Sri Lanka | Diversified Holdings EQUITY RESEARCH Initiation of coverage 10 July 2013 Aitken Spence PLC (SPEN) A play on tourism and power Aitken Spence PLC (SPEN), the third-largest conglomerate listed on the Key statistics Colombo Stock Exchange (CSE) by market cap, has operations in the tourism, CSE/Bloomberg tickers SPEN.N0000/SPEN SL power, logistics and services industries, as well as smaller interests in a Share price (9 July 2013) LKR124 number of other businesses. We forecast SPEN to post a revenue CAGR of No. of issued shares (m) 406 3.4% over FY14E-FY16E. This modest revenue growth partly reflects the Market cap (USDm) 384 company’s significant exposure to the power sector, where the potential non- Enterprise value (USDm) 458 renewal of power purchasing agreements (PPAs) could hurt SPEN’s growth Free float (%) 40% prospects. However, growth in SPEN’s tourism segment should offset the 52-week range (H/L) LKR139/108 decline in its power operations. Our DCF valuation analysis and P/E analysis Avg. daily vol (shares, 1yr) 324,148 suggest a valuation range of LKR110-157, compared with the share price of Avg. daily turnover (USD 301 LKR124 as of 9 July 2013. ‘000) We expect SPEN’s revenues to increase at a 3.4% CAGR over FY14E-FY16E. Source: CSE, Bloomberg The group’s top-line growth should be fuelled mainly by the tourism segment, which Note: USD/LKR = 128.7 (avg. for the 1 year ended 9 July 2013) comprises hotels in Sri Lanka, the Maldives, Oman and India. A 13.8% addition to room inventory, a 430bps increase in blended occupancy levels and rising average Share price movement room rates (ARRs) should boost the segment’s revenue over the forecast period. This, together with a modest 5.3% revenue CAGR over FY14E-FY16E from the cargo 140% logistics and services segments, should help compensate for the anticipated 4.8% CAGR decline in the strategic investments segment revenue over the forecast period. 120% We expect SPEN’s EBITDA margin to rise 290bps to 21.6% in FY16E. SPEN’s tourism segment accounted for 38% of overall firm revenue but 62% of EBITDA in FY13. Accordingly, the 150bps margin expansion in the tourism segment to 31.5% in 100% FY16E will have a significant impact on SPEN’s overall EBITDA margin. The strategic investments segment’s EBITDA margin should increase marginally from its FY13 level to 10.8% in FY16E. Downside risk to margins comes from the possible renewal 80% Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 of the PPAs for the Matara and Horana thermal power plants, since the revised prices SPEN ASPI S&P SL 20 are likely to be below the original contract prices. In our view, the cargo logistics segment’s EBITDA margin should remain at its FY13 level of 13.0%, as new Source: CSE, Bloomberg businesses in Fiji and in Bangladesh should compensate for the loss of contracts in Africa. Share price performance Low net debt and stable cash generation should allow for further investment. 3m 6m 12m SPEN has been able to maintain a low net debt position compared to its close local SPEN 3% 2% 8% peers, despite new projects typically being funded by debt. A long-term debt-to- S&P SL 20 1% 7% 20% capital ratio of less than 30% and stable free cash flow (FCF) generation over the past few years (the company’s FCF has ranged from LKR1.2bn to LKR4.1bn over the All Share Price Index 3% 4% 22% past five years, with negative FCF posted only in FY12) reflects SPEN’s financial Source: CSE, Bloomberg flexibility to reduce leverage further or pursue new growth opportunities should it choose to do so. Summary financials We establish a share price range of LKR110-157 in FY14E, compared with the LKRm (year end 31 March) 2013 2014E 2015E current share price of LKR124. We used DCF analysis and P/E analysis to arrive at a valuation range for the company. SPEN currently trades at a 12-month forward P/E Revenue 36,606 36,042 38,015 of 13.0x FY14E; this has ranged between 10.6x-18.6x since July 2011. We have also EBITDA 6,840 6,954 7,829 used scenario analysis to arrive at the valuation range. Our bull-case scenario EBIT 5,490 5,584 6,391 assumes a more positive tourism segment performance, with higher occupancies and Net profit 3,267 3,875 4,486 ARRs, and renewal of operations at the Matara and Horana power plants, albeit at a Recurrent EPS 8.0 9.5 11.0 lower tariff rate. Our bear case assumes lower occupancies and lower ARR growth in tourism, and renewal of the PPA for the Embilipitiya plant, upon its expiry in FY15E at ROE (%) 12.3 13.1 13.6 a lower tariff rate. In the coming quarters, we will track SPEN’s performance across a P/E (x) 14.9 13.0 11.2 number of key areas (see page 19) and update our valuation range in future earnings Source: SPEN, Amba estimates updates. Also see page 16 for potential upside/downside risks to our valuation range. 1 A capital market development initiative by the Colombo Stock Exchange in association with Amba Research Aitken Spence PLC Table of Contents SPEN’s revenue should grow at a 3.4% CAGR over FY14E-FY16E .................................................................................. 3 Higher room count, occupancy levels and ARRs to drive tourism revenue CAGR of 12.7% through FY16E ....................................... 3 Strategic investments segment revenue to decline at a CAGR of 4.8% over FY14E-FY16E ............................................................... 6 Cargo logistics and services segments to make a sizeable contribution to top-line growth .................................................................. 9 We anticipate a 290bps increase in EBITDA margin to 21.6% over FY14E-FY16E ......................................................... 10 Tourism segment EBITDA margin to expand 150bps over FY14E-FY16E ......................................................................................... 11 Strategic investments segment EBITDA margin likely to increase slightly to 10.8% in FY16E ........................................................... 11 Cargo logistics and services segments together make a noteworthy contribution to SPEN’s margin ................................................. 11 Relatively low net debt and stable liquidity position should allow for further borrowing for new projects .......................... 12 We expect shares to trade in the range of LKR110-157 per share ................................................................................... 13 DCF valuation gives a range of LKR111-157 per share ..................................................................................................................... 13 P/E analysis yields a valuation range of LKR110-135 per share ........................................................................................................ 15 Where is additional potential upside? ................................................................................................................................................. 16 Share price performance .................................................................................................................................................................... 17 Earnings release focus areas ............................................................................................................................................. 19 Appendix 1: Company overview......................................................................................................................................... 20 SPEN’s key businesses ...................................................................................................................................................................... 21 Management strategy and transparency ............................................................................................................................................ 22 Shareholding structure ....................................................................................................................................................................... 23 Board of directors ............................................................................................................................................................................... 24 Appendix 2: Key financial data ........................................................................................................................................... 26 Summary group financials (LKRm) ..................................................................................................................................................... 26 Key ratios............................................................................................................................................................................................ 27 Segmental summary ........................................................................................................................................................................... 28 Appendix 3: Industry analysis using Porter’s framework ................................................................................................... 30 Hotels ................................................................................................................................................................................................. 30 Appendix 4: SWOT analysis .............................................................................................................................................. 32 Appendix 5: Diversified sector overview ...........................................................................................................................