Saudi Arabia a Guide to the Market by HSBC

MENA Research Team

Raj Sinha* Head of EEMEA equity research HSBC Bank Middle East Limited, Dubai +971 4 423 6932 [email protected]

Equities Saudi Arabia July 2014

Ammash Aljuraid* Analyst HSBC Saudi Arabia Limited +966 11 299 2105 [email protected]

Sriharsha Pappu* Analyst HSBC Bank Middle East Limited, Dubai +971 4 423 6924 [email protected]

Sagar Kumar* Analyst HSBC Saudi Arabia Limited +966 11 299 2104 [email protected]

Vikram Viswanathan* Analyst HSBC Bank Middle East Limited, Dubai +971 4 423 6931 [email protected]

Yazeed M Alturki* Analyst HSBC Saudi Arabia Limited +966 11 299 2260 [email protected]

Nicholas Paton* Analyst HSBC Bank Middle East Limited, Dubai +971 4423 6923 [email protected]

Telecom Herve Drouet* Analyst HSBC Bank Plc +44 20 7991 6827 [email protected]

Simon Williams Chief Economist, Middle East and North Africa HSBC Bank Middle East Limited, Dubai +971 4 423 6925 [email protected] Rana Nasser Senior Economist, Middle East and North Africa HSBC Bank Middle East Limited, Dubai +971 4423 6928 [email protected] Egypt Shirin Panicker* Analyst HSBC Securities, Egypt, S.A.E. +202 2529 8439 [email protected]

Saudi Arabia A guide to the market

Equities

United Arab Emirates Aybek Islamov* Analyst HSBC Bank Middle East Limited, Dubai +971 4 423 6921 [email protected]

Saudi Arabia

Saudi Arabia Patrick Gaffney*, CFA Analyst HSBC Saudi Arabia Limited +966 11 299 2100 [email protected]

After moves towards increased accessibility over the past seven years, the Saudi Arabian cabinet has now authorised the Capital Market Authority to allow foreign institutions to trade stocks on the Saudi stock market, paving the way for potentially a complete opening of the market in 2015 We believe valuations should see a positive effect from the potential inclusion of the stocks in various equity indices, which could follow soon after the opening of the market

Oilfield services Peter Hitchens* Analyst HSBC Bank plc +44 20 7991 6822 [email protected]

In this report we provide a macro overview of the market, and look at this new opportunity from an equity strategy, industry sector and stock perspective

Utilities Levent Bayar* Analyst HSBC Yatirim Menkul Degerler A.S. +90 212 3764617 [email protected] Equity Strategy John Lomax* Head of Equity Strategy, GEMs HSBC Bank plc, London +44 20 7992 3712 [email protected]

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.

By the MENA Research Team

Issuer of report: HSBC Bank Middle East Limited, Dubai

July 2014

Disclosures and Disclaimer This report must be read with the disclosures and analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it


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Summary Middle Eastern markets continue to be a focus for global investors with the announcement from the Saudi Capital Market Authority that its equity markets could open to foreign investors in the first half of 2015. Should this occur, we would expect Saudi stocks to become eligible for admission to global benchmark indices, as such implying significant fund inflows both from active funds tracking FTSE, MSCI and other indices as well as from the passive funds. In this report we provide a guide to the structural drivers in the key equity sectors and details of 44 stocks we cover, and we include profiles on an additional 17 stocks with interesting profiles but lower liquidity. We have also provided the views of our Economics, Equity Strategy and Equity Quant teams. Saudi Arabia's oil-funded expansionary fiscal stance will remain the prime driver of growth in the country, with current and capital spending set to rise from last year's record high. Longer-term, Saudi's demographics look attractive with 60% of the population under the age of 30 and a middle class set to grow from less than 20m today to 40m by 2050 (OECD). Furthermore, the local stock market is well-established, with a healthy return of 120% since 2004, buoyed by rising oil prices and a GDP that has averaged 6.4% per annum, albeit with a high level of volatility due to retail investors representing 90% of volumes. In Saudi Arabia, both the cyclical and secular narratives remain attractive, in our view, with the announcement regarding the opening of market to foreign investors acting as an additional catalyst. The obstacles however relate more to valuations and more challenging bottom-up stock selection. Nevertheless, from an equity strategy perspective we continue to favour an off-benchmark exposure, emphasising the petrochemical sector as a whole as well as selected consumer and telecom stocks. We are also positive on the banks sector in the Kingdom again from an equity strategy perspective. We see significant advantages in many of the sectors in the Kingdom, most of which are difficult to replicate. Saudi banks have access to one of the cheapest source of funds from low interest deposits while the vast energy resources of the Kingdom should help industrials to get cheap electricity and fuel. However petrochemical and fertiliser companies benefit the most as they have access to one the cheapest sources of feedstock globally. We also see strong growth potential for Saudi consumer-facing companies as they gain from Saudiasation (moves that encourage employers to hire more Saudis) and employment growth in the Kingdom. On the other hand telecom companies should see a growth rate that is among the highest in the world in data usage as other forms of entertainment are limited in the Kingdom. Since 2007 the market has been open for investment for citizens of the Gulf Cooperation Council (GCC) and since 2008 it has been accessible to non-GCC investors via swap agreements. A formal opening to non-GCC investors would carry a much more significant impact from direct investment and the potential inclusion or upgrade in equity market indices. Should Saudi Arabia be admitted to the EM indices we estimate that it would constitute 4% of the MSCI EM index.

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HSBC Saudi Arabia coverage Company

Ticker

Abdullah Al-Khodari Abdullah Al Othaim Advanced Petro Chem. Al Mouwasat Medical Alinma Bank Almarai Alrajhi Banking Arab National Bank Astra Industrial Banque Saudi Fransi Dallah Healthcare Dar Al Arkan Etihad Etisalat(Mobily) Fawaz Alhokair Herfy Food Services Jabal Omar Jarir Marketing Maaden Methanol Chemicals NIC (Tasnee) National Medical Care National Petrochemical Qassim Cement PetroRabigh Riyad Bank Sahara Petrochemical Samba Financial Group Saudi Airlines Catering Saudi Arabian Amiantit Saudi Arabian Fertilizer Saudi Basic Industries Saudi Cement Company Saudi Electricity Co. Saudi Industrial Invst. Saudi International Petro Saudi Kayan Saudi Pharmaceutical Saudi Real Estate Saudi Steel Pipes Saudi Telecom Co. Savola Yamamah Cement Yanbu Cement Yanbu Petrochemical Zamil Industries

1330.SE 4001.SE 2330.SE 4002.SE 1150.SE 2280.SE 1120.SE 1080.SE 1212.SE 1050.SE 4004.SE 4300.SE 7020.SE 4240.SE 6002.SE 4250.SE 4190.SE 1211.SE 2001.SE 2060.SE 4005.SE 2002.SE 3040.SE 2380.SE 1010.SE 2260.SE 1090.SE 6004.SE 2160.SE 2020.SE 2010.SE 3030.SE 5110.SE 2250.SE 2310.SE 2350.SE 2070.SE 4020.SE 1320.SE 7010.SE 2050.SE 3020.SE 3060.SE 2290.SE 2240.SE

Rating

MCap (USDm)

CP

TP

OW N N (V) OW N N N OW N N OW N N N N N OW N N (V) N N N (V) N OW N N OW OW N OW OW OW N OW N N N N N OW N N N N N

722 1,302 2,160 1,443 7,939 11,678 29,354 7,759 947 10,766 1,309 3,916 17,853 6,019 1,287 13,133 4,799 9,175 531 6,349 879 4,402 2,328 7,852 14,678 2,761 13,438 4,236 557 14,264 98,784 4,508 17,997 4,487 3,500 6,039 1,529 1,389 480 38,394 11,283 3,334 3,087 10,501 972

51.00 108.50 49.40 108.25 19.85 73.00 67.75 29.10 47.90 33.50 104.00 13.60 86.96 107.50 104.50 53.00 200.00 37.20 16.50 35.60 73.50 34.40 97.00 33.62 18.35 23.60 42.00 193.75 18.10 160.50 123.50 110.50 16.20 37.40 35.80 15.10 47.80 43.40 35.30 72.00 79.25 61.75 73.50 70.02 60.75

44.00 82.00 45.00 126.00 21.30 67.00 74.00 37.00 63.00 37.00 115.00 14.00 98.00 90.50 107.86 47.00 237.00 38.00 16.00 35.00 78.00 28.00 101.00 45.00 20.40 23.00 55.00 186.00 16.40 176.00 130.00 130.00 15.90 41.00 34.00 16.00 47.08 40.00 37.50 71.00 74.00 70.00 78.00 77.00 48.00

Source: Thomson Reuters Datastream, HSBC estimates Note: Closing price as on 22 Jul 2014

2

_____ PE ______ 2013 2014e 2015e 42.1 25.4 14.5 26.9 29.3 29.2 14.8 11.5 14.0 16.8 35.9 21.6 10.0 36.5 25.2 0.0 27.6 10.6 27.6 21.6 35.6 0.0 14.9 82.0 13.9 17.9 11.2 30.4 20.6 13.2 14.7 15.0 22.2 23.6 21.2 0.0 21.2 29.0 21.0 13.9 24.8 15.1 14.1 14.9 15.5

28.2 19.5 15.8 25.9 24.5 25.0 14.2 10.0 11.4 13.2 31.0 15.5 9.8 28.6 23.2 40.9 23.8 7.8 14.8 11.5 28.8 14.3 14.6 12.1 12.9 14.4 10.5 27.4 12.5 15.4 11.7 14.8 20.4 10.4 15.9 13.9 17.7 31.9 15.5 12.1 22.7 16.4 14.1 12.5 13.6

17.6 17.1 15.9 20.2 21.5 18.0 13.4 9.1 9.3 12.4 25.1 12.6 9.6 23.0 20.6 40.6 20.4 6.5 16.1 11.7 25.3 15.2 16.7 8.6 11.8 13.8 9.7 22.2 10.7 12.9 11.6 13.3 17.7 10.9 14.4 13.2 15.1 29.7 12.9 11.6 18.7 18.0 16.7 12.6 12.6

_____ EV/EBITDA_______ 2013 2014e 2015e 16.2 16.4 10.5 21.2 NM 16.7 NM NM 19.3 NM 27.0 17.5 8.3 30.7 20.4 0.0 27.2 26.5 10.6 11.4 26.0 35.0 11.4 26.7 NM 17.1 NM 26.7 8.8 11.7 8.3 12.6 9.9 35.2 11.5 20.5 12.4 26.8 14.4 7.2 12.8 10.5 11.3 10.6 11.3

13.7 12.8 10.8 19.4 NM 14.5 NM NM 13.6 NM 22.7 13.5 7.9 22.6 18.0 39.6 23.0 37.7 8.1 8.1 22.5 11.2 11.1 10.2 NM 12.2 NM 23.1 7.6 13.6 7.1 12.3 10.4 11.1 9.1 10.6 11.0 23.6 11.9 6.7 11.2 10.8 10.7 9.4 10.0

11.1 11.4 10.7 14.5 NM 12.2 NM NM 9.8 NM 18.7 11.5 7.5 17.2 16.0 35.1 19.3 21.4 8.0 7.9 19.5 10.8 12.7 7.6 NM 9.7 NM 18.6 7.2 11.3 6.8 11.2 10.8 10.8 8.1 9.8 9.3 21.9 10.0 6.2 9.6 11.5 12.4 9.4 9.0

________ RoE __________ 2013 2014e 2015e 8.1% 25.8% 25.9% 24.4% 6.0% 17.0% 21.6% 14.2% 13.5% 10.7% 11.9% 4.1% 29.8% 36.1% 34.1% -0.4% 59.3% 17.2% 4.6% 9.2% 13.0% -1.6% 29.4% 4.1% 12.5% 10.3% 14.0% 47.1% 6.5% 41.1% 16.7% 35.3% 5.5% 11.4% 10.9% -2.4% 8.0% 5.5% 10.6% 19.2% 18.9% 22.2% 25.0% 18.9% 15.4%

11.4% 28.8% 22.2% 22.5% 6.9% 16.6% 20.6% 14.8% 15.9% 12.5% 12.9% 5.4% 26.9% 35.5% 32.4% 12.6% 58.6% 22.0% 8.3% 16.6% 13.8% 25.3% 29.7% 25.0% 12.8% 12.0% 13.7% 47.4% 10.6% 32.7% 19.2% 35.3% 5.7% 23.8% 13.8% 11.0% 8.5% 4.9% 14.0% 19.9% 18.4% 19.4% 24.9% 20.4% 16.1%

16.3% 29.5% 21.1% 26.1% 7.3% 20.9% 20.1% 14.9% 17.9% 12.0% 14.6% 6.4% 24.8% 36.8% 32.1% 11.3% 57.4% 25.8% 7.4% 15.2% 15.1% 20.6% 25.6% 29.8% 13.3% 11.8% 13.6% 52.5% 12.2% 39.7% 17.6% 38.7% 6.2% 20.1% 14.3% 10.4% 9.8% 5.3% 16.4% 18.9% 20.9% 17.6% 20.7% 19.5% 16.2%

Perf. YTD 53.5% 79.4% 28.0% 17.5% 0.0% 37.3% 0.0% 0.0% -6.3% 0.0% 52.3% 40.9% 2.9% 53.8% 31.2% 71.2% 26.5% 17.7% 7.1% 7.0% 35.3% 30.3% 10.1% 33.3% 0.0% 22.8% 0.0% 34.8% 16.8% 2.4% 13.4% 8.6% 19.2% 21.5% 18.0% -3.4% 12.3% 27.6% -3.9% 31.5% 31.2% 8.3% 10.8% -2.9% 42.4%

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Contents Saudi to open its equity market

5

Equity Market Strategy

10

Economics

16

Sectors & companies

17

Banks

19

Arab National Bank

23

Banque Saudi Fransi

26

Riyad Bank

29

Samba Financial Group

32

Alrajhi Banking & Investment

35

Alinma

38

Bank AlBilad

41

Bank AlJazira

43

Saudi Hollandi Bank

45

Saudi Investment Bank

47

Chemicals & fertilisers

49

Advanced Petrochemical

57

Methanol Chemicals Co (Chemanol)

60

Saudi Basic Industries Co (SABIC)

63

National Industrializatio (Tasnee (NIC))

66

Saudi Industrial Investment (SIIG)

70

National Petrochemical Company (Petrochem)

73

Yansab

76

Kayan

79

Saudi International Petro (Sipchem)

82

Rabigh Refining and Petro (PetroRabigh)

85

Ma’aden

89

Saudi Arabian Fertiliser Company (SAFCO)

92

Cement & construction

95

Yamamah Cement Company

100

Saudi Cement Company (SACCO)

103

Qassim Cement

106

Yanbu Cement

109

Abdullah A. M. Al-Khodari Sons

112

Saudi Arabian Amiantit Co.

115

Saudi Steel Pipes

118

Zamil Industries

121

Arabian Pipes Co.

124

Middle East Specialized Cables Co.

126

Saudi Cable Co.

128

Saudi Paper Manufacturing Company

130

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United Wire Factories Company

Real Estate 132

Consumers

135

203

Dar Al Arkan

208

Jabal Omar

211

Abdullah Al Othaim Markets

138

Saudi Real Estate Co.

214

Almarai

141

Emaar Economic City

217

Fawaz Abdulaziz Alhokair

144

Insurance

Jarir Marketing Co.

147

Herfy Food Services

150

The Mediterranean & Gulf Insurance & Reinsurance Co (Medgulf) 222

Savola

153

Saudi Airlines Catering

156

Al Khaleej Training & Education

159

Al Tayyar Travel Group

161

Budget (United International Transportation Co.)

219

The Company for Cooperative Insurance (Tawuniya)

224

Malath Cooperative Insurance & Reinsurance Co (Malath)

226

Telecoms

229

Etihad Etisalat (Mobily)

233

163

Saudi Telecom Company

236

eXtra (United Electronics Co.)

165

Zain KSA

239

Farm Superstores (Saudi Marketing Co.)

167

Halwani Brothers

169

Saudia Dairy & Foodstuff Company

171

Saudi Automotive Services Co.

173

Saudi Ceramic Co.

175

Saudi Fisheries Co.

177

Shaker (Al Hassan Ghazi Ibrahim Shaker Co)

179

Healthcare

181

Astra Industrials Group

185

Dallah Healthcare

188

Al Mouwasat Medical Services Co

191

National Medical Care Co (NMCC)

194

Saudi Pharmaceuticals (SPIMACO)

197

Al Hammadi Dev. & Investment Co.

200

4

Utilities Saudi Electricity Company (SEC)

241 244

Disclosure appendix

249

Disclaimer

252

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Saudi to open its equity market Saudi stock market to open in 1H 2015 Saudi Arabia’s authorities announced on Tuesday, 22 July 2014, their plan to open the country's listed stock market to foreign investors in the first half of 2015. This is the first time the Saudi authorities are expected to allow foreign institutional investors to directly trade equities in the Tadawul, without restrictions. Since 2008, the Kingdom has only allowed foreign investors indirect access to the market through swaps and p-notes and investors needed AUM of at least USD 5bn to be considered.

Next steps for the Saudi authorities  The Capital Market Authority has been given scope to complete and publish the regulatory requirements over the next 30 days  Investors and Authorised Participants will have the opportunity to provide feedback in the following 90 days.

Market consultations to commence

flow; clearing and settlement (T+0); custody and transferability with respect to the needs and requirements of global investors.

Potential global index benchmark impact Given the uncertainty regarding the potential market classification of Saudi Arabia; Developed, Emerging or Frontier, in the tables which follow, we simulate the potential impact to MSCI indices, on the basis of the following: 1)

Saudi is classified as an Emerging Market

2)

Saudi is classified as a Frontier Market

Vijay Sumon* Head of Indexation HSBC Bank plc +44 20 7991 6839 [email protected] Joaquim de Lima * Head of Equity Quantitative Research HSBC Bank plc +44 20 7991 6836 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

Scenario analysis In our analysis, we assume the following: the current domestic inclusion factor is equivalent to the investable free float for Saudi stocks; we apply minimum size criteria of USD1.4bn at the company level. Using these criteria we estimate the new opportunity set for Saudi Arabia will consist of 45 stocks.

Index providers are expected to commence consultations on country / market classifications for the Saudi market based on the following criteria: openness to foreign ownership; ease of capital inflows and outflows; efficiency of the operational framework and stability of the institutional framework. In terms of market accessibility, factors that will need to be assessed will include: foreign ownership limits; equal rights to foreign investors; market regulations; competitive landscape of brokers; information

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Saudi as an Emerging Market

We would expect China, South Korea, Taiwan and Brazil to be the most negatively impacted in terms of weight changes and likely to see decreases of between 49-78 basis points individually.

We now examine, in detail, the potential impact on investors benchmarked to MSCI EM in the event of Saudi being classified as an Emerging Market. In what follows, we assume all passive funds will rebalance fully to match the new benchmark.

In terms of regions, we believe EM Asia is set to be the most negatively impacted with a decrease of 260 basis points, followed by Latam with a decrease of 80 basis points whilst we would expect EMEA to experience an increase of 350 basis points.

Impact of Saudi entering MSCI EM Country and Regional impact

We find the Saudi market would account for 4% in terms of weight in MSCI EM and potentially be the ninth largest country in terms of weighting.

Table 1: Simulated MSCI Emerging Market regional indices + Saudi Arabia Region

_______Current EM Index_______ Number of stocks Weight %

____Potential EM regional Indices + Saudi Arabia____ Number of stocks Weight % Weight change %

Net flow USDm

Asia EMEA Latam

535 159 140

62.2% 18.1% 19.7%

535 204 140

59.6% 21.6% 18.9%

-2.6% 3.5% -0.8%

-5,480 7,215 -1,735

Total

834

100%

879

100%

0.0%

0

Source: MSCI, HSBC estimates. Data as of 21 July 2014

Table 2: Simulated MSCI Emerging Market country indices + Saudi Arabia Country

______ Current EM Index______ Number of stocks Weight %

______Potential EM country Indices + Saudi Arabia ______ Number of stocks Weight % Weight change % Net flow USDm

Saudi Arabia Egypt Hungary Czech Republic Peru Qatar UAE Greece Philippines Colombia Chile Poland Turkey Thailand Indonesia Malaysia Russia Mexico India South Africa Brazil Taiwan Korea China

0 4 3 3 3 10 9 10 20 14 20 23 25 29 30 43 22 30 68 50 73 101 103 141

0.0% 0.2% 0.2% 0.2% 0.4% 0.5% 0.5% 0.7% 1.0% 1.0% 1.5% 1.6% 1.8% 2.3% 2.7% 3.9% 4.9% 5.2% 6.6% 7.5% 11.5% 12.1% 15.2% 18.4%

45 4 3 3 3 10 9 10 20 14 20 23 25 29 30 43 22 30 68 50 73 101 103 141

4.2% 0.2% 0.2% 0.2% 0.4% 0.4% 0.5% 0.7% 0.9% 1.0% 1.4% 1.6% 1.7% 2.2% 2.6% 3.7% 4.6% 5.0% 6.3% 7.2% 11.0% 11.6% 14.6% 17.7%

4.2% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% -0.1% -0.1% -0.1% -0.1% -0.1% -0.2% -0.2% -0.2% -0.3% -0.3% -0.5% -0.5% -0.6% -0.8%

8,808 -18 -18 -19 -38 -41 -47 -62 -86 -90 -130 -143 -155 -201 -235 -342 -428 -461 -584 -661 -1,016 -1,067 -1,340 -1,624

Total

834

100%

879

100%

0.0%

0


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Table 3: Simulated MSCI Emerging Market sectors + Saudi Arabia Sector

_______Current EM Index_______ Number of Weight % stocks

____Potential EM sectors + Saudi Arabia____ Number Weight Weight of stocks % change %

Net flow USDm

Materials Financials Telecom. Services Consumer Staples Health Care Utilities Consumer Discretionary Industrials Energy Information Technology

98 210 46 81 30 52 88 112 51 66

8.80% 27.10% 7.10% 8.30% 1.90% 3.60% 9.10% 6.50% 10.50% 17.10%

114 226 49 83 30 53 91 114 53 66

9.90% 27.60% 7.20% 8.20% 1.80% 3.50% 8.90% 6.30% 10.20% 16.40%

1.10% 0.50% 0.20% -0.10% -0.10% -0.10% -0.20% -0.20% -0.40% -0.70%

2,313 968 338 -262 -164 -143 -453 -353 -735 -1,510

Total

834

100%

879

100%

0.0%

0


Sector impact

We believe Materials, Financials and Telecoms sectors could be positively impacted in terms of weight changes, up 110, 50 and 20 basis points respectively. We believe these sectors combined could account for 35 of the 45 Saudi stocks that could potentially enter MSCI EM. The Information Technology, Energy, Consumer Discretionary and Industrial sectors could potentially experience weight decreases, in the range of 20-70 basis points.

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Table 4: Simulated MSCI Frontier Market regional indices + Saudi Arabia Region

_______Current EM Index_______ Number of stocks Weight %

____Potential EM regional Indices + Saudi Arabia____ Number of stocks Weight % Weight change %

Net flow USDm

Asia EMEA Latam

34 87 6

14.3% 77.6% 8.1%

34 132 6

5.4% 91.5% 3.1%

-8.9% 14.0% -5.1%

-99 156 -57

Total

127

100%

172

100%

0.0%

0


Saudi as a Frontier Market In this section we detail the potential impact on investors benchmarked to MSCI FM in the event of Saudi being classified as a Frontier Market. In what follows, we assume all passive funds will rebalance fully to match the new benchmark.

impacted in terms of weight changes and could see decreases ranging between 5 and 15%. Regionally, this could lead to potential distortions in MSCI Frontier Market representation with EMEA accounting for at almost 92%, Asia dropping to 5% and Latam at 3%.

Impact of Saudi Arabia entering Frontier Markets Country and regional impact

We find the Saudi market would dominate the MSCI FM index, accounting for 62% in terms of weight. We would expect Kuwait, Nigeria, Argentina and Pakistan to be the most negatively Table 5: Simulated MSCI Frontier Market index + Saudi Arabia Country Saudi Arabia Lithuania Bulgaria Ukraine Serbia Estonia Tunisia Jordan Mauritius Bahrain Croatia Bangladesh Sri Lanka Romania Lebanon Slovenia Vietnam Kazakhstan Oman Kenya Morocco Pakistan Argentina Nigeria Kuwait Total

_______ Current FM index ________ Number of stocks Weight % 0 2 2 2 2 2 2 3 2 3 3 4 3 4 4 4 12 3 9 5 9 15 6 18 8

0.0% 0.2% 0.2% 0.2% 0.3% 0.4% 0.6% 0.7% 1.2% 1.4% 1.7% 1.8% 1.9% 2.2% 2.2% 2.7% 3.5% 3.7% 4.6% 4.9% 6.1% 7.2% 8.1% 19.6% 24.8%

45 2 2 2 2 2 2 3 2 3 3 4 3 4 4 4 12 3 9 5 9 15 6 18 8

62.2% 0.1% 0.1% 0.1% 0.1% 0.2% 0.2% 0.3% 0.5% 0.5% 0.6% 0.7% 0.7% 0.8% 0.8% 1.0% 1.3% 1.4% 1.7% 1.9% 2.3% 2.7% 3.1% 7.4% 9.4%

62.2% -0.1% -0.1% -0.1% -0.2% -0.3% -0.3% -0.5% -0.8% -0.8% -1.1% -1.1% -1.2% -1.4% -1.4% -1.7% -2.2% -2.3% -2.8% -3.1% -3.8% -4.5% -5.1% -12.2% -15.4%

695 -1 -1 -2 -2 -3 -4 -5 -9 -9 -12 -12 -13 -15 -15 -19 -24 -26 -32 -34 -42 -50 -57 -137 -172

127

100%

172

100%

0.0%

0


8

___________New FM Index + Saudi Arabia ___________ Number of stocks Weight % Weight change % Net flow USDm

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Table 6: Simulated MSCI Frontier Market sectors + Saudi Arabia Sector

_______Current FM Index_______ Number of Weight % stocks

____Potential FM sectors + Saudi Arabia____ Number of Weight Weight change stocks % %

Net flow USDm

Materials Consumer Discretionary Utilities Information Technology Industrials Health Care Telecom. Services Consumer Staples Energy Financials

15 3 2 0 5 3 14 11 16 58

5.70% 0.50% 0.40% 0.00% 3.40% 2.70% 14.50% 10.50% 12.10% 50.10%

15 3 2 0 5 3 14 11 16 58

24.00% 2.70% 1.40% 0.00% 2.90% 1.00% 12.30% 7.30% 5.90% 42.60%

18.30% 2.10% 1.00% 0.00% -0.60% -1.70% -2.20% -3.20% -6.20% -7.50%

204 24 11 0 -6 -19 -25 -36 -69 -84

Total

127

100%

127

100%

0.0%

0


Sector impacts

We believe the Materials and Consumer Discretionary sectors could be positively impacted in terms of weight changes, up 18% and 2% respectively. Financials, Energy and Consumer Staple could experience the largest negative impacts with potential weight decreases of between 3 and 7%.

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Equity Market Strategy  Saudi Arabia has a strong cyclical and secular position  Prospective market liberalisation should provide an additional

catalyst  Prefer petrochemicals and selected consumer, telecoms and

bank exposure

For EM and FM investors, we recommend an off-benchmark exposure to Saudi Arabia In Saudi Arabia, both the cyclical and secular narratives remain attractive. The obstacles relate more to valuations and more challenging bottomup stock selection. Nevertheless, we continue to favour an off-benchmark exposure, emphasising the petrochemical sector as a whole as well as selected consumer and telecom stocks. We are also positive on the bank sector. The long-term, secular dynamic in Saudi Arabia, is grounded in demographics and middle class growth (see Frontier Market Equity Strategy: Frontier markets and the rise in middle class spending, 23 July 2014). The total middle class population is forecast to grow from less than 20m today to 40m by 2050 (OECD). This would be the fourth-largest middle class population in the frontier index. Simon Williams, our Chief Middle Eastern Economist, remains upbeat on the Kingdom’s nearterm economic prospects, and continues to look for strong growth in domestic demand, underpinned by high oil receipts and two more years of fiscal and current account surplus.

10

The government’s oil-funded expansionary fiscal stance will remain the prime driver of growth, with current and capital spending set to rise from last year’s record high. The government will also be a prime driver of a raft of other large industrial and infrastructure development projects (such as the Riyadh metro) which are state sponsored but not directly state financed. With inflation low and the dollar peg in place, we also expect the Saudi Arabian Monetary Agency’s (SAMA’s) monetary stance to remain loose. In aggregate, the equity market is not very expensive, with the PE relative (compared with GEM) trading a little above its five-year history. However, neither is it very cheap, and stock selection is becoming more complicated. In the domestically-focussed part of the market we like selected consumer, telecom and banks stocks. For the consumer sector, sales growth should continue to rebound this year. In aggregate “Saudisation” initiatives (policies favouring the employment of locals) should ultimately help the sector by enhancing purchasing power. The undertow from the long-term secular story works in the sector’s favour. The impediment is that the discount to the peer group has closed, so there is less valuation support. The telecoms sector is another way to play the theme.

John Lomax* Head of Global Emerging Market Equity Strategy HSBC Bank plc +44 20 7992 3712 [email protected] Kishore Muktinutalapati* Associate Bangalore *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

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The case for the banks is also slowly coming into view. The first rise in US interest rates, which positively impacts them, is no longer extremely distant (Q3 next year in the view of HSBC’s US economist). Sectoral earnings in any case should pick up on the back of falling loan loss provisions and domestic macro is supportive. Valuations are looking increasingly attractive. The petrochemical sector should benefit from both demand and supply support. Chinese polymer demand should receive support from the ongoing strength of the Chinese economy. Unlike, other parts of the global material sector, Saudi petrochemicals will not be negatively impacted by the rebalancing of the Chinese economy towards consumption and away from infrastructure spending – since packaging and autos are the key demand drivers. On the supply side, the developing supply vacuum should allow room for margin expansion from current levels. Dividend yield, which has scope to be enhanced by these developments, is an additional source of sectoral support.

Saudi Arabia’s Equity Market The Saudi equity market has performed strongly over the last 10 years. The main index, the Tadawul All-Share Index (TASI), has returned a healthy 121% since 2004, buoyed by rising oil prices and GDP growth that has averaged 6.4% per annum. However, the volatility has been significant in a market with over 90% of trading volumes accounted for by Saudi retail investors. The TASI returned a 720% from early 2002 to February 2006, but investors who bought at the peak in February 2006 have lost 53%, even though the market has returned 95% since early 2009. The market has been open for investment since 2007 for citizens of the nations within the Gulf Co-operation Council (which also includes the UAE, Kuwait, Qatar, Bahrain and Oman). Since 2008, non-GCC investors have been able to access the market via swap agreements. The Saudi equity market tends to trade at a premium to the MSCI emerging markets index, reflecting its vast hydrocarbon wealth and one of the most attractive demographic profiles globally, including a very young population and a labour force growing at nearly 3% per annum. The Saudi bourse, the largest in the Middle East, is open for trading in equities between 11.00am and 3.30pm (one session) Sunday through Thursday. 164 stocks are listed on the Tadawul exchange. SABIC and Saudi Telecom both account for c25% of the Tadawul All Share Index, with the top 5 names representing c38% of the market. The top 10 names account for about 52% of the index total market capitalization, and have an average free float of about 30%. This means that the Saudi market is more diversified than most other regional exchanges but it is still is fairly concentrated by developedmarket standards. The materials sector (which includes petrochemical companies) accounts for 34.6% of the market, followed by a 33.8% weight for Financials by market capitalisation.

11

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Tadawul All Share price index

Tadawul trading volumes

4.0

6000

3.5

5000

3.0

4000

2.5

3000

2.0

2000

1.5 1.0

1000

0.5

0 01 02 03 04 05 06 07 08 09 10 11 12 13 14

0.0 07

TADAWUL All Share Index (USD) Source: Tadawul, Thomson Reuters Da tastream

The Saudi market has exhibited a low correlation to global equity benchmarks, partly because the market is currently closed for direct foreign investment. Non-GCC parties can only invest in Saudi equities through swap contracts and via a limited selection of exchange traded funds. Several local Saudi brokerage firms offer swap contracts to international investors. These contracts enable the investor to

Sector composition of TADAWUL All Share index

Source: Tadawul, Thomson Reuters Da tastream, HSBC

12

09 10 11 12 13 Tadawul Index 6m ADTV (USDbn)

14

Source: Tadawul, Thomson Reuters Da tastream

The Saudi equity market is one of the most heavily traded in the emerging markets space, with average daily turnover at USD1.4bn in 2013 and USD2.5bn currently. At times, the market turnover has been higher than the combined turnover in all other CEEMEA equity markets, even though volumes are still far below the market peak in 2005/06. The ratio of market capitalisation to GDP, at about 51%, is decent by emerging-market standards.

Sector Materials Financials Telecommunication Services Consumer Staples Consumer Discretionary Industrials Utilities Energy Health Care Total

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obtain economic exposure while the legal ownership remains with a Saudi-registered entity.

Market liberalisation According to Reuters (Saudi Arabia prepares to open $530 billion bourse to foreigners, 22 July 2014), the Saudi Arabian cabinet authorized the Capital Market Authority (CMA) – at a time it sees as appropriate – to allow foreign financial institutions to buy and sell stocks on the Saudi stock market, according to rules to be laid down by the CMA.

Major stocks in TADAWUL All Share index

Weight (%) 34.6% 33.8% 11.0% 5.5% 4.5% 3.9% 3.6% 2.1% 1.0% 100.0%

Rank 1 2 3 4 5 Top 5 6 7 8 9 10 Top 6-10

Stock Name Saudi Basic Industries Saudi Telecom Al Rajhi Bank Kingdom Holding Saudi Electricity Etihad Etisalat Co. Riyad Bank Saudi Arabia Frtz. The Saudi British Bk. Samba Financial Group

Source: Tadawul, Thomson Reuters Da tastream, HSBC

Weight (%) 17.5% 7.1% 5.4% 4.5% 3.4% 37.8% 3.2% 2.7% 2.7% 2.5% 2.4% 13.5%

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If Saudi opens its market to direct foreign investment, it may potentially be included in the MSCI Emerging Markets index. According to Sebastien Lieblich, executive director in the index research team at MSCI, the index provider would wait for the changes to be implemented before consulting investors, with a decision as to whether to include it as emerging market unlikely to be made before June 2015. However, should this materialise, the Saudi market could take up about 4% of the MSCI EM index. However, adjusted for the foreign ownership caps, the weight should be lower. The high turnover of the Saudi market suggests that it could be a key constituent of this key benchmark. Inclusion in the MSCI EM (or even Frontiers EM) index, were it to happen, could be important for at least two reasons: first, it should allow Saudi to tap the broad international pool of EM liquidity; second, it has the potential to stimulate more efficient behaviour from Saudi equities, allowing them to better reflect market fundamentals.

Implications for equity markets Below we examine the possible consequences of the decision by the Saudi Arabian Capital Markets Authority (CMA) to allow limited foreign equity ownership on the Kingdom’s Tadawul Exchange. The results we would expect include a decrease in the volatility of returns, and the crowding-out of irrational trading behaviour. This should push prices to increasingly reflect fundamentals and to move in line with their intrinsic values. We believe allowing foreign ownership would render the Saudi market less volatile, and consequently more efficient. Additionally, as investors are given greater insight into companies’ decision-making processes, financial disclosure and corporate transparency should also improve while foreign investment, we think, will also bring additional analyst coverage to the region’s equities, thereby improving the quality of information available.

The CMA opened Saudi Arabia’s stock exchange to limited foreign investment in late 2008. Nonnationals were given the right to trade shares listed on the exchange by entering into swap agreements. We expect market efficiency to have improved since this liberalisation process. However, given the high transaction costs associated with this indirect trading mechanism, we believe market efficiency would further improve once direct foreign ownership is permitted. Volatility, liquidity and market efficiency

In order to examine market efficiency, we look at changes in volatility of returns by comparing the standard deviation of returns for the two-year pre(partial) liberalisation period with that of the subsequent two-year period. (For more details on the methodology see Mispriced: CEEMEA equity projections, 12 December 2011). Changes in liquidity are examined by measuring average daily traded volumes (ADTV) and turnover by volume for the year preceding the (partial) liberalisation process and comparing them with levels for the following two-year period. Finally, market efficiency is measured by investigating the relationship between current and past returns. A market is more efficient when current returns depend less on their previous values. After limited foreign trading was allowed, the weekly standard deviation of returns decreased substantially from 0.056 to 0.030 – a 47.3 % decrease. After December 2008, large spikes in returns have decreased both in frequency and intensity. We believe this to be attributable in part to increased market efficiency as a result of allowing limited foreign investment. However, the period around the decrease in volatility coincides with a time when the CMA greatly increased market surveillance in an effort to discourage market manipulation by groups of wealthy investors. This development may also serve as a partial explanation for the decrease in volatility.

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Weekly returns of Tadawul index pre and post partial liberalisation in December 2008 15%

300%

10%

250%

5%

200%

0%

150%

-5%

100%

-10%

50%

-15%

Pre liberalisation

-20% Jan-07

Oct-07

Jul-08

Turnover ratios*

Apr-09

Jan-10

1992

Prior to the liberalisation, the Saudi turnover ratio was much higher than in many developed and emerging markets, as shown above. We believe this drop in turnover ratio indicates that herd behaviour and noise trading in the market decreased after the liberalisation process. We calculate a drop in average ADTV from USD1.77bn in the first period to USD1.07bn after the liberalisation process. However, we note that these measures were implemented at the peak of the 2008 financial crisis, so the decrease in ADTV may be explained by the drying-up of international liquidity. However, the country’s turnover ratio has consistently converged towards levels seen in developed and emerging markets, which leads us to believe that foreign investments are also responsible for this drop in liquidity. When assessing the impact of the liberalisation on market efficiency, we found current daily returns to be significantly correlated with past returns during the two-year period before the liberalisation process. In the subsequent two-year period, however, there was a noticeable drop in the significance level of the coefficients. The table below summarises these results.

1995

Saudi Arabia

Oct-10

Source: Tadawul, Thomson Reuters Datastream

14

0%

Post liberalisation

1998

2001

2004

DM

2007 EM

2010 GCC

Notes: *Turnover ratio is the total value of shares traded during the period divided by the average market capitalisation for the period. Source: Tadawul, Thomson Reuters Datastream

After foreign trading was permitted by the exchange, the test was unable to detect any significant pattern among daily returns, except for t2, which still influences current returns. There has clearly been an improvement in the level of efficiency in the Saudi market since the liberalisation process took place. We expect further improvements once direct foreign ownership is allowed. TASI market efficiency Time period

___________ Coefficients ____________ Pre liberalisation Post liberalisation

t-1 t-2 t-3 t-4 t-5 t-6 t-7 ** 1% significance level; * 5% significance level Source: Thomson Reuters Datastream, HSBC

0.073** -0.047* 0.043* 0.066** -0.021 -0.042* 0.017

-0.006 0.104** 0.000 -0.041 -0.016 -0.051 0.032

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Earnings and valuations Price/Earnings ratio

Earnings growth and equity performance

28.0x

60%

60%

24.0x

50%

40%

40%

20%

30%

0%

20%

-20%

10%

-40%

20.0x 16.0x 12.0x

-60%

0%

8.0x 06

07 08 09 10 12 month trailing PE

07

11 12 13 14 12 month forward PE

08

09 10 11 12 13 14 12 month forward Earnings growth y-o-y returns (RHS)

Source: Tadawul, Bloomberg


Price/Sales ratio

Price/Book ratio

6.0x

4.0x 3.5x

5.0x

3.0x 2.5x

4.0x

2.0x 3.0x

1.5x 1.0x

2.0x 08

09 10 11 12 month trailing P/S

08

12 13 14 12 month forward P/S

09

11

12 month trailing PB



Earnings yield

Dividend Yield

12.0%

10

12

13

14

12 month forward PB

5.0%

11.0%

4.5%

10.0% 9.0%

4.0%

8.0%

3.5%

7.0%

3.0%

6.0%

2.5%

5.0%

2.0%

4.0% 06

07

08 09 10 11 12 13 12 month forward Earnings Yield


14

08

09

10

12 month trailing DY

11

12

13

14

12 month forward DY


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Economics Slowing, but still strong We remain upbeat on the Kingdom’s near-term economic prospects, and continue to look for strong growth in domestic demand, underpinned by high oil receipts and two more years of fiscal and current account surplus. The impact that unrest in Iraq, Libya and Ukraine has had on global energy prices represents upside risk to this view. The government’s oil-funded expansionary fiscal stance will remain the prime driver of growth, with current and capital spending set to rise from last year’s record high. The government will also be a prime driver of a raft of other large industrial and infrastructure development projects (such as the Riyadh Metro) which are state sponsored, but not directly state financed. With inflation low and the dollar-peg in place, we also expect SAMA’s monetary stance to remain loose, with funding from domestic sources enhanced by improving access to global debt and equity markets. Saudi Arabia’s demographic profile – 60% of the population are under the age of 30 – will support gains in consumption. With

reserves equivalent to some 90% of GDP and a public debt at less than 5% of GDP, the Kingdom is also well placed to weather even a pronounced increase in regional political risk or prolonged fall in oil earnings. In this context, though, we see some signs that the economy is decelerating with markers of consumption and investment growth all easing over the first half of the year. Though driven in part by the short-term disruption caused by the expulsion of a large number of expatriates in late 2013, it also marks the Kingdom’s increased fiscal caution as the budget surplus continues to decline. We see signs that alongside more modest gains in spending, there is also a greater commitment to economic liberalisation and structural reform. In our view, however, the pace of change as yet lacks the urgency required if the Kingdom’s long-term demand for goods, services and employment is to be met in an environment of more modest public spending gains.

Key data and forecasts

GDP (% y-o-y) Current account (% GDP) Budget Balance (% GDP) Trade Balance (% GDP) CPI (% end year) Public Debt (% GDP) External debt (% GDP) Policy rate (% end year) USD/SAR (end year) EUR/SAR (end year)

2008

2009

2010

2011

2012

2013e

2014f

2015f

8.2 24.4 29.8 40.9 9.0 12.1 18.5 1.50 3.75 5.22

2.0 3.5 -5.4 24.6 4.2 14.0 23.2 0.25 3.75 5.40

7.5 13.4 4.4 29.3 5.4 8.5 19.7 0.25 3.75 5.02

8.6 22.8 11.6 36.6 5.3 5.4 16.6 0.25 3.75 4.87

5.8 21.8 13.7 34.0 3.9 3.6 15.8 0.25 3.75 4.94

4.1 17.1 6.4 30.1 3.0 2.7 15.3 0.25 3.75 5.13

4.2 13.4 3.7 26.6 3.5 2.9 14.4 0.25 3.75 4.79

3.9 9.2 2.3 23.7 4.3 3.1 14.1 0.25 3.75 4.68

Source: Saudi Arabia Monetary Agency, Central Department of Statistics and Information (CDSI), HSBC estimates and forecasts

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Simon Williams Economist HSBC Bank Middle East Ltd +971 4423 6925 [email protected] Razan Nasser Economist HSBC Bank Middle East Ltd +971 4423 6928 [email protected]


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Sectors & companies

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Banks

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Banks  We do not expect core revenue growth to rise above 10% during

2014e-15e; we factor in a 20bp increase in interest rates in 2015e and expect core revenue growth to recover to 13% in 2016e  Balance sheets are asset-driven in a market with ample deposit

funding; we estimate banks can sustain 10-15% pa increase in loans but should also raise collective provisions in the medium term  We have Overweight ratings on Samba (TP SAR55) and ANB (TP

SAR 37), Neutral ratings on Alinma (TP SAR21.3), Alrajhi (TP SAR74.0), BSF (TP SAR37.0) and Riyad (TP SAR20.4)

Sector view Core revenue growth will struggle to recover in 2014e and 2015e A combination of low interest rates, a cap on loan to deposit ratios of 85% and the strong capitalisation of Saudi banks means that the sector will struggle to substantially improve its core revenue growth in 2014e and 2015e, in our view. Alinma Bank and Riyad Bank are the exceptions due to faster and more stable loan growth, mainly as a result of their surplus capital positions. We forecast sector core revenues to increase 9% in 2014e and 2015e. Q2 2014 earnings results confirmed our full year expectation. An increase in interest rates will be a key driver of improvement. We factor in a 20bp increase in 2015e and expect Saudi banks’ core revenue growth to recover to 13% in 2016e.

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Saudi banks' y-o-y core revenue* growth: latest trends and our forecasts (%) Alinma Alrajhi ANB BSF Riyad Samba Avg.

Q2 13 Q3 13 Q4 13 Q1 14 2014e 2015e 2016e 12 1 2 (1) 5 (0) 3

15 (2) 4 2 7 4 5

20 2 15 3 12 7 10

15 0 10 12 15 (3) 8

16 4 9 9 9 8 9

15 5 8 9 12 9 9

15 8 10 20 16 16 13

Source: Company data, HSBC estimates; Note: *core revenue = net interest income + fees; latest core revenue figures for Q2 14 are not out yet

In the meantime, as core revenue growth remains below 10%, Saudi banks will have to rely increasingly on other non-interest income, such as gains on trading and investments, and FX revenue. These are more volatile sources of earnings, which dilute earnings quality. As we illustrate in the next table, the average contribution from these sources to total revenue was 9 to 12% over the last six quarters.

Aybek Islamov* Analyst HSBC Bank Middle East + 971 4423 6921 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

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Contribution of other non-interest income (FX, trading and investment gains) to total revenue (%) Alinma Alrajhi ANB BSF Riyad Samba Average

Q4 12 Q1 13 Q2 13 Q3 13 Q4 13 Q1 14 1 16 13 9 7 9 9

7 10 15 9 6 14 10

2 9 13 10 12 11 10

3 13 10 9 8 12 9

3 15 12 15 10 6 10

5 10 16 9 11 17 12

Source: company data, HSBC estimates, Q2 14 details are not out yet

Loan growth pipeline remains healthy As was recently discussed in the initiation report on GCC construction contractors Ride the next order wave (17th April 2014, Nicholas Paton et al), cUSD100bn of projects are still to be awarded in 2014 in Saudi Arabia. These are concentrated in the power, transportation, oil & gas, water and construction sectors of the economy. Assuming that a quarter of these projects, ie cUSD25bn, are funded with bank loans, this translates into an 8-10% increase in the sector loan book. We estimate that the capitalisation and liquidity positions of Saudi banks can easily sustain a 10-15% annual increase in sector loans. The risk is that contractors may not be getting paid on time, thereby causing asset quality risks to banks. In 2013, there was much discussion of the potential introduction of a new law in Saudi to enable companies to claim compensation for work that has not been paid for. If such a law were to be introduced, it would not only reduce the ratio of receivables to sales for construction contractors (which is running north of 120% in Saudi), but would also give more confidence to investors in Saudi banks.

Banks need to deal with the structural deficit in collective provisions With loan growth remaining in the low teens in 2014, we see increasing pressure on Saudi banks to improve loan loss reserves. Most banks we cover tend to write off NPLs immediately against specific loan loss reserves. Hence, quite often, it is not the NPL ratio which is indicative of real asset quality, but the write-offs to loans ratio. Specific reserves to loan ratios averaged 1.1% in 2013 and were as high as 2.2% in 2010, at a time of rising impairments

Albilad Alinma Alrajhi ANB BSF NCB Riyad SABB Samba SHB SIB Total

2010

2011

2012

2013

4.4% 0.0% 1.0% 2.8% 1.0% 3.4% 1.1% 2.7% 2.6% 2.3% 4.5% 2.2%

4.4% 0.0% 0.9% 2.9% 0.9% 2.8% 0.8% 1.2% 1.9% 2.0% 6.0% 1.8%

n/a 0.2% 1.5% 2.5% 0.7% 2.7% 1.2% 1.1% 1.3% 1.6% 0.6% 1.5%

1.7% 0.4% 0.9% 1.7% 1.1% 1.3% 0.6% 1.1% 1.1% 1.3% 0.5% 1.1%

Source: Company data, HSBC estimates

The problem is that, with a low buffer of portfolio provisions (also known as collective provisions), such write-offs require banks to take specific provision charges which, in turn, dampen earnings growth. The collective provision reserve works as a counter-cyclical buffer in the event of unexpected impairments, absorbing negative earnings shocks. The table above illustrates that most banks have reduced their specific reserves to loan ratios over the last 3 years. In the meantime, collective provision to loans ratios were generally steady, with the exceptions of SIB, Samba, and Riyad where this ratio declined (see table below). However, 5 out of the 8 banks currently have a collective provision to loans ratio that is below 1%.

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Collective provisions to loans ratio - below 1% for 5 out of 8 banks in 2013 (grey colour coded)

Albilad Alinma Alrajhi ANB BSF NCB Riyad SABB Samba* SHB SIB Total

2010

2011

2012

2013

0.5% 0.0% 2.0% 0.4% 0.9% 1.2% 1.0% 0.7% 1.8% 0.9% 1.5% 1.2%

1.7% 0.5% 1.6% 0.6% 0.7% 1.4% 0.9% 1.2% 1.8% 0.8% 1.6% 1.2%

n/a 0.5% 1.3% 0.5% 0.7% 1.5% 0.9% 1.3% 1.6% 0.8% 1.7% 1.1%

2.0% 0.7% 1.3% 0.5% 0.8% 1.3% 0.8% 1.0% 1.3% 0.8% 1.0% 1.1%

Source: Company data, HSBC estimates; Note *Samba does not disclose total collective provisions. We only include the collective provisions which the company reports in its Tier 2 capital

We therefore think that, even in the absence of further impairments, banks will need to improve their collective provision reserves. We model our cost of risk forecasts accordingly, which we show in the table below. Our cost of risk expectations (bp) Alinma Alrajhi ANB BSF Riyad Samba Average

2012 49 142 63 46 100 30 72

2013 2014e 2015e 2016e 2017e 66 141 70 88 50 32 74


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61 110 53 57 50 37 61

67 93 53 58 60 37 61

72 83 58 58 78 46 66

76 88 85 58 91 54 75

Searching for relative value in a sector with pedestrian EPS growth While the near-term earnings growth that we expect for most Saudi banks is somewhat sluggish, we still see pockets of value, which we identify on the basis of PEG. As can be seen from the table below, although both ANB and Samba are expected to post below-average earnings growth over the next two years, their valuations are sufficiently low that they still show up as best value on a PEG basis. ANB and Samba are our only OW-rated Saudi banks. PE and PEG multiples

Alinma Alrajhi ANB BSF Riyad Samba Average Source: HSBC estimates

PE 2015e

EPS CAGR 13-15e

PEG

21.4 13.4 9.1 12.5 11.8 9.7 12.8

17% 5% 12% 16% 9% 7% 9%

1.3 2.7 0.8 0.9 1.3 1.4 1.4

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Arab National Bank ARNB AB, Price SAR29.1, Overweight, TP SAR37 Company description

ANB’s loan growth may lag the sector this year – at only 8% – we expect it to recover to 11% and 14% in 2015e and 2016e, respectively.

Aybek Islamov* Analyst HSBC Bank Middle East + 971 4423 6921 [email protected]

ANB was established in 1979. Arab Bank (Jordan) is the majority shareholder, with a 40% stake. In 2000 it was the first bank to offer internet banking services in Saudi Arabia. The bank provides a full range of retail and corporate banking services. On our estimates, it had 8% market share of loans and deposits, as at March 2014. ANB teamed up with Dar Al Arkan, the real estate developer, to set up the Saudi Home Loan Company, in order to gain a foothold in the housing finance market.

Financials

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

Investment thesis Good improvement in core revenue despite weak loan growth. Recent quarters confirm that

ANB has been able to grow its net interest income and fees faster than customer loans. This is due to it optimising its asset mix. In 2012 and 2013, despite weak loan growth, the loan to asset ratio continued to improve, reaching 64% in Q4 13, up from 62% in Q4 11. We expect this trend to continue and forecast net interest income and fees to grow by 7% and 11%, respectively, in 2015e. We estimate ANB can grow its pre-provision income by 8% in 2014e, and by 10% in 2015e. Cut in pay-out ratio saves more capital. As

ANB has now rebuilt its capital buffer, we expect the bank to re-accelerate its loan growth from 2015. ANB reduced its pay-out ratio to 17% in 2013 from 36% in 2012. The cut delivered a 130bp improvement in the capital adequacy ratio, to 16.3% in Q1 14 from 15% in Q1 13. While

We forecast Arab National Bank to report earnings of SAR2.9bn (before zakat) in 2014e, an increase of 15% over 2013, on the back of 5% and 7% increases in non-interest income and net interest income respectively and a 20% decline in bad asset charges, generating an ROE of 14.8%. Our earnings estimates are 11% and 12% above Bloomberg consensus for 2014e and 2015e respectively.

