namunukula plantations- review 3q 2011

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February 2011

Stronger Earnings through Crop Diversification...

NAMUNUKULA PLANTATIONS

Crishani Perera : [email protected]

COMPANY UPDATE



1

STRONGER EARNINGS THROUGH CROP

DIVERSIFICATION...

Namunukula Plantations (NAMU.LKR127.60) recorded a net profit of

LKR146.7mn in FY10 (vs. net earnings of LKR40.7mn in FY09) mainly on the back

of the 19.2% YoY growth in top line backed by attractive Net Sales Averages (

NSA’ s) achieved for all 3 main crops (Tea, Rubber and Oil Palm) of the company.

NAMU, one of the well diversif ied plantation company’s in Sri Lanka has a

distinct advantage over its competitors in terms of balanced crop mix. NAMU

which is renowned for its quality low grown type of tea, focuses heavily on

maintaining the quality of end product consistently, which would enable them

to grab high prices for their products.

With Plantation worker wage revision due in April 2011 (current agreement will

expire in March 2011), it’ll have a considerable impact on Profit margins in tea

segment as a whole (tea is a highly labour intensive commodity). But since tea

segment contributes only up to circa 20% of gross profit of NAMU, where Oil

Palm and rubber which are less labour intensive crops constitute major portionof Profits, NAMU’s profit margins would have a lesser impact compared to its

competitor firms which rely highly on tea.

We believe NAMU has strong earnings growth potential on the back of, strong

demand for low grown tea ( particularly from Middle East & Russia ) together

with premium prices expected to boost earnings, recovery of crude oil prices

leading the demand and prices of natural rubber to recover strongly and sustain

at current attractive levels (global NR supply is expected to fall behind its

consumption up to 2020), backed by enhanced contribution from Oil Palm

segment (area cultivated under Oil Palm expected to go beyond 1,600hectares

Within next 3 years). In line with this, we expect NAMU to record LKR460.7mn in

FY11E (up by 214% YoY) and net earnings of LKR539.5mn in FY12E (17% YoY

growth).

NAMU (voting) currently trades at 6.6X forecasted FY11E net profit, 5.6X

estimated FY12E net profit and 3.3X PBV, as opposed to a Plantation sector PE of

circa 27.5X and a current trailing market P/E of 22X. Hence we see great value

potential in the counter.

PRICE VS ASI

STOCK DATA

Avg. Daily Turnover

(LKR mn) 6.3

Shares in Issue 23.8

Market Cap (USD

mn) 3.4

market Cap (LKR bn) 3.8

PERFORMANCE

% chg. 1m 3m 12m

Absolute 14.7 32.2 118.25

MAJOR SHAREHOLDERS

Voting (as at 30th Sep'10) %

RPC Plantation Mgt

Services 58.74

The Secretary to the

Treasury 15.85

Mr. J. R. De Silva 2.12

Alliance Finance Company 1.67

Sakuvi Investment Trust 1.54

0100020003000

40005000600070008000

0

50

100

150

200

ASIClose

Price

Close Price

ASI



3

Tea – Net Sales Average

0

50

100

150200

250

300

350

400

450

FY06 FY07 FY08 FY09 FY10 FY11

LKR

HighGrown

MidGrown

LowGrown

Renowned for its Quality Low Grown Type Tea…

NAMU which is renowned for its quality Low Grown (LG) type of tea

(Low grown type tea trades at a premium to High and mid grown types

of tea), focuses heavily on maintaining the quality of end product

consistently which would enable them to grab high prices for theirproducts.

NAMU cultivates circa 2mn kgs of tea, in around 9

estates located mainly in the low country. The

company recorded a 13% YoY drop in crop in FY10

which was mainly due to prolonged dry weather

(Total tea production in Sri Lanka also saw a dip of

9%). Despite of absorbing 40% wage hike, tea

segment was able to record an operational profit of

LKR63.3mn in FY10, against a loss of LKR 23.3 mn in

the FY09.This was mainly due to the improved

plucker productivity and strictly adhering to

agricultural practices.

Tea prices remained attractive during the FY10,

where company achieved a low grown average NSA

(Net Sales Average) of LKR387.7, which is a 15%

increase YoY.

With superior price performance of low grown type of tea (low grown

tea has historically being traded at a premium of 6% over Sri Lankan

overall NSA, backed mainly by strong demand from Middle East region

and Russia), we expect tea segment to continue to boost earnings inthe coming years. Meanwhile, the market conditions for LG tea is

expected to improve further with the rebound in Middle East

economy.

