Saudi Income Stocks Portfolio

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1 Investment Strategy Table of Contents Table of Contents: Saudi investment strategy: Income stocks 2 Saudi Investment Strategy: Portfolio selection 7 Cement sector 9 Southern Province Cement Company 10 Saudi Cement Company 14 Yamama Saudi Cement Company 18 Qassim Cement Company 22 Eastern Cement Company 26 Tabuk Cement 30 Petrochemical Sectors 34 Saudi Arabian Fertilizers Company 34 Advanced Petrochemicals Company 39 Companies from other sectors 44 AlAbdullatif Industrial Investment Company 44 Saudi Chemical Company 48 Saudi Hotels & Resort Areas Company 52 Arriyadh Development Company 56 1

2 Investment Strategy AlJazira Capital Saudi investment strategy: Income stocks Introduction This report focuses on identifying investment opportunities in Income Stocks in the Kingdom of Saudi Arabia. We define income stocks as stocks that offer high and sustainable source of income via dividends, both cash and stock (bonus shares). Thus, we scanned the Saudi stock market for stocks that generate high dividend yields along with analysis of their business models. There has been a strong growth in the amount of dividends distributed in the KSA over the last ten years, due to healthy economic expansion, which has fuelled corporate earnings growth. Although the global financial crisis resulted in a setback in earnings and dividend distribution in 2008, the trend remained positive over the last 10 years. KSA dividend payouts and earnings on an upward growth trajectory Over the last ten years, companies listed on the Saudi stock exchange (Tadawul) have witnessed a strong growth in earnings, except in 2008, when earnings declined due to a significant drop in economic activity amid project cancellations. Nevertheless, aggregate earnings of Saudi corporates have increased at a CAGR of 13.4% over , resulting in a 10.9% growth in aggregate cash dividends during the same period. Dividend payouts have improved over the last five years, with aggregate dividend payout averaging 63.4% over compared with an average dividend payout of 45.6% over Figure 1: Dividend payouts led by earnings growth SAR bn Aggregate earnings Dividend Payout (%) - RHS Mirroring the trend in the GCC and some EMs Dividend payouts across the GCC region and other emerging markets have remained strong over the last ten years. In the region, companies listed on the Abu Dhabi Securities Exchange have registered the highest growth in aggregate dividend payout (grew from 37.5% in 2003 to 53.7% in 2012), followed by Kuwait (51.7% to 65.7%) and Dubai (4% to 52.6%). Oman, Saudi Arabia 1, and Qatar registered a decline in payouts over However, all of the GCC nations had dividend payouts of more than 5% in Kuwaiti companies registered the highest dividend payout in 2012, followed by Saudi companies. On comparison with emerging economies, Saudi Arabia registered the highest dividend payout. Brazil witnessed the highest increase in dividend payouts (grew from 16.0% in 2003 to 57.2% in 2012), which fell slightly short of those by Saudi companies. Figure 2: Dividend payout (%) vs. GCC Figure 3: Dividend payout (%) vs. EM K uw ait Saudi Arabia Q at ar Abu Dh abi O m an Dubai Saudi Arabia Braz il C h ina India Rus s ia AGM - Head of Research Abdullah Alawi a.alawi@aljaziracapital.com.sa 1. Div payment in Saudi was particularly high in 2003, but the trend has otherwise been positive 2

3 Investment Strategy AlJazira Capital Saudi average dividend yield hovers around 4% With increasing earnings and dividend payouts, the aggregate dividend yields 2 of Saudi companies improved from 3.7% in 2003 to 4.0% in While companies aggregate cash dividends grew 10.9% over , a 10.1% rise in market capitalization resulted in an average dividend yield of 3.0% over the 10-year period. Taking into account stock dividends (bonus issues) and cash dividends distributed to investors, Saudi companies have given an average total return of 3.8% over Aggregate total returns 3 given by Saudi companies increased from 3.8% in 2003 to 4.8% in Dividend yields and total returns peaked in 2008, primarily due to a 51.7% YoY decline in aggregate market capitalization. Although earnings during 2008 declined 45.4% YoY, cash dividends fell by a marginal 2.2% whereas bonus issues rose 18.1%. Figure 4: Saudi dividend yields (%) Figure 5: Saudi total returns (%) On analyzing dividend yields across the GCC region and emerging markets, we found that Saudi Arabia has witnessed the least change in dividend yields during Figure 6: Dividend yields (%) vs. GCC Figure 7: Dividend yields (%) vs. EM Abu Dh abi O m Q Dubai an at ar Saudi Arabia K uw ait Saudi Arabia C h s Braz il ina India Rus ia Economic expansion to drive dividend payout Over the last ten years, the Saudi business community has witnessed a considerable growth, led by the Kingdom s strong oil-led economic growth stoking demand for goods and services, improving business environment, and rising prominence of stock markets. We expect Saudi companies to remain on a strong growth trajectory, with rising government expenditure, strong project pipeline, and improving investor confidence and participation in the stock markets Dividend Yields are calculated as Cash Dividends /Share price at the end of the period 3. Total returns are calculated as (Cash Dividends + Stock Dividends (bonus issues))/share price at the end of the period.