Valuation We derive our target prices for Saudi banks using a residual income methodology, using an inflation differential model to calculate the cost of equity. The residual income valuation approach calculates the fair value of the company as the sum of its current net asset value and the present value of its future residual income. The residual income is measured as an excess return over cost of equity. To calculate the cost of equity by the inflation differential method, we assume cost of equity as the sum of the US risk-free rate (3.0%), the inflation differential between Saudi Arabia and the US (2.6%) and the equity risk premium (5.5%) multiplied by the stock beta (1.0 for Saudi banks we cover). Our estimated cost of equity for ANB is 11.1%. Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage points above and below the hurdle rate for Saudi stocks of 9.0%. Our target price of SAR37 implies a potential return of 27%,

23


which is above the Neutral band of 4%-14% for non-volatile Saudi stocks; therefore, we rate the stock Neutral. The stock is currently trading at 1.4x 2014e book value, for an ROE of 14.8%. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated. We do not include dividend yields in our potential returns for the Saudi banks, since we use residual income methodology to value our stocks.

Risks Key downside risks include:

Downside risks centre on stronger-than-expected cost of risk as a result of weaker asset quality, as well as slower loan growth.

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Financials & valuation: Arab National Bank Financial statements Year to

Core profitability (% RWAs) and leverage 12/2013a

12/2014e

12/2015e

12/2016e

3,375 1,053 65 616 5,110 -1,994 -627 36 2,525 0 2,525 0 -3 2,522 2,522

3,613 1,194 18 604 5,428 -2,070 -499 42 2,900 0 2,900 0 -3 2,897 2,897

3,860 1,326 0 663 5,848 -2,162 -547 48 3,188 0 3,188 0 -3 3,185 3,185

4,215 1,473 0 719 6,407 -2,258 -671 52 3,530 0 3,530 0 -4 3,526 3,526

18,655 18,655 88,456 28,248 106,373 133,787 137,935

20,425 20,425 95,875 34,762 115,946 139,836 148,853

22,369 22,369 105,963 35,679 127,541 151,966 162,392

24,522 24,522 120,284 36,660 144,121 168,001 181,126

P&L summary (SARm) Net interest income Net fees/commissions Trading profits Other income Total income Operating expense Bad debt charge Other HSBC PBT Exceptionals PBT Taxation Minorities + preferences Attributable profit HSBC attributable profit Balance sheet summary (SARm) Ordinary equity HSBC ordinary equity Customer loans Debt securities holdings Customer deposits Interest earning assets Total assets Capital (%) RWA (SARm) Core tier 1 Total tier 1 Total capital

123,778 15.1 15.1 16.0

136,476 15.0 15.0 15.9

148,392 15.1 15.1 15.9

164,996 14.9 14.9 15.6

12/2013a

12/2014e

12/2015e

12/2016e

7.4 5.4 8.8 6.4 6.4 -50.0 10.0

6.2 3.8 7.8 14.9 14.9 36.5 9.5

7.7 4.4 9.8 9.9 9.9 9.9 9.5

9.6 4.4 12.6 10.7 10.7 10.7 9.6

Year-on-year % change Total income Operating expense Pre-provision profit EPS HSBC EPS DPS NAV (including goodwill)

12/2013a

12/2014e

12/2015e

12/2016e

2.7 0.1 0.5 -1.6 2.5 -0.5 2.1 6.9 13.5

2.8 0.0 0.5 -1.6 2.6 -0.4 2.2 6.7 14.1

2.7 0.0 0.5 -1.5 2.6 -0.4 2.2 6.7 14.2

2.7 0.0 0.5 -1.4 2.6 -0.4 2.3 6.7 14.3

Net interest income Trading profits Other income Operating expense Pre-provision profit Bad debt charge HSBC attributable profit Leverage (x) Return on average tier 1

Valuation data Year to

12/2013a

12/2014e

12/2015e

12/2016e

11.5 9.3 1.6 8.3 1.5

10.0 8.7 1.4 6.9 2.0

9.1 7.9 1.3 8.1 2.2

8.3 7.0 1.2 8.1 2.4

PE* Pre-provision multiple P/NAV Equity cash flow yield (%) Dividend yield (%) Note: * = Based on HSBC EPS (fully diluted)

Issuer information Share price

(SAR)29.10

Reuters (Equity) Market cap (USDm) Free float (%) Country Analyst

Target price

1080.SE 7,804 34 Saudi Arabia Aybek Islamov

33 31 29 27 25 23 21 19 17 15 2012

2013 Arab National Bank

Ratios (%) Cost/income ratio Bad debt charge Customer loans/deposits NPL/loan NPL/RWA Provision to risk assets/RWA Net write-off/RWA Coverage ROE (including goodwill)

Year to

Bloomberg (Equity) Market cap (SARm) Sector Contact

1 (%) 1 . 8

(SAR)37.00

ARNB AB 26,605

COMMERCIAL BANKS +9714 423 6921

Price relative

Ratio, growth & per share analysis Year to

Overweight

39.0 0.7 83.2 1.1 0.8 1.7 1.0 204.7 14.2

38.1 0.5 82.7 1.1 0.8 1.4 0.5 172.0 14.8

37.0 0.5 83.1 1.1 0.8 1.3 0.3 169.7 14.9

35.2 0.6 83.5 1.1 0.8 1.3 0.3 166.1 15.0

2.52 2.52 0.43 18.66 18.66

2.90 2.90 0.58 20.42 20.42

3.18 3.18 0.64 22.37 22.37

3.53 3.53 0.71 24.52 24.52

2014

33 31 29 27 25 23 21 19 17 15 2015

Rel to TADAWUL ALL SHARE INDEX

Source: HSBC, price at close of 22 July 2014

Per share data EPS reported (fully diluted) HSBC EPS (fully diluted) DPS NAV NAV (including goodwill)

25

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Banque Saudi Fransi BSFR AB, Price SAR33.5, N, TP SAR37 Company description

and 2015e, respectively, and expect the majority of future loan loss provisions to be directed into the collective provision reserve.

Aybek Islamov* Analyst HSBC Bank Middle East + 971 4423 6921 [email protected]

Banque Saudi Fransi established in 1977 is among the top 5 banks in Saudi Arabian banking sector by loan market share. It controls 11% of the total loan market & 9% of assets in Saudi Arabia as of the end of March 2014. Credit Agricole CIB, the corporate and investment banking entity of Credit Agricole Group (ACA FP, Price EUR10.3, OW), is the largest stakeholder in the bank, with a 31.1% stake, followed by the Government of Saudi Arabia with a 13.2% stake.

Recovery in fee income growth. The pick-up in off


Banque Saudi Fransi is the leading commercial bank in KSA serving both national and international clientele. It provides conventional and Islamic commercial banking services including asset management services, credit cards and corporate banking solutions. It has a fully owned subsidiary, Saudi Fransi Capital, which mainly provides investment banking services. As of December 2013, BSF had a distribution network of 83 branches across Saudi Arabia with an employee base of 2,660.

Investment thesis One-off normalisation in bad asset charge should lift 2014e ROE to 12.5% from 10.7% last year. We

forecast a 28% drop in bad asset charges in 2014e. As a result, we expect a sharp improvement in ROE, to 12.5% in 2014e from 10.7% in 2013. BSF has made positive progress in terms of portfolio provisions, increasing them to 0.8% in 2013 from 0.7% in 2012. However, we still think the ratio will need to improve further from here. We forecast cost of risk of 57bp and 58bp in 2014e

26

balance sheet business (+17% yoy in 2013) should lead to better fee growth. We expect BSF to grow its total fees 9% in 2014e and 8% in 2015e.

Financials We forecast BSF to report earnings of SAR3.07bn (before zakat) in 2014e, increasing 27% y-o-y with ROE of 12.5%. Our earnings estimates are inline with Bloomberg consensus for 2014e and 6% below consensus for 2015e.

Valuation We derive our target prices for Saudi banks using a residual income methodology, using an inflation differential model to calculate the cost of equity. The residual income valuation approach calculates the fair value of the company as the sum of its current net asset value and the present value of its future residual income. To calculate the cost of equity by the inflation differential method, we assume cost of equity as the sum of the US risk-free rate (3.0%), the inflation differential between Saudi Arabia and the US (2.6%) and the equity risk premium (5.5%) multiplied by the stock beta (1.0 for Saudi banks we cover). Our estimated cost of equity for BSF is 11.1%. Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage points above and below the hurdle rate for Saudi stocks of 9%. Our target price of SAR37 implies a potential return of 10%, which is within the Neutral band of 4%-14% for


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non-volatile Saudi stocks; therefore, we rate the stock Neutral. The stock is currently trades at 1.6x 2014e book value, for an ROE of 12.5%. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated. We do not include dividend yields in our potential returns for the Saudi banks, since we use residual income methodology to value our stocks.


 Downside risks centre on further deceleration in loan growth, largely driven by weak corporate demand. Key upside risks include:

 Upside risks centre on lower bad asset charges than we estimate. A 10bp reduction in cost of risk versus our base case would lead to an additional 7ppt of EPS growth in 2014e.

27

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Financials & valuation: Banque Saudi Fransi Financial statements Year to


12/2014e

12/2015e

12/2016e

3,363 1,150 106 434 5,053 -1,684 -957 -5 2,406 0 2,406 0 0 2,406 2,406

3,697 1,251 150 428 5,526 -1,776 -688 3 3,066 0 3,066 0 -2 3,064 3,064

4,041 1,350 40 447 5,878 -1,853 -768 4 3,261 0 3,261 0 -2 3,259 3,259

4,981 1,465 0 417 6,863 -1,976 -865 4 4,026 0 4,026 0 -2 4,023 4,023

23,217 23,217 111,307 34,299 131,601 157,803 170,057

25,798 25,798 123,491 38,264 144,761 172,655 185,799

28,543 28,543 137,109 42,823 162,133 190,209 205,918

31,932 31,932 152,722 48,066 180,595 210,788 227,771


165,884 13.9 13.9 15.6

183,839 14.0 14.0 15.6

204,086 14.0 14.0 15.4

227,212 14.1 14.1 15.3

12/2013a

12/2014e

12/2015e

12/2016e

0.9 8.5 -2.6 -20.2 -20.2 -66.7 6.1

9.4 5.4 11.3 27.4 27.4 27.4 11.1

6.4 4.3 7.3 6.4 6.4 6.4 10.6

16.8 6.6 21.4 23.5 23.5 23.5 11.9


33.3 0.9 84.6 1.3 0.9 1.3 -0.2 146.2 10.7

32.1 0.6 85.3 1.2 0.8 1.4 -0.2 168.0 12.5

31.5 0.6 84.6 1.0 0.7 1.4 -0.2 194.4 12.0

28.8 0.6 84.6 1.1 0.8 1.4 -0.3 176.6 13.3

2.00 2.00 0.16 19.26 19.26

2.54 2.54 0.20 21.40 21.40

2.70 2.70 0.21 23.68 23.68

3.34 3.34 0.26 26.49 26.49


28

12/2013a

12/2014e

12/2015e

12/2016e

2.1 0.1 0.3 -1.1 2.1 -0.6 1.5 7.1 10.4

2.1 0.1 0.2 -1.0 2.1 -0.4 1.8 7.1 11.9

2.1 0.0 0.2 -1.0 2.1 -0.4 1.7 7.1 11.4

2.3 0.0 0.2 -0.9 2.3 -0.4 1.9 7.1 12.6



12/2013a

12/2014e

12/2015e

12/2016e

16.8 12.0 1.7 3.6 0.5

13.2 10.8 1.6 4.5 0.6

12.4 10.0 1.4 4.6 0.6

10.0 8.3 1.3 6.0 0.8



(SAR) 33.50


Target price


36 34 32 30 28 26 24 22 20 18 16 2012

2013 Banque Saudi Fransi


Year to


8 (%) . 8

(SAR)37.00

BSFR AB 30,737


Price relative


Neutral


2014 Rel to TADAWUL ALL SHARE INDEX

36 34 32 30 28 26 24 22 20 18 16 2015

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Riyad Bank RIBL AB, Price SAR18.35, Neutral, TP SAR20.5 Company description Riyad Bank was established in 1957. It has the third-largest branch network in Saudi Arabia and is currently mainly owned by Saudi shareholders. We estimate it had market share of around 12% in loans and 11% in deposits as of March 2014. Riyad bank is engaged in a wide array of retail and corporate banking services. The bank is primarily a corporate bank with corporate loans forming 74% of the total loan book end of Q1 2014. In December 2013, SAMA issued the first license for real estate financing and lease financing to Riyad Bank.

Investment thesis Good growth in core revenue. Stable increases

in the customer loan portfolio provide a good base for core revenue to grow. Core revenue improved sequentially in both Q4 13 and Q1 14 and we forecast growth of 9% in 2014e and 12% in 2015e, which is above the sector averages. Funding cost optimisation remains a strategic priority. Riyad Bank has the second highest

funding costs in our coverage (after BSF) at 57bp as at Q1 14 (peer group average = 40bp). While funding costs do not appear to be an issue within a very liquid banking sector and low interest rate environment, Riyad Bank does need to improve its collection of demand deposits. The ratio of demand deposits reduced to 42% in Q1 14, down from 47% the year before.

Collective provisions too low in view of the current loan growth. Similar to BSF, we think Riyad Bank should reconsider the adequacy of its collective provision reserves, which reduced to 0.8% of gross loans in 2013, from 1% in 2010. In fact, the size of Riyad Bank’s collective provision reserve has not changed since 2010, despite a 23% increase in the loan book. We forecast cost of risk of 50bp and 60bp in 2014e and 2015e, respectively, and, in the absence of large impairments, expect the bulk of provisions to flow into the collective provision reserve.


Financials We forecast Riyad bank to report earnings of SAR4.26bn (before zakat) in 2014e, an increase of 8% over 2013, on the back of 11% and 8% increases in non-interest income and net interest income respectively, generating an ROE of 12.8%. Our earnings estimates are 2% and 1% above Bloomberg consensus for 2014e and 2015e respectively.

Valuation We derive our target prices for Saudi banks using a residual income methodology, using an inflation differential model to calculate the cost of equity. The residual income valuation approach calculates the fair value of the company as the sum of its current net asset value and the present value of its future residual income. The residual income is measured as an excess return over cost of equity. To calculate the cost of equity by the inflation differential method, we assume cost of equity as the sum of the US risk-free rate (3.0%), the inflation differential between Saudi Arabia and the US (2.6%) and the equity risk premium (5.5%) multiplied by the stock beta (1.0 for Saudi banks

29


we cover). Our estimated cost of equity for Riyad bank is 11.1%. Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage points above and below the hurdle rate for Saudi stocks of 9%. Our target price of SAR20.5 implies a potential return of 12%, which is within the Neutral band of 4%-14% for non-volatile Saudi stocks, therefore we rate the stock as Neutral. The stock is currently trading at 1.6x 2014e book value, for an ROE of 12.8%. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated. We do not include dividend yields in our potential returns for the Saudi banks, since we use residual income methodology to value our stocks.

Risks Key upside risks include:

 Upside risks centre on stronger loan growth, exceeding our base case forecast of 13% in 2014e. Also, an increase in the dividend payout ratio would accelerate ROE recovery at Riyad Bank. The bank currently has a pay-out ratio of 56%. Key downside risks include:  Downside risks relate to worse-than-expected asset quality and a stronger decline in NIM than we forecast .

30

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Financials & valuation: Riyad Bank

Neutral

Financial statements Year to


12/2014e

12/2015e

12/2016e

4,697 1,821 -4 559 7,074 -2,578 -627 79 3,947 0 3,947 0 0 3,947 3,947

5,058 2,019 0 616 7,693 -2,789 -710 62 4,257 0 4,257 0 0 4,257 4,257

5,692 2,196 0 592 8,479 -2,901 -966 69 4,681 0 4,681 0 0 4,681 4,681

6,704 2,416 0 590 9,710 -3,078 -1,434 76 5,274 0 5,274 0 0 5,274 5,274

32,470 32,470 131,191 43,538 153,200 191,641 205,246

34,170 34,170 146,765 45,179 170,052 208,640 222,464

36,040 36,040 168,437 46,887 195,163 230,632 249,511

38,158 38,158 192,998 48,663 223,621 259,319 280,143


204,525 16.6 16.6 17.1

222,820 16.0 16.0 16.4

250,164 15.0 15.0 15.4

281,103 14.1 14.1 14.4

12/2013a

12/2014e

12/2015e

12/2016e


4.2 9.7 1.3 13.9 13.9 11.5 5.3

8.7 8.2 9.1 7.8 7.8 7.6 5.2

10.2 4.0 13.8 10.0 10.0 10.0 5.5

14.5 6.1 18.9 12.7 12.7 12.7 5.9

12/2014e

12/2015e

12/2016e

2.4 0.0 0.3 -1.3 2.3 -0.3 2.0 6.1 11.7

2.4 0.0 0.3 -1.3 2.3 -0.3 2.0 6.4 12.0

2.4 0.0 0.3 -1.2 2.4 -0.4 2.0 6.7 12.5

2.5 0.0 0.2 -1.2 2.5 -0.5 2.0 7.2 13.3



12/2013a

12/2014e

12/2015e

12/2016e

13.9 12.2 1.7 4.7 4.0

12.9 11.2 1.6 5.4 4.3

11.8 9.9 1.5 5.0 4.7

10.4 8.3 1.4 5.6 5.3



(SAR)18.35


Target price



2 (%) 4 . 2

(SAR)20.50

RIBL AB 49,500


21

21

19

19

17

17

15

15

13

13

11

11

9 2012

2013 Riyad Bank


12/2013a

Price relative


Year to

36.4 0.5 85.6 0.9 0.6 0.9 0.8 152.8 12.5

36.3 0.5 86.3 1.0 0.7 1.1 0.1 152.1 12.8

34.2 0.6 86.3 1.2 0.8 1.2 0.1 142.1 13.3

31.7 0.8 86.3 1.2 0.9 1.4 0.1 167.5 14.2

1.32 1.32 0.73 10.82 10.82

1.42 1.42 0.78 11.39 11.39

1.56 1.56 0.86 12.01 12.01

1.76 1.76 0.97 12.72 12.72

2014

9 2015




31

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Samba Financial Group SAMBA AB, Price SAR42.0, OW, TP SAR55 Company description Samba was established in 1980 and was branded the Saudi American bank until 2003. Samba is primarily a corporate bank. As of March 2014, Samba had a network of 72 branches. Samba has 10% market share in loans & 11% in assets in Saudi Arabia as of the end of March 2014. Samba was established as a joint-stock company with the takeover of Citibank branches in Jeddah and Riyadh, under a Saudi programme that forced all foreign banks to share ownership, with local Saudi nationals acquiring 60% ownership. In 1999, Samba merged with United Saudi Bank (USB) through a share exchange. Citibank sold its 20% ownership stake in Samba in 2003 to the General Organization of Social Insurance (GOSI). In 2007 Samba acquired majority ownership in the then-named Crescent Commercial Bank, now known as Samba Bank Limited Pakistan. The subsidiary provides commercial banking services and turned profitable in 2011 for the first time. Samba increased its ownership in the subsidiary in 2010, from 68% to 81% currently.

Investment thesis Strong capacity to improve asset mix in favour of loans. Samba’s loan to asset ratio improved to 57%

in Q2 14 from a low of 43% in 2010. We see further scope for improvement, as the bank focuses on loandriven growth. We normalise Samba’s loan to asset ratio at 60%, and see scope for it to rise further. For comparison, peer banks in Saudi have loan to asset ratios of 65% on average.

32

Core revenue growth and strong funding franchise. As a result, we expect core revenue

growth at Samba to recover to 8% in 2014e and 9% in 2015e from -3% in 2013. Samba’s competitive advantage centres on its strong funding franchise. Demand deposits make up 67% of total deposits at the bank and the absolute funding cost was just 68bp in Q1 14. This gives Samba strong capacity to grow its customer loans without large upside risk to funding costs. Samba’s loan to deposit ratio remains low at 72% and we normalise this to 75% going forward. Generous collective reserve keeps cost of risk low. While the bank does not fully disclose its collective provision reserves, the portion of the collective reserve disclosed in Tier 2 (SAR1,566m), is equivalent to 1.3% of the loan book. This makes Samba the bank with highest collective provision ratio within our Saudi coverage. Although, similar to Alrajhi bank, Samba appears to have a shortfall in terms of specific loan loss reserves, Samba can cover any shortfall by using its collective provisions. Hence, rich collective provision should prevent volatility in cost of risk, which is so common to other Saudi banks.

Financials We forecast Samba to report earnings of SAR4.8bn (before zakat) in 2014e, an increase of 7% over 2013, on the back of 7% increases in non-interest income and net interest income respectively, generating an ROE of 13.7%. Our earnings estimates are 2% and 1% above Bloomberg consensus in 2014e and 2015e, respectively.



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Valuation We derive our target prices for Saudi banks using a residual income methodology, using an inflation differential model to calculate the cost of equity. The residual income valuation approach calculates the fair value of the company as the sum of its current net asset value and the present value of its future residual income. The residual income is measured as an excess return over cost of equity. To calculate the cost of equity by the inflation differential method, we assume cost of equity as the sum of the US risk-free rate (3.0%), the inflation differential between Saudi Arabia and the US (2.6%) and the equity risk premium (5.5%) multiplied by the stock beta (1.0 for Saudi banks we cover). Our estimated cost of equity for Samba is 11.1%. Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage points above and below the hurdle rate for Saudi stocks of 9%. Our target price of SAR55 implies a potential return of 31%, which is above the Neutral band of 4%-14% for non-volatile Saudi stocks; therefore, we rate the stock Overweight. The stock is currently trading at 1.4x 2014e book value, for an ROE of 13.7%. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated. We do not include dividend yields in our potential returns for the Saudi banks, since we use a residual income methodology to value our stocks.


 Downside risks to our rating and target price include stronger aversion to loan risk as a result of negative pressure on loan pricing, in particular in the corporate banking segment.

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Financials & valuation: Samba Financial Group Financial statements Year to


12/2014e

12/2015e

12/2016e

4,528 1,600 293 579 7,001 -2,137 -353 0 4,510 0 4,510 0 0 4,510 4,510

4,727 1,813 215 730 7,485 -2,221 -451 0 4,812 0 4,812 0 0 4,812 4,812

5,240 2,011 140 659 8,049 -2,346 -507 0 5,197 0 5,197 0 0 5,197 5,197

6,152 2,231 0 639 9,022 -2,541 -703 0 5,778 0 5,778 0 0 5,778 5,778

33,787 33,787 113,455 60,341 158,337 190,929 205,037

36,623 36,623 125,644 57,092 172,587 203,557 221,107

39,686 39,686 140,616 57,328 189,846 221,364 241,429

43,091 43,091 157,897 56,137 212,627 244,111 267,615


188,295 18.6 18.6 19.4

197,755 18.6 18.6 19.4

215,777 18.5 18.5 19.2

235,954 18.3 18.3 19.0

12/2013a

12/2014e

12/2015e

12/2016e


4.6 3.6 5.0 4.2 4.2 0.3 10.1

6.9 3.9 8.2 6.7 6.7 6.7 8.4

7.5 5.6 8.4 8.0 8.0 8.0 8.4

12.1 8.3 13.6 11.2 11.2 11.2 8.6

30.5 0.3 71.7 1.7 1.1 1.6 0.2 145.5 14.0

29.7 0.4 72.8 1.7 1.1 1.6 0.1 149.1 13.7

29.1 0.4 74.1 1.7 1.1 1.7 0.1 148.3 13.6

28.2 0.5 74.3 1.7 1.2 1.8 0.1 152.5 14.0

3.76 3.76 1.22 28.16 28.16

4.01 4.01 1.31 30.52 30.52

4.33 4.33 1.41 33.07 33.07

4.82 4.82 1.57 35.91 35.91


34

12/2013a

12/2014e

12/2015e

12/2016e

2.6 0.2 0.3 -1.2 2.7 -0.2 2.5 5.5 12.9

2.4 0.1 0.4 -1.2 2.7 -0.2 2.5 5.5 13.1

2.5 0.1 0.3 -1.1 2.8 -0.2 2.5 5.4 13.1

2.7 0.0 0.3 -1.1 2.9 -0.3 2.6 5.5 13.4



12/2013a

12/2014e

12/2015e

12/2016e

11.2 10.4 1.5 5.9 2.9

10.5 9.6 1.4 8.2 3.1

9.7 8.8 1.3 7.8 3.4

8.7 7.8 1.2 8.7 3.7



(SAR)42.00


Target price



2 (%) 7 . 0

(SAR)55.00

SAMBA AB 49,485


62

62

57

57

52

52

47

47

42

42

37

37

32

32

27

27

22 2012

2013 Samba Financial Group


Year to

Price relative


Overweight



22 2015

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Alrajhi Banking & Investment RJHI AB, Price SAR67.75, Neutral, TP SAR74 Company description Al Rajhi was established in 1957 and was established as a Saudi share holding company in 1988. Al Rajhi bank is run by a management organization that includes the headquarters in Riyadh and six regional departments. The bank has the largest network of branches (over 500 branches) in the Kingdom and largest ATM network. The bank also has a presence in Malaysia, Kuwait and Jordan.

Investment thesis Core revenue growth will struggle to improve.

Slowing loan growth and a declining NIM will constrain core revenue growth at Alrajhi Bank. We estimate net interest income and fee income will grow at a 4% CAGR 2013-2015e. Pressure on operating costs constrains pre-provision income growth. In addition to slow core revenue growth, we expect Alrajhi bank to see upward pressure on operating costs. A relatively heavy reliance on remittance business – where the bank has to rely on outsourced labour – means upside risk to operating costs in light of the recent labour crackdown in Saudi Arabia. We believe that outsourced labour costs could more than double as the supplying companies either have to employ more Saudis or pay up for work permits for expat

employees. Growth in operating costs already accelerated to 12% yoy in Q1 14, from 7% in 2013. We therefore expect pre-provision income in 2014e to remain flat on last year. Specific provisions may need to rise further.

The low 2.3% collateral to loan ratio means the specific provisions may continue to surprise negatively as and when impairments occur at Alrajhi. We note that the sum of disclosed collateral against individually impaired loans of SAR971m and specific loan loss reserves of SAR1,789m fell short of NPLs of SAR3,008m by SAR248m as at Q4 13. This shortfall is equivalent to 2% of 2013 pre-provision income. We factor in a cost of risk of 110bp and 93bp in 2014e and 2015e, respectively.


Financials We forecast Al Rajhi to report earnings of SAR7.75bn (before zakat) in 2014e, an increase of 4% over 2013, on the back of 5% increase in net interest income, generating an ROE of 20.6%. Our earnings estimates are 1% and 6% below Bloomberg consensus in 2014e and 2015e, respectively.

Valuation We derive our target prices for Saudi banks using a residual income methodology, using an inflation differential model to calculate the cost of equity. The residual income valuation approach calculates the fair value of the company as the sum of its

35


current net asset value and the present value of its future residual income. The residual income is measured as an excess return over cost of equity. To calculate the cost of equity by the inflation differential method, we assume cost of equity as the sum of the US risk-free rate (3.0%), the inflation differential between Saudi Arabia and the US (2.6%) and the equity risk premium (5.5%) multiplied by the stock beta (1.0 for Saudi banks we cover). Our estimated cost of equity for Al Rajhi is 11.1%. Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage points above and below the hurdle rate for Saudi stocks of 9%. Our target price of SAR74 implies a potential return of 9%, which is within the Neutral band of 4%-14% for non-volatile Saudi stocks; therefore, we rate the stock Neutral. The stock is currently trading at 2.8x 2014e book value, for an ROE of 20.6%. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated. We do not include dividend yields in our potential returns for the Saudi banks, since we use residual income methodology to value our stocks.


 Downside risk includes further cuts in the dividend pay-out ratio. Note that Alrajhi Bank reduced its pay-out ratio to 50% based on 2013 profit from 62% a year ago. Key upside risks include:

 Upside risks centre on stronger lending volumes, in particular in the corporate segment. Also, a stronger-than-expected decline in bad asset charges may lead to stronger EPS growth than we forecast.

36

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Financials & valuation: Alrajhi Banking & Investm Financial statements Year to


12/2014e

12/2015e

12/2016e

9,606 2,846 0 1,663 14,115 -4,057 -2,619 0 7,438 0 7,438 0 0 7,438 7,438

10,056 2,916 0 1,507 14,480 -4,474 -2,253 0 7,752 0 7,752 0 0 7,752 7,752

10,474 3,095 0 1,553 15,122 -4,804 -2,109 0 8,209 0 8,209 0 0 8,209 8,209

11,341 3,302 0 1,622 16,265 -5,152 -2,051 0 9,062 0 9,062 0 0 9,062 9,062

36,155 36,155 186,813 16,117 231,589 264,634 279,871

39,274 39,274 208,452 16,843 257,064 281,249 306,430

42,586 42,586 228,708 17,618 287,912 308,377 340,801

45,942 45,942 250,527 18,445 322,461 343,460 379,199


207,670 18.5 18.5 19.6

220,577 18.8 18.8 19.8

244,510 18.3 18.3 19.2

282,752 17.0 17.0 17.9

12/2013a

12/2014e

12/2015e

12/2016e


0.9 7.4 -1.4 -5.7 -5.7 -23.1 10.8

2.6 10.3 -0.5 4.2 4.2 3.4 8.6

4.4 7.4 3.1 5.9 5.9 5.9 8.4

7.6 7.2 7.7 10.4 10.4 10.4 7.9

12/2013a

12/2014e

12/2015e

12/2016e

4.8 0.0 0.8 -2.0 5.0 -1.3 3.7 5.9 19.4

4.7 0.0 0.7 -2.1 4.7 -1.1 3.6 5.7 18.7

4.5 0.0 0.7 -2.1 4.4 -0.9 3.5 5.7 18.4

4.3 0.0 0.6 -2.0 4.2 -0.8 3.4 6.0 18.8



12/2013a

12/2014e

12/2015e

12/2016e

14.8 10.9 3.0 5.9 3.4

14.2 11.0 2.8 6.2 3.5

13.4 10.7 2.6 5.9 3.7

12.1 9.9 2.4 5.8 4.1



(SAR)67.75


Target price



2 (%) 7 . 0

(SAR)74.00

RJHI AB 110,094


78

78

73

73

68

68

63

63

58

58

53

53

48

48

43

43

38 2012

2013 Alrajhi Banking & Investm


Year to

Price relative


Neutral

28.7 1.5 80.7 0.0 1.4 2.1 1.3 0.0 21.6

30.9 1.1 81.1 0.0 1.4 2.1 0.9 0.0 20.6

31.8 1.0 79.4 0.0 1.4 2.2 0.6 0.0 20.1

31.7 0.9 77.7 0.0 1.2 2.0 0.6 0.0 20.5

4.58 4.58 2.31 22.25 22.25

4.77 4.77 2.39 24.17 24.17

5.05 5.05 2.53 26.21 26.21

5.58 5.58 2.79 28.27 28.27

2014

38 2015




37

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Alinma ALINMA AB, Price SAR19.85, Neutral, TP SAR21.30 Company description Alinma Bank was founded in 2006 and is headquartered in Riyadh. As of January 2014, the banks had a network of 96 branches and 830 ATMs. As of March 2014 the bank had 4% market share in loans & 3% in assets in Saudi Arabia.

Investment thesis Good collateral coverage of loan book. Alinma

has the highest collateral to loan ratio (at 86%) among the banks in our coverage which disclose collateral. The higher collateral level at Alinma (which improved from 41% in 2010) should result in less upward pressure on cost of risk as and when impairments start to rise. We factor in cost of risk of 61bp and 67bp in 2014e and 2015e, respectively, and expect the bulk of provision expenses to be directed into the collective provision reserve. The collective loan loss reserve to loans ratio reached 0.7% in Q4 13, up from 0.5% in 2012. Surplus capital provides room for a dividend payment. Alinma remains extremely well

capitalised, with a Tier 1 ratio of 27.8% as at Q1 14, despite loan book tripling in size since 2010. We see scope for a dividend payment, although we view this as a potential positive surprise which we do not factor into our explicit 2014e-2018e forecast period. Assuming a 16% CAGR 13-18e in customer loans, we calculate that Alinma could pay SAR3bn to SAR3.5bn in dividends. This represents 10-12% of

38

the bank’s current market cap. The payment of a deferred tax liability in Q4 13, of SAR894.4m points to a potential preparation by the company for a dividend payment, in our view.

Financials We forecast Alinma to report earnings of SAR1.2bn (before zakat) in 2014e, an increase of 20% over 2013, on the back of 16% and 7% increases in net-interest income and net interest income respectively, generating an ROE of 6.9%. Our earnings estimates are 4% and 12% above Bloomberg consensus in 2014e and 2015e, respectively.

Valuation We derive our target prices for Saudi banks using a residual income methodology, using an inflation differential model to calculate the cost of equity. The residual income valuation approach calculates the fair value of the company as the sum of its current net asset value and the present value of its future residual income. The residual income is measured as an excess return over cost of equity. To calculate the cost of equity by the inflation differential method, we assume cost of equity as the sum of the US risk-free rate (3.0%), the inflation differential between Saudi Arabia and the US (2.6%) and the equity risk premium (5.5%) multiplied by the stock beta (1.0 for Saudi banks we cover). Our estimated cost of equity for Alinma is 11.1%. Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage points above and below the hurdle rate for Saudi stocks of 9%. Our target



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price of SAR21.30 implies a potential return of 7%, which is within the Neutral band of 4%-14% for non-volatile Saudi stocks; therefore, we rate the stock Neutral. The stock is currently trading at 1.6x 2014e book value, for an ROE of 6.9%. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated. We do not include dividend yields in our potential returns for the Saudi banks, since we use a residual income methodology to value our stocks.


 Downside risks centre on negative surprises in asset quality and a stronger deceleration in loan growth than we forecast. Key upside risks include:

 Upside risks centre on a stronger-thanexpected increase in interest rates, either long term or short term, as well as better asset quality than we forecast.

39

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Financials & valuation: Alinma

Neutral



12/2014e

12/2015e

12/2016e

1,835 273 31 141 2,279 -990 -274 -10 1,005 0 1,005 0 0 1,005 1,005

2,132 316 39 120 2,606 -1,098 -303 0 1,205 0 1,205 0 0 1,205 1,205

2,421 371 44 138 2,974 -1,208 -393 0 1,372 0 1,372 0 0 1,372 1,372

2,755 435 49 152 3,390 -1,317 -490 0 1,584 0 1,584 0 0 1,584 1,584

16,832 16,832 44,924 5,399 42,763 55,594 63,001

18,037 18,037 53,734 5,939 53,453 66,134 75,077

19,409 19,409 62,123 6,533 69,489 76,071 92,676

20,993 20,993 71,193 7,187 83,387 87,467 108,358


60,495 0.0 27.8 28.4

75,621 0.0 23.9 24.3

96,785 0.0 20.1 20.4

110,521 0.0 19.0 19.3

12/2013a

12/2014e

12/2015e

12/2016e


24.8 7.0 43.1 37.0 37.0

14.4 11.0 16.9 19.9 19.9

14.1 10.0 17.1 13.9 13.9

14.0 9.0 17.4 15.4 15.4

1.0

7.2

7.6

8.2

43.4 0.7 105.1 0.7 0.5 0.9 0.0 170.0 6.0

42.1 0.6 100.5 1.1 0.8 1.0 0.0 131.3 6.9

40.6 0.7 89.4 1.4 0.9 1.2 0.0 128.7 7.3

38.8 0.7 85.4 1.7 1.1 1.4 0.0 131.1 7.8

0.68 0.68 0.00 11.33 11.33

0.81 0.81 0.00 12.15 12.15

0.92 0.92 0.00 13.07 13.07

1.07 1.07 0.00 14.14 14.14


40

12/2014e

12/2015e

12/2016e

3.3 0.1 0.3 -1.8 2.3 -0.5 1.8 3.3 6.0

3.1 0.1 0.2 -1.6 2.2 -0.4 1.8 3.9 6.7

2.8 0.1 0.2 -1.4 2.0 -0.5 1.6 4.6 7.1

2.7 0.0 0.1 -1.3 2.0 -0.5 1.5 5.1 7.5



12/2013a

12/2014e

12/2015e

12/2016e

29.3 22.9 1.8 1.2 0.0

24.5 19.6 1.6 0.5 0.0

21.5 16.7 1.5 -0.4 0.0

18.6 14.2 1.4 2.1 0.0



(SAR)19.85


Target price



2 (%) 7 . 0

(SAR)21.30

ALINMA AB 29,775


22

22

20

20

18

18

16

16

14

14

12

12

10

10

8 2012

2013 Alinma Bank


12/2013a

Price relative


Year to



8 2015

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Bank AlBilad ALBI AB, Not Rated Company description

2011 to 2% now. Also, coverage ratio has increased to 194% from c130% levels in 2011.

Bank Albilad is a Saudi Joint Stock Company incorporated in 2004; commencing its operations in 2005. The bank is engaged in providing full range of banking services, financing and investing activities through various Islamic instruments. The activities of the Bank are conducted in accordance with Islamic Shariah and within the provisions of the Articles and Memorandum of Association, bylaws and the Banking Control Law.

The bank largely funds itself through customer deposits and equity, which make up 80% and 14% of total capital, respectively. As at 1Q14, 92% of customer deposits were low-cost current account deposits.

The bank has 2 fully owned subsidiaries, 1) AlBilad Investment Company- it is involved in dealing, managing, arranging, advising and custody of securities. 2) AlBilad Real Estate Company – the subsidiary is involved in registering the real estate collateral that the bank obtains from its customers. As at the end of March 2014, the bank had a network of 102 branches and 151 exchange and remittance centers.

Financials

Recent news  The bank reported net income of SAR204mn for the first quarter of 2014, which is an increase of 18% q-o-q and 16% y-o-y. The net interest income increased by 14% q-o-q and y-o-y. The sequential increase in NII was driven by both increase in net interest margins and loan growth. The NII/avg assets increased by 8 bps q-o-q to 2.59% in Q2'14. The noninterest income was up 10% q-o-q and 8% yo-y. The loan book grew sharply, up 10% qo-q and 32% y-o-y. Whereas, the deposits increased by 5% q-o-q and 24% y-o-y which resulted in LDR moving to 80% in Q2'14 compared to 77% in Q1'14 and 76% in Q2'13.

Bank Albilad had a 2% market share in total loans & assets in Saudi Arabia as at March 2014. The bank had an above industry average capital adequacy ratio of 19% as at Q1 2014. The tier1 capital ratio is at 14% at the end of Q1 2014. As at 30 June 2014, total assets stood at SAR41bn, customer deposits at SAR33bn, and loans and advances at SAR26.8bn. NPL ratio at the end of Q1 2014 was 2%; the bank has managed to bring down NPL ratio from c5% in

41

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Financials & valuation: Bank Al-Bilad

Not Rated



12/2011a

12/2012a

12/2013a

P&L summary (SARm) Net interest income Net fees/commissions Trading profits Other income Total income Operating expense Bad debt charge Other PBT Taxation Minorities + preferences Attributable profit

625 342 0 133 1,099 -717 -290 0 92 0 0 92

703 458 0 212 1,374 -792 -252 0 330 0 0 330

840 645 0 253 1,737 -894 -275 373 942 0 0 942

947 666 0 305 1,917 -1,018 -170 0 729 0 0 729

3,103 12,290 382 16,932 20,430 21,117

3,416 13,780 422 23,038 27,020 27,727

4,371 18,256 571 23,742 29,301 29,778

5,101 23,415 976 29,108 35,425 36,323

18,160 16.6 17.4

19,982 15.4 18.3

25,086 13.7 18.5

25,086 13.7 18.5

Year to

12/2010a

12/2011a

12/2012a

12/2013a

3.4 0.0 0.7 3.9 6.8 0.5

3.5 0.0 1.1 4.0 7.9 1.6

3.3 0.0 1.0 3.6 7.9 3.8

3.8 0.0 1.2 4.1 8.9 2.9

Net interest income Trading profits Other income Operating expense Pre-provision profit Attributable profit


12/2010a

12/2011a

12/2012a

12/2013a

156.9 4.7

43.9 4.2

15.4 3.3

19.9 2.8

PE P/NAV

Balance sheet summary (SARm) Ordinary equity Customer loans Debt securities holdings Customer deposits Interest earning assets Total assets Capital (%) RWA (SARm) Total tier 1 Total capital


12/2010a

12/2011a

12/2012a

12/2013a

Year-on-year % change Total income Operating expense Pre-provision profit EPS DPS NAV

20.9 -9.7 232.5 -137.2 0.0 3.4

25.0 10.4 52.4 257.0 0.0 10.1

26.5 12.9 45.0 185.7 0.0 27.9

10.4 13.9 6.5 -22.6 0.0 16.7

65.3 2.0 76.3 5.5 -3.9 89.4 3.0

57.6 1.8 63.7 4.7 -3.4 129.0 10.1

51.4 1.6 81.5 3.9 -3.0 145.4 24.2

53.1 0.8 83.5 1.9 -1.8 194.3 15.4

0.31 0.00 10.34

1.10 0.00 11.39

3.14 0.00 14.57

2.43 0.00 17.00

Per share data EPS reported (fully diluted) DPS NAV (including goodwill)

42

Share price

(SAR)

Reuters (Equity) Market cap (USDm) Free float (%) Country

4 (%) . 8

48.30 1140.SE 4,712 51 Saudi Arabia

Bloomberg (Equity) Market cap (SARm) Sector

ALBI AB 19,322 Commercial Banks

Price relative 40

40

35

35

30

30

25

25

20

20

15

15

10 2012

10 2013 Bank Albilad


Ratios (%) Cost/income ratio Bad debt charge Customer loans/deposits NPL/loan NPL/RWA Coverage ROE (including goodwill)

Issuer information

2014 Relative to Tadawul

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Bank AlJazira BJAZ AB, Not Rated Company description Bank Al-Jazira (BAJ) is a Joint Stock Company incorporated in 1976 with the takeover of The National Bank of Pakistan's (NBP) branches in the Kingdom of Saudi Arabia. BAJ is one of the leading Shari'ah- compliant, client-driven, service-oriented and fast-growing financial institutions in Saudi Arabia, providing individuals, businesses and institutions with innovative Shari'ah-compliant financial services. BAJ was the first banking institution in Saudi Arabia to introduce Takaful Ta'awuni (TT) in 2002 as a full-fledged Shari'ah-compliant alternative solution for traditional life insurance. Since then, TT has proved itself as a market leader. The bank has 2 subsidiaries: 1)AlJazira Capital Company and 2) Aman Development and Real Estate Investment Company; these are engaged in brokerage, asset management, holding & managing collateral on behalf of the Bank. The bank also has 35% stake in AlJazira Takaful Ta’awuni Company which provides insurance activities in the sector of protection and saving. As per latest available data, BAJ had a relatively small branch network of 62 branches.

Financials Bank Al-Jazira had 3% market share in total loans & assets in Saudi Arabia as at March 2014. The bank is slowly increasing market share in loans & assets since last few years (market share was 2% in total loans & assets 2 years back). The bank’s capital adequacy ratio was 14.1% at end of Q1 2014 with a Tier 1 ratio of 11.5%. The NPL ratio at the end of Q1 2014 was 1.2% down from 3.3% in Q4 2012. The bank has improved its coverage ratio to 158% from 134% in last 1 year. As at 30 June 2014, total assets stood at SAR60.6bn, customer deposits at SAR48.5bn, and loans and advances at SAR36.7bn.

Recent news  Bank Al Jazira reported net profit came in at SAR 167m for Q2’14 which is up 5% qoq but flat y-o-y. The net interest income increased by 11% q-o-q and 18% y-o-y. The sequential increase in NII was driven by loan growth and increase in net interest margins. The loan growth was 6% q-o-q and 17% y-o-y (above sector average). The non-interest income was also up at 9% q-o-q and 45% y-o-y. The deposits increased by 7% q-o-q and 15% y-oy which resulted in LDR going down to 75% in Q2'14 compared to 76% in Q1'14.

.

43

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Financials & valuation: Bank AlJazira

Not Rated Core profitability (% RWAs) and leverage


12/2010a

12/2011a

12/2012a

12/2013a


717 265 28 145 1,155 -764 -362 0 29 0 0 29

781 356 11 59 1,208 -835 -70 0 303 0 0 303

951 564 36 50 1,601 -928 -172 0 501 0 0 500

1,223 468 38 148 1,839 -1,051 -136 0 651 0 0 651

4,806 18,704 27,345 31,438 33,018

4,937 23,307 1,000 31,159 37,414 38,898

5,186 29,897 1,000 40,675 49,243 50,957

5,729 34,995 1,000 48,083 53,542 59,976

29,894 15.1 15.7

34,708 13.6 17.4

41,349 12.1 15.7

46,863 12.2 15.0

Year to

12/2010a

12/2011a

12/2012a

12/2013a

2.4 0.1 0.5 -2.6 1.3 0.1

2.3 0.0 0.2 -2.4 1.1 0.9

2.3 0.1 0.1 -2.2 1.6 1.2

2.2 0.1 0.1 -2.0 1.6 1.3



12/2010a

12/2011a

12/2012a

12/2013a

342.4 2.1

32.7 2.0

19.8 2.0

15.2 1.7

PE P/NAV



12/2010a

12/2011a

12/2012a

12/2013a


-1.4 5.3 -12.2 5.0 2.4

4.6 9.2 -4.5 947.5 2.7

32.5 11.1 80.3 65.3 5.0

15.1 13.7 17.1 30.0 14.3


44

Share price

(SAR)


66.2 2.1 68.4 6.7 4.5 84.5 0.6

69.1 0.3 74.8 4.2 3.0 117.4 6.2

58.0 0.6 73.5 3.3 2.5 132.4 9.9

57.1 0.4 72.8 1.2 1.8 154.0 12.1

0.10 16.02

1.01 0.53 16.46

1.67 17.29

2.17 19.1

4 (%) . 8

33.00 1020.SE 3,437 74 Saudi Arabia


BJAZ AB 13,200 Commercial Banks

Price relative 45

45

40

40

35

35

30

30

25

25

20

20

15

15

10 2012

10 2013 Bank Aljazira


Per share data (SAR) EPS reported (fully diluted) DPS NAV (including goodwill)

Issuer information

2014 Relative to Tadawul

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Saudi Hollandi Bank AAAL AB, Not Rated Company description Originally known as “The Netherlands Trading Society”, Saudi Hollandi Bank (SHB) was the first operating bank in Saudi Arabia. The bank was established in 1977 as a Joint Venture Company. ABN AMRO Bank N. V. is the largest stakeholder in the bank with a 40% stake. Saudi Hollandi Bank is engaged in conventional as well as Islamic banking solutions. The bank is primarily a corporate bank with corporate loans representing c85% of total loans at end of Q1 2014. The bank has 3 subsidiaries, 1) Saudi Hollandi Capital (SHC) – it engages as principle and agent in retail equity brokerage, asset management, corporate finance and investment advisory activity, debt arrangement and securities custody services. 2) Saudi Hollandi Real Estate Company (SHREC) –involved in the registration of real estate title deeds in support of the Bank’s Home Financing products. 3) Saudi Hollandi Insurance Agency Company (SHIAC), a wholly owned subsidiary of SHB, the subsidiary commenced its operations in 2012 and is licensed in insurance activities. The bank acquired a 20% stake in in Wataniya Insurance Company in 2008; this acquisition enables the Bank to have an insurance capability to complement the existing retail banking offering.

Financials Saudi Hollandi Bank had a 5% market share in total loans & 4% in total assets in Saudi Arabia as at March 2014. The bank had a above industry capital adequacy ratio of 18% as at Q1 2014 (up from 16% in Q3 2012). As at 30 June 2014, total assets stood at SAR89.5bn, customer deposits at SAR71bn and loans and advances at SAR60bn. NPL ratio at the end of Q1 2014 was 1.3%, with a provision coverage of 160%. The bank has maintained stable NPL ratio of 1.4% since start of the year with a coverage ratio of c160%.

Recent news  In December 2013, the bank privately placed SAR2.5bn ($667mn) tier 2 sukuk. The sukuk has a tenor of 10 years carries a half yearly profit of 6 months SIBOR + 1.55%.  SHB reported net income of SAR 480mn for the second quarter 2014, increasing 28% yoy and 15% on a sequential basis. Customer loans and deposits increased by 18% and 16%, respectively, to reach SAR60.4bn and SAR71bn.

As per latest available data, the bank had a network of 48 branches (December 2013).

45

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Financials & valuation: Saudi Hollandi Bank Financial statements Year to

Not Rated Core profitability (% RWAs) and leverage

12/2010a

12/2011a

12/2012a

12/2013a


1,287 455 31 181 1,954 -772 -389 -3 790 0 0 790

1,290 519 6 191 2,005 -802 -161 -8 1,034 0 -2 1,032

1,372 628 5 215 2,219 -845 -140 19 1,253 0 0 1,253

1,624 732 -1 261 2,616 -895 -218 0 1,502 0 -1 1,502

6,387 35,039 1,500 41,604 50,643 52,864

7,408 37,745 1,500 45,024 54,551 56,940

8,306 45,276 2,900 53,914 59,490 68,506

9,401 53,652 4,625 61,875 74,360 80,468

50,176 12.7 16.3

53,073 13.2 16.6

63,196 12.4 17.6

75,790 11.8 18.3

Year to

12/2010a

12/2011a

12/2012a

12/2013a

3.1 0.0 0.4 1.6 4.7 0.2

2.6 0.1 0.4 1.5 4.3 1.6

2.4 0.0 0.4 1.5 4.1 1.9

2.2 0.0 0.3 1.3 3.9 2.0



12/2010a

12/2011a

12/2012a

12/2013a

20.5 2.5

15.7 2.2

15.5 2.3

12.9 2.1

PE P/NAV



12/2010a

12/2011a

12/2012a

12/2013a

-9.0 -4.9 -11.4 819.8 13.4

2.6 3.9 1.8 30.6 16.0

10.7 5.4 14.2 1.2 -1.8 -6.6

17.9 5.9 25.3 19.8 0.0 13.2


39.5 1.0 84.2 2.6 1.9 124.4 13.2

40.0 0.4 83.8 1.9 1.4 145.4 15.0

38.1 0.3 84.0 1.6 1.1 152.8 15.9

34.2 0.4 86.7 1.3 1.0 161.5 17.0

2.39 0.00 19.31

3.12 1.14 22.40

3.16 1.12 20.93

3.78 1.12 23.69


46

Share price

(SAR)


4 (%) . 8

48.90 1040.SE 4,530 50 Saudi Arabia


AAAL AB 23,290 Commercial Banks

Price relative 45

45

40

40

35

35

30

30

25

25

20 2012

20 2013

2014 SHB



Issuer information

Relative to Tadawul

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Saudi Investment Bank SIBC AB, Not rated Company description The Saudi Investment Bank was established in 1976. The bank provides traditional wholesale, retail and commercial banking products. On the retail side they offer Shari-ah compliant products and services including accounts, murabaha investments and personal finance solutions. The bank has established joint-ventures and subsidiaries to cater to investment banking and share trading, asset management, leasing, mortgages, insurance and credit cards. The bank’s subsidiaries and associates include Alistithmar Capital (100%), SAIB BNP Paribas Asset Management Company Limited (55%), Saudi Investment Real Estate Company (100%), Amex Saudi Arabia Limited (50%), Saudi Orix Leasing Company (38%), Mediterranean Gulf Insurance and Reinsurance Co. – KSA (19%), and Amlak International for Finance and Real Estate Development Co. (32%). As at end of December 2013, SIB had a relatively small network of 48 branches.

Financials Saudi Investment Bank has 4.5% market share in loans and assets in Saudi Arabia as at March 2014. The bank has an above industry average capital adequacy ratio – 15.6% as at Q1 2014 (although this is down from 18% in Q3 2012). The tier1 capital ratio is above average at 14.8% in Q1 2014.

As at 30 June 2014, total assets stood at SAR88bn, customer deposits at SAR67.7bn, and loans and advances at SAR54.8bn. NPL ratio at the end of Q1 2014 was 0.76%, with provision coverage of 205%. Since the start of 2012, SIB has brought its NPL ratio from 6% to less than 1 % and has increased provision coverage from c130% to above 200% currently. The bank largely funds itself through customer deposits and equity, which make up 75% and 13% of total capital, respectively. As at 31 March 2014, 23% of customer deposits were low-cost demand deposits.

Recent news  Saudi Investment Bank reported net profit came in at SAR 353m which is up 5% qoq and 10% y-o-y. The net interest income increased by 5% q-o-q and 8% y-o-y. The sequential increase in NII was primarily driven by growth in loan book which was up 5% q-o-q and 36% y-o-y. However, the pressure on NIM continued and we estimate NIM to have declined by 5 bps q-o-q and 45 bps y-o-y to 1.92% in Q2'14. The deposits also grew by 9% q-o-q and 39% y-o-y which resulted in LDR moving down to 81% in Q2'14 compared to 84% in Q1'14 and 83% in Q2'13.  In December 2013, Saudi Investment Bank’s board of directors recommended to increase the Bank capital by 9.1% from SAR5.5bn to SAR6bn by distributing 1 bonus share for every 11 shares held.