During FY11, with attractive tea market conditions prevailing coupled

with relatively improved weather conditions, NAMU is expected to

record a tea production of circa 3mn kg where company is currently

enjoying a GP margin of 9% for tea. Furthermore, Sri Lanka tea fetched

higher prices in FY2010, over FY2009 (throughout the period) and

recorded the highest across the world which lead the country to record

an all time high overall NSA of LKR370.



4

Indonesia46%

Malaysia41%

Thailand3%

Columbia2%

Nigeria2%

Other6%

World Oil Palm Production Trend

0.00

10.00

20.00

30.00

40.00

50.00

60.00

200520062007 2008 2009 2010

mn tons

Palm Oil Production (mn tons)

Reaping benefits from Oil Palm Venture…

Oil Palm Industry

Oil Palm could be considered as the ‘sunrise’ industry in the south

Asian region, where many growers in the region seen moving

aggressively towards the crop in the light of highly attractive returns.

Palm Oil is the 2nd most consumed vegetable oil crop in the world,whilst over 90% of world’s palm oil exports are produced in Malaysia

and Indonesia.

Palm Oil is a crop that could be utilized for diverse

purposes including producing edible fats (margarine),

soaps and candles, as an important raw material for

aloe chemistry, and further as a bio diesel.

Although Palm Oil is still mostly used in the

manufacture of food products, its Potential demand as

a bio fuel or for biomass energy is significantly large

which signals a potential to drastically increase thedemand for the crop. The increasing trend in petroleum

prices with global economic recovery has stimulated

the bio fuel industry in European Union, United States

and as well in Malaysia to some extent.

Palm Oil industry experienced high volatility in prices

during year 2009, but saw prices stabilizing at realistic

levels during year 2010 (Palm oil currently trades around

LKR20 per kg). Gross margins remain highly attractive

around 60%.

In Sri Lankan context, Palm Oil is a commodity having

huge growth potential, where only 5 out of 22 regional

plantation companies are currently serving this

segment. Sri Lanka produced 54.3 mn kg of fresh fruit

during year 2009, which reflects a growth of 3.2% YoY.

Recently Sri Lankan Government has taken some

important steps to spread palm oil cultivation in the

country, identifying its huge potential as a highly

profitable commercial crop. Accordingly, the

Government aims to achieve a fivefold growth in area

cultivated to reach 50,000 acres in the near future.

Sri Lankan Government has already signed an agreement with

Indonesia, world’s largest palm oil producing nation, where they have

agreed to help expand oil palm cultivation in the country . Currently Sri

Lanka imports around 160,000 metric tons of palm oil annually

World Oil Palm Production Composition

Source: United States Department of Agriculture

http://usda.mannlib.cornell.edu/








5

Oil Palm Revenue vs. Gross Profit

-50

0

50

100

150

200

250

300

350

400

LKR 'mn

Revenue

GrossProfit

incurring a cost of LKR14 bn. This indicates the massive potential palm

oil industry has within the country itself.

NAMU being one of the pioneer plantation companies to venture in to

Oil Palm, is a member of AEN Palm oil processing (pvt) Ltd ( AEN )

which is a joint venture between 3 plantation companies (Namunukula,

Agalawatte & Elpitiya). The venture was initiated as a strategic step

going along with the recent development in South East Asia to movemore towards Oil Palm ( Malaysia and Indonesia together contributes

to 87% of global oil palm production ), where company views Oil Palm

to be its main stay crop in the future. AEN is in to

palm oil processing where it purchases oil palm

crop from these 3 companies and manufacture

crude palm oil for both export and for local

consumption.

This venture will enable higher ROI’S for the

company in the long term since palm oil is a crop

that generates high margins compared to other

crops. NAMU currently enjoys gross margins of

around 70% for oil palm where it contributed up

to 44% of operational profits in FY10. But oil palm

constituted only up to 21% of the total turnover

of the company, where the ratio would improve

with planned oil palm expansion.

Oil Palm as expected proved to be the most

profitable crop of NAMU. The Company

harvested 14.650mn kg of oil palm which is a 3% increase over last

year. The company continues to invest in expansion of oil palm where

it considers oil palm to be its largest revenue generator in the future.

The price received from AEN factory remained attractive where

company achieved a 24% increase in profits in oil palm segment.

Despite the impact from wage hike and escalation of input stocks, cost

of production was maintained at a reasonable level of LKR6.4 per kg,

where cost of fertilizer contributes to almost 50% of total cost of

production.

Palm oil industry has been growing at an impressive rate of circa 9% for

last few years and the demand is expected to improve further with

increased global economic conditions, shouldered with impact from

increased population and as well due to increasing demand for

alternative energy sources. Furthermore, AEN is planning to expand its

production in the coming years with demand for edible oil in Sri Lanka

is seen growing.