4 Investment Strategy AlJazira Capital Economic expansion drives earnings growth Saudi Arabia s real GDP expanded at an average rate of 6.7% over compared with the world GDP growth of 2.7%. The Kingdom s strong economic performance can be ascribed to oil-fuelled current account surpluses that the government is channeling in economic diversification through large investments in infrastructure. The economic outlook for the KSA remains stable, with the IMF forecasting an average growth of 4.2% over 2013E 18E. This is expected to be largely driven by expectations of stable oil prices and Saudi Arabia s commitment to diversification. Moreover, KSA s demographic drivers, such as rising proportion of young population and increasing per capita income, would continue to bolster the economy. With 53% of Saudi Arabia s total population aged 15 44, we believe there would be a surge in the employed population, which would lead to growth in the economy. Furthermore, according to the IMF, KSA s per capita GDP has been on an up-move (except for 2008), with per capita income rising 3.1% over to SAR 42,642. Additionally, the IMF projects Saudi Arabia s per capita income to expand at a CAGR of 2.1% over E to SAR 47,527. Figure 8: KSA age-wise population Figure 9: Rising real per-capita income in KSA Ag e b r a c k et S AR ' % o f t o t a l p o p u l a t i o n Source: United Nations Population division, AlJazira Capital E 2012E 2013E 2014E 2015 E 2016 E 2017 E 2018E Source: IMF (October 2013 WEO), AlJazira Capital Figure 10: KSA vs. world real GDP growth (%) Figure 11: Cash dividends and real GDP S AR b n S AR t n E 2014E 2015 E 2016 E 2017 E 2018E W orl d K SA Rea l G DP - RH S Ca s h di v i dends Source: SAMA, IMF (October 2013 WEO Update), AlJazira Capital Source: SAMA, Bloomberg, AlJazira Capital Rising government and corporate capex The Saudi government s focus on infrastructure development has led to an increase of 25.7% in the government s capital expenditure over Furthermore, in the 2013 budget, the government has stepped up the planned capital expenditure to SAR 285bn, up 8.9% from the 2012 budgeted figure. Moreover, private sector capital expenditure plans are likely to surge in 2013, benefiting from improving business sentiment and high liquidity. According to recent Bloomberg estimates, capital expenditure plans of TASI-listed companies are likely to aggregate to nearly SAR 547.8bn in 2013E, 82 2% higher than capital investments in

5 Investment Strategy AlJazira Capital Figure 12: Government capex Figure 13: Rising corporate capex plans S AR b n S AR m n P * E 2014 E Source: SAMA, *P - Planned Strong growth in projects market Saudi Arabia has witnessed a massive increase in the number of projects executed over the last five years. While around projects were completed during , project value increased from USD 10.5bn in 2008 to USD 4bn in However, in 2013 YTD 4, around 72 projects have been completed with an aggregate value of just USD 10.4bn. Nevertheless, KSA s project pipeline remains strong with nearly USD 30bn (over SAR 102bn) worth of contracts being awarded in first six of months of 2013 and projects worth USD 876.6bn in the pipeline. Figure 14: Rise in completed projects in KSA U SD bn P s * roj ect val ue No. of proj ect - RH S 20 0 Source: Zawya Projects, AlJazira Capital; * 2013 YTD figures Increasing depth of Saudi stock market The Kingdom s robust economic performance and improved business environment boosted the broader capital market. The benchmark TASI, at the current level of 8,298 (as of November 13, 2013) has increased more than threefold since The rise in the TASI has been accompanied by an increase in market liquidity, which was led by increases in the number of IPOs and investor participation. The volume of stocks traded on the TASI grew from 5.6bn in 2003 to 86.0bn in 2012, while the value of stocks traded gained from SAR 596.5bn to SAR 1.9tn over the same period. We expect the Saudi market to remain buoyant, given the positive economic and earnings outlook. Furthermore, the anticipated opening up of the Tadawul to foreign institutional investors and international money managers is expected to significantly boost the exchange s liquidity. 4. YTD - January 2013 till August 14,

6 Investment Strategy AlJazira Capital Figure 15: Saudi Arabia stock market performance 25, , , , B n 5, Sep-02 Mar-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 V o l u m e - RH S T AS I Index Cash dividends correlation analysis The analysis of Saudi companies aggregate cash dividends with a few macroeconomic parameters over the last ten years revealed a very strong correlation of cash dividends with crude oil prices (91.8%) and the country s real GDP (95.5%). However, cash dividends have a low correlation of 33.1% with Saudi s budget surplus and of 21.0% with real GDP growth. Figure 16: Correlation analysis with crude price Figure 17: Correlation analysis with real GDP Cr u de p r i c es ( U S D/ b b l ) s h v i ( S b Ca di dends AR n) Source: SAMA, Bloomberg, AlJazira Capital Rea l G DP ( S AR t n) 5 6 s h v i ( S b Ca di dends AR n) Source: SAMA, Bloomberg, AlJazira Capital Figure 18: Correlation with KSA budget surplus Figure 19: Correlation with real GDP growth % B u dg et S u r p l u s ( S AR b n) Ca s h di v i dends ( S AR b n) Source: SAMA, Bloomberg, AlJazira Capital Rea l G DP g r o w t h ( % ) 6 s h v i g r o w t h ( % ) 8.0%.0% 4.0% % % -10% % 10% 20% Ca di dends Source: SAMA, Bloomberg, AlJazira Capital 6