47

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Financials & valuation: Saudi Investment Bank Financial statements Year to

Not Rated


12/2011a

12/2012a

12/2013a


1,315 242 123 69 1,749 -559 -738 -12 440 0 -11 429

1,226 311 12 66 1,616 -624 -288 8 712 0 -4 708

1,242 315 21 144 1,722 -632 -255 78 912 0 0 912

1,365 394 158 99 2,017 -762 -105 137 1,287 0 0 1,287

8,103 31,002 500 37,215 48,547 51,491

8,557 27,114 1,500 36,770 48,897 51,946

9,379 34,051 2,000 40,414 56,130 59,067

10,253 47,567 2,000 57,044 77,144 80,495

44,888 17.2 17.3

42,506 19.0 19.1

51,027 17.4 17.6

70,716 14.5 15.1

Year to

12/2010a

12/2011a

12/2012a

12/2013a

2.9 0.3 0.2 1.2 4.1 1.0

2.9 0.0 0.2 1.5 4.0 1.7

2.4 0.0 0.3 1.2 3.7 1.8

1.9 0.2 0.1 1.1 3.0 1.8

12/2010a

12/2011a

12/2012a

12/2013a

34.3 1.9

21.2 1.8

16.5 1.6

11.7 1.5


Valuation data Year to PE P/NAV



12/2010a

12/2011a

12/2012a

12/2013a

15.3 3.7 21.7 -33.2 0.0 -10.3

-7.6 11.6 -16.7 61.8 0.0 5.6

6.5 1.3 9.9 28.1 40.0 9.6

17.1 20.5 15.2 41.1 0.0 9.3


32.0 2.3 83.3 5.4 4.0 110.4 5.5

38.6 0.9 73.7 6.1 4.2 124.6 8.5

36.7 0.8 84.3 1.3 0.9 181.3 10.2

37.8 0.3 83.4 0.8 0.6 178.2 13.1

0.80 0.00 14.73

1.29 0.50 15.56

1.66 0.70 17.05

2.34 0.70 18.64


48

Share price

(SAR)


4 (%) . 8

27.40 1030.SE 4,268 37 Saudi Arabia


SIBC AB 16,440 Commercial Banks

Price relative 35

35

30

30

25

25

20

20

15

15

10 2012

10 2013

2014 SIB



Issuer information

Relative to Tadawul


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Chemicals & fertilisers

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Chemicals & fertilisers  Saudi Arabia is now a major player in the world of basic chemicals  Efforts to add value to hydrocarbon resources and create jobs will

fuel growth  Future growth is towards downstream chemicals, integrated

projects, M&A and a drive towards overseas growth

Evolution of the Middle East chemical industry Early days Petrochemicals production in the Middle East is a relatively recent phenomenon, dating back a couple of decades. Apart from some small capacity in Iran, the development of significant integrated ethylene and derivatives production began with the commissioning of SABIC’s capacities at Yanbu and Al Jubail in Saudi Arabia in 1985, which were 50/50 joint ventures that with Exxon and Shell, respectively.

Middle East ethylene capacity as % of world capacity 20% 18% 16% 14%

12% 10% 8% 6%

Middle East ethylene production by country (2013)

Others 1% UAE 8%

Kuw ait 6%

Qatar 10% Iran 16%

4% 2% 0% 1990

1995

Source: IHS Chemical, HSBC

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From inception, the Saudi petrochemicals industry was developed specifically to add value to cheap associated gas created by the nation’s upstream oil production, which was initially priced to petrochemical companies at 50 cents per mmbtu. Although this was cheaper than commercial gas prices elsewhere in the world, it was not subsidised. Since the alternative use for this associated gas was flaring, the delivery to the petrochemicals industry generated revenues that would otherwise have been absent. Other countries, notably Iran, Qatar, Kuwait and the UAE, also brought on-stream their first ethylene crackers in the mid-1990s driven by the urge to diversify away from petrochemical exports.

2000

2005

2010 Source: IHS Chemical, HSBC

Saudi Arabia 59%

Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East + 971 4 4236924 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

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However, this scenario changed once US natural gas prices rose in 2000 as a wave of gas-based power plants came on-stream, providing an alternate use for the gas and pushing up prices from their historical levels of USD1 to 2 per mmbtu to over USD6 per mmbtu. As the US chemical industry struggled with rising underlying prices, the Middle Eastern chemical industry was able to develop given its cost advantage.

However, the capacity expansion boom as witnessed over the last decade was absent, and Middle East chemical capacity remained at a fairly low level of 3-4m tonnes through most of the 1990s. Saudi Arabia has the largest petrochemical capacity in the region, accounting for c59% of Ethylene production in Middle East in 2013.

A rise in US gas prices The influence that the Middle East has come to have on the global commodity chemical industry would not have been the same without the dramatic change in the energy price environment that began with the rise in US natural gas prices in 2000 (see chart at the bottom of the page). Although the Middle East states had access to cheap stranded gas reserves in the 1990s (as they took their first steps in developing their chemical industry), rapid industry growth had been constrained by the fact that until 2000 the US also had cheap gas reserves. The pre-2000 cheap US gas, coupled with access to scale economies, technology, and proximity to the largest chemical demand centre in the world, made the US Gulf Coast one of the most competitive chemical manufacturing locations in the world and led to limited capacity growth in the Middle East.

This is shown in the chart below depicting both crude and natural gas prices from the early 1990’s. The bold blue line represents average prices through the 1990’s. It is clear that there was a secular change in the energy price environment post 2000.

Shutdowns and a pledge to never build again Following the rise in gas prices in the US, several chemical industries that were large consumers of natural gas – namely, the ammonia and methanol producers – became uncompetitive and shut down their US operations, leading to a wide-scale shift in production capacity to regions with more competitive natural gas prices.

Change in feedstock pricing regime 160

16

140

14

120

12

100

10

80

8

60

6

40

4

20

2

0 Jan-90

0 Jan-92

Jan-94

Jan-96

Brent ($/bbl)

Jan-98

Jan-00

Jan-02

Natural gas ($/mmbtu), RHS

Jan-04

Jan-06

Jan-08

Jan-10

Jan-12

Jan-14

Natural gas (Avergae in 1990's ), RHS

Source: Thomson Reuters Datastream, HSBC

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Growth of Middle East basic chemical capacity _____________ Middle East share of capacity_______________ 2000e 2011e Ethylene LLDPE LDPE HDPE Propylene Polypropylene Ammonia Urea Methanol

7% 10% 6% 7% 2% 3% 5% 8% 16%

Share of capacity growth (2000-11e)

18% 19% 12% 19% 7% 12% 9% 11% 20%

41% 29% 45% 42% 16% 24% 23% 23% 20%

Source: CMAI, HSBC

This in turn led to a wave of capacity expansion for these products in the Middle East. The petrochemical industry in the US did not experience the same level of shutdowns, as increasing demand from emerging economies and elevated crude oil prices allowed for higher costs to be passed onto consumers. However, while large-scale petrochemical capacity shutdowns in the US were averted, it became apparent that the region did not have a feedstock position that allowed for new capacity to be built. A similar pattern was seen across Europe, with existing producers passing on higher costs to consumers in a strong demand environment, but recognizing that they would not be competitive as far as adding new capacity was concerned. Reinvestment economics for chemical projects in the new volatile raw material price environment dictates that in order to be competitive, one must either have a rapidly growing end market to offtake products or a guaranteed integrated supply of low-cost feedstock – neither of which was available to producers in the US or Europe. This effectively limited chemical expansion to the Middle East, which had a low-cost position in a world of relatively high energy prices, and to China, which had a large captive market.

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Against this backdrop, the Middle East emerged as the most important region for global chemical investment, with exceptionally competitive feedstock positions and opportunities to export to growth markets in Asia. The region accounted for well over 40% of basic chemical capacity additions globally during 2000-11 (see table at the top of the page), with strong export positions in each of the product areas highlighted above.

Advent of shale gas in US US gas prices have over the last few years fallen vis-à-vis oil prices as supply has increased with the advent of shale gas. This has resulted in a move by operators to crack ethane where possible resulting in a move away from naphtha and a significant increase in the share of ethane within US ethylene production (see chart at the top of the next page). Furthermore, newly rediscovered cost competitiveness and rising cash flows inevitably bring about a desire to reinvest. Apart from making existing US production competitive, shale gas has also made the US attractive for Greenfield cracker capacity investments for the first time since the late 1990’s. The Saudi petrochemical sector is not impacted by either the increased profitability in the US petrochemical sector as well as the new Greenfield capacity that is under consideration, in our view.

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Ethane based share of US ethylene production 75%

Ethane prices US vs. Saudi (USD/ton) 700

600

60%

500

45%

400

30%

300 200

15%

100

0%

0

Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 07 07 08 08 09 09 10 10 11 11 12 12 13 13 Source: IHS Chemical, HSBC

Q1'11

On the supply side, we believe the question of market share competition between low cost ethane based producers is misdirected. Low cost producers run to optimize production capacity and as long as they are offered a pricing umbrella by higher cost naphtha based producers, both sets of

US vs. Middle East: EBITDA margin comparison 60%

Q1'13

Q3'13

Q1'14

Saudi Ethane

ethane based producers will be able to sell all of their output. Low cost producers take market share from high cost naphtha producers in an environment where demand is weak, rather than from each other. The point to be made here is that, as long as cheap US gas means that the US industry moves down the cost curve, but does not move the curve itself lower, the competitive position of other gas based ethylene producers is unaffected. If cheap US gas were to result in a downward shift in the entire cost curve, then that would, of course, impact the competitiveness and profitability of gas based producers in the Middle East and in South East Asia, and also the US.

Naphtha based ethylene capacity

(mn tons)

40% 30% 20% 10% Q1'12

Q3'12

Q1'13

Westake Olefins LyondellBasell - O&P Americas Yansab Source: Company reports

Q3'12

US Ethane

50%

Q3'11

Q1'12


The US ethane prices which are at their more than a decade low levels of USD0.2-0.4/gal translate into a price of cUSD150-300/ton – vs. the USD37/ton (USD0.75/mmbtu) paid by Saudi producers. This differential, coupled with the discount that Saudi producers enjoy on liquid feeds (28% on propane and butane), means that even a mixed feed producer in Saudi Arabia (such as Yansab) is substantially more advantaged than a mixed feed US producer (see chart at the bottom of the page).

Q1'11

Q3'11

Q3'13

60%

180 160 140 120 100 80 60 40 20 0

50% 40% 30% 20% 10% 0% 1990 1995 2000 Naphtha based Naphtha as a % of total

2005

2010 2015e Total

Source: IHS Chemical, HSBC

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For the entire cost curve to move lower though, one of two things would need to occur a) a significant fall in crude prices or b) the US to add enough new capacity to push some of the naphtha based capacity out of the market and move the marginal cost of production lower. The second item would be a direct consequence of lower US gas prices, so let us look at that in more detail. The chart at the top of the previous page shows the amount of naphtha based ethylene capacity as a proportion of total global ethylene capacity. As the chart suggests, this proportion has been fairly stable at c50% and is likely to remain so over the next few years. One of the reasons for this is feedstock availability – the decision to build an ethylene cracker and its choice of feedstock is based not just on price but on security of feedstock supply. Given the relatively few sources of stranded gas, the bulk of the global chemical industry has been based around naphtha, in most cases integrated into refining. With regard to costs, the broad uniformity in crude prices means that the naphtha based cost curve is broadly homogenous, with some differentials based on scale and integration. Hence, for new US capacity to push the entire cost curve lower – i.e. move the marginal cost of production away from naphtha to gas – we calculate the US would need to add capacity equivalent to c50% of the current global installed base. Even under the most optimistic scenarios, such an influx of new US capacity appears highly unlikely. Therefore, in our opinion, the US shale gas revolution is unlikely to significantly alter the competitive position of other gas based low cost producers. For more details please see our March 2013 note “Global Commodity Chemicals: Beware of the supply side”.

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The road ahead for Middle Eastern chemicals Limited domestic opportunities driving companies overseas A recurring theme across our CEEMEA chemicals coverage is the lack of domestic growth opportunities for capacity expansion – largely driven by feedstock limitations. These limitations span the gamut of companies that we cover in CEEMEA, from SABIC in Saudi Arabia, to IQCD in Qatar, to Petkim in Turkey, Sidi Kerir in Egypt and also Sasol in South Africa. At the same time, the existing domestic asset bases of these companies are exceptionally profitable and cash generative, given their cost- competitiveness. On our estimates, the listed CEEMEA chemical space is expected to generate over USD40bn in free cash flows over the next three years. All that cash flow, with limited room for domestic reinvestment, implies that the chemical companies in CEEMEA that are looking for growth opportunities increasingly need to look at their options overseas – either through greenfield investments or through M&A. The big push into the US

The shale gas phenomenon in the US has meant that CEEMEA-based companies starved of domestic gas-based growth are increasingly looking to the US as a potential base for capacity expansions. Sasol is at the forefront of this push, planning investment of cUSD20bn in the US, with two large projects (Ethane cracker and GTL plant) aimed at capitalising on cheap US natural gas. SABIC is similarly looking to expand its manufacturing footprint in the US and is considering projects within all of its major gas- based business lines – methanol, fertilisers and the ethylene chain. Unlike Sasol though, SABIC is not looking to venture into the US on its own. The company

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believes that going it alone in the US would result in execution risks and elongated timelines and also higher costs resulting from investments in greenfield infrastructure. The company would prefer to partner with a producer that has an existing footprint, and preferably with some integration into raw material, which would help offset the risks of raw material price volatility. In January at the World Economic Forum in Davos, SABIC’s CEO Mohammed Al Mady stated that the company was in discussions with several majors in the US and expected to make an announcement around its entry into the market sometime over the course of this year. Other companies that are potentially looking at opportunities in the US include Advanced Petrochemical Company (APC) (which signed an MOU with Vinmar in February 2013 to explore US projects). However, given the ticket sizes involved in greenfield US projects (upwards of USD3bn), the number of CEEMEA companies that can directly participate in the US is limited to those with access to the most resources – such as SABIC, Sasol and IQCD, in our view.

M&A, consolidation The Middle Eastern chemical names are the most likely to participate in M&A and consolidation moves to boost growth, in our view, as growth options are limited on account of lack of additional feedstock availability.

Inevitably, a lot of attention is focused around deals that SABIC could potentially make – given its acquisitive history and growing cash pile. The company has, in the past, stated that it is on the look-out for opportunities to accelerate growth within product chains such as acetyls, polyurethanes and acrylics. Given the careful consideration with which the portfolio gap mapping and technology licensing programme has been proceeding over the last three years, we see any deals done by SABIC as likely to be small (under USD10bn), technology-driven and focused on product gaps. That said, despite all the attention focused on SABIC, one should not discount potential moves made by the unlisted Middle Eastern companies or even the smaller listed Middle Eastern names. In the unlisted space, we have in the past seen clear willingness to do deals. Examples include IPIC’s acquisition of Canadian chemical company, Nova, at the peak of the financial crisis in 2008/09, and the failed USD18bn deal between Kuwait Petroleum’s PIC unit and Dow Chemical for Dow’s commodity chemical assets in 2008. And Oman Oil just last year concluded a deal to buy Oxea from Advent International. With some of the global chemical majors – Dow and DuPont, for example – under increasing pressure from activist investors to optimise their portfolios, there could be further asset spinoffs from the global majors, with potential interest from the unlisted MENA names.

Recent downstream Middle East chemical projects Project

Sponsors

Cost

Location

Commercialisation timeline

PetroRabigh II – Nylon, MMA, PMMA Acetyls Kayan – Polycarbonates Acrylics, SAP Sadara – PU, EO, PO, specialty PE Kemya - Al Jubail Elastomers

Aramco and Sumitomo Sipchem SABIC Dow, Tasnee, Evonik, Sahara Aramco and Dow Chemical SABIC and ExxonMobil

USD 7bn USD 1.2bn USD 12bn USD 2.0bn USD 20bn USD 3.4bn

Rabigh, Saudi Arabia Jubail, Saudi Arabia Jubail, Saudi Arabia Jubail, Saudi Arabia Jubail, Saudi Arabia Jubail, Saudi Arabia

2016 2011 2011/12 2014 2015/16 2015

Source: ICIS news, HSBC

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Aramco’s chemical ambitions are also worth highlighting in light of this discussion. The company has a stated ‘accelerated transformation plan’ that aims to turn it into a global integrated energy and chemical business by 2020. While Aramco is investing in organic growth projects – USD20bn in Sadara, USD14bn in the Yanbu refinery and USD7bn in PetroRabigh Phase II – with over USD1bn of daily revenues, there is still considerable firepower available in our view should it choose to pursue M&A as a route to achieve its ‘accelerated transformation plan’. The smaller (relative to SABIC) Middle Eastern listed companies also have the potential to be active in M&A. Tasnee, for one, has done deals in the past – Millennium Inorganics and Bemax – and it is notable that it is small and midcap assets that are most ripe for industry consolidation, as growth options are limited on account of lack of additional feedstock availability. The proposed Sipchem-Sahara merger, which has been now cancelled, is unlikely to be the last of such deals in the medium term, in our view.

The downstream imperative for organic growth As we highlighted in our September 2010 thematic “Beyond Cost: A roadmap for Middle Eastern chemicals”, the focus of the policymakers in the Kingdom of Saudi Arabia is almost wholly on job creation and the role that the petrochemical industry can play within that framework – by moving downstream towards higher value-added products, which can aid cluster development, manufacturing and stimulate domestic employment. Every single incremental feedstock allocation in Saudi Arabia has riders around job creation and product portfolio, with no more feedstock available for projects that are simply based on exporting commodity-grade chemicals. There does appear to be incremental cheap feedstock available – as demonstrated by the extra ethane allocation for

56

SABIC’s Yanpet cracker. But that was clearly linked to the progress of the company’s rubber joint venture with Exxon. We see more of these investments as likely to occur over the next several years – with organic growth in the Kingdom being driven primarily by the downstream imperative. We also see potential for the M&A strategies of companies being driven by this requirement to move downstream, with the potential to acquire assets that provide a unique technology or product footprint that could then result in favourable feedstock allocations that would drive new organic growth within the Kingdom.

Move towards heavier fuels Over the next five years or so we also expect a significant increase in the cracking of heavier feedstocks. The supply of ethane is fixed given that the bulk of it is associated gas and linked to OPEC production quotas. This has meant that newer crackers have had to incorporate higher proportions of heavier feeds such as propane and butane rather than being pure ethane crackers. Furthermore, as the Saudi industry moves towards producing downstream chemicals and complicated product chains, these require heavier fuels as inputs. We expect the split between light and heavier fuels to average 50:50 going forward, a move away from the historical predominance of lighter fuels. We expect to see more of light naphtha, condensates, raffinates and other refinery streams being cracked across the region along with LPG. For more details please see our January 2011 note “What price is right: Re-evaluating the feedstock environment”.

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Advanced Petrochemical APPC AB, SAR49, N(V), TP SAR45 Company description APC (formerly Advanced Polypropylene Company) was incorporated in Saudi Arabia in 2005 to develop an integrated polypropylene complex in Al Jubail. The company went public in January 2007, and the project started commercial operations in August 2008 and the plant was formally commissioned in November 2008. APC is essentially a single-plant, single-product company. It was initially set up with a polypropylene capacity of 450ktpa, which was further increased to 500ktpa in Q3’10 via a debottlenecking project. The company uses propane feedstock, supplied by Saudi Aramco, to produce propylene, which is then converted into polypropylene and sold under long-term volume offtake agreements. It is the only company in our MENA chems coverage with feedstock pricing completely linked to crude oil prices, and as a result its earnings have a high degree of correlation on the PP-Naphtha spread.

Investment thesis APC has announced three projects over the course of the last 2 years : 1) an MoU with Bayegan to set up a USD1bn PP plant in Turkey, which was announced in May 2012 but subsequently cancelled in January 2013; 2) an agreement with Saudi Aramco Total Refining and Petrochemical Company (SATROP) for the supply of 50ktpa propylene, which was later increased to 80ktpa, with a Q1 2014 start-up timeline; 3) an MoU with Vinmar Projects to explore and evaluate growth opportunities in the US, signed

in February 2013; and 4) MOU with SK Gas company signed in March 2014 for a 600ktpa PDH plant in South Korea.

Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East + 971 4423 6924 [email protected]

Of these projects, the Turkish one has been cancelled, the details of the potential projects with Vinmar in the US remain vague, while the PDH plant in Sout Korea is still in early stages of discussion, leaving the propylene supply agreement with Aramco/Total as the only growth project in the pipeline.


This project is for the company to get additional propylene and to use that to produce polypropylene at the company’s existing plant via debottlenecking. However, in our view, this project is not hugely accretive to earnings for APC. APC’s margins come from taking propane at a discount from Aramco and converting it into propylene and then PP. Buying finished propylene at market prices from Aramco and then converting it into PP would yield a conversion margin of 4-5% at best, on our estimates, well below the company’s current 28% EBITDA margin. So, while this propylene allocation is positive for tonnage, it does not have a significant bottom-line impact, in our view. The project was initially scheduled to start in Q1 2014, but has been delayed.

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APC: Stock performance

APC: EBITDA (SARm) vs. PP spreads (USD/t)

220

300

200

800

250

180

700

200

160 140 120

150

600

100

500

50

100

400

0

80 Jul-12

Jan-13 APC

Jul-13 Tadawul All Share

Jan-14

Jul-14 Tadawul Petro


-50

Q2 08

Q2 09

Q2 10

Q2 11

EBITDA

Q2 12

Q2 13

PP - Naphtha (RHS)

Source: Company reports, IHS Chemical, HSBC

Valuation vs peers

Risks

In the absence of clarity on growth options, we see the stock as fully valued at current levels. On a 15.8x 2014e PE and offering a 5% yield, the stock is trading at a premium to the broader Saudi chemical sector, which is not justified given the growth constraints, in our view.

Key upside/downside risks include:

Valuation We use DCF to value APC. Our cost of equity is 10.8% and includes a risk-free rate of 3.5%, a market risk premium of 6% and a beta of 1.22. We use a 4% cost of debt assumption and a 30% debt weighting, which yields a WACC estimate of 8.7%. This yields a DCF valuation for APC of SAR45 per share which is our target price for the stock. Under our research model, for stocks with a volatility indicator, the Neutral band is 10ppts above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price, it implied a potential return that was within the Neutral band; therefore, we rate the stock Neutral (V). Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

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300

 Commodity prices: APC is highly leveraged to PP prices. Any significant changes in the correlation between PP and naphtha price movements would constitute a risk to our earnings estimates and valuation for the company, either to the downside or the upside. Key downside risks include:

 Operating rates: as a single-plant entity, APC’s earnings are highly sensitive to its operating rates. Any significant outages remain a key downside risk to our estimates and rating on the company.

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Financials & valuation: Advanced Petro Chemical C Financial statements Year to

Valuation data 12/2013a

12/2014e

12/2015e

12/2016e

Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit

2,786 773 -208 566 -15 557 557 0 557 557

2,996 738 -208 530 -12 521 521 -8 513 513

2,962 730 -207 524 -9 517 517 -8 510 510

2,831 689 -208 481 -6 478 478 -7 471 471

Year to

Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity

744 -110 -111 -328 -314 645

692 -128 -128 -407 -174 578

705 -133 -133 -407 -179 583

680 -139 -139 -380 -171 548

87 2,163 974 544 3,225 359 580 36 2,254 2,320

87 2,082 1,061 593 3,232 385 455 -138 2,360 2,252

87 2,009 1,097 634 3,194 383 317 -317 2,463 2,176

87 1,940 1,097 653 3,125 375 165 -488 2,553 2,095

Balance sheet summary (SARm)

12/2013a

12/2014e

12/2015e

12/2016e

2.9 10.5 3.5 14.5 3.6 8.0 4.6

2.7 10.8 3.5 15.8 3.4 7.1 5.0

2.6 10.7 3.6 15.9 3.3 7.2 5.0

2.7 11.0 3.6 17.2 3.2 6.8 4.7

Target price

(SAR)45.00

EV/sales EV/EBITDA EV/IC PE* P/Book value FCF yield (%) Dividend yield (%)

Note: * = Based on HSBC EPS (fully diluted)


Cash flow summary (SARm)

Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders funds Invested capital

Neutral (V)

(SAR)49.40

Reuters (Equity) 2330.SE Market cap (USDm) 2,160 Free float (%) 47 Country Saudi Arabia Analyst Sriharsha Pappu

53

53

48

48

43

43

38

38

33

33

28

28

23

23

18 2012

2013 Advanced Petro Chemical C

12/2013a

2014

18 2015


Source: HSBC

12/2014e

12/2015e

12/2016e Note: price at close of 22 Jul 2014

Y-o-y % change Revenue EBITDA Operating profit PBT HSBC EPS

Bloomberg (Equity) APPC AB Market cap (SARm) 8,101 Enterprise value (SARm) 7961 Sector Chemicals Contact 971 4 4236924

Price relative

Ratio, growth and per share analysis Year to

8 . 9

12.7 42.2 63.3 69.7 69.7

7.5 -4.6 -6.4 -6.5 -7.9

-1.1 -1.0 -1.1 -0.6 -0.6

-4.4 -5.7 -8.2 -7.7 -7.7

1.2 23.9 25.9 17.6 27.8 20.3 52.5 1.6 0.0 2061.2

1.3 22.8 22.2 16.2 24.6 17.7 63.6 -5.8 -0.2

1.3 23.3 21.1 16.1 24.7 17.7 80.2 -12.9 -0.4

1.3 22.2 18.8 15.1 24.3 17.0 108.8 -19.1 -0.7

3.40 3.40 2.25 13.74

3.13 3.13 2.48 14.39

3.11 3.11 2.48 15.02

2.87 2.87 2.32 15.57

Ratios (%) Revenue/IC (x) ROIC ROE ROA EBITDA margin Operating profit margin EBITDA/net interest (x) Net debt/equity Net debt/EBITDA (x) CF from operations/net debt Per share data (SAR) EPS Rep (fully diluted) HSBC EPS (fully diluted) DPS Book value

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Methanol Chemicals Co (Chemanol) CHEMANOL AB, SAR16.50, N(V), TP SAR16 Company description Methanol Chemical Company (Chemanol), established in 1989 and initially known as Saudi Formaldehyde Chemical Company, started commercial operations in 1991 with production capacity of 24ktpa of formaldehyde. Over the next decade the company added capacity for formaldehyde as well as other methanol derivatives such as super plasticizers in small increments, moving to a total sales volume of over 300ktpa by 2006. In 2006 the company changed its name to Methanol Chemical Company and embarked on a methanol integration and expansion project after securing gas feedstock from the Saudi Government. The plan was to source methanol internally (rather than purchasing it from SABIC at market linked prices) Chemanol quarterly earnings (SARm)

and add some more formaldehyde capacity to boost both volumes and margins. Chemanol went public in August 2008 as part of the fundraising for the expansion project.

Investment thesis Still awaiting earnings recovery

Chemanol started commercial operations at its 231ktpa methanol plant in Q3’10 with a view to expanding margins through feedstock integration, but the expected margin improvement never materialised. The company reported net earnings of SAR11m in the 12 months following the plant start-up, significantly lower than the average annual earnings of SAR34m during the 2005-09 period as the weak operating performance and start-up costs weighed on earnings. Earnings stabilized slightly during Q3’11-Q3’12 (though much below potential earnings), but have been volatile since then.

Chemanol: stock performance

180

60 50

160

40

140

30

120

20

100

10

80

0 -10

Q1 10 Q3 10 Q1 11 Q3 11 Q1 12 Q3 12 Q1 13 Q3 13 Q1 14

-20 Net Income Source: Company reports, HSBC estimates

60

Historical

Rebased

60 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Chemanol Tadawul All Share Tadawul Petro Source: Thomson Reuters Datastream, HSBC


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We believe the company has not been able to take full advantage of its backward integration into methanol production owing to operational issues. More importantly, in our view, it is difficult to judge if and when these issues will be resolved. If the plant operates at close to full capacity and is able to take benefit of its methanol integration, we think the business would start to look attractive at a c11x annualised forward PE. However, based on the most recent twelve-month period (Q3’12Q2’14), the stock trades at c20x.

Risk Key upside/downside risks include:

 In our estimates, we build in operating rates of 95% for the company in 2013 and thereafter. Any significant variation in the operating rates would constitute a key risk to our Neutral (V) rating on the stock, either on the upside or downside.

Valuation Our preferred methodology for valuing commodity chemical companies is DCF. In our DCF valuation we model cash flows and EBITDA explicitly up to 2017, after which we build in semi-explicit cash flow forecasts running off a sales growth assumption and a profitability metric through to 2020. Thereafter, we move to a terminal valuation phase. We use DCF to value Chemanol. Our cost of equity for Chemanol is 10% and includes a riskfree rate of 3.5%, a market risk premium of 6% and a beta of 1.08. We use a 4% cost of debt assumption and a 30% debt weighting, which yields a WACC estimate of 8.1%. This yields a DCF valuation of SAR16 per share, which is our target price. Under our research model, for stocks with a volatility indicator, the Neutral band is 10 ppts above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price, it implied a potential return that was within the Neutral band; therefore, we rate the stock Neutral (V). Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

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Financials & valuation: Methanol Chemicals Co. Financial statements Year to


12/2014e

12/2015e

12/2016e


874 279 -162 117 -37 78 78 -6 72 72

895 345 -167 177 -34 142 142 -7 135 135

851 328 -168 160 -28 130 130 -7 124 124

823 321 -172 148 -22 125 125 -6 119 119

Year to


252 -71 -77 -60 -115 179

301 -77 -77 -66 -159 227

308 -79 -79 -60 -169 231

301 -81 -81 -60 -161 223

18 2,260 489 79 2,793 143 1,066 988 1,583 2,546

18 2,169 489 83 2,702 139 912 829 1,652 2,455

18 2,079 486 97 2,609 136 757 660 1,715 2,350

18 1,988 479 103 2,511 135 603 500 1,773 2,248


12/2013a

12/2014e

12/2015e

12/2016e

3.4 10.6 1.2 27.6 1.3 9.1 3.6

3.1 8.1 1.1 14.8 1.2 11.5 3.3

3.1 8.0 1.1 16.1 1.2 11.8 3.0

3.0 7.7 1.1 16.8 1.1 11.3 3.0

Target price

(SAR)16.00






Neutral (V)

(SAR)16.50

Reuters (Equity) 2001.SE Market cap (USDm) 531 Free float (%) 60 Country Saudi Arabia Analyst Sriharsha Pappu

22

22

20

20

18

18

16

16

14

14

12

12

10

10

8 2012

2013 Methanol Chemicals Co.

12/2013a

Source: HSBC

12/2014e

12/2015e



-5.1 -6.8 -14.1 -19.3 -21.1

2.4 23.7 52.0 82.1 86.5

-4.9 -4.7 -9.6 -7.9 -7.9

-3.3 -2.4 -7.4 -4.3 -4.3

0.3 4.2 4.6 3.7 31.9 13.4 7.6 62.4 3.5 25.5

0.4 6.7 8.3 6.1 38.5 19.8 10.2 50.2 2.4 36.4

0.4 6.3 7.4 5.7 38.6 18.8 11.8 38.5 2.0 46.6

0.4 6.1 6.8 5.4 38.9 18.0 14.9 28.2 1.6 60.3

0.60 0.60 0.60 13.13

1.12 1.12 0.55 13.69

1.03 1.03 0.50 14.22

0.98 0.98 0.50 14.70


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Bloomberg (Equity) CHEMANOL AB Market cap (SARm) 1,990 Enterprise value (SARm) 2794 Sector CHEMICALS Contact 971 4 4236924

Price relative


3 . 0


8 2015

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Saudi Basic Industries Co (SABIC) SABIC AB, SAR123.5, OW, TP SAR130 Company description SABIC is the largest and the most diversified petrochemical company in the Middle East, with products ranging from basic commodity chemicals to ‘differentiated commodities’. It has interests in fertilizers and steel, and is one of the largest nitrogen fertilizer producers in Middle East, although its steel and fertilizer business are small in the context of the company (8% and 4% of its sales respectively in 2012). SABIC unlike the other petrochemical companies in the region has a global footprint with significant assets outside MENA, primarily in Europe due to its acquisitions of GE Plastics (in 2007), Hunstsman’s petrochemical assets in UK (in 2006), and DSM’s European base chemical assets (in 2002).

Oil (LHS) vs. Revenue (USD/ton) and Margin (USD/ton) 120 1,400 100 80 60 40

0

SABIC has a significant leverage to rising chemicals margins in our view. Its current profitability profile is broadly the same as it was during the previous sector peak in 2006/07. This is structurally the same business, with similar leverage to sector cyclicality as in the past. The impact of GE Plastics acquisition on SABIC’s profitability profile is far smaller than that indicated by the headline numbers, while the feedstock mix of the company has not changed significantly, despite the start-up of new mix-feeds crackers (Yansab, Kayan). SABIC: Earnings power (EPS in SAR) 14 13

10

800

8

600

6

2000 2002 2004 2006 2008 2010 2012 Oil (USD/bbl) Revenue Margin Source: Company reports, HSBC estimates

fundamentals

1,000

0


Significant leverage to rising chemical

12

200


Investment thesis

1,200

400

20

SABIC was created in 1976 by royal decree to add value to Saudi Arabia’s hydrocarbon resources, especially the natural gas associated with its oil production, most of which was previously flared off. The Saudi government is the largest shareholder in the company with a 70% stake.

10.6 8.5 7

4 2 0 Peak adjusted

Trough

Mid cycle

T12m

Source: HSBC estimates

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The company’s current EBITDA margins are in the 28-30% range, below mid-cycle levels for SABIC, which we estimate at 32-33%, while peak-cycle margins are in the 40-41% range, broadly unchanged from the 42-43% realised during the previous peak in the chemical cycle. On an earnings basis, we estimate mid-cycle earnings for SABIC at SAR10.6 per share, with peak earnings power of SAR13 per share. SABIC is also not just an oil play, another common investor perception. SABIC’s revenues are indeed highly correlated to the oil price, but realised margins are in fact less so, as seen in 2012 where, despite stable oil prices and flat revenues, margins dropped significantly, driven by weaker utilisation rates within the chemical sector. In 2013, on the other hand, despite a 3% decline in oil prices, the margin improved y-o-y.

Financials SABIC reported Q2 net income of SAR6.45bn broadly flat q-o-q and up 7% y-o-y. The Q2 earnings imply an annualized eps run rate of SAR 8.6 per share, c19% below our mid-cycle earnings estimate of SAR10.6 for the company.

Valuation Our preferred methodology for valuing commodity chemical companies is DCF. In our DCF valuation we model cash flows and EBITDA explicitly up to 2017, after which we build in semi-explicit cash flow forecasts running off a sales growth assumption and a profitability metric through to 2020. Thereafter, we move to a terminal valuation phase. Our cost of equity for SABIC is 12.3% and includes a risk free rate of 3.5%, a market risk premium of 6% and a beta of 1.47. We use a cost of debt of 4% and a 30% debt weighting to get to our WACC estimate of 9.8%. Our DCF valuation gives a target price of SAR130.

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Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price, it implied a potential return that was outside the Neutral band; therefore, we rate the stock Overweight. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.


 Cyclicality: All of SABIC’s products are commodity products, whose earnings are inherently cyclical and driven by industry operating rates and supply/demand fundamentals. Although we would argue that the cycle for each product is different and so provides a degree of offset, there is no denying that earnings are linked to global GDP growth as well as being affected by supply cycles for the products themselves.  Cash usage risks: SABIC is cash rich, underlevered, has an acquisitive history and is growth constrained, making it a ripe candidate for any M&A speculation within the sector. Any low return or high cost acquisition which does not add to the longterm value thus constitutes a risk to our Overweight rating

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Financials & valuation: Saudi Basic Industries Co Financial statements Year to


12/2014e

12/2015e

12/2016e


189,038 56,622 -14,031 42,591 -769 42,391 42,391 -2,300 25,228 25,228

203,993 63,898 -14,370 49,528 -545 50,182 50,182 -2,258 31,615 31,615

203,333 63,611 -14,768 48,842 -119 50,323 50,323 -2,265 31,955 31,955

200,779 62,625 -15,176 47,449 254 49,203 49,203 -2,214 31,244 31,244

59,997 -11,650 -18,039 -12,738 -16,001 44,888

62,197 -11,951 -11,951 -15,000 -18,937 49,047

62,979 -12,417 -12,417 -15,000 -19,459 48,963

62,693 -12,901 -12,901 -15,000 -19,047 48,292

22,197 165,874 144,025 75,189 345,588 52,526 69,864 -5,324 172,836 204,381

22,197 163,522 149,242 80,648 348,453 52,436 55,864 -24,784 189,791 201,878

22,197 161,247 151,025 83,195 347,961 52,199 39,364 -43,831 206,035 199,074

Balance sheet summary (SARm) Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders funds Invested capital

Year to

12/2013a

12/2014e

12/2015e

12/2016e

2.5 8.3 2.3 14.7 2.4 9.8 4.0

2.2 7.1 2.2 11.7 2.1 10.7 4.0

2.1 6.8 2.1 11.6 2.0 10.7 4.0

2.1 6.6 2.1 11.9 1.8 10.6 4.0

Target price

(SAR)130.00




Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity

Overweight

(SAR)123.50


129

129

119

119

109

109

99

99

89

89

79

79

69 2012

2013 Saudi Basic Industries Co

12/2013a

2014

69 2015


Source: HSBC

12/2014e

12/2015e



Bloomberg (Equity) SABIC AB Market cap (SARm) 370,500 Enterprise value (SARm) 452408 Sector CHEMICALS Contact 971 4 4236924

Price relative

22,197 168,294 135,028 68,251 339,011 50,563 81,864 13,613 156,221 206,704


5 . 3

0.0 4.2 4.0 3.8 1.8

7.9 12.8 16.3 18.4 25.3

-0.3 -0.4 -1.4 0.3 1.1

-1.3 -1.6 -2.9 -2.2 -2.2

0.9 19.1 16.7 12.3 30.0 22.5 73.6 6.6 0.2 440.7

1.0 23.0 19.2 14.5 31.3 24.3 117.2 -2.4 -0.1

1.0 23.0 17.6 14.2 31.3 24.0 534.2 -10.3 -0.4

1.0 22.6 15.8 13.8 31.2 23.6 -17.1 -0.7

8.41 8.41 5.00 52.07

10.54 10.54 5.00 57.61

10.65 10.65 5.00 63.26

10.41 10.41 5.00 68.68


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National Industrializatio (Tasnee (NIC)) NIC AB, SAR35.60, N, TP SAR35 Company description

Investment thesis

National Industrialization Company (Tasnee) is a diversified industrial conglomerate with interests in several industrial projects apart from its petrochemical businesses. However, the major petrochemical assets account for over 85% of the company’s revenues and are the key drivers of the company’s profitability.

We expect Tasnee’s earnings to increase by over 87% y-o-y in 2014 after the 28% and 37% declines in 2012/13, on the back of improvements in TiO2 margins, scheduled start-up at the Acrylic acid plant of the Saudi Acrylic Monomers Company (in which Tasnee owns a c39% stake) and the start-up of the ilmenite smelting plant of Cristal during 2014.

The petrochemicals segment is made up of investments in Cristal (66% stake, TiO2), Saudi Polyolefins (75% stake, polypropylene plant), SEPC (45.3% stake, 1mtpa integrated ethylene cracker), and SAMC (44.5%, integrated acrylics plant, under construction).

However, we believe that the stock’s recent strong performance – up 40% in the last 1 year – largely prices in the expectation of an earnings recovery in 2014.

2014 to be better, but in the price

The manufacturing business consists of a number of small scale battery, packaging and services businesses and accounts for c15% of Tasnee’s revenue.

Tasnee earnings profile (SARm) and net income margins 14% 3,000

12%

2,500

The TiO2 segment, which was the primary driver of earnings growth for Tasnee in 2010 and 2011, weakened significantly post H1 2012 on lower demand growth, high producer inventory levels and a margin squeeze from higher ore prices.

Tasnee: stock performance 80%

60%

10%

2,000 1,500 1,000

8%

40%

6%

20%

4%

500

2% 0%

0 2010

2011 2012 Net Income

Source: Company reports, HSBC estimates

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TiO2 markets have troughed

2013 2014e Margins (RHS)

0% -20% 3m Tasnee

6m

1 yr

Tadawul All Share

Source: Thomson Reuters DataStream, HSBC

2 yr

3 yr

Tadawul Petro


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Tasnee: Segment EBIT margins

TiO2 spreads (USD/ton)

40%

4,000

35% 30%

3,000

25% 20% 15%

2,000

10% 5% 0% Q1 10 Q3 10 Q1 11 Q3 11 Q1 12 Q3 12 Q1 13 Q3 13 Q1 14 Industrial

Petrochemical

Source: Company reports, HSBC

While margins within Tasnee’s petrochemical business remained relatively stable, the decline in TiO2 margins from a high base had an outsize impact on Tasnee’s profitability in H2 2012 and H1 2013.We believe that the TiO2 segment has troughed, with product prices beginning to improve, while ore prices have already softened, leading to expansion of product spreads (see charts above). New projects on track

Tasnee has 2 new projects starting this year  Acrylic acid: Tasnee has a c39% stake in Saudi Acrylics Monomer Company (SAMC), an integrated acrylic acid project with a nameplate capacity of c250ktpa. The project started commercial operations in July 2014.  Cristal’s slagger project: Cristal, Tasnee’s TiO2 subsidiary is bringing on an ilmenite smelting plant in H2 2014. The plant will have an initial capacity to produce 500ktpa of titanium slag by using ilmenite as a feedstock, and will also produce 235ktpa of pig iron as a by-product. The plant gives Cristal the ability to use cheaper ilmenite ore instead of rutile, by upgrading ilmenite to titanium slag, which can then be used at its existing plants to produce TiO2.

1,000 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 TiO2 - Rutile *1.07

TiO2 - Ilmenite *1.7

Source: Thomson Reuters Datastream, Bloomberg, HSBC

Financials We expect Tasnee’s earnings to increase by 87% yo-y in 2014, compared to a 37% y-o-y decline in 2013. The stock is trading a 2014e PE of 11.5x on our ahead of consensus estimates, at a premium to its historical 12-m forward P/E multiple.

Valuation We use a DCF to value Tasnee. Our cost of equity is 11% and includes a risk-free rate of 3.5%, a market risk premium of 6.0% and a beta of 1.25. We use a 5% cost-of-debt assumption and a 30% debt weighting. We use a 10% marginal tax rate for the forecast period – the Cristal business is spread across various geographies and, thus, pays a higher effective tax rate than the Saudi domestic businesses – which results in a WACC of 9.1%. This yields a DCF value of SAR35 per share, which is our target price. Under our research model, for stocks without a volatility indicator, the Neutral band is 5pp above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price, it implied a potential return that was within the Neutral band; therefore, we rate the stock Neutral. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

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 TiO2 margins: Tasnee has a large exposure to TiO2 markets and a stronger/faster-thanexpected margin recovery is an upside risk to our estimates and rating for the company Key downside risks include:

 Project delays: SAMC (Saudi Acrylic Monomers Company) is currently in the construction phase. We assume a Q2’14 startup. Any delays would have a negative impact on our valuation of Tasnee.

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Financials & valuation: National Industrializatio Financial statements Year to


12/2014e

12/2015e

12/2016e


18,201 4,428 -1,359 3,069 -606 2,399 2,399 -122 1,104 1,104

20,338 6,271 -1,561 4,710 -559 4,380 4,380 -438 2,069 2,069

21,117 6,441 -1,749 4,692 -643 4,279 4,279 -471 2,044 2,044

20,890 6,407 -1,749 4,658 -522 4,366 4,366 -480 2,133 2,133

3,269 -3,045 -3,276 -1,140 2,892 -1,053

5,296 -2,166 -2,166 -1,138 -1,991 2,899

5,208 -1,433 -1,433 -1,022 -2,752 3,544

5,742 -1,059 -1,059 -1,066 -3,616 4,453

3,666 25,690 11,943 987 43,691 5,533 15,611 14,623 12,925 34,779

3,666 25,375 12,826 1,456 44,259 5,599 13,327 11,871 13,947 34,813

3,666 24,685 14,030 2,788 44,773 5,578 11,042 8,255 15,013 34,016


Year to

12/2013a

12/2014e

12/2015e

12/2016e

2.8 11.4 1.5 21.6 2.0 -3.1 4.2

2.5 8.1 1.5 11.5 1.8 8.0 4.8

2.4 7.9 1.5 11.7 1.7 9.1 4.3

2.4 7.7 1.5 11.2 1.6 10.8 4.5

Target price

(SAR)35.00





Neutral

(SAR)35.60


47

47

42

42

37

37

32

32

27

27

22

22

17 2012

2013 National Industrializatio

12/2013a

2014

17 2015


Source: HSBC

12/2014e

12/2015e



Bloomberg (Equity) NIC AB Market cap (SARm) 23,813 Enterprise value (SARm) 50927 Sector CHEMICALS Contact 971 4 4236924

Price relative

3,666 25,086 15,989 5,179 47,133 5,596 21,793 16,614 11,993 33,966


1 . 7

1.7 -19.1 -25.1 -32.7 -37.4

11.7 41.6 53.4 82.6 87.4

3.8 2.7 -0.4 -2.3 -1.2

-1.1 -0.5 -0.7 2.0 4.3

0.6 8.9 9.2 6.2 24.3 16.9 7.3 84.9 3.8 19.7

0.6 12.3 16.6 9.8 30.8 23.2 11.2 65.3 2.3 36.2

0.6 12.0 15.2 10.0 30.5 22.2 10.0 47.2 1.8 43.9

0.6 12.0 14.7 9.8 30.7 22.3 12.3 29.5 1.3 69.6

1.65 1.65 1.50 17.93

3.09 3.09 1.70 19.32

3.06 3.06 1.53 20.85

3.19 3.19 1.59 22.44


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Saudi Industrial Investment (SIIG) SIIG AB, SAR37.4, OW(V), TP SAR41 Company description SIIG was one of the earliest privately held petrochemical companies to be established in Saudi Arabia, incorporated in 1996, and has been publicly listed since 2004. SIIG is essentially a combination of three separate, but integrated petrochemical projects.  Saudi Chevron Phillips (SCP): A 50:50 JV with Chevron Phillips Chemicals. SCP was SIIG’s first project and started operation in 2000. The plant produces motor gasoline (789ktpa), benzene (835ktpa) and cyclohexane (290ktpa).  Jubail Chevron Phillips (JCP): Another 50:50 JV with Chevron Phillips, JCP started commercial operations in July 2009. The plant is integrated into benzene from SCP and produces styrene (550ktpa) along with propylene (150ktpa).  Saudi Polymers Company (SPC): SIIG owns a 32.5% stake in SPC via its 50% stake in Petrochem. SPC is owned by a JV between Petrochem and Chevron Phillips. The SPC project is based around a 1.1mtpa ethylene cracker and is integrated into styrene from the JCP project, which will be used to produce polystyrene (200ktpa). Its other major products include HDPE (550ktpa), LDPE (550ktpa) and PP (400ktpa).

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Investment thesis 2014 to be better for Saudi Polymers

We view the operating issues that the Saudi Polymers plant has had to date post its Q4 2012 commercial start-up, as primarily teething problems that should start to dissipate over the course of 2014. Petrochem, the entity that owns 65% of the Saudi Polymers (SPC) plant reported its first quarterly profit in Q4 2013 on an estimated average operating rate of c60% during the quarter. We expect operations at SPC to stabilise over the course of 2014 and estimate that the plant will reach close to full utilisation rates by the end of the year – driving volume and earnings growth for both Petrochem and in turn SIIG. SIIG’s older assets de-risk SIIG from operating issues at Saudi Polymers

SIIG’s older business, Saudi Chevron Phillips (SCP) and Jubail Chevron Phillips (JCP) substantially de-risk the company from the start-up related risks at Saudi Polymers, in our view. SIIG paid a dividend of SAR1per share last year, at c60% pay-out ratio, despite a negative SAR33m contribution from Saudi Polymers in 2013. Nylon project on track

SIIG is constructing a new nylon and compounding project in Jubail though PCC (Petrochemical Conversion Company), a 50/50 JV between SIIG and Arabian Chevron Phillips Company. The project comprises a 50ktpa nylon 6,6 plant and compounding capacity of 170ktpa.



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The project appears to be on track, with the company announcing 75% completion in early Jan 2014, and subsequent trial run at some of the compounding plants in early-Feb. We expect the plant to start operations in H2 2014.

Financials We expect SIIG’s net income to roughly double in 2014, driven primarily by a positive contribution from the Saudi Polymers unit.

Valuation We use a sum-of-the-parts to value SIIG. We use a 2014e PE multiple of 11x to value the exPetrochem (National Petrochemical Co.) businesses, while to value the company’s 50% stake in Petrochem, we use our Petrochem target price of SAR28. This yields a sum-of-the-parts valuation for SIIG of SAR41 per share, which is our target price for the stock. Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price, it implied a potential return that was outside the Neutral band; therefore, we rate the stock Overweight. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.


 Saudi Polymers operating risks: Any further significant delays in stabilisation of operations at Saudi Polymers would have a negative impact on our earnings estimates and constitute a downside risk to our Overweight rating.

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Financials & valuation: Saudi Industrial Investment Financial statements Year to


12/2014e

12/2015e

12/2016e


4,437 941 -787 154 -203 774 774 -103 714 714

8,027 2,888 -813 2,076 -231 2,893 2,893 -74 1,622 1,622

8,180 2,922 -884 2,039 -302 2,747 2,747 -70 1,549 1,549

8,921 3,229 -926 2,303 -322 2,897 2,897 -80 1,531 1,531

Year to


22 -1 556 -450 88 71

2,607 -290 229 -675 -2,172 2,318

2,520 -491 4 -675 -1,879 2,039

2,710 -503 -55 -675 -2,018 2,225

0 21,603 3,383 1,510 25,374 901 14,625 13,115 6,332 22,576

0 21,600 4,056 2,156 26,044 952 13,100 10,943 7,279 22,548

0 21,702 5,046 3,110 27,136 968 12,174 9,065 8,153 22,671

0 21,727 6,293 4,202 28,408 1,025 11,249 7,047 9,009 22,795


12/2013a

12/2014e

12/2015e

12/2016e

7.5 35.2 1.5 23.6 2.7 0.4 2.7

4.0 11.1 1.4 10.4 2.3 10.9 4.0

3.8 10.8 1.4 10.9 2.1 9.1 4.0

3.4 9.5 1.3 11.0 1.9 9.4 4.0

Target price

(SAR)41.00






Overweight

(SAR)37.40


45

45

40

40

35

35

30

30

25

25

20

20

15 2012

2013 Saudi Industrial Investme

12/2013a

Source: HSBC

12/2014e

12/2015e



417.2 318.2 30.7

80.9 206.8 1244.3 273.8 127.2

1.9 1.2 -1.8 -5.1 -4.5

9.0 10.5 13.0 5.5 -1.2

0.2 0.6 11.4 3.4 21.2 3.5 4.6 133.5 13.9 0.2

0.4 9.0 23.8 11.9 36.0 25.9 12.5 91.4 3.8 23.8

0.4 8.8 20.1 11.3 35.7 24.9 9.7 64.9 3.1 27.8

0.4 9.9 17.8 11.4 36.2 25.8 10.0 43.7 2.2 38.4

1.59 1.59 1.00 14.07

3.60 3.60 1.50 16.18

3.44 3.44 1.50 18.12

3.40 3.40 1.50 20.02


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Bloomberg (Equity) SIIG AB Market cap (SARm) 16,830 Enterprise value (SARm) 32195 Sector CHEMICALS Contact 971 4 4236924

Price relative


9 . 6


15 2015

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National Petrochemical Company (Petrochem) PETROCH AB, SAR37.4, N(V), TP SAR28 Company description Petrochem was established in April 2008 and went public in August 2009 in an issue worth SAR2.4bn. Petrochem’s sole asset is the Saudi Polymers project, which is a JV between Petrochem (65%) and Chevron Phillips (35%). Saudi Polymers consists of a world scale cracker (1.17mt ethylene + 0.45mt propylene), with corresponding downstream units that include HDPE (550ktpa), LDPE (550ktpa), PP (400ktpa), Polystyrene (200 ktpa). Its feedstock mix consists of Ethane (40%) and Propane (60%). The plant was constructed at a total cost of SAR19.5bn and started commercial operations in October 2012. Saudi Industrial Investment (SIIG) is the largest shareholder in Petrochem with a 50% stake.

Petrochem vs. SIIG stock performance

Investment thesis Prefer SIIG on a risk-adjusted basis

SIIG owns a 50% stake in Petrochem, which in turn own a 65% stake in the Saudi Polymers project. Saudi Polymers is Petrochem’s only asset, while SIIG has stable existing business (SCP and JCP) that generated SAR1.65 of EPS in 2013 and allowed the company to pay SAR1 per share in dividends. Moreover, we believe SIIG has a better growth profile than Petrochem, post the start-up at Saudi Polymers, owing to its upcoming nylon project.

Petrochem vs. SIIG net income (SARm) 300

250

250

220

200

0 (100) (200) (300)

50

100 70 Aug-09

100

100

130

(400) (500)

0 Aug-10 Aug-11 Petrochem

Source: Thomson Reuters DataStream, HSBC

Aug-12

Aug-13 SIIG

300 200

150

160


Petrochem clearly offers greater leverage to earnings growth from Saudi Polymers (SPC) and we expect the operating performance at SPC to improve substantially in 2014. However, Petrochem also offers greater exposure to the start-up risks inherent in Saudi Polymers. Given earnings support from existing business units, and a better growth profile, we believe SIIG is a better risk-adjusted play on the Saudi Polymers start-up than Petrochem.

