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Tkyo Corporate Update Strong Buy 20-09-162(3)

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   Corporate Update   FC Research Analyst: Amanda Lokugamage SRI LANKA   TOKYO CEMENT COMPANY (LANKA) PLC   STRONG BUY   TKYO.N/ TKYO.X Sep 2016  illars of Success   Current Price: LKR 54.9/45.1 Fair Value: LKR 83.0/66.0   Tokyo Cement Company (Lanka) PLC, one of the two cement manufacturers in Sri Lanka is expected to grow its earnings at a CAGR of c. 20% FY16-FY19E reaching c.LKR 3.0Bn in FY18E and c.LKR 3.4Bn in FY19E. TKYO is expected to grow its earnings mainly through increase in its topline by seizing the opportunities created by the boom in the construction sector coupled with enhanced capacity. FC Research expect TKYO.N and TKYO.X to provide a return of 58% and 55% at LKR 54.9 and LKR 45.1 respectively. STRONG BUY Construction sector boom to improve topline: TKYO’s topline is expected to register a YoY growth of c. 15% and c. 17% to reach c. LKR 34.8Bn and c. LKR 40.8Bn in FY17E and FY18E respectively resultant to the boom in the construction sector coupled with the investment into capacity enhancement to reach total plant capacity to 2.8Mn MT that’s coming into effect by end 2016 and increased Maximum Retail Price (MRP) of cement towards the latter part of the 1H2016.  Improved Margins driven by increased volumes and cost efficacies: GP, EBIT and NP margins are expected to register at c. 24%, c. 11% and c. 7% respectively in FY17E as opposed to 23%, 10% and 6.5% recorded in FY16 on the back of lower cost of production coupled with the comparatively lower commodity prices that are yet to recover and cost savings resulting from the increase in renewable energy generation. Risks associated: Given the nature of the industry TKYO is exposed to exchange rate, fluctuations in commodity price, change in government policy and rivalry competition risks.  TKYO to provide a 58% and 55%return over 18-months period:   FC Research expect TKYO.N to achieve a fair value of LKR 83.0 providing a total return of 58% (Dividend yield 7%) over 18-month period. [DCF based LKR 83.8 and PER based LKR 81.4] while TKYO.X to provide a return of 55% at LKR 66.0. Figure 1: TKYO Price Volume Graph Disclosure on Shareholding: First Capital Group and its affiliates holds 86,980 shares in TKYO. Neither First Capital Group nor its affiliates have traded in the shares in the three trading days prior to this document, and will not trade in the shares for three trading days following the issue of this document. Y/E 31 Mar FY15 FY16 FY17E FY18E FY19E  Revenue (LKR mn)29,674 30,117 34,783 40,799 47,123  YoY % Growth3%1%15%17%16% Net Profit (LKR Mn)1,642 1,931 2,270 3,023 3,350  EPS (LKR)4.9 5.8 6.8 9.0 10.0  YoY % Growth-23%18%18%33%11% Valuations Voting - PER (x)11.2x9.5x8.1x6.1x5.5xVoting - PBV (x)1.8x1.6x1.4x1.2x1.0xVoting - Dividend Yield (%)2.2%2.5%3.0%4.1%4.6%Non-Voting - PER (x)9.2x7.8x6.6x5.0x4.5xNon-Voting - PBV (x)1.5x1.3x1.1x1.0x0.8xNon-Voting - Dividend Yield (%)2.6%3.0%3.6%5.0%5.6% NAVPS29.9 34.2 39.3 46.1 53.7   Adjusted DPS (LKR)1.2 1.4 1.6 2.3 2.5  Dividend Payout24%23%24%25%25% KEY DATAShare Price (LKR)Average Daily Volume (Shares '000) V/NV90.5/284.6Average Daily Turnover (LKR 'Mn) V/NV4.0/3.8334.1 12,229Price Performance (%) 1 mth3 mths12 mthsTKYO.N1.7%30.7%10.0%TKYO.X-1.7%21.9%12.2%ASPI-2.5%-0.3%-9.5%27.5%20.3%20.1%3.0%2.4%2.4%1.7%1.3%0.7%0.5%Public Holdings (%) V/NV28.84/ 100 Non - Voting Voting  St. Anthony's Consolidated (Pvt) LtdNippon Coke & Engineering Co. LtdSouth Asian Investment (Pvt) LtdCapital City Holdings (Private) LimitedThe Ceylon Guardian Investment Trust Plc A/C # 02Employees Provident FundMajor Shareholders as at 30th June 2016Hinl-Jpmcb-Butterfield Trust ( Bermuda ) LimitedJ.B. Cocoshell (Pvt) LtdCitibank Newyork S/A Norges Bank Account 2Hsbc Intl Nom Ltd-State Street Luxembourg C/O SsMarket Capitalisation (LKR mn)52w High/Low (LKR) (Voting)58.0/30.454.9/45.152w High/Low (LKR) (Non-Voting)47.3/25.0Issued Share Capital (Shares mn)    FC Research 2 illars of Success   1.0 Introduction 1.1 “  Indistinctive Leader in the Oligopoly Market”: Tokyo Cement Company (Lanka) PLC (TKYO) is one of the largest cement manufacturers in Sri Lanka is a joint venture formed between St. Antony’s Consolidated and Nippon Coke & Engineering Company of Japan. TKYO offers wide array of cements including Portland cement under the name ‘Nippon Cement and Tokyo Cement’. It also provides Tokyo Super Pozzolana for marine, hydraulic and  larger mass concreate structures. The group structure consists of 4 subsidiaries which comprise of Tokyo Super Cement Company Lanka (Pvt) Ltd, Tokyo Cement Power (Lanka) Ltd, and Tokyo Eastern Cement Company Ltd which are wholly owned while Tokyo Super Aggregate Ltd is a subsidiary with a 51% stake. Tokyo Cement operates an existing cement grinding plant with a capacity of 1.8Mn MT and new plant in Tricomalee adding another 1Mn MT per annum to increase the overall grinding capacity to 2.8Mn MT per annum by end 2016. Bagging plant operates with an installed capacity of 600,000 MT per annum bringing the total capacity to 2.4Mn MT per annum. 