.0% 3.2%

Net profit margin (%) 2.9% 2.6% 1.9% 1.7% 2.1% 2.3%

ROCE (%) 13.6% 9.6% 6.5% 4.7% 6.5% 7.5%

ROE (%) 10.5% 9.7% 9.3% 7.5% 7.4% 7.4%

Liquidity and efficiency

Current ratio (x) 0.8 0.7 0.7 0.5 0.6 0.7

Total asset turnover (x) 1.3 1.4 1.1 1.3 1.4 1.4

Gearing and cash Flow

Debt/Capital (%) 38.1% 37.7% 42.6% 42.5% 42.6% 42.4%

Interest cover (x) 4.5 4.2 2.2 1.0 1.2 1.4

Free cash flow (FCF) yield (%) -2.2% -12.7% -15.9% 2.5% 8.6% 8.8%

Net debt/FCF (x) (11.9) (3.2) (4.6) 23.7 7.2 7.3

Valuation

P/E (x) 25.4 28.2 22.1 23.9 21.3 17.9

P/BV (x) 3.8 2.2 1.3 1.5 1.4 1.3

EV/Sales (x) 1.1 0.8 0.7 0.6 0.6 0.5

EV/EBITDA (x) 10.2 8.1 7.6 8.6 7.9 7.4

EV/EBIT (x) 13.8 11.4 10.9 15.1 12.1 10.6

EV/FCF (x) (66.2) (13.3) (13.2) 64.0 18.8 18.7

Dividend yield (%) 1.0% 1.1% 0.0% 0.6% 0.9% 1.1%

Dividend cover (x) 9.0 6.3 NA 6.7 6.7 6.7

Note: Revenue and net profit growth are for continuing operations

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

Recurrent diluted EPS (LKR) 5.9 6.4 6.3 5.8 6.6 7.8

Common dividend per share (LKR) 1.5 2.1 - 0.9 1.2 1.5

Book value per share (BVPS) 52.4 67.7 95.3 96.0 101.3 107.7

Net operating cash flow per share 14.7 11.7 15.4 20.5 27.3 26.9

Net cash flow per share (6.2) (12.8) 12.0 3.0 1.9 1.3


Segmental summary


Retail and wholesale distribution 2011 2012 2013 2014E 2015E 2016E

Revenue 33,880 42,205 46,998 51,938 56,603 60,521

PAT 630 926 533 731 853 968

YoY growth

Revenue 19.5% 24.6% 11.4% 10.5% 9.0% 6.9%

PAT 120.8% 47.0% -42.5% 37.2% 16.7% 13.5%

Margins

PAT 1.9% 2.2% 1.1% 1.4% 1.5% 1.6%

Food processing 2011 2012 2013 2014E 2015E 2016E

Revenue 2,387 4,666 6,468 8,255 10,071 11,934

PAT 405 195 164 101 352 453

YoY growth

Revenue 43.9% 95.5% 38.6% 27.6% 22.0% 18.5%

PAT 4.7% -51.8% -16.3% -38.0% 247.5% 28.7%

Margins

PAT 17.0% 4.2% 2.5% 1.2% 3.5% 3.8%

Restaurants 2011 2012 2013 2014E 2015E 2016E

Revenue 1,119 1,383 1,955 2,457 3,017 3,602

PAT 125 194 176 213 278 342

YoY growth

Revenue 32.4% 23.6% 41.3% 25.7% 22.8% 19.4%

PAT 185.3% 54.5% -9.1% 20.9% 30.4% 23.3%

Margins

PAT 11.2% 14.0% 9.0% 8.7% 9.2% 9.5%

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Real estate 2011 2012 2013 2014E 2015E 2016E

