Company riches to grow on rubber boom, stocks to get re-rated

June 25, 2006 (LBO) – Sri Lankan plantation companies are expected to rake in the riches in the ongoing rubber boom, with analysts expecting stocks to trade at higher multiples than in the past. Crepe is about 35 percent of local production and liquid latex used to make gloves, about 30 percent, most of which is produced by plantation companies Rubber prices have soared over the past 18 months, driven by strong demand from countries like India and China, amidst shortages in supply from producer countries.

In Sri Lanka, prices for its latex crepe, in high demand world over for its superior quality, soared past 350 rupee levels a kilo in June, with some companies hedging at even 400 rupees for August supplies.

“Prices are unlikely to take a breather in the medium term and will remain strong,” Geeth Balasuriya, Analyst at HNB Stockbrokers told an industry forum last week.

Four regional plantation companies, Kelani Valley, Kegalle Plantations, Agalawatte and Kotagala Plantations, listed on the Colombo Stock Exchange, have dominant exposure to rubber.

The four companies contribute 15-20 percent of the country’s annual production and are among the largest listed rubber manufacturers.

Analysts at HNB forecast net profits at Kelani Valley for the financial year ending 2006, to jump 50 percent, reaching 231 million rupees over 154.4 million rupees in 2005.

“Kelani Valley has high quality standards and a balanced crop mix between tea and rubber. It also has low gearing at 22 percent, which puts it in a better position for borrowing,” Balasuriya said.

Kegalle Plantations is expected to post net profits of 338.9 million rupees for the year ending March 2007, a 77 percent hike over the 191.4 million rupees the year before.

Forecasts for Agalawatte Plantations are a huge 225.8 percent increase in net profits for this year, at 116 million rupees, on a turnover of 1.5 billion.

Balasuriya says the stock however is trading below potential and expects it to be re-rated in the market. “The 122 percent gearing however is a concern in our opinion, because it will be difficult for them to borrow beyond this.”

Net profits of 256.4 million has been forecasted for Kotagala Plantations for the year ending March 2007, an 81.2 percent hike on the 141.5 million the year before.

Volatile earnings from the sector of the past five to ten years are expected to stabilise and the sector re-rated to trade at higher multiples on the market.

“The plantation sector counters generally trade at a discount to the market, largely due to volatility in earnings, insufficient liquidity etc,” Balasuriya said.

“However, in our opinion, natural rubber prices are expected to remain strong in the medium to long term, improving the stability of the earnings of key rubber producing plantations.”

“Thus we believe the sector to get re-rated and these stocks to trade at higher multiples than in the past. This would further improve the upside potential of these stocks.”

HNB Stockbroker estimates National Sale Average (NSA) of rubber for the financial year 2007 at about 220 rupees a kilo, though some industry estimates pitch it higher at 250 rupees.

Upcoming wage hikes on the plantations, weather and local volatile political uncertainty and violence are thought to be risk factors.

About 35 percent of the Sri Lanka’s total production is sheet rubber, produced almost entirely by small holders.

Demand is almost entirely locally driven, used up by domestic industries.