Saudi Income Stocks Portfolio

Transcription

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 [email protected] 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

23 K QQ O Q U Saudi Income Stocks Portfolio Cement Sector Qassim Cement Company Figure 49: Total returns 18.0 Bonus is s ue in ( % ) * Di v i dend Y i el d T o t a l Ret u r ns ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M 2013 Peer comparison Qassim pays higher dividends as compared to its local and regional peers. The company s dividend payout and yield is higher than all regional players, except the UAE. Figure 50: Comparison with GCC peers as s im U AE Di v i dend p a y o u t ( % ) K uw ait at ar O m an Saudi Di v i dend y i el d ( % ) Note: Regional peers include major cement manufacturers in respective countries Dividend sustainability analysis Qassim distributes high dividends supported by its strong cash flows. Over the last 10 years, the company paid its dividends from its operating cash flows, barring 2012, when the company s dividend payments exceeded its free cash flows. The falling cash balance may be a cause for concern. 23

24 Cement Sector Qassim Cement Company Figure 51: Strong operating cash flows enabled high dividend payments SAR m n C l os ing c as h bal ance C I* C O * C C h f f C FO as rom inancing apex Dividend paym ent Debt repaym ent Note: Cash flow numbers are not available for 2003; *CI- Cash Inflows CO Cash outflows Operating cash flows: We expect Qassim s cash flows from operations to remain strong, led by the Kingdom s robust cement demand and high margins of the company. Capital expenditure: Qassim is unlikely to incur high capital expenditure in the near term, as cement companies are facing difficulties in securing fuel supply from Saudi Aramco for their new plants, thus impacting feasibility of new expansions. Impending debt repayments: Qassim is a zero debt company, and thus does not have any scheduled debt repayments. Key financials SAR mn Revenues , Growth (% YoY) (1.8) 6.9 (4.7) EBITDA Operating margins (%) Net income Growth (% YoY) (16.9) 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 24

25 Cement Sector Qassim Cement Company Share price volatility and valuations Figure 52: Share price performance Figure 53: Price-to-earnings valuation multiple Jan-03 O ct -03 Jan-07 Jun-04 Sep-07 Feb-05 Jun-08 O ct -05 Feb-09 O ct -09 Jun-10 Feb-11 O ct -11 Mar-13 Nov-13 Jun-06 Feb-07 O ct -07 Jun-08 Feb-09 O ct -09 Jun-10 Feb-11 O ct -11 Feb-13 P /E Avg.+1 SD C em ent index P /E Avg. Avg.-1 SD Q a s s i m T a da w u l c em ent i ndex Figure 54: Price-to-book valuation multiple Figure 55: 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 -09 Jun-10 Feb-11 O ct -11 Feb-13 P / B Av g. Av g. + 1 S D Av g. - 1 S D Cem ent i ndex P / B EV/EBITDA Avg.+1 SD C em ent index Avg. Avg.-1 SD Qassim s healthy earnings are reflected in the growth of its stock price. Qassim s stock has increased by nearly 4 times since January 2003 and has grown 20.5% YTD since January 2013 as against 22.2% growth registered by the cement index. The company s current valuation on the basis of price-to-earnings and price-to-book value is value is above the company s average since However, on enterprise value to EBITDA metric, the company is trading below its average historical valuations. On comparison with the Tadawul Cement Index, the company is currently trading at a lower EV/EBITDA multiple of 11 1x vis-à-vis index EV/EBITDA multiple of 11.9x. Stock price movement EV/EBITDA YTD 1 Year 5 Year 10 Year Current 2013E Qassim 20.5% 26.0% 155.5% NA 11.1x 10.7x 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 -1.7% -2.7% 64.2% NA -7.3% -8.3% Relative to TASI -1.5% 4.5% 104.2% NA -11.2% 0.7% Qassim - Risks and concerns Source: Bloomberg Note: Closing price for stock price movement is calculated considering prices as on November 13, Issues of fuel supply from Saudi Aramco restrict any further expansions in capacity, and thus, revenue. 25

26 Cement Sector Eastern Province Cement Company Eastern Province Cement Company Company overview Established in 1982, Eastern Cement Company (EPCC) is a cement manufacturer based near Dammam in the eastern region of Saudi Arabia. As of 2012, the company s production capacity stood at 3.3 mn tons. EPCC s operations are strategically located in the eastern region, with easy access to cities where the demand is high, such as Jubail and Riyadh. Furthermore, the company is located close to export markets such as Bahrain. However, given the export ban by Saudi government, EPCC s proportion of exports in total sales reduced from ~31% in 2007 to ~4% in Key drivers Expansion plans to support growth: EPCC currently has a production capacity of 3.3 mn tons, with a market share of 5.9% in In February 2013, the company announced that it has entered into an agreement with a cement contractor for establishing cement mill with a production capacity of ~1.1 mn tons. The project is scheduled to be completed by Given the expectation of a strong demand for cement in the coming years, we believe EPCC s expansion plans will help enhance its market presence and support growth in profitability. Favorable location: EPCC is located in the Kingdom s eastern region with easy access to the cities of Jubail and Riyadh, where projects worth an estimated USD 158bn are expected to be completed in the coming years. Furthermore, the company is located close to export markets such as Bahrain. The Saudi government has permitted 25,000 tons per week of export to Bahrain, and Saudi Cement and Eastern Cement are the only two companies capable of capitalizing on this exemption. Healthy balance sheet: EPCC has historically maintained a healthy cash balance, which stood at SAR 376.4mn in 2012 after paying dividends worth SAR 299.4mn. Furthermore, the company successfully moved to zero debt in Dividend yield supported by healthy balance sheet EPCC has a dividend yield of 6.1% in 2012 (industry yield 6.2%), given its strong balance sheet with higher cash levels and zero debt, which gives it room to comfortably meet planned expenditure and dividend payments. The company has also maintained strong cash flow from operations (above SAR 300mn) since During 2012, the cash flow from operations stood at SAR 499.6mn. Dividend trend EPCC s cash dividends increased at a CAGR of 3.2%, while earnings rose by 5.2% over However, the company s dividend payout decreased from 95.2% in 2003 to 82.7% in Dividend payouts declined in 2008 and 2009 due to a fall in the company s earnings, and have risen substantially since The company s average dividend payout of 89.7% over was higher than the cement industry s average of 73.2%. EPCC s dividend yield over the past three years averaged 6.7% vis-à-vis the cement sector s average dividend yields of 7.2% over The company s yields have declined marginally since 2010, primarily owing to the 26.9% increase in the share price over The company s dividends for 2013 could not be analyzed based on the announced interim results as the company did not declare any interim dividend. Figure 56: Dividend payout and yields Di v i dend p a y o u t ( % ) Di v i dend y i el d ( % ) - RH S 26

27 K Q U Saudi Income Stocks Portfolio Cement Sector Eastern Province Cement Company Total returns trend Besides distributing high cash dividends, EPCC has distributed stock dividends to its investors. Over the past 10 years, the company distributed one bonus issue of 33% worth SAR 215mn in As per our total returns analysis, EPCC has generated average total returns of 6.2% over almost in line with the KSA cement industry s average of 6.0%. Figure 57: Total returns 1 Bonus is s ue in ( % ) Di v i dend Y i el d T o t a l Ret u r ns Peer comparison EPCC pays higher dividends than regional peers. However, the company s payouts are marginally below its domestic peers. The company s dividend payout and yield are higher than all regional players, except UAE. Figure 58: Comparison with GCC peers Di v i dend p a y o u t ( % ) K uw ait at ar OO m an EP C C Saudi U AE Di v i dend y i el d ( % ) ; Note: Regional peers include major cement manufacturers in the respective countries 27

28 C Saudi Income Stocks Portfolio Cement Sector Eastern Province Cement Company Dividend sustainability analysis EPCC has relied on its operating cash flows, debt, internal accruals, and sale of investments for distributing dividends. However, since 2010, the company s high operating cash flows and relatively lower capital expenditure have enabled the payment of dividends from the company s operating cash flows. With no debt, EPCC has the ability to generate enough CFO to meet capex and dividend obligations. Figure 59: Strong operating cash flows, debt, internal accruals enabled high dividend payments 7 0 l os ing cas h bal ance ( SAR m n) S AR m n C I* C O * 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 Source: Bloomberg, Zawya, AlJazira Capital *CI- Cash Inflows CO Cash outflows Operating cash flows: We expect EPCC s cash flows from operations to remain strong, led by the Kingdom s robust cement demand. The company s expansion plans will also help cater to the rising demand and, consequently, impact the operating cash flows. The company has a CFO run rate of about SAR 400mn annually. Capital expenditure: In February 2013, the company announced plans to establish a new plant at the cost of SAR 82mn. We expect the company s capex levels to remain high in the coming years. Impending debt repayments: EPCC has been able to de-leverage with the debt-to-equity ratio declining from 5.7% in 2009 to no debt in The capacity expansions are expected to be funded internally by the company. Key financials SAR mn Revenues Growth (% YoY) 5.3 (0.8) 2.2 EBITDA Operating margins (%) Net Income Growth (% YoY) (2.2) 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 28

