DISTILLERIES [DIST] INTERIM RESULTS 26 AUGUST 2015

Distilleries (DIST:LKR285.00) is the market leader in Sri Lankan hard liquor industry with a c.70% market share. The core liquor business contributes c.66% to DIST’s net revenue and 85% to Profit before tax (42% PBT margin). Further the liquor business has been a pure cash generator over the years where the firm does c.90% of its business on cash basis. While focusing on its core distilling business, DIST also has interests in finance, insurance, plantations, telecom and textile industries through its fully owned subsidiary Melstacorp which is on the voyage of becoming the financing arm of Distilleries Group.

DIST also has indirect access to tourism, logistic operations and power generation through its associate Aitken Spence Holdings (SPEN:LKR98.00), the largest resort operator and the freight forwarder in the country of which DIST owns c.41%. Although SPEN is not a subsidiary as yet DIST has indirect control over Spence through the related companies such as Milford Exports and Stassen Exports.

DIST’s net revenue up 7.6% YoY to LKR7,577.0 mn in 1QFY16. Liquor sector net revenue has increased 19.8% YoY (3.4% QoQ) to LKR5,326.1 mn possibly due to volume growth. Given the declining tea prices (down 2.9% for 1QFY16) the Plantations sector saw its revenue dip 23.0% YoY to LKR564.3 mn in 1QFY16. Telecommunication sector topline also fell 6.3% YoY to LKR829.6 mn during the quarter. Further Diversified sector revenue fell 12.5% YoY to LKR857.0 mn in 1QFY16.

EBIT margins up 140 bps QoQ and but fell 430 bps YoY to 28.8%. EBIT margin was up QoQ largely on the back of 15.4% QoQ dip in distribution cost and decline in losses in Plantation & Telecommunication sectors. However EBIT margin dipped YoY due to higher administration costs and losses made in Plantation & Telecommunication sectors (made profits at EBIT level in 1QFY15). Liquor sector EBIT grew 9.2% YoY but margins dropped 390 bps YoY to 39.9%.

Equityholder profit down 4.9% YoY to LKR1,755.4 mn in 1QFY16. A 44.4% YoY reduction in other operating income, 6.1% YoY increase in administration cost and 46.2% YoY reduction in associate income profit contributed to the net profit dip in DIST. However on an encouraging note net revenue was up 7.6% YoY whilst finance income was also up 33.4% YoY.

Impact of one off super gain tax. As per the interim budget 2015, an additional one-off tax of 25% has been imposed on the profits of the groups which have earned in excess of LKR2,000 Mn for the year of assessment 2013/2014. The estimated tax liability, based on our current understanding for the DIST on its Group taxable income would amount to c.LKR2,039.4 mn.

Forecast net earnings (excluding one off super gain tax) for FY16E maintained at LKR7,764.9 mn and FY17E earnings at LKR8,619.1 mn. We expect gross revenue to grow at c.5% YoY in the medium term, and our growth forecasts are based around DIST’s core beverage segment, which should enhance revenue growth through higher average selling prices mainly to incorporate increases in excise duty and moderate volume growth. However due to the one off super gain tax the FY16E earnings would reduce by LKR2,039.4 mn to LKR5,725.5 mn.

Share continues to offer value. DIST is the only conglomerate which trades at 11.0X FY16E earnings, a multiple which is almost at a 18% discount to the market 4 quarter trailing PER. Further it trades at a PBV of 1.3X in FY16E with a ROE of 11.0%. The stock is reaching its breakup value of LKR300.00 (market based sum of the parts), but we believe there would be further upside potential on anticipation of volume growth and possible value unlocking of the liquor business, thus we Maintain Buy.