Road to 25,000 ASPI: Banking sector fuels market optimism

The Colombo Stock Exchange (CSE) has been a focal point of market enthusiasm as the All Share Price Index (ASPI) surged past the 17,000-point mark during the week ending January 24, 2025, setting an all-time high.

“This remarkable achievement is largely attributed to the resurgence of the banking sector, with heavyweights such as DFCC, Sampath Bank (SAMP), NDB, and HNB dominating market turnover and attracting a mix of retail and high-net-worth (HNW) investors,” Stock Market Analysis said to ‘Daily News Business’.

“As the ASPI charts its trajectory toward an ambitious 25,000-point milestone, the banking sector emerges as the primary catalyst in this journey.”

Despite the impressive rally in banking stocks, the sector remains undervalued by most metrics, presenting a compelling case for further upside. Analysts point to the imminent release of fourth-quarter financial results as a potential game-changer.

“Many banks are expected to report exceptional performance, driven by reversals in impairment provisions on investments in International Sovereign Bonds (ISBs),” First Capital Research earlier said.

Over the past few years, a significant number of listed banks had allocated provisions exceeding 50% on their ISB holdings, reflecting cautious accounting practices amidst economic uncertainty.

However, under the recently concluded bond exchange program, the “local option” resulted in a present value loss of approximately 37% due to ISB restructuring. This outcome is now unlocking opportunities for provision writebacks, which analysts project to range between 12% and 15%.

“These reversals will substantially improve the financial health of banks, with positive ripple effects on earnings per share (EPS), net interest margins (NIMs), and return on equity (ROE).”

Even with these favorable adjustments, banking stocks continue to trade at discounted valuations. Current price-to-book values (P/BVs) range from 0.6 to 0.85, while trailing twelvemonth price-to-earnings (P/E) ratios remain between 5.2 and 6.9 times.

“These metrics underscore the undervaluation of Sri Lanka’s banking sector relative to regional and global benchmarks. For instance, data from Bloomberg shows that the average P/BV for banking stocks in emerging markets is 1.4, while the global average hovers around 1.6. This discrepancy highlights the untapped value in Sri Lankan banking stocks,” Capital Research said.

Positive Macro-Economic Environment The banking sector’s rally is underpinned by a favorable macroeconomic environment, which supports credit growth and investor confidence.

Several key factors are contributing to this optimistic outlook. These include the Low and Stable Interest Rates. “For example, the benchmark policy interest rate was reduced to 8.5% in 2024, compared to 15.5% in mid-2022.”

Controlled Inflation reducing from a peak of 69.8% in September 2022 to single digits by late 2024, is another reason while one of the other prime factors is the Political Stability.

Another key factor that is driving the market is ‘Real GDP growth’ which is projected at approximately 5%, marking the highest annual growth rate since 2017. “This resurgence is driven by improved exports, which grew by 12.3% year-over-year in 2024, and a 45% increase in tourism earnings, as reported by the Central Bank of Sri Lanka,” the Finance Ministry said.

Additionally, Sri Lanka’s successful exit from default status and anticipated upgrades to local banks’ credit ratings are expected to unlock access to lower-cost funding.

This development will enhance net interest margins and strengthen banks’ ROE. Furthermore, liquidity enhancements from ISB provision reversals are likely to bolster capital adequacy ratios, paving the way for higher dividend payouts and improved investor sentiment.

Fitch Ratings recently upgraded ratings for several key banks, citing improved asset quality and capital buffers.

The current macroeconomic conditions bear a striking resemblance to the post-war recovery period in 2010, a time when Sri Lanka’s banking sector experienced a stellar bull run.

With macroeconomic fundamentals aligning and the banking sector poised for a resurgence, the ASPI’s journey to 25,000 points appears increasingly attainable.

The banking sector’s potential to unlock value is supported by several catalysts:

• Earnings Growth: Improved financial performance driven by ISB reversals, cost optimization, and revenue growth. For example, initial estimates suggest that major banks like HNB and Sampath Bank could see EPS growth exceeding 25% in 2025.
• Valuation Re-rating: A shift toward regional valuation benchmarks as investor confidence builds.
• Dividend Payouts: Enhanced liquidity and profitability enabling higher dividends, attracting income-focused investors. Historical data shows that Sri Lankan banks have offered an average dividend yield of 4.2%, which could rise significantly as earnings improve.
• Foreign Investment: Increased foreign inflows into the CSE as Sri Lanka’s macroeconomic stability and growth prospects improve.

“Moreover, parallels with the 2010 post-war rally suggest that the banking sector could act as the engine driving the ASPI to new heights. If banking stocks were to trade at P/BVs of 2.0 or higher, as seen in regional markets, the sector’s market capitalization would rise significantly, propelling the overall index.”

In conclusion analysts say that the ASPI’s climb from 17,000 to 25,000 points represents not just a numerical milestone but a testament to the resilience and growth potential of Sri Lanka’s capital markets.

“The banking sector, with its undervalued stocks and improving fundamentals, stands at the forefront of this transformation. As macroeconomic conditions stabilize and investor confidence strengthens, the road to 25,000 is not just a possibility but a probability.”

“With disciplined policy implementation, sustained economic growth, and strategic sectoral focus, Sri Lanka’s stock market is poised to reach unprecedented heights, unlocking value for all stakeholders involved.”

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