29 Cement Sector Eastern Province Cement Company Share price volatility and valuations Figure 60: Share price performance 16 Figure 61: Price to- earnings valuation Jan-07 Sep-07 Jun-08 Feb-09 O ct -09 Jun-10 Feb-11 O ct -11 Mar-13 Nov-13 EP CC 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 62: Price- to- book valuation multiple 6.0 Figure 63: 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 Sep-09 May-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 EPCC s stock price has increased more than 2 times since January 2003, and has grown 12.2% YTD since January 2013 as against 22.2% growth registered by the cement index. The company s current valuation on the basis of price to-earnings multiple is above the company s average historical valuations since On the price-to-book metrics, the company s current valuation is same as the company s average historical valuations since However, on enterprise value-to-ebitda metric, the company is trading below its average historical valuations. EPCC s current EV/EBITDA multiple is trading lower than index at 10.4x vis-à-vis index EV/EBITDA multiple of 11.9x for the Tadawul cement index. Stock price movement EV/EBITDA YTD 1 Year 5 Year 10 Year Current 2013E Eastern Cement 12.2% 21.8% 72.3% NA 10.4x 10.6x 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 -1% -6.9% -18.9% NA -12.6% -9.3% Relative to TASI -9.8% 0.2% 21.0% NA -16.4% -0.5% EPCC - Risks and concerns Source: Bloomberg Note: Closing price for stock price movement is calculated considering prices as on November 13, 2013 Delay in implementation of the company s expansion plans could limit its growth prospects in the coming years. Declining clinker inventory levels could also limit the company s growth amid the current scenario of strong demand. 29

30 Cement Sector Tabuk Cement Company Tabuk Cement Company Company overview Established in 1991, Tabuk Cement Company (TCC) has an annual production capacity of 1.4mn tons. TCC s plant is located in the northwest of the Kingdom. The company mainly manufactures and markets ordinary portland cement, sulfate resistant cement and pozzolan portland cement. As of 2012, TCC s market share stood at 2.5%, in terms of production capacity. Key drivers Expansion plans to support growth: In August 2013, the company announced that it has entered into an agreement with a cement contractor to establish a mill with a production capacity of ~1.2 mn tons. Given the expectation of strong demand for cement in the coming years, we believe TCC s expansion plans would enhance its market presence and boost profitability. Unleveraged balance sheet and strong operating cash flows: TCC has a debt-free balance sheet, which provides it with the required financial independence and flexibility given the capital-intensive nature of the business. Furthermore, the company s operating cash flows remain strong at SAR 276.7mn in Healthy dividend payments TCC had a dividend yield of 6.6% in 2012, higher than the industry aggregate yield of 6.2%. The company also paid dividends during , despite a decline in earnings. However, in the past two years, TCC has utilized its cash reserves for dividend payment as it has incurred high capex of SAR mn annually. Consequently, the cash balance declined to SAR 85.2mn in 2012 from SAR 328.8mn in This poses a major concern for the company s future dividend payments. Dividend trend Between 2003 and 2012, TCC s cash dividends increased at a CAGR of 8.3%, while earnings rose 10.4%. Furthermore, the company s dividend payout rose to 105.2% in 2012 from 88.9% in However, during 2006, TCC did not declare any dividends. Moreover, during 2008 and 2009, the dividend payouts declined to 61.3% and 74.4%, respectively, due to lower earnings and dividends (per share). During , the company s average dividend payout of 88.5% exceeded the cement industry s average of 73.2%. Over , TCC s dividend yield averaged 6.7% vis-à-vis the cement sector s 7.2%. According to the interim dividend announced by the company, its annualized dividend payout for 2013 is expected to remain high at 99.8% while annualized dividend yield also remains high at 6.7%. Figure 64: Dividend payout and yields * Dividend payout ( % ) Dividend yiel d ( % ) - RH S - ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M

31 QQ Saudi Income Stocks Portfolio Cement Sector Tabuk Cement Company Total returns trend Besides distributing high cash dividends, TCC has distributed stock dividends to investors. Over the past 10 years, the company distributed one bonus issue of 29% (worth SAR 200mn) in According to our total returns analysis, TCC generated average total returns of 5.2% during , lesser than the KSA cement industry s average of 6.0%. Figure 65: Total returns 1 Bonus is s ue in ( % ) * Dividend Y iel d Tot al Ret urns ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M 2013 Peer comparison TCC pays higher dividends than its local and regional peers. While the company s dividend payout was higher than all regional players, except the UAE, the dividend yield also surpassed peers, barring the UAE. Figure 66: Comparison with GCC peers 12 TC C Di v i dend p a y o u t ( % ) KK uw ait at ar 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 Historically until 2009, barring 2008, TCC relied on its operating cash flows for distributing dividends. Recently, the company has been paying high dividends despite an increase in capital expenditure. These payments have been funded by the company s internal accruals. Consequently, TCC s cash balance has declined to SAR 85.2mn in 2012 from SAR 426.6mn in

32 Cement Sector Tabuk Cement Company Figure 67: Strong operating cash flows and internal accruals enable high dividend payments S AR m n C l os ing c as h bal ance ( SAR m n) C I* C O * 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 Source: Bloomberg, Zawya, AlJazira Capital *CI- Cash Inflows CO Cash outflows Dividend sustainability analysis Operating cash flows: We expect TCC s cash flows from operations to remain strong, led by robust demand for cement in the Kingdom. The company s expansion plans would also help to cater to the rising demand and, in turn, boost operating cash flows. Capital expenditure: TCC has announced plans for capacity expansion along with development and rehabilitation of the existing production line. The capital expenditure for the new cement mill is expected to be ~SAR 218.7mn. During June 2013, the company also announced the establishment of a second line at its power plant for SAR 735.9mn. We expect the company s capex levels to remain high in the coming years. Impending debt repayments: TCC has been able to de-leverage its balance sheet and currently has no debt (2012). However, the company plans to raise debt in the near term for its upcoming projects. With SAR 125mn in dividend payments about SAR mn in capex, TCC may need to raise ~SAR 500mn debt considering it generates about SAR 250mn from operations annually. Resultantly the debt to equity ratio (at the current equity base) would rise to ~43%( 2012 industry average is at 19.8%). Rising capital expenditure, impending debt repayments, and declining cash levels pose a concern for dividend distribution going forward. Key financials SAR mn Revenues Growth (% YoY) EBITDA Operating margins (%) Net Income Growth (% YoY) (0.1) 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 32

33 Cement Sector Tabuk Cement Company Share price volatility and valuations Figure 68: Share price performance Figure 69: 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 T T a w u l c i CC da em ent ndex 6.0 Dec-07 Aug-08 Apr-09 Dec-09 Jul -10 Mar-11 Nov-11 Jul -12 Feb-13 P / E Av g. Av g. + 1 S D Av g. - 1 S D Cem ent i ndex P / E Figure 70: Price-to-book valuation multiple Figure 71: EV-to-EBITDA valuation multiple Dec-04 Sep-05 May-06 Jan-07 Sep-07 May-08 Jan-09 O ct -09 Jun-10 Feb-11 O ct -11 Feb-13 Dec-04 Sep-05 May-06 Jan-07 Sep-07 May-08 Jan-09 O ct -09 Jun-10 Feb-11 O ct -11 Feb-13 P / B Av g. Av g. + 1 S D Av g. - 1 S D Cem ent i ndex P / B / g. g. + 1 S g. - 1 S i EV EB IT DA Av Av D Av D Cem ent ndex TCC s stock price has more than doubled since January 2003, and 26.5% YTD since January 2013 vis-à-vis the 22.2% growth registered by the cement index. The company s current valuation on the basis of price-to-earnings multiple is higher than the average historical valuation. However, in terms of price-to-book metric and enterprise value-to-ebitda metric is below the average historical valuations. TCC s current EV/EBITDA multiple is trading at a discount at 9.6x vis-à-vis the EV/EBITDA multiple of 11.9x for the Tadawul cement index. Stock price movement EV/EBITDA YTD 1 Year 5 Year 10 Year Current 2013E TCC 26.5% 33.1% 57.6% 63.5% 9.6x 8.7x 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 4.3% 4.4% -33.6% NA -19.8% -25.9% Relative to TASI 4.5% 11.6% 6.4% -38.6% -23.3% -18.7% Source: Bloomberg Note: Closing price for stock price movement is calculated considering prices as on November 13, 2013 TCC Risks and concerns Delay in implementation of expansion plans could limit growth prospects Declining cash levels and rising capital expenditure pose a threat to dividend payments 33