7 Investment Strategy AlJazira Capital Saudi Investment Strategy: Portfolio selection Figure 20: Stock selection process Defining stock universe Stocks listed on S a u di s t o c k exc h a ng e, T a da w u l ( S t o c k s ) Dev el o p i ng Di v i dend Y i el d P o r t f o l i o Dev el o p i ng T o t a l Ret u r n P o r t f o l i o S t o c k s c r eeni ng Av g. 3 y ea r Di v i dend Y i el ds > Avg. 3 year KSA Inflation Rate ( 5 0 S t o c k s ) S t o c k s c r eeni ng Av g. 3 y ea r T o t a l Ret u r ns > Avg. 3 year KSA Inflation Rate ( 6 3 S t o c k s ) Ident i f y i ng t o p 1 0 s t o c k s f o r t h e p o r t f o l i o a s p er a v g. 3 y ea r di v i dend y i el ds Ident i f y i ng t o p 1 0 s t o c k s f o r t h e p o r t f o l i o a s p er a v g. 3 y ea r t o t a l r et u r ns Source: AlJazira Capital Defining stock universe Our universe consists all of the 161 stocks listed on the Tadawul. Stock screening Dividend yield portfolio: Under the stock selection process, we shortlisted stocks whose three-year average dividend yield were higher than Saudi s three-year average inflation rate 5. Consequently, this process resulted in the selection of 50 stocks from our stock universe of 161 stocks. Total returns portfolio: Under the stock selection process, we shortlisted stocks that reported three-year average total returns higher than Saudi s three-year average inflation rate 6. Consequently, this process resulted in selection of 63 stocks from our stock universe of 161 stocks. Portfolio development We build two portfolios of the top 10 stocks based on the above parameters, viz. dividend yield and total returns, respectively. Based on the screening and ranking methodology, we arrived at the following two portfolios: Figure 21: Dividend Yield Portfolio Company Industry Avg. Dividend Yield (%) Avg. Total Returns (%) Al Abdullatif Industrial Investment Industrial Investment Saudi Chemical Co Industrial Investment Saudi Cement Co Cement Qassim Cement Cement Saudi Arabian Fertilizer Co Petrochemical Industry Southern Province Cement Co Cement Advanced Petrochemicals Co Petrochemical Industry Eastern Cement Cement Tabuk Cement Cement Arriyadh Development Co Real Estate Source: AlJazira Capital Note: In our initial results for the Dividend Portfolio we had Saudi Arabian Amiantit Co. However, we replaced them with: Arriyadh Development Co. for qualitative reasons 5. The dividend yields and inflation rate for each of the year was based on end of period prices 6. The dividend yields and inflation rate for each of the year was based on end of period prices 7

8 Investment Strategy AlJazira Capital Figure 22: Total Returns Portfolio Company Industry Avg. Dividend Yield (%) Avg. Total Returns (%) Saudi Cement Co Cement Al Abdullatif Industrial Investment Industrial Investment Yamamah Saudi Cement Co Cement Saudi Chemical Co Industrial Investment Advanced Petrochemicals Co Petrochemical Industry Saudi Hotels & Resort Hotel and Tourism Saudi Arabian Fertilizer Co Petrochemical Industry Qassim Cement Cement Southern Province Cement Co Cement Eastern Cement Cement Source: AlJazira Capital, The shaded companies are common between both portfolios Note: In our initial results for the Total Returns Portfolio we had the following three companies: 1- National Industrialization Co., 2- Saudi Arabian Amiantit Co., and 3. Co. For Cooperative Insurance. However, we replaced them with: 1- Qassim Cement Co,, 2- Southern Province Cement Co., and 3- Eastern Cement Co. for qualitative reasons. The final portfolio has stocks across five sectors, with majority of the stocks from the Cement and Petrochemical sectors. Further, there are eight stocks common between the two portfolios, thus our combined portfolio consists of 12 stocks, eight common and two unique. Figure 23: Combined portfolio 12 stocks Company Industry Avg. Dividend Yield (%) Avg. Total Returns (%) Al Abdullatif Industrial Investment Industrial Investment Saudi Chemical Co Industrial Investment Saudi Cement Co Cement Qassim Cement Cement Saudi Arabian Fertilizer Co Petrochemical Industry Southern Province Cement Co Cement Advanced Petrochemicals Co Petrochemical Industry Eastern Cement Cement Tabuk Cement Cement Yamamah Saudi Cement Co Cement Arriyadh Development Co Real Estate Saudi Hotels & Resort Hotel and Tourism Source: AlJazira Capital Individual stock analysis In the following section, we have analyzed each of these 12 stocks on the basis of their business models, dividend and total returns trends. Moreover, we have performed a dividend sustainability analysis to determine the ability of the company to maintain the strong cash and stock dividend payouts. We have also analyzed the risk profiles and valuations for the portfolio companies. For cement and petrochemical companies, we have also analyzed the common industry drivers and risks. 8