Revenue 1,001 489 472 503 517 528

PAT (38) (68) 207 1 10 16

YoY growth

Revenue 125.8% -51.2% -3.4% 6.6% 2.6% 2.1%

PAT -90.4% 78.5% -406.2% -99.3% 595.5% 53.2%

Margins

PAT -3.8% -13.8% 43.8% 0.3% 2.0% 3.0%

Entertainment 2011 2012 2013 2014E 2015E 2016E

Revenue 69 105 157 165 177 189

PAT (4) 1 5 11 8 16

YoY growth

Revenue -2.0% 53.0% 49.8% 5.3% 7.0% 7.0%

PAT 568.6% -124.8% 346.4% 134.7% -0.6% 9.7%

Margins

PAT -6.1% 1.0% 2.9% 8.6% 8.0% 8.2%


Note: PAT refers to proft after taxation from continuing operations

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 two key industries in which CTHR operates.

Organized food retail

Conclusion: The industry should remain neutral through 2016

The organized food retail sector in Sri Lanka is dominated by a few large firms. The industry is highly competitive and still in its growth phase, with opportunities for revenue growth resulting from rising disposable income in Sri Lanka. Customers can choose whether or not to go to a retail store, as most products sold are day-to-day FMCG items, for which substitutes are freely available in open-air markets or other small grocery stores. Moreover, consumers have very little brand loyalty. However, if large retail chains expand their distribution networks, manage the impact of new regulations and retain their customer base, they can generate margin growth.

Threat of new entrants – low

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

Barriers to exit – moderate

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

Rivalry among competitors – high

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

Bargaining power of buyers – high

The industry is home to a large number of consumers who remain extremely price conscious, despite rising GDP and the desire for a more comfortable lifestyle. They are not willing to pay significantly higher prices for products that are readily available at a considerably lower price elsewhere. The generic nature of FMCG products and the highly elastic nature of demand mean there are several substitutes available and customer switching cost is extremely low, as they can easily opt not to visit a large retailer for weekly FMCG requirements. Further, based on statistics from the CBSL, at the end of 2011, more than 40% of the average monthly household spend was

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on key FMCG products. This is a significant proportion of the buyer’s income, which should increase price sensitivity further.

Bargaining power of suppliers – low

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

Threat of substitutes – high

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

Government action – moderate

Most large retailers have been able to absorb the 12% VAT together with their suppliers, which means customers will not face any significant price increases. There is also a recent proposal to ban foreign investments in retail trade to protect domestic investors, although further details on this regulation are not yet available. The government reserves the right to make any tax and policy amendments in most areas, without having to give any prior notice to businesses. This creates uncertainty for the industry and the impact depends on how quick the businesses are in responding to such changes.

Food and beverage manufacturing

Conclusion: The industry should remain attractive through 2016.

Sri Lanka’s food and beverage manufacturing industry comprises branded F&B manufacturers such as Cargills, Keells, Nestle and Unilever. The customer base includes distributors, comprising large organized retailers, small local grocery stores/retailers and markets across Sri Lanka.

The sector should hold substantial opportunities for firms to increase volumes and revenues. The industry is likely to remain competitive, with key players constantly focusing on maintaining brand equity through innovation and product differentiation. Positive industry dynamics such as rising per capita GDP, a growing middle-class population, strong brand awareness and the government’s efforts to promote the domestic F&B sector are expected to stimulate industry demand.

The industry’s attractiveness also means that there is a threat of new entrants. The strong market positions of incumbent producers in the sector, and the economies of scale and low costs of production they enjoy relative to both smaller local competitors and international F&B companies contemplating entering the Sri Lankan market, somewhat diminish this risk, however.

Threat of new entrants – moderate

There are a few large established F&B manufacturers in Sri Lanka that mostly produce their own label/branded products in large quantities, and enjoy economies of scale and other cost advantages. Differentiation occurs through product variations (flavors, package sizes, etc.) and branding. Customer (retailer) brand loyalty is high – in the case of smaller retail customers, they may be compelled to stock these large local brands to attract customers, and in the case of larger organized retail customers such as Cargills and Keells, they may give preference to their own manufactured brands within the product ranges that they offer (e.g., ice-creams and soft drinks). Even though raw materials are easily available, a new entrant would have to incur high initial

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capital expenditure to set up a manufacturing facility, or else import goods for sale, which would force it to sell at higher prices. Furthermore, establishing a distribution network would be difficult, as the majority of the large locally established F&B manufacturers have their own retail distribution networks or have tied up with other large organized and smaller local retailers to sell their products.