34 Petrochemical Sector Saudi Arabian Fertilizers Company Petrochemical Sector According to our stock selection methodology, three of the 14 stocks under both the Cash Dividends and Total Return portfolios belong to the petrochemical sector. Saudi Arabia is the largest producer of petrochemical in the GCC region, with a capacity of 86.4mn tons (67.6% of regional capacity). The Kingdom has major expansion plans for the petrochemical space; the expansion would be led by both basic and specialty chemicals that add value to production. According to news sources, investments in KSA s petrochemical sector have reached SAR 3.6tn 9. Saudi Arabia s strong macroeconomic fundamentals and rising demand from fast-growing emerging markets such as China and India are expected to drive the demand for petrochemicals. There is a large disparity in the per capita consumption of petrochemicals between emerging and developed economies. Furthermore, the Kingdom s focus on moving down the petrochemical value chain is likely to put the sector on a higher growth trajectory. Moreover, petrochemical companies in the KSA benefit from lower feedstock costs, and their proximity to key growing markets gives them a competitive advantage over regional peers. Petrochemical Sector Risks and Concerns Any move by the Saudi government to lift its base rate for gas would erode the cost advantage of petrochemical producers and result in a contraction in their margins. International natural gas prices are likely to decline when new shale gas reserves come online in the US; this would result in higher competition, and challenge the Saudi producers comparative advantage in terms of feedstock costs and impact their profit margins. Any negative movement in petrochemical prices would negatively affect the sector s revenues. Saudi Arabian Fertilizers Company Company overview Saudi Arabian Fertilizers Company (SAFCO) is principally engaged in the production of urea and ammonia. The company is located in Jubail and has a total installed capacity of 2.7 mn tons of urea and 2.1 mn tons of ammonia. Currently, SAFCO is the main producer of ammonia, urea, melamine and sulfuric acid in KSA. The company was established in September 1965 and commenced commercial production in Key drivers Dominant market position: SAFCO is the largest producer of ammonia, urea, melamine and sulfuric acid in Saudi Arabia. Relatively price inelastic products assure revenue sustainability: Demand for SAFCO s products, such as ammonia and urea, is relatively price inelastic vis-à-vis demand for potash and phosphate, as farmers need to reapply them every year for plant growth. Urea prices increased over and remained stable until the beginning of 2013; thereafter, it started to decline. Prices of urea sold in Europe and the US decreased around 22% YTD (until the end of July) to USD 315 and USD 325 per ton, respectively. The decline was primarily ascribed to lower costs of Chinese producers due to a correction in coal prices (key input used by 80% of China s available capacity). Nevertheless, the outlook for fertilizer prices remains strong with prices bottoming at around USD 300 per ton amid a rebound in coal prices Saudi Plastic & Petrochem 10. Market Realist 34

35 - Saudi Income Stocks Portfolio Petrochemical Sector Saudi Arabian Fertilizers Company Highest margins in petrochemical space: SAFCO has one of the lowest production costs among global peers due to its dominant market position in fertilizers and feedstock cost advantage. In 2012, the company s operating margin stood at 77.7% compared to the Saudi petrochemical industry average of 27.1% and global peer average of 43.8%. Moderate expansion plans: SAFCO s expansion plans are limited to SAFCO V plant and includes setting up of production capacity of 1.2mn tons of ammonia and 1.5mn tons of urea. The new facility is scheduled to be commissioned by 2H2014, after which the company has no additional capacity expansion plans in the pipeline. The disinclination of SAFCO towards further expansion is likely on account of the estimated over supply of fertilizer worldwide in the near future as the company derives around 99% of revenues from exports. While this reduces capital expenditure requirements, it is not creating growth channels for FCF that, in turn, would lead to dividend growth. Strong balance sheet: SAFCO s cash base rose by SAR 1.3bn over to SAR 3.6bn, led by robust operating cash flows and low capital expenditure. Moreover, the company managed to reduce its leverage with debt-toequity ratio declining from 8.4% in 2009 to 0.5% in In our opinion, the company s balance sheet would strengthen due to its moderate expansion plans providing scope for repayment of entire debt and maintaining a high dividend payout. Additionally, the company s effective cash management is likely to boost non-operating income. Dividend payout has declined to 100% but yield has held up at ~8% Dividend trend SAFCO s cash dividends increased at a CAGR of 32.4%, while earnings rose 28.6% over Consequently, the company s dividend payout has remained robust, averaging 130.4% over compared to the petrochemical industry s average of 53.6%. In six of the past 10 years, the company has paid more than 100% of its earnings as cash dividends. Over the period of analysis ( ), SAFCO registered an average dividend yield of 6.1% vis-à-vis the petrochemical sector s 3.2%. According to the interim dividend announced by the company, its annualized dividend payout for 2013 is expected to rise to 127.2% while annualized dividend yield also increases to 8.1%. Figure 72: 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

36 m K Saudi Income Stocks Portfolio Petrochemical Sector Saudi Arabian Fertilizers Company Total returns trend In addition to distributing high cash dividends, SAFCO has distributed stock dividends to investors. Over the past 10 years, the company has made two bonus issues. SAFCO distributed aggregate bonus issues worth SAR 1.3bn over As per our total returns analysis, the company has given average total returns of 6.5% during the same period, much higher than the KSA petrochemical industry s average of 3.8%. Figure 73: Total returns 18.0 Tw o bonus is s ues acros s t en years w ort h SAR 1.3bn ( % ) * Dividend Y iel d Tot al Ret urns ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M 2013 Peer comparison SAFCO earns the highest margins and pays the highest dividends among peers. The company s dividend payout and yield were much above the average of domestic, regional and global players (except Terra Nitrogen). Figure 74: Comparison with global and local peers Di v i dend p a y o u t ( % ) 12 Terra Nit rogen 10 SAFC O 8 Scot t tt ss Miracl e Taiw an 6 Saudi Arabia G erm any 4 K uw ait P ot as h CC orp India 2 S. KK orea Agrium C F Indus t ries Di v i dend y i el d ( % ) ; Note: Global peers include major petrochemical manufacturers in the respective countries and major fertilizer producers Dividend sustainability analysis SAFCO has historically ( ) relied on operating cash flows, debt and income from investments for paying high dividends. However, low capital expenditure over the last seven years enabled the company to fund dividend payments via operating cash flows, cash balance and income from investments. Strong cash balance of the company enabled payment of high dividends in 2009 and 2010 despite lower operating cash flows. Over the last two years, SAFCO has accumulated strong cash base of SAR 3.6bn, supported by robust operating cash flows and low capital expenditure. 36

37 Petrochemical Sector Saudi Arabian Fertilizers Company Figure 75: Strong operating cash flows leads to high dividend payments C l os ing c as h bal ance ( SAR m n) , , 918 2, , , 280 3, S AR b n C I* C O * 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: We expect SAFCO s cash flow from operations to remain strong led by robust demand for fertilizers which is price inelastic and the company s strong margins due to subsidized feedstock from Aramco. Capital expenditure: SAFCO is currently setting up new capacities under SAFCO-V which is expected to commission in 2H 2014; thereafter, the company might not undertake any further expansion plans. Thus, SAFCO s capital expenditure is projected to remain high until 2014 and thereafter it is likely to be limited. Given the high cash balance and about SAR 4bn of CFO, the company should be able to meet these obligations comfortably. Impending debt repayments: SAFCO s debt-to-equity ratio declined from 8.4% in 2009 to 0.5% in 2012 as the company managed to repay debts with robust cash flows. Key financials SAR mn Revenues 2,741 3,789 5,051 4,980 Growth (% YoY) (1.4) EBITDA 1,960 2,921 3,989 3,869 Operating margins (%) Net Income 1,804 3,235 4,110 3,866 Growth (% YoY) (5.9) 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 37

38 Petrochemical Sector Saudi Arabian Fertilizers Company Share price volatility and valuations Figure 76: Share price performance Figure 77: 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 SAF C O P et r o c h em ic a l s index 4 2 Jan-03 O ct -03 Jun-04 Feb-05 O ct -05 Jun-06 Feb-07 O ct -07 Jun-08 Feb-09 P / E Av g. Av g. + 1 S D Av g. - 1 S D P et c h em. i ndex O ct -09 Jun-10 Feb-11 O ct -11 Feb-13 Figure 78: Price-to-book valuation multiple Figure 79: 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 -09 Jun-10 Feb-11 O ct -11 Feb-13 P /B Avg.+1 SD P et ch em. index Avg. Avg.-1 SD E V / E B I TDA A vg. A vg.+ 1 S D A vg.- 1 S D P etc h em. index SAFCO s strong earnings have been reflected in the stock price growth. The company s stock price increased more than 19x since January However, it has risen 11.4% YTD since January 2013 compared to the 20.1% increase witnessed in the petrochemical index. The company s current valuation, on the basis of price-to-earnings and enterprise value-to-ebitda, is below its average historical valuations (since 2003 until date). However, in terms of price-to-book metric, the company is trading much higher vis-à-vis the average historical valuations. In comparison with the Tadawul petrochemical index, SAFCO is trading at a lower P/E multiple of 14.9x relative to 17.4x for the index. Stock price movement EV/EBITDA YTD 1 Year 5 Year 10 Year Current 2013E SAFCO 11.4% 13.6% 300.1% 916.5% 14.9x 14.8x Petrochemical Index 20.1% 21.7% 93.0% NA 17.4x 14.6x TASI 2% 21.5% 51.3% 10% 17.0x 14.7x Relative to Petrochemical Index -8.7% -8.1% 207.1% NA -14.1% 1.0% Relative to TASI -10.6% -7.9% 248.8% 814.5% -12.2% 0.6% Source: Bloomberg Note: Closing price for stock price movement is calculated considering prices as on November 13, SAFCO Risks and concerns Any further decline in fertilizer prices would largely impact SAFCO s revenue. The fertilizer industry is expected to become more competitive with upcoming capacity expansions in GCC and developing countries. This, in turn, might impact fertilizer prices and reduce opportunities for the company. 38