280

190


Q1 12

Q3 12

Q1 13 SIIG

Q3 13 Q1 14 Petrochem (RHS)

Source: Company reports, HSBC

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Financials Petrochem’s Q2’14 net income was up 40% q-o-q, compared to +89% increase in Q1, with the stock trading at 21x based on annualized Q2 earnings.

Valuation We use a DCF to value Petrochem. Our cost of equity for Petrochem is 10.6% and includes a riskfree rate of 3.5%, a market risk premium of 6% and a beta of 1.19. We use a 4% cost of debt assumption and a 30% debt weighting, which yields a WACC estimate of 8.6%. This yields a DCF valuation of SAR28 per share, which is our target price. Under our research model, for stocks with a volatility indicator, the Neutral band is 10pp above and below the hurdle rate for Saudi stocks of 9%. Although the stock is not volatile according to the HSBC model (over 40% average 30-day vol), we keep the volatility (V) flag to reflect the start-up risks inherent in the Saudi Polymers project, which is Petrochem’s only asset. At the time we set our target price, it implied a potential return that was within the Neutral band; therefore, we rate the stock Neutral (V). Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated

Risks Key upside/downside risks include:

 Saudi Polymers ramp-up: As Saudi Polymers is Petrochem’s only asset, a faster/slower than expected ramp-up of operations would have a positive/negative impact on our earnings estimates and valuation for the company, and represents an upside/downside risk

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Financials & valuation: National Petrochemical Co Financial statements Year to


12/2014e

12/2015e

12/2016e


4,437 952 -787 165 -203 -38 -38 -38 -66 -66

8,027 2,888 -813 2,076 -231 1,845 1,845 -46 1,153 1,153

8,180 2,922 -884 2,039 -302 1,736 1,736 -43 1,085 1,085

8,921 3,229 -926 2,303 -322 1,981 1,981 -50 1,238 1,238

Year to


-38 0 0 0 -102 -46

2,536 -290 -290 -288 -1,952 2,245

2,553 -491 -491 -543 -1,520 2,063

2,753 -503 -503 -619 -1,630 2,249

0 18,369 2,520 673 21,006 804 14,625 13,952 4,121 19,413

0 17,847 3,323 1,330 21,291 873 13,331 12,001 4,985 18,966

0 17,454 3,373 1,341 20,948 889 11,822 10,481 5,528 18,596

0 17,031 3,655 1,462 20,808 946 10,312 8,850 6,147 18,278


12/2013a

12/2014e

12/2015e

12/2016e

7.5 35.0 1.7

4.0 11.2 1.7 14.3 3.3 11.0 1.7

3.9 10.8 1.7 15.2 3.0 9.8 3.3

3.4 9.5 1.7 13.3 2.7 10.3 3.7

Target price

(SAR)28.00


4.0 -0.2 0.0





Neutral (V)

(SAR)34.40


39

39

34

34

29

29

24

24

19

19

14 2012

2013 National Petrochemical Co

12/2013a

2014

14 2015


Source: HSBC

12/2014e

12/2015e



Bloomberg (Equity) 3569689Z AB Market cap (SARm) 16,512 Enterprise value (SARm) 32464 Sector CHEMICALS Contact 971 4 4236924

Price relative


1 8 . 6

417.2

80.9 203.3 1154.7

1.9 1.2 -1.8 -5.9 -5.9

9.0 10.5 13.0 14.1 14.1

0.2 1.7 -1.6 1.6 21.5 3.7 4.7 251.2 14.7

0.4 10.5 25.3 9.6 36.0 25.9 12.5 169.9 4.2 21.1

0.4 10.6 20.6 9.5 35.7 24.9 9.7 127.6 3.6 24.4

0.5 12.2 21.2 10.9 36.2 25.8 10.0 92.9 2.7 31.1

-0.14 -0.14 0.00 8.59

2.40 2.40 0.60 10.39

2.26 2.26 1.13 11.52

2.58 2.58 1.29 12.81


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Yansab YANSAB AB, N, TP SAR77 Company description Yansab is essentially a single project company, with a world scale cracker with 1.3mt ethylene capacity, and corresponding downstream units. Its main products include MEG (700ktpa), PP (400ktpa), HDPE (400ktpa), and LLDPE (400ktpa). Its feedstock mix consists of ethane (35%) and propane (65%). Yansab was set up in 2005 and had its IPO in January 2006. The company started commercial operations in Q1 2010. SABIC is the majority shareholder with a 51% stake.

Investment thesis Dividend growth to continue but upside priced in

The investment case for Yansab – that of continued dividend expansion as a growthconstrained single asset operator – remains intact, in our view.

Yansab stock performance

240 220 200 180 160 140 120 100 80 Jan-10Jul-10Jan-11Jul-11Jan-12Jul-12Jan-13Jul-13Jan-14Jul-14 Yansab Tadawul Petro Tadawul All Share Source: Thomson Reuters Datastream, HSBC

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If anything, the move towards paying out c100% of its earnings as dividends has been faster than we expected. The dividend of SAR3 per share for 2013represented a c64% pay-out ratio, and the SAR1.5 dividend for H1’14 implies a 72% payout ratio. We expect to see the dividend stream continue to grow in 2014, ramping up to c100% of earnings over the next 18-24 months given the company’s structural growth constraints and strong cash flow generation. However, given lack of growth and re-rating , we view the dividend growth expectations as being fully in the price. Yansab is currently trading on a 2014e PE of 12.5x and EV/EBITDA of 9.4x, while offering a 2014e dividend yield of 5.7% and a FCF yield of 9.7%.

Yansab 12-month forward PE multiple

16 15 14 13 12 11 10 9 8 7 Jun-10

Jun-11

Jun-12

12m fwd P/E Source: Thomson Reuters Datastream, HSBC

Jun-13 Median

Jun-14


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Valuation

Risks

We use a dividend discount model to value Yansab, as the method is appropriate based on our view that Yansab will pay out all of its earnings as dividends in the medium term, with the quantum of dividends paid driving the value of the stock.

Key upside/downside risks include:

We use a dividend discount factor for Yansab derived from the market-implied discount rate for Saudi Arabian Fertilizer (SAFCO). SAFCO is the closest comparable as both are low cost producers, with limited growth options and will act as a cash cow to the primary shareholder SABIC. Given the comparable structures of both companies, we believe the long-run dividend payout of each company should be discounted at the same rate. Applying a market-implied SAFCO discount rate to our estimates for Yansab’s dividends yields a fair value of SAR77 per share which is our target price for the company.

 Plant shutdown: Yansab is a single-project company and highly sensitive to any shutdowns. Any production problems would hurt Yansab’s earnings and represent a downside risk to our Neutral rating.  Commodity prices: Any sharp increase in crude oil prices and tightening supplydemand in commodity plastics and the polyester chain represent upside risks to our Neutral rating and vice versa.

Under our research model, for stocks without a volatility indicator, the Neutral band is 5pp above and below the hurdle rate for Saudi stocks of 9%. Our target price implies a potential return of 10%, within the Neutral band; therefore, we rate the stock Neutral. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated

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Financials & valuation: Yanbu Petrochemical Financial statements Year to


12/2014e

12/2015e

12/2016e


9,354 4,073 -1,080 2,993 -260 2,762 2,762 -118 2,645 2,645

9,711 4,435 -1,006 3,429 -157 3,302 3,302 -141 3,161 3,161

9,723 4,335 -1,016 3,318 -75 3,273 3,273 -139 3,134 3,134

9,522 4,186 -992 3,194 -25 3,199 3,199 -136 3,063 3,063

3,620 -106 -204 -561 -2,879 3,655

4,052 -194 -194 -2,250 -1,609 3,829

4,127 -293 -293 -2,821 -1,013 3,803

4,115 -397 -397 -2,910 -808 3,688

305 15,001 7,280 3,321 22,586 1,119 5,512 2,191 15,955 18,146

305 14,278 6,972 2,958 21,555 1,151 4,136 1,178 16,268 17,447

305 13,683 6,341 2,390 20,329 1,148 2,760 370 16,421 16,791


Year to

12/2013a

12/2014e

12/2015e

12/2016e

4.6 10.6 2.3 14.9 2.6 9.3 4.3

4.3 9.4 2.3 12.5 2.5 9.7 5.7

4.2 9.4 2.3 12.6 2.4 9.7 7.2

4.2 9.5 2.4 12.9 2.4 9.4 7.4

Target price

(SAR)77.00





Neutral

(SAR)70.02


Ratio, growth and per share analysis 12/2013a

80 75 70 65 60 55 50 45 40 35 2012

2013

Source: HSBC

12/2014e

12/2015e



0.6 4.6 4.1 8.5 8.1

3.8 8.9 14.6 19.5 19.5

0.1 -2.3 -3.2 -0.9 -0.9

-2.1 -3.4 -3.8 -2.3 -2.3

0.5 14.9 18.9 12.8 43.5 32.0 15.7 25.3 0.9 95.3

0.5 17.8 20.4 14.6 45.7 35.3 28.2 13.7 0.5 184.9

0.5 17.9 19.5 14.5 44.6 34.1 57.7 7.2 0.3 350.2

0.6 17.9 18.7 14.7 44.0 33.5 170.8 2.3 0.1 1112.3

4.70 4.70 3.00 26.74

5.62 5.62 4.00 28.36

5.57 5.57 5.01 28.92

5.45 5.45 5.17 29.19


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Bloomberg (Equity) YANSAB AB Market cap (SARm) 39,386 Enterprise value (SARm) 41577 Sector CHEMICALS Contact 971 4 4236924

Price relative

305 15,814 6,782 3,021 22,901 1,036 6,821 3,800 15,043 18,843

Yanbu Petrochemical

Year to

1 0 . 0


80 75 70 65 60 55 50 45 40 35 2015

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Kayan KAYAN AB, N, TP SAR16 Company description The Saudi Kayan Petrochemical Company was set up in 2005 with PMD, a private Saudi company, as the original project sponsor. SABIC replaced PMD in 2006 and the company held an IPO in May 2007. SABIC is the majority shareholder of the company with a 35% stake. Kayan is the largest project built by SABIC. The base complex is a world scale cracker with a nameplate ethylene capacity of 1.3mt, integrated along the olefins and benzene chains. Its main prodcuts include: MEG (530ktpa), HDPE (400ktpa), LDPE (350ktpa), PP (350ktpa), Polycarbonate (260 ktpa). Kayan’s feedstock slate consists of Ethane (35%) and Butane (65%). The company announced in July 2010, that the total cost of the integrated complex had exceeded the initial estimates of SAR37.5bn by SAR9bn.

Saudi Kayan earnings profile (SARm)

1,000

Kayan started commercial operations at most of its plants on 1 October 2011, while some of the remaining plants are yet to start commercial operations.

Investment thesis Feedstock slate, depreciation and operating

Saudi Kayan started commercial operations at most of its plants in October 2011, with the exception of the LDPE unit, which started up in April 2013. The company lost money in every single quarter during Q4 2011-Q2 2013, with cumulative losses of over SAR1.3bn. While earnings have started to recover from H2 2013 onwards as operating performance has stabilised, the project still has an overhang from its feedstock slate and its high cost of construction. Kayan has the heaviest feedstock slate of all of the new Saudi crackers. The project has a significant downstream chemical component, which requires a higher proportion of butane (c70%) and less ethane.

Saudi Kayan vs Yansab: EBITDA margins

50%

800

0

40%

600

(100)

30%

400

(200)

20%

200

(300)

10%

(400)

0%

Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 11 12 12 12 12 13 13 13 13 14 EBITDA Net Income (RHS) Source: Company reports, HSBC estimates


rates weigh on earnings

100

0


Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 11 12 12 12 12 13 13 13 13 14 Yansab

Kayan


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Butane prices are linked to naphtha prices in Saudi and thus do not enjoy the large discount that ethane does. This means that a higher butane content implies a lower cost advantage and lower EBITDA margins, as seen in the EBITDA margin comparison with Yanasb, which has a lighter feedstock slate than Kayan. Coupled with cost overruns and a heavy debt load, this has meant that, for the plant to even hit breakeven levels of profitability, it needs to operate at a very high level of utilisation. However, as operating rates ramp up over the course of 2014, we expect the company’s earnings profile to improve.

Financials Kayan reported a net loss of SAR133m in Q2 compared to an average net income of SAR20m over the previous 3 quarters on account of higher SG&A, feedstock costs and an inventory revaluation, despite higher product prices and volumes, confirming our view that the overhang from heavy feedstock slate and high cost of construction remains.

Valuation We use DCF to value Kayan. Our cost of equity for Kayan is 10.6% and includes a risk-free rate of 3.5%, a market risk premium of 6% and a beta of 1.19. We use a 6% cost of debt assumption and a 60% debt weighting, which yields a WACC estimate of 7.7%.This yields a DCF value of SAR16 per share, which is our target price. Under our research model, for stocks without a volatility indicator, the Neutral band is 5pp above and below the hurdle rate for Saudi stocks of 9%. Our target price implies a potential return of 6%, within the Neutral band, therefore, we rate the stock as Neutral. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

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 Saudi Kayan’s plants are, still in the ramp-up phase. A faster-than-expected ramp-up represents an upside risk to our Neutral rating. Key downside risks include:

 Greenfield projects typically entail some teething problems in the start-up phase. While Saudi Kayan has faced these issues since its start-up, further persistence of such issues would have a negative impact on our earnings estimates and valuation for the company.

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Financials & valuation: Saudi Kayan Petrochemical Financial statements Year to


12/2014e

12/2015e

12/2016e


10,353 2,526 -2,291 235 -483 -256 -256 -90 -346 -346

11,715 4,484 -2,325 2,159 -466 1,703 1,703 -68 1,635 1,635

12,014 4,515 -2,325 2,190 -411 1,789 1,789 -72 1,717 1,717

12,373 4,854 -2,325 2,529 -411 2,127 2,127 -85 2,042 2,042

1,372 -729 -1,375 0 -28 640

4,283 -212 -212 0 -4,071 4,061

3,922 -439 -439 0 -3,482 3,472

4,130 -887 -887 -630 -2,612 3,232

0 37,096 8,270 2,603 45,365 2,652 27,615 25,012 15,728 40,110

0 35,210 9,775 3,939 44,985 2,701 25,469 21,530 17,446 38,345

0 33,772 10,453 4,378 44,225 2,702 23,295 18,918 18,858 37,145


Year to

12/2013a

12/2014e

12/2015e

12/2016e

5.0 20.5 1.2

4.1 10.6 1.2 13.9 1.4 17.9 0.0

3.7 9.8 1.2 13.2 1.3 15.3 0.0

3.4 8.6 1.1 11.1 1.2 14.3 2.8

Target price

(SAR)16.00


1.6 2.8 0.0




Neutral

(SAR)15.10


23

23

21

21

19

19

17

17

15

15

13

13

11

11

9

9

7 2012

2013 Saudi Kayan Petrochemical

12/2013a

2014

7 2015


Source: HSBC

12/2014e

12/2015e



Bloomberg (Equity) KAYAN AB Market cap (SARm) 22,650 Enterprise value (SARm) 47662 Sector CHEMICALS Contact 971 4 4236924

Price relative

0 39,208 6,380 269 45,588 2,772 29,352 29,083 14,094 42,546


6 . 0

9.2 34.0

13.2 77.5 816.9

2.5 0.7 1.4 5.1 5.1

3.0 7.5 15.5 18.9 18.9

0.2 0.7 -2.4 0.7 24.4 2.3 5.2 206.4 11.5 4.7

0.3 5.0 11.0 4.6 38.3 18.4 9.6 159.0 5.6 17.1

0.3 5.4 10.4 4.7 37.6 18.2 11.0 123.4 4.8 18.2

0.3 6.4 11.3 5.5 39.2 20.4 11.8 100.3 3.9 21.8

-0.23 -0.23 0.00 9.40

1.09 1.09 0.00 10.49

1.14 1.14 0.00 11.63

1.36 1.36 0.42 12.57


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Saudi International Petro (Sipchem) SIPCHEM AB, SAR35.8, N, TP SAR34 Company description

Investment thesis

Sipchem was established in 1999 and went public in 2006. It has evolved in a fairly structured way, starting with the basic chemicals projects (methanol, BDO), then using those basic chemical streams to develop downstream integrated projects (acetic acid, VAM). The next phase of development is a planned polyvinyl acetate (PVA) and ethylene-vinyl acetate (EVA) facility that will be integrated into VAM from the second phase.

Sipchem has near-term volume growth catalysts in the form of its phase III start-up in H2 2014. The phase III projects include a 100ktpa EA/BA plant (which started commercial operations in September 2013), a 200ktpa EVA/LDPE plant, which is yet to start commercial operations, and a 63ktpa PBT plant which is under construction and has a end-2014 start-up timeline.

Sipchem is best thought of as an integrated petrochemical company with three phases, of which phases I & II are operational, while most plants of phase III have not yet started commercial operational.  Phase I consists of a methanol (1,200ktpa) plant and a butanediol (75ktpa) plant which is integrated into the methanol capacity  Phase II consists of an integrated acetic acid (460ktpa), VAM (330ktpa) and CO (345ktpa) facility, with the acetic acid plant integrated into methanol from Phase I and the VAM plant integrated into acetic acid from Phase II  Phase III includes a100ktpa ethyl acetate (EA)/butyl acetate (BA) plant (commercial operations started in September 2013), a 200 ktpa ethylene vinyl acetate (EVA)/LDPE project (yet to start commercial operations) and a 63ktpa Polybutylene Terephthalate (PBT) plant (under construction)

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Impact of Phase III start-up

For its EVA/LDPE plant, the company has access to low-cost gas (priced at USD0.75/mmbtu) through an ethylene tolling arrangement with SABIC. This arrangement, at current market prices, is highly accretive and will result in an earnings boost once the unit starts commercial operations. The construction of the plant is completed and we expect the plant to start commercial operations in H2 2014. Merger with Sahara stands cancelled

Sipchem and Sahara announced in June 2013 that they were considering a merger and in December the companies entered in a MOU to begin confirmatory due diligence for their proposed merger. As per the proposal Sahara would have become a subsidiary of Sipchem, and shareholders of Sahara would have received 0.685 shares of Sipchem for every existing share of Sahara. As per this existing shareholders of Sipchem would have owned 55% of the combined entity with existing Sahara shareholders owning the remaining 45%. The merger was scheduled to be completed in H1 2014.



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However in early- June 2014 the companies announced that they were postponing the merger as their mutually acceptable merger structure with both companies continuing to exist while having operational integration was difficult to implement under the regulatory framework. The merger has essentially been cancelled in our view.

Financials Our full year estimates call for a 33% y-o-y increase in earnings in 2014 after broadly flat earnings in 2013 and a 15% decline in 2012. The stock trades at a 16x PE based on our 2014 estimates.

Valuation We use a DCF to value Sipchem. Our cost of equity for Sipchem is 10.0% and includes a riskfree rate of 3.5%, a market risk premium of 6% and a beta of 1.09. We use a 5% cost of debt assumption and a 30% debt weighting, which yields a WACC estimate of 8.5%. This yields a DCF valuation of SAR34 per share, which is our target price. Under our research model, for stocks without a volatility indicator, the Neutral band is 5pp above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price, it implied a potential return that was within the Neutral band; therefore, we rate the stock Neutral. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated

Risks Key upside/downside risks include:

 A faster/slower-than-expected ramp-up in production from new plants is a key upside/downside risk

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Financials & valuation: Saudi International Petro Financial statements Year to


12/2014e

12/2015e

12/2016e


3,959 1,707 -539 1,169 -192 991 991 -55 620 620

4,606 2,056 -549 1,508 -214 1,309 1,309 -79 824 824

5,308 2,243 -633 1,610 -214 1,412 1,412 -71 912 912

5,289 2,085 -633 1,452 -198 1,269 1,269 -63 820 820

1,249 -1,621 -1,621 -495 1,535 -619

2,159 -215 -215 -458 -965 1,652

2,157 -312 -312 -458 -827 1,561

2,085 0 0 -458 -493 1,823

193 11,714 4,405 2,881 16,313 1,525 6,758 3,877 6,160 11,907

193 11,394 4,559 2,784 16,146 1,690 5,834 3,050 6,614 11,672

193 11,126 4,044 2,257 15,363 1,731 4,814 2,557 6,975 11,376


Year to

12/2013a

12/2014e

12/2015e

12/2016e

5.0 11.5 1.6 21.2 2.3 -4.2 3.5

4.1 9.1 1.6 15.9 2.1 11.1 3.5

3.4 8.1 1.6 14.4 2.0 10.3 3.5

3.4 8.5 1.6 16.0 1.9 12.0 3.5

Target price

(SAR)34.00





Neutral

(SAR)35.80


39

39

34

34

29

29

24

24

19

19

14 2012

2013 Saudi International Petro

12/2013a

Source: HSBC

12/2014e

12/2015e



0.9 3.4 2.8 0.4 3.2

16.3 20.4 29.0 32.0 32.9

15.2 9.1 6.8 7.9 10.6

-0.4 -7.0 -9.8 -10.1 -10.1

0.3 9.7 10.9 6.9 43.1 29.5 8.9 65.2 2.8 25.8

0.4 11.7 13.8 8.6 44.6 32.7 9.6 48.7 1.9 55.7

0.5 13.0 14.3 9.5 42.3 30.3 10.5 35.5 1.4 70.7

0.5 12.0 12.1 8.8 39.4 27.5 10.5 28.1 1.2 81.5

1.69 1.69 1.25 15.80

2.25 2.25 1.25 16.80

2.49 2.49 1.25 18.04

2.24 2.24 1.25 19.02


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Bloomberg (Equity) SIPCHEM AB Market cap (SARm) 13,127 Enterprise value (SARm) 18799 Sector CHEMICALS Contact 971 4 4236924

Price relative

193 12,048 4,493 2,854 16,734 1,537 7,696 4,842 5,794 12,344


5 . 0


14 2015

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Rabigh Refining and Petro (PetroRabigh) PETROR AB, Price SAR33.6, OW, TP SAR45 Company description History

PetroRabigh was commissioned initially as a basic topping refinery in 1989. Its refining capacity was expanded from 325Mbbl/d to 400Mbbl/d in 1998. In 2005, Aramco decided to upgrade and expand the existing asset through a 50:50 JV with Sumitomo Chemical Company. A 25% stake in the company was then offered to the public via an IPO in Jan’08, with Aramco and Sumitomo each holding a 37.5% stake thereafter. The total cost of the upgrade was cUSD10bn, and the project was commissioned in November 2009. The refining capacity remained unchanged at 400Mbbl/d, while the petrochemical business was given an ethane allocation of 95mmscfd from Aramco and would be supplied with 900ktpa of propylene from the refinery. The petrochemical complex was anchored through a world-scale cracker with ethylene capacity of 1,250ktpa. Petrorabigh has two broad operating segments:  Refining: The refinery, post the upgrade, is less skewed towards the negative margin fuel oil business. However, with a large proportion of product sales into the domestic market, a simple product mix and significant marketing fees paid to the parents, the refining segment, despite accounting for c85% of total company revenues, has been consistently loss making since commissioning.

 The petrochemical business, while accounting for only 15% of total sales, is the segment that is profitable, with exposure to the basic commodity chemical chains (PE, PP and MEG). The business has an exceptionally low cost base given the high ethane content of its feedstock, yet has struggled with consistency in terms of operating rates.


Investment thesis A multi-leg equity story

We view PetroRabigh as a multi-leg equity story playing out over several phases in the 2014-16 timeframe. The issues that the company has been facing have been: a) a loss-making refinery that represents a heavy drag on profitability; b) a chemical plant that while highly profitable in theory has had significant operational problems, mostly stemming from utility supply; and c) uncertainty around growth, the value of PetroRabigh 2 and the participation of the listed entity in the project. We believe that each of these issues is now being addressed in a phased manner and the underlying equity value is starting to crystallise.  The first phase was the new commercial agreements announced on 15 Dec 2013, which provided SAR1.3bn to net income, or SAR1.5 in EPS. These new terms significantly enhanced the profitability of the loss-making refinery unit, moving it to cash breakeven on our estimates.

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 The second phase commenced with the settlement reached with the utility provider RAWEC on 1 Jan 2014. The settlement was crucial as it addressed the root causes behind the operational issues at the cracker. This settlement started the phase for better operations at the cracker and a turnaround in chemical segment profitability – evident in the results in Q1’14. We expect this to continue through the course of 2014.  The third phase commenced with the announcement on 14 May 2014 that PetroRabigh 2 refinery would be executed at the listco level. Rabigh 2 has been under construction and was being developed directly by the founding shareholders. Moving the project to the listco instead of at founding shareholders level has multiple benefits for minority shareholders.  Improves the economics of the refinery – currently c18% of the refinery slate that comprises naphtha loses on average USD5-6/bbl. This naphtha will now be upgraded at Rabigh 2 to higher-value chemical products.  Gives shareholders a stake in the ethane allocation – with Rabigh 2 being executed at the listco level, shareholders of the listed entity will benefit from the inherent value in the 30mmscfd of ethane allocated to the Rabigh 2 project. PetroRabigh will be the only listed Saudi petrochemical company with an additional ethane allocation.  Gives shareholders a stake in growth – the lack of additional ethane has meant that the Saudi chemical industry is essentially viewed as ex-growth, with companies that have meaningful growth prospects. With Rabigh 2 moving to the

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listco, PetroRabigh now becomes the strongest growth story in the Middle Eastern chemical space – with the potential to more than double aggregate and saleable capacity by 2016.  Value creation – on our estimates, the NPV of Rabigh 2 is cSAR8.7bn, roughly SAR10 per share. With the project now being done at the listco level, this value is being shared with the minority shareholders of PetroRabigh, rather than just accruing to the founding shareholders. There are obviously execution risks related to Rabigh 2 and investors will undoubtedly highlight the fact that the turnaround of Rabigh 1 is still very much a work in process. That said, there is significant value, in our opinion, in the additional ethane, the naphtha integration and volume growth. While there will most likely be a requirement for additional equity, on our estimates the project would be accretive to existing shareholders if financed at any debt ratio above 40%, and significantly accretive on a pershare basis above the 60% debt component. Petrorabigh is an HSBC GEMs Super 15 portfolio constituent.

Valuation We use DCF to value PetroRabigh. Our cost of equity is 10.1% and includes a risk-free rate of 3.5%, a market risk premium of 6% and a beta of 1.1. We use a 5% cost-of-debt assumption and a 30% debt weighting to get to our WACC estimate of 8.6%. This yields a DCF value of SAR38 per share (for standalone Rabigh 1). Given the announcement on 15 May 2014 that Rabigh 2 will be executed at the listco level, we incorporated the value of Rabigh 2 into our estimates. Our NPV for the project is SAR10 per share, and we apply a 30% discount to that

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PetroRabigh: Combined chemical capacities by phase (000 tons) Rabigh 1 Ethylene Propylene MEG PP HDPE LLDPE PO Benzene LDPE Polyether Polyols Paraxylene MTBE Cumene Phenol Acetone PET Nylon-6 EPR TPO EVA MMA p-MMA Acrylic Acid SAP PTA

1,250 900 600 700 300 600 200

Total

4,550

Rabigh 2

Total

424 80 120 1,340 424 384 275 170 420 75 75 15 70 86 50 80 60 700

1,250 900 600 700 300 600 200 424 80 120 1340 424 384 275 170 420 75 75 15 70 86 50 80 60 700

4,848

9,398

Source: Company data, HSBC

estimate to account for risks of project delays and execution risks. We therefore add a SAR7 per share value for Rabigh 2 to our SAR38 DCF value for PetroRabigh – yielding a value of SAR45 per share, which is our target price for the stock. Under our research model, for stocks without a volatility indicator, the Neutral band is 5pp above and below the hurdle rate for Saudi stocks of 9.0%. Our target price of SAR45 implies a potential return of 34%, above the above the Neutral band; therefore we rate the stock as Overweight. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

Risks Key downside risks include:  Operating risks: PetroRabigh has faced multiple operating issues in the past. A continued persistence of such issues would have a negative impact on our estimates and valuation of the company.  Refining margins: The company’s refining segment has faced negative margins on a persistent basis in the past. We expect margins in the refining segment to improve in 2014 given the reduction in marketing costs charged by the parent companies, Aramco and Sumitomo. Any increase in marketing fees, reversing this reduction, would have a negative impact on our estimates and valuation of the company.

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Financials & valuation: Rabigh Refining And Petro Financial statements Year to


12/2014e

12/2015e

12/2016e


50,598 1,884 -2,197 -313 -297 359 359 0 359 359

54,036 4,560 -2,134 2,425 -265 2,424 2,424 0 2,424 2,424

53,763 5,552 -2,155 3,396 -236 3,437 3,437 0 3,437 3,437

51,970 5,470 -2,155 3,315 -208 3,392 3,392 0 3,392 3,392

-1,129 -106 16 0 1,112 -1,526

4,709 -178 24 -876 -3,913 3,639

5,400 -359 -109 -1,314 -4,033 4,765

5,545 -453 -203 -1,752 -3,617 4,807

208 24,680 18,093 3,332 45,167 14,251 20,353 17,020 10,466 25,397

208 22,828 19,777 5,175 44,750 13,901 18,163 12,988 12,589 23,737

208 21,099 20,731 6,602 43,724 13,425 15,973 9,370 14,229 22,010


Year to

208 26,690 16,259 1,610 45,594 14,036 22,543 20,933 8,917 27,511

12/2013a

12/2014e

12/2015e

12/2016e

1.0 26.7 1.8 82.0 3.3 -5.2 0.0

0.9 10.2 1.8 12.1 2.8 12.4 3.0

0.8 7.6 1.8 8.6 2.3 16.2 4.5

0.7 7.1 1.8 8.7 2.1 16.3 5.9

Target price

(SAR)45.00





Overweight

(SAR)33.62


39

39

34

34

29

29

24

24

19

19

14

14

9 2012

2013 Rabigh Refining And Petro

12/2013a

Source: HSBC

12/2014e

12/2015e



-18.4 -33.6 -147.9 -26.5 -26.5

6.8 142.1 575.0 575.0

-0.5 21.8 40.0 41.8 41.8

-3.3 -1.5 -2.4 -1.3 -1.3

1.9 -1.2 4.1 0.8 3.7 -0.6 6.3 234.7 11.1

2.0 9.2 25.0 5.3 8.4 4.5 17.2 162.6 3.7 27.7

2.2 13.8 29.8 7.6 10.3 6.3 23.5 103.2 2.3 41.6

2.3 14.5 25.3 7.7 10.5 6.4 26.3 65.9 1.7 59.2

0.41 0.41 0.00 10.18

2.77 2.77 1.00 11.95

3.92 3.92 1.50 14.37

3.87 3.87 2.00 16.24


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Bloomberg (Equity) PETROR AB Market cap (SARm) 29,451 Enterprise value (SARm) 46463 Sector OIL & GAS Contact 971 4 4236924

Price relative


3 3 . 8


9 2015

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Ma’aden MAADEN AB, N, TP: SAR38 Company description The Saudi Arabian Mining Company (Ma’aden) was formed to facilitate the development of Saudi Arabia’s mineral resources. The company is viewed as a vehicle for diversification in an economy reliant on oil and petrochemicals. Ma’aden’s objective is to engage in projects relating to mining, including the development, advancement and improvement of the industry, as well as in mineral products and by products. These activities exclude petroleum and natural gas and their derivatives. Ma'aden's main projects are gold, phosphate, aluminium, and infrastructure. The gold business has been operational since the inception of the company. The phosphate project is a joint venture with SABIC, (which owns 30%) and includes a phosphate rock mine, a beneficiation plant, and a chemical complex containing sulphuric acid and ammonia plants. The aluminium project is a joint venture with Alcoa, which has a 25.5% stake. It includes a bauxite mine, an alumina refinery, an aluminium smelter and a rolling mill. Ma’aden announced a delay in commercial production at its aluminium smelter. This was initially set for end of 2013, brought forward to end Q2-2014 and has now been delayed to September 2014. While in 2015 we expect to see the bauxite mine and alumina refinery come on-line.

Investment case We rate Ma’aden Neutral. Although Ma’aden is one of a few companies with the ability to

generate value from Saudi Arabia’s natural resources, this positive is offset by both short term risks to the execution schedule of the Aluminium project and long-term risks from the lack of detail on the longer-term DAP projects. It is worth noting that the projects currently running represent SAR19 per share value in our SOPbased valuation, compared to the current share price of SAR37.

Nicholas Paton*, CFA Analyst HSBC Bank Middle East + 971 4423 6923 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

Financials Ma’aden Q2-14 earnings came in at SAR371m, a major beat on consensus and our forecasts by 102% and 28%, respectively. Major improvements on the operating level with EBIT at SAR502m, up 161% qoq and 38% above our estimate of SAR364m. The company attributed the great results to an increase in volumes and prices of DAP and aluminum. Aluminium sales were SAR817m for the quarter, up c100% from Q1-14. DAP operating rates increased to 79% from 70% last quarter and 64% in 2013.

Valuation We value Ma’aden using a DCF-based sum-ofparts (SOP) valuation (we value each part using a DCF), taking account of the debt allocated to each individual project and Ma’aden’s stake in it. We apply a uniform risk-free rate of 1.8%, an equity risk premium of 12.5% and beta of 0.9 across the different business units, giving us an 11.4% cost of equity. The cost of debt is estimated at 4.0%. Using an equity: debt structure of 80:20 for gold

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and corporate, and 42:58 for phosphate and aluminium, we arrive at WACCs of 9.9% for gold and 9.0% for corporate and 7.1% for both phosphate and aluminium. We assume an unchanged terminal growth rate of 2.0% for both Ma’aden’s phosphate and aluminium projects. Based on the sum-of-the parts for the valuation of each project, we arrive at our 12-month target price of SAR38 per share. Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage points above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price, it implied a potential return that was within the Neutral band of our model; therefore, we rate the stock N. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

Risks The key risks to our Neutral rating on Ma’aden are:  A reduction in the Saudi Arabian government’s subsidies on natural gas.  That Ma’aden will struggle to export DAP without offering higher price discounts, especially when Wa’ad Al Shamal project comes online.  The release of more details on longer-term projects could give the market enough visibility for their value to be reflected in the stock price.

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Financials & valuation: Maaden

Neutral



12/2014e

12/2015e

12/2016e


6,047 957 1,019 1,976 -183 3,174 3,174 -55 3,252 3,252

7,585 1,658 1,876 3,534 -191 3,344 3,344 -66 4,396 4,396

11,766 3,200 1,882 5,083 -1,262 3,821 3,821 -85 5,286 5,286

13,184 3,631 1,888 5,520 -1,254 4,266 4,266 -103 5,824 5,824

1,538 -10,548 -7,528 0 10,931 -10,445

-2,335 -7,283 -7,283 0 7,550 -9,684

-622 -425 -425 0 -1,026 -1,132

1,386 -325 -325 0 -3,140 958

420 23,602 757 -2,359 32,503 2,207 33,545 35,904 20,234 24,931

420 22,144 2,121 -2,532 25,551 1,268 32,347 34,878 20,726 25,948

420 20,579 4,603 -590 26,369 920 31,148 31,738 21,530 25,273


420 18,196 7,180 4,389 63,231 5,618 32,743 28,354 19,760 15,789

12/2013a

12/2014e

12/2015e

12/2016e

4.2 26.5 1.6 10.6 1.7 345.3 0.0

8.3 37.7 2.5 7.8 1.7 -36.3 0.0

5.8 21.4 2.6 6.5 1.7 -3.4 0.0

5.0 18.0 2.6 5.9 1.6 2.8 0.0

Target price

(SAR)38.00





Year to

(SAR)37.20


1211.SE 9,175 36 Saudi Arabia Nicholas Paton

44

44

39

39

34

34

29

29

24

24

19 2012

2013 Maaden

12/2013a

2014

19 2015


Source: HSBC

12/2014e

12/2015e



Bloomberg (Equity) MAADEN AB Market cap (SARm) 34,410 Enterprise value (SARm) 62590 Sector Metals & Mining Contact +971 4 423 6923

Price relative


2 . 2

8.4 -65.3 12.2 107.2 198.1

25.4 73.3 78.9 5.4 35.2

55.1 93.0 43.8 14.3 20.3

12.1 13.5 8.6 11.6 10.2

0.4 11.8 17.2 5.6 15.8 32.7 5.2 113.4 29.6 5.4

0.4 17.0 22.0 7.2 21.9 46.6 8.7 147.4 21.6

0.5 19.5 25.8 17.1 27.2 43.2 2.5 149.7 10.9

0.5 21.0 27.6 20.8 27.5 41.9 2.9 141.4 8.7 4.4

3.52 3.52 0.00 21.36

4.75 4.75 0.00 21.87

5.72 5.72 0.00 22.41

6.30 6.30 0.00 23.28


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Saudi Arabian Fertiliser Company (SAFCO) SAFCO AB, OW, TP: SAR176 Company description SAFCO is the largest fertiliser company in Saudi Arabia; with a combined ammonia/urea capacity base of 4.5mt. The company was set up in 1965 as a JV between the government and the citizens of Saudi Arabia. Initially, the government held a 51% stake in the company, while the remainder was held by the private sector. Over the years, the capital of the company has been increased several times. At present, SABIC owns a 43% stake in the company, while the remaining stake is held by the private sector.

Yield play

SAFCO is essentially a yield play given its limited growth profile and high dividend payout ratio. SAFCO has been a cash cow for SABIC and has paid out c90% of its earnings as dividends since 2007. We expect the company to continue with its high dividend policy as capacity growth for the company is constrained by new gas allocations, which we consider unlikely.

Financials

Investment thesis

SAFCO reported Q2 14 net income of SAR638m, down 8% yoy on higher volumes but lower prices for its products, namely urea, which is down c16% yoy and 8% qoq.

Pure play on nitrogen fertilisers

Valuation

SAFCO is a nitrogenous fertiliser producer with a capacity of 2.4mt of urea and 2.1mt of ammonia. Its urea production is backward-integrated into its ammonia capacity, with c66% of the ammonia being consumed internally. Its feedstock prices are fixed, making it a pure play on nitrogen fertilisers.

 Dividend yield. We believe SAFCO is a dividend yield-driven stock. The local Saudi Arabian market is currently trading at an average 2014e dividend yield of 4.6%. Given SAFCO’s high valuation metrics such as PE and EV/EBITDA we do not believe it is likely to rally to this level. However, we believe the company can trade on a 7.0% dividend yield as it has done historically. At a 7.0% dividend yield SAFCO would trade at SAR176, which is the basis for our price target.

Limited growth options

SAFCO is currently increasing its urea capacity by 1.1mt, by using existing excess ammonia as feedstock. The new capacity is expected to be on line in Q1-2015. Further expansion options are limited because new gas allocation for expansion is unlikely, while SAFCO would be internally consuming c93% of its ammonia production after the current expansion phase is concluded.

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 DCF. In our DCF valuation we model cash flows and EBITDA explicitly up to 2020, after which we build in a terminal value assumption running off a 1.0% sales growth

Nicholas Paton*, CFA Analyst HSBC Bank Middle East + 971 4423 6923 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations


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assumption and profitability metric through to 2020. Our cost of equity for SAFCO is 8.3% and includes a risk-free rate of 3.5%, a market risk premium of 6.0% and a beta of 0.8. We use a 4.0% cost of debt assumption and a 20% debt weighting, which yields a WACC estimate of 7.4%. Our DCF valuation for the company is SAR167. Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage points above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price, it implied a potential return that was above the Neutral band of our model; therefore, we rate the stock OW. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

Risks Nitrogen fertiliser prices

SAFCO has high structural leverage to nitrogen fertiliser prices. Any reductions in urea or ammonia prices would be key downside risks to our Overweight rating on SAFCO Operating rates

Any changes from the expected operating rates constitute a key risk to both our earnings estimates and our valuation of the company.

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Financials & valuation: Saudi Arabian Fertilizer Financial statements Year to


12/2014e

12/2015e

12/2016e


4,240 3,171 -374 2,797 25 3,273 3,273 -112 3,160 3,160

4,413 3,461 -340 3,121 37 3,579 3,579 -96 3,483 3,483

5,349 4,188 -392 3,796 30 4,247 4,247 -114 4,134 4,134

5,357 4,249 -444 3,805 24 4,250 4,250 -114 4,137 4,137

3,085 -925 -925 46 1,414 2,064

3,482 -496 -496 37 -1,772 2,876

4,313 -604 -604 30 684 3,599

4,269 -643 -643 24 592 3,517

0 3,838 5,279 3,952 11,521 469 40 -3,912 10,406 4,696

0 3,922 4,877 3,269 11,644 569 40 -3,229 10,430 4,962

0 3,968 4,288 2,676 11,565 570 40 -2,636 10,350 5,010


Year to

12/2013a

12/2014e

12/2015e

12/2016e

11.7 15.6 10.0 16.9 6.5 4.0 7.5

10.7 13.6 10.0 15.4 5.1 5.6 7.7

8.9 11.3 9.6 12.9 5.1 7.1 7.9

8.9 11.2 9.5 12.9 5.2 7.0 8.1

Target price

(SAR)176.00





Overweight

(SAR)160.50


2020.SE 14,264 35 Saudi Arabia Nicholas Paton

181 171 161 151 141 131 121 111 101 91 2012

2013 Saudi Arabian Fertilizer


12/2013a

Source: HSBC

12/2014e

12/2015e



-14.9 -18.0 -20.6 -17.6 -18.3

4.1 9.1 11.6 9.4 10.2

21.2 21.0 21.6 18.7 18.7

0.2 1.5 0.2 0.1 0.1

0.9 57.3 36.9 32.4 74.8 66.0

0.9 62.9 37.3 33.2 78.4 70.7

1.1 76.5 39.7 35.7 78.3 71.0

1.1 74.3 39.8 35.6 79.3 71.0

-25.9 -0.7

-37.6 -1.1

-31.0 -0.8

-25.5 -0.6

9.48 9.48 12.00 24.81

10.45 10.45 12.33 31.22

12.40 12.40 12.65 31.29

12.41 12.41 13.03 31.05


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Bloomberg (Equity) SAFCO AB Market cap (SARm) 53,500 Enterprise value (SARm) 47184 Sector CHEMICALS Contact +971 4 423 6923

Price relative

0 4,320 3,368 2,140 9,460 587 0 -2,140 8,269 4,962

9 . 7


181 171 161 151 141 131 121 111 101 91 2015


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Cement & construction

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Cement & construction  1H Saudi cement deliveries were down 2% yoy but we estimate

that sales in 2H could be up 10% yoy, as the construction environment improves  But the companies continue to have significant inventory that may

be a burden on their working capital  Given this backdrop, we continue to be neutral on the Saudi

cement names, except for SACCO given planned expansions

Cement

Labour shortage

Over the past five years, the Saudi cement industry has witnessed a dramatic change. Demand has increased significantly in the Kingdom, from 30m tons in 2008 to 55m tons in 2013, on the back of high government expenditure and the young demographic of the country requiring even more housing. The government has tried to limit the impact of higher demand by granting new cement licenses (together with the all-important fuel allocation) as well as banning exports and capping local prices.

In 2013, the Saudi government announced a plan to organise the labour market. It first announced a three-month amnesty for workers to amend their legal status in the country. After that, the government planned to start a large inspection and enforcement campaign. In July, the government extended the amnesty period to the Islamic New Year in early November.

The government has generally been unwilling to give the incumbent cement players additional fuel allocations; rather it has allowed new players to emerge in new locations. Hence the number of cement players has gone from eight in 2007 to fifteen today. This “share the wealth” policy helps distribute the higher profits generated to a wider range of people within the Kingdom, although it has been frustrating for incumbents that would like to, and have the ability to, increase capacity.

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During the amnesty period, according to the Economist, close to 1m foreign workers were deported. At the same time, up to 1.2m people corrected their visa status, and 1.6m work permits were renewed. Since the Islamic New Year (November 4, 2013), the government has tightened its stance on workers of illegal status. The state news agency, SPA, quoted on November 19, 2013 the Interior Minister as saying that 60,000 workers had been deported over a period of two weeks, and that more were expected to be.

Patrick Gaffney*, CFA Analyst HSBC Saudi Arabia + 966 1 299 2100 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

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Impact on the sector We did not see a noticeable impact on the sector from labour shortage until November of last year where local consumption was down 18% yoy, which was also when the inspection and enforcement campaign began. While demand has improved in the second quarter, up 1% yoy, but a few companies continue to report double digit declines; namely Yamamah and Saudi Cement, which as of June 2014 showed deliveries were down 18% and 17% yoy, respectively. We believe the labour situation will start to improve towards the end of the year, with companies actively looking to import new labour from abroad to replace the labour that has recently been lost. Quarterly cement deliveries 18 16 14 12 10 8 6 4 2 0 2012

2013

1Q

2012

2013

2Q

2012

2013

3Q

2012

Kingdom is investing in new roads and railroads connecting cities, and most recently a metro in Riyadh. Most recently an announcement was made of an integrated transport system by the Mayor of the Eastern Province linking Qatif to Damamm and Bahrain. The USD16bn project would include buses as well as trains. In Jeddah, the USD12bn metro will take seven years to complete according to the Jeddah Municipality, but awards for these contracts are to take at least one year and most likely won’t begin construction till 2016 at the earliest, similar to the Riyadh metro project discussed below. The USD22.5bn metro project, which was awarded a year ago, began construction on April 3, 2014. According to Arab News, the 177km sixline metro project will cover five different areas across Riyadh, and the Olaya station, designed to cover 400,000 passengers daily, will cover an area of 28,000sqm and will have shopping centers, service facilities and car parks. There will be three stations linking the King Abdullah Financial District (KAFD) in Riyadh.

2013

4Q


For 2014, we estimate 3% growth in cement consumption, which compares to the 4% growth seen in 2013.

The construction market We believe that the construction market is slowly picking up after the downturn last year because of a labour shortage. In the 2014 budget, the Saudi government announced plans to spend SAR855bn on schools, hospitals, new roads and railways, and upgrades of ports and airports. Looking at the table above, construction and transport continue to make up the lion’s share of projects underway. The

Projects in execution in Saudi Arabia as of June 2014 Sector

Budget (USDm)

Percentage

67,930 405,322 25,384 33,550 42,270 68,625 152,204 8,400 803,685

8% 50% 3% 4% 5% 9% 19% 1% 100%

Chemical Construction Gas Industrial Oil Power Transport Water Grand Total Source: Meed projects

Inventories rising Based on our data as of May 2014, clinker inventory levels have reached 17 million tons, which is the highest level ever recorded in the Saudi market. This is due to lower demand, last year’s requirement that cement companies import close to 10m tons, and a government requirement that every company have two months of demand. Looking at the companies

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that have excess inventories, Yanbu, Saudi, Najran, Riyadh and Yamamah all have significant additional clinker inventories. Clinker inventory required as of May 2014 (‘000 tons) Company Minimum Current Excess Inventory inventory inventory over as a % of requireme required deliveries nt Yanbu Arabia Al Safwa Qassim City* Riyadh Yamama SCC Eastern Tabuk Northern Al Jouf Hail Southern Najran Total

1,000 676 327 567 292 567 1,067 1,663 600 300 517 267 267 1,167 893 10,167

2,033 828 82 477 550 1,306 1,702 2,684 595 336 914 482 622 1,527 2,421 16,559

1,033 152 -245 -90 258 739 635 1,021 -5 36 397 215 355 360 1,529 6,393

16% 9% 7% 29% 2% 21% 14% 28% 11% 23% 23% 18% 23% 11% 15%

Total imports

748 1,410 110 14 471 677 1,028 281 400 188 999 420 6,746


Cement capacity in the region Region

Company

Current capacity (‘000s tpa)

New capacity (‘000s tpa)

Expected online

Current Capacity Utilization (2013)

Yanbu Arabia Al Safwa Umm AlQurra

6,000 4,054 1,960 -

2,000

2016

108% 110% 95% -

Central - north

Qassim

3,400

-

-

123%

Central - east Central - east Central - east

City Riyadh Yamama

1,750 3,400 6,400

1,900 1,740 -

Q2-14 2015 -

100% 93% 99%

East - central East - central

SCC Eastern

9,980 3,600

1,000 -

Q3-14 -

88% 85%

North North North North

Tabuk Northern Al Jouf Hail

1,800 3,100 1,600 1,600

1,600 -

Q2-14 -

82% 62% 84% 38%

South South South

Southern Najran Baha

7,000 5,355 -

1,500 1,600

May-14 2015

105% 83% -

60,999

11,340

-

94%

West West West West

Total Source: Company data, HSBC estimates

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Construction According to MEED Projects data, projects worth more than USD1.3trn are under active status and more than USD200bn are under main Contract PQ/Bid due to be awarded in 2014. In 2013, of the USD126bn planned a total of USD66bn was actually awarded, implying c50% award rate. Even after applying a 50% discount to the unawarded projects we still estimate that cUSD100bn worth of projects are due to be awarded in 2014; this gives a sense of the market: it is significant. However getting paid on time remains a challenge for contractors working on projects in Saudi Arabia. Post the 2008 crisis, all the GCC contractors concentrated on Saudi Arabia to benefit from the spending surge. While this has certainly provided sales growth, cash flow generation has lagged earnings and sales growth by a big margin. Given the nature of contracting and procurement laws in Saudi Arabia, contractors have witnessed significant payment delays with account receivables rising as high as 144% of sales in 2013 for Al Khodrai, which has operations only in Saudi Arabia.

According to www.arabnews.com (8 September 2013) Saudi Arabia plans to adopt a version of the standard-form contracts recommended by the International Federation of Consulting Engineers (FIDIC) to replace the current law which was adopted in 1976. According to Al Khodari management (stated in the 2013 annual results call), the new procurement law is with the Consultative Council (Shuraa Council). The Consultative Council has sent the final draft to the Contractors Committee to review the final draft and give any final input before the council proceed with the approval process. Management further stated in the results call that this should serve as proof that progress is being made on this and considers that the law will be enacted by the end of 2014. We do not believe this law will be introduced any time soon, given the time consuming nature of the Saudi legislative process, but if it were to be introduced we estimate it could halve the level of receivables for contractors operating in the Saudi market, leading to a significantly better cashflows and valuations.

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Yamamah Cement Company YACCO AB, Price SAR62, N, TP SAR70 Company description Located in the central region, Yamamah Cement is the Kingdom’s second-largest cement producer, with capacity of 6.4mtpa. The company holds a 33% stake in Cement Product Industry Co. Ltd. (CPI), which produces cement bags (among other things). Yamamah was asked to move its plant, which is on the eastern side of Riyadh, to outside the city limits in order to reduce pollution. The company is waiting for the government to approve the grant for the land to which the plant will be relocated, after which it will build a new plant. Depending on the additional gas allocation Yamamah may receive from Aramco, it could increase its capacity by a third according to management. At the minimum, we believe we could see an increase of c15% as a result of a more efficient plant design. Management has stated that its current land is very valuable and it could either sell it or develop it. We expect an announcement regarding the land plot and the move hopefully sometime this year.

Investment thesis The main reason for our Neutral stance on Yamamah is our belief that numbers will be disappointing this year. We expect volumes to fall 4% this year. Given that sales volumes are down more than 20% in 1H2014, this implies a big

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improvement, helped by the Riyadh metro project and very weak comps in the fourth quarter (down 11%). EBIT falls by 10% on higher costs. In the first quarter, the ex-depreciation raw material costs were SAR91 per ton, most likely due to imports that had a higher cost basis than the company’s own production. This should work its way out of the system over the next few quarters. In our valuation, importantly, we have included some value to the land bank, which was previously not included in our model. The company will soon start the process of moving from its current location inside the Riyadh city limits. This will take some time, and we are somewhat doubtful that it will mean an expansion of capacity beyond the 10% the company has been guiding. Any additional capacity would require additional fuel from the government, which we do not expect to materialize, at least in the near term. However, we estimate that net value of the land (SAR4bn minus the cost of the new plant of SAR3.5bn) is SAR500m. The company received a letter from the Ministry of Petroleum and Mineral Resources on Thursday, May 8, 2014, granting the company a license for the exploration of the raw materials, limestone, sand and clay in three locations outside the city of Riyadh. Whichever one of these the company chooses will be the new plant location.

Patrick Gaffney*, CFA Analyst HSBC Saudi Arabia +966 1 299 2100 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

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Financials Yamamah reported Q2-2014 net income of SAR207m, well above our SAR181m estimate on higher investment income and the selling of some shares. Net income was up 8% qoq but still down 29% yoy. Despite the beat on the net income line, gross profit of SAR199m was almost exactly in line with our estimate of SAR201m. As with net income, gross profit was down 26% yoy but up 9.9% qoq. Part of the beat appears to come from lower SG&A, as EBIT was SAR183m, compared to our SAR190m forecast. But the main reason for the beat is likely non-operating items. Sales of SAR366m were flat qoq but down 20% yoy.

