AFC on the Road – Sri Lanka

Dear Investors and Newsletter Readers,

As we begin our travels again, this is the first travel report in almost three years. Ruchir Desai, co-fund manager of the AFC Asia Frontier Fund, visited Colombo in November for an investor conference and, after that, visited Weligama.

For the better part of 2022, the media stories about Sri Lanka centred around political instability, protests, and a lack of basic essentials. The last few months have not been straightforward in Sri Lanka and so travelling to Colombo after more than three years, I was not sure what to expect. However, upon landing at Bandaranaike International Airport in Colombo, the immigration process, as always, was very smooth – I was out to collect my bags within 10 minutes of getting off the plane. The visa process has always been easy and visitor friendly. It is an online E-visa which you receive within 10-15 minutes after applying. Getting to Sri Lanka is an easy process as well, unlike travelling to other tourist destinations in Asia.

Getting a taxi at the airport also was not an issue, given all the media stories about the lack of fuel in the country. There is still a fuel shortage, but the situation is much better now compared to four or five months ago and getting around Colombo, or much of the country, is normal.

Since I was spending the weekend in Colombo before the start of the investor conference, a visit to the sea facing Galle Face Green was a good way to get a feel of the city since it was crowded with people out enjoying the sunny Saturday afternoon – this did not feel like a city which was in the midst of heavy protests only a few months earlier, and there was no visible security which reflects the much-improved situation on the ground.

A Saturday afternoon at Galle Face Green with the Galle Face Hotel in the Background

It was also good to have a morning run along the seafront on Galle Face Green on Sunday but much more can be done to make this prime seafront location more attractive to tourists and the local population.

The Galle Face Green and the adjacent Galle Face Road area are prime property spots in Colombo and besides the various well-known hotels that already exist in the neighbourhood, over the past few years the landscape has changed significantly with many new real estate projects coming up, including residential, commercial, and leisure properties.

Walking along Galle Face Green with Upcoming Real Estate Projects in the Background

At the conference, I had the chance to meet face-to-face with many Sri Lankan company executives across various sectors for the first time in more than three years. The key takeaway from the meetings was that the bottom-up fundamentals of most companies are very stable. This is because these companies have very well-established brands which have been built up over the past few decades and have withstood previous crises as well.

One of the key highlights of the conference was the presence of the President of Sri Lanka, Ranil Wickremesinghe, at the conference dinner as the chief guest, and it was a pleasure to be able to speak with him one on one in person!

Having said that, Sri Lanka is not out of the woods yet, given the scale of its external debt repayments in the coming few years. However, talks with the International Monetary Fund (IMF) and bilateral creditors appear to be progressing, and there is an expectation that there could be an agreement on the restructuring of both external and domestic debt sometime in early 2023, after which there will be greater comfort on receiving the IMF funds.

Sri Lanka has already carried out quite a few reforms and taken some tougher decisions in the last few months. Fuel and electricity prices have been increased, tax rates have been raised, interest rates have risen, the Sri Lankan Rupee has been devalued significantly, and the government is working very actively on privatising or reducing its stake in various state-owned enterprises.

Furthermore, other important steps like introducing a new gaming law have been executed, which should be a long-term positive for the important tourism sector. The Colombo Port City has also seen investment commitments in various sectors like education, healthcare, and leisure and this project is something to watch over the next 5-10 years as it could change the face of Colombo.

Though I mentioned that Sri Lanka is not out of the woods yet, valuations are at extremely depressed and all-time low levels. The Colombo All Share Index now trades at a P/E ratio of only 4x! All blue-chip companies trade at a P/E ratio of less than 10x, with Ceylon Tobacco and Nestle Lanka, which the fund holds, trading at a P/E ratio of only 6x! And this includes strong fundamentals and RoEs of greater than 15-20% for most blue chip companies.

The P/E ratio of the Colombo All Share Index is at an All-time Low of only 4.2x

It seems to me we are at the bottom of the cycle in Sri Lanka with valuations being so low and inflation and interest rates seemingly peaking out. If and when interest rates do begin to get cut sometime in 2023, it will not be surprising to see a stock market rally in Sri Lanka, given these depressed valuations.

After two days of meeting companies, the final day was spent conducting site visits. Our first site visit was to the Asiri Central Hospital in downtown Colombo. This hospital is part of the Asiri Hospital Group, the largest private sector hospital operator in Sri Lanka, with 800 beds across key Sri Lankan cities with a market share of 40%. The hospital business in Sri Lanka does hold a lot of potential as almost 20% of the country’s population is 60 or above, which means more requirements for longer-term medical care.