39 Petrochemical Sector Advanced Petrochemicals Company Advanced Petrochemicals Company Company Overview Established in 2005, Advanced Petrochemicals Company (APC) has its plants located in Jubail Industrial City. The company is primarily engaged in the production of polypropylene (PP), with an annual installed production capacity of 455 tons for propylene and 450 tons for PP. APC uses the CATOFIN technology to convert propane into propylene and the NOVOLEN technology to convert propylene into PP. CATOFIN technology has lower investment and operating costs owing to a high per pass conversion rate (48 53%), high catalyst selectivity, and on-stream efficiency of more than 98%. NOVOLEN technology is a simple, gas-phase, solvent-free process, which requires low operating and maintenance costs. This technology allows processing of a full range of homopolymers, and random & impact copolymers in only two reactors with catalysts, which enables it to cover a broad range of products. The company s propylene production is fully integrated into downstream PP production. APC commenced production in the first quarter of Key Drivers Growth in PP demand: The total PP resin market for local conversion in the GCC region is expected to reach USD 1.4bn in 2016 from USD 983.1mn in 2011, led by Saudi Arabia and the UAE due to a strong government support 11. PP prices picking-up: The prices of PP strengthened in 2Q 2013, led by production cutbacks in Europe amid an already weak price scenario. Thus, with an improvement in global economic environment and replenishment of inventories, PP prices are likely to receive a boost. Strategic marketing alliances to provide revenue sustenance: APC has set up long-term (eight years) strategic alliances with leading global players, including Vinmar International Ltd (USA), Mitsubishi Corp. (Japan), and Domo Chemicals (Netherlands), for supplying its products to the domestic and global markets. The term of the alliance may be extended to 12 years. The target markets for the company s products will be Europe, South East Asia (particularly China), and the Middle East. The long-term tie-ups for off-take of the company s production reinforces confidence in the company s earnings sustainability. Increased feedstock supply at lower cost to boost revenue and margins: APC recently signed an agreement with Aramco to increase the supply of contracted propylene by 30,000 tons per year to 80,000 tons per year. Furthermore, the duration of supply of the entire 80,000 tons per year has now been increased to five years from the earlier three years. A higher propylene supply would help increase PP production and sales and, thus, boost the company s revenue. Low dividend payout at 50% provides room for growth Dividend Trend While APC was established in 2005, its plants commenced operations in It started paying dividends from the second year of its operations, i.e., The company s cash dividends increased at a CAGR of 32.4% over , led by 37.2% growth in its earnings over the same period. Consequently, the company s dividend payouts in the last four years have averaged 103.0%, led by 194.6% dividend payout in 2010; this was much higher than the petrochemical sector s dividend payout of 7% over APC registered an average dividend yield of 6.3% vis-à-vis the petrochemical sector s average of 3.9% during According to the interim dividend announced by the company, its annualized dividend payout for 2013 is expected to remain strong at 62.2% while annualized dividend yield also remains high at 6.0%. 11. Frost & Sullivan 39

40 Petrochemical Sector Advanced Petrochemicals Company Figure 80: Dividend payout and yields * - Dividend payout (%) Dividend yield (%) - RHS ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M 2013 Total Returns Trend In addition to distributing high cash dividends, APC has given stock dividend to its investors. Over the last five years of operations, the company made one bonus issue worth SAR 226.2mn in According to our total returns analysis, the company generated an average total return of 7.6% over , much higher than the Saudi petrochemical industry s average of 4.1%. Figure 81: Total returns 15.0 Bonus is s ue in 2012 w ort h SAR 226.2m n (%) * Dividend Yield Total Returns ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M 2013 Peer Comparison APC pays higher dividends than most of its domestic and global peers. The company s dividend payout was higher than those of global players (except Taiwan), but lower than domestic peer average, while its dividend yield was the highest among peers. 40

41 K Saudi Income Stocks Portfolio Petrochemical Sector Advanced Petrochemicals Company Figure 82: Comparison with global and local peers Di v i dend p a y o u t ( % ) G erm any 4 3 India Taiw an Saudi Arabia AP C K uw ait KK v i i ( % ) 2 S. orea Di dend y el d ; Note: Global peers include major petrochemical manufacturers in the respective countries Dividend Sustainability Analysis APC started paying dividends from the second year of its operations and the first year of its positive operating cash flows. Over , the company s strong operating cash flows and cash base enabled payment of strong dividends along with debt repayments and capital expenditure. Figure 83: Strong operating cash flows and cash base enabled high dividend payments 1.6 C I* C l os ing cas h bal ance ( SAR m n) S AR b n ( 0.4) C O * 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 Source: Bloomberg,Zawya, AlJazira Capital *CI Cash Inflows CO Cash outflows Operating cash flows: We expect APC s cash flows from operations to remain robust, led by a revival in the global economy, improving PP prices, and an increase in contracted feedstock from Aramco. Moreover, the company s off-take alliances are expected to ensure sustained revenues. The company has been generating about SAR 500mn in CFO over the last three years. Capital expenditure: In 2012, APC announced plans to establish a SAR 3.8bn propane dehydration (PHD) and PP plant in Bayegan, Southern Turkey, in collaboration with the Bayegan group; the project s target for completion is end However, the company withdrew from the MoU in early 2013 and has not announced any expansions since. Impending debt repayments: With consistent debt repayments over , APC has been able to reduce its debt-toequity ratio from 88.2% in 2009 to 39.8% in 2012, this is much lower than Saudi petrochemical peers average debt-toequity ratio of 148% in

42 Petrochemical Sector Advanced Petrochemicals Company Key financials SAR mn Revenues 1,467 2,031 2,791 2,472 Growth (% YoY) (11.4) EBITDA Operating margins (%) Net income Growth (% YoY) (36.0) 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 Share Price Volatility and Valuations Figure 84: Share price performance Figure 85: 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 AP C P et r o c h em i c a l s i ndex Dec-08 Sep-09 May-10 Jan-11 Sep-11 P / E Av g. Av g. + 1 S D Av g. - 1 S D P et c h em. i ndex May-12 Jan-13 Figure 86: Price-to-book valuation multiple Figure 87: EV-to-EBITDA valuation multiple Jan-07 O ct -07 Jun-08 Feb-09 O ct -09 Jun-10 Feb-11 O ct -11 Feb-13 P / B Av g. Av g. + 1 S D Av g. - 1 S D P et c h em. i ndex Dec-08 Sep-09 May-10 Jan-11 Sep-11 May-12 Jan-13 / g. g. + 1 S g. - 1 S P c h. i EV EB IT DA Av Av D Av D et em ndex APC s strong earnings are reflected in its stock price growth. The company s stock price has risen more than six times since January Furthermore, it surged 62.3% YTD since January 2013 compared to the 20.1% growth witnessed in the petrochemical index. APC s current valuation on the basis of price-to-book is higher than the company s average historical valuation. However, in terms price-to-earnings the company is currently trading almost in line with average historical valuations and enterprise value-to-ebitda is marginally below the historical valuations. On comparison with the Tadawul petrochemical index, the company is trading at a lower P/E multiple of 12.7x vis-à-vis the index s P/E multiple of 17.4x. 42

43 Petrochemical Sector Advanced Petrochemicals Company Stock price movement EV/EBITDA YTD 1 Year 5 Year 10 Year Current 2013E APPC 62.3% 77.2% 270.7% NA 12.7x 14.0x Petrochemical Index 20.1% 21.7% 93.0% NA 17.4x 14.6x TASI 2% 21.5% 51.3% 10% 17.0x 14.7x Relative to Petrochemical Index 42.2% 55.5% 177.7% NA -26.8% -4.4% Relative to TASI 40.3% 55.6% 219.4% NA -25.2% -4.8% SSource: Bloomberg Note: Closing price for stock price movement is calculated considering prices as on November 13, APC Risks and Concerns Any decline in propylene prices would majorly impact APC s revenue. 43