Barriers to exit – moderate

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

Rivalry among competitors – moderate

A few large firms (Cargills, Keells and Nestle) dominate the F&B manufacturing industry in Sri Lanka. With anticipated increases in per capita GDP and consumer demands for a more convenient lifestyle, the demand for branded, high-quality F&B products should increase. High levels of product and brand differentiation enable existing players to compete on a distinct basis effectively and seek opportunities to increase volumes and market share. Innovation is critical in this industry to maintain brand equity and keep customers engaged. Existing firms may also have the option of enhancing capacity easily without the need for additional fixed costs (by simply adding on another shift at an existing factory).

Bargaining power of buyers – high

This analysis has been broken down to include both types of buyers:

Large organized retail buyers: high bargaining power – There are a few large organized retailers (including the manufacturers’ own distribution networks) in Sri Lanka that account for 15% of retail trade in the country. These include Cargills, Keells, Arpico, Laugfs and Sathosa. Although they account for a smaller proportion of the customer base, they can be considered more important than the smaller retail buyers, as they have more extensive distribution networks and will therefore account for a large volume of sales to the F&B manufacturer. Buyer switching cost is low (with the exception of retailers stocking own-branded products), as these organized retailers are aware of their importance to the manufacturers. As retail margins are generally low (2-3%) and since they purchase in bulk, these buyers should be able to squeeze the manufacturers’ margins, indicating higher bargaining power.

Small local retail buyers: low bargaining power – Small local retailers (buyers) account for 85% of the customer base for the large F&B manufacturers. However, they have lower bargaining power, because they buy in small quantities from the few large firms producing these locally branded, high-quality products (that are trusted and preferred by the local end-consumer). Brand differentiation is high, which makes switching costs high, as these small local retailers may be required to stock certain brands to meet demands from their customer base. Further, these small retailers do not have much room for margin improvement, as the large F&B manufacturers are in a more dominant position and will try to squeeze the smaller retailers ’ margins.

Bargaining power of suppliers – low

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

Threat of substitutes – moderate

Substitutes are available in the form of other local brands and some internationally branded items as well. However, customer switching costs may be high – smaller local substitute brands may not be well recognized and international brands may be too expensive for the end consumer, which would result in unsold inventories for retail distributors (who would consequently opt not to stock

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such brands). Therefore, existing branded F&B manufacturers would only be exposed to substitute brands from their direct local competitors.

Government action – favorable

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

equipment, and zero tax concessions on processed foods; making the industry more attractive.

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Appendix 4: SWOT analysis

Strengths Weaknesses

Cargills is one of the most valuable and recognized brands in the country

First-mover advantage with most of its new outlet openings

More comprehensive distribution network – more extensive than competitors

Holds a large and valuable land bank

Higher finance costs may temper profitability in the short term

Volatility in the real estate segment, particularly in terms of profitability

Opportunities Threats

Uptake in consumption appetite supported by rising disposable income in Sri Lanka

Further potential acquisitions to drive future growth

Any new taxes on supermarkets may further pressure margins

Risk of further pressure on operating costs such as electricity and fuel expenses through price hikes

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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 32: 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 33: Details of conglomerates listed on the main board of the CSE

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)

Restaurants

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 and free float 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 34: 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 35: 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: CBSL, Department of Census and Statistics Source: Central Bank of Economic and Social Statistics of Sri Lanka 2012, Road Map 2013 - CBSL

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, CBSL 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: CBSL Source: CBSL

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

2016E

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

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80

100

120

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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, CBSL 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

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1,000

1,500

2,000

2,500

3,000

2009 2010 2011 2012 2013(August)

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1,066 1,338

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1,500

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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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