Valuation Our DCF-based target price of SAR70 for Yamamah uses a WACC of 9% which we calculate using a risk-free rate based on the 12month SAIBOR rate of 1.8%. We obtain the cost of debt by adding 220bp to the 12-month SAIBOR, arriving at 4%. Our market risk premium, based on a combination of relative index returns, Saudi CDS spread and inflation differential, is 12.7%. We use a beta of 0.9, which is the average for various large international cement companies. In our DCF calculations, we assume a long-term debt-to-equity ratio of 30:70 and a long-term growth rate of 2.5%. We also add the net value of the land (as discussed above) at SAR500m. Given the uncertainty over this value (4m sqm at SAR1,000 per sqm), we have used a discount of 40%. This is similar to the discounts we use for real estate companies in the region.

Under our research model, for stocks without a volatility indicator the Neutral band is 5pp above and below the hurdle rate for Saudi Arabian stocks of 9%. Our target price implies a potential return of 13%, which is within the Neutral band, so we rate the stock Neutral. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

Risks Upside risks include:

 The value of Yamamah’s land could be more than we expect, given its location in a developing part of the city.  If demand returns strongly, Yamamah could sell their inventory down, which would boost the income statement and the cash balance.  Continued strong demand with prices remaining at the ceiling beyond 2015 will increase the company's long-term profitability. Downside risks include:

 Government relaxes import restrictions to ease the supply shortages and pricing pressure.  New licensees start to operate earlier than expected.  A further delay in the expansion, whose timing will depend both on management ability and additional fuel allocations.

101

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Financials & valuation: Yamamah Cement Company Financial statements Year to


12/2014e

12/2015e

12/2016e


Neutral

1,542 1,016 -185 832 -4 856 856 -26 830 830

1,511 966 -183 783 -1 785 785 -24 761 761

1,474 900 -187 713 -1 715 715 -22 693 693

1,474 895 -170 725 -1 727 727 -23 705 705

Year to


822 -28 -258 -608 -30 766

930 -136 -136 -722 -202 790

885 -118 -118 -658 -42 764

878 -103 -103 -669 -115 771

17 1,758 1,839 1,254 4,263 224 31 -1,223 3,893 2,136

17 1,712 2,041 1,455 4,418 227 31 -1,424 3,931 2,087

17 1,643 2,089 1,497 4,397 235 31 -1,466 3,966 2,016

17 1,575 2,200 1,613 4,441 233 31 -1,582 4,001 1,947

12/2014e

12/2015e

12/2016e

6.9 10.5 5.0 15.1 3.2 6.5 4.9

6.9 10.8 5.0 16.4 3.2 6.7 5.8

7.0 11.5 5.2 18.0 3.2 6.4 5.3

7.0 11.5 5.3 17.7 3.1 6.5 5.4

Target price

(SAR)70.00





12/2013a

(SAR)61.75


3020.SE 3,334 78 Saudi Arabia Patrick Gaffney

1 3 . 4

Bloomberg (Equity) YACCO AB Market cap (SARm) 12,504 Enterprise value (SARm) 10432 Sector CONSTRUCTION MATERIALS Contact +966 1 299 2100


Price relative 73

73

68

68

63

63

58

58

53

53

48

48

43

43

38

38

33 2012

Yamamah Cement Company


12/2013a

12/2014e

12/2015e

12/2016e

-2.2 -3.9 -3.9 -1.1 1.6

-2.0 -4.9 -5.8 -8.4 -8.4

-2.5 -6.9 -9.0 -8.9 -8.9

0.0 -0.5 1.6 1.7 1.7

0.7 38.4 22.2 20.2 65.9 53.9 279.0 -31.4 -1.2

0.7 36.0 19.4 17.6 63.9 51.8 669.2 -36.2 -1.5

0.7 33.8 17.5 15.8 61.0 48.4 623.3 -37.0 -1.6

0.7 35.5 17.7 16.0 60.7 49.2 620.1 -39.5 -1.8

4.10 4.10 3.00 19.23

3.76 3.76 3.57 19.41

3.42 3.42 3.25 19.59

3.48 3.48 3.31 19.76


Per share data (SAR) EPS Rep (fully diluted) HSBC EPS (fully diluted) DPS Book value

102

Source: HSBC

Note: price at close of 22 Jul 2014

Ratios (%) Revenue/IC (x) ROIC ROE ROA EBITDA margin Operating profit margin EBITDA/net interest (x) Net debt/equity Net debt/EBITDA (x) CF from operations/net debt

2013

2014

33 2015


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Saudi Cement Company (SACCO) SACCO AB, Price SAR110.5, OW, TP SAR130 Company Description Located in the eastern region, Saudi Cement (SCC) was established in 1955. SCC operates two cement plants namely in Hofuf and Ain Dar, which are 35km apart and are both about 120km away from King Abdulaziz port in Dammam, in which SCC owns and operates an export terminal. The terminal enables it to load cement and clinker to the ships at the rates of 800 tons/hr and 700 tons/hr, respectively. SCC transports its cement and clinker to the terminal by railway wagons. SCC is currently the largest cement producer in the Kingdom, with capacity of at least c9mtpa, this after restarting old production line which added c2mtpa to its capacity. The lines were shutdown due to an export ban, which resulted in a massive inventory build-up to 2.6 million tons. SCC cement is of a specialized nature that is well suited to be used as finishing material alongside normal use. This uniqueness allowed for its cement to be sought after from across the region.

Financials Saudi Cement reported 2Q2014 net income of SAR288m, in-line with our estimate of SAR280m and a beat on consensus estimates of SAR272m. Net income was up 1% qoq, but still down 6% yoy, with the beat coming from non-operational items. Revenues of SAR538m were in line with our estimate of SAR539m, and up 1% qoq, but down 14% yoy.


Valuation Our DCF-based target price of SAR130 for Saudi Cement is based on a WACC of 9%. The WACC is calculated using a risk-free rate based on the 12-month SAIBOR rate of 1.8%. We obtain the cost of debt by adding 220bp to the 12month SAIBOR, arriving at 4%. Our market risk premium, based on a combination of relative index returns, Saudi CDS spread and inflation differential, is 12.7%. We use a beta of 0.9, which is the average for various large international cement companies.

Investment thesis

In our DCF calculation, we assume a long-term debt-to-equity ratio of 25:70 and a long-term growth rate of 3%.

We expect some improvement in gross margin yoy given the very good performance in 1Q2014. The company is no longer importing clinker. Gross margin suffered from 2Q2013 to 4Q2013 due to the higher cost of these imported products, but we saw a strong reversal in 1Q2014.

Under our research model, for stocks without a volatility indicator the Neutral band is 5pp above and below the hurdle rate for Saudi Arabian stocks of 9%. Our target price implies a potential return of 17%, which is above the Neutral band, so we rate the stock OW. Potential return equals

103


the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

Risks Downside risks include:

 SACCO could lose its additional fuel allocation, which would lower capacity utilisation and profits.  New plants could start to operate earlier than expected.  Aramco could increase the cost of fuel for cement companies.

104

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Financials & valuation: Saudi Cement Company Financial statements Year to


12/2014e

12/2015e

12/2016e


2,187 1,386 -200 1,186 -13 1,171 1,171 -47 1,124 1,124

2,214 1,392 -200 1,193 -13 1,190 1,190 -48 1,142 1,142

2,533 1,517 -188 1,329 -11 1,328 1,328 -54 1,275 1,275

2,554 1,530 -177 1,353 -10 1,353 1,353 -55 1,299 1,299

Year to

1,202 -57 -53 -1,071 54 1,222

1,329 -57 -55 -1,085 -384 1,226

1,457 -66 -63 -1,211 -99 1,332

1,474 -66 -64 -1,234 -173 1,344

0 3,151 1,071 398 4,310 183 661 263 3,263 3,640

0 3,029 1,176 396 4,292 203 561 165 3,325 3,606

0 2,918 1,276 495 4,279 203 486 -9 3,388 3,498

12/2013a

12/2014e

12/2015e

12/2016e

8.0 12.6 4.4 15.0 5.3 7.3 6.3

7.7 12.3 4.7 14.8 5.2 7.3 6.4

6.7 11.2 4.7 13.3 5.1 7.9 7.2

6.6 11.0 4.8 13.0 5.0 8.0 7.3

Target price

(SAR)130.00





Overweight

(SAR)110.50



1 7 . 6

Bloomberg (Equity) SACCO AB Market cap (SARm) 16,907 Enterprise value (SARm) 17081 Sector CONSTRUCTION MATERIALS Contact +966 1 299 2100


0 3,293 986 113 4,371 199 761 648 3,208 3,967

Price relative 119

119

109

109

99

99

89

89

79

79

69

69

59 2012

Saudi Cement Company


12/2013a

12/2014e

12/2015e

12/2016e

-0.7 3.2 3.9 2.5 2.0

1.2 0.4 0.5 1.6 1.6

14.4 8.9 11.4 11.6 11.6

0.8 0.9 1.8 1.9 1.9

0.6 29.2 35.3 26.1 63.4 54.2 106.3 20.2 0.5 185.6

0.6 30.1 35.3 26.6 62.9 53.9 106.0 8.1 0.2 504.7

0.7 35.2 38.7 29.9 59.9 52.5 134.5 5.0 0.1 884.3

0.7 36.6 38.7 30.5 59.9 53.0 159.4 -0.3 0.0

7.35 7.35 7.00 20.97

7.47 7.47 7.09 21.33

8.33 8.33 7.91 21.73

8.49 8.49 8.06 22.14


2013

2014

59 2015


Source: HSBC



105

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Qassim Cement QACCO, Price SAR97, N, TP SAR101 Company Description Located in the central region, Qassim Cement is among the mid-sized cement producers in the Kingdom, with annual clinker production capacity of 3.0mtpa (but grinding capacity of 4.1m tonnes). Qassim’s premium location, situated north of Riyadh, allows it to distribute its product not only into the central region, but also to Hail in the North and Madina in the western province.

Investment thesis The main reason for our Neutral stance on Qassim is we expect revenues to be flat in 2014, but to fall in 2015 due to higher competition in the northern region. Qassim has been losing market share in the Northern region to players like Hail Cement (not covered) since Hail starting production at its 2mtpa plant in May 2013.

Financials Qassim reported 2Q2014 net profit: of SAR161m down a beat on our estimate of SAR153m by 5%, but 2% yoy and up 1% qoq, EBIT of 164m was in line with our estimate of SAR161m, but down 6% yoy and up 1% qoq. Revenues of SAR270m down 10% yoy and missing our estimate of SAR276m by 2%. The beat in earnings came from a decline in cogs and an increase in other income (murabaha income). .

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Valuation Our DCF-based target price of SAR101 for Qassim uses a WACC of 9%, which is calculated using a risk-free rate based on the 12-month SAIBOR rate of 1.8%. We obtain the cost of debt by adding 220bp to the 12-month SAIBOR, arriving at 4%. Our market risk premium, based on a combination of relative index returns, Saudi CDS spread and inflation differential, is 12.7%. We use a beta of 0.9, which is the average for various large international cement companies. In our DCF calculations, we assume a long-term debt-to-equity ratio of 30:70 and a long-term growth rate of 3%. On an EV/ton basis, Qassim trades at an EV/ton of USD601, which appears relatively expensive compared to the average of USD506 for all thirteen cement stocks in Saudi. Under our research model, for stocks without a volatility indicator the Neutral band is 5pp above and below the hurdle rate for Saudi Arabian stocks of 9%. At the time we set our target price it implied a potential return that was within the Neutral band, so we rate the stock Neutral. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.


 Continued strong demand, with prices remaining at the ceiling beyond 2015 would increase long-term profitability at the company.



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Downside risks include:

 Government relaxes import restrictions to ease the supply shortages and pricing pressure.  New plants could start operating earlier than expected.  An unexpected increase in fuel costs

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Financials & valuation: Qassim Cement Company Financial statements Year to


12/2014e

12/2015e

12/2016e


Neutral

1,051 693 -86 606 0 621 621 -36 585 585

1,054 695 -85 611 13 633 633 -36 597 597

964 605 -76 529 15 555 555 -32 523 523

1,006 628 -68 560 16 586 586 -34 552 552

Year to


646 -30 64 -540 -103 602

761 -63 -63 -567 -167 687

584 -48 -48 -497 -57 526

577 -50 -50 -552 -14 516

0 1,095 1,098 844 2,193 124 0 -844 1,997 1,225

0 1,074 1,257 1,012 2,331 231 0 -1,012 2,027 1,088

0 1,046 1,307 1,068 2,354 228 0 -1,068 2,053 1,057

0 1,029 1,328 1,083 2,357 231 0 -1,083 2,053 1,043

12/2014e

12/2015e

12/2016e

7.5 11.4 6.4 14.9 4.4 6.9 6.2

7.3 11.1 7.1 14.6 4.3 7.9 6.5

7.9 12.7 7.2 16.7 4.3 6.0 5.7

7.6 12.2 7.3 15.8 4.3 5.9 6.3

Target price

(SAR)101.00





12/2013a

(SAR)97.00



4 . 1

Bloomberg (Equity) QACCO AB Market cap (SARm) 8,730 Enterprise value (SARm) 7718 Sector CONSTRUCTION MATERIALS Contact +966 1 299 2100


Price relative 113

113

103

103

93

93

83

83

73

73

63

63

53 2012

Qassim Cement Company


12/2013a

12/2014e

12/2015e

12/2016e

0.3 4.1 4.6 4.7 9.9

0.3 0.4 0.7 2.1 2.1

-8.5 -13.0 -13.3 -12.5 -12.5

4.3 3.8 5.8 5.7 5.7

0.8 45.3 29.4 26.9 65.9 57.7

0.9 49.8 29.7 26.4 66.0 58.0

0.9 46.5 25.6 22.3 62.8 54.9

1.0 50.3 26.9 23.5 62.4 55.7

-42.3 -1.2

-49.9 -1.5

-52.0 -1.8

-52.7 -1.7

6.50 6.50 6.00 22.19

6.63 6.63 6.30 22.52

5.81 5.81 5.52 22.81

6.14 6.14 6.14 22.81



108

Source: HSBC



2013

2014

53 2015


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Yanbu Cement YNCCO AB, N, TP SAR 78 Company overview Located in the western region, Yanbu Cement has recently become one of the largest producers in terms of capacity after adding a new fifth production line in 2011 and securing fuel allocation from Aramco in 2012, bringing their total capacity to 6mtpa. The company holds a 60% stake in Yanbu Al Shuaiba Paper Products Company, a bag producer.

Investment thesis We expect an increase in sales in the second half, but given the very weak comps (3Q2013 was down 4% and 4Q2013 was down 12%), we expect the company’s sales to improve as construction picks up (as discussed in the sector section above).We also believe that the construction market in Jeddah and the Western Province is improving after the slowdown last year. Construction on Kingdom Tower, expected to be the tallest building in the world, has started. Other major projects include King Abdullah Medical City, the railroad from Mecca to Madinah (going through Jeddah) and the King Abdullah Economic City, where activity has restarted.

Financials The company reported 2Q 2014 net income that was 4% better than we expected due to nonoperational items. On a year-over-year basis, results were down double digits, with EBIT down 20%. However, quarter-over-quarter we are starting to see improvement. Net income for 2Q2014 came in at SAR241m, down -12% yoy

but up 18% qoq and a beat on our estimate of SAR232m. Gross profit SAR238m fell 19% yoy and was below our estimate of SAR255m, but it was up 7% qoq . The miss in gross profit was most likely due to lower volumes than we expected, and not due to higher COGS since Yanbu has met the import requirements and hasn't imported any clinker since Q12014. Yanbu imported a total of 560,000 tons in 2013 and 188,000 tons in the first quarter of this year. EBIT of SAR229m fell 20% yoy (but +8% qoq) and missed our estimate of SAR244m by 6%.


Revenues of SAR446m missed our estimate of SAR465m by 4% and were down 7% yoy and up 2% qoq.

Valuation Our DCF-based target price of SAR78 for Yanbu uses a WACC of 9%, which we calculate using a risk-free rate based on the 12-month SAIBOR rate of 1.8%. We obtain the cost of debt by adding 220bp to 12-month SAIBOR, arriving at 4%. Our market risk premium, based on a combination of relative index returns, CDS spread and inflation differential, is 12.7%. We use a beta of 0.9, which is the average for various large international cement companies. In our DCF calculations, we assume a long-term debt-to-equity ratio of 30:70 and a long-term growth rate of 3%. Under our research model, for stocks without a volatility indicator the Neutral band is 5pp above and below the hurdle rate for Saudi Arabian stocks of 9%. Our target price implies a 6.5% potential return

109


which is within the Neutral band; we therefore reiterate our Neutral rating. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.


 Continued strong demand with prices remaining at the ceiling beyond 2015 would increase the company’s long-term profitability. Downside risks include:

 Aramco could stop providing additional fuel for Yanbu, which would hurt its market share.  New plant capacity in the Western region could increase competition.  Aramco could start charging more for fuel.

110

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Financials & valuation: Yanbu Cement Company Financial statements Year to


12/2014e

12/2015e

12/2016e


Neutral

1,620 1,053 -206 847 -13 842 842 -16 821 821

1,653 1,070 -207 863 -21 848 848 -21 822 822

1,488 916 -207 709 -1 714 714 -18 692 692

1,474 903 -206 697 3 704 704 -18 683 683

Year to


828 -90 -90 -630 104 718

1,193 -83 -83 -779 -480 1,105

923 -74 -74 -655 -69 843

895 -74 -74 -646 -166 816

0 3,281 1,032 311 4,313 182 688 377 3,281 3,819

0 3,156 1,149 617 4,305 212 514 -103 3,322 3,476

0 3,024 1,039 529 4,063 210 357 -172 3,357 3,323

0 2,891 1,203 695 4,094 210 357 -338 3,391 3,189

12/2014e

12/2015e

12/2016e

7.4 11.3 3.1 14.1 3.5 6.2 5.4

6.9 10.7 3.3 14.1 3.5 9.5 6.7

7.7 12.4 3.4 16.7 3.4 7.3 5.7

7.6 12.4 3.5 17.0 3.4 7.0 5.6

Target price

(SAR)78.00





12/2013a

(SAR)73.50



6 . 1

Bloomberg (Equity) YNCCO AB Market cap (SARm) 11,576 Enterprise value (SARm) 11473 Sector CONSTRUCTION MATERIALS Contact +966 1 299 2100


Price relative 82

82

72

72

62

62

52

52

42

42

32 2012

Yanbu Cement Company


12/2013a

12/2014e

12/2015e

12/2016e

8.3 11.3 11.8 12.2 -24.0

2.0 1.6 1.9 0.7 0.1

-10.0 -14.4 -17.8 -15.8 -15.9

-0.9 -1.4 -1.8 -1.3 -1.3

0.4 22.0 25.0 18.6 65.0 52.3 83.4 11.4 0.4 219.9

0.5 23.1 24.9 19.6 64.8 52.2 51.3 -3.1 -0.1

0.4 20.3 20.7 16.6 61.6 47.7 1146.5 -5.1 -0.2

0.5 20.9 20.2 16.8 61.3 47.3

5.21 5.21 4.00 20.83

5.22 5.22 4.95 21.09

4.39 4.39 4.16 21.31

4.33 4.33 4.10 21.53


2013

2014

32 2015


Source: HSBC



-9.8 -0.4


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Abdullah A. M. Al-Khodari Sons ALKHODAR AB, Price SAR51, OW, TP SAR44 Company description Abdullah A. M. Al-Khodari Sons Company was established in 1966 and was publicly listed in September 2010. It is mainly involved in the construction of roads, buildings and environmental services such as waste management and city cleaning. Al-Khodari’s operations are limited to Saudi Arabia and it derives more than 95% of its revenues from the government sector.

Investment thesis 2013 saw Al Khodari perform well during the H1 only to give most of that back in the H2. The stock price was influenced by Saudisation related labour costs that led to a sharp decline in gross margins. Going forward we think margins will recover as labour issues subside and legacy contracts with old pricing finish. On the 1Q conference call, Al Khodari said that while the exact framework and implementation of any change in the procurement laws remain uncertain, changes could take place by 2H. If they were to be introduced, we estimate this could halve the level of receivables for contractors operating in the Saudi market, which could add SAR58 per share to our SAR44 target price. We believe the law is unlikely to be ratified any time soon, but this represents significant option value with Al Khodari stock. The stock is up 53.5% year to date.

112

Financials The 2Q14 net income of SAR7.9m was higher than our estimate of SAR2.7m mainly due to lower material and selling costs, but down -68.8% from 2Q13 net income of SAR25.3m. Higher material and manpower costs contributed to decline in net profit when compared to last year. The increased manpower costs were mainly due to addition of 5,931 employees and work permit costs for expatriate employees. The total contract backlog reached to SAR3,223m at the end of 2Q14. Our core thesis on Al Khodari is for an improving margin due to a tapering of issues related to Saudisation and a declining proportion of legacy contracts (those that pre-date the higher labour costs). According to the company, this improvement is still on track, and margin recovery should start in 2H14.

Valuation We use a DCF methodology to value Al Khodari and our DCF uses explicit forecasts out to 2023 and terminal value assumptions thereafter. WACC of 8.8% is derived from a risk-free rate of 1.8%, representing the 12-month SAIBOR rate. The cost of debt is derived by adding 100bp to the risk-free rate while the market cost of equity is based on a combination of relative index returns, CDS spread and inflation differential to arrive at 12.7%. The long-term beta is Bloomberg’s adjusted beta of 1.18. The debt/equity ratio is assumed to be 50:50 as we think Al Khodari will raise debt to finance working capital requirements. We assume a longterm growth rate of 2.5%.

Nicholas Paton*, CFA Analyst HSBC Bank Middle East +971 4423 6923 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations


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Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price it implied a potential return above the Neutral band; therefore, we rate the stock Overweight. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

Risks  Saudi labour reforms (Saudisation): Al Khodari would experience severe margin pressure in a scenario where the government announced further labour reforms that included higher levels or Saudisation or a further increase in salary for Saudi nationals.  Abrupt slowdown in Saudi spending: Al Khodari’s new order volume will decline significantly in the case of a spending slowdown by the KSA government. Though unlikely in the near term, this presents a risk as Al Khodari derives more than 95% of its revenues from the Saudi government sector.

113

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Financials & valuation: Abdullah A. M. Al-Khodari Financial statements

Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


1,530 243 -145 97 -34 66 66 -2 64 64

1,597 277 -152 126 -42 99 99 -2 96 96

2,100 381 -199 182 -43 158 158 -4 154 154

2,499 473 -237 236 -46 212 212 -5 207 207

Cash flow from operations Capex FCF enterprise Cash flow from investment Dividends Change in net debt FCF equity

Tangible fixed assets Current assets Cash & others Total assets Gross debt Net debt Shareholders funds Invested capital

-65 -247 -278 -247 -27 325 -312

413 -240 200 -240 -27 -147 159

-82 -315 -373 -315 -27 424 -416

91 -325 -210 -325 -27 260 -256

568 2,576 218 3,176 1,483 1,265 810 2,116

655 2,593 364 3,280 1,483 1,119 880 2,039

771 2,840 -60 3,643 1,483 1,543 1,007 2,590

858 3,105 -320 3,996 1,483 1,803 1,187 3,031

(SARm)


12/2013a

12/2014e

12/2015e

12/2016e

0.4 -11.5 -28.4 -54.2 -52.4

4.3 14.3 29.0 49.3 49.3

31.5 37.4 44.5 60.0 60.0

19.0 24.2 29.9 34.6 34.6

0.8 4.9 8.1 3.3 15.9 6.4 7.2 156.1 5.2

0.8 5.9 11.4 4.2 17.4 7.9 6.7 127.2 4.0 36.9

0.9 7.7 16.3 5.6 18.2 8.7 8.9 153.2 4.0

0.9 8.2 18.9 6.6 18.9 9.4 10.2 151.9 3.8 5.1

1.21 1.21 0.50 15.25

1.81 1.81 0.50 16.56

2.89 2.89 0.50 18.95

3.89 3.89 0.67 22.35

Y-o-y % change Revenue EBITDA EBIT PBT HSBC EPS

Per share data (SAR) EPS Rep (fully diluted) HSBC EPS DPS Book value

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12/2013a

12/2014e

12/2015e

12/2016e

2.6 16.2 1.9 42.1 3.3 -11.7 1.0

2.4 13.7 1.9 28.2 3.1 5.9 1.0

2.0 11.1 1.6 17.6 2.7 -15.6 1.0

1.8 9.5 1.5 13.1 2.3 -9.6 1.3

EV/sales EV/EBITDA EV/IC PE* P/Book value FCF yield (%) Dividend yield (%) Note: * = Based on HSBC EPS (fully diluted)

Issuer information (SAR)51.00


Target price (SAR)

1330.SE 722 40 Saudi Arabia Nicholas Paton

44.00

-13.7

Bloomberg (Equity) ALKHODAR AB Market cap (SARm) 2,709 Enterprise value (SARm) 3796 Sector CONSTRUCTION & ENGINEERING Contact +971 4 423 6923

Price relative 54

54

49

49

44

44

39

39

34

34

29

29

24

24

19 2012

2013 Abdullah A. M. Al-Khodari

Source: HSBC


Year to

Share price


Balance sheet summary

Overweight



19 2015

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Saudi Arabian Amiantit Co. SAAC AB, Price SAR18.10, N, TP SAR16.40 Company description Established in Dammam in 1968, Amiantit’s core business is the manufacture and sale of pipe systems. The company serves the municipal, civil engineering, industrial, energy and agricultural markets. It generates 90% of its sales from pipe manufacturing, over 50% of that in Saudi Arabia. The division comprises almost 30 wholly-owned, majority-owned or joint-venture manufacturing facilities in 18 countries, with 11 of them in Saudi Arabia. Amiantit makes pipes from a variety of materials, such as glass reinforced plastic (GRP), glass reinforced epoxy (GRE), thermoplastic (HDPE, PVC and PP), concrete, polymer concrete and ductile iron. GRP is by far the biggest product in this segment. The product range includes pipes and accessories for water, sewage, hydro-power, gas, oil services, construction, engineering, municipal, industrial, agricultural and marine applications.

Investment thesis Amiantit continues to see weak margins and declining revenues. We believe that a recovery may start in later half of 2014 as competitors are forced to exit because of depressed margins, but we remain Neutral on the stock pending any actual signs of recovery.

Financials Amiantit continued to see weak numbers in Q2 14. Net income for the quarter was down 20% while for H1 14 was down 26%. Group top-line also saw significant as sales revenue were down 14% in Q2 14 (down 16% in H1 14). The management pointed to lower average diameter mix in fibreglass sales as well as crackdown on illegal labour in Saudi which hit construction work for the weak growth.

Raj Sinha* Head of EEMEA Research HSBC Bank Middle East Ltd +971 4423 6932 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

Valuation We value Amiantit using a DCF model. The key determinants of our WACC of 11.4% are: a riskfree rate based on the 12-month SAIBOR rate, which is 1.8%; a cost of debt of 4%, which is based on 12- month SAIBOR plus 220bp; and a market cost of equity, based on a combination of relative index returns, CDS spread and inflation differential, which is 12.7%. We use a long-term debt-to-equity ratio of 30:70 and a beta of 1.17. We assume a terminal growth rate of 2%. Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price it implied a potential return above the Neutral band hence we have Neutral rating for Amiantit. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

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 Competition starts to exit the market owing to unsustainable margins  Private sector projects pick up more quickly than expected; and  The concrete piping division starts to break even Key downside risks include:

 Spending in water-transmission piping comes through later than expected;  Demand for steel piping in other segments is slower than we forecast; and  European stabilisation proves unsustainable

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Financials & valuation: Saudi Arabian Amiantit Co Financial statements

Valuation data

Year to

12/2012a

12/2013a

12/2014e

12/2015e


3,455 377 -114 263 -86 140 140 -45 111 111

3,131 296 -69 227 -87 137 137 -44 113 113

3,473 430 -118 312 -57 260 260 -83 167 167

3,614 453 -118 335 -74 276 276 -69 196 196



Year to

-426 -115 -97 -115 732 -546

341 -100 -100 -115 -172 240

112 -108 -108 -142 -292 4

262 -116 -116 -166 -4 146

0 848 3,795 127 4,857 1,179 1,964 1,837 1,568 3,336

0 849 3,457 149 4,411 907 1,814 1,665 1,564 3,250

0 817 3,873 592 4,884 1,174 1,964 1,372 1,583 2,924

0 815 3,949 596 4,972 1,197 1,964 1,368 1,612 2,970

(SARm)

12/2012a

12/2013a

12/2014e

12/2015e

1.1 9.9 1.1 18.8 1.3 -29.0 5.5

1.2 12.3 1.1 18.5 1.3 12.0 5.5

0.9 7.6 1.1 12.5 1.3 0.2 6.8

0.9 7.2 1.1 10.7 1.3 7.7 8.0

Target price

(SAR)16.40






Neutral

(SAR)18.10


2160.SE 557 87 Saudi Arabia Raj Sinha

23

23

21

21

19

19

17

17

15

15

13

13

11

11

9 2012

2013 Saudi Arabian Amiantit Co

12/2012a

2014

9 2015


Source: HSBC

12/2013a

12/2014e



Bloomberg (Equity) SAAC AB Market cap (SARm) 2,091 Enterprise value (SARm) 3279 Sector Building Products Contact +971 4423 6932

Price relative


9 . 4

-3.0 -20.7 -18.8 -38.9 -26.4

-9.4 -21.4 -13.6 -1.9 1.1

10.9 45.1 37.0 89.2 48.1

4.1 5.3 7.6 6.4 17.3

1.2 6.0 7.0 2.1 10.9 7.6 4.4 107.2 4.9

1.0 4.7 7.2 2.0 9.5 7.3 3.4 98.4 5.6 20.5

1.1 6.9 10.6 3.8 12.4 9.0 7.6 79.9 3.2 8.1

1.2 8.5 12.2 4.2 12.5 9.3 6.1 77.7 3.0 19.1

0.97 0.97 1.00 13.59

0.98 0.98 1.00 13.56

1.45 1.45 1.23 13.72

1.70 1.70 1.44 13.98


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Saudi Steel Pipes SSP AB, Price SAR35.3, N, TP SAR37.50 Company description Saudi Steel Pipes (SSP) was established by three Saudi entrepreneurs and Hu Steel Pipe Company of South Korea. SSP produces galvanised and non-galvanised steel pipes, square and rectangular pipes, and HFI (high-frequency induction) welded steel pipe. It predominantly serves the region’s oil and gas and construction markets. The company currently has production capacity of 160,000 metric tons of high-quality HFI welded steel pipe. Its four lines produce pipes ranging in diameter from half an inch to 16 inches. Large-diameter pipes: SSP’s HFI welding steel pipe mill produces pipes with diameters ranging from 6 inches to 16 inches. Small-diameter pipes – tubing: The other three lines produce a variety of small diameter pipes, including pipes for construction (scaffolding and fence posts), conduits for electrical cables, pipes for water, steam and compressed air, and chilled water system pipes. The company can also produce small-diameter pipes that are zinc galvanised.

Investment thesis SSP was one of the best performers in the Saudi infrastructure space during 2013. The company saw strong top-line growth of 16% during 2013, while competitors saw falling revenues and shrinking margins. In contrast, SSP saw a significant improvement in profitability with the 2013 operating margin increasing by 2pp y-o-y. In our

118

note ‘Saudi Infrastructure: Prefer SSP over Zamil and Amiantit’, 6 August 2013, we pointed out that we thought SSP was best placed within the Saudi infrastructure space to weather the headwinds from oversupply and construction project delays because it relies more on Aramco contracts, which are generally more stable. However 2014 has been a weak year for SSP as increasing competition from international players as well as problems in associate companies hit the margins.

Financials SSP reported 38% drop in net income during Q2 14 with H1 14 net income seeing a significant 60% drop as the group’s profitability was hit by increasing international competition as well as problems in associates and increasing labour costs.

Valuation We value SSP using a DCF model. The key determinants of our WACC of 11.6% are: a riskfree rate based on the 12-month SAIBOR rate, which is 1.8%; a cost of debt of 4%, which is based on 12-month SAIBOR plus 220bp; and a market cost of equity, based on a combination of relative index returns, CDS spread and inflation differential, which is 12.7%. We use a long-term, debt-to-equity ratio of 30:70 and a beta of 1.20. We assume a long term growth rate of 2%. Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi stocks of 9%. Our target price of SAR37.5 implies a potential return of 6%, within the Neutral band, hence we are Neutral on SSP. Potential return

Raj Sinha* Head of EEMEA Research HSBC Bank Middle East Ltd + 971 4423 6932 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations


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equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.


 Higher-than-expected order flow, especially from Saudi Aramco Key downside risks include:

 SSP being unable to increase capacity for smalldiameter pipes to cope with growing demand  Competition from seamless piping hurting large-diameter sales

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Financials & valuation: Saudi Steel Pipes Financial statements

Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


839 107 -24 83 -2 79 79 0 79 79

1,012 138 -27 111 -3 116 116 0 116 116

1,118 168 -33 135 -3 140 140 0 140 140

1,233 193 -38 155 -3 160 160 0 160 160



Year to

56 -215 -222 -69 267 -167

154 -74 -74 -93 -369 64

181 -115 -115 -112 46 52

214 -62 -62 -128 -24 135

0 701 519 54 1,344 134 415 362 794 1,031

0 487 521 154 1,156 169 146 -8 840 685

0 568 473 108 1,198 183 146 38 868 750

0 592 490 132 1,247 201 146 14 900 750

(SARm)

12/2013a

12/2014e

12/2015e

12/2016e

2.4 19.0 2.0 22.7 2.3 -10.0 3.8

1.6 11.9 2.4 15.5 2.1 3.9 5.2

1.5 10.0 2.2 12.9 2.1 3.2 6.2

1.3 8.5 2.2 11.3 2.0 8.3 7.1

Target price

(SAR)37.50






Neutral

(SAR)35.30



47

47

42

42

37

37

32

32

27

27

22

22

17 2012

2013 Saudi Steel Pipes

12/2013a

Source: HSBC

12/2014e

12/2015e



15.6 33.3 44.2 47.9 47.9

20.6 28.8 33.3 46.1 46.1

10.5 21.4 21.4 20.6 20.6

10.3 15.2 15.0 14.3 14.3

0.9 9.3 10.0 6.6 12.8 9.9 59.7 45.5 3.4 15.5

1.2 12.9 14.2 9.3 13.6 11.0 48.0 -0.9 -0.1

1.6 18.8 16.4 11.9 15.0 12.0 55.7 4.4 0.2 475.9

1.6 20.7 18.1 13.1 15.7 12.6 55.7 1.5 0.1 1542.7

1.56 1.56 1.34 15.57

2.28 2.28 1.82 16.47

2.74 2.74 2.20 17.02

3.14 3.14 2.51 17.65


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Bloomberg (Equity) SSP AB Market cap (SARm) 1,800 Enterprise value (SARm) 1645 Sector BUILDING PRODUCTS Contact +971 4423 6932

Price relative


6 . 2


17 2015

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Zamil Industries ZIIC AB, Price SAR60.75, N, TP SAR48 Company description Zamil Industrial Investment Company (ZIIC) operates through four primary business units: Zamil Air Conditioners, Zamil Steel Industries, Zamil Glass Industries and Arabian Fibreglass Insulation Co Ltd. The company sells its products in more than 60 countries and has manufacturing facilities in Saudi Arabia, United Arab Emirates, Egypt, Austria, India, Vietnam and Italy. The Zamil Air Conditioning (ZAC) division designs, manufactures, tests, markets and services a comprehensive range of air-conditioning products, from compact room air conditioners and mini splits to large-scale central air conditioners, chillers and air-handling units for highly specialised commercial and industrial applications, marketed under various brand names. ZAC’s factories are located in Dammam, Saudi Arabia, for standard units and in Italy and Austria for specialised units. ZAC also produces branded air conditioners for several international manufacturers, including a joint venture with General Electric. Zamil Steel (ZS) manufactures pre-engineered steel buildings and various structural steel products, including transmission towers. It manufactures a total of 250,000mt of fabricated steel a year for both lowand high-rise steel buildings and structures for diverse uses, including storage for the oil and gas industries.

ZS’s main factories are in Dammam, Saudi Arabia. Additional factories are located in Egypt, Vietnam and Ras Al Khaima (UAE). The insulation division is a much larger component of revenues (10%) following the completion of the merger with the Gulf Insulation Group, consolidated from 1st January 2011 – Zamil owns 51% of the merged entity.


Investment thesis We see strong growth potential for Zamil’s air conditioning division and estimate double digit growth in 2015. However, in order to see further upside in the stock, we believe the steel division will also need to show revenue growth without compromising margins. In the current market conditions, this is difficult to predict, but we believe the recent labour shortages will have affected competitors who tend to hire more temporary workers and, as a result, an environment with better pricing power for Zamil may arise.

Financials Zamil reported 3% drop in revenues during Q2 14 with both air-conditioning and steel divisions seeing marginal declines. However, operating margins of the group saw 50bp improvement thanks to improving margins in steel division which we believe is due to dropping competition in the sector.

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Valuation We value Zamil using a DCF model. The key determinants of our WACC of 10.4% are: a riskfree rate based on the 12-month SAIBOR rate, which is 1.8%; a cost of debt of 4%, which is based on 12-month SAIBOR plus 220bp; and a market cost of equity, based on a combination of relative index returns, CDS spread and inflation differential, which is 12.7%. We use a long-term debt-to-equity ratio of 30:70 and a beta of 1.03. Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price it implied a potential return within the Neutral band; hence, we have a Neutral rating on Zamil. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.


 An improvement in steel division margins in the near term; and  Stronger-than-expected growth in the air conditioning market. Key downside risks include:

 A fall in demand for prefabricated building units in the commercial sector; and  Entry of competitors to the Saudi airconditioning market and probable pricing pressure

122

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Financials & valuation: Zamil Industries Financial statements

Valuation data

Year to

12/2012a

12/2013a

12/2014e

12/2015e


5,393 510 -146 364 -91 285 285 -41 201 201

5,414 540 -139 400 -86 287 287 -35 235 235

5,927 599 -161 437 -88 354 354 -35 268 268

6,196 649 -191 458 -80 383 383 -38 289 289



Year to

311 -216 -211 -90 81 91

302 -191 -155 -90 -45 44

451 -190 -190 -134 -198 256

515 -198 -198 -173 -183 312

181 1,585 4,436 346 6,478 1,545 3,218 2,872 1,451 4,310

159 1,624 4,512 269 6,908 1,932 3,095 2,826 1,609 4,094

181 1,651 4,847 589 6,955 1,647 3,218 2,628 1,729 4,442

181 1,658 5,086 772 7,202 1,723 3,218 2,446 1,845 4,430

(SARm)

12/2012a

12/2013a

12/2014e

12/2015e

1.2 12.2 1.4 18.1 2.5 2.7 2.5

1.1 10.9 1.4 15.5 2.3 1.5 2.5

1.0 10.0 1.4 13.6 2.1 7.6 3.7

0.9 9.0 1.3 12.6 2.0 9.3 4.8

Target price

(SAR)48.00






Neutral

(SAR)60.75




64 59 54 49 44 39 34 29 24 19 2012

2013

2014

64 59 54 49 44 39 34 29 24 19 2015


Source: HSBC

12/2013a

12/2014e



Bloomberg (Equity) ZIIC AB Market cap (SARm) 3,645 Enterprise value (SARm) 5997 Sector BUILDING PRODUCTS Contact +971 4423 6932

Price relative

Zamil Industries

Year to

2 1 . 0

13.8 24.6 33.8 33.6 30.7

0.4 5.8 10.0 1.0 16.8

9.5 11.0 9.2 23.3 13.7

4.5 8.3 4.8 8.0 8.0

1.3 7.5 14.4 5.1 9.5 6.7 5.6 167.4 5.6 10.8

1.3 8.4 15.4 4.9 10.0 7.4 6.3 150.3 5.2 10.7

1.4 9.2 16.0 5.7 10.1 7.4 6.8 125.7 4.4 17.1

1.4 9.3 16.2 5.9 10.5 7.4 8.1 108.1 3.8 21.1

3.36 3.36 1.50 24.18

3.92 3.92 1.50 26.81

4.46 4.46 2.23 28.82

4.82 4.82 2.89 30.75


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Arabian Pipes Co. APCO AB, Price SAR25, Not Rated Company description Arabian Pipes Co. (APC), which started production in mid-1995, specialises in the manufacturing and anti-corrosion coating of medium-range highfrequency welded (HFW) steel pipe, mainly for the oil and gas and petrochemical sectors. APC is among the largest manufacturers of HFW pipes in the Middle East. The main areas of application of products manufactured by APC are: line pipe applications used in the long distance transport of oil and gas, structural applications used for general fabrication and construction, general-purpose applications used for industrial water, irrigation and distribution, standard pressure applications used to transmit different types of fluids, casting applications used primarily for oil, gas and water well casings. Abdul Kader Muhaidib and Sons Co. is the major shareholder in the company with 13.8% stake.

Financials APC reported FY2013 net income of SAR9.7m compared to a net loss of SAR25m in FY2012 which according to the company was mainly on the back of selling of Taqa investment for SAR56m. The company saw loss at the operating profit line to the tune of SAR17m as margins continued to remain weak. During FY 2012, even though the company had seen significant growth in top-line which more than doubled, margins remained under pressure and APC reported net loss of SAR25m. The management has attributed the significant drop to lack of projects in Jubail plant.

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Recent news  On 17 Jul 2014, APC announced Q2 14 results. The company reported net loss of SAR14m during the quarter compared to SAR5m loss seen in Q2 13. Management pointed to increase in cost of production as a result of increase in raw material price for some projects as the main reason for the weaker performance. Furthermore no dividends from associates were seen in Q2 14 compared to SAR6m in Q2 13.  On 4 May 2014, APC management announced that the group won a SAR46m contract for supplying 258km of welded steel pipes to Saudi Aramco. The financial impact of this project will be seen in Q3 2014 according to management.

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Financials & valuation: Arabian Pipes

Not Rated

Financial statements

Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a

Profit & loss summary (SARm) 256 34 14 -6 -8 4 4 0 -4 -4

Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit

275 50 -2 9 -18 1 1 0 -7 -7

680 42 6 2 -25 -19 -19 0 -25 -25

383 16 32 -17 -25 21 21 0 10 10

103 -6 -6 0 -111 97

-57 -14 -14 0 57 -71

-135 -10 -10 0 143 -144

98 -5 163 0 -232 94

0 513 649 21 1,306 51 515 494 733 1,285

0 489 747 7 1,377 70 572 565 727 1,370

0 467 880 6 1,463 38 715 709 701 1,458

0 442 792 35 1,234 29 483 447 711 1,199



(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

5.7 43.7 1.1

5.3 29.6 1.1

2.2 34.8 1.0

3.8 91.4 1.2

1.4 9.5 0.0

1.4 -7.0 0.0

1.5 -14.1 0.0

1.4 9.2 0.0






Year to

(SAR) 25.51

Reuters (Equity) Market cap (USDm) Country Analyst

Target price

2200.SE 272 Saudi Arabia Not Rated

Bloomberg (Equity) APCO AB Market cap (SARm) 1,020 Sector Building Products Contact Not Rated

Price relative 40

40

35

35

30

30

25

25

20

20

15

15

10 2012

10 2013 Arabian Pipes

2014 Rel to Tadawul

Source: HSBC


1 7 . 2

(SAR) Not Rated

12/2010a

12/2011a

12/2012a

12/2013a

-41.7 -58.8 -111.9 -85.7 -114.0

7.4 47.9 -250.9 -68.1 90.8

147.5 -14.9 -78.3

-43.6 -62.0

0.2 -0.3 -0.5 -0.3 13.1 -2.2 4.1 0.7 14.7 0.2

0.2 -0.5 -0.9 -0.5 18.1 3.1 2.8 0.8 11.4 -0.1

0.5 -1.7 -3.6 -1.7 6.2 0.3 1.7 1.0 16.8 -0.2

0.3 0.8 1.4 0.8 4.2 -4.5 0.6 0.6 27.9 0.2

-0.09 -0.09 0.00 18.33

-0.17 -0.17 0.00 18.16

-0.63 -0.63 0.00 17.53

0.24 0.24 0.00 17.77


Y-o-y % change Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) Revenue/IC (x) ROIC ROE ROA EBITDA margin Operating profit margin EBITDA/net interest (x) Net debt/equity Net debt/EBITDA (x) CF from operations/net debt Per share data (SAR) EPS Rep (fully diluted) HSBC EPS (fully diluted) DPS Book value

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Middle East Specialized Cables Co. MESC AB, Price SAR16.5, Not Rated Company description Middle East Specialized Cables Company (MESC), established in 1993, manufactures industrial, instrumentation and process control cables. It also makes power cables and control cables, which include telephone computer cables, specialized to transfer data and radio signals. In 2003, the company acquired a controlling stake in Jordanian National Cables Company (JNCC) – publicly listed in Jordan – to complete its product range of low-voltage power cables. JNCC serves the Jordanian and Saudi markets. In May 2007, MESC started production of medium-voltage power cables by establishing a joint venture in Jordan with Fujikura Company. MESC Fujikura Cable Company produces lowand medium-voltage power cables and began commercial production at the beginning of 2009. MESC generates significant revenues from Saudi, Jordan and UAE markets. The company’s clients include oil & gas industry, industrial projects, hotel, hospitals as well as commercial establishments

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Financials During FY2013 MESC reported a drop of 1.5% in net income which came in at SAR30.6m. During the year the company saw 9.3% drop in gross profits and 4.5% drop in operating profits. Management pointed to drop in sales volumes on the back of postponement of some orders from EPC (Engineering, procurement and construction) customers for the weaker gross profits during the year.

Recent news  On 21 Jul 2014, MESC announced Q2 14 results. Net income for the quarter came in at SAR10m compared to SAR0.02m in Q2 13. According to management, increased sales volumes as well as better margins were key drivers of net income growth. Operating income for the quarter came in at SAR17.85m compared to SAR7.69m in Q2 13.

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Financials & valuation: Middle East Specialized Cable Co. Financial statements

Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a

Profit & loss summary (SARm) 1,029 50 -45 6 -31 -119 -119 -2 -95 -95


1,139 31 -51 -20 -39 -161 -161 0 -120 -120

991 101 -46 55 -41 8 8 0 31 31

931 95 -45 50 -41 24 24 -7 30 30

108 -63 -63 -42 29 46

-61 -37 -39 0 87 -97

97 -30 -30 0 -34 67

-51 -29 15 0 -187 -73

75 608 687 54 1,417 154 809 756 367 1,364

4 609 734 48 1,382 189 896 848 243 1,335

3 594 706 70 1,354 179 862 792 282 1,284

0 546 781 37 1,400 198 675 638 504 1,363



Year to

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

1.6 32.3 1.2

1.4 53.0 1.2

2.1 4.6 4.2

3.2 -9.9 0.0

1.6 16.1 1.3 31.8 2.7 6.8 0.0

1.7 17.2 1.2 32.5 2.0 -8.1 0.0






Not Rated

(SAR) 16.48


Target price


Bloomberg (Equity) MESC AB Market cap (SARm) 989 Sector Building Products Contact Not Rated

Price relative 25

25

20

20

15

15

10

10

5 2012

5 2013 MESC

2014 Rel to Tadawul

Source: HSBC


1 7 . 2

(SAR) Not Rated

12/2010a

12/2011a

12/2012a

12/2013a

-0.5 -66.9 -95.1

10.7 -39.0

-13.1 228.5

-6.0 -6.1 -9.9



-2.2


0.8 -7.0 -25.9 -6.7 4.9 0.6 1.6 2.1 15.0 0.1

0.9 -9.0 -49.5 -8.7 2.7 -1.8 0.8 3.5 27.6 -0.1

0.8 2.4 11.0 2.3 10.2 5.6 2.4 2.8 7.9 0.1

0.7 2.2 6.0 2.2 10.2 5.3 2.3 1.3 6.7 -0.1

-1.58 -1.58 0.69 7.90

-2.00 -2.00 0.00 5.22

0.52 0.52 0.00 6.06

0.51 0.51 0.00 8.40


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Saudi Cable Co. SCACO AB, Price SAR12.4, Not Rated Company description Saudi Cable Company (SCC) is a manufacturer of power cables in Saudi Arabia founded in 1975 by the Xenel Industrial Group. SCC manufactures and sells power and telecom cables and accessories. It also provides turnkey services for the energy and telecom sectors. SCC operates a fully integrated Jeddah power cable plant where it produces its own copper rod, plastic (PVC) and PE insulation compounds as well as its own packaging materials. SCC currently has a total production capacity of more than 140k metric tons. SCC produces fibreoptic cables as well as power cables. It owns a controlling interest in Mass Khablo, the Turkish cable maker, and a non-controlling interest in Bahrain-based Midal. The company also has a 79% stake in Elmison, a Turkish producer of power switches and accessories. The company also has international trade office in Ireland and UAE.

Financials During 2013, Saudi Cable Co reported 9% drop in sales revenues. Losses widened and the company reported a net loss of SAR229m in 2013 compared to SAR156m in 2012. Management pointed to inadequate funding which was leading to material disruption in the group’s operations for the weaker numbers.

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Recent news  On 17 Jul 2014, SCC announced Q2 14 results. Net loss for the quarter came in at SAR51m compared to SAR132m in Q2 13. Management highlighted lower operating expenses and lower provisions for doubtful debts as drivers of a better performance yoy.  On 2 Jul 2014, SCC management announced that the company will initiate the process of applying to the CMA for the capital increase through a rights issue.  On 27 May 2014, SCC management announced that a fire had broken out in the Fiberoptic Cables factory in Jeddah Industrial City, Phase 4. Management explained that the fire has not had any significant effect on the Fiberoptic Cables factory and that nobody was hurt or injured.

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Financials & valuation: Saudi Cable Co. Financial statements

Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a

Profit & loss summary (SARm) 1,857 -61 -97 -158 -64 -77 -77 -4 -88 -88


3,200 58 -74 -16 -72 1 1 0 5 5

2,688 -34 -86 -120 -110 -160 -160 -4 -156 -156

2,448 -102 -94 -196 -153 -209 -209 -29 -229 -229

-244 -165 -134 -57 450 -401

-271 -122 -121 -57 418 -355

515 -154 -146 0 -330 384

436 -62 -54 0 -389 398

101 857 2,366 124 3,643 473 1,817 1,693 1,184 3,518

132 874 2,786 93 4,107 712 2,236 2,142 1,009 4,014

144 920 2,369 132 3,774 807 1,906 1,773 915 3,642

154 826 1,748 122 3,212 906 1,517 1,395 674 3,090



Year to

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

1.3

0.9

1.0

0.7

0.7 40.6 0.6

0.6

0.8

0.8 -43.2 6.0

0.9 -41.5 6.0

1.0 38.1 0.0

1.4 39.6 0.0






Not Rated

(SAR) 12.44


Target price


Bloomberg (Equity) SCACO AB Market cap (SARm) 945 Sector Building Products Contact Not Rated

Price relative 30

30

25

25

20

20

15

15

10

10

5

5

0 2012

0 2013 Saudi Cables

2014 Rel to Tadawul

Source: HSBC


1 7 . 2

(SAR) Not Rated

12/2010a

12/2011a

12/2012a

12/2013a

-24.5

72.3

-16.0

-8.9



31.0 46.5


0.5 -2.5 -7.4 -2.4 -3.3 -8.5 -1.0 1.4 -27.6 -0.1

0.8 0.1 0.5 0.1 1.8 -0.5 0.8 2.1 37.2 -0.1

0.7 -4.3 -17.1 -4.1 -1.3 -4.5 -0.3 1.9 -52.1 0.3

0.8 -7.4 -34.0 -7.1 -4.2 -8.0 -0.7 2.1 -13.7 0.3

-1.16 -1.16 0.75 15.57

0.07 0.07 0.75 13.28

-2.06 -2.06 0.00 12.04

-3.01 -3.01 0.00 8.86


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Saudi Paper Manufacturing Company SPM AB, Price SAR42.7, Not Rated Company description Saudi Paper Manufacturing Company was established in 1989. Its business activity is mainly comprised of the manufacture of high quality tissue paper and paper recycling. In 1992, the first paper machine was installed to produce 16,000 ton/year of jumbo tissue paper rolls. In 1994, a de-inking plant was installed to treat waste paper and turn it into raw material suitable for tissue machine production. In 1995, a second paper machine was installed to produce 24,000 ton/year. In 2001, a third 30,000 ton/year paper machine was installed, bringing the total production capacity of tissue paper to 70,000 ton/year. Saudi Recycling Co. was established in 2002 to collect all kinds of waste paper, partly for in-house use in the de-inking plant and the rest is sold to outside consumers. Saudi Converting Co. was established in 2003 to produce several consumer tissue paper products. The company uses virgin pulp, blended-fibers, and de-inked papers as raw materials.

Financials Saudi Paper Manufacturing Company reported 3% growth in revenues during 2013. The group gross margins were down 4.5pp while operating margins were down 5.65pp on a y-o-y basis.

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Recent news  On 21 Jul 2014, Saudi Paper Manufacturing Company announced Q2 14 results. Net income for the quarter was up by 29% mainly due to one-off write down of non-usable raw materials in the base period. Operating profit for the period was down 12% due to drop in gross margins and cut in selling prices of converted tissue products.