44 Other Sectors AlAbdullatif Industrial Investment Company Companies from other sectors The remaining four companies are from industrial investment, real estate, hotel and tourism sectors. These companies are also expected to benefit from the Kingdom s stable economic growth, and favorable demographics like rising population growth and increasing per-capita income. Furthermore, rise in infrastructure spending by the KSA government is also expected to benefit these companies. Some of the company specific drivers are increase in construction activities, rising demand for civil and military explosives in the Kingdom and strong growth expected in Saudi Arabia s pharmaceutical market for Saudi Chemical Company (SCC). AlAbdullatif Industrial Investment Company (Abdullatif) is expected to benefit from declining household size, an increase in the number of households and higher levels of disposable income. While Saudi Hotels & Resort Areas Company (SHARACO) is expected to benefit from growth in KSA tourism industry, especially religious tourism, Arriyadh Development would be led by expanding construction sector. AlAbdullatif Industrial Investment Company Company Overview Established in 1981, AlAbdullatif Industrial Investment Company (Abdullatif) is a fully integrated textile company in Saudi Arabia. The company, headquartered in Riyadh, is vertically integrated from extrusion and spinning plant up to finished carpets. With a production capacity of nearly 125 tons of carpet yarn per day and a global network, Abdullatif caters to a vast international market. The company offers three kinds of carpets: tufted, woven and non-woven; also, it is the largest carpet manufacturer in the Middle-East and ranks among the top 10 largest carpet manufacturers in the world. Abdullatif s subsidiaries and associates include National Spinning Co., Eastern Textile Co., Adfa Blanket Co., Nadeen Arabian Colors Co., Shahd Paper Mfg Co. and Western Textile Co. Key Drivers Saudi demographics boost demand outlook: Factors such as rising population, declining household size, an increase in the number of households and higher levels of disposable income are driving growth in the consumer market that, in turn, is boosting demand for carpets in the Kingdom. Robust economic expansion and rise in demand for housing, especially finished housing, are likely to bolster retail sales of carpets and rugs. Integration supports margins: Abdullatif s fully-integrated operations reduce dependence on external suppliers. The company reported average operating margins of 23.9% over Capacity expansion to strengthen market position: The company plans further expansion of around 13,000 tons of carpet yarn per year which is expected to commence at the beginning of This expansion is expected to drive revenues and, in turn, strengthen the company s market position. Moreover, capacity addition would create efficiency and productivity gains as the bulked continuous filament (BCF) S+ plant offers sophisticated technology, and delivers 99% efficiency and significant cost savings. This is expected to augment Abdullatif s margins. Dividend Trend While Abdullatif was established in 1981, it started paying dividends from 2008 (except in 2009). The company s cash dividends increased at a CAGR of 13.6% over , while earnings grew 7.0%. Consequently, Abdullatif s dividend payouts averaged 102.4%, well above the industrial investments sector s 54.4%, led by more than 100% payouts in two of the four dividend-paying years. Abdullatif registered an average dividend yield of 6.8% vis-à-vis the industrial investments sector s 4.4% during The company s dividends for 2013 could not be analyzed based on the announced interim results as the company did not declare any interim dividend. 44

45 O H Saudi Income Stocks Portfolio Other Sectors AlAbdullatif Industrial Investment Company Figure 88: Dividend payout and yields ( ) Di v i dend p a y o u t ( % ) Di v i dend y i el d ( % ) - RH S Total Returns Trend In addition to the distribution of high cash dividends, Abdullatif has offered stock dividend to investors. Over the last 10 years, the company has offered one bonus issue worth SAR 162.5mn in According to our total returns analysis, Abdullatif s average total return stood at 7.7% over , much higher than 5.3% for the industrial investments sector. Figure 89: Total returns ne bonus is s ue in t en years w ort h SAR m n 15.0 ( % ) Di v i dend Y i el d T o t a l Ret u r ns Peer Comparison Abdullatif does not have any direct comparable peer; hence, we have performed global peer analysis on trading companies with market capitalization comparable with Abdullatif. The analysis reflected Abdullatif pays higher dividends vis-à-vis domestic and global peers. The company s dividend payout and dividend yield were the highest among peers. Figure 90: Comparison with global and local peers Di v i dend p a y o u t ( % ) Abdul l at if 8 Saudi Arabia 6 UU S U K 4 S. Af rica S. KK orea G erm any Japan 2 ong K ong CC hh ina Di v i dend y i el d ( % ) ; Note: Global peers include major trading companies in the world and domestic peers comprise comparable companies under the industrial investment index 45

46 Other Sectors AlAbdullatif Industrial Investment Company Dividend Sustainability Analysis Abdullatif started paying dividends from 2008, barring The company used operating cash flows to repay a part of its debt in Over , Abdullatif paid high dividends via its strong operating cash flows, low capital expenditure, debt borrowings and cash base. However, the company s cash base declined from SAR 229.0mn in 2009 to SAR 91.8mn in Figure 91: Strong operating cash flows, debt and cash base enabled high dividend payments C l os ing C as h bal ance ( SAR m n) S AR m n C O * 10 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 Source: Bloomberg, Zawya, AlJazira Capital *CI Cash Inflows CO Cash outflows Operating cash flows: We expect Abdullatif s cash flows from operations to remain robust, led by rising demand for finished housing, the company s vertical integration and upcoming expansion initiatives. Capital expenditure: Abdullatif placed an order with Oerlikon Neumag for production equipment including three S+ BCF systems for mono-color polypropylene and two further systems for polyester. The systems are expected to commence production at the beginning of Thus, Abdullatif s capital expenditure is expected to increase in Impending debt repayments: Although Abdullatif has been consistently raising debt since 2010, its leverage remained comfortable at 35.5% in We remain optimistic about Abdullatif s ability to pay dividends due to strong operating cash flows and consistent dividend payments over the last three years. However, the company s capital expenditure in 2013 raises concerns over dividend payouts. Key financials SAR mn Revenues 996 1,139 1,337 1,455 Growth (% YoY) EBITDA Operating margins (%) Net income Growth (% YoY) (9.7) 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 46

47 Other Sectors AlAbdullatif Industrial Investment Company Share Price Volatility and Valuations Figure 92: Share price performance 21 Figure 93: Price-to-earnings valuation Feb-07 Aug-07 Feb-08 Aug-08 Feb-09 Ab du l l a t i f Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Feb-12 Aug-12 Feb-13 Aug-13 Ind. Inv es t. Index Feb-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Feb-12 Aug-12 Feb-13 O C T-13 P / E Av g. Av g. + 1 S D Av g. - 1 S D Ind. Inv es t. Index Figure 94: Price-to-book valuation multiple 6.0 Figure 95: EV-to-EBITDA valuation multiple Feb-07 O ct -07 Jun-08 Feb-09 O ct -09 Jun-10 Feb-11 O ct -11 Feb-13 P / B Av g. Av g. + 1 S D Av g. - 1 S D Ind. Inv es t. Index ( 1) Feb-07 O ct -07 Jun-08 Feb-09 O ct -09 Jun-10 Feb-11 O ct -11 Feb-13 / g. g. + 1 S g. - 1 S EV EB IT DA Av Av D Av D Ind. Inv es t. Index Abdullatif s strong earnings have been reflected in stock price growth. The company s stock price increased more than 1.5 times since February Furthermore, it surged 33.9% YTD since January 2013 compared with only 3.9% growth in the industrial investments index. Abdullatif s current valuation on the basis of price-to-book is marginally higher than its average historical valuation. However, on the basis of price-to-earnings and enterprise value-to-ebitda, it is almost on par with the company s average historical valuation. In comparison with the Tadawul industrial investments index, Abdullatif is trading at a lower P/E multiple of 12.3x vis-à-vis the index s 14.8x. Stock price movement EV/EBITDA YTD 1 Year 5 Year 10 Year Current 2013E Abdullatif 33.9% 3% 14.1% NA 12.3x NA Industrial Investment Index 3.9% 4.4% 81.4% NA 14.8x 18.5x TASI 2% 21.5% 51.3% 10% 17.0x 14.7x Relative to Industrial Investment Index 3% 27.6% -67.3% NA -17.1% NA Relative to TASI 11.9% 10.5% -37.2% NA -27.7% NA Abdullatif Risks and Concerns Source: Bloomberg Note: Closing price for stock price movement is calculated considering prices as on November 13, 2013 In 2009, the company had not paid dividends and utilized cash flows for debt repayment. Going forward, any debt repayments might impact dividend payouts. 47

