Equity Analysis /
Sri Lanka

Sri Lanka construction sector: Setting sights on a residential thrust

    Asia Securities
    19 February 2020
    Published byAsia Securities

    Following a hiatus of two years, construction activity is set to rebound in 2020 with several elements lining up to spark growth. In what has been a norm following a regime change, benefits were given out to consumers and corporates in the form of sharp tax cuts following the November 2019 elections; the main catalyst for the rebound. 

    While there has been much talk around the rebound, we admit it does not mean it is “all good” for the sector in 2020. Since our last sector update in November 2017 where we anticipated the slowdown in the sector, activity levels slackened in the two years that followed causing profitability to decline, a sector-wide liquidity crunch was created, and sector borrowings have risen to the highest levels seen in the decade. 

    Other issues also gained attention as most of the companies were left with excess capacity following expansions in 2016/17 subsequent to a period of robust postwar growth. The timing of the expansion was justifiable as the momentum looked likely to continue for the rest of the decade. However, the slowdown in activity that followed led to low utilisation and low fixed cost absorption across the sector. Therefore, despite our expectation of a bounce back, we expect some of the challenges originating in the last two years to follow the sector into 2020/21. 

    While the tax cuts will lead to deeper pockets for consumers, the GoSL will have to look at ways to bridge the resultant revenue losses to the state. This mostly likely will come out of expenditure cuts on infrastructure as compromise on other large expenditure components is seems highly unlikely.

    In this 132-page sector report, we cover various segments in construction, look at profitability, valuation and ways to invest in the sector, and pick construction-related stocks that would benefit in 2020. Some of the key highlights include: 

    • Pent-up demand, low interest rates, and higher disposable income to drive volume growth over 2020-2022E
    • Higher fiscal deficit and external debt burden to lead to tepid growth of infrastructure projects in the short run, but long-term requirements persist
    • Oversupply in both apartment and hotel segments to drive tepid demand in the medium term. Port city remains a larger opportunity, but implementation lacks visibility
    • ROE to see an uptick on better residential demand, and tax cuts
    • Cement consumption to grow at a 5.2% CAGR 2019-23E; existing players to see a dilution with new capacity being added through 2022
    • Aluminium extrusion industry to remain in over-supply territory in the medium-term
    • Tile demand to grow in line with housing, at a 8.0% CAGR 2019-23E
    • Tile sector is undervalued given high exposure to the residential growth story
    • Sector trades at a 44.1% discount to historic levels; main opportunities in the Tile and Cables sector