Sri Lanka: Equity Strategy - Deep Value Unveiled As Hyperinflation Subsides

As hyperinflationary dynamics begin to subside, the residual effect has unveiled a large dislocation in valuations of listed domestic players.

Steep price increases taken by domestic firms have been more than enough to offset a decline in volumes over 2022, resulting in strong revenue and earnings growth to new highs, despite a deteriorating macro picture. With the expansion in bottom line to new highs, it is our view that valuations need to adjust accordingly with the risk premium attached to overall market valuations to diminish with a potential IMF agreement imminent.

As the economy turns the corner and macro indicators improve, we expect a slight scaling back of prices to be met with a pickup in demand driven by our expectations of improving consumption patterns.

Against this backdrop, we expect Net Importers to be the key beneficiary of the current trends played out on the economic front, which includes an appreciating LKR, reducing interest rates, easing inflation and a pickup in consumption.

We expect earnings to see a sharp step up from pre-2022 levels and to be sustained at a high level going forward.

In line with an overall market re-rating, we expect deep value fundamental counters, which are heavily discounted in comparison to their historical valuation ranges, to re-rate upwards supported by strong profitability and earnings growth. However, we expect valuations to remain discounted to long-term averages in FY24E, with a discount warranted at this point, given the level of macro uncertainty still remaining around the overall direction of the economy.

Given that our banking and finance sector coverages are currently under review, we have excluded these counters in this report.