48 Other Sectors Saudi Chemical Company Saudi Chemical Company Company overview Established in 1972, Saudi Chemical Company (SCC) is a joint venture between Nitro Nobel AB Sweden and private Saudi investors. The company operates through two major segments: Explosives and Medical products. SCC provides explosives for civil purposes in different applications of rock displacement such as building of roads, tunnels and mines, mining, and oil excavation. In 2006, SCC established an ammonium nitrate company (the main raw material in civil explosives) in Egypt with a production capacity of 100,000 MT per year. Under medical products, SCC distributes drugs through subsidiary Saudi International Trading Company Limited (SITCO), which it acquired in SITCO is one of the key pharmaceutical distributors in Saudi Arabia, offering drugs of 13 major international pharmaceutical companies. Key drivers Dominant position in niche sector: SCC holds a dominant position in the civil explosive manufacturing industry in Saudi Arabia, catering to domestic and international requirements. The company has the capability to adequately meet the domestic demand for civil and military explosives. Furthermore, being the industry leader in KSA s explosives industry, the company faces limited competition. This segment contributes ~19% to the company s overall revenues (2011). However, in terms of profitability, explosives is a high-margin segment, representing ~53% of gross profit and ~63% of net profit (2011). Strong foothold in pharmaceutical segment: Subsidiary SITCO is one of the key pharmaceutical distribution companies in Saudi Arabia, and accounts for the majority of SCC s revenues (~81% in 2011). During 2013, SCC announced plans to build a pharmaceutical plant in Hail Industrial City with an investment of ~SAR 16mn. We believe the company s strong foothold in KSA s pharmaceutical market would help to capitalize on the growing demand for drugs. According to EIU, the size of the Saudi pharmaceutical market was estimated to be USD 3.7bn in 2011 and reach USD 4.7bn by Growing population, an expanding ageing segment, and increase in chronic lifestyle-related diseases are the primary drivers. Furthermore, the government s increased focus on healthcare is expected to boost demand for pharmaceuticals. Vertical integration supports margins: During 2006, SCC founded ammonium nitrate firm Suez International Nitrate Company (SINCO) in Egypt. Ammonium nitrate is a key raw material in the production of explosives. Diversification into raw material production reduces dependence on external suppliers and ensures strong margins. Margins in the explosive segment rose to 63.7% in 2011 from 60.1% in Rise in infrastructure spending to support growth: Demand in the explosive segment is propelled by increased infrastructure activity such as construction of roads and tunnels. We believe the growing construction sector in KSA coupled with SCC s dominant position would boost demand for its products and, in turn, profitability. Dividend trend Comparison over the past 10 years reveals that SCC initiated dividend payments in Barring 2008, SCC consistently paid dividends until Between 2006 and 2012, the cash dividends increased at a CAGR of 23.2%, while earnings grew 11.9%. The company s dividend payout increased to 82.8% in 2012 from 57.5% in This is higher than the index 12 payout of 15.7% and 64.6%, during the same period. During , SCC s average dividend yield stood at 8.8% vis-à-vis the index s 5.4%. According to the interim dividend announced by the company, its annualized dividend payout for 2013 is expected to increase to 84.0% while annualized dividend yield also rises to 8.4%. Figure 96: Dividend payout and yields ( 2) * Dividend payout ( % ) Dividend yiel d ( % ) - RH S ( ) ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M

49 Other Sectors Saudi Chemical Company Total returns trend Besides distributing high cash dividends, SCC has distributed stock dividends to investors. Over the past 10 years, the company distributed one bonus issue of 20% (worth SAR 105.4mn) in According to our total returns analysis, SCC generated average total returns of 6.8% during , higher than the index average of 4.4%. Figure 97: Total returns 1 Bonus is s ue in ( % ) * Dividend Y iel d Tot al Ret urns ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M 2013 Peer comparison As SCC does not have any direct comparables, we performed a global peer analysis considering companies in the explosives or pharmaceutical industry. The analysis reflects that SCC pays higher dividends than all domestic and global peers, barring peers in Australia. The company s dividend payout and dividend yield were the highest among peers. Figure 98: Comparison with global and domestic peers U K Di v i dend p a y o u t ( % ) C h ina Sout h K orea U S Japan Saudi SC C Aus t ral ia Di v i dend y i el d ( % ) ; Note: Global peers include companies in the explosives or pharmaceutical industry, and Saudi peers include comparable companies under the industrial investment index 12. Includes comparable companies under the industrial investment index 49

50 Other Sectors Saudi Chemical Company Dividend sustainability analysis SCC initiated dividend payment in 2006; the company has funded its dividend payments from operating cash flows, internal accruals and debt. In line with this, SCC s cash balance declined to SAR 97mn in 2012 from SAR 375mn in Figure 99: Strong operating cash flows and internal accruals enable high dividend payments C l os ing cas h bal ance ( SAR m n) S AR m n C I* C O * 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 Source: Bloomberg, Zawya, AlJazira Capital *CI- Cash Inflows CO Cash outflows Operating cash flows: SCC s operating cash flows are expected to remain healthy, aided by the company s dominant position in the explosive industry and growing demand for pharmaceuticals. Its CFO has been volatile but almost reached the SAR 200mn mark in 2012, first time in three years. Capital expenditure: According to Bloomberg estimates, SCC s capital expenditure in the coming two years is expected to remain at similar levels as in 2011 and The company recently announced plans to build a pharmaceutical plant in Hail Industrial City with an investment of ~SAR 16mn. Impending debt repayments: At 12.2% in 2012, SCC s debt-to-equity remains at comfortable levels. SCC s strong and consistent revenues and margins, supported by its dominant market position, place it well to continue paying high dividends. However, the company s declining cash balance remains a concern. Key financials SAR mn Revenues 1,643 1,687 1,868 2,001 Growth (% YoY) EBITDA Operating margins (%) Net Income Growth (% YoY) 0.7 (11.8) 8.9 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 50

51 Other Sectors Saudi Chemical Company Share price volatility and valuations Figure 100: Share price performance Figure 101: Price-to-earnings valuation multiple Jan-07 Sep-07 May-08 S CC Jan-09 Sep-09 May-10 Feb-11 O ct -11 Feb-13 Inds t l Inv t Index Mar-06 O ct -06 May-07 Dec-07 Jul -08 Feb-09 Sep-09 Apr-10 Nov-10 Jun-11 Jan-12 Aug-12 Mar-13 P / E Av g. Av g. + 1 S D Av g. - 1 S D Indl. Inv t. i ndex Figure 102: Price-to-book valuation multiple Figure 103: 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 P / B Av g. Av g. + 1 S D Av g. - 1 S D Indl. Inv t. i ndex 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 EV / EB IT DA Av g. Av g. + 1 S D Av g. - 1 S D Indl. Inv t. i ndex SCC s stock price has increased more than two times since January 2007, and 23.4% YTD since January 2013 vis-à-vis the 3.9% growth registered by the index. The company s current valuation on the basis of enterprise value-to-ebitda metric is below its average historical valuations while price-to-earnings multiple is marginally above the historical valuations. However, in terms of price-to-book multiple, SCC is trading in line with the historical average. SCC s current EV/EBITDA multiple is trading at a discount of 50.5% at 9.4x vis-à-vis 18.9x for the industrial investment index. Stock price movement EV/EBITDA YTD 1 Year 5 Year 10 Year Current 2013E SCC 15.1% 3% 53.9% 196.9% 9.0x NA Industl Invt. Index 1.9% 3.6% 13.6% NA 18.4x 15.5x TASI 17.1% 16.4% 6.8% 86.2% 12.2x 10.4x Relative to Industl Invt.Index 13.2% 28.4% 40.3% NA -51.4% NA Relative to TASI -% 15.6% 47.1% 110.7% -26.8% NA SCC Risks and concerns Source: Bloomberg Note: Closing price for stock price movement is calculated considering prices as on November 13, 2013 Slowdown in government spending on infrastructure and delay or cancellation of projects could negatively impact SCC s explosives segment. Declining cash levels and rising debt-to-equity pose a threat to future dividend payments. Government intervention to provide subsidized medical services, entry of new players in the market, and increasing cost of imported raw materials pose a downside risk to margins and profitability in the pharmaceutical segment. 51

52 Other Sectors Saudi Hotels & Resort Areas Company Saudi Hotels & Resort Areas Company Company overview Founded in 1976, Saudi Hotels & Resort Areas Company (SHARACO) owns, manages, operates, constructs, rents, invests in as well as enters into partnerships for hotels, resorts, recreational villages, and residential and commercial compounds. The group currently owns and operates 11 five-star hotels in Saudi Arabia, five of which are in Mecca. Key drivers KSA hospitality industry on a high growth trajectory: According to the World Travel and Tourism Council, Saudi Arabia s travel & tourism sector contributed SAR 120.5bn to the Kingdom s economy in 2012; this is expected to increase at a CAGR of 4.1% to SAR 180.2bn by Saudi Arabia s hospitality industry is primarily led by religious tourism. KSA earned about SAR 62bn from the annual pilgrimage rituals of the Hajj and Umrah in 2012 as over 7mn pilgrims visited the Kingdom. According to Business Monitor International (BMI), the total number of tourists to Saudi Arabia is projected to increase from 17.5mn in 2011 to 24mn by 2017, with around 178,870 hotel rooms in the Kingdom. As SHARACO has a major presence in the holy city of Mecca, it would benefit from the expected growth in tourism. Expansions: SHARACO currently has two hotels under-construction, one each in Medina and Riyadh. Moreover, four other expansion projects are currently under study. The expansion is likely to help the company capitalize on the growth in the hospitality sector and, in turn, boost earnings. Highest margins among peers: The prime location of SHARACO s properties helps the company record the highest margins in the Kingdom. Over , the company reported average operating margins of 49.6% vis-àvis the industry average of 33.3%. Entry into KSA s mid-market hotel segment: SHARACO is exploring opportunities to set up three-star and fourstar properties in secondary cities, which is expected to be the next growth driver in the hotel industry. According to Colliers, demand for economy hotel rooms across major and secondary cities would exceed the expected supply by 34,882 over the next five years. Furthermore, Colliers stated that the economy hotels operate with a very costefficient structure characterized by a less volatile and sustainable pricing strategy. Thus, the company s expansion into the mid-market segment is expected to drive earnings in the long term. Dividend yield has nudged up to just under 6% in 2012 Dividend Trend SHARACO s cash dividends increased at a CAGR of 20.7% over led by a 23.3% growth in earnings. During the period, the company s average dividend payout of 78.0% was much higher than the hotel & tourism sector s average of 30.7%. SHARACO registered an average dividend yield of 3.2% vis-à-vis the hotel & tourism sector s average of 2.5% during However, according to the interim dividend announced by the company, its annualized dividend payout for 2013 was lower at 70.8% while annualized dividend yield was also low at 2.8%. Figure 104: 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