6

Oil Palm Concerns

Recently anti-palm oil campaigns were launched by certain

environmental NGO’s. The strongest argument against the crop is that

it dries up soil and cultivation in the wet zone, invariably becoming an

environmental hazard. Furthermore, palm oil consumes ten times

more fertilizer than rubber, which could become a serious concern

with escalating fertilizer costs.

However, with the field level cost of production is only about LKR4/kg

of fresh fruit bunches, as against a selling price of LKR20 per kg; the

massive margins can easily absorb the high fertilizer costs.

To benefit from the rising Rubber Market…

NAMU is set to benefit from a rising rubber market, where rubber

prices has recorded historical high levels during the past few months

(Sri Lankan rubber prices increased from a lower of circa LKR111 per

kg (RSS1) in December 2008 to an all time high level of circa LKR624(RSS1) in February 2011).

According to world rubber magazine, the global natural rubber

production is expected to fall behind its consumption up to 2020.

Meanwhile with the current tight market conditions for rubber, rubber

supply is not growing at the expected pace due to older plantations

and due to weather constraints whereas demand conditions are

continuously improving with global economic recovery, we can expect

rubber to trade at current high levels.

Furthermore, since the price of crude oil shows a tendency to move up

further on higher consumption by the recovering US economy, worldnatural rubber prices are more likely to witness an increasing trend.

NAMU produces a substantially high volume of rubber of circa 2mn kgs

annually, which enables the company to reap benefits from the rising

rubber market. NAMU has invested LKR48.7mn on rubber replanting

during FY10 which will enable the company to maintain their rubber

production at considerably high levels in the long term, thus benefiting

from the attractive rubber prices. Rubber contributes up to circa 32%

of NAMU’s revenue.

NAMU harvested 1805 mn kg in FY10, which amounts to 96% of that of

the previous year, which was mainly due to continued wet weatherexperienced during 1QFY10 and 2QFY10. The company has three crepe

rubber & two sheet rubber factories in which 60% of production is

processed. The balance production is sold as liquid latex.

The company’s sales average for the year was LKR265.8 (vs. a Sri

Lankan NSA of LKR211.65), which is a 28% increase compared to

previous year.



7

Revenue Contribution

-

500.0

1,000.0

1,500.0

2,000.0

2,500.0

3,000.0

FY08 FY09 FY10 FY11 FY12

LKR ,mn

Coconut

Oil palm

Rubber

Tea

Financial Performance

For the financial year ended 31st March 2010, NAMU recorded a total

turnover of LKR1.516bn which is of circa 19% growth YoY. But this

growth was on top of 28% decline in turnover during the year before

(FY09 saw a drastic dip in tea production, with the drought conditions

prevailing, together with weak market conditions for rubber). For the

1-3QFY11, NAMU posted a turnover of 1.559bn which reflected animpressive growth of 49% YoY, backed mainly by improved NSA’s for

both tea, rubber and increased

production with better weather

conditions.

Company recorded a Gross Profit

Margin of circa 21% where the highest

contributor in terms of gross margin

was oil palm. It constituted circa 58%

NAMU’s GP, which was due to oil palm

achieving a significantly high GP Marginof 70% during the year. For 1-3QFY11,

NAMU achieved a substantially

improved GP Margin of circa 31%

backed heavily by improved

contribution from tea & rubber

segments.

The NP Growth for the year was

outstandingly high at 261% YoY, where

such significant growth was achieved on the back of increase in NSA of

low grown tea, attractive rubber prices, maintaining momentum from

the contribution of palm oil to the company profit and effective costcontrol measures. For 1-3QFY11, company recorded a net profit of

LKR308.7mn vs. a profit of LKR54.4mn for the same period last year.

The Company’s interest cover improved from 1.4X to 3.0X whilst

gearing improved significantly from a high of circa 81% to a reasonable

level of circa 61%.

Company incurred capital expenditure amounting to LKR132mn during

the year, which is a decrease of 7% compared to previous year, but the

total field development expenditure increased by 38% which

amounted to LKR 115.8mn. Capital expenditure on field development

of Oil Palm saw a significant growth of 152% YoY which is in aid of

pursuing NAMU’s strategy of making oil palm its main stay crop in the

future. Value of long term investments (Unquoted) of the company

which reflect their strategic investment in AEN Palm Oil Processing

Company (33.33% stake), saw a growth of 71% YoY with improved

profit contribution from AEN ( NAMU’s profit share f rom joint venture

in AEN saw a growth of 177.1% YoY during FY10). Company’s Net Asset

Value per share remained LKR38.9 which exhibited a growth of circa

19% YoY.