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Financials & valuation: Saudi Paper Manufacturing Co. Financial statements

Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a

Profit & loss summary (SARm) 804 185 -50 135 -12 125 125 0 123 123


836 152 -40 112 -15 104 104 0 100 100

794 152 -50 102 -21 106 106 0 102 102

820 108 -49 59 -27 35 35 0 32 32

85 -110 -110 -38 62 -23

74 -118 -164 -45 167 -41

116 -62 -51 -53 44 54

140 -10 -9 -56 -162 133

13 855 614 36 1,507 72 821 785 595 1,471

28 952 715 67 1,732 69 989 922 651 1,665

25 946 839 123 1,848 89 1,033 909 701 1,725

23 907 830 70 1,765 129 930 860 677 1,694



Year to

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

3.5 15.1 1.9 15.7 3.2 -1.3 2.0

3.3 18.3 1.7 19.1 3.0 -2.3 2.3

3.5 18.3 1.6 18.8 2.7 2.8 2.7

3.4 25.8 1.6 60.6 2.8 6.8 2.9






Not Rated

(SAR) 42.67


Target price


Bloomberg (Equity) SPM AB Market cap (SARm) 1,920 Sector Building Products Contact Not Rated

Price relative 60

60

50

50

40

40

30

30

20

20

10 2012

10 2013 Saudi Paper

2014 Rel to Tadawul

Source: HSBC


1 7 . 2

(SAR) Not Rated

12/2010a

12/2011a

12/2012a

12/2013a

44.1 24.9 26.5 29.4 30.4

4.0 -17.8 -16.7 -17.3 -18.1

-5.0 0.2 -9.0 1.8 1.7

3.3 -29.2 -42.2 -66.7 -69.0

0.5 8.3 20.6 8.1 23.0 16.7 15.5 1.3 4.3 0.1

0.5 6.0 15.4 5.8 18.2 13.4 10.1 1.4 6.1 0.1

0.5 5.9 14.6 5.5 19.2 12.8 7.4 1.3 6.0 0.1

0.5 1.9 4.7 1.8 13.1 7.2 4.0 1.3 8.0 0.2

2.72 2.72 0.83 13.22

2.23 2.23 1.00 14.46

2.27 2.27 1.17 15.58

0.70 0.70 1.25 15.04



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United Wire Factories Company ASLAK AB, Price SAR49.9, Not Rated Company description United Wire Factories (Aslak) was established in 2006 as a result of the mergers of three companies:  Saudi Wire Factory (est. 1982)  AlRiyadh Wire Company (est. 1989)  Gulf Wire Company (est. 1990) The company manufactures and markets products for the construction and building materials sector through eight factories spread throughout the Kingdom. Aslak supplies steel rebars, concrete welded mesh, nails, chain link fence, barbed wires, and cloth hangers. The company went public in June 2011.

Financials Aslak reported flat revenues in 2013 while gross margins improved by 1.35pp on a y-o-y basis. Operating margins of the group improved by 55bps y-o-y. The management pointed to strong cost control for the better performance. During 2013, construction & building material sector accounted for 81% of the revenues while civil sector accounted to the rest.

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Recent news  10 July 2014 Aslak management announced Q2 14 results. Net income for the group dropped by 11% y-o-y in Q2 14 implying 17.7% drop in H1 14. According to management, a drop in sales and increases in operating costs were the key causes of weaker performance.

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Financials & valuation: United Wire Factories Co. Financial statements

Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a

Profit & loss summary (SARm) 571 139 -22 117 0 116 116 0 116 116


855 121 -15 106 0 107 107 0 107 107

1,005 133 -19 115 0 115 115 0 115 115

1,001 138 -18 120 0 121 121 0 121 121



Year to

121 -27 -24 -56 -2 94

80 -26 -25 -49 0 54

72 -17 -17 -73 0 55

123 -32 -31 -49 0 91

0 109 275 74 384 54 0 -74 329 311

0 119 299 79 418 37 0 -79 378 339

0 118 316 61 434 19 0 -61 411 373

0 131 386 104 517 41 0 -104 473 413

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

3.7 15.1 6.7 18.9 4.2 4.3 2.6

2.4 17.3 6.2 20.5 5.8 2.5 2.2

2.1 15.6 5.6 19.0 5.3 2.5 3.3

2.1 15.1 5.0 18.0 4.6 4.2 2.2






Not Rated

(SAR) 49.90


Target price


Bloomberg (Equity) ASLAK AB Market cap (SARm) 2,189 Sector Building Products Contact Not Rated

Price relative 60

60

50

50

40

40

30

30

20

20

10 2012

10 2013 Aslak

2014 Rel to Tadawul

Source: HSBC


1 7 . 2

(SAR) Not Rated

12/2010a

12/2011a

12/2012a

12/2013a

36.9 23.1 25.6 24.6 24.6

49.9 -12.7 -9.3 -7.6 -7.6

17.6 10.4 8.4 7.9 7.9

-0.4 3.6 4.5 5.2 5.2

1.8 37.2 35.2 30.1 24.3 20.5

2.5 31.6 28.3 25.6 14.1 12.4

2.7 31.0 28.0 26.6 13.3 11.4

2.4 29.3 25.7 23.5 13.8 12.0

-0.2 -0.5 -1.6

-0.2 -0.7 -1.0

-0.1 -0.5 -1.2

-0.2 -0.8 -1.2

2.64 2.64 1.28 11.79

2.44 2.44 1.11 8.62

2.63 2.63 1.67 9.38

2.76 2.76 1.11 10.78



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Consumers

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Consumers  We see strong growth for Saudi consumers in coming years from

an increasing number of jobs, while Saudis are borrowing aggressively and companies are ramping up investment  2013 growth was always likely to be muted due to a high base effect and little movement in salaries in 2012  However, Saudi consumers are now trading on par with peers; hence, while the backdrop remains positive, we believe it is time to be more selective

4,000 2,000 2009 Salary-Public Growth-Public (rhs) Source: HSBC estimates

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2011

2012 Salary-Private Growth-Private (rhs)

15

10

CEEMEA Source: Thomson Reuters Datastream

Saudi

Jan-14

6,000

20

Jul-13

8,000

Jan-13

10,000

Jul-12

60% 50% 40% 30% 20% 10% 0% -10% -20%

12,000

Jan-12

14,000

One-year forward PE – MENA consumers on par with CEEMEA consumers 25

Jul-11

Public and private sector monthly salaries in Saudi (SAR)

However, the lacklustre growth of 2013 has not prevented multiple expansion in the Saudi consumer sector – when we look at one-year forward PE multiples, the stocks in aggregate are now trading at record high levels and are on par

Jan-11

In our note Saudi Consumers: More incomes not more income, published on 14 August 2013, we highlighted how salaries have evolved in Saudi Arabia, with the biggest change occurring in 2011 and subsequent changes being relatively small (although in the case of the private sector, there were cuts).

Jul-10

Since the ‘Arab Spring’ in 2011, the Saudi government has embarked on a number of initiatives to increase the income of the Kingdom’s population and increase the number of people employed.

Hence, for consumer stocks, while sales growth in 2012 was fuelled by these salary increases in 2011, the sales growth for the consumer stocks for 2013 was always going to be more muted. This was particularly the case for Q3 (which in any case is seasonally a weak quarter) and many investors worried it was due to Saudization initiatives.

Jan-10

2012 was a tough act to follow

Raj Sinha* Head of EEMEA Research HSBC Bank Middle East Ltd. +971 4 423 6932 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

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with CEEMEA consumer peers. And we can see why this has occurred: the story of the Saudi consumer is one of a young population finding employment via various government-driven initiatives. Further, the currency peg offers a degree of comfort to investors who wish to avoid the uncertainties in other emerging markets.

Discount to peers has closed, what next? The question is what to do next with the Saudi consumer stocks. It is entirely possible for the Saudi sector to move to a premium, again based on the reasons mentioned above and because further spending could be stimulated by the reintroduction of the unemployment benefit, affecting 12% of the workforce. In our previous report we have discussed the impact of the unemployment benefit being removed; the impact is approximated SAR2.4bn per month, however, this now looks to be continued in one form or another. To begin with, compulsory unemployment insurance is being introduced by the government; here the employer will contribute, whilst the individual is employed and the insurance fund will pay up upon the individual losing his/her job. Second, the Human Resources Development fund has effectively introduced training programmes for those who cannot find employment, where the individual

Total salaried income by segment per month (SARbn) 40

35 30 25 20 15 10 5 2009 Public

2011 Private

2012

Unemployment benefit

Source: HSBC estimates

will receive a stipend (although it’s not clear, whether Saudis need to attend the programme to simply receive the income).

Loan growth supports a more positive take Since December 2011 we’ve seen loan growth to the consumer sector increase at quite some pace. Whilst the latest data we have is until Q3 2013, the read-across from the latest results from banks is that there is no slowdown here. Given that the loans have grown somewhat since the last peak, one could raise concerns about an overburdened consumer; however, the number of people employed has grown significantly and so has the average salary, and as the chart shows below, there is still more room to borrow.

Saudi Arabia – consumer loans – strong growth for consumer loans outside auto and credit cards

Saudi – total consumer loans (SARm) versus consumer loans per people employed to avg. salary

350

1,400

35

1,200

30

250

1,000

25

200

800

20

150

600

15

100

400

10

50

200

5

0

0

Jun-13

Dec-12

Jun-12

Dec-11

Credit cards

Jun-11

Jun-10

Others

Dec-10

Dec-09

Jun-09

Jun-08

Dec-07

Source: SAMA

Dec-08

Auto & equipment

300

0 2009 Loans

2010

2011

2012

2013

Loans per emplo yed to avg. salary (rhs)

Source: SAMA, HSBC estimates

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Abdullah Al Othaim Markets AOTHAIM AB, Price SAR108.50, Neutral, TP SAR82 Company description Abdullah Al Othaim Markets is the second largest food retailer in Saudi Arabia. Established in 1980, the company has a major presence in the Central and Eastern regions of the Kingdom, rather than in the country’s most populated area, the Western region. During 2013, Central region contributed 74%, while Eastern region contributed 12% of group revenues. The company operates 121 stores across Saudi Arabia as of end-2013, including supermarkets, hypermarkets, corner stores and wholesale markets, with more than 200,000 sqm of selling space.

Investment thesis Al Othaim has been seeing strong revenue growth over the last few quarters, as the strong store openings made in 2013 are now starting to contribute to the group’s top line. We estimate the strong growth to continue in the medium term with increasing penetration of modern retail in the country of which Al Othaim is among the biggest beneficiaries. In 2012, the company’s top-line growth had slowed down as the new store openings were quite limited. However, in 2013-14, the growth has picked up following a spate of openings.

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Apart from this, Al Othaim has also seen a strong increase in rental income during 2013-14 on a y-o-y basis. From discussions with shopkeepers in the malls that OREIDC (Othaim Real Estate Investment and Development Co) operates we believe that rents are going up; however, this has not been confirmed by the company. Although we see strong growth prospects for Al Othaim in the medium term, especially at the topline level, retail operating margins of the group have failed to report any strong improvement unlike its main competitor Panda. Furthermore, Al Othaim’s share price is up by more than 80% over the last 12-month period, which, in our view, prices in the growth potential; hence, we are Neutral on the stock.

Financials Al Othaim reported more than 30% revenue growth in Q2 2014, leading to more than 22% revenue growth for the first half of the year. Management has pointed to strong pre-buying for Ramadan as the main reason for the strong growth. The pre-buying period fell in Q2 during 2014 instead of Q3 which was the case in 2013. However, as per our estimates, Ramadan buying could lead to 8-10% incremental growth, which still leaves c20% organic sales growth for the group in Q2 2014, which implies it was among the strongest quarter over the last three-year period. In terms of operating margins for H1 2014, the group has seen only a 5bp improvement.

Raj Sinha* Head of EEMEA Research HSBC Bank Middle East Ltd + 971 4423 6932 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations


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Valuation We value Al-Othaim using a DCF model. The WACC of 11% is derived from a risk-free rate based on the 12-month SAIBOR rate of 1.8%; we obtained the cost of debt by adding 220bp to the 12-month SAIBOR, arriving at 4%. Our cost of equity, based on a combination of relative index returns, CDS spread and inflation differential, is 12.7%. We use a long-term debt-to-equity ratio of 30%:70% and a beta of 1, obtained from Bloomberg. Our DCF generates a 12-month target price of SAR82. Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price, it implied a potential return within the Neutral band; therefore, we rate the stock Neutral. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.


 Stronger-than-expected improvement in operating margins  Strong growth in rental revenues Key downside risks include:

 Slower-than-expected switch to organised retail in Saudi Arabia  Increased competition and the introduction of discount stores by competitors, which could attract Al Othaim’s target demographic of low to middle income customers

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Financials & valuation: Abdullah Al Othaim Market Financial statements

Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


4,580 263 -91 172 -8 197 197 -5 192 192

5,181 326 -111 216 -7 257 257 -7 250 250

5,687 369 -124 245 -3 292 292 -7 285 285

6,328 417 -139 279 -5 327 327 -8 319 319


Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders’ funds Invested capital

Year to

338 -213 -201 -135 -73 106

424 -207 -207 -250 -91 206

386 -227 -227 -427 55 146

488 -253 -253 -478 4 222

15 711 567 110 2,000 887 258 148 807 296

15 808 795 279 2,368 1,053 336 57 932 286

15 911 790 224 2,512 1,125 336 112 1,003 366

15 1,025 849 220 2,734 1,268 336 116 1,083 402

(SARm)

12/2013a

12/2014e

12/2015e

12/2016e

0.9 16.4 14.6 25.4 6.1 2.5 2.8

0.8 12.8 14.7 19.5 5.2 5.0 5.1

0.7 11.4 11.5 17.1 4.9 3.6 8.8

0.7 10.0 10.3 15.3 4.5 5.5 9.8

Target price

(SAR)82.00






Neutral

(SAR)108.50


4001.SE 1,302 49 Saudi Arabia Raj Sinha

125

125

105

105

85

85

65

65

45

45

25 2012

2013 Abdullah AL Othaim Market

12/2013a

Source: HSBC

12/2014e

12/2015e



11.6 31.5 46.7 44.5 44.8

13.1 24.0 25.4 30.4 30.4

9.8 13.3 13.7 13.8 13.8

11.3 13.0 13.6 11.8 11.8

17.2 63.0 25.8 10.6 5.7 3.8 32.9 18.4 0.6 228.5

17.8 72.3 28.8 11.8 6.3 4.2 44.7 6.1 0.2 745.8

17.4 73.3 29.5 11.8 6.5 4.3 107.1 11.2 0.3 345.3

16.5 70.7 30.6 12.3 6.6 4.4 91.8 10.7 0.3 422.0

4.27 4.27 3.00 17.92

5.56 5.56 5.56 20.70

6.33 6.33 9.50 22.29

7.08 7.08 10.62 24.06


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Bloomberg (Equity) AOTHAIM AB Market cap (SARm) 4,883 Enterprise value (SARm) 4,189 Sector Food Products Contact +971 4 423 6932

Price relative


5 1 . 2

2014

25 2015


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Almarai ALMARAI AB, Price SAR73, Neutral, TP SAR67 Company description Almarai is the world’s largest integrated dairy company, measured by the size of its herds. Dairy products provide the largest part of its sales turnover; it also sells poultry, bakery products and fruit juices across all six GCC countries and Egypt. As of 2013, c65% of Almarai’s sales came from Saudi Arabia. We believe Almarai has core strengths that are hard to replicate: a vast number of livestock, an expansive distribution network and a milk yield per cow above the developed market average. Almarai is also the flagship brand of the company, a widely known and reputable name in the GCC region.

Investment thesis Amongst the Saudi consumer stocks, Almarai is the best understood, in our view. The investment thesis is predicated on the dairy division – as dairy consumption per capita increases from its current below-developed market levels – and on the company’s ability to enter new product categories and rapidly gain market share. In the long term, we believe the poultry division offers the most potential for the company; however, for 2013, the poultry division reported a net loss of SAR339m, while the other divisions of the company reported strong improvements in terms of margins. On 4 February 2014, Almarai announced the completion of a third production line for its poultry division. Following the completion of this production line, the division can reach a capacity of

200m birds per annum (compared to 64m birds sold in 2013e) in the medium term. According to management, the poultry division should be able to achieve breakeven once it starts to produce 110m birds per annum. However, the current mortality rate among the birds, which management states is at high double digits, means the division will likely continue to lose money for at least the next year. According to management, the division will need to bring down the mortality rate to 6-10% to achieve profitability. Whilst we believe the company is on course to achieve the 110m birds per annum break-even level in Q4 2014e, the mortality level is still an issue. The poultry division currently accounts for only c7% of sales; however, as a result of the significant investment in the division, we estimate it will contribute 14% of total sales by 2016e, with potential risk to the upside.


Financials Almarai reported 14% revenue growth for Q2 2014, with all divisions contributing to the growth. The group’s operating margins dropped by 1.4ppt during the quarter as the poultry division continues to be loss-making. Management has pointed to a 17% increase in staff strength, mainly due to the growing poultry division, for the faster growth of expenses.

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Valuation

Risks

We value Almarai using a DCF. The WACC of 9.3% is derived from a risk-free rate based on the 12-month SAIBOR rate of 1.8%; we obtain the cost of debt by adding 220bp to the 12-month SAIBOR, arriving at 4%. Our market cost of equity, based on a combination of relative index returns, CDS spread and inflation differential, is 12.7%. We use a long-term debt-to-equity ratio of 30%:70% and a beta of 1, obtained from Bloomberg. We assume a long-term growth rate of 2.5%. Our DCF generates a 12-month target price of SAR67.

Key upside risks include:

Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price, it implied a potential return within the Neutral band; therefore, we rate the stock Neutral. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

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 Almarai is able to realise a significant premium when it comes to pricing within its poultry business; we currently assume prices in line with the market Key downside risks include:

 The company imports 60% of its animal feed and all of its ingredients for cheese, butter and fruit juice, mainly from Europe; therefore, changes in the EUR/SAR exchange rate affect profit margins  There is currently no insurance on the company’s livestock. Although its six large dairy farms are spread across the country, an epidemic in one farm could materially affect the company’s performance

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Financials & valuation: Almarai

Neutral


Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


11,219 3,127 -1,331 1,796 -254 1,542 1,542 -42 1,502 1,502

13,094 3,575 -1,503 2,072 -273 1,799 1,799 -48 1,753 1,753

15,145 4,295 -1,544 2,751 -253 2,498 2,498 -64 2,436 2,436

17,020 4,894 -1,561 3,333 -178 3,155 3,155 -78 3,079 3,079

Balance sheet summary Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders’ funds Invested capital

2,586 -2,799 -3,302 -600 -76 -572

3,910 -3,072 -3,072 -876 382 605

3,845 -2,859 -2,859 -1,218 553 752

4,681 -2,848 -2,848 -1,540 90 1,600

1,310 16,984 6,296 1,829 26,062 3,545 10,372 8,543 11,019 19,217

1,310 18,728 6,403 1,276 27,913 4,180 10,372 9,096 12,237 20,986

1,310 20,487 6,938 1,186 30,207 4,937 10,372 9,186 13,776 22,613

(SARm)

12/2013a

12/2014e

12/2015e

12/2016e

4.6 16.7 2.9 29.2 4.3 -1.3 1.4

4.0 14.5 2.7 25.0 4.0 1.4 2.0

3.5 12.2 2.5 18.0 3.6 1.7 2.8

3.1 10.7 2.3 14.2 3.2 3.7 3.5

Target price

(SAR)67.00





Year to

(SAR)73.00




79 74 69 64 59 54 49 44 39 34 29 2012

2013

2014

79 74 69 64 59 54 49 44 39 34 29 2015


Source: HSBC

12/2014e

12/2015e



Bloomberg (Equity) ALMARAI AB Market cap (SARm) 43,800 Enterprise value (SARm) 51,864 Sector Food Products Contact +971 4 423 6932

Price relative

1,310 15,028 5,471 1,811 23,280 2,037 9,972 8,161 10,142 17,961

Almarai

Year to

8 . 2

13.5 32.7 7.4 3.4 4.2

16.7 14.4 15.4 16.7 16.7

15.7 20.1 32.7 38.8 39.0

12.4 13.9 21.2 26.3 26.4

0.7 10.4 17.0 8.2 27.9 16.0 12.3 75.8 2.6 31.7

0.7 10.8 16.6 8.2 27.3 15.8 13.1 73.4 2.4 45.8

0.8 13.3 20.9 9.9 28.4 18.2 17.0 70.8 2.1 42.3

0.8 14.9 23.7 11.2 28.8 19.6 27.5 63.8 1.9 51.0

2.50 2.50 1.00 16.90

2.92 2.92 1.46 18.36

4.06 4.06 2.03 20.39

5.13 5.13 2.57 22.96


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Fawaz Abdulaziz Alhokair ALHOKAIR AB, Price SAR107.50, Neutral, TP SAR90.50 Company description Fawaz Abdulaziz Alhokair (Alhokair) is the leading branded apparel retailer in Saudi Arabia. The company currently has more than 40% market share in the apparel retail sector. Established in 1990, the company currently operates 1,600 stores, including 1,217 in Saudi Arabia, with a total retail space of more than 350,000 sqm. Apart from Saudi Arabia, Alhokair has a presence in North Africa and Central Asia, as well as North America.

Investment thesis Over the last few quarters Alhokair has made a host of acquisitions that have helped it grow at a strong pace, both in Saudi and international markets. Alhokair continued to report strong topline growth, with Q2 2014 seeing more than a 30% increase in revenues on a y-o-y basis. For 2014e, we see a boost in Alhokair’s growth, mainly from its new acquisition of the Spanish company Blanco. We believe that the company’s accelerated expansion plan in international markets that has seen the proportion of selling space outside Saudi increase to 30% by end-2013 from 10% in March 2011 bodes well for its future growth. Rental costs represent more than 10% of Alhokair’s sales, and we believe the increasing rental rates in Saudi could start to put pressure on the company’s margins going forward. According to JLL estimates, retail rental rates in Riyadh and Jeddah have increased by c8% over the last year.

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Also the stock is currently trading at a significant premium to Saudi consumer peers in terms of one-year forward PE multiples, which already prices in the strong growth potential, in our view.

Financials Alhokair reported 32% revenue growth in the June ending first quarter, well above our estimate of 14%. We believe that this was partly due to the earlier-than-expected realisation of a contribution from the Blanco acquisition and due to strong sales from the start of Ramadan. We believe that coming quarters will also see strong growth, especially from the integration of Blanco as well as organic growth in Saudi. Although the group’s revenue growth was strong in the June ending quarter, gross margin and operating margin dropped by 50bp and 90bp, respectively. We believe that this is partly due to the low-margin Blanco business. We estimate Blanco’s margins to improve in coming years, which should support a strong improvement in group margins.

Valuation We value Alhokair using a DCF model. The WACC of 10.1% is derived from a risk-free rate based on the 12-month SAIBOR rate of 1.8%; we obtained the cost of debt by adding 220bp to the 12-month SAIBOR, arriving at 4%. Our cost of equity, based on a combination of relative index returns, CDS spread and inflation differential, is 12.7%. We use a long-term debt-to-equity ratio of 30%:70% and a beta of 1, obtained from Bloomberg. We assume a long-term growth rate of 3%. Our DCF generates a 12-month target price of SAR90.5.



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 Stronger-than-expected improvement in margins, especially in international operations Key downside risks include:

 The Inditex group (which includes the Zara brand) accounts for almost one-quarter of the company’s sales; therefore, any further attempts by Inditex to move away from Alhokair could have an adverse impact  Rental inflation continues at a high level and higher-than-expected growth in this area could result in pressure on margins

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Financials & valuation: Fawaz Abdulaziz Alhokair Financial statements

Valuation data

Year to

03/2013a

03/2014e

03/2015e

03/2016e


4,659 758 -174 584 -34 648 648 -31 618 618

5,748 1,034 -216 819 -49 830 830 -41 788 788

7,376 1,364 -255 1,109 -56 1,065 1,065 -85 980 980

8,213 1,544 -268 1,276 -62 1,226 1,226 -98 1,128 1,128


Year to

346 -494 -1,232 -420 783 -242

686 -460 -700 -788 154 226

837 -553 -565 -980 122 284

1,186 -575 -587 -1,128 -109 611

0 2,412 1,956 147 4,667 972 1,259 1,112 2,416 3,249

0 2,722 2,219 25 5,253 1,067 1,259 1,234 2,906 3,849

0 3,040 2,527 134 5,890 1,141 1,259 1,125 3,470 4,292

(SARm)

03/2013a

03/2014e

03/2015e

03/2016e

5.0 30.7 8.4 36.5 11.2 -1.1 1.9

4.1 22.6 7.2 28.6 9.3 1.0 3.5

3.2 17.2 6.1 23.0 7.8 1.3 4.3

2.8 15.1 5.4 20.0 6.5 2.7 5.0

Target price

(SAR)90.50





Neutral

(SAR)107.50



127

127

107

107

87

87

67

67

47

47

27

27

7 2012

2013 Fawaz Abdulaziz Alhokair

03/2013a

Source: HSBC

03/2014e

03/2015e



45.5 40.5 37.2 40.0 45.2

23.4 36.5 40.2 28.1 27.5

28.3 31.9 35.5 28.3 24.2

11.4 13.2 15.1 15.1 15.1

2.3 27.0 36.1 18.6 16.3 12.5 22.6 46.9 1.3 36.1

1.9 25.9 35.5 18.0 18.0 14.2 21.2 45.6 1.1 61.7

2.1 28.7 36.8 19.7 18.5 15.0 24.2 42.2 0.9 67.8

2.0 28.8 35.4 20.2 18.8 15.5 24.7 32.2 0.7 105.4

2.94 2.94 2.00 9.63

3.75 3.75 3.75 11.51

4.66 4.66 4.66 13.84

5.37 5.37 5.37 16.52


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Bloomberg (Equity) ALHOKAIR AB Market cap (SARm) 22,575 Enterprise value (SARm) 23,387 Sector Multiline Retail Contact +971 4 423 6932

Price relative

0 1,928 1,903 352 4,070 717 1,310 958 2,022 2,762


6 8 . 4

2014

7 2015


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Jarir Marketing Co. JARIR AB, Price SAR200, Overweight, TP SAR237 Company description Established in 1979, primarily as a bookstore, Jarir Marketing Co. has since branched into the retailing of computers, electronics goods, and office and school supplies, as well as other small gift items. The company also undertakes the translation of bestselling books into Arabic. As of end-H1 2014, the company operated 35 showrooms. Apart from Saudi Arabia, Jarir has outlets in Qatar, the UAE and Kuwait, and has real estate investments in Egypt.

Investment thesis Jarir was among the few Saudi Arabian consumer companies to record top-line growth in 2013.We believe the fact that Jarir’s 13% top-line growth came without a single new store opening implies strong growth potential once the new store openings resume in 2014. Management has guided that the company will open seven new stores in 2014 (three stores already opened in H1 2014). Although H1 2014 sales growth has been pretty muted and came in at 4%, we believe that in the second half we will see a strong pick-up, as the newly opened stores start contributing to the top line. Furthermore, we believe that mere top-line growth does not tell the whole story, as the group’s net income for H1 2014 was up by 10%. In H1 2014, the company reported that the lower sales growth was due to a decline in the sales of computers and tablet PCs, with low growth in smartphones that

has been compensated for by growth in other categories of more than 20% y-o-y. With increasing sales in more profitable divisions, we believe that Jarir should see improving margins in coming quarters, a trend we have seen in first half of the year.


Financials Jarir reported a slowdown in revenue growth, which came in at 2.5% in Q2 2014. However, the group’s operating margin improved by 20bp and the gross margin improved by 50bp during the quarter. For H1 2014, Jarir reported 4% revenue growth, but again reported 80bp gross margin expansion and 50bp operating margin expansion. Management has pointed to a changing product mix for the improving margins of the group. We expect revenue growth to pick up in coming quarters as newly opened stores start contributing to the group top line, while margin expansion should continue due to a changing product mix.

Valuation We value Jarir using a DCF. The WACC of 9.3% is derived from a risk-free rate based on the 12-month SAIBOR rate of 1.8%; we obtain the cost of debt by adding 220bp to the 12-month SAIBOR, arriving at 4%. Our market cost of equity, based on a combination of relative index returns, CDS spread and inflation differential, is 12.7%. We use a longterm debt-to-equity ratio of 30%:70% and a beta of 0.9, obtained from Bloomberg. We assume a longterm growth rate of 2.5%. This yields a 12-month target price of SAR237.

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Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi stocks of 9%. Our target price implies a potential return of 19%, above the Neutral band; therefore, we rate the stock Overweight. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.


 Higher number of store openings than expected  Stronger-than-expected revenues from e-book sales Key downside risks include:

 The company’s expansion plans, which could lead to a cannibalisation of existing sales  The strong top-line growth currently being seen is mainly on the back of smart phone sales. If consumers start preferring cheaper versions of smartphones in the Saudi market, this could negatively affect Jarir’s growth

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Financials & valuation: Jarir Marketing Co Financial statements

Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


5,242 669 -21 648 -7 673 673 -21 652 652

5,942 780 -27 753 -5 780 780 -25 755 755

6,887 912 -33 879 1 913 913 -29 884 884

7,665 1,041 -39 1,002 13 1,047 1,047 -33 1,014 1,014



Year to

587 -218 -143 -720 58 338

826 -91 -91 -614 -213 611

1,030 -27 -27 -795 -389 790

1,123 -33 -33 -912 -295 941

0 999 1,173 86 2,200 778 250 164 1,172 1,308

0 1,063 1,503 299 2,593 938 250 -49 1,405 1,328

0 1,057 2,052 688 3,138 1,213 250 -438 1,675 1,208

0 1,051 2,470 983 3,548 1,406 250 -733 1,893 1,132

(SARm)

12/2013a

12/2014e

12/2015e

12/2016e

3.5 27.2 13.9 27.6 15.4 1.9 4.0

3.0 23.0 13.5 23.8 12.8 3.4 3.4

2.6 19.3 14.5 20.4 10.7 4.4 4.4

2.3 16.6 15.3 17.8 9.5 5.2 5.1

Target price

(SAR)237.00






Overweight

(SAR)200.00



226

226

206

206

186

186

166

166

146

146

126

126

106

106

86

86

66 2012

2013 Jarir Marketing Co

12/2013a

2014

66 2015


Source: HSBC

12/2014e

12/2015e



Bloomberg (Equity) JARIR AB Market cap (SARm) 18,000 Enterprise value (SARm) 17,951 Sector Multiline Retail Contact +971 4 423 6932

Price relative


1 8 . 5

13.1 14.6 15.3 14.4 -23.7

13.4 16.6 16.2 15.9 15.8

15.9 16.9 16.8 17.0 17.0

11.3 14.2 13.9 14.7 14.7

4.3 52.0 59.3 31.2 12.8 12.4 95.6 14.0 0.2 357.9

4.5 55.3 58.6 31.5 13.1 12.7 158.7 -3.5 -0.1

5.4 67.1 57.4 30.8 13.2 12.8

6.6 82.9 56.8 30.3 13.6 13.1

-26.2 -0.5

-38.7 -0.7

7.24 7.24 8.00 13.02

8.39 8.39 6.82 15.61

9.82 9.82 8.84 18.61

11.26 11.26 10.14 21.03


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Herfy Food Services HERFY AB, Price SAR104.50, Neutral, TP SAR107.86 Company description Herfy is one of the largest players in the Saudi fast food sector with interests in rusk production and meat processing, as well as bakeries. The company also has franchised fast food outlets in Bahrain, Kuwait and the UAE, but this is a small component for the moment. The fast food operations contribute c85% of the company’s revenue as of 2013. As of H1 2014, Herfy operated 220 fast food outlets, one of the largest such groups in the Kingdom. The company has been opening 10-20 stores per year over the last five years.

Investment thesis We see the following positive factors that should help Herfy in the long term:  Market growth: Herfy should gain from the strong growth in the Saudi fast food sector as the mainly young population is more likely to consume fast food.  Presence in markets outside major cities: Our analysis shows that Herfy is one of the few operators with a strong presence in markets outside major cities in Saudi. We believe that should help it to grow at a faster rate.  Store coverage and expansion: We believe Herfy has one of the largest coverage in Saudi in terms of outlets, which demonstrates its ability to execute a large number of store openings.

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 Vertical integration: Herfy’s meat processing plant gives it an added advantage, which should help it achieve better control of its input costs in fast food outlets. However, even after opening 30 new outlets over the last six quarters, the group’s sales growth has remained at low single digits. Furthermore, the stock is up by more than 30% year to date and trades at a premium to Saudi peers in terms of one-year forward PE multiples, which, in our view, prices in the long-term potential. Hence, we are Neutral on Herfy.

Financials Herfy reported revenue growth of 1.8% in Q2 2014, implying mere 2.6% growth in H1 2014. This follows 13 new outlet openings for the year, implying c7% growth in the number of outlets. Although the groups’ revenue growth has been weak, operating margins have seen robust improvements so far in 2014. In H1 2014, the operating margin improved by 60bp. We estimate the operating margin for the group to see further improvements in coming quarters as the level of the group’s backward integration increases.

Valuation Our DCF-based valuation for Herfy points to a 12-month target price of SAR107.86, using a WACC of 10.1%, an ERP of 12.7%, a RFR of 1.8% and a beta of 0.9.



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 Delays in new outlet openings from expected levels could lead to slower-than-expected growth  Around 50% of Herfy’s outlets are currently in Riyadh. Further new openings in the city could lead to cannibalisation, which in turn could decrease the outlets’ yields  Herfy’s fast food division’s like-for-like growth potential could be negatively affected by weak Saudi consumer confidence, especially since the company deals with discretionary items that are usually the first to be cut from consumers’ purchasing list in case of weakness  Higher raw material prices, which could negatively affect the company’s margins and its valuation Key upside risks include:

 Strong improvement in like-for-like growth  Accelerated growth in the number of outlets

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Financials & valuation: Herfy Food Services Financial statements

Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


849 237 -50 187 -2 196 196 -5 191 191

937 268 -57 211 -2 213 213 -5 208 208

1,051 302 -63 238 -2 241 241 -6 235 235

1,185 344 -72 272 -1 276 276 -7 269 269



Year to

205 -130 -111 -112 8 63

266 -120 -120 -125 -12 142

281 -150 -150 -141 10 127

331 -160 -160 -161 -10 167

0 568 223 57 790 126 63 6 601 607

0 631 218 44 848 126 38 -6 684 678

0 717 212 13 930 135 17 4 778 781

0 805 236 14 1,041 148 8 -6 885 879

(SARm)

12/2013a

12/2014e

12/2015e

12/2016e

5.7 20.4 8.0 25.2 8.0 1.3 2.3

5.1 18.0 7.1 23.2 7.1 2.9 2.6

4.6 16.0 6.2 20.6 6.2 2.6 2.9

4.1 14.0 5.5 18.0 5.5 3.5 3.3

Target price

(SAR)107.86






Neutral

(SAR)104.50


6002.SE 1,287 Saudi Arabia Raj Sinha

Year to

109

109

99

99

89

89

79

79

69

69

59

59

49

49

39 2012

2013

Source: HSBC

12/2013a

12/2014e

12/2015e

12/2016e

0.8 4.4 3.3 5.8 5.9

10.4 13.3 13.2 8.7 8.7

12.1 12.5 12.8 12.8 12.8

12.8 14.2 14.2 14.4 14.4

1.5 32.3 34.1 25.6 27.9 22.0 157.2 1.0 0.0 3399.0

1.5 32.1 32.4 25.4 28.6 22.5 147.4 -0.9 0.0

1.4 31.8 32.1 26.4 28.7 22.7 198.0 0.5 0.0 7108.9

1.4 32.0 32.3 27.3 29.1 23.0 413.5 -0.7 0.0

4.14 4.14 3.34 13.01

4.50 4.50 3.78 14.81

5.08 5.08 4.27 16.84

5.81 5.81 4.88 19.16


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Bloomberg (Equity) HERFY AB Market cap (SARm) 4,828 Sector Hotels Restaurants & Leisure Contact +971 4 423 6932

Price relative

Herfy Food Services

Ratio, growth and per share analysis

4 4 . 5



39 2015

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Savola SAVOLA AB, Price SAR79.25, Neutral, TP SAR74 Company description Savola is one of the largest business conglomerates in Saudi Arabia, with operations spanning food production, retail, plastic packaging and real estate, in addition to a host of other strategic investments in various industries across MENA and Central Asia. The company has three core operations: edible oils, sugar and retail. As of 2013, the foods division accounted for more than 55% of the company’s revenues, while the retail arm (Panda) contributed 41%. Panda operates 110 supermarkets, 52 hypermarkets and 23 convenience stores, with selling space of 547,000 sqm across Saudi Arabia, the UAE and Lebanon as of end-2013.

Investment thesis In 2013, Savola’s top-line growth has been slow, mainly on the back of weak Egyptian operations and a significant drop in revenue from the sugar division. However, in terms of margins, the company has been reporting strong improvement throughout the year. We see strong growth potential for Savola in the medium term. Our analysis on food retail formats in the region clearly shows that hypermarkets are the best format to be in Saudi and Savola with its strong presence in the format should benefit from this. Savola launched its new food retail format “My Panda”, a small convenience store format, last year. As of Q1 2014, the company has already opened more than 50 such stores. We believe that Savola’s retail expansion will pick up pace as this new format

requires less space selling space (200 sqm versus 2,000 sqm and 7,000 sqm for Panda’s supermarkets and hypermarkets, respectively), which means real estate acquisition/leasing will be easier. We expect Panda to see a selling space CAGR of 11% over next five years compared to 8% over the last four years. We also see a strong structural growth potential for the company’s edible oil division, considering the current level of consumption in the region, as well as the company’s focus on business segments that are growing.


However, looking at the historical levels of the implied forward PE for Savola’s consolidated operations we can see the current multiple is at a c40% premium to the historical average. Given this, and the 50% run-up during the last 12-month period, we believe the stock is close to fairly valued. Although we acknowledge the strong growth potential and believe the medium-term outlook for the company is healthy (especially considering the strong margin improvement), we would need to see even higher growth before becoming more positive.

Financials Savola reported a strong improvement in sales growth for Q2 2014, with revenue increasing by 13% in a y-o-y basis. The main reason for such a strong growth was 25% revenue growth in the retail division partly due to the shift in Ramadan. The group’s net profit growth was even stronger at 32% due to lower finance charges and lower minority interest outlay.

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Valuation

Risks

We use a DCF methodology to value Savola’s core subsidiaries, with a WACC of 10.5%, which is derived from a risk-free rate based on the 12month SAIBOR rate of 1.8% to obtain the cost of debt we add 220bp to the 12-month SAIBOR, arriving at 4%. Our market cost of equity, based on a combination of relative index returns, CDS spread and inflation differential, is 12.7%. We use a long-term debt-to equity ratio of 30%:70% and a beta of 1, which is the average for the international peer group; we assume a long-term growth rate of 2.5%. To this we add the associates, which we value using market capitalisation where listed or book value where unlisted. Based on this, we arrive at a target price of SAR74 for Savola.

Key upside risks include:


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 Stronger-than-expected top-line growth, especially for the Egyptian operations  Strong pick-up in margins at the sugar division Key downside risks include:

 Any change in sanctions against Iran, which for the moment do not include staple foods  In case real estate developers started to reduce the number of malls being built, Savola would need to start building more stand-alone supermarkets, which might not attract significant footfall

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Financials & valuation: Savola

Neutral


Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


26,365 3,226 -649 2,577 -254 2,455 2,455 -311 1,704 1,704

27,921 3,592 -720 2,872 -342 2,530 2,530 -278 1,861 1,861

29,947 4,095 -733 3,362 -353 3,009 3,009 -331 2,264 2,264

31,545 4,369 -718 3,651 -363 3,288 3,288 -362 2,491 2,491


642 -1,039 342 -1,068 -82 481

2,485 -838 -242 -1,117 -690 2,299

2,338 -599 146 -1,585 -546 2,627

2,541 -631 254 -1,744 -689 3,022

1,324 6,503 10,940 3,011 27,149 5,303 9,395 6,383 10,493 10,452

1,324 6,368 12,234 3,822 28,805 5,602 9,659 5,837 11,173 10,503

1,324 6,281 13,479 4,752 30,552 5,925 9,901 5,149 11,920 10,407

(SARm)

12/2013a

12/2014e

12/2015e

12/2016e

1.6 12.8 4.0 24.8 4.3 1.4 2.5

1.4 11.2 3.9 22.7 4.0 6.8 2.6

1.3 9.6 3.7 18.7 3.8 7.9 3.7

1.2 8.7 3.7 17.0 3.6 9.2 4.1

Target price

(SAR)74.00





Year to

(SAR)79.25



81

81

71

71

61

61

51

51

41

41

31

31

21 2012

2013 Savola

12/2013a

2014

21 2015


Source: HSBC

12/2014e

12/2015e



Bloomberg (Equity) SAVOLA AB Market cap (SARm) 42,318 Enterprise value (SARm) 40,319 Sector Food Products Contact +971 4 423 6932

Price relative

1,324 6,385 9,046 1,322 24,741 5,030 8,395 7,073 9,749 10,403


6 . 6

-3.7 7.6 5.1 18.6 21.6

5.9 11.3 11.4 3.1 9.2

7.3 14.0 17.1 18.9 21.7

5.3 6.7 8.6 9.3 10.0

2.6 22.3 18.9 9.7 12.2 9.8 12.7 64.5 2.2 9.1

2.7 24.5 18.4 9.9 12.9 10.3 10.5 52.8 1.8 38.9

2.9 28.6 20.9 10.7 13.7 11.2 11.6 44.2 1.4 40.1

3.0 31.1 21.6 10.9 13.8 11.6 12.0 35.8 1.2 49.4

3.19 3.19 2.00 18.26

3.49 3.49 2.09 19.65

4.24 4.24 2.97 20.92

4.66 4.66 3.27 22.32


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Saudi Airlines Catering CATERING AB, Price SAR193.75, OW, TP SAR186 Company description Saudi Airlines Catering (SACC) provides complete catering services for Saudi Arabian Airlines (Saudia) along with partial services for various other major airlines. SACC also has divisions that are involved in retailing within airlines (Skysales), provides lounge services at airports, and on the ground catering services to both companies and religious travellers.

Investment thesis Currently, the in-flight catering business generates c76% of the company’s sales with Skysales the next major contributor at c10%. It should also be noted that c70% of SACC’s revenues are from Saudia, which has c90% of the Saudi domestic airline market in terms of passengers carried. As the main caterer for Saudia, our positive investment thesis for SACC is based on the following factors:  Strong growth in air passenger traffic in the MENA region: Over the last two years the MENA region has seen the highest growth in airline passenger traffic globally and airlines continue to expect further growth as load factors remain below the DM average.  Strong fleet expansion plans for Saudia: Saudia plans to increase its fleet size to 164 airplanes by 2015 from 106 in 2012. This implies a CAGR for the number of planes of 16% between 2012 and 2015, but seats growth should be above a c19% CAGR

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between 2012 and 2015 as the planes added will have more capacity.  More long-haul flights at Saudia: Saudia is currently planning to increase its long-haul flights. Aside from the new flights, SACC should also benefit from the increase in meals per flight.  Saudi Arabian Airlines (Saudia) has a 35.7% stake in SACC: Currently, more than two-thirds of SACC’s revenue is from Saudia. We believe the 35.7% Saudia owns in SACC implies a constant revenue stream and from Saudia’s perspective the income that it earns from associates effectively acts as a rebate against its own costs.  Growing number of Hajj visitors: SACC also provides catering services to Hajj visitors and strong growth in this area in the long term could positively impact the top line.  Airport expansion plans at Saudi: This may help the lounge business segment of SACC.

Financials During Q2 2014, SACC reported strong revenue growth of 16% with its in-flight catering division reporting 14% growth and its business lounge division reporting more than 30% growth. We believe the group will continue to see such strong growth rates in coming quarters. However, in terms of margins, the group saw a significant drop; operating margin in Q2 2014 dropped by c4pp, mainly due to increases in general and administrative costs.



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Valuation Our DCF-based valuation for SACC produces a 12-month target price of SAR186 using a WACC of 10.1%, an ERP of 12.7%, a RFR of 1.8% and a beta of 0.9. Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price, it implied a potential return above the Neutral band; therefore, we rate the stock Overweight. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.


 c70% of the company’s revenue is from Saudia, which represents a high concentration risk both in terms of the airline as well as its significant exposure to Saudi Arabia  A considerable proportion of our long-term growth forecast is dependent on Saudia’s fleet expansion. If the fleet expansion is below estimates, it could lead to lower revenues for SACC  Since air travel is a discretionary expenditure, a drop in consumer confidence could negatively affect the top-line forecast for SACC

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Financials & valuation: Saudi Airlines Catering Financial statements

Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


1,867 561 -15 546 0 569 569 -46 523 523

2,123 644 -18 627 0 637 637 -57 579 579

2,608 799 -22 777 0 787 787 -71 717 717

2,911 894 -24 870 0 880 880 -79 801 801



Year to

500 -24 -24 -451 129 408

656 -32 -32 -509 -115 557

701 -39 -39 -630 -32 581

869 -44 -44 -704 -121 736

0 238 1,451 893 1,689 527 0 -893 1,159 268

0 252 1,595 1,008 1,848 559 0 -1,008 1,286 281

0 270 1,768 1,040 2,038 591 0 -1,040 1,443 406

0 289 1,953 1,161 2,243 620 0 -1,161 1,619 461

(SARm)

12/2013a

12/2014e

12/2015e

12/2016e

8.0 26.7 55.9 30.4 13.7 2.6 2.8

7.0 23.1 53.0 27.4 12.4 3.5 3.2

5.7 18.6 36.5 22.2 11.0 3.7 4.0

5.1 16.5 31.9 19.8 9.8 4.6 4.4

Target price

(SAR)186.00






Overweight

(SAR)193.75



203

203

183

183

163

163

143

143

123

123

103

103

83

83

63

63

43 2012

2013 Saudi Airlines Catering

12/2013a

Source: HSBC

12/2014e

12/2015e



10.7 7.4 7.7 16.9 18.4

13.7 14.8 14.8 11.8 10.8

22.8 24.0 24.0 23.7 23.7

11.6 11.9 11.9 11.7 11.7

12.1 325.0 47.1 32.2 30.1 29.2

7.7 207.8 47.4 32.8 30.4 29.5

7.6 205.9 52.5 36.9 30.6 29.8

6.7 182.4 52.3 37.4 30.7 29.9

-77.1 -1.6

-78.4 -1.6

-72.0 -1.3

-71.7 -1.3

6.38 6.38 5.50 14.13

7.07 7.07 6.21 15.68

8.74 8.74 7.68 17.60

9.76 9.76 8.58 19.75


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Bloomberg (Equity) CATERING AB Market cap (SARm) 15,888 Enterprise value (SARm) 14,879 Sector Commercial Services Contact +971 4 423 6932

Price relative


4 . 0


43 2015

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Al Khaleej Training & Education ALKHLEEJ AB, Price SAR65.54, Not Rated Company description Al Khaleej Training and Education Company, founded in 1993, is a pioneer in the field of information technology, English language and administrative training for both government enterprises and private sector companies in Saudi Arabia. The company also provides professional call centre solutions for public and private companies in the Kingdom. Apart from the above areas, Al Khaleej operates online training in different fields through its E-Learning solutions. The company currently has c3,500 employees.

Recent news  On 15 July 2014, Al Khaleej reported Q2 2014 results. Net income for the group grew by 17% during the quarter, implying 29% growth during the first half of the year. Operating profit for the quarter was up by 13.5%. Management pointed to increased sales in the corporate, education and call centre divisions for the strong performance.

The company has franchise rights to operate centres for various global providers in the field of education. These include New Horizons for computer education, Direct English for English language training, Crestcom for administrative training, and OTA (Online Trading Academy) for training in stock and currency trading.

Financials Al Khaleej reported 16% revenue growth during 2013, with divisions like information technology seeing strong growth. The English training division contributed 31% of revenue, while the information technology division contributed 28% of revenue during the year. The group’s operating margin improved by 85bp during the year, leading to 17% net income growth.

159

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Financials & valuation: Al Khaleej Training & Education Financial statements

Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a



515 83 -22 60 -5 59 59 0 53 53

574 90 -18 72 -7 73 73 0 67 67

664 107 -18 89 -7 85 85 0 79 79



Year to

48 -25 -25 -8 -10 23

65 -57 -53 -8 15 24

78 -74 -91 -10 25 4

60 -125 -123 -13 66 -63

17 247 211 33 481 65 110 77 264 447

35 265 239 26 541 61 134 108 309 514

36 321 264 25 644 74 161 136 365 619

36 427 316 28 800 81 243 215 430 772

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

6.9 37.1 6.2 46.8 9.3 0.2 0.4

6.1 34.7 5.4 43.3 7.9 1.0 0.4

4.7 29.4 4.7 37.3 7.2 0.4 0.4

4.2 27.1 3.9 29.2 6.0 0.1 0.5






Not Rated

(SAR)65.54


Target price


Year to

70

70

65

65

60 55

60 55

50 45

50 45

40 35

40 35

30

30

25 20 2012

Source: HSBC

12/2010a

12/2011a

12/2012a

12/2013a

12.9 6.8 9.1 9.0 8.1

30.2 18.1 23.6 20.6 15.9

11.4 8.4 18.9 23.5 28.1

15.8 19.3 23.8 15.5 16.9

0.9 10.2 17.2 9.5 17.7 12.3 27.7 0.3 1.1 0.6

1.0 10.2 17.1 9.7 16.1 11.7 15.9 0.3 1.3 0.6

0.9 10.9 18.5 10.5 15.6 12.5 13.5 0.4 1.5 0.6

0.9 10.2 18.3 9.9 16.1 13.4 15.8 0.5 2.0 0.3

1.51 1.51 0.25 8.26

1.76 1.76 0.25 9.12

2.25 2.25 0.33 10.99

2.63 2.63 0.42 12.29


160

Bloomberg (Equity) ALKHLEEJ AB Market cap (SARm) 2,294 Sector Diversified Consumer Services Contact Not Rated

Price relative

25 20 2013 Al Khaleej


1 7 . 2

(SAR) Not Rated


2014 Rel to Tadawul

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Al Tayyar Travel Group ALTAYYAR AB, Price SAR130.71, Not Rated Company description Established in 1980, Al Tayyar Travel Group (Al Tayyar) is among the largest travel and tourism service providers in Saudi Arabia. The group provides reservation and ticketing services for domestic and international flights, trains and cruise ships. It also provides hotel booking services in Saudi Arabia. Al Tayyar also organises special group tours for Hajj and Umrah programmes. Al Tayyar has subsidiaries in Egypt, the UAE, Lebanon, Malaysia and Sudan. The group has more than 300 offices in the Kingdom along with 20 offices in international locations.

Financials Al Tayyar reported top-line growth of 16% in FY13, mainly on the back of growing revenues from ticketing services. The company’s operating profit grew by 20% and net profit was up by 25% in FY13. In terms of divisional performance, as of 2013, ticketing services contributed 53% in terms of sales. The second major source of revenue for the company was from tourism-related services, which contributed 24% in terms of revenues. However, in terms of gross profits, ticketing services accounted for 70% of the total group’s gross profits.

Recent news  On 17 July 2014, Al Tayyar announced Q2 2014 results. Group sales grew by 18% during the quarter, which led to operating income growth of 16.8% and net income growth of 8.3%. For H1 2014, net revenue growth was at 17% with net income growth at 16% partly due to gains from the sale of property and equipment.  On 28 May 2014, Al Tayyar announced that it has signed an acquisition agreement with CTM that allows it to acquire 100% of the shares of the British company. The value of the deal amounted to SAR85m. CTM is considered one of the top ranking travel and tourism companies in the UK, operating in the field of travel and tourism services, as well as railway tickets beside air transport and ground services. It also operates in the field of organising conferences, as well as hotel accommodation services in Britain, Ireland and Scotland. Sales of CTM in 2013 amounted to SAR825m.