53 Other Sectors Saudi Hotels & Resort Areas Company Total Returns Trend SHARACO has distributed stock dividends to its investors. Over the last 10 years, the company made one bonus issue in 2012 worth SAR 309.9mn. According to our total returns analysis, the company s average total return of 4.3% over was much higher than the Saudi hotel & tourism sector s average of 2.9%. Figure 105: Total returns O ne bonus is s ue in t en years w ort h SAR 309.9m n 15.0 ( % ) * Dividend Y iel d Tot al Ret urns ; *2013 annualized values based on Dividends announced for 1H 2013 and earnings registered in 9M 2013 Peer Comparison SHARACO pays higher dividends vis-à-vis most local and regional peers. The company s dividend payout and dividend yield were higher than those of all regional and global players, except UK peers. Figure 106: Comparison with global and local peers U K Di v i dend p a y o u t ( % ) U S Saudi Bah rain U AE C h ina SH ARAC O Mal ays ia H ong K ong Di v i dend y i el d ( % ) ; Note: Global peers include major Hotel companies in the world and domestic peers include comparable companies under the Hotel and Tourism index 53

54 Other Sectors Saudi Hotels & Resort Areas Company Dividend Sustainability Analysis Over , SHARACO relied on its operating cash flows to pay high dividends, except in 2007 and 2008, when the company relied on income from investments and its cash base to pay dividends. During the past four years, the company paid high dividends despite increase in capital expenditure. Figure 107: Strong operating cash flows enabled high dividend payments S AR m n C l os ing cas h bal ance ( SAR m n) C I* C O * 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 Source: Bloomberg, Zawya, AlJazira Capital *CI Cash Inflows CO Cash outflows Operating cash flows: We expect SHARACO s cash flows from operations to improve led by strong growth in KSA tourism and hospitality as well as the company s location advantage. Capital expenditure: SHARACO is currently constructing two properties in the prime regions of Mecca and Riyadh. Additionally, the company is planning four other expansion projects and exploring options to diversify into the mid-market hotel segment. We expect SHARACO s capital expenditure to remain high; based on the company s historical trend, we believe it is likely to finance capex via internal accruals and cash balance. Impending debt repayments: With a total debt of SAR 25.4mn, SHARACO s debt-to-equity ratio is low at 1.4%. SHARACO is well-positioned to continue paying high dividends due to its strong operating cash flows and absence of scheduled debt payments. High capital expenditure may pose a threat to the dividend payments, but the company s sustained dividend payments during high capital expenditure in the past boost confidence. Key financials SAR mn Revenues Growth (% YoY) (61.7) EBITDA Operating margins (%) Net Income Growth (% YoY) (67.7) Dividend payout (%)* Dividend yield (%)* Total Returns (%)*# FCF/CFO (%) (729.3) (40.2) 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 54

55 Other Sectors Saudi Hotels & Resort Areas Company Share Price Volatility and Valuations Figure 108: Share price performance 35 Figure 109: Price-to-earnings valuation multiple Jan-07 Sep-07 May-08 Jan-09 O ct -09 Jun-10 Feb-11 O ct -11 Mar-13 Nov-13 S H ARCO H o t el & t o u r i s m i ndex 4 2 Jan-03 O ct -03 Jun-04 Feb-05 O ct -05 Jun-06 Feb-07 O ct -07 Jun-08 Feb-09 O ct -09 Jun-10 Feb-11 O ct -11 Feb-13 P /E Avg. Avg.+1 SD Avg.-1 SD H & T index ; Note: H&T index - Hotel & tourism index Figure 110: Price-to-book valuation multiple 6.0 Figure 111: 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 P / B Av g. Av g. + 1 S D Av g. - 1 S D H & T i ndex Dec-06 Sep-07 May-08 Jan-09 EV/EBITDA Avg.+1 SD H&T index Sep-09 May-10 Jan-11 O ct -11 Feb-13 Avg. Avg.-1 SD SHARACO s stock price grew due to its strong earnings. The stock price has increased more than six times since January Furthermore, it surged 39.6% YTD since January 2013 compared with the 107.4% growth witnessed in the hotel and tourism index. SHARACO s current valuation on the basis of price-to-earnings, enterprise value-to-ebitda and price-to-book is higher than the company s average historical valuation. On comparison with the Tadawul hotel and tourism index, the company is trading almost at P/E multiple of 26.0x vis-à-vis the index s P/E multiple of 25.6x. Stock price movement EV/EBITDA YTD 1 Year 5 Year 10 Year Current 2013E SHARCO 39.6% 44.4% 191.7% 40% 26.0x NA Hotel & Tourism Index 107.4% 107.6% 286.2% NA 25.6x 20.9x TASI 2% 21.5% 51.3% 10% 17.0x 14.7x Relative to Hotel & Tourism Index -67.8% -63.2% -94.5% NA 1.7% NA Relative to TASI 17.6% 22.9% 140.4% 298.0% 53.1% NA SHARACO Risks and Concerns Source: Bloomberg; Note: Closing price for stock price movement is calculated considering prices as on November 13, 2013 Geo-political tensions in the region may lead to a decline in the number of foreign tourists, thus impacting the company s revenues. A slowdown in the global economy is likely to impact the company s revenues as SHARACO has presence in the luxury hospitality segment. SHARACO s aggressive capital expenditure plans may impact dividend payments. 55

56 Other Sectors Arriyadh Development Company Arriyadh Development Company Company overview Established in 1994, Arriyadh Development Company (ADCO) is headquartered at Riyadh in the Kingdom of Saudi Arabia. The company mainly constructs, sells, and rents commercial & residential buildings and complexes. The company is also engaged in developmental projects such as construction of public parks as well as construction and management of commercial & industrial exhibits. Key drivers Expanding construction sector to drive growth: Saudi Arabia s construction sector, which contributes ~7.4% to GDP, expanded at a CAGR of 7.2% over The increase in construction activities remains a major stimulus for the Kingdom s growth. ADCO s commercial & institutional construction segment represents ~40% of its revenues and ~43% of gross earnings. As a result, we believe increasing government expenditure would drive the segment s growth Favorable demographics and mortgage law to boost demand for housing units: Rising population, coupled with a declining household size, is expected to boost demand for residential units in the Kingdom. Moreover, around 30% 13 of KSA s population currently owns a house compared to 66% in developed economies like the US and 75% in developing economies like Brazil. Furthermore, the mortgage law is expected to play a key role in boosting demand for housing units over the long term. We believe these factors would benefit real estate companies that have residential projects in the pipeline. Healthy dividend payments ADCO has consistently made healthy dividend payments since its first dividend payment in The company s dividend yield and payout stood at an average of 4.8% and 90.9%, respectively, during This was significantly above the industry average of 1.6% 14 and 38.7%, respectively. Healthy dividend payments have been supported by steady earnings growth. Dividend trend ADCO s cash dividends increased at a CAGR of 27.0% over , supported by a 26.5% earnings growth over the same period. The strong growth in earnings has been supported by revenues accruing from sale of land. Land subdivision s revenue contribution surged from 0.74% in 2010 to 46.6% in The company s payout and yield improved in the later years; average yield stood at 6.5% over vis-à-vis 3.1% during Similarly, ADCO s dividend payout averaged 121.3% during compared to 60.5% during The company s dividends for 2013 could not be analyzed based on the announced interim results as the company did not declare any interim dividend. Figure 112: Dividend payout and yields Di v i dend p a y o u t ( % ) Di v i dend y i el d ( % ) - RH S 13. For domestic peers, we have considered companies in the Real Estate Index. 14. For domestic peers, we have considered companies in the Real Estate Index 56