9 Investment Strategy Cement Sector Southern Province Cement Company Cement sector Cement stocks represent 50% of both Cash Dividends and Total Return portfolios. Six of the 12 portfolio stocks are part of the cement sector. The Saudi cement sector, with a capacity of 56.2mn tons (2012), is the largest in the GCC. The sector benefits from the ongoing construction activity, led by government-backed infrastructure projects, and rising young population and increasing labor force ( CAGR 6.6%) driving demand for housing units. Cement consumption witnessed steady growth from 30.6mn tons in 2007 to 53.0mn tons in Consequently, supply rose from 33.0mn tons to 56.2mn tons during the same period, driven by the entry of new players, increasing demand and expansion by existing companies. Currently, the Kingdom is facing significant supply shortage due to a strong rise in project activities and limited cement supply. The government has undertaken a series of measures to mitigate supply concerns. It has instructed all the cement factories to import 10 MT of additional cement; the government also plans to build four new factories with a capacity of 12 MT to cater to the local market demand. Besides boosting supply, the government regulated prices due to unprecedented price hikes by retailers. During 2011 and 2012, prices increased 2.6% YoY and 4.2% YoY, respectively, given the rise in demand and limited supply. In March 2012, the government imposed a price ceiling for cement at SAR 240/ton (from SAR250/ton earlier). However, cement companies still benefit from higher profitability vis-à-vis their regional and global peers. Saudi cement producers margins are higher than their regional counterparts primarily owing to a favorable cost structure due to access to cheaper raw materials and fuel. Average gross and net margins (TTM ending June 2013) for Saudi cement companies stood at 53.7% and 46.1%, respectively, vis-à-vis the regional averages of 34.1% and 28.3%. Strong profitability aids dividend payments The cement sector s healthy earnings have supported high dividend payouts. Earnings increased at a CAGR of 10.1% over ; resultantly, cash dividends grew 9.5% during the same period. The sector s average dividend payout stood at 73.2% during A decline in earnings in 2008 and 2009 (due to the global and domestic slowdown) impacted dividend payouts. The average payout stood at 60.2% in 2008 and However, payouts averaged 79.9% ( ). The dividend yield for the cement sector averaged 7.2% in and 5.4% over Given the healthy outlook for the sector, we expect the profitability of cement producers to remain strong and consequently support high dividend payments. Cement sector Risks and concerns A delay in implementation of planned infrastructure projects or cancellation could dent demand. Various companies have planned capacity expansions in the coming years. However, inability to enter into fuel supply agreements with Saudi Aramco could restrict expansions and thereby have an adverse impact on revenue. Profitability across companies could be lower if the government undertakes further measures to reduce prices. Furthermore, the ruling on maintaining a minimum inventory level could hurt profitability. Southern Province Cement Company Company overview Established in 1978, Southern Province Cement Company (SPCC) is a cement manufacturer based in the southwest region of Saudi Arabia. SPCC is the Kingdom s third largest cement manufacturer with a capacity of 6.9 mn tons in The company owns cement factories at Jizan, Bisha, and Tihama and primarily manufactures and markets ordinary Portland cement and sulfate-resisting cement The dividend yields and inflation rate for each of the year was based on end of period prices 6. The dividend yields and inflation rate for each of the year was based on end of period prices

10 - Saudi Income Stocks Portfolio Cement Sector Southern Province Cement Company Key drivers Well positioned to capitalize on rising demand: SPCC has a strong market position, with a 14.0% share of total dispatches of cement and clinker in Furthermore, the company is strategically located near the western region, which has witnessed an increase in cement demand due to redevelopment projects such as the construction of a new airport in Jeddah and other upcoming infrastructure projects. We believe factors such as strong market position along with favorable location would enable the company to capitalize on the expected rise in cement demand in the Kingdom. Low production cost aids margin expansion: SPCC benefits from low production costs, given the captive power plants at all its factories. During 2012, the company had the lowest cost of production in the industry at SAR102/ton, compared to the peer average 7 of SAR120/ton. Consequently, it reported gross margins of 58.2% (industry average: 52.8%) and net margins of 55.4% (industry average: 44.2%). Strong balance sheet: SPCC is a cash-rich company with cash and cash equivalents totaling SAR 435mn as of December Moreover, the company s debt-free balance sheet provides it with financial independence and flexibility that is much needed, given the capital-intensive nature of the business. High dividend payouts driven by healthy earnings growth Dividend trend SPCC s cash dividends increased at a CAGR of 9.6%, whereas earnings rose by 8.4% during Consequently, the company s dividend payout increased from 9% in 2003 to 109.4% in Although dividend payout declined in 2008, it has risen substantially since The company s average dividend payout of 89.5% during is higher than the cement industry s average of 73.2%. Additionally, SPCC s average dividend yield during was in line with the industry average of 7.2%. However, according to the interim dividend announced by the company, its annualized dividend payout for 2013 was lower at 83.7% while annualized dividend yield was also low at 5.6%. Figure 24: Dividend payout and yield * Dividend p ay out (%) Dividend y ield (%) - RH S ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M 2013 Total returns trend Besides distributing high cash dividends, SPCC has also distributed stock dividends to its investors. During the past ten years, the company had one bonus issue. It distributed 33% bonus issues worth SAR 350mn in As per our total returns analysis, SPCC has provided average total returns of 5.9% during , almost in line with the KSA cement industry s average of 6.0%. 7. Compared with costs of Yamama Cem, Saudi Cem, Eastern Cem, Qassim Cem, Yanbu Cem, Southern Cem, Tabuk Cem, Najran Cem, and AlJouf Cem 10

11 K QQ U Saudi Income Stocks Portfolio Cement Sector Southern Province Cement Company Figure 25: Total returns 1 Bonus is s ue in (%) * T otal r etur ns Dividend Y iel d Tot al Ret urns Peer comparison ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M 2013 SPCC pays higher dividends vis-à-vis its local and regional peers. During 2012, the company s dividend payout and yield were higher than all regional players, except the UAE. Figure 26: Comparison with GCC peers Di v i dend p a y o u t ( % ) 12 SP CC CC Saudi at ar K uw ait OO mm an v i i ( % ) Di dend y el d U AE Note: Regional peers include major cement manufacturers in the respective countries Dividend sustainability analysis As part of the dividend sustainability analysis, we have compared cash inflows with cash outflows for all the companies under the portfolio. For inflows, we have considered operating cash flows and cash from financing, while outflows reflect capital expenditure, debt repayments, and dividends. The graphical representation of these parameters is displayed below to better understand how the company has historically financed its cash outflows. SPCC has primarily relied on its operating cash flows to distribute dividends. During , high capital expenditure amid lower operating cash flows resulted in the company relying on other sources of cash (internal accruals and cash inflow from sale of investments) for dividends payments. However, since 2009, the company s high operating cash flows and low capital expenditure have enabled the payment of dividends from operating cash flows. 11