8

Production Trend

-

2,000.0

4,000.06,000.0

8,000.0

10,000.0

12,000.0

14,000.0

16,000.0

18,000.0

FY06 FY07 FY08 FY09 FY10 FY11 FY12

Kg'000

Tea

Oil palm

Rubber

Coconut

Future Outlook

Going forward the company in pursuing its

strategy of making Oil Palm its main stay

crop, hence would invest circa LKR 250mn in

FY12 on expansion of Oil Palm cultivation

and the company is planning to have over

1,600 hectares of Oil Palm by the year

2017(NAMU currently having circa 1300 hec.

of palm oil). This will enhance company’s Oil

Palm production in the years to come which

will in turn strengthen its profit marginswhere company is currently enjoying gross

margins of around 65-70% for oil palm.

NAMU is also a member of AEN Palm oil

processing (Pvt) Ltd which is a joint venture

between 3 plantation companies (Namunukula, Agalawatte & Elpitiya).

This venture will enable higher ROI’S for the company in the long term

since palm oil is a crop that generates high margins compared to other

crops. This was evident by the fact that, although oil palm contributed

only up to 21% of the total turnover of the company, it contributed up

to 44% of operational profits in FY10.

In addition, with NAMU’s all estates producing low grown type of tea

which enjoys premium prices over high and medium grown on the back

of strong demand from Middle East and Russia tea (Low grown NSA

from January to December 2010 has been circa LKR393 compared to

Country Total Sales Average of LKR 369 for the same period), we

believe it to post sustainable earnings growth in the years to come.

Overall demand conditions for tea, also expected to enhance further

with global economic recovery and with emerging trend



9

Turnover & Profitability

(500.0)

-

500.0

1,000.0

1,500.0

2,000.0

2,500.0

3,000.0

FY06 FY07 FY08 FY09 FY10 FY11E FY12E

LKR mn

Revenue GP Net profit

towards tea, from other beverages with newly proven health benefits

of tea.

However, in tea segment with labor cost accounting to around 55% of

total cost of production and plantation workers’ wages are being

reviewed every 2 years (next wage revision is due in April 2011), it will

have a severe impact on overall cost of production of the company in

the years to come. So company’s future performance will rest heavilyon the fact that company adopt effective cost control measures and

improve productivity particularly in tea production. NAMU has already

taken the initiative by taking measures to improve plucker productivity,

implementing required harvesting rounds and restriction of

deployment of workers on unproductive work.

The world rubber prices are expected to continue its rising trend on

the back of, full recovery of Global recession and as well due to the

huge supply deficit that prevails in the rubber market. NAMU, having a

significant share of rubber, where rubber production expected to

remain circa 2mn kg, company will benefit significantly from the

attractive market conditions for rubber. NAMU has historically

achieved premium prices for its rubber grades, where its high quality

crepe rubber continues to achieve top prices regularly (NAMU

recorded a rubber NSA of LKR 265.8 per kg in FY09, as oppose to a Sri

Lankan overall NSA of LKR211.7).

NAMU’s management is very positive about its future and plans to

obtain HACCP certification for all its factories in the near future. As well

company will be strictly adhering to all agricultural practices with no

restrictions imposed on fertilizer applications which would enhance its

crop yield and quality of end product.

Valuation

Forecast FY2011E earnings to record

LKR460.7 mn. With NAMU’s tea production

expected to go beyond 3mn kg in the next 2

years where low grown NSA’s are expected

to sustain at LKR360-370 levels, recovery of

crude oil prices leading the demand and

prices of natural rubber to recover strongly

and sustain at current attractive levels

(global NR supply is expected to fall behind

its consumption up to 2020), backed byenhanced contribution from Oil Palm

segment (area cultivated under Oil Palm

expected to go beyond 1600ha. Within next

3 years), we forecast the company to post a

net profit of LKR460.7mn in FY2011E (up

214% YoY) and reach LKR539.5mn in

FY2012E (up 17% YoY).



10

In terms of earnings based valuation, we believe that the share is fairly

valued at 6.6X forecast FY2011E net profits and 5.6X forecast FY2012E

net profits showing attractive value potential.

Based on an analysis of a historic 52 week price movement (Voting),

we derived a price movement of +/-LKR 32.4 on a mean of LKR60.6

Hence, the flux is approximately +/- 53.4%. Furthermore, if it is

assumed that the same upside price movement is seen pushing theprice to LKR195.8 levels (from a current level of LKR127.60) the

forward PE multiples would be 10.1X for FY2011E and 8.6X for

FY2012E.