57 QQ Saudi Income Stocks Portfolio Other Sectors Arriyadh Development Company Total returns trend ADCO has not distributed stock dividends to investors over the past 10 years; hence, its dividend yield is equal to total return. Peer comparison We performed peer group analysis for ADCO. For the comparison, we selected real estate companies in Saudi and other GCC countries. The analysis reveals that ADCO pays higher dividends than its peers in the domestic as well as regional market. Figure 113: Comparison with global and regional peers ADC O 2012 Dividend payout ( % ) Saudi Arabia at ar K K uw ait U U AE Di v i dend y i el d ( % ) Note: Regional peers include major real estate developers in the GCC and domestic peers include companies under the Real Estate index Dividend sustainability analysis ADCO distributes high dividends, supported by strong cash flows. Over the last 10 years, the company has paid dividends from operating cash flows, barring 2012, when the company s dividend payments exceeded its operating cash flows. Figure 114: Healthy dividend payments Closing cash balance ( SAR m n) SAR m n C I* C O * C FO Cash from financing C apex Dividend payment Debt repayment Source: Bloomberg, Zawya, AlJazira Capital *CI- Cash Inflows CO Cash outflows 57

58 Other Sectors Arriyadh Development Company Operating cash flows: We expect ADCO s cash flows from operations to remain strong, led by an increase in construction activities in the Kingdom. Furthermore, the company s high margin land segment is expected to boost operating cash flows in the coming years. Capital expenditure: According to Bloomberg estimates, ADCO s capital expenditure would be SAR 25mn in 2013 and SAR 21mn in Debt repayment: ADCO is a zero debt company with no scheduled debt repayments. Strong operating cash flows, lower capital expenditure, and no impending debt repayment would help ADCO maintain steady dividend payments. Key financials SAR mn Revenues Growth (% YoY) EBITDA 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 Share price volatility and valuations Figure 115: Share price performance Figure 116: Price to- earnings valuation Jan-07 Sep-07 May-08 Jan-09 ADCO O ct -09 Jun-10 Feb-11 O ct -11 Mar-13 Nov-13 RE Index 2 1 Jan-08 Sep-08 May-09 P /E Avg.+1 SD RE index Dec-09 Aug-10 Mar-11 Nov-11 Feb-13 Avg. Avg.-1 SD ; Figure 117: Price- to- book valuation multiple Figure 118: EV-to-EBITDA valuation multiple Jan-08 Sep-08 May-09 P /B Avg.+1 SD RE index Dec-09 Aug-10 Mar-11 Nov-11 Feb-13 Avg. Avg.-1 SD Apr-08 Dec-08 Aug-09 EV/EBITDA Avg.+1 SD RE index Mar-10 Nov-10 Jun-11 Feb-12 Sep-12 May-13 Avg. Avg.-1 SD 58

59 Other Sectors Arriyadh Development Company ADCO s stock price has risen more than four times since January 2003 levels. The stock increased 21.0% YTD vis-à-vis a 44.2% rise registered by the Tadawul Real Estate index. The company s current price-to-book multiple is 1.6x, implying a premium to the Tadawul Real Estate index s 1.4x. ADCO s current valuation based on price-to-book and enterprise value-to-ebitda metrics is above its average historical valuation. Stock price movement EV/EBITDA YTD 1 Year 5 Year 10 Year Current 2013E ADCO 21.0% 29.8% 245.5% 104.7% 1.6x 1.7x RE Index 44.2% 41.5% 43.7% NA 1.4x 1.3x TASI 2% 21.5% 51.3% 10% 2.1x x Relative to RE Index -23.3% -11.7% 201.8% NA 13.6% 26.8% Relative to TASI -1.0% 8.3% 194.3% 2.6% -23.6% -18.2% ADCO Risks and concerns Source: Bloomberg Note: Closing price for stock price movement is calculated considering prices as on November 13, ADCO s operating costs are likely to remain high due to the Nitaqat law (shift in the labor market) in the Kingdom. This is primarily due to dominance of Non-Saudis in the company. Slowdown in construction activity in the Kingdom or a delay in implementing planned infrastructure projects could hurt the company s growth prospects. 59

60 RESEARCH DIVISION AGM - Head of Research Abdullah Alawi [email protected] Senior Analyst Talha Nazar [email protected] Senior Analyst Syed Taimure Akhtar [email protected] Analyst Saleh Al-Quati [email protected] Analyst Jassim Al-Jubran [email protected] BROKERAGE AND INVESTMENT CENTERS DIVISION General Manager - Brokerage Division Ala a Al-Yousef [email protected] Sales And Investment Centers Central Region Manger Sultan Ibrahim AL-Mutawa [email protected] AGM-Head of international and institutional brokerage Luay Jawad Al-Motawa [email protected] Area Manager - Qassim & Eastern Province Abdullah Al-Rahit [email protected] Regional Manager - West and South Regions Abdullah Al-Misbahi [email protected] RESEARCH DIVISION AlJazira Capital, the investment arm of Bank AlJazira, is a Shariaa Compliant Saudi Closed Joint Stock company and operating under the regulatory supervision of the Capital Market Authority. AlJazira Capital is licensed to conduct securities business in all securities business as authorized by CMA, including dealing, managing, arranging, advisory, and custody. AlJazira Capital is the continuation of a long success story in the Saudi Tadawul market, having occupied the market leadership position for several years. With an objective to maintain its market leadership position, AlJazira Capital is expanding its brokerage capabilities to offer further value-added services, brokerage across MENA and International markets, as well as offering a full suite of securities business. RATING TERMINOLOGY 1. Overweight: This rating implies that the stock is currently trading at a discount to its 12 months price target. Stocks rated Overweight will typically provide an upside potential of over 10% from the current price levels over next twelve months. 2. Underweight: This rating implies that the stock is currently trading at a premium to its 12 months price target. Stocks rated Underweight would typically decline by over 10% from the current price levels over next twelve months. 3. Neutral: The rating implies that the stock is trading in the proximate range of its 12 months price target. Stocks rated Neutral is expected to stagnate within +/- 10% range from the current price levels over next twelve months. 4. Suspension of rating or rating on hold (SR/RH): This basically implies suspension of a rating pending further analysis of a material change in the fundamentals of the company. Disclaimer The purpose of producing this report is to present a general view on the company/economic sector/economic subject under research, and not to recommend a buy/sell/hold for any security or any other assets. Based on that, this report does not take into consideration the specific financial position of every investor and/or his/her risk appetite in relation to investing in the security or any other assets, and hence, may not be suitable for all clients depending on their financial position and their ability and willingness to undertake risks. It is advised that every potential investor seek professional advice from several sources concerning investment decision and should study the impact of such decisions on his/her financial/legal/tax position and other concerns before getting into such investments or liquidate them partially or fully. The market of stocks, bonds, macroeconomic or microeconomic variables are of a volatile nature and could witness sudden changes without any prior warning, therefore, the investor in securities or other assets might face some unexpected risks and fluctuations. All the information, views and expectations and fair values or target prices contained in this report have been compiled or arrived at by Aljazira Capital from sources believed to be reliable, but Aljazira Capital has not independently verified the contents obtained from these sources and such information may be condensed or incomplete. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on the fairness, accuracy, completeness or correctness of the information and opinions contained in this report. Aljazira Capital shall not be liable for any loss as that may arise from the use of this report or its contents or otherwise arising in connection therewith. The past performance of any investment is not an indicator of future performance. Any financial projections, fair value estimates or price targets and statements regarding future prospects contained in this document may not be realized. The value of the security or any other assets or the return from them might increase or decrease. Any change in currency rates may have a positive or negative impact on the value/return on the stock or securities mentioned in the report. The investor might get an amount less than the amount invested in some cases. Some stocks or securities maybe, by nature, of low volume/trades or may become like that unexpectedly in special circumstances and this might increase the risk on the investor. Some fees might be levied on some investments in securities. This report has been written by professional employees in Aljazira Capital, and they undertake that neither them, nor their wives or children hold positions directly in any listed shares or securities contained in this report during the time of publication of this report, however, The authors and/or their wives/children of this document may own securities in funds open to the public that invest in the securities mentioned in this document as part of a diversified portfolio over which they have no discretion. This report has been produced independently and separately by the Research Division at Aljazira Capital and no party (in-house or outside) who might have interest whether direct or indirect have seen the contents of this report before its publishing, except for those whom corporate positions allow them to do so, and/or third-party persons/institutions who signed a non-disclosure agreement with Aljazira Capital. Funds managed by Aljazira Capital and its subsidiaries for third parties may own the securities that are the subject of this document. Aljazira Capital or its subsidiaries may own securities in one or more of the aforementioned companies, and/or indirectly through funds managed by third parties. The Investment Banking division of Aljazira Capital maybe in the process of soliciting or executing fee earning mandates for companies that is either the subject of this document or is mentioned in this document. One or more of Aljazira Capital board members or executive managers could be also a board member or member of the executive management at the company or companies mentioned in this report, or their associated companies. No part of this report may be reproduced whether inside or outside the Kingdom of Saudi Arabia without the written permission of Aljazira Capital. Persons who receive this report should make themselves aware, of and adhere to, any such restrictions. By accepting this report, the recipient agrees to be bound by the foregoing limitations. Asset Management Brokerage Corporate Finance Custody Advisory Head Office: Madinah Road, Mosadia P.O. Box: 6277, Jeddah 21442, Saudi Arabia Tel: Fax: Aljazira Capital is a Saudi Investment Company licensed by the Capital Market Authority (CMA), license No