Healthcare costs in Sri Lanka are also a fraction of what one would pay in Hong Kong or Singapore, while the quality of doctors and nurses is very good. This makes Sri Lanka a candidate to attract overseas patients if it can promote its medical tourism potential.

Next up on our site visit was the much-anticipated Cinnamon Life project in the heart of Colombo. This project is being developed by John Keells Holdings (JKH SL), one of the leading conglomerates in Sri Lanka whose stock the fund holds.

The Cinnamon Life Project seen from Galle Face Green

Cinnamon Life is an integrated mixed-use development which includes residential and office towers, a hotel, a mall, a convention centre, and the space to operate a casino. Once fully operational in the next 18-24 months, this project will be the only integrated development in South Asia and could potentially be a platform for attracting visitors to Sri Lanka for conferences, leisure, or longer-term stays.

View from the Top Floor of the Cinnamon Life Residential Tower

Our final site visit was to the upcoming West Container Terminal in the Port of Colombo. This project is a partnership between the Adani Group of India, John Keells Holdings (JKH SL) and the Sri Lankan government. The Port of Colombo currently has four container terminals with a capacity of handling 8 million TEUs (twenty-foot equivalent units), and the port is now operating at a utilisation of almost 90%. The West Container Terminal will be the fifth terminal at the port.

This high utilisation rate of 90% reflects the strategic location of the Port of Colombo, which straddles the crucial east-to-west sea lanes. The Port of Colombo has become the most important transhipment hub in South Asia, as almost 80% of its volumes are transhipped mainly to India.

More importantly, Colombo is the only deep water port in this part of South Asia which also adds to its very strategic geographic location. To put into context the strategic geographic location of the Port of Colombo, at close to 8 million TEUs a year, it handles almost 50% of the total TEUs handled by all of India. 

The West Container Terminal will have a draft of 20 meters which is very impressive, and it will be able to accommodate two large container vessels at once in its first phase and three large vessels when both phases are complete by 2026. This ability to handle larger vessels and the lack of remaining capacity in the port provides a good platform for growth for the West Container Terminal and for JKH, which holds a 34% stake in this project.

At the Under-construction West Container Terminal with the China International Container Terminal in the Background

After the site visits, I took off for Weligama, which is on the southern tip of Sri Lanka and overlooks the vast expanse of the Indian Ocean. This is the best part about visiting Sri Lanka – one can visit other attractive locations in the country within a 2-3 hour car drive from Colombo, which is made easier by the modern and extensive highway network.

Weligama Beach

Since getting around to other tourist attractions from the capital Colombo is quite easy, Sri Lanka has not yet met its tourism potential. Of course, the pandemic and other factors have not been easy for the tourism industry in Sri Lanka, but even the pre-pandemic tourist arrival number of approximately 2 million is way below potential. Cambodia and Vietnam were doing tourist arrivals of close to 7 million and 19 million respectively in 2019.

With India, China and other important Asian source markets being only a few hours away by flight, more can be done to attract tourists to Sri Lanka. The attractions are there, the highway network has been built, and the country is returning to much more normalcy. One choke point could be the airport capacity when tourism numbers do pick up more, so the government should focus on modernising and expanding capacity at the Colombo airport.

Weligama is very well known for its waves and attracts a lot of surfers, both local and foreign. The beach was dotted with quite a few foreign tourists out to catch the surf, and this is an indication that tourism in Sri Lanka is seeing the early signs of a recovery.

Surfers Catching the Waves at Weligama

On the way back to the airport, I once again took advantage of the expressway network, which goes directly to the airport from tourist destinations like Weligama, and this makes it much easier to plan a trip to other parts of Sri Lanka.

The key takeaway from my visit was that though the road ahead still has some uncertainties, the situation on the ground is much better and much more normal than earlier in the year, while valuations are at rock bottom.

Lots more still needs to be done to get Sri Lanka on the right track economically, but the worst is behind us, and I hope the government and the regulators remain committed to following through on many of the actions they have taken in the past few months so that Sri Lanka can meet its full potential, especially in the logistics and tourism sector.

Sunset at Galle Face in Colombo

As always, I look forward to being back in Colombo and exploring other parts of Sri Lanka!

For further information on our AFC Asia Frontier Fund, please find below the links to the latest factsheets, investor presentations and webinars:

      Asia Frontier Capital - Market Update Webinar on Friday, 28^th October 2022

I hope you have enjoyed reading our AFC on the road 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 & Ruchir Desai
Co-Fund Managers

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