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AFC Asia Frontier Fund - Sri Lanka - at the bottom of the cycle?

AFC Asia Frontier Fund - Sri Lanka - at the bottom of the cycle?

Dear Investors and Friends,

As part of our continuing on the ground research, Ruchir Desai, Co-Manager of the AFC Asia Frontier Fund, traveled to Colombo last month to attend an investor conference. Photos are by Asia Frontier Capital.

Going back to Colombo for an annual investor conference that I attend every year felt a bit different this time given the tragic Easter Sunday attacks that took place just a couple of months ago. The attacks were completely unexpected and given their scale and intensity, the important tourism sector, which accounts for close to 5% of GDP and is the third highest foreign exchange earner for the country, will likely see a negative impact.

Tourist arrivals for the month of June 2019 were down by 57% given the initial negative reaction to the attacks and though tourist arrivals will be lower this year, the country is currently in “off-season mode” for tourism, due to the monsoon, so the recent initiatives taken by the authorities to promote the country as being safe for tourists as well as the lifting of travel advisories by key source markets such as China and India could help bring stability to tourist arrivals once the country enters the peak season towards the end of the year.

As expected, security across all major city hotels has increased significantly. After the civil war ended in 2009, Sri Lanka was the only country in South Asia where one could enter a hotel without going through the whole security screening process, a pity that this has now changed due to the current circumstances. Though occupancy at the Galle Face Hotel where I was staying was low, it was still much better than I expected and, in any case, local wedding events were being held on a daily basis, helping to keep the environment at the hotel quite lively as life goes on.

The tourism sector should see a recovery in arrivals in the longer term as other tourist destinations such as Egypt and Indonesia have seen tourist arrivals rebound after terror-related incidents. Furthermore, given what the country has on offer, the tourism potential in Sri Lanka appears to be untapped compared to other Asian tourist destinations like Cambodia, Thailand or Vietnam.


(Source: Asia Frontier Capital)

A visit to Colombo would be incomplete without a stroll on Galle Face Green, which overlooks the Indian Ocean and also hosts the recently re-opened Shangri-La hotel and the upcoming mixed-used development from India based ITC. The investor conference took place at its usual location, the Cinnamon Grand hotel which belongs to the conglomerate John Keells Holdings (JKH SL). Unsurprisingly, the buzz that this hotel usually has was not evident this time around due to it being affected by the recent events.

Galle Face Green, Colombo


Over two days of meetings it was good to get updated on various sector outlooks by Sri Lankan companies, most of whom I have met on previous occasions. Gauging the mood across company management teams, I would say the banks had a somber outlook relative to other sectors given the large uptick in non-performing loans for the entire banking sector over the last few quarters.

During the conference I also visited the upcoming Colombo Port City project which is being executed by China Harbor Engineering Company across 269 hectares of reclaimed land. The Sri Lankan government will provide a 99-year lease on this land and the project continues to see consistent execution as most of the land reclamation has been completed with infrastructure construction expected to begin in 2020.

Given the scale of the project (269 hectares) there is still some way for it to go, but if executed as planned, the Colombo Port City may change the look and feel of the city and add a lot of value to Sri Lanka’s economy as the project envisages hosting the Colombo International Financial City (along similar lines to the Dubai International Financial City) as well as various residential and leisure related developments.

Development of Colombo Port City in progress


Model of Colombo Port City


The last day of my trip was spent carrying out on-site factory visits to Ceylon Cold Stores and Lion Brewery. We started with the Ceylon Cold Stores (CCS SL) factory which is located about an hour’s drive from downtown Colombo. To give a bit of background, CCS is part of John Keells Holdings and is the market leader for soft drinks and ice-cream via their age-old brand “Elephant House” which is a household name across Sri Lanka. Though the company has opened a new ice-cream factory, we visited the older one which produces both soft drinks and ice cream with all the equipment being European and most processes being automated. One of the top selling products within the soft drinks category is Elephant Ginger Beer, also known as EGB, of which we got a taste.

Getting a taste of the local favorite “EGB”


After sampling some EGB as well as ice cream, we were off to the Lion Brewery (LION SL) factory which is also located outside of Colombo. Lion Brewery is only one of two companies in Sri Lanka that has a beer manufacturing license, the other being Heineken Lanka (a unit of Heineken Asia Pacific). LION has a near monopoly of the beer market with a market share of 86% and Carlsberg Malaysia owns 25% of the company. Unlike other markets, Sri Lanka is one of the few countries globally where “strong” beer (alcohol content of >5%) has a higher consumption rate than “mild” beer and this is due to the fact that the main consumers are only looking for a “kick” rather than actually consuming the beverage leisurely or socially. However, this is changing as mild beer is increasing its share in overall consumption due to the increase of tourism as well as greater urbanization.

Coming to the factory, it is extremely modern and automated and is one of the most impressive factories I have visited across our fund universe. Unfortunately, no pictures were allowed but we did get to sample the beer!

Beer tasting at the Lion Brewery factory


Getting back to the airport using an Uber was no problem and the onset of ride hailing apps has made getting around in many of our markets much easier compared to 3-4 years ago. Besides Uber, another ride hailing/food delivery app making inroads into the market is a local player named “Pick Me” which will be an interesting company to watch. Before entering the airport premises though, every vehicle was thoroughly checked, given the heightened security which does add some time to the journey, but other than that there is no issue getting into or out of the airport.

So what is the view on Sri Lanka? It has been a tough few quarters for the country due to the political crises in late 2018 and the recent events during Easter in April 2019. The lack of political consensus over the last few years has not helped market sentiment either. However, the recent events have made valuations very attractive on a bottom up basis with blue chips such as John Keells Holdings and the top thee private sector banks trading at price to book ratios which are at a decade low. The question is what is the trigger to re-rate multiples?

The issue is not the quality of companies or management teams but the uncertainty over the future direction of policy making as presidential elections are due at the end of the year followed by parliamentary elections most likely in the first quarter of 2020. Hence, a major boost to market sentiment could occur if there is political stability or at least political consensus post these two elections which could lead to a recovery in overall business and consumer sentiment leading to a pick-up in economic growth as there is still a significant amount of unmet economic potential in Sri Lanka.

As always, I look forward to being back in Sri Lanka as there are not many better locations to sip a Lion beer than on the verandah of the Galle Face Hotel overlooking the Indian Ocean!

The Verandah at the Galle Face Hotel, Colombo


I hope you have enjoyed reading this travel report. If you would like any further information about the AFC Asia Frontier Fund, please get in touch with me or my colleagues.

With kind regards,
Thomas Hugger
Fund Manager

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