It’s hot in Sri Lanka: Building a new Dubai (or Singapore) in Colombo
Burton Flynn and Ivan Nechunaev
March 2024
Bring on the heat
We came to Sri Lanka during a heat wave. While it's always quite hot on the island of Ceylon, this time because of the extra heat and humidity the 37°C weather felt like 47°C, according to both our local contacts and our own sweaty backs. To us, this unusual climate event epitomized the current state of the Sri Lankan economy which has finally started to warm up after a tough pandemic crisis period during which the country’s tourism industry was frozen and the currency depreciated by two thirds.
Our purpose for the trip to this country we haven’t explored in depth before was to search for hidden gems by meeting with promising companies, learn more about Sri Lanka’s macro risk, and feel and test consumer sentiment on the ground. We also wanted to visit Sri Lanka’s own highly ambitious economic free zone project which has the potential to drive the economy forward in the years to come.
Our visit turned out to be timely: while Sri Lanka is best known for its tourism potential, friendly elephants and Ceylon tea, we also identified investment opportunities in this exotic market which are benefiting from the beginning of a long-awaited growth momentum in the economy.
We went on a research trip to Sri Lanka in search of them gems
Taking a lift to prosperity
The pandemic-era crisis has hit Sri Lanka – which had already had a tendency to spend money before making it – particularly hard. Tourist arrivals dissipated, the currency plummeted, the government went bankrupt, and in a classic emerging markets textbook scenario the IMF came to the rescue.
However, the speedy recovery that has started recently can already be easily seen through consumer activity and traffic on the streets, heard through conversations with local business people, and felt when taking the fastest lift in Sri Lanka to the top of the country’s tallest skyscraper in the form of a lotus flower – a new local attraction measuring 352 meters in height. Tourism is already above pre-pandemic levels, there are new restaurants opening, and real estate development activity has picked up substantially. It appears that the forward trajectory of the economy is sloping upward.
Enjoying Ceylon tea while visiting a 352-meter tower – Sri Lanka’s tallest building equipped with the fastest lift in the country. At this point, we don't plan to be the first ones to test the tower's new 253-meter bungee jump.
Built on water to become a land of opportunity
We toured Sri Lanka’s megaproject: a new island city in Colombo built from scratch on land reclaimed from the sea, which aspires to be a global business hub on par with Dubai and Singapore. While at the moment the project site is mostly empty, we must give credit to Sri Lanka for already having accomplished the following despite the crisis mode in the economy in the recent years: thinking big to come up with such a project, attracting investment to start executing this idea, and managing to reclaim land from the sea.
Further steps will include building a financial center, world-class healthcare and education facilities, high-end residential developments, a beach, a golf course, and other appealing amenities seeking to attract 80,000 white-collar professionals and wealthy individuals willing to set up residence in this artificial island city. What might entice them the most? The tax-free status the city will offer.
This up-and-coming Sri Lankan project has a great ambition to become the Dubai (or Singapore) of South Asia, welcoming businesses from countries like India, Bangladesh and Pakistan whose employees will surely appreciate working in a tropical paradise environment with pleasant tax incentives. We are impressed by the bold and brave vision for this project by Sri Lanka, and believe if it does get executed as planned it can be a game-changer for the island nation.
While in the past people were competing to be in the countries and cities of their dreams, our view is that going forward it will be the countries and cities that will have to compete for and attract the best talent – which has over the years become much more flexible, demanding, and skilled.
View of the land reclaimed from the sea for an up-and-coming new city which will lure both talent and wealth with its free economic zone status
Economic barometer and spillover from India
We met a few local companies in Sri Lanka, of which two stood out thanks to their cheap valuation and potential earnings growth of 20% or higher this year.
The first was an $800m conglomerate present in most Sri Lankan industries: it has assets in hospitality, real estate, retail, transportation, and financial services. Given its exposure to a wide variety of sectors, this holding can serve as a barometer to measure the state of the entire Sri Lankan economy – and our reading of that measurement is very positive. Most businesses of the group are recovering from the crisis, growing revenues and earnings again, and planning expansion – be it in the form of building out a local container port, or constructing a new hotel capable of hosting 1,000 visitors (in addition to a few existing quintessential Sri Lankan hotels in its portfolio), or growing the number of stores in its retail chain which is already the second-largest in Sri Lanka.
The company prides itself on its strength in data analytics: it spent several years developing a capability to process all the data it collects in the retail stores in order to precisely tailor its product strategy, while the competition does not have that sort of analytical capability. The business is also benefiting from the huge economic progress in Sri Lanka’s big brother/sister – India – which through wealth and trade spillover effects helps propel the company’s tourism and container shipping results higher.
Meeting with the management of a $800m diversified conglomerate in Sri Lanka
Every third adult in Sri Lanka
The second promising company was a $125m consumer goods and healthcare business which is a household name in Sri Lanka given that two out of three kids in the country use products sold by this company, and every third Sri Lankan adult buys medicines it distributes. In addition to distribution, the company also operates its own pharmaceutical manufacturing plant which is steadily growing market share.
The firm’s future growth will be driven by expanding its margins thanks to focusing on manufacturing pharmaceutical molecules under its own brand as well as focusing on other high-margin products (for example, in the personal hygiene segment). In a sign of improving financial outlook, the management expects debt levels to come down with cash conversion to improve. The company carries out a materiality assessment every year in order to efficiently allocate its resources to ESG matters, which are not just about ticking a box but are rather entrenched across the entire business.
Meeting with the management of a $125m consumer goods and healthcare company in Sri Lanka
Discussing terrible markets to invest in with central bank governor
To our pleasant surprise, while on the ground we were invited to speak on a panel at a frontier markets investing event together with Sri Lanka’s former central bank governor and a fellow emerging markets fund advisor from New York who also happened to be in Colombo that week. We learned a lot from the governor’s perspective on the Sri Lankan economy, and we shared our highly optimistic view on emerging markets for the next decade, informed by the fact that we see a great number of undervalued, growing, high-quality bottom-up opportunities in developing countries at the moment. Our big ask of Sri Lanka’s stock market – which we expressed on the panel – was to improve trading liquidity, which still leaves a lot to be desired.
We explained to the audience that we are no macro experts with unique insights on Sri Lanka, and the central bank governor or local analysts would have better-informed macro views than we have. Our bread and butter is our bottom-up focus on finding hidden gems which can double in 12 months, which has led to our fund's #1 rank out of 1,500 emerging markets funds on Bloomberg over 10 years, and #1 over 5 years. The countries which our fund had the highest exposure to over the past decade – Malaysia, Pakistan and Turkey – were terrible markets to invest in (with their respective indices losing money in EUR terms over 10 years), but by focusing on bottom-up fundamentals we managed to identify huge winners in these markets full of cheap, liquid, small companies with growing earnings – a breeding ground for a successful stock-picking strategy. Shaky macro may simply mean less efficient markets and thus more opportunities for outsized returns – which could also be the case in Sri Lanka.
Speaking on a panel together with a fellow fund advisor from New York and the former Sri Lanka central bank governor
We had a good time
We visited Sri Lanka at a good time: the economy is picking up, companies’ earnings are set to recover, and a gigantic new city is about to be built to (try to) compete with Dubai and Singapore and exceed everyone’s expectations. We will keep watching this growing frontier market for positive improvements in stock market liquidity which will be essential for us to consider investing.
Thanks for the great hospitality, Sri Lanka. We enjoyed learning a lot not only about your efficient companies but also about your diverse culture, beautiful religious temples, complex history, and delicious food. Until next time!