Financial Times

Locals overtake foreigners
Rising costs could rein in stocks boom
Robust buying by local retail investors who have overtaken foreigners in driving the Colombo bourse for the first time is likely to sustain the stock market at current record levels but brokers warn that rising inflation fuelled by skyrocketing oil prices could hurt corporate profits in the months ahead.

Active trading by local retail investors is now providing the longed-for depth that foreigners, who previously dominated the market, had complained was lacking in the Colombo bourse. An increasing flow of funds from the outstations is also fuelling the boom.

"There's widespread buying interest from local investors who have become very resilient," declared Channa Amaratunga of Asia Capital. Colombo Stock Exchange (CSE) Director General Hiran Mendis said that unlike the early 1990s when foreign investors mainly drove the market, they now contribute only 20 percent of the market turnover.

"During the South Asian crisis, foreign interest in emerging markets in this part of the world waned and many foreign investors pulled their funds out of these markets," he told The Sunday Times FT, adding this flight of capital from South Asian markets greatly affected Sri Lanka. However, the past few years have seen the local investor base growing.

"2001 showed a revival in the market and from then up to now we have experienced positive growth rates in excess of 30 percent per annum," Mendis said. He said that earlier one of the main complaints of foreign investors was that the local market was not strong. "Earlier the balance was tilted towards the foreign investors, but it has changed now," he added.

Increasing local investments will add liquidity and help sustain the market. Asanga Seneviratne, Managing Director, Asia Securities and head of the Stock Brokers Association, told The Sunday Times FT that future market expectations depend heavily on the budget next month. "Currently there is a lot of negativity in the air about the proposed taxes like the wealth tax which will push the market down," he said, adding if the government doesn't have any such surprises, the All Share Price Index (ASPI) will reach the 1700 range. He predicted that overall, the ASPI will be in the range of 1450 to 1550 in coming months.

"Local investors have kept the market going mainly because the tourism sector has taken off very well," he said, adding these investors can sustain the market. Hotels had become the best performing sector in the stock market and seemed to be isolated from macro-economic problems facing the rest of the country as their income is in dollars, said Shafi Waheed of DFCC Stockbrokers. "The hotels deserve it as well after having gone through such a lean period," he said. "We're just seeing the beginning of a huge boom in tourism, if peace prevails. Hotels are expanding and increasing room capacities and refurbishing their properties. They are at the threshold of a better period."

Asked whether the hotels sector had become overheated, Waheed said: "The whole sector has to get re-rated. There's a little more time for it to get overheated."

The boom will last until the industry gets saturated when the number of arrivals exceed available rooms as the infrastructure is not enough to cater to the sudden influx of tourists.

"Tourism sector would continue to grow and face a crunch situation at the end of 2005 due to a lack of sufficient hotel rooms if the cease-fire agreement prevails," SC Securities said in a market report.

"However," it warned, "the only negative factor for the industry in the short-term would be profits not improving in real terms due to the depreciating rupee and escalating local operational costs."

Asked how rising costs could affect hotel profits, Waheed said; "They'll probably be able to recover their costs. Most hotels have increased room rates by 10-15 percent as they couldn't cope with the demand. Also, the average spend of tourists has gone up."

Furthermore, now there are no tourist seasons anymore. The influx of Indian visitors helps fill hotels during the traditional off-season. However, listed firms in other sectors may not fare so well. Amaratunga of Asia Capital expects macro-economic conditions to get worse, particularly inflation.

"We expect to see steep rises in inflation in the last three months. This will impact on corporate profitability. Not every firm can pass on higher costs to consumers. The more monopolistic firms can do so but not others. Also, employees will demand higher wages and utility costs will rise further which will erode corporate profits.

"We will see a slow down in profits but robust local buying interest is likely to sustain the market unless the economy really deteriorates." While local investors have taken a dominant role in the stock market, foreign funds have been guarded because of the macro-economic risks associated with delays in the peace talks, rising inflation and pressures on the government budget. "Foreign institutional investors have been very quiet in the past year," said Amaratunga. "They take a top-down approach when analysing investments. Country factors such as the political and macro-economic situation must be positive before they look at individual companies. So most long term investors have second thoughts about the market."

But local investors are not so concerned and many have a trading mentality, chasing 'penny stocks', which in absolute terms are cheap and on which they can make trading profits. Brokers said the renewed buying interest by local retail investors was partly because of speculation and partly ignorance, with the more discerning investors being selective in picking stocks.

"You get informed investors who know the risks but are willing to speculate in order to make trading profits. But some are actually trading through ignorance - they do not know what the valuation multiples are," said a broker.

Buying by local retail investors comes in phases. The 'land phase', where investors chased property stocks, is over and now they are going after hotel stocks. "Undoubtedly tourism is one sector you want to be in but that does not mean every hotel in the market will do well," said Amaratunga. "Some will not make money, some are burdened with tremendous amounts of debt, some price:earnings ratios are quite high and can't be justified." Investors in Kandy and Matara are making a growing contribution to market turnover.

"Bigger and bigger amounts are coming from the outstations," said Amaratunga.

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