12 Cement Sector Southern Province Cement Company Figure 27 : Strong operating cash flows enabled high dividend payments 1, 40 C l os ing cas h bal ance ( SAR m n) , 20 S AR m n 1, C O * C I* CF O Ca s h f r o m f i na nc i ng Ca p ex Di v i dend p a y m ent Deb t r ep a y m ent ; Data available from 2004 only *CI- Cash Inflows CO Cash outflows Operating cash flows: We expect SPCC s cash flows from operations to remain strong led by the Kingdom s robust cement demand, the company s dominant market position, and its favorable geographic location. Capital expenditure: In 2012, SPCC announced the expansion of the power generation plant at two sites amounting to SAR 192mn and a third production line amounting to SAR 707mn. We expect the company s capex levels to be higher in coming years. However, the company has generated over SAR 1bn of CFO in 2011 and 2012, which will enable it to meet these planned expenditures comfortably. Impending debt repayments: SPCC is a zero-debt company and thus does not have any scheduled debt repayments. Consequently, we believe SPCC is well placed to continue distributing high dividends going forward owing to its dominant market position, strong margins, and no pending debt repayments. Key financials SAR mn Revenues 1,318 1,309 1,691 1,805 Growth (% YoY) (0.7) EBITDA ,046 1,159 Operating margins (%) Net Income ,000 Growth (% YoY) (10.2) Dividend payout (%)* Dividend yield (%)* Total Returns (%)*# FCF/CFO (%) CFO/Revenues (%) Debt to equity (%) RoE (%) ROA (%) Source: Bloomberg, Zawya, *Dividend ratios based on cash dividends # Total Returns reflect the value of cash dividends and Bonus issue as a percentage of share price 12

13 Cement Sector Southern Province Cement Company Share price volatility and valuations Figure 28: Share price performance Figure 29: Price-to-earnings valuation multiple Jan-07 Sep-07 Jun-08 Feb-09 O ct -09 Jun-10 Feb-11 O ct -11 Mar-13 Nov-13 S P CC T a da w u l c em ent i ndex Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Sep-07 Jun-08 Feb-09 O ct -09 P / E A A S A S C P / E vg. vg.+ 1 D vg.- 1 D em ent index Jun-10 Feb-11 O ct -11 Mar-13 Nov-13 Figure 30: Price-to-book valuation multiple Figure 31: EV-to-EBITDA valuation multiple Jan-03 O ct -03 Jun-04 Feb-05 O ct -05 Jun-06 P /B Avg.+1 SD C em ent index P /B Feb-07 O ct -07 Jun-08 Feb-09 O ct -09 Jun-10 Feb-11 Avg. Avg.-1 SD O ct -11 Feb-13 Dec-04 Sep-05 May-06 Jan-07 EV/EBITDA Avg.+1 SD C em ent index Sep-07 May-08 Jan-09 Sep-09 May-10 Jan-11 Sep-11 May-12 Avg. Avg.-1 SD Jan-13 SPCC s strong earnings have been reflected in growth in its stock price. The company s stock price increased by more than 4 times since January 2003 and has grown 26.7% YTD. Tadawul Cement index also posted gains of 22.2% YTD. SPCC s current valuation on the basis of price-to-earnings and price-to-book value is much higher than its average historical valuations from 2003 till date. However, on the basis of EV/EBITDA, the company is trading marginally below its average historical valuations. In comparison with the Tadawul cement index, SPCC is currently trading at a EV/EBITDA multiple of 14.3x vis-à-vis the cement index EV/EBITDA multiple of 11.9x. Stock price movement EV/EBITDA YTD 1 Year 5 Year 10 Year Current 2013E SPCC 26.7% 34.1% 171.7% 276.5% 14.3x 13.2x Cement Index 22.2% 28.7% 91.2% NA 11.9x 11.7x TASI 2% 21.5% 51.3% 10% 12.5x 10.7x Relative to Cement Index 4.5% 5.4% 80.4% NA 19.4% 12.8% Relative to TASI 4.7% 12.6% 120.4% 174.5% 14.3% 23.8% SPCC Risks and concerns Source: Bloomberg Note: Closing price for stock price movement is calculated considering prices as on November 13, 2013 Issues of fuel supply from Saudi Aramco could restrict the company s capacity expansions and thus adversely impact revenue. Moreover, if SPCC continues to fulfill higher requirement for clinker through third party purchases, its margins are likely to be impacted. SPCC s declining levels of clinker inventory could limit its growth amid the current scenario of strong demand. 13