Furthermore, when adjusting NAMU’s returns to its risk (deviation of

the share price), Sharpe ratio of the counter is at 2.2 whilst the

Plantation sector is at 2.8. NAMU’s risk adjusted return is lower

because its deviation has been much higher at 67.8% as opposed to the

sector’s deviation of 34.1% over the past one year trading period.

Hence, NAMU shows a lower risk adjusted return when compared to

the sector.

NAMU.N - * Price of LKR195.8 is based on incorporating an upside

growth of 53.4%, derived via 52 week standard deviation of marketprice, whilst LKR159.9 is based on the maximum appreciation during

Past 52 weeks.



February 2011

................................................................................................…………………… Research

.................................................................................................…………………… Head of Research Saminda Weerasinghe Senior Analyst Amali Perera

(94-11)5320250 (94-11)5320256

[email protected] [email protected]

Corporates Economy

Akeela Rasheed (94-11)5320252 Umayangana Randeniya (94-11)5320254

Nuwan De Silva (94-11)5320258 Dhanusha Pathirana (94-11)5320257

Crishani Perera (94-11)5320251 Nuwan Pradeep (94-11)5320257

Minoli Mallwaarachchi (94-11)5320360

Nirmala Samarawickrama (94-11)5320253

Shehara Fernando (94-11)5320253

Dilan Wijekoon (94-11)5320253

Sales

.................................................................................................…………………… INSTITUTIONAL SALES RETAIL SALES

Sabri Marikar (94-11) 5320224, 077 3576868 [email protected] Shiyam Subaulla (94-11) 5320218, 0773502016 [email protected] Wijayakoon (94-11) 5320208, 0777 713645 [email protected] Gagani Jayawardhana (94-11) 5320236, 0714084953 [email protected] Aboobucker (94-11) 5320213, 0777-727352 [email protected] Priyantha Hingurage (94-11) 5320217, 0773502015 priyantha@asiacapitChaminda Mahanama (94-11) 5320223, 0777 556582 [email protected] Hiran Bibile (94-11) 5320238, 0777 352032 [email protected] Neluka Rodrigo (94-11) 5320214, 0777366280 [email protected] Hapugoda (94-11-5320240, 0777 256740 [email protected] Subeeth Perera (94-11) 5320227, 0714042683 subeeth@asiacapitaAnura Hedigallage (94-11) 5320211, 0777 713663 [email protected]

BRANCHESKiribathgoda Asian Alliance Building, No.04, Sirimawo Bandaranayake Mw, Kadawatha. Asiri Perera 011-5734773, 0773-692812 [email protected]

Kurunegala Asian Alliance Building, No.254, Colombo Rd, Kurunegala. Asanka Samarakoon 037-5628844, 0773-690749 asanka@asiacapita

Matara Asian Alliance Building, No. 312,Galle Road Nupe, Matara. Sumeda Jayawardena041-5677525, 0773-687307 sumeda@asiacapit

Galle Capital Reach Building, 2nd Floor, No. 16A, Gamini Mw, Galle. Ruchira Silva 091-5629998, 0773-687027 ruchira@asiacapitaLasitha Wijewardena 091-5676766, 077-6681884 lasitha@asiacapital

CSE Floor CSE,01-04, World Trade Centre, Colombo – 1. Thushara Adhikari 011-5735122, 0773-688202 adhikari@asiacapit

Negombo Asia Asset Finance, 171/1, Station Road, Negombo. Uthpala Karunatilake 031-5676881, 0773691685 uthpala@asiacapita

SERVICE CENTRESKandy Capital Reach Building, No.165, Katugodella Veediya, Kandy. Nilupul Hettiarachchi 081-5628500, 0773-691816 nilupul@asiacapital

Radhika Hettiarachchi 081-5625577, 0777-810694 radhika@asiacapita

Hambantota Hambanthota Chember of Commerce, Thangalle Road, Hambantota. Gayan Sanjeewa 047-5679240, 0715-536309 sanjeewa@asiacapAnusha Muthumali 047-5679241, 0772-351716 muthu@asiacapitalShermin Ranasinghe 0772378352 [email protected]

Ampara 2nd

Floor, T.K.S. Building, D.S. Senanayake Street, Ampara. Fawshan Mohamed 063-5679070, 0778-848870 fawshan@asiacapit

Jaffna 11-8, First Floor, Stanley Road, Jaffna Sutharshan 021-5671800, 0772-395811 suthan@asiacapitaNirmalan 021-5671801, 0778-449773 nirmal@asiacapital

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namunukula plantations- review 3q 2011

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