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Financials & valuation: Al Tayyar Travel Group Financial statements

Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a

Profit & loss summary (SARm) 3,824 558 -40 518 0 549 549 -53 496 496


4,607 692 -34 658 0 651 651 -39 612 612

5,390 815 -40 775 -29 796 796 -41 755 755

6,260 940 -45 895 -13 986 986 -43 943 943

839 -70 163 -320 -428 769

624 -94 -85 -493 -17 530

1,224 -182 -481 -307 -95 1,042

2,157 -144 -370 -440 26 2,014

136 450 1,367 380 2,198 893 117 -263 1,160 1,817

144 494 1,412 407 2,240 931 101 -307 1,170 1,833

147 630 2,034 747 3,250 1,471 6 -741 1,723 2,503

139 1,602 3,215 2,117 5,429 2,940 506 -1,611 2,215 3,311



Year to

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

4.7 32.2 9.9 31.6 15.3 3.9 2.0

3.9 26.0 9.8 25.6 15.3 2.7 3.1

3.3 22.1 7.2 20.8 10.0 5.3 2.0

2.9 19.1 5.4 16.6 7.6 10.3 2.8






Not Rated

(SAR) 130.71


Target price

1810.SE 5,228 Saudi Arabia Not Rated

Year to

140 130 120 110 100 90 80 70 60 50 40 30 2012

Source: HSBC

12/2010a

12/2011a

12/2012a

12/2013a

24.6 36.1 32.7 30.1 25.4

20.5 24.0 26.9 18.7 23.3

17.0 17.9 17.8 22.2 23.4

16.1 15.3 15.4 23.9 24.9

2.1 27.3 42.8 22.6 14.6 13.6

2.5 33.4 52.3 27.3 15.0 14.3

-0.2 -0.5 -3.2

-0.3 -0.4 -2.0

2.2 30.2 43.8 23.2 15.1 14.4 27.6 -0.4 -0.9 -1.7

1.9 28.5 42.6 17.4 15.0 14.3 72.3 -0.7 -1.7 -1.3

4.14 4.14 2.66 8.53

5.10 5.10 4.11 8.56

6.29 6.29 2.56 13.14

7.86 7.86 3.67 17.30


162

Bloomberg (Equity) ALTAYYAR AB Market cap (SARm) 19,607 Sector Hotels, Restaurants & Leisure Contact Not Rated

Price relative 140 130 120 110 100 90 80 70 60 50 40 30 2013 Al Tayyar


1 7 . 2

(SAR) Not Rated


2014 Rel to Tadawul

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Budget (United International Transportation Co.) BUDGET AB, Price SAR79.14, Not Rated Company description Established in 1978, United International Transportation Co. (UITC) is the market leader in the vehicle renting and leasing industry in Saudi Arabia. The company has been operating under a franchise agreement with Avis-Budget, the global leader in vehicle rental services. UITC currently operates a combined rental and leasing fleet of over 24,000 vehicles and has a presence in over 95 locations in the Kingdom. Apart from vehicle rental services, UITC is also involved in pre-owned car sales. The company’s clients include FMCG companies, banks, courier, trading as well as construction companies. UITC also has the largest workshop facility in the Kingdom and employs more than 1,200 people across the group.

In terms of margins, even though the company saw only a slight improvement at the gross margin level, a significant decrease in general and administrative expenses as a result of better cost control and timely collection of trade receivables led to a strong improvement in operating margin.

Recent news  On 17 July 2014, UITC announced Q2 2014 results. Net income for the quarter was up by 11% with operating income being up by 19%. The increase in revenues from long-term rentals along with the gain on sales of vehicles was pointed out as the main reason for the strong growth. For H1 2014, net income was up by 11% and operating income was up by 30%.

Financials UITC reported top-line growth of 15% in 2013, mainly on the back of growing revenues from long-term rentals of vehicles and trucks. According to management, the company also benefited from high demand for short-term car rental services in the Umrah season in Ramadan and the summer, mainly in the Western region.

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Financials & valuation: United International Transportation Co. Financial statements

Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a



508 293 -260 34 -9 101 101 0 101 101

582 350 -330 20 -9 125 125 0 126 126

668 435 -487 52 -13 155 155 0 150 150



Year to

190 -386 -213 -37 46 -196

350 -511 -332 -41 42 -161

334 -571 -403 -46 109 -238

411 -628 -436 -51 90 -217

0 706 129 11 834 84 271 260 461 823

0 850 153 27 1,003 153 313 286 517 976

0 1,003 115 17 1,146 106 423 405 593 1,129

0 1,153 161 27 1,342 111 513 486 688 1,315

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

8.2 14.2 4.5 25.5 5.2 -6.1 1.5

7.3 12.6 3.8 24.0 4.7 -5.0 1.7

6.4 10.6 3.3 19.2 4.1 -7.4 1.9

5.5 8.5 2.8 16.1 4.7 -6.7 2.1






(SAR) 79.14


Target price


12/2010a

12/2011a

12/2012a

12/2013a

8.9 -0.9 56.7 11.3 10.5

12.7 12.8 -24.1 3.0 6.2

14.6 19.3 -41.2 24.4 24.9

14.8 24.4 162.5 23.3 19.4

0.5 11.5 20.6 11.4 57.7 9.8 25.8 0.6 1.0 0.7

0.5 10.3 19.5 10.0 57.7 6.6 30.9 0.6 1.0 1.2

0.5 11.1 21.2 11.0 60.1 3.4 36.9 0.7 1.2 0.8

0.5 11.4 21.8 11.2 65.1 7.7 34.3 0.7 1.1 0.8

3.11 3.11 1.20 15.15

3.30 3.30 1.35 17.00

4.13 4.13 1.50 19.46

4.93 4.93 1.68 16.92


164


BUDGET AB 3,218 Road & Rail Not Rated

100

100

90

90

80

80

70

70

60

60

50

50

40

40

30

30

20 2012

Source: HSBC


1 7 . 2

(SAR) Not Rated

Price relative

20 2013 Budget

Year to

Not Rated


2014 Rel to Tadawul

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eXtra (United Electronics Co.) EXTRA AB, Price SAR124.25, Not Rated Company description Established in 2003, United Electronics Company (eXtra) is one of the largest consumer electronics retailers in Saudi Arabia. The company’s core activities include the retailing of consumer electronics, home appliances, mobile communication solutions, digital imaging equipment and gaming consoles. As of June 2014, eXtra operated 38 stores across Saudi Arabia (with approximately 5,000 sqm for large stores and 2,000 sqm for small stores). The company has a major presence in Riyadh, where it operates eight stores. Outside Saudi Arabia, the company has operations in Oman and Bahrain. The company also has plans to open stores in Qatar. Al Fowzan Holding Company is currently the major shareholder with a 45% stake in the company.

Financials eXtra reported top-line growth of 12.4% in FY13 as the company significantly increased its store count from 29 to 37 during the year. However, in Q4 2013, the company saw a 5.1% drop in net sales revenue on a y-o-y basis as it had hosted the yearly ‘mega sale’ event in the third quarter of 2013 instead of the fourth quarter, when it generally hosts the event.

In terms of margins, even though on a full-year basis gross margins saw a slight improvement, increasing operational costs from accelerated store openings during the year led to a 30bp drop in the operating margin of the company. During the fourth quarter the company gross margins saw a significant improvement of 170bp due to the shift in the timing of yearly ‘mega sale’ event. The company reported SAR167m net income for FY13, implying 5% y-o-y growth; however, for Q4 2013, the net income growth was slower, at 1%, due to the aforementioned factors.

Recent news  On 17 July 2014, eXtra’s management announced Q2 2014 results. Net revenue growth for the quarter was 1.3%, mainly due to a high base effect, as Q2 2013 included 10year anniversary promotion sales. Excluding the promotional sales, net revenue growth for Q2 2014 was 27.6%. Net income for Q2 2014 was up by 1%, while net income growth in H1 2014 was 4.4%.The group added one new store during the quarter, taking the total store number to 38.

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Financials & valuation: United Electronics (eXtra) Financial statements

Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a

Profit & loss summary (SARm) 1,706 46 -19 27 -4 100 100 0 98 98


2,366 62 -22 40 -1 135 135 0 132 132

3,013 190 -28 161 0 163 163 0 159 159

3,383 206 -38 168 -1 172 172 0 167 167



Year to

7 -115 -113 0 -70 -109

129 -72 -73 0 -18 56

153 -109 -109 -60 0 44

153 -107 -107 -98 40 46

0 267 322 30 589 304 21 -9 243 559

0 317 457 65 775 370 0 -65 375 710

0 390 556 48 946 439 0 -48 473 898

0 459 594 35 1,053 486 40 5 488 1,018

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

2.2 81.5 6.7 38.1 15.3 -2.9 0.0

1.6 60.1 5.3 28.2 9.9 1.5 0.0

1.2 19.7 4.2 23.5 7.9 1.2 1.6

1.1 18.1 3.7 22.3 7.6 1.2 2.6






Not Rated

(SAR) 124.25


Target price


Year to

12/2011a

12/2012a

12/2013a

20.6 29.0 73.0 134.9 138.1

38.7 35.5 48.3 35.4 35.1

27.4 20.5 20.1

12.3 8.7 4.1 5.4 5.5

3.1 17.5 40.2 16.6 2.7 1.6 10.5 0.0 -0.2 -0.7

3.3 18.6 35.2 17.0 2.6 1.7 93.8 -0.2 -1.0 -2.0

3.4 17.7 33.6 16.8 6.3 5.4

3.3 16.4 34.3 15.9 6.1 5.0

-0.1 -0.3 -3.2

0.0 0.0 29.5

3.26 3.26 0.00 8.11

4.40 4.40 0.00 12.51

5.29 5.29 2.00 15.75

5.58 5.58 3.25 16.27


166

EXTRA AB 3,728 Specialty Retail Not Rated

130

130

120

120

110

110

100

100

90

90

80

80

70

70

60

60

50 2012

Source: HSBC

12/2010a


Price relative

50 2013 Extra


1 7 . 2

(SAR) Not Rated


2014 Rel to Tadawul

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Farm Superstores (Saudi Marketing Co.) SMARKETI AB, Price SAR128.49, Not Rated Company description SAMCO operates retail stores and indoor entertainment centres in Saudi Arabia, as well as a shopping mall in Lebanon. Established in 1978, SAMCO opened its first retail outlet (Farm Superstore 1) in Dammam in October 1979. As of June 2014, Farm was operating 48 supermarkets, 20 mini markets, thee wholesale outlets as well as seven indoor entertainment centres, under its Adventures World brand. The company also owns Beirut Mall in Lebanon, which hosts over 50 tenants in an area of 50,000 m2. The company plans to open five supermarkets, two mini markets, and one indoor entertainment centre in H2 2014. Lacking a presence in the Central region of Saudi Arabia, SAMCO is leasing a retail area of 8,974 m2, distributed over three stores in Riyadh. The company also seeks to improve its margins by introducing store-branded products, such as apparel and bottled water, and shifting its sales mix towards higher margin offerings such hardware, gifts and toys.

Financials In F13 (ended 31 December 2013), the company posted revenue growth of 9%, slowing its pace from a CAGR of 15% in 2009-12. However, gross margins improved by nearly 2pp from 20% to 22%. Sub-leases accounted for 10% of SAMCO’s revenues in FY13. As of Q2 2014 (ended 30 June 2014), the company posted revenue growth of 23% y-o-y, partly due to pre-buying for Ramadan, as well as due to three new store openings.

Recent news  On 10 July 2014, SAMCO announced plans to increase its capital from SAR250m to SAR350m via capitalisation of its retained earnings. The company plans to issue bonus shares to current shareholders at a rate of 2:5.  On 22 May 2014, SAMCO announced the opening of a branch in the city of Arar, in the Northern region of Saudi, with an area of 3,524 m2.  On 1 May 2014, SAMCO announced that it will cease Farm Superstore operations in Lebanon, instead leasing the space on a 10year contract for an annual amount of SAR1.88m.

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Financials & valuation:

Farm Superstores (Saudi Marketing)


Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a



1,253 86 -24 62 0 70 70 -1 67 67

1,496 99 -27 72 -4 82 82 -1 79 79

1,626 124 -29 94 -5 99 99 0 95 95



Year to

60 -66 -66 0 0 -1

129 -77 -82 0 -39 53

163 -98 -88 -11 -49 66

20 -64 -54 0 35 -44

7 396 318 17 724 158 247 229 287 707

6 448 308 20 765 193 208 188 348 744

5 517 362 38 886 293 159 120 414 848

4 547 377 35 929 304 193 158 392 894

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

3.2 40.7 4.5 57.3 11.2 -0.2 0.0

2.6 37.1 4.3 48.3 9.2 1.6 0.0

2.1 32.3 3.8 40.8 7.8 2.0 0.3

2.0 26.0 3.6 33.8 8.2 -1.4 0.0






Not Rated

(SAR) 128.49


Target price


Year to

150 140 130 120 110 100 90 80 70 60 50 40 30 2012

Source: HSBC

12/2010a

12/2011a

12/2012a

12/2013a

10.9 22.1 16.5 24.0 23.8

25.7 9.4 11.0 21.2 18.7

19.4 14.8 16.2 17.8 18.3

8.7 24.5 30.0 20.1 20.8

1.4 7.9 19.5 7.7 7.9 5.6 52.3 0.8 2.9 0.3

1.7 8.9 19.1 8.7 6.9 5.0 208.2 0.5 2.2 0.7

1.8 9.3 19.0 8.9 6.6 4.8 24.5 0.3 1.2 1.4

1.8 10.6 24.3 10.2 7.6 5.8 26.8 0.4 1.3 0.1

2.24 2.24 0.00 11.49

2.66 2.66 0.00 13.91

3.15 3.15 0.42 16.56

3.81 3.81 0.00 15.69


168

Bloomberg (Equity) SMARKETI AB Market cap (SARm) 3,212 Sector Food & Staples Retailing Contact Not Rated

Price relative 150 140 130 120 110 100 90 80 70 60 50 40 30 2013 Farm Superstores


1 7 . 2

(SAR) Not Rated


2014 Rel to Tadawul

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Halwani Brothers HB AB, Price SAR82.80, Not Rated Company description Established in 1968, Halwani Brothers is engaged in the production, marketing and distribution of food products, mainly in Saudi Arabia and Egypt. Halwani also exports its products to more than 32 countries around the world. In Saudi Arabia, Halwani has a dominant market share in five products.

Recent news  On 14 July 2014, Halwani reported Q2 2014 results. Net revenue growth for the quarter came in at 15% with operating profit growing at 16.6%. However, net income growth slowed down to 5.5% due to higher corporate tax expenses.

The main line of business includes two products made from sesame seeds: halawa and tahina (which is also an ingredient of halawa). Other key products include, jam, pastries, dates and cold cut meat. Apart from these, Halwani also has a presence in other segments like juice and dairy (yogurt and labneh) within Saudi Arabia. The company manufactures and distributes a range of moistened tissues for different uses. The principal business in Egypt is the cold cut meat business, in which Halwani is the market leader. Currently, Dallah Industrial Investment is the major shareholder in the company with more than a 55% holding.

Financials Halwani reported net revenue growth of 7.4% in 2013 with operating income growing by 10.8%. Management pointed to the strong improvement in operating cost control, which led to an operating margin improvement of 40bp. Gross margins of the group dropped 80bp during the year. The company reported net income growth of 6% during the year.

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Financials & valuation: Halwani Brothers Financial statements

Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a

Profit & loss summary (SARm) 732 116 -18 98 0 101 101 -11 80 80


814 124 -19 104 0 109 109 -20 81 81

892 143 -24 119 3 119 119 -23 87 87

958 157 -25 132 -1 131 131 -30 93 93



Year to

74 -73 -71 -29 0 1

114 -78 -77 -43 13 37

116 -48 -47 -57 16 68

101 -113 -111 -57 45 -12

0 209 444 117 653 117 0 -117 508 536

0 266 423 121 689 108 13 -108 538 568

0 288 457 144 745 124 29 -116 561 601

0 368 463 113 831 146 69 -44 581 717

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

3.2 20.1 4.3 29.4 4.7 0.0 1.2

2.9 18.8 4.1 29.4 4.4 1.5 1.8

2.6 16.3 3.9 27.2 4.2 2.9 2.4

2.4 14.8 3.2 25.6 4.1 -0.5 2.4






Not Rated

(SAR) 82.80


Target price


Year to

12/2011a

12/2012a

12/2013a

18.6 41.7 56.6 77.4 88.6

11.2 7.0 6.9 8.3 0.2

9.7 15.5 13.7 9.2 8.0

7.4 9.9 10.8 10.2 6.3

1.4 15.0 15.8 12.3 15.8 13.4

1.4 14.2 15.0 11.7 15.2 12.8

1.5 14.5 15.5 11.7 16.0 13.3

1.3 12.9 15.9 11.1 16.4 13.7

-0.2 -1.0 -0.6

-0.2 -0.9 -1.1

-0.2 -0.8 -1.0

-0.1 -0.3 -2.3

2.81 2.81 1.00 17.76

2.82 2.82 1.50 18.82

3.05 3.05 2.00 19.64

3.24 3.24 2.00 20.34


170

HB AB 2,366 Food Products Not Rated

90

90

80

80

70

70

60

60

50

50

40

40

30 2012

Source: HSBC

12/2010a


Price relative

30 2013 Halwani


1 7 . 2

(SAR) Not Rated


2014 Rel to Tadawul

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Saudia Dairy & Foodstuff Company SADAFCO AB, Price SAR110.80, Not Rated Company description Established in 1976, Saudia Dairy & Foodstuff Company (Sadafco) is one of the major players in the Kingdom’s dairy market. The company also manufactures tomato paste, ice cream, snacks and drinks. Sadafco is the leader in Saudi’s long-life milk segment and has dominated close to one-third of the total drinking milk market in the Kingdom. Over the last few years the company has increased its offering to include cheese, butter and powdered milk, as well as frozen French fries. The company’s major manufacturing facilities are in Jeddah and Dammam. The company also has 19 distribution centres across the Kingdom. Sadafco also operates three international distribution centres in Qatar, Bahrain and Jordan. Qurain Petrochemical Industries is the major shareholder in Sadafco with a 29% stake.

Recent news  On 17 July 2014, Sadafco’s management announced Q1 2014 (ending June 2014) results. Net income for the quarter grew by 2.4% with operating income growing by 3%. Management pointed to slow growth in sales revenue for the weaker performance.

Financials In FY14 (period ending March 2014), Sadafco reported 0.2% top-line growth. The slow growth was mainly due to non-supply of water by the International Water Distribution Company (Tawzea) for over a month between July and August 2013, resulting in the loss of sale orders of SAR30m. Sadafco’s gross margins improved by 85bp y-o-y on the back of a better product mix and improving production efficiencies. The company’s operating margins also improved in FY14 by 50bp, while net income grew by 4% on a y-o-y basis.

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Financials & valuation: Saudi Dairy and Foodstuff Co. Financial statements

Valuation data

Year to

03/2011a

03/2012a

03/2013a

03/2014a

Profit & loss summary (SARm) 1,134 165 -40 126 0 146 146 0 132 132


1,336 195 -41 154 0 164 164 0 152 152

1,549 221 -46 176 0 179 179 0 164 164

1,553 241 -57 184 0 186 186 0 171 171

73 -68 -9 -49 0 5

56 -96 -245 -98 0 -40

169 -147 -71 -98 0 23

213 -135 -56 -98 0 78

0 268 806 338 1,074 272 0 -338 730 736

0 323 773 202 1,096 238 0 -202 783 894

0 422 680 128 1,103 174 0 -128 849 975

0 498 640 113 1,138 135 0 -113 922 1,025



Year to

(SARm)

03/2011a

03/2012a

03/2013a

03/2014a

3.1 21.1 4.7 27.3 4.9 0.1 1.4

2.6 17.9 3.9 23.7 4.6 -1.1 2.7

2.3 15.7 3.6 21.9 4.2 0.6 2.7

2.2 14.5 3.4 21.0 3.9 2.2 2.7






Not Rated

(SAR)110.80


Target price


Year to

03/2012a

03/2013a

03/2014a

10.9 14.8 -0.9 -33.3 -36.0

17.7 17.8 22.4 12.3 15.2

16.0 13.7 14.1 8.7 8.1

0.2 8.8 4.8 4.2 4.2

1.5 17.9 18.1 12.3 14.6 11.1

1.5 17.0 19.4 13.9 14.6 11.5

1.6 16.9 19.4 14.9 14.3 11.3

1.5 16.7 18.6 15.0 15.5 11.8

-0.5 -2.0 -0.2

-0.3 -1.0 -0.3

-0.2 -0.6 -1.3

-0.1 -0.5 -1.9

4.06 4.06 1.50 22.46

4.68 4.68 3.00 24.10

5.06 5.06 3.00 26.12

5.27 5.27 3.00 28.35


172

SADAFCO AB 3,601 Food Products Not Rated

120

120

110

110

100

100

90

90

80

80

70

70

60

60

50

50

40 2012

Source: HSBC

03/2011a


Price relative

40 2013 SADAFCO


1 7 . 2

(SAR) Not Rated


2014 Rel to Tadawul

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Saudi Automotive Services Co. SACO AB, Price SAR31.80, Not Rated Company description SASCO was established in 1982. It owns and operates gas stations, auto service centres, highway motels and restaurants, as well convenience stores inside cities and on highways. In its petroleum retail segment, the company operates 74 gas stations and 15 quick service centres. Of the 89 sites, three are scheduled to cease operations due to lacklustre performance and 38 sites are under construction. In 2013, the segment serviced 6.9m vehicles, or 37m travellers, posting an increase of 9% y-o-y. In its other segments, SASCO owns and operates 30 convenience stores under its SASCO Palm brand, 10 coffee shops under its Palm Café brand, as well as motels, restaurants and auto service centres in some of its gas station across Saudi Arabia. The company also owns a transportation fleet of 55 tankers and 61 trailers, servicing both SASCO branches as well as non-affiliated customers.

As a result of price ceilings as well as government subsidies of fuel prices, SASCO maintains stable margins in its petroleum segment, at SAR0.09/l for petroleum and SAR0.035/l for diesel. In H 2014 (ended 30 June 2014), SASCO posted 69% y-o-y growth in net income, largely due to the liquidation of its equities portfolio. During the same period it posted an 11.3% increase in sales, y-o-y, with gross margins in line with previous years.

Recent news  On 16 July 2014, SASCO announced the distribution of six-month dividends to shareholders in the amount of SAR33.75m, at a DPS of SAR0.75, or 7.5% of book value.  On 25 June 2014, SASCO announced the completion of the liquidation of its equities portfolio, for a total amount of SAR194m. The company aims to invest the proceeds into its core activities in line with its strategic goals and expansion plans.

Financials In 2009-13, SASCO sales posted a CAGR of 18%, mainly driven by its petroleum retail operations, which accounted for 89% of sales in 2013. The Central region accounted for 41% of 2013 sales, up from 39% in 2012, outgrowing other regions of operations.

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Financials & valuation: Saudi Automotive Services Financial statements

Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a

Profit & loss summary (SARm) 213 21 -11 11 0 37 37 0 36 36


244 19 -14 5 0 41 41 0 40 40

345 21 -14 7 0 46 46 0 45 45

370 24 -16 8 -1 44 44 0 40 40



Year to

51 -113 -114 -23 0 -62

39 -107 -84 0 61 -63

84 -245 -229 0 89 -153

43 -97 -76 0 106 -54

0 280 108 59 587 72 0 -59 513 529

0 351 129 57 678 81 0 -57 544 621

0 573 170 91 933 86 150 59 694 843

0 624 247 131 1,085 97 256 125 729 955

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

7.3 73.3 2.9 39.7 2.8 -4.4 1.6

6.4 80.4 2.5 35.7 2.6 -4.8 0.0

4.5 74.3 1.8 31.8 2.1 -11.2 0.0

4.2 63.5 1.6 36.0 2.0 -3.7 0.0






Not Rated

(SAR)31.80


Target price


Year to

40

40

30

30

20

20

10

10

0 2012

Source: HSBC

12/2010a

12/2011a

12/2012a

12/2013a

11.8 21.2 39.5 6.2 14.3

14.5 -8.9 -50.7 8.8 11.3

41.4 8.3 38.5 14.1 12.5

7.1 16.9 16.5 -4.5 -11.7

0.4 6.8 7.0 6.1 10.0 5.0

0.4 6.5 7.4 5.9 7.9 2.1

0.4 5.3 6.5 4.8 6.1 2.1

-0.1 -2.8 -0.9

-0.1 -2.9 -0.7

0.1 2.8 1.4

0.4 4.2 5.5 3.7 6.6 2.3 25.8 0.2 5.1 0.3

0.80 0.80 0.50 11.39

0.89 0.89 0.00 12.10

1.00 1.00 0.00 15.42

0.88 0.88 0.00 16.19


174

Bloomberg (Equity) SACO AB Market cap (SARm) 1,431 Sector Commercial Services Contact Not Rated

Price relative

0 2013 Saudi Automotive Svs


1 7 . 2

(SAR) Not Rated


2014 Rel to Tadawul

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Saudi Ceramic Co. SCERCO AB, Price SAR139.58, Not Rated Company description Established in 1977, Saudi Ceramics manufactures and markets ceramic and porcelain tiles, sanitary ware, ceramic road markers, electrical water heaters and bathroom accessories. The company currently has 11 plants and employs 3,600 individuals. Saudi Ceramics has an annual capacity of 1.5m electrical water heater units, 64m sqm of ceramic and porcelain tiles, 6m pieces of decorative tiles, 2.5m pieces of sanitary ware, 1.8m pieces of ceramic road markers and 5m pieces of tile accessories. The company has plans to increase its production capacity to 3.5m pieces for sanitary ware. Saudi Ceramics sells its products through multiple outlets, including showrooms, wholesale distribution and direct exports. The company currently has a chain of 30 showrooms across the major cities of Saudi Arabia, along with a wide network of distributors across the Kingdom. It also exports its products to more than 70 countries in the GCC, Africa, Russia and Europe.

Financials On 16 January 2014, Saudi Ceramic Co announced Q4 2013 results. The company’s net income for the quarter grew by 11%, while operational profit for the quarter remained more or less flat. A lower zakat provision during the quarter led to the growth in net income. For FY13, the company reported net income growth of 25% and operational profit growth of 28%. Management pointed to higher production volumes and an increase in sales for the growth in the bottom line.

Recent news  On 14 July 2014, Saudi Ceramic Co announced Q2 2014 results. Net income for the quarter was up by 2%, implying 4% growth for H1 2014. Operating income for the quarter was down 12% with H1 2014 operating profits dropping by 7.5%.

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Financials & valuation: Saudi Ceramics Co. Financial statements

Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a

Profit & loss summary (SARm) 1,080 323 -101 222 -9 226 226 0 221 221


1,221 365 -121 244 -17 239 239 0 232 232

1,447 387 -129 258 -16 261 261 0 248 248

1,601 472 -140 331 -12 322 322 0 309 309

180 -184 -172 -76 72 -5

355 -276 -286 -88 45 79

298 -286 -311 0 95 12

483 -376 -373 0 -30 107

0 1,259 622 39 1,935 118 775 736 1,004 1,896

0 1,415 793 64 2,269 253 820 756 1,147 2,205

0 1,572 893 57 2,546 285 904 846 1,306 2,488

0 1,806 922 42 2,806 350 874 832 1,521 2,764



Year to

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

5.6 18.8 3.2 23.7 5.2 -0.1 1.5

5.0 16.6 2.8 22.6 4.6 1.5 1.7

4.2 15.7 2.4 21.1 4.0 0.2 0.0

3.8 12.9 2.2 16.9 3.4 2.0 0.0






Not Rated

(SAR) 139.58


Target price


Year to

150

150

140

140

130

130

120

120

110

110

100

100

90

90

80

80 70

70 60 2012

Source: HSBC

12/2010a

12/2011a

12/2012a

12/2013a

12.7 14.3 13.0 13.1 11.9

13.1 12.9 9.7 5.4 5.2

18.5 6.1 5.8 9.3 6.7

10.6 21.9 28.4 23.4 25.0

0.6 11.6 22.0 11.4 29.9 20.6 36.3 0.7 2.3 0.2

0.6 10.5 20.2 10.2 29.8 20.0 21.3 0.7 2.1 0.5

0.6 9.9 19.0 9.7 26.7 17.8 23.7 0.6 2.2 0.4

0.6 11.2 20.3 11.0 29.5 20.7 38.8 0.5 1.8 0.6

5.88 5.88 2.04 26.77

6.19 6.19 2.36 30.58

6.60 6.60 0.00 34.82

8.25 8.25 0.00 40.56


176

Bloomberg (Equity) SCERCO AB Market cap (SARm) 5,234 Sector Building Products Contact Not Rated

Price relative

60 2013 Saudi Ceramics


1 7 . 2

(SAR) Not Rated


2014 Rel to Tadawul

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Saudi Fisheries Co. SFICO AB, Price SAR38.28, Not Rated Company description Founded in 1981, Saudi Fisheries is engaged in fishing, fish and shrimp farming, as well as the sale of frozen and pre-cooked seafood. The company is involved in the marketing, local distribution and export of its products. The largest shareholder is the Saudi government through its Public Investment Fund (PIF), with a 40% share as of June 2014. The company operates two shrimp farms, with a total capacity of 4,500t/annum. An additional capacity of 3,000t/annum of shrimp is planned over the next three years. Saudi Fisheries also operates a freshwater fish farm, as well as five processing plants with a combined capacity of 13,000mt/annum and 6,000mt/annum of fish and shrimp, respectively.

In H1 2014 (ended 30 June 2014), Saudi Fisheries reported a net loss of SAR24m, compared to SAR23m over the same period in 2013. Management cited higher operating and selling costs as reasons behind the increased losses.

Recent news  On 21 July 2014, Saudi Fisheries reiterated its capex plans, announced in its prospectus, of SAR116.6m, allocated out of the company’s IPO proceeds of SAR335.4m. The plans include provisions for a farm and processing plant for shrimp, additions to the distribution network, as well as opening new outlets and the maintenance of existing facilities.  On 17 April 2014, Saudi Fisheries announces the receipt of lands from the Public Investment Fund (PIF), for which additional shares are to be issued to the PIF.

In 2013, the sale of fish accounted for 76% of revenue of Saudi Fisheries, while the sale of shrimp contributed 15%, and the sale of other products accounted for 10% of revenue.

Financials In FY13, Saudi Fisheries reported top-line growth of 10%. However, in 2009-12, the company’s sales contracted at a compound annual rate of 16%. The company has been registering losses since 2009, with cumulative losses at SAR233.8m, or 44% of its capital as of FY13.

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Financials & valuation: Saudi Fisheries Co. Financial statements

Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a

Profit & loss summary (SARm) 98 -11 -12 -24 -1 -26 -26 0 -27 -27


87 -13 -8 -21 -2 -22 -22 0 -22 -22

70 -26 -11 -36 -2 -34 -34 0 -40 -40

78 -33 -10 -43 -2 -43 -43 0 -49 -49



Year to

-26 -13 -13 0 39 -40

1 -7 -7 0 23 -6

-54 -43 -43 0 2 -97

-20 -13 -13 0 3 -33

0 122 74 2 197 31 48 46 109 195

0 121 415 355 536 42 71 -284 413 181

0 156 316 260 472 39 73 -187 351 212

0 159 276 231 436 47 76 -155 302 205

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

19.4 NM 9.7 NM 13.9 -1.9 0.0

21.9 NM 10.5 NM 13.9 -0.3 0.0

26.9 NM 8.9 NM 13.9 -4.7 0.0

24.4 NM 9.3 NM 13.9 -1.6 0.0






Not Rated

(SAR)38.28


Target price


Year to

12/2011a

12/2012a

12/2013a

-17.1 -9.8 -7.0 -4.3 -6.2

-11.6 12.5 -11.4 -18.8 -18.1

-18.7 98.8 71.0 59.8 81.2

10.2 29.1 18.8 23.8 22.8

0.5 -13.8 -24.7 -13.7 -11.7 -24.5

0.5 -12.2 -5.3 -4.1 -14.9 -24.5

0.3 -18.8 -11.4 -8.4 -36.5 -51.6

0.4 -4.0 -0.6

-0.7 22.0 0.0

-0.5 7.3 0.3

0.4 -23.9 -16.2 -11.2 -42.7 -55.5 -14.3 -0.5 4.7 0.1

-0.50 -0.50 0.00 2.74

-0.41 -0.41 0.00 2.74

-0.75 -0.75 0.00 2.74

-0.91 -0.91 0.00 2.74


178

SFICO AB 2,049 Food Products Not Rated

50

50

40

40

30

30

20

20

10 2012

Source: HSBC

12/2010a


Price relative

10 2013 Saudi Fisheries


1 7 . 2

(SAR) Not Rated


2014 Rel to Tadawul

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Shaker (Al Hassan Ghazi Ibrahim Shaker Co) SHAKER AB, Price SAR83.96, Not Rated Company description The parent company of Shaker Group was established in 1950 for the import and wholesale of air conditioners and home appliances. Currently, Shaker Co. is the main distributor in Saudi Arabia for eight brands of air conditioners and home appliances through its sales outlets, service centres and warehouses. Brands distributed by Shaker Company include LG, Ariston, Indesit, Maytag, DeLonghi, American Standard and McQuay. The company also sells some products under its own brand name. Currently, the group operates four subsidiaries through its holding company, Al Hassan Ghazi Ibrahim Shaker Company: Ibrahim Shaker Company Limited: Established in 1982, the company undertakes wholesale and retail of home appliances, including kitchen appliances, water coolers and air conditioning units. Ibrahim Hussein Shaker Project and Maintenance Company: Established in 2006, the company focuses on providing services to government entities and projects. LG Shaker Company: A joint venture between Korea’s LG Electronics and Shaker Company, the company has manufactured LG air conditioning units under licence in Saudi Arabia since 2006.

New Vision for Electronics and Electrical Appliances: Incorporated in Jordan, the company produces and distributes household, electrical and electronic appliances.

Financials In 2013 Shaker Co. reported 2% top-line growth, which was relatively low compared to earlier years, mainly due to increasing competition in the sector. The company’s operating margin for the period saw a 2.75pp drop due to the increasing cost of marketing in the wake of increasing competition, although the gross margin improved by 12bp y-o-y.

Recent news  On 22 July 2014, Shaker’s management announced that Ibrahim Hussein Shaker Projects and Maintenance Company, one of its fully owned subsidiaries, has been awarded a contract worth SAR38m by the Ministry of Education to supply air conditioning units to a number of its associated schools located in several regions across the Kingdom.  On 20 July 2014, Shaker announced Q2 2014 results. Net income for the quarter came in at SAR382m compared to SAR75m in Q2 2013, due to one-off gains, while operating income for the quarter was down 11%.

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Financials & valuation: Al Hassan Ghazi Ibrahim Shaker Co. Financial statements

Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a

Profit & loss summary (SARm) 1,156 197 -17 180 -3 182 182 -6 145 145


1,566 239 -24 215 -11 206 206 -4 180 180

1,707 270 -30 240 -16 226 226 -6 188 188

1,741 226 -30 196 -19 178 178 -8 125 125



Year to

159 -96 -96 -105 57 63

-45 -73 -72 -123 237 -118

133 -40 -39 -140 62 93

88 -32 -38 0 -36 56

1 242 626 52 874 188 180 128 423 822

1 290 917 61 1,213 203 418 356 481 1,151

0 300 1,052 75 1,357 212 481 405 528 1,282

0 301 1,176 89 1,489 219 445 356 654 1,400

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

2.8 17.1 4.4 22.2 7.7 6.6 4.0

2.4 14.1 3.4 20.2 7.0 2.6 3.6

1.8 11.7 2.4 16.3 6.1 -4.8 4.2

1.6 10.3 2.2 15.7 5.6 3.8 4.8






Not Rated

(SAR)83.96


Target price


Year to

12/2011a

12/2012a

12/2013a

8.7 38.0 39.1 39.1 28.6

15.8 20.7 18.3 18.1 9.6

35.5 21.3 19.0 13.0 24.1

9.0 13.0 11.7 10.1 4.1

1.6 20.9 34.6 20.1 16.4 15.3 73.2 0.2 0.4 3.2

1.4 17.7 34.3 16.6 17.0 15.6 61.2 0.3 0.6 1.2

1.4 15.7 37.5 14.9 15.3 13.7 20.9 0.7 1.5 -0.1

1.3 14.6 35.5 13.8 15.8 14.0 17.2 0.8 1.5 0.3

3.78 3.78 3.35 10.91

4.15 4.15 3.00 12.06

5.15 5.15 3.50 13.71

5.36 5.36 4.00 15.09


180

SHAKER AB 2,431 Distributors Not Rated

100

100

90

90

80

80

70

70

60

60

50

50

40 2012

Source: HSBC

12/2010a


Price relative

40 2013 Shaker


1 7 . 2

(SAR) Not Rated


2014 Rel to Tadawul


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Healthcare

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Healthcare  The proportion of Saudi citizens in the 65+ age group is projected

to grow at 6% pa as per UN estimates until 2025 as a result of falling birth and mortality rates  This will likely increase the incidence of lifestyle diseases, which

the current infrastructure is ill-equipped to deal with  The shortfall in healthcare infrastructure means that the private

sector will likely play an increasing role in satisfying demand

Higher growth to come Even after rising by c40% between 2009 and 2012, healthcare spending levels and related infrastructure in Saudi Arabia remain well below those seen in developed markets or even some emerging markets. We believe this indicates significant structural growth potential for the sector, especially as the living standard of the people in the Kingdom improves and they start using more healthcare services. We believe a host of factors will come into play in the medium term which could lead to strong growth in these spending levels.

Healthcare spend per capita (USD, 2012)

These include increasing penetration of medical insurance among Saudi citizens, which should drive higher usage levels; an ageing population, with the proportion of people above sixty almost doubling by 2020 according to UN estimates; and the growing prevalence of lifestyle diseases like obesity, diabetes and hypertension. These structural growth factors along with the increasing presence of private players implies there is a lot more growth potential left in the sector for the coming years, in our opinion.

Saudi population – breakdown based on age 100% 4% 6% 7% 8% 19% 19% 21% 80% 24%

9,000 7,500 6,000

60%

4,500 3,000

46%

20%

Source: World Bank WDI

US

France

Germany

UK

Qatar

Kuwait

Abu Dhabi

UAE

Dubai

Bahrain

Saudi

Oman

0

30%

29%

28%

44%

42%

39%

27%

25%

23%

2025

2030

40%

1,500

182

47%

9%

0% 2010

2015 0-14

Source: UN data

2020 15-39

40-59

60+


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Currently low levels of medical infrastructure along with government initiatives to shift the burden of healthcare to the private sector imply a strong growth in private healthcare spending, in our view. We believe differentiating among the private sector hospitals is a matter of verifying whether they have the accreditation that both insurers and corporate customers (which deal directly with the hospitals) require, and whether they are able to attract and hire the necessary staff. All three Saudi companies that we cover belong to the select group that meets these requirements. As such, choosing between them comes down to valuation and earnings momentum, in our view.

Hospital competitive landscape Admission rate The admission rate is the ratio of inpatients to outpatients in a hospital. Generally we find that hospitals’ operating margins decrease as the admission rate increases. Mouwasat has the lowest admission rate among these three private hospital operators, but it also has a high bed occupancy rate, which we believe helps it achieve comparatively higher margins along with low staff costs due to its presence outside Riyadh.

Outpatients per clinic In terms of outpatients per clinic, Mouwasat appears best placed at first glance, with close to 20% more patients per clinic than Dallah and around 10% more than NMCC. However, if we examine the revenue per outpatient, the numbers corroborate statements from all three management teams that Dallah targets the Tier 1 segment whereas Mouwasat targets the segment just below: revenue per outpatient at Dallah clinics is almost double that of Mouwasat. Interestingly, NMCC also has high revenue/outpatient despite targeting the same segment as Mouwasat. We believe this to be a function of higher prices and

more procedures per patient as well as NMCC’s presence in the high-priced Riyadh market, where Mouwasat currently does not have operations. We would also argue that Mouwasat has been held back in its pricing through overreliance on corporate accounts, which accounted for 23% of its revenues until 2011.

Inpatients per bed We believe Dallah is the clear leader among the three major Saudi private hospitals in the inpatient division, in terms of both inpatients per bed and revenue per inpatient. Its revenue per inpatient is almost 40% higher than that of Mouwasat and 70% higher than that of NMCC. We believe that this is mainly a reflection of the clients that come to Dallah, which obtains a higher proportion of its revenues from cash business (as opposed to insurance business and corporate accounts), for which the hospital can increase prices with few constraints.

Revenue streams Generally hospitals have two main revenue streams: inpatient and outpatient revenues. In addition to this, they operate pharmacies and some also provide operational and maintenance support to other hospitals, which generates fixed fee income that attracts lower margins. Dallah generates around 90% of its revenues from hospital operations (inpatient and outpatient), but NMCC and Mouwasat obtain less than 80% of their revenues from hospitals.

Pharmaceutical sector In most MENA markets the contribution of the government to healthcare spending is much lower than in other regions. Therefore, the shift from branded generics to plain generics would need to be driven mostly by consumers rather than the authorities, in our view. But in most MENA countries brands have historically ensured a certain quality of product and unless there are alternate regulatory mechanisms to convey this

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assurance, we believe the move towards plain generics in the MENA region will be slow. If we look at the Saudi market, the take-up of generics is still quite weak as it accounts for just c10% of the prescription drug market (by value). We believe this is for several reasons:  Manufacturers of originals spend large sums on sales and marketing in order to persuade doctors and pharmacists to dispense originals.  Local manufacturers have signed marketing agreements to sell patented drugs.  The government has to issue licences to enable companies to manufacture generics. Until recently this was a rare occurrence. Delving into the first issue, it is apparent how important sales and marketing are to the take-up of products as these costs amount to 24% of SPIMACO’s sales and Tabuk Pharmaceuticals spends around 50% of its revenues on this area. This high level of spend is effectively a barrier to entry. Within the generics segment, the government pricing mechanism forms another barrier to entry. The first company to launch a generic for a particular drug coming off patent is allowed to price it at up to a 20% discount to the price of the original. The second entry is allowed up to a 40% discount, and the discount continues to increase thereafter. This,

Breakdown of top nine MENA pharmaceutical markets (2013) Jordan 2% Tunisia 5%

Kuw ait 2%

Lebanon 6%

Saudi 24%

Source: IMS

184

.

Growth in top nine MENA pharmaceutical market 20% 2011

15%

2012

2013

10% 5% 0%

Source: IMS

Kuwait

Jordan

Tunisia

Lebanon

Morocco

-5%

UAE

Egy pt 22%

Algeria

Algeria 21%

Nevertheless, local manufacturers have been reducing their exposure to these tenders, preferring to focus on the still higher margins in the export markets, which are more prone to allowing the entrance of plain generics. Although there is little to suggest that the domestic retail market will welcome plain generics in the near term, spend on drugs per capita in Saudi is still low, at less than a third of OECD levels, which we believe suggests strong growth potential for the entire pharmaceutical market going forward.

Egypt

UAE 9%

On the demand side, pharmaceutical drugs for the public sector in Saudi are procured through the Secretariat-General of Health (SGH) and the National Unified Procurement Company for Medical Supplies (NUPCO). SGH tenders procure pharmaceuticals for the whole of the GCC and, generally, the regional drug manufacturers, which are based in the GCC, get preferential treatment in these tenders.

Saudi

Morocco 9%

combined with the cost of the sales force, means that it is difficult to build a business case for launching generic drugs when the first and second entries have already been launched.

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Astra Industrials Group ASTRA AB, Price SAR47.90, N, TP: SAR63 Company description The company has three main business segments: pharmaceuticals represented by the Tabuk Pharmaceutical Manufacturing Co., specialty chemicals represented by Astra Polymer Compounding Co & Astra Industrial Complex Co., and finally, steel industries represented by the International Building Systems Factory Co. and Al Tanmia Steel. All these subsidiaries, excluding Al Tanmia Steel, are 100% owned by Astra Industrials through either direct or indirect ownership.

Investment thesis Through its diversified segments and revenue streams, we believe Astra is an attractive collection of companies operating in what we view as Saudi Arabia's most attractive segments. The company's different holdings operate in the healthcare, petrochemical, fertiliser and infrastructure segments. Tabuk Pharmaceuticals is the second largest local pharmaceutical company in Saudi Arabia by market share. The company also exports to different regional markets – exports accounted for 28% of revenue in 2013. Tabuk Pharmaceuticals accounted for over 85% of the group's net income in 2012 although it accounted for only 49% of revenue. During 2013, Astra’s pharmaceutical division reported 32% top-line growth. This was partly due to a surge in bulk tenders, which are usually sold to the government. We believe that the strong growth in the pharmaceutical division will continue in

2014e, however, this year, it will likely be mostly driven by the new injectables capacity coming online. Although the Dammam injectables plant, which was set for a Q1 2014 start, is now postponed due to a labour shortage, it is expected to add around 20-25% of capacity, which we expect could imply strong growth for the division along with the organic growth we have been seeing over the last few quarters.


However, Astra’s steel division continues to face margin pressure. Although we believe that Astra’s steel division (especially its operations in Iraq) present a strong growth opportunity for the company in the long term, in the medium term, we continue to see increasing margin pressure on the division. Over the last few quarters, the division has been seeing a significant drop in margins, and during H1 14 management pointed to increasing costs and lower production in Iraqi steel operations. The recent tensions in Iraq led to the stoppage of production of the plant, which put further pressure on profits.

Financials During Q2 14, Astra reported net profit of SAR3m, well below the SAR62m net profit seen in Q2 13. The main reasons for the significantly weak results include the write downs and plant shutdowns in Iraqi steel operations.

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Valuation

Risks

We value Astra using a DCF methodology. The WACC of 10.8% is derived from a risk-free rate of 1.8% (SAIBOR rate for 12 months). We assume a cost of debt of 4% while the market cost of equity is based on a combination of relative index returns, CDS spread (for five year sovereign Saudi Arabia CDS) and inflation differential to arrive at 12.5%. The long-term beta is Bloomberg’s adjusted beta for the stock of 1.09. The DCF valuation yields an equity fair value of SAR63.

Key downside risks are:

Under the HSBC research model for stocks without a volatility indicator, the Neutral band is 5 percentage points above and below the hurdle rate for Saudi Arabia of 9%. At the time we set our target price it implied a potential return within the Neutral band, hence we have a Neutral rating on Astra. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

186

 Increased competition in the Saudi generic pharmaceuticals market.  Reduced demand for products in the chemical and steel sectors. Key upside risks are:

 The steel smelter in Iraq gets up and running, which would positively impact profits.

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Financials & valuation: Astra Industrial Group Financial statements

Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


1,772 222 -48 174 -30 211 211 0 253 253

2,005 305 -56 249 -31 278 278 0 311 311

2,233 408 -57 351 -29 382 382 0 382 382

2,346 492 -58 434 -26 468 468 0 468 468



Year to

-27 -224 190 -130 -123 -276

265 -201 -201 -156 -160 5

378 -89 -89 -191 -133 229

385 -94 -94 -468 -100 231

46 1,329 2,274 197 3,651 834 936 739 1,881 2,617

46 1,474 2,404 216 3,927 1,095 795 579 2,037 2,613

46 1,507 2,608 349 4,163 1,140 795 446 2,228 2,671

46 1,542 2,851 450 4,441 1,419 795 345 2,228 2,571

(SARm)

12/2013a

12/2014e

12/2015e

12/2016e

2.4 19.3 1.6 14.0 1.9 -7.8 3.7

2.1 13.6 1.6 11.4 1.7 0.1 4.4

1.8 9.8 1.5 9.3 1.6 6.4 5.4

1.7 7.9 1.5 7.6 1.6 6.5 13.2






Neutral

(SAR)47.90


Target price



71 66 61 56 51 46 41 36 31 26 2012

2013

2014

71 66 61 56 51 46 41 36 31 26 2015


Source: HSBC

12/2014e

12/2015e



Bloomberg (Equity) ASTRA AB Market cap (SARm) 3,550 Enterprise value (SARm) 4127 Sector CONGLOMERATES Contact +971 4423 6932

Price relative

Astra Industrial Group

Year to

3 1 . 5

(SAR)63.00

18.4 -1.3 -6.1 -1.1 4.3

13.2 37.1 43.1 31.4 23.0

11.4 33.8 40.9 37.6 22.8

5.0 20.8 23.8 22.5 22.5

0.7 6.5 13.5 6.7 12.5 9.8 7.4 39.3 3.3

0.8 9.5 15.9 8.2 15.2 12.4 9.7 28.4 1.9 45.8

0.8 13.3 17.9 10.2 18.3 15.7 14.1 20.0 1.1 84.7

0.9 16.6 21.0 11.5 21.0 18.5 18.6 15.5 0.7 111.5

3.42 3.42 1.75 25.42

4.20 4.20 2.10 27.52

5.16 5.16 2.58 30.10

6.32 6.32 6.32 30.10


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Dallah Healthcare DALLAH AB, Price SAR104, OW, TP: SAR115 Company description Founded in 1987, Dallah Healthcare owns and operates a single hospital in north Riyadh while also offering its management services to other healthcare providers. The company is also in the process of building a new 300-bed hospital in west Riyadh. Furthermore, Dallah has a pharma division which is responsible for the wholesale of pharmaceutical, herbal and cosmetic products. The company also has an operations management division which currently manages two hospitals via 5-year contracts, one of the contracts operational and one strictly management. The contracts are set to expire in November 2015 and April 2016, respectively.

Investment thesis During Q4 2013, Dallah opened its new paediatric unit. This expansion increases the number of operational beds by c20%, which should drive strong top-line growth in the second half of 2014e, by our estimates. The company also plans to open 65 new clinics by the end of 2014e, implying more than a 40% increase in the number of clinics operated, which we expect to lead to strong growth for 2015e. We estimate Dallah’s hospital division to generate c20% top-line growth during 2014-15e as new capacity comes online. During H1 2013, margins dropped significantly, mainly due to expansion costs. Administrative costs as a percentage of sales increased to 21% in H1 2013 compared to 12% in

188

FY12, implying to an 18% operating margin. However, the company has been able to contain costs with the admin expenses to sales ratio coming in at 18.5% for Q1 2014, despite the opening of the new paediatric block, which should mature as the year progresses. We expect operating margins of 18% for 2014e. On 31 March 2014, Dallah announced that it has signed a MoU with Dr. Erfan and Badego General Hospital (not listed) to acquire its 326-bed facility in Jeddah. We believe this is likely to be a hospital where Dallah can improve margins, given the low support staff to doctor ratios and heavy focus on inpatients, both of which weigh on margins. The 326-bed hospital, which is one of a select group of JCI (Joint Commission International) accredited hospitals in Saudi, saw 1.6k to 1.8k outpatients and 170-200 inpatients per day during 2013. Since Badego’s admission rates are well ahead of Dallah’s (at c10% versus 4%), we believe that this hospital caters to the mid to high-end patient category, as generally only government hospitals focus as much on in-patients (most other private hospitals focus on outpatients). We assume the per patient revenue generated by Badego is 30% lower compared to Dallah considering the location and Dallah’s premium reputation, but the risk is this discount is likely to be too high, in our view; this leads to our estimate that Badego generated a net revenue of SAR650m during 2013. Given the low proportion of support staff to doctors (4x vs. 7.3x for Dallah) and the high in-patient admission ratio, we would expect margins to be much lower than Dallah’s. We would expect


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Dallah, should it be successful in its takeover, to increase support staff and open more clinics to drive outpatient volumes, all of which would require little investment and improve margins, in our view.

Financials We estimate Dallah to see more than 18% revenue growth in 2014e and more than 20% revenue growth in 2015e due to the new capacity additions. The group has already added a new paediatric wing which should start contributing to the top-line and plans to add 65 new outpatient clinics by end 2014, which we expect to drive growth in 2015e.


 The new hospital coming on line in 2016 causing a larger drag than expected on revenues per patient; we currently estimate that revenue per patient will be 10% lower than at the existing hospital.  We expect “Saudisation” to force the company to have 50% Saudis in the workforce by 2016; any acceleration in this timetable would be a negative, in our view.

Valuation We value Dallah using a DCF methodology. The WACC of 9.2% is derived from a risk-free rate of 1.8% (SAIBOR rate for 12 months). We assume a cost of debt of 4% while the market cost of equity is based on a combination of relative index returns, CDS spread (for five year sovereign Saudi Arabia CDS) and inflation differential to arrive at 12.5%. We use a terminal growth rate of 2.5% and a beta of 0.90 (based on historical Bloomberg beta).. This yields a target price of SAR115. Under our research model, for stocks without a volatility indicator, the Neutral band is 5pp above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price it implied a potential return above the Neutral band. Hence we have an Overweight rating for Dallah. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

189

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Financials & valuation: Dallah Healthcare Financial statements

Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


750 176 -39 137 0 148 148 -11 137 137

886 212 -48 164 -3 171 171 -13 158 158

1,078 263 -57 206 -5 211 211 -16 195 195

1,215 288 -56 231 -5 236 236 -18 218 218



Year to

170 -421 -628 -71 526 -256

170 -152 -152 -71 59 45

204 -228 -228 -71 105 15

245 -36 -36 -71 -125 228

0 821 500 150 1,479 108 121 -29 1,190 1,063

0 920 493 91 1,571 118 121 30 1,272 1,204

0 1,090 491 15 1,740 133 150 135 1,396 1,433

0 1,070 671 140 1,900 146 150 10 1,543 1,455

(SARm)

12/2013a

12/2014e

12/2015e

12/2016e

6.3 27.0 4.5 35.9 4.1 -5.4 1.4

5.4 22.7 4.0 31.0 3.9 0.9 1.4

4.6 18.7 3.4 25.1 3.5 0.3 1.4

3.9 16.7 3.3 22.5 3.2 4.8 1.4

Target price

(SAR)115.00






Overweight

(SAR)104.00



115

115

105

105

95

95

85

85

75

75

65

65

55

55

45 2012

2013 Dallah Healthcare

12/2013a

Source: HSBC

12/2014e

12/2015e



17.8 10.1 4.7 9.3 2.7

18.2 20.6 19.7 16.1 15.9

21.7 24.1 25.7 23.2 23.3

12.6 9.1 12.2 11.6 11.6

0.9 15.3 11.9 10.0 23.5 18.3 512.7 -2.4 -0.2

0.8 13.4 12.9 10.5 24.0 18.5 84.3 2.4 0.1 569.5

0.8 14.5 14.6 12.1 24.4 19.1 54.4 9.7 0.5 151.4

0.8 14.8 14.8 12.3 23.7 19.0 53.0 0.6 0.0 2450.0

2.90 2.90 1.50 25.21

3.36 3.36 1.50 26.94

4.14 4.14 1.50 29.58

4.62 4.62 1.50 32.70


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Bloomberg (Equity) DALLAH AB Market cap (SARm) 4,909 Enterprise value (SARm) 4810 Sector HEALTH CARE PROVIDERS Contact +971 4423 6932

Price relative


1 0 . 6


45 2015

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Al Mouwasat Medical Services Co MOUWASAT AB, Price SAR108.25, OW, TP: SAR126 Company description Mouwasat is one of the largest hospital operators in Saudi Arabia, currently operating four hospitals with 594 beds and 231 outpatient clinics. The group currently does not have a presence in Riyadh but has a strong presence in Eastern cities. Mouwasat has a strong corporate client base with companies like Saudi Aramco, Saudi Electricity Company and SABIC utilizing its services.