14 - Saudi Income Stocks Portfolio Cement Sector Saudi Cement Company Saudi Cement Company Company overview Saudi Cement Company is the Kingdom s largest cement producer with a production capacity of 11.5mn tons. The company s operations are strategically located in the eastern region, thereby providing access to high-demand regions and enabling exports to Bahrain. Being the market leader, Saudi Cement accounted for 17.2% of domestic market sales volume in Key drivers Robust cement demand in the KSA: The rise in construction activities in the Kingdom led to an 11.6% increase in cement consumption during to 53.0mn tons. KSA s cement demand is expected to remain strong, led by an 8 10% 8 growth in the residential building sector (a major consumer of cement), rising infrastructure spending by the government, and a strong project pipeline in the Kingdom. Strategic location: Saudi Cement is strategically located in the Kingdom s eastern region, close to highdemand cities such as Dammam, Khobar, and Riyadh. Moreover, the company s proximity to Bahrain helps it capitalize on the Saudi government s permit to export 25,000 tons of cement per week to Bahrain. Saudi Cement accounts for more than 80% of exports to Bahrain, which does not have any price ceiling and, thus, allows cement manufacturers to raise prices. However, due to the political instability in Bahrain, demand has declined over the last two years. Capacity upgrades: Saudi Cement recently announced plans to construct two cement kilns in order to replace its three aging mills; this would increase its cement grinding capacity by 600,000 tons per annum. However, the project is still in initial stages, and no timeline has been finalized yet. The implementation of this project would lead to enhanced milling efficiency and cement quality for the company, thereby enhancing revenues and margins. Good earnings growth has enabled Saudi Cement s dividend payouts Dividend trend Saudi Cement s cash dividends increased at a CAGR of 13.3%, while earnings rose 11.9% over Consequently, the company s dividend payout increased from 101.0% in 2003 to 128.8% in Although dividend payout declined in 2008 and 2009 due to lower earnings, it has risen substantially since The company s average dividend payout of 86.5% over has been higher than the cement industry average of 73.2%. Additionally, Saudi Cement s dividend yield has increased over the last three years and averaged 8.1% vis-à-vis the cement sector s average dividend yield of 7.2% over However, according to the interim dividend announced by the company, its annualized dividend payout for 2013 was lower at 91.6% while annualized dividend yield was also low at 6.5%. Figure 32: Dividend payout and yields * Dividend p ay out (%) Dividend y ield (%) - RH S ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M NRCC Prospectus 14

15 K QQ U Saudi Income Stocks Portfolio Cement Sector Saudi Cement Company Total returns trend In addition to distributing high cash dividends, Saudi Cement has distributed stock dividend to investors. Over the past 10 years, the company distributed one bonus issue of 50% worth SAR 510mn in According to our total returns analysis, Saudi Cement has given an average return of 5.9% over , almost in line with the KSA cement industry s average of 6.0%. Figure 33: Total returns 18.0 Bonus issue in worth SAR 510mn (%) * Total returns Dividend Yield Total Returns ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M 2013 Peer comparison Saudi Cement pays higher dividends compared with its local and regional peers. The company s dividend payout was higher than those of regional players, and its dividend yield was greater than those of its peers (excluding UAE). Figure 34: Comparison with GCC peers 14 Saudi C em ent Di v i dend p a y o u t ( % ) at ar K uw ait OO mm an Saudi U AE v i i ( % ) Di dend y el d ; Note: Regional peers include major cement manufacturers in the respective countries Dividend sustainability analysis Saudi Cement has primarily relied on its operating cash flows for distributing dividends. The company s high capital aexpenditure over amid lower operating cash flows in 2008 and 2009 led the company to raise debt in However, since 2010, the company s operating cash flows have been sufficient to meet capex and dividend payments. 15

16 Cement Sector Saudi Cement Company Figure 35: Strong operating cash flows enabled high dividend payments C l os ing cas h bal ance ( SAR m n) S AR b n C I* CCO* CF O Ca s h f r o m f i na nc i ng Ca p ex Di v i dend p a y m ent Deb t r ep a y m ent *CI Cash Inflows CO Cash outflows Operating cash flows: Saudi Cement s cash flows from operations would remain strong, driven by robust demand for cement in the Kingdom and the company s dominant market position and favorable geographic location. It has not needed to raise debt baring 2009, for meeting capex requirements. Capital expenditure: Although the company has announced its plans for capacity upgrade, the plan remains in initial stages. However, the company is likely to incur capital expenditure once it awards EPC contract for the expansions. While we cannot ascertain the quantum of these capex, given the low gearing and cash balance, Saudi Cement should be able to manage the same. Impending debt repayments: Saudi Cement has been able to reduce its leverage; debt-to-equity ratio declined from 49.1% in 2009 to 26.0% in 2012, and the company does not have any major, scheduled debt repayments in the near term. The company is well positioned to continue distributing high dividends. Key financials SAR mn Revenues 1,346 1,526 1,716 2,203 Growth (% YoY) EBITDA ,051 1,344 Operating margins (%) Net Income ,103 Growth (% YoY) Dividend payout (%)* Dividend yield (%)* Total Returns (%)*# FCF/CFO (%) CFO/Revenues (%) Debt to equity (%) RoE (%) ROA (%) Source: Bloomberg, Zawya, *Dividend ratios based on cash dividend s # Total Returns reflect the value of cash dividends and Bonus issue as a percentage of share price 16

