Banking rally sets stage for ASPI’s ambitious 25,000 point target: Analysts

As the All Share Price Index (ASPI) charts its trajectory toward an ambitious 25,000-point milestone, the banking sector has emerged as the primary catalyst, analysts said.

Favourable macroeconomic conditions, including low and stable interest rates, controlled inflation, political stability, and economic growth, are driving this rally. These factors have shored up credit growth and investor confidence, creating a supportive environment for the sector.

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,” analysts said.

The Colombo Stock Exchange (CSE) has been a focal point of market enthusiasm, with the ASPI surging past the 17,000-point mark during the week ending 24 January, setting an all-time high. This achievement is largely attributed to the resurgence of the banking sector. Heavyweights such as DFCC, Sampath Bank (SAMP), NDB, and HNB have dominated market turnover, attracting a mix of retail and high-net-worth (HNW) investors.

Despite the impressive rally, the banking sector remains undervalued by most metrics. Analysts point to several factors that could further unlock value in the sector, including the improved financial performance expected in fourth-quarter results. Many banks are likely to report exceptional performance driven by reversals in impairment provisions on investments in International Sovereign Bonds (ISBs).

Enhanced liquidity and profitability from ISB reversals, cost optimisations, and revenue growth are expected to enable higher dividend payouts, attracting income-focused investors. 

Historical data shows Sri Lankan banks have offered an average dividend yield of 4.2 percent, which could rise significantly as earnings improve. 
Analysts also highlight the undervaluation of Sri Lankan banking stocks compared to regional peers, such as India and the Philippines, where price-to-book values (P/BVs) exceed 2.0, and price-to-earnings (P/E) ratios range between 11 and 13 times.

“This disparity highlights the immense upside potential within the sector,” analysts said. 

The current macroeconomic environment bears a striking resemblance to the post-war recovery period in 2010, when Sri Lanka’s banking sector experienced a stellar bull run. Back then, banking stocks traded at P/BVs exceeding 3.0, reflecting robust investor confidence and strong earnings growth.

Over the past few years, listed banks allocated provisions exceeding 50 percent on their ISB holdings, reflecting cautious accounting practices during economic uncertainty. The recently concluded bond exchange programme resulted in a present value loss of approximately 37 percent due to ISB restructuring. 

Analysts note that this outcome is now unlocking opportunities for provision writebacks, which analysts project to range between 12 percent and 15 percent. These reversals are expected to substantially improve banks’ financial health, boosting earnings per share (EPS), net interest margins (NIMs), and return on equity (ROE).

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

Long-term investors are likely to find unique opportunities in Sri Lanka’s deeply undervalued banking stocks, especially as foreign inflows into the CSE are expected to increase alongside the country’s improving economic stability and growth prospects, analysts said.