1.2 Share Price Performance:  Over the past 12 months TKYO’s shares have  outperformed the market mainly driven by the aggressive growth experienced in the earnings. TKYO.N has been trading between LKR 34.0-56.8 while TKYO.X has been trading between LKR 32.1-46.6 on the back of impressive earning growth. 1.3 Industry Analysis Cement Industry in Sri Lanka:  Sri Lanka cement industry had shown considerable growth in the last few years with cement consumption growing at a CAGR of 9% from 2011-15 while 2015 cement consumption grew by only a mere 2%YoY due to the uncertainty emerged over several state funded projects over cost element, feasibility, etc…  resulted in several mega infrastructure development projects being halted. The current total consumption is approximately 6.4Mn MT of cement per annum. (Source: Economic and Social Statistics of Sri Lanka, Central Bank Annual Report 2015). But 2016 looks promising with during the 1H2016 Sri L anka’s cement production and imports rose by 0.67Mn MT, up 23%YoY to 3.6Mn MT. Cement production rose by 0.196Mn MT to 1.2Mn MT (19%YoY) and imports rose 25%YoY to 2.3Mn MT in the first six months as opposed to 1.9Mn MT during 1H2015. In 1H2015 domestic production and imports rose 19%YoY to 2.9Mn MT. The domestic production of cement is dominated by Tokyo Cement and Holcim Lanka each having approximately 30% market share (including imported cement). Figure 2: ASPI vs TKYO Figure 3: Cement Industry Composition    FC Research 3 illars of Success   Sri Lanka’s is quite different from the global cement industry as world trade in cement is hardly 4% whereas Sri Lanka imports 64% of its requirement either in the form of cement or clinker. Considering clinker is being imported for grinding units the total cement imports could increase further. Sri Lanka imports cement from various plants in neighboring countries like India, Vietnam, Pakistan, Malaysia, Indonesia and Thailand. This dependability of imports has its flip side, as it sometimes limits the choice and type of cement and can diminish the assurance of consistent quality if there is no proper quality mechanism in process. Under the Indo-Sri Lanka Free Trade Agreement (ISFTA) and Pakistan- Sri Lanka Free Trade Agreement (PSFTA) Sri Lanka offers Zero-Duty Tariff Concession for import of Cement from India and Pakistan. Figure 4: Cement Production Process    FC Research 4 illars of Success   2.0 Construction Sector boom to improve topline A Revenue to grow by 15%:  TKYO topline is expected to register a growth of c. 15% in FY17E to reach c. LKR 34.8Bn with a CAGR of 16% over FY15-17E amidst the increased volumes coupled with the increase in the Maximum Retail Price of cement in June 2016. 2.1 Thriving Construction sector to increase volumes The boom witness in the construction sector at present is expected to experience an accelerated growth in the near future with the recommencement and initiation of several government led mega infrastructure development projects coupled with the growing demand created in the retail construction sector and the growth in the construction of high-rise structures specially in the capital city. Urbanisation on the rise:  With the steady increase in the middle income segment in Sri Lanka, the country is likely to move into upper middle income levels of USD 4,035 per capita GDP from current lower middle income levels by 2017, a rise in urbanization has witnessed which currently stands at 18%. This rapid increase in urban population triggered an increase in demand for condominium apartments and housing closer to the city which in turn led to a growth in the residential construction segment which is expected to have a favourable impact on the cement industry as a whole given the absence of a close substitute.   Products to meet the Demand specification:  With a product portfolio comprised of over 12 varieties of cement, TKYO is poised to cater to the varying requirements in the construction sector which provides a unique position in the industry. Further, TKYO entered into a collaboration agreement with Ube Industries Limited, Japan in August 2016 to obtain technical support and to import part of the raw material requirement from Japan for high quality cement Figure 5: Growth - TKYO Revenue and Cement Consumption in Sri Lanka
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