17 Cement Sector Saudi Cement Company Share price volatility and valuations Figure 36: Share price performance Figure 37: Price-to-earnings valuation multiple Jan-07 Sep-07 Jun-08 Feb-09 O ct -09 Jun-10 Feb-11 O ct -11 Mar-13 Nov-13 S a u di Cem ent T a da w u l c em ent i ndex Jan-03 O ct -03 Jun-04 Feb-05 O ct -05 Jun-06 Feb-07 O ct -07 P /E Avg.+1 SD C em ent index P /E Jun-08 Feb-09 O ct -09 Jun-10 Feb-11 O ct -11 Feb-13 Avg. Avg.-1 SD Figure 38: Price-to-book valuation multiple Figure 39: EV-to-EBITDA valuation multiple Mar-04 Dec-04 Aug-05 Apr-06 Dec-06 Aug-07 Apr-08 Dec-08 Sep-09 May-10 Jan-11 Sep-11 May-12 Jan-13 Dec-04 Sep-05 May-06 Jan-07 Sep-07 May-08 Jan-09 O ct -10 Jun-10 Feb-11 O ct -11 Feb-13 P /B Avg.+1 SD C em ent index P /B Avg. Avg.-1 SD EV/EBITDA Avg.+1 SD C em ent index Avg. Avg.-1 SD Saudi Cement s strong earnings have been reflected in the growth of its stock price. The company s stock price has multiplied more than five times since January 2003 and grown 23.0% YTD since January 2013 as against the 22.2% growth registered by the cement index. Saudi Cement s current valuation on the basis of price-to-earnings and price-to-book value is higher than the company s average historical valuations since 2003 to date. However, on the basis of enterprise value-to-ebitda, the company is trading marginally below its average historical valuation vis-à-vis the Tadawul cement index, Saudi Cement is trading at a higher TTM EV/EBITDA multiple of 13 0x against the index EV/EBITDA of 11.9x. Stock price movement EV/EBITDA YTD 1 Year 5 Year 10 Year Current 2013E Saudi cement 23.0% 29.8% 247.8% 332.6% 13.0x 12.1x Cement Index 22.2% 28.7% 91.2% NA 11.9x 11.7x TASI 2% 21.5% 51.3% 10% 12.5x 10.7x Relative to Cement Index 0.8% 1.1% 156.6% NA 8.6% 3.2% Relative to TASI 1.0% 8.3% 196.5% 230.5% 4.0% 13.2% Source: Bloomberg Note: Closing price for stock price movement is calculated considering prices as on November 13, Saudi Cement Risks and concerns Fuel supply issues related to Saudi Aramco could restrict Saudi Cement from expanding its capacity, thereby adversely affecting the company s revenues. Declining clinker inventory levels could limit Saudi Cement s growth amid the current scenario of strong demand. 17

18 Cement Sector Yamama Cement Company Yamama Saudi Cement Company Company overview Established in 1961, Yamama Saudi Cement Company (Yamama) is the fourth largest company in terms of capacity and the third largest in terms of cement production in KSA. Located in central Saudi Arabia, the company has an annual installed production capacity of 5.8 mn tons. During 2012, the company accounted for 12.2% of the domestic market sales volume. Yamama enjoys a comparative advantage over its peers due to its dominance in the central region, which also accounts for the largest share of KSA s total population. Key drivers Dominant position in the central region: The central region accounts for nearly one-third of total cement demand in the Kingdom, with significant construction activities and also the largest share of population. Yamama is the largest cement producer in the central region, catering to about 38% of the region s demand. With continued rise in construction activity in the central region, the company would benefit from its favorable location. Capacity expansion plans help Yamama to cater to rising demand: Yamama currently has a capacity of 5.8 mn tons, representing ~10% of the capacity in the Kingdom. It also has plans for capacity expansion, with the addition of ~3.5 mn tons by We believe Yamama s strong foothold in central region coupled with expected commissioning of a new production line would enable the company to strengthen its position in the market and cater to the rising demand. Healthy balance sheet: Yamama has a strong cash position, with cash and equivalents at SAR 1.2bn at the end of The company s cash position increased at a CAGR of 23.0% over The company has also gradually de-levered itself with its debt-to-equity declining from 13.9% in 2009 to 1.3% in Payout has picked up but yields around 6% Dividend trend Yamama s cash dividends increased at a CAGR of 9.4%, while earnings rose by 8.6% over However, the company s dividend payout in 2012 is similar to the levels in The company s payout declined significantly in 2008 as the earnings were impacted by the global and domestic slowdown. The average payout during stood at 61.2% vis-à-vis 86.8% in the past three years. Similarly, average yield during was 3.9% vis-à-vis 6.6% in the past three years. However, according to the interim dividend announced by the company, its annualized dividend payout for 2013 is expected to decline to 65.8% while annualized dividend yield lowered to 5.7%. Figure 40: Dividend payout and yields * Dividend payout and yields Dividend payout (%) Dividend yield (%) - RHS ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M

19 K QQ U Saudi Income Stocks Portfolio Cement Sector Yamama Cement Company Total return analysis Besides distributing high cash dividends, Yamama cement has distributed stock dividends to its investors. The company distributed 200% bonus issues worth SAR 900mn in 2006 and 50% bonus issue worth SAR 675mn in As per our total returns analysis, Yamama has generated average total returns of 6.3% over as compared to KSA cement industry s average of 6.0%. Figure 41: Total returns 15.0 Bonus issue in 2006 Bonus issue in (%) * Dividend Yield Total Returns ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M 2013 Peer comparison Yamama Cement pays higher dividends than its regional peers. The company s dividend payout and yield was higher than all regional players, except in the UAE and Saudi Arabia, while its dividend yield was higher than its peers barring the UAE. Figure 42: Comparison with GCC peers Di v i dend p a y o u t ( % ) K uw ait at ar OO mm an Saudi Y am am a U AE v i i ( % ) Di dend y el d Note: Regional peers include major cement manufacturers in the respective countries Dividend sustainability analysis Yamama has distributed high dividends supported by its strong cash flows. The company needed big cash infusions from financing in 2004 and 2005 but has generated enough cash from operations since then to meet outflows and build a considerable cash war chest of SAR 1.2bn by

20 Cement Sector Yamama Cement Company Figure 43: Strong operating cash flows enabled high dividend payments 1, 40 1, 20 C l os ing cas h ( SAR m n) , 241 1, 00 SAR m n C I* 20 C O * C FO C as h f rom f inancing C apex Dividend paym ent Debt repaym ent *CI- Cash Inflows CO Cash outflows # includes Islamic investments Operating cash flows: We expect Yamama s cash flows from operations to remain strong, led by the Kingdom s robust cement demand and dominant market position of the company. Capital expenditure: Yamama may incur high capital expenditure in the near term as it has capacity expansion plans in the pipeline but should be able to meet the same comfortably given the high cash balance and annual CFO of ~SAR 1bn. Impending debt repayments: The company has gradually de-levered itself with debt-to-equity ratio declining from 13.9% in 2009 to 1.3% in 2012, and thus, does not have any major scheduled debt repayments. Key financials SAR mn Revenues 1,163 1,272 1,442 1,576 Growth (% YoY) EBITDA ,062 Operating margins (%) Net income Growth (% YoY) Dividend payout (%)* Dividend yield (%)* Total returns (%)*# FCF/CFO (%) CFO/revenues (%) Debt to equity (%) RoE (%) ROA (%) Source: Bloomberg, Zawya, *Dividend ratios based on cash dividends # Total Returns reflect the value of cash dividends and Bonus issue as a percentage of share price 20

21 Cement Sector Yamama Cement Company Share price volatility and valuations Figure 44: Share price performance Figure 45: Price-to-earnings valuation multiple Jan-07 Sep-07 Jun-08 Feb-09 O ct -09 Jun-10 Feb-11 O ct -11 Mar-13 Y a m a m a T a da w u l c em ent i ndex Nov-13 Dec-06 Sep-07 May-08 Jan-09 Sep-09 May-10 Jan-11 O ct -11 Feb-13 P / g. g. + 1 S g. - 1 S i P / E Av Av D Av D Cem ent ndex E Figure 46: Price-to-book valuation multiple Mar-04 Dec-04 Aug-05 Apr-06 Dec-06 Aug-07 Apr-08 Dec-08 Sep-09 May-10 Jan-11 Sep-11 May-12 Jan-13 P / B Av g. Av g. + 1 S D Av g. - 1 S D Cem ent i ndex P / B Figure 47: EV-to-EBITDA valuation multiple Dec - 04 S ep - 05 M ay - 06 J an- 07 S ep - 07 M ay - 08 J an- 09 O c t- 09 J un- 10 F eb - 11 O c t- 11 J un- 12 E V / E B I A A S A S C TDA vg. vg.+ 1 D vg.- 1 D em ent index F eb - 13 O c t- 13 Yamama s healthy earnings are reflected in the growth of its stock price. The stock has increased by more than 4.0 times since January 2003 and grown 33.9% YTD. Tadawul Cement index also posted gains of 22.2% YTD. The company s current valuation on the price-to-earnings basis is above its average historical valuations. However, on price-to-book value and enterprise value-to-ebitda metrics, the company is trading below its average historical valuations. On comparison with the Tadawul cement index, the company is trading at a lower EV/EBITDA multiple of 10.2x vis-à-vis index multiple of 11.9x. Stock price movement EV/EBITDA YTD 1 Year 5 Year 10 Year Current 2013E Yamama 33.9% 43.6% 191.7% 264.3% 10.2x 9.9x Cement Index 22.2% 28.7% 91.2% NA 11.9x 11.7x TASI 2% 21.5% 51.3% 10% 12.5x 10.7x Relative to Cement Index 11.7% 14.9% 100.5% NA -14.6% -15.6% Relative to TASI 11.9% 2% 140.5% 162.3% -18.2% -7.3% Source: Bloomberg Note: Closing price for stock price movement is calculated considering prices as on November 13, 2013 Yamama - Risks and concerns Issues of fuel supply from Saudi Aramco could restrict the company s capacity expansion plan, and thus, adversely impact revenue. Declining clinker inventory levels could limit the company s growth amid the current scenario of strong demand. 21

22 Cement Sector Qassim Cement Company Qassim Cement Company Company overview Qassim Cement Company (Qassim) is one of the largest cement producers, located in central Saudi Arabia. The company has an annual installed production capacity of 4.3 mn tons, with one of the highest utilization rates in the industry. It accounted for 7.9% of the domestic market sales volume in Qassim manufactures ordinary portland cement, sulfate-resistant cement (SRC), and limestone cement. The company generates its revenues from Riyadh and the Central regions. Key drivers Capacity expansion: Although Qassim has announced clinker capacity addition of 5,500tpd, the lack of clarity on fuel supply remains a major concern. Any positive development in the company s capacity expansion plans is likely to boost its revenues and margins. Highest operating margins in the Kingdom: Qassim s higher-than-industry price realizations and better efficiency has helped it earn the highest margins among its peers. In 2012, Qassim reported gross margins of 58.6% as compared to Saudi cement industry s average of 53.7%. Dividend yield just over 7% while payout has declined Dividend trend Qassim s cash dividends have increased at a CAGR of 12.1%, while earnings rose by 9.7% over Consequently, the company s dividend payout increased from 83.0% in 2003 to 97.7% in The company s average dividend payout of 85.9% over is higher than the cement industry s average of 73.2%. Furthermore, the average yield during stood at 5.2% vis-à-vis 7.8% in the past three years. However, according to the interim dividend announced by the company, its annualized dividend payout for 2013 is expected to be marginally lower at 82.6% while annualized dividend yield is also lower at 6.6%. Figure 48: Dividend payout and yields * - Di v i dend p a y o u t ( % ) Di v i dend y i el d ( % ) - RH S ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M 2013 Total returns trend Besides distributing high cash dividends, Qassim has distributed stock dividend to its investors. Over the past 10 years, the company has had one bonus issue in The company distributed 100% bonus issues worth SAR 450mn in As per our total returns analysis, Qassim has generated average total returns of 6.7% over as compared to KSA cement industry s average of 6.0% during the same period. 22