Investment thesis Our Overweight rating on Mouwasat is based on the following:  We see strong growth potential in the Saudi private healthcare sector due to factors ranging from an ageing population to an increasing number of people with insurance coverage. Mouwasat is one of the largest players in the sector and should benefit from this, in our view  Mouwasat has a very strong expansion plan, which could see the group more than double its inpatient bed capacity by 2018e and expand its outpatient clinics by more than 50% by 2018e  Mouwasat has been able to generate strong organic growth from an increasing number of patients as well as improving tariffs/case mix. We see this trend continuing and complementing the group’s expansion plans

 We expect improving margins in the medium term from the improving mix as the contribution of the low-margin pharmaceutical division drops as a percentage of total sales and from improving gross margins in hospitals. However, following the probable opening of a new Riyadh hospital in Q3 2014, there could be slight margin pressure in the short term


Financials During 2013, Mouwasat saw a slowdown in terms of top-line growth as revenue grew by 13% (slower compared to the 16% average growth seen between 2010 and 2012). One of the main reasons was the significant drop in outpatient revenue growth (11% growth in 2013 vs. three-year average growth of 23%). Although the company has not pointed to any particular factors, we believe the general slowdown in Q3 following the crackdown on illegal labourers was likely one of the reasons. Furthermore, over the last five years the group has not added any new beds, implying that all the growth we are seeing is purely organic. We believe 2014/15e should see strong revenue growth due to the improving claim per patient as well as the opening of a new hospital in Riyadh. We estimate 12% revenue growth in 2014e and 20% in 2015e as the new hospital matures.

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 Over the last few quarters Mouwasat has seen a strong improvement in margins. We believe the improvement at the gross margin level is due to two factors:  Improving mix as the contribution of the low margin pharmaceutical division dropped as a percentage of total sales  Improving gross margins in hospitals We believe the opening of the new hospital could put some pressure on margins initially, however, we see the decrease in the contribution of pharmaceuticals to total sales continuing. This and strong margins in the hospital division should help the company post operating margins of 24% in the medium term, on our estimates.

Valuation We value Mouwasat using a DCF methodology. The WACC of 9.2% is derived from a risk-free rate of 1.8% (SAIBOR rate for 12 months). We assume a cost of debt of 4%, while the market cost of equity is based on a combination of relative index returns, CDS spread (for five year sovereign Saudi Arabia CDS) and inflation differential to arrive at 12.5%. The long-term beta is Bloomberg’s adjusted beta for the stock of 0.90. The DCF valuation yields our target price of SAR126 per share. Under the HSBC research model for stocks without a volatility indicator, the Neutral band is 5ppt above and below the hurdle rate for Saudi Arabia of 9%. Our target price of SAR126 implies a 16% potential return, above the Neutral band, hence we reiterate our Overweight rating. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

192


 20% of the company’s revenue comes from the ARAMCO contract, which is up for renewal in mid-2015. ARAMCO’s new JV with JHI might negatively affect the profitability of this contract  Further incentives offered to large insurance customers could put pressure on margins  Any further regulation to increase “Saudisation” levels past the 50% threshold that we forecast would be a negative, in our view

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Financials & valuation: Al Mouwasat Medical Services Co Financial statements

Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


902 263 -40 222 -1 232 232 -14 201 201

1,014 289 -49 240 -8 241 241 -12 209 209

1,218 386 -80 306 -9 306 306 -15 267 267

1,417 445 -85 360 -9 361 361 -18 315 315



Year to

275 -221 -218 -75 60 36

260 -180 -180 -126 46 71

336 -150 -150 -160 -25 177

393 -142 -142 -189 -62 243

17 868 481 180 1,475 149 342 161 889 1,037

17 1,000 473 135 1,597 169 342 207 972 1,186

17 1,069 565 160 1,759 200 342 182 1,079 1,292

17 1,126 693 222 1,943 231 342 119 1,205 1,383

(SARm)

12/2013a

12/2014e

12/2015e

12/2016e

6.2 21.2 5.4 26.9 6.1 0.7 2.2

5.5 19.4 4.7 25.9 5.6 1.3 2.3

4.6 14.5 4.3 20.2 5.0 3.3 3.0

3.9 12.4 4.0 17.2 4.5 4.5 3.5

Target price

(SAR)126.00






Overweight

(SAR)108.25




122 112 102 92 82 72 62 52 42 32 2012

2013

2014

122 112 102 92 82 72 62 52 42 32 2015


Source: HSBC

12/2014e

12/2015e



Bloomberg (Equity) MOUWASAT AB Market cap (SARm) 5,413 Enterprise value (SARm) 5612 Sector HEALTH CARE PROVIDERS Contact +971 4423 6932

Price relative

Al Mouwasat Medical Servi

Year to

1 6 . 4

13.3 17.0 19.8 20.1 17.3

12.3 10.0 8.0 3.7 4.0

20.2 33.7 27.4 27.1 27.8

16.3 15.2 17.8 17.8 17.9

0.9 22.0 24.4 16.3 29.1 24.6 187.7 17.0 0.6 170.3

0.9 20.5 22.5 15.4 28.5 23.7 35.6 19.7 0.7 125.5

1.0 23.4 26.1 17.8 31.7 25.1 45.2 15.4 0.5 184.6

1.1 25.6 27.6 19.0 31.4 25.4 52.1 8.9 0.3 329.4

4.02 4.02 2.41 17.77

4.19 4.19 2.51 19.44

5.35 5.35 3.21 21.58

6.30 6.30 3.78 24.10


193

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National Medical Care Co (NMCC) CARE AB, Price SAR73.50, N, TP SAR78 Company description National Medical Care Co (NMCC) was established in 2003 as a joint-stock company. The purpose of the company was to transfer the ownership of 20% of both Al Riyadh Care and The National Hospital to a group of investors by the General Organization for Social Insurance (GOSI). Before that, both hospitals were fully owned by the GOSI. NMCC operates the aforementioned two hospitals in Riyadh, with a combined bed capacity of c600 beds and c90 clinics. In 2009, the Al Riyadh Care hospital gained JCI accreditation.

Investment thesis NMCC’s hospitals were originally under government control, which explains two things: that both its hospitals are located in the southeast of Riyadh, which is the older and perhaps less affluent part of the city; and that its staff costs are higher than those of the other two groups. NMCC had strong revenue growth in the last few quarters. However, in terms of margins we are seeing slight pressure. We expect strong revenue growth of 22% in 2014e due to the recent new openings. NMCC added 208 inpatient beds (paediatric beds and adult intensive care units) during April 2014 along with 24 outpatient clinics. We believe these additions will likely lead to strong

194

growth. Furthermore, the company plans to renovate 96 inpatient beds and 46 outpatient clinics in coming quarters, which could lead to strong traffic in the longer term.

Financials NMCC reported strong revenue growth during Q2 14, thanks to the new opening. The group’s operating profits grew by 39% while net income grew by 40% during the quarter. For H1 14, operating profit growth was a strong 16%. For the full year 2014e we estimate more than 20% revenue growth.

Valuation We value NMCC using DCF methodology. The WACC of 9.2% is derived from a risk-free rate of 1.8% (SAIBOR rate for 12 months). We assume a cost of debt of 4%, and the market cost of equity is based on a combination of relative index returns, CDS spread (for five year sovereign Saudi Arabia CDS) and inflation differential to arrive at 12.5%. We use a terminal growth rate of 2.5% and a beta of 0.90 (based on historical beta from Bloomberg). Our DCF model generates a target price of SAR78. Under our research model, for stocks without a volatility indicator, the Neutral band is 5pp above and below the hurdle rate for Saudi stocks of 9%. Our target price implies a potential return of 5%, within the Neutral band; therefore, we are reiterating our Neutral rating for NMCC. Potential return equals



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the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

Risks Key upside risks:

 That the company is able to bring staff costs down aggressively by hiring more support staff  That the new clinics, which have lower overhead, lead to a more aggressive increase in margins than anticipated Key downside risks:

 We expect “Saudisation” to force the company to have 50% Saudis in the workforce by 2016; any acceleration of this timetable would be a negative, in our view  The high prices may be negotiated downward by insurance companies

195

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Financials & valuation: National Medical Care Co Financial statements

Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


586 123 -31 92 0 100 100 -7 92 92

716 147 -32 115 0 123 123 -9 114 114

783 173 -41 132 0 140 140 -10 130 130

874 199 -43 156 0 164 164 -11 153 153



Year to

79 -130 -130 -65 -58 -74

111 -150 -150 -80 119 -47

150 -110 -110 -91 52 32

166 -70 -70 -107 11 88

0 558 512 186 1,071 171 87 -99 812 714

0 676 445 67 1,121 187 87 20 847 867

0 745 452 45 1,197 194 117 72 886 958

0 772 511 64 1,283 204 147 83 932 1,014

(SARm)

12/2013a

12/2014e

12/2015e

12/2016e

5.5 26.0 4.5 35.6 4.1 -2.2 2.0

4.6 22.5 3.8 28.8 3.9 -1.4 2.4

4.3 19.5 3.5 25.3 3.7 1.0 2.8

3.9 17.0 3.3 21.6 3.5 2.7 3.2

Target price

(SAR)78.00






Neutral

(SAR)73.50




133 123 113 103 93 83 73 63 53 43 33 2012

2013

Source: HSBC

12/2014e

12/2015e



11.7 -7.2 -12.4 -10.6 -12.3

22.1 19.8 25.8 23.6 23.7

9.3 17.4 14.6 13.6 13.9

11.7 14.9 17.9 16.9 17.3

0.9 13.3 13.0 9.9 21.0 15.6

0.9 13.5 13.8 10.4 20.6 16.1

0.9 13.5 15.1 11.3 22.1 16.9

0.9 14.7 16.8 12.3 22.7 17.8

-12.2 -0.8

2.4 0.1 544.9

8.1 0.4 208.1

8.9 0.4 201.3

2.06 2.06 1.45 18.11

2.55 2.55 1.79 18.87

2.91 2.91 2.04 19.75

3.41 3.41 2.39 20.77


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Bloomberg (Equity) CARE AB Market cap (SARm) 3,296 Enterprise value (SARm) 3317 Sector HEALTH CARE PROVIDERS Contact +971 4423 6932

Price relative

National Medical Care Co

Year to

6 . 1

2014

133 123 113 103 93 83 73 63 53 43 33 2015


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Saudi Pharmaceuticals (SPIMACO) SPIMACO AB, Price SAR47.80, N, TP SAR47.08 Company description Saudi Pharmaceutical (SPIMACO) is the leading Saudi pharmaceutical company. It is involved in the development, manufacture, distribution and marketing of its own products as well as licensed products of other international manufacturers. The company was established in 1986 but only began operations in 1990 with 6 products. In 2000, the company began operations in Algeria. An important and distinctive advantage of SPIMACO's strategy is its relationships with multinational companies. Most of SPIMACO's earlier deals were structured so that SPIMACO manufactures products for multinationals. In addition, SPIMACO would undertake the sales and marketing, which meant dealing with the Ministry of Health (MOH) and other government institutions. SPIMACO actively markets most of its registered products to all the various segments in the market: MOH, private institutions and the export market. Today, the company has over 150 products, controls around 14% of the Saudi pharmaceuticals market and has three of the top ten selling products by value.

Investment thesis SPIMACO has been seeing robust gross margin improvements over the last few quarters. We believe this is a result of the company’s continued expansion into higher-margin export and private

sales at the expense of government sales which carry lower margins. SPIMACO’s management has said it will continue with this strategy and sees opportunities in countries like Turkey, which they can access through their 7-year marketing agreement with Abdi Ibrahim signed in August 2013. However we are seeing increasing SG&A expenses for the group over the last few quarters. Management have said that the increasing S,G&A had little to do with the recent crackdown on illegal labour in the Kingdom, rather it was the result of investment in therapeutic categories that are new to them such as high blood pressure, diabetes and digestive system disorders. We estimate margins to remain weak in 2014 and believe that things should improve in 2015. However the stock is up by more than 35% over the last 12 month period which in our opinion prices in the potential growth.


Valuation We value SPIMACO’s core pharmaceutical business using a DCF methodology with a WACC of 10.9% derived from a risk-free rate of 1.8% representing the 12-month SAIBOR rate, a cost of debt derived from adding 220bps to the risk-free rate, and a market cost of equity of 12.7% derived from a combination of relative index returns, CDS spread and inflation differential. The long-term beta of 0.99 is derived from Bloomberg’s adjusted beta and the debt/equity ratio is assumed to be 30:70. We value the investment holdings at book value, which is below market valuation. This yields an equity fair value of SAR47.08 per share.

197


Under the HSBC research model for stocks without a volatility indicator, the Neutral band is 5 percentage points above and below the hurdle rate of Saudi Arabia of 9%. At the time we set our target price it implied a potential return within the Neutral band hence we have Neutral rating SPIMACO. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.


 Increased competition in the generic pharmaceuticals market.  An inability to gain first entrant registration for off-patent drugs would reduce margins for the company. Key upside risks include:

 Ramp up in SG&A leads to much better sales than expected  Company decides to divest its non-core assets and distribute the proceeds to shareholders.

198

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Financials & valuation: Saudi Pharmaceutical Financial statements

Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


1,297 239 -28 211 -2 289 289 0 270 270

1,394 260 -29 231 0 346 346 0 324 324

1,501 301 -31 270 0 403 403 0 379 379

1,600 306 -34 272 0 400 400 0 375 375



Year to

163 -46 -59 -187 47 9

291 -56 -63 -243 -113 142

342 -60 -60 -303 -63 173

346 -64 -64 -338 -3 178

3 376 1,326 119 4,368 426 20 -99 3,758 1,160

6 407 1,524 232 4,601 449 20 -212 3,839 1,257

5 438 1,679 295 4,785 473 20 -275 3,915 1,354

5 469 1,769 298 4,906 497 20 -278 3,952 1,447

(SARm)

12/2013a

12/2014e

12/2015e

12/2016e

2.3 12.4 2.6 21.2 1.5 0.3 3.3

2.1 11.0 2.3 17.7 1.5 4.6 4.2

1.9 9.3 2.1 15.1 1.5 5.6 5.3

1.7 9.1 1.9 15.3 1.5 5.8 5.9

Target price

(SAR)47.08






Neutral

(SAR)47.80


2070.SE 1,529 Saudi Arabia Raj Sinha

Bloomberg (Equity) SPIMACO AB Market cap (SARm) 5,736 Sector HEALTH CARE PROVIDERS Contact +971 4423 6932

Price relative 55

55

50

50

45

45

40

40

35

35

30

30

25

25

20 2012

2013 Saudi Pharmaceutical

2014

20 2015


Source: HSBC


5 0 . 6

12/2013a

12/2014e

12/2015e

12/2016e

9.6 3.5 5.4 15.0 16.0

7.5 8.8 9.6 19.7 20.0

7.7 15.7 16.7 16.4 17.0

6.6 1.5 0.7 -0.6 -1.1

1.2 19.8 8.0 7.3 18.4 16.3 119.5 -2.6 -0.4

1.2 19.3 8.5 7.7 18.7 16.6

1.2 20.8 9.8 8.6 20.1 18.0

1.1 19.5 9.5 8.3 19.1 17.0

-5.5 -0.8

-6.9 -0.9

-6.9 -0.9

2.25 2.25 2.38 31.33

2.70 2.70 3.10 32.00

3.16 3.16 3.87 32.63

3.13 3.13 4.30 32.95



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Al Hammadi Dev. & Investment Co. ALHAMMAD AB, Not Rated Company description Al Hammadi Development & Investment Co. (Al Hammadi) owns and operates Al Hammadi Hospital in the Olaya district of Riyadh. Established in 1985, the hospital has a capacity of 200 beds, with 74 outpatient clinics, employing 196 doctors and 400 nurses. Al Hammadi announced plans to open two new hospitals in Riyadh in Q3 of 2014 and early 2015. The two hospitals are to be opened in the southwest and northeast areas of Riyadh, with a planned capacity of 428 beds each, bringing the total capacity of the group to 1,156 beds. The company also plans to add 128 new outpatient clinics (64 each in both the new hospitals), which would take the total number of clinics to 202. The company listed on the Saudi market on 15 June, 2014, after raising SAR630m in its IPO. 75% of the proceeds are targeted for capital investments.

Financials During 2013, Al Hammadi reported 14.6% revenue growth due to strong growth in both inpatient and outpatient revenues. Although the number of inpatients in Al Hammadi hospital dropped by 5% during the year, the sharp increase in claim per patient helped boost revenue growth. In terms of operating margins the group reported a 1.4pp improvement as general & administrative expenses as a percentage of sales saw a significant drop during the year.

200

Recent news  On 20 July, 2014, Al Hammadi reported Q2 14 results. During the quarter the group saw 18% net income growth along with 24.5% operating income growth. For the first half of 2014, the group reported 16.6% net income growth along with 22% operating income growth.

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Financials & valuation: Al Hammadi

Not Rated


Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a


302 102 -14 88 -5 84 84 -4 80 80

331 105 -13 92 -2 92 92 -2 90 90

379 106 -14 92 -2 97 97 -3 94 94

434 126 -14 112 0 116 116 -4 112 112



102 0 0 -12 -99 92

105 0 0 -27 26 102

106 0 0 0 144 102

126 0 0 -95 389 121

0 317 174 21 491 37 0 -21 444 433

0 398 166 35 564 46 40 5 474 483

0 650 193 63 843 59 213 149 569 721

0 1,028 209 42 1,236 67 580 538 586 1,127

(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

12.2 36.1 8.5 46.2 8.3 2.5 0.3

11.2 35.2 7.6 41.0 7.8 2.8 0.7

10.1 36.2 5.3 39.1 6.5 2.8 0.0

9.7 33.6 3.8 33.1 6.3 3.3 2.6






Year to

(SAR)49.20


Target price


Bloomberg (Equity) ALHAMMAD AB Market cap (SARm) 3,690 Sector HEALTH CARE PROVIDERS Contact Not Rated

Price relative 51

51

46

46

41

41

36

36

31 2012

2013 Al Hammadi

2014

31 2015


Source: HSBC


1 . 6

(SAR)Not Rated

12/2010a

12/2011a

12/2012a

12/2013a

-2.7 3.3 8.6 1.9 4.5

9.7 3.4 4.9 9.5 12.6

14.5 0.8 0.2 5.3 4.8

14.6 18.7 21.4 19.6 18.3

0.7 18.7 19.4 15.6 33.7 29.1 19.0 -4.7 -0.2

0.7 19.7 19.6 17.0 31.8 27.9 65.2 1.0 0.0 2173.3

0.6 14.9 18.1 13.4 28.0 24.4 63.9 26.2 1.4 71.0

0.5 11.7 19.3 10.7 29.0 25.8 393.0 91.8 4.3 23.4

1.06 1.06 0.16 5.93

1.20 1.20 0.36 6.32

1.26 1.26 0.00 7.58

1.49 1.49 1.26 7.81



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Real Estate

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Real Estate  Saudi Government still driving the market  Long term fundamentals are still there, but how to play it?

Saudi real estate Saudi Arabia is a strong residential real estate market: the country has a significant shortage of housing, a very young population (c60% under the age of 25), and strong GDP growth, about 4.2% in 2014e, according to our economists. The government plans to build 500,000 new homes and issue more than 60,000 loans a year on very attractive terms, which should also support the market. It is also working on market reforms which could act as a positive catalyst to develop the sector as a whole.

Residential The residential market in both Riyadh and Jeddah is very undersupplied. We estimate that the government needs to build 1m homes over the next five years in order to meet demand. Residential supply in Riyadh and Jeddah (in thousands of units) 1,100 1,000 900 800 700

Riyadh Completed Source: JLL

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Jeddah Additions

2016

2015

2014

2013

2012

2016

2015

2014

2013

2012

600

With minimal supply additions planned in the next 3 years, prices will keep increasing if the government, or developers, do not launch new projects. As of the end of 1Q2014, Riyadh’s current residential stock stands at 944,000 units according to Jones Lang LaSalle (JLL). There are 93,000 additional units that will be added through 2016, or a 9.6% increase from 1Q2014 levels. Of the total future supply, less than 9.9% of residential units are expected to be expat compounds over the next 5 years. Jeddah has 754,000 units with 73,000 units being added through 2016, for a 9.7% increase. New affordable housing stock that will be built by JDURC, PPA and the Ministry of Housing may increase this figure. Over the past 6 months in Riyadh, the residential market has experienced an overall upward trend, with sales prices for apartments increasing 7% during the period as of the end of 1Q2014. JLL expects villa prices to also increase after increasing 2.6% during the same period. Residential rental yields remain high, at c7-9%, making it a very attractive segment.


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Office The office market in Jeddah witnessed strong demand in 2013, mostly driven by government spending. We are also seeing more demand from the private sector with international firms expanding their business across Jeddah. Vacancy for the overall market stood at 10% as of 1Q2014, down from 30% levels in 2011. It is expected to fall further in the short term, with no significant new supply coming on. Office stock in the CBD area is now 723,000sqm. As of the end of 1Q2014, supply is expected to increase 35% through 2016 which we think will be absorbed.

Riyadh Completed

2016

2015

2014

2013

Jeddah is a similar story, with a positive trend in the residential market and overall sales prices increasing slightly for both villas and apartments. Rents have not done as well over the past 6 months with villa rents down 1.7% and apartment rents down 1.4% during the period. West Jeddah, which is already at a 30% premium to the rest of the city, saw increases in rents mainly because of high demand due to its proximity to the sea. The main reason for the decline in rents is the addition of 15,000 units to the market in the past 6 months but they should recover going forward.

2012

Source: JLL

2016

2,700 4,419 Apartments 32,900 37,133

2015

4,383 4,700 Villa 121,700 121,000

2014

Apartments

2013

Riyadh Jeddah Rentals (SAR per annum) Riyadh Jeddah

Villa

2012

Sale (SAR/sqm)

Office Supply Riyadh and Jeddah (in GLA '000 sqm) 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0

Jeddah Additions

Source: JLL, HSBCe

Riyadh is a different story, however, with vacancy rates city-wide standing at 19%. There will be further upward pressure on vacancy rates over the next 12 months given the expected new supply entering the market. As at the end of 1Q2014, office space in Riyadh stood at 2.16m sqm. This is expected to increase by 1.54m sqm by the end of 2016. A big contributor to this increase will be the King Abdullah Financial District and the IT and Communications Complex (ITCC). Office vacancy rates 40 35 30 25 20 15 10 5 0 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14

Riyadh and Jeddah sales and rental prices

Jeddah

Riyadh

Source: JLL, HSBC estimates

Retail The retail market in Jeddah is doing well. Average mall vacancy is around 7% and has fallen over the past 6 months (as of the end of 1Q2014) according to JLL. We do not expect any supply shocks going forward and supply should be spread out across the city, we do not expect this figure to change much. According to JLL supply is

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1Q2014

4Q2013

3Q2013

2Q2013

4Q2012

3Q2012

1Q2014

4Q2013

3Q2013

2Q2013

1Q2013

1Q2013

Jeddah

Source: JLL, HSBCe

2016

2015

2014

2013

Hospitality

Jeddah Additions

Source: JLL, HSBCe

Riyadh’s retail space stands at around 1.28m sqm as of the end of 1Q2014, with supply expected to increase by 39% through 2016e as per JLL. Average mall vacancy in Riyadh is around 12% but it varies quite a lot between the different major malls, ranging between 0-30%. We expect vacancies around the city to remain at those levels, with some newer and higher quality malls outperforming the older ones. Average Rental Performance has increased 4.1% over the past 6 months as of 1Q14 across all categories (sizes of malls) with average rents for super regional malls at around SAR2,700/sqm p.a. Although there is some downward pressure on rentals coming from poorer quality malls, demand is strong as retailers expand their portfolios.

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4Q2012

Riyadh

2012

2016

2015

2014

2013

2012

Riyadh and Jeddah retail supply 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400

Riyadh Completed

Saudi retail rents (SAR/sqm pa) 2,800 2,700 2,600 2,500 2,400 2,300 2,200 2,100 2,000 3Q2012

expected to increase by 23% through 2016e which we expect will all be absorbed as GLA/capita is still one of the lowest in the region. Average Rental Value is expected to remain stable at around SAR2,636/sqm p.a., but we could see some rents dropping a little in the older malls as newer supply comes online.

Saudi Arabia is expecting enormous growth in its hospitality sector as it is an important job creator employing 751,000 people as at the end of 2013 (with around 27% of the positions being held by Saudis). The aim is to increase the number to 1.7 million jobs by 2020 by further developing the tourism sector, according to the Saudi Commission for Tourism and Antiquities. Riyadh hotel supply will likely outpace demand growth in 2014 and 2015 as arrivals fail to keep pace with the significant supply coming online. The next two years alone will see a 73% increase in hotel supply as of the end of 1Q2014. Even though the market is showing signs of improvement, with occupancy at 67% in 3M2014 compared to 63% in 3M2013, we expect occupancy to decline again in 2014 as more rooms come online.

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Pilgrims in millions (LH)

2013

50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50%

2012

Jeddah has underperformed over the past 3 years (ending 1Q2014) with occupancy declining to 76% in 3M2014 compared to 78% in 3M2013 and 3M2012. This is mainly due to a drop in religious tourism (see chart below) due to the Middle East Respiratory Syndrome (MERS). This is a very good performance and points to the resilience of the Jeddah hotel market and better than when it averaged in the high 60s. Jeddah remains one of the best performing hotel markets in MENA. According to JLL supply is expected to increase by 50% by the end of 2017, but we believe this will be absorbed as it is well spread over the next four years with no sudden supply shocks.

Hajj foreign pilgrims - Saudi 2.0 1.9 1.8 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 2011

Source: JLL, HSBCe

2010

2017

Jeddah Additions

2009

Completed

2008

Riyadh

2016

2015

2014

2017

2016

2015

2014

0

2007

5,000

2006

10,000

2005

15,000

2004

20,000

Religious tourism still has a lot of room for growth. 2013 was a tough year as only 1.37m foreign pilgrims were able to perform Hajj. This was down 21.3% YoY with the expansion of the Holy Mosque given as the main reason for the reduction in the number of Haj visas granted, though there also may also have been fears over the MERS-Coronavirus and its potential to spread throughout the Kingdom.

2003

Saudi hotel supply (in rooms) 25,000

YoY % change (RH)

Source: Saudi Embassy, Newswires

Hotel occupancy Jeddah and Riyadh YT-March 2014 350

100%

300

80%

250 200

60%

150

40%

100

20%

50 0

0% 2008 2009 2010 2011 2012 2013 2014 Jeddah ADR (USD) Riy adh Occupancy (%)

Riy adh ADR (USD) Jeddah Occupancy (%)

Source: JLL, STR Glboal

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Dar Al Arkan ALARKAN AB, Price SAR13.6, Neutral, TP SAR14.0 Company description Dar Al Arkan (DAAR) is one of the largest property developers in Saudi Arabia and is based in Riyadh. The company also has operations in Jeddah and Makkah. DAAR is a developer, although it derives most of its revenues ( more than 90%) from land sales, with the rest coming from the sale of residential units and rental income. The company would like over time, to derive more of its revenue from unit sales. Within its property portfolio, its key focus is residential, particularly villas.

Investment thesis Our investment thesis for Dar Al Arkan is based primarily on valuation and also we believe that 2013 has been the slowest period in terms of land sales, a situation which should improve in 2H2014. Additionally, the balance sheet is very strong, with net debt to equity of 22.7% as of the end of 1Q14 and no major loan or bond repayments in 2014. The company has a book value per share of SAR16.0. This is a very conservative valuation, in our view, since all of its land is recorded at cost. The average life of the land bank is around 3-4 years, and we estimate that we have seen around a 25% increase in land prices over the last 3 years (implying something like a high-single digit increase in the value of DAAR’s land). Given this, we believe that, even with slow monetisation

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of its land bank assets, the stock should trade closer to its book value. We are now waiting for construction to start on Shams Arriyadh, a development that has been in the pipeline for some time. The company has decided not to pay a dividend, and we believe that some of the cash retained will go towards the development of Shams Arriyadh. We expect construction to start this year (with sales next year). The company will likely develop a small number of units, in order to increase the appeal of the remaining land plots, which it will then likely sell to sub-developers or retail buyers. Next year, we expect construction on Shams Al-Arous to start, but we believe that there is much less to do there, since the land already has infrastructure in place.

Financials Dar Al Arkan reported 2Q2014 earnings of SAR121.3m, lower than our SAR236m estimate, but 17% higher YoY (although 2Q2013 was a weak quarter). Net profit was 48% lower QoQ on the back of lower sales of developed properties, as well as an increase in SG&A and finance charges according to the company. Gross profit for 2Q2014 of SAR294.2m, was 14.7% lower than our SAR345m estimate, and down 27% QoQ, on the back of lower sales and lower gross margins attributable to the geographical location of the properties sold according to the company. Gross profit in 2Q2014 was 41% higher YoY but this is from a lower base as 2Q2013 was a weak quarter. Operational profit was also lower than expected at SAR224.4m for the quarter, up 29.2% YoY but down 34% QoQ. We don't have revenue figures


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yet, so we do not know how strong land sales were, but it appears likely that they were lower than our SAR833m estimate for the quarter which we expected to be flat QoQ. Overall, these appear to us to be weak numbers, but we still need to see full financials when they are released.

Valuation We derive our target price for DAAR of SAR14.0 using a SOTP methodology. We value the company’s rental stream, land/residential sales and Shams Al- Arous/Shams Arriyadh using a DCF methodology, which leads to a value of SAR6.2 per share. We estimate a cost of equity of 12.5%, based on a risk-free rate of 3.0%, a country risk premium of 6%, and an inflation differential of 3.5%. With a 6% cost of debt, this results in a WACC of 10.5%. We assume a 3% terminal growth rate for the rental properties. We then add the SAR10.9 per share for the residual land – we calculate this using a SAR607 price per sqm and then discount it by 40% to account for timing. We then subtract SAR3.1 from the enterprise value for net debt to arrive at the SAR14.0 per share valuation.

Risks Downside risks to our rating include: 

Slower-than-expected sales at Sham Arriyadh and Shams Al-Arous because of delays at the projects could result in the share price falling.

 Lower occupancy rates may hurt rental revenues and share performance  Slower land sales than we estimate, which would make it difficult for DAAR to invest in project development and reinvest in its land bank. Upside risks to our rating include:  A faster build out could boost the shares more than we expect.  If occupancy rates and rents are higher than we expect, the shares could perform better. Also, if the company is more quickly able to move its business model towards owning and renting units.

Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi stocks of 9.0%, or 4% to 14% potential return from the current price. At the time we set our target price, it implied a potential return within the Neutral band; therefore we have a Neutral rating on the stock. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

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Financials & valuation: Dar Al Arkan

Neutral


Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


2,931 1,002 -32 970 -314 699 699 -18 681 681

3,339 1,275 -33 1,242 -271 971 971 -24 946 946

4,037 1,499 -35 1,463 -267 1,196 1,196 -30 1,166 1,166

4,600 1,659 -37 1,622 -196 1,426 1,426 -36 1,390 1,390

Cash flow summary (SARm) Cash flow from operations Capex FCF enterprise Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary Tangible fixed assets Current assets Cash & others Total assets Gross debt Net debt Shareholders funds Invested capital

959 -1 1,274 -751 0 -224 960

1,232 -17 1,484 -941 0 -291 1,212

1,036 -19 1,282 -423 -540 -73 1,015

1,346 -20 1,520 -28 -1,080 -238 1,324

19,258 5,043 2,470 25,049 5,804 3,334 17,939 20,526

19,646 3,661 855 24,054 4,116 3,261 18,566 21,079

19,636 4,035 1,093 24,419 4,116 3,023 18,876 21,151

(SARm) 18,350 5,099 2,279 24,197 5,904 3,624 16,993 19,870

Year to

12/2013a

12/2015e

12/2016e


13.9 27.3 28.0 38.9 38.9

20.9 17.5 17.8 23.3 23.3

14.0 10.7 10.8 19.2 19.2

0.1 5.0 4.1 4.3 34.2 33.1 3.2 21.3 3.6 26.4

0.2 6.1 5.4 4.9 38.2 37.2 4.7 18.6 2.6 36.9

0.2 7.0 6.4 5.8 37.1 36.3 5.6 17.6 2.2 31.8

0.2 7.6 7.4 6.5 36.1 35.3 8.5 16.0 1.8 44.5

0.63 0.63 0.00 15.73 24.83

0.88 0.88 0.00 16.61 26.61

1.08 1.08 0.50 17.19 27.89

1.29 1.29 1.00 17.48 28.71

Ratios (%) Revenue/IC (x) ROIC ROE ROA EBITDA margin Operating profit margin EBITDA/net interest (x) Net debt/equity Net debt/EBITDA (x) CF from operations/net debt Per share data (SAR) EPS Rep (fully diluted) HSBC EPS DPS NAV NAV (adjusted)

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12/2016e

0.9 0.5 21.6 6.9 0.0

0.8 0.5 15.5 8.7 0.0

0.8 0.5 12.6 7.3 3.7

0.8 0.5 10.6 9.5 7.4


(SAR)13.60


Target price (SAR)


Price relative 16 15 14 13 12 11 10 9 8 7 6 2012

2013

Source: HSBC


-17.6 -19.2 -18.1 -31.1 -31.1

12/2015e


Dar Al Arkan

12/2014e

12/2014e

Premium/ (discount) to NAV Premium/ (discount) to NAV (adj) PE* FCF yield (%) Dividend yield (%)


12/2013a

2.9

14.00

Bloomberg (Equity) ALARKAN AB Market cap (SARm) 14,688 Enterprise value (SARm) 17274 Sector REAL ESTATE Contact +966 1 299 2100


16 15 14 13 12 11 10 9 8 7 6 2015

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Jabal Omar JOMAR AB, Price SAR53, Neutral, TP SAR47 Company description

debt. It appears that the revenue will not be recognized until next Hirji year (starting in late October), based on comments from the company.

Patrick Gaffney*, CFA Analyst HSBC Saudi Arabia + 966 1 299 2100 [email protected]

Established in 2006 by royal decree, the company was set up as the master developer for the Jabal Omar area, next to the Al Haram Mosque in Mecca. The project will be a mixed use development spread on around 230,000sqm of land and c2 million sqm of BUA. It will be comprised of 38 high-rise buildings with 26 hotels and over 11,000 rooms. They will partner up with international hotel operators to operate the hotels. This will be one of the largest hotel developments in the world. They will also build a 14,000sqm mosque that can hold up to 150,000 people. The project will also include 200,000sqm of retail space as well as villas for sale.

The first hotel has also opened in April. It is a 480 room Hilton, split in two towers (one of which has opened). We expect more hotels to open throughout the year and we assume rates of SAR1,200 on average per night and occupancy of 70% (once up and running, and on average throughout the year).


Investment thesis Shares of Jabal Omar have soared 77% this year and we believe the shares are now fully valued. We also believe risks are also relatively high as JOMAR has experienced multiple delays and has no previous experience with projects of this size, even though we remain positive on the project in the longer term. Villa auctions have started with Jabal Omar announcing in June that it sold 8 villas in for SAR320.5m, or SAR40m per villa. The high price is attributed to the location - the units will overlook the Holy Mosque in Mecca. The average price per sqm was SAR122,375 or USD32,633. The company has a further 12 to sell in this first phase. Jabal Omar will use the cash to pay down

Financials Jabal Omar showed significant improvement but still recorded a loss in 2Q2014 of SAR0.47m compared to a loss of SAR6.1m in 2Q2013. Notably, gross profit was solid at SAR12.7m. This is an improvement on both a QoQ and YoY basis, as the company starts to recognize revenue from its retail space. The company also had lower SG&A according to JOMAR which contributed to an improvement in the bottom line. Overall, it appears that construction is progressing fairly well (albeit slower than the original announcements) and we should see a significant increase in revenues and profits this year. The first hotel, a Hilton, is open (according to the hotel website, which is currently taking reservations), and we should see continuous openings of other hotels throughout this year and for the next few years. Note that Jabal Omar follows the Hijri calendar, so its 2Q2014 ended 29 April 2014.

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Valuation

Risks

We value Jabal Omar using a discounted cash flow model for Phases 1-3 of the project (SAR42.3 per share) and then we add the remaining land value (SAR10.4 per share). We use an average price of SAR150,000 per sqm and then apply a 20% discount.

Downside risks to our rating include:

We then subtract net debt of SAR5.4 per share to arrive at the company's equity value of SAR47 per share. In our DCF, we assume a risk-free rate of 6.5% (3.0% represents US Treasuries and 3.5% is the inflation differential for Saudi), a country risk premium of 6% and a beta of 1.3 (based on the three-year beta from Bloomberg). This results in a cost of equity of 14.3%. Coupled with a cost of debt of 6%, this leads to a WACC of 10.9%. We assume a terminal growth rate of 5% Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi Arabia stocks of 9.0%, or 4% to 14% potential return from the current price. At the time we set our target price, it implied a potential return which was within the Neutral band; we therefore have a Neutral rating on the stock. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

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 Once the company is producing high cash flows from its operations, it may undertake value-destructive projects.  The company has limited experience in construction and just a short history of being a public company.  There is a very wide ownership, including a large number of founder owners that make up 32% of the total ownership. The founders’ shares could overhang the stock. Upside risks to our rating include:  If the company is able to build the phases faster than we expect, the shares could rise.  Selling prices for the villas could be significantly higher than we anticipate, given their scarcity. This would likely boost the shares.

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Financials & valuation: Jabal Omar Development Co Financial statements

Valuation data

Year to

12/2013a

12/2014e

12/2015e

12/2016e


46 -25 -24 -49 0 -33 -33 0 -33 -33

2,650 1,304 -23 1,281 -46 1,234 1,234 -31 1,204 1,204

2,915 1,447 -23 1,424 -179 1,245 1,245 -31 1,214 1,214

4,719 2,460 -23 2,437 -233 2,204 2,204 -55 2,149 2,149


64 -2,381 -2,335 -2,381 0 2,487 -2,335

821 -1,751 -884 -1,751 0 929 -930

1,060 -2,001 -763 -2,001 0 941 -942

2,081 -1,001 1,312 -1,001 0 -837 1,079

12,439 3,397 2,889 18,177 7,153 4,264 10,142 12,069

12,640 1,967 1,448 18,725 6,653 5,205 11,356 12,448

10,840 2,367 1,785 20,102 6,153 4,367 13,262 10,741

(SARm) 12,189 2,872 2,818 15,925 6,153 3,335 8,938 11,412

12/2013a

Year to

12/2013a

12/2014e

12/2015e

12/2016e

5.5 1.1

4.9 1.0 40.9 -2.0 0.0

4.3 0.9 40.6 -2.1 0.0

3.7 0.8 22.9 2.5 0.0


12/2014e

12/2015e

12/2016e

Y-o-y % change

-4.8 0.0



(SAR)53.00


Target price (SAR)


-11.3

47.00

Bloomberg (Equity) JOMAR AB Market cap (SARm) 49,258 Enterprise value (SARm) 51683 Sector REAL ESTATE Contact +966 1 299 2100

Price relative 56

56

46

46

36

36

26

26

16

16

6 2012

2013 Jabal Omar Development Co


Neutral

2014

6 2015


Source: HSBC


Revenue EBITDA EBIT PBT HSBC EPS

5712.8

10.0 11.0 11.2 0.9 0.9

61.9 70.0 71.1 77.0 77.0

37.3 -134.4 1.9

0.2 10.6 12.6 7.3 49.2 48.3 28.3 42.0 3.3 19.3

0.2 11.3 11.3 7.5 49.7 48.8 8.1 45.8 3.6 20.4

0.4 20.5 17.5 12.2 52.1 51.6 10.6 32.9 1.8 47.6

-0.04 -0.04 0.00 9.62 50.42

1.30 1.30 0.00 10.91 55.33

1.31 1.31 0.00 12.22 58.61

2.31 2.31 0.00 14.27 64.64


0.0 -0.5 -0.4 -0.2 -54.4 -108.1

Per share data (SAR) EPS Rep (fully diluted) HSBC EPS DPS NAV NAV (adjusted)

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Saudi Real Estate Co. SRECO AB, Price SAR43.4, Neutral, TP SAR40 Company description Saudi Real Estate Company (SRECO), also known as Al Akaria, is a real estate developer focused on developing and managing rental properties, mainly in Riyadh. Recurring rentals are the main driver of revenues, although the company occasionally sells land plots, which can result in a significant increase in annual revenue and profit. Over time, we expect SRECO will develop more projects, such as it is already doing with Knowledge Economic City (KEC) in Medina, and a residential development in Binban, transforming the company into a developer, rather than just a property manager.

Investment thesis SRECO is the only publicly-traded company we cover in Saudi with a large investment property portfolio currently producing income. We believe this gives investors a good opportunity to gain exposure to strong rental inflation in Saudi. Our economists expect inflation to increase by 3.5% in 2014 and 4.3% in 2015, and this will likely result in a continued increase in rents. What would make the stock more attractive, in our view, is if the company were to start to monetise its 13.0 m sqm land bank. Yet it rarely develops or sells any of it: it made no land sales in 2013, and in 2012, it made just one (for SAR80m in 3Q). We saw a similar pattern in 2011, when the company made only one SAR30m sale.

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The company has talked for some time about a development in Binban, a city north of Riyadh where it has 2m sqm of land. However, we still have not seen any progress, and until we see the actual start of construction, we will not include it in our model. All-in-all the stock appears fully valued, in our view, especially with a 2014e dividend yield below 3.0%.

Financials Saudi Real Estate Company reported 2Q2014 earnings of SAR48m, beating our SAR40.4m estimate and higher than the SAR19.3m profit they reported in the same period last year (although they recognized a SAR17.7m loss from their Arabian United Float Glass Company in 2Q2013). Even after excluding the SAR17.7m loss in 2Q2013, earnings in 2Q2014 were still 30% higher YoY. The company attributes the strong beat to the associate income line (although no further details were given). SRECO reported SAR45.3m in gross profit which was 8.5% lower than our estimate but 9.2% up YoY, while operating profit of SAR36.7m was 17% lower than our estimate for the quarter but flat compared to the same period last year. Although the company did not provide further details, we assume revenues were weaker than we expected this quarter. More details as full financials are released.


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Valuation

Risks

We use a DCF approach to value SRECO's current projects (SAR24.6 per share) and then add the value of the remaining land bank at a 10% premium to cost (SAR10.4 per share), plus the short-term investments – most of which are held in money market funds (SAR4.5) – and the net cash (SAR0.2 per share). Previously we valued the land at cost, but we now raise the valuation to reflect our expectation of continued inflation in Saudi.

Downside risks to our Neutral rating include:

For our WACC calculation, our assumptions include: a 3.0% risk free rate, a 6% country risk premium and a 3.5% inflation differential between the US and Saudi (the average over the past five years). We use a beta of 0.9 to arrive at our cost of equity of 11.9%. We then assume a cost of debt of 4% and a 20% debt weighting, which leads to our WACC estimate of 10.2%. We assume a terminal growth rate of 3% (unchanged). Note that we do not include future land sales in our valuation. Overall this results in a target price of SAR40. Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi Arabia stocks of 9.0%, or 4% to 14% potential return from the current price. At the time we set our target price, it implied a potential return within the Neutral band; we therefore have a Neutral rating. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

 Oversupply in the office space in Riyadh could put upward pressure on market yields and hurt SRECO’s valuation.  The shift from single-building lease properties to large-scale sale projects could stretch management and operational capacity, introducing the risk of delays or cancellations.  Since most of SRECO’s projects are in Riyadh, exposure to any downturn in the property market there is high. Upside risks to our Neutral rating include:  If land and project sales are faster than expected, the stock could outperform the broader market.  If the Riyadh property market is boosted by government spending faster than other Saudi markets, then SRECO would benefit.

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Financials & valuation: Saudi Real Estate Valuation data


12/2013a

12/2014e

12/2015e

12/2016e


259 193 -30 163 0 191 191 -11 180 180

282 205 -29 176 0 180 180 -16 163 163

301 219 -31 188 4 192 192 -16 175 175

318 231 -33 198 0 198 198 -17 181 181

193 -54 127 -45 -121 -16 127

235 231 462 264 -150 -349 462

206 -31 172 8 -180 -34 175

215 -33 182 8 -180 -42 182

2,270 166 18 3,566 0 -18 3,304 2,172

1,981 446 368 3,553 0 -368 3,317 1,840

1,950 496 401 3,563 0 -401 3,313 1,821

1,917 541 444 3,568 0 -444 3,314 1,787


(SARm)

12/2013a

12/2014e

12/2015e

6.8 6.9 6.9 6.7 7.2

5.4 5.4 5.3 3.3 3.5

0.1 7.1 5.5 5.1 74.7 63.1

0.1 8.0 4.9 4.6 72.6 62.3

0.2 9.4 5.3 4.9 72.7 62.3

0.2 10.1 5.5 5.1 72.7 62.3

-0.6 -0.1

-11.1 -1.8

-12.1 -1.8

-13.4 -1.9

1.50 1.50 1.00 27.53 42.00

1.36 1.36 1.25 27.65 42.11

1.46 1.46 1.50 27.61 42.07

1.51 1.51 1.50 27.62 0.00

Ratios (%) Revenue/IC (x) ROIC ROE ROA EBITDA margin Operating profit margin EBITDA/net interest (x) Net debt/equity Net debt/EBITDA (x) CF from operations/net debt Per share data (SAR) EPS Rep (fully diluted) HSBC EPS DPS NAV NAV (adjusted)

216

12/2015e

12/2016e

1.6 1.0 29.0 2.4 2.3

1.6 1.0 31.9 8.9 2.9

1.6 1.0 29.7 3.4 3.5

1.6 28.7 3.5 3.5


(SAR)43.40


Target price (SAR)


-7.8

40.00

Bloomberg (Equity) SRECO AB Market cap (SARm) 5,208 Enterprise value (SARm) 4840 Sector REAL ESTATE Contact +966 1 299 2100

Price relative 49

49

44

44

39

39

34

34

29

29

24

24

19 2012

2013


9.1 6.0 7.7 -5.8 -9.0

12/2014e


12/2016e

-20.4 7.2 1.1 -0.5 0.0

12/2013a


Source: HSBC


Year to

Saudi Real Estate


Neutral


19 2015

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Emaar Economic City EMAAR AB, Price SAR17.5, Not Rated Company description

To facilitate investment in the city, the Saudi Arabian General Investment Authority (SAGIA) will provide 128 services under one roof.

Emaar, The Economic City (EEC), was established in 2006 by Dubai-based Emaar PJSC and other prominent investors. The company is leading the planning and development of the King Abdullah Economic City (KAEC), to be situated along the Red Sea coast, between major shipping routes connecting Europe, Africa and Asia, and north of the commercial centre of Jeddah.

Financials

KAEC will be spread over 168m sq m and will be developed as an investment and lifestyle destination intended to help drive economic growth in Saudi Arabia. The city is to be fully developed by 2025. Development will take place in four phases, with the first phase currently under construction. KAEC will have a sea port, an industrial zone, a central business district, an educational zone, resorts and a residential area. The port at KAEC became operational in January with the opening of a container terminal capable of handling 1mn twenty foot equivalent (TEU) units a year. Once complete, the port will eventually handle 20mn TEU, making it one of the biggest in the world. The industrial zone will be spread over 63m sq m and will be home to about 2,500 factories upon completion, according to the company. KAEC is projected to create up to 1 million job opportunities and house about 2 million residents.

Emaar Economic City reported 2Q 2014 net income of SAR212.8m compared to net income of SAR49.9m in 2Q2013. The company reported gross profit of SAR287.8m for the quarter vs. SA117.6m in Q2 2013. According to the company the increases in the quarter were due to an increase in sale of industrial lands and the completion of selling the entire port land to the Ports Development Company

Recent news  On 7 July 2014, Emaar The Economic City has announced that its shareholders have approved a plan to raise USD1.4bn (SAR5.2bn) so it can invest in the expansion of the port at King Abdullah Economic City (KAEC). The company said it would use USD700m (SAR2.6bn) to increase its stake in the Port Development Company at KAEC. This would bring its stake in the firm to just over 50% with joint venture partner Huta Marina holding the rest of the shares. Its investment will be used to help develop the next phase of the port, which will then drive the growth of the neighbouring Industrial Valley that takes up around one-third (63mn m2) of the city's 189mn m2 built-up area.

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Financials & valuation: Emaar The Economic City Financial statements Year to


12/2011a

12/2012a

12/2013a


91 -532 -58 -590 0 -578 -578 -6 -584 -584

408 170 -45 125 0 89 89 -6 83 83

545 266 -47 219 -1 191 191 -5 186 186

834 308 -26 282 61 304 304 -31 273 273

-340 -170 -185 0 525 15

-64 -174 -3565 0 516 278

-330 -186 1862 0 874 358

97 -568 -594 0 1214 743

550 1564 339 8877 0 -339 7298 8538

517 6005 4885 13746 5062 177 7380 8861

569 4822 4117 13878 5168 1051 7563 9761

2108 4443 3039 14346 5304 2265 7836 11307

Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) Tangible fixed assets Current assets Cash & others Total assets Gross debt Net debt Shareholders funds Invested capital

Year to

12/2010a

12/2011a

12/2012a

12/2013a

-65.1 98.4 93.3 98.2 89.0

348.5

33.7 56.3 75.8 115.8 125.3

52.9 15.9 28.5 59.2 46.7

0.0 -7.0 -8.0 -6.6 -585.5 -649.2

0.0 1.3 1.1 0.9 41.7 30.6

0.1 2.2 2.5 1.6 48.8 40.2

-4.6 0.6 100.3

2.4 1.0 -36.0

13.9 4.0 -31.4

0.1 2.2 3.5 2.0 37.0 33.8 -5.0 28.9 7.4 4.3

-0.69 -0.69 0.00 8.59 8.59

0.10 0.10 0.00 8.68 8.68

0.22 0.22 0.00 8.90 8.90

0.32 0.32 0.00 9.22 9.22

Per share data (SAR) EPS Rep (fully diluted) HSBC EPS DPS NAV NAV (adjusted)

218

12/2012a

12/2013a

2.0

2.0

2.0

1.9

2.0

2.0 180.1 -1.6 0.0

2.0 79.9 -3.5 0.0

1.9 54.5 -3.2 0.0

-3.4 0.0


(SAR)

17.5


4220.SE 3,967 55% Saudi Arabia NR

Target price (SAR)

NR

19

19

17

17

15

15

13

13

11

11

9

9 7 2013

Source: HSBC


24.4

Bloomberg (Equity) EMAAR AB Market cap (SARm) 14,875 Enterprise value (SARm) 15,926 Sector REAL ESTATE Contact NR

Price relative

Emaar EC


12/2011a



12/2010a


7 2012


Not Rated

2014 Rel to Tadawul


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Insurance

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Insurance  The insurance industry is experiencing rapid growth from a low base

and remains relatively fragmented: Tawuniya is a leading player  The introduction of compulsory health insurance is a key driver  A lack of experience in setting rates may be a risk for the sector

Rapid growth The insurance market in Saudi Arabia has experienced one of the highest growth rates within the industry globally in the last few years: Nonlife premiums more than doubled to SAR24.4bn in 2013 from SAR10.2bn in 2008, according to data from the Saudi Arabian Monetary Authority (SAMA). Industry revenues grew by about 19% y-o-y in 2013. Over half of the growth has come from the health segment, driven by progressively stricter requirements for Saudi Arabian businesses to provide employees with health insurance: In 2011, health premiums reached SAR11.3bn, three times the level in 2007 and up 16% on 2011. Motor insurance is the second largest segment, with premiums at SAR6.4bn in 2013 (+36% on 2012)

followed by property premiums at SAR1.6bn (+24% on 2012). Life insurance has experienced the fastest growth of all areas of Saudi insurance, with revenues increasing fivefold between 2006 and 2010. However, as this comes from a very low base, gross premiums from life underwriting still did not exceed SAR1bn in 2013 and equated to only about USD10 per capita. As in other GCC countries, one key challenge for the life insurance market is that many local citizens do not believe that they need coverage, given a very generous cradle-to-grave social safety net.

Ranking of companies by premiums (2010-2011)

Company Tawuniya Medgulf BUPA Arabia for Coop. Ins. United Cooperative Assurance Co. Malath Coop. Ins. & Reins. Co. Saudi Arabian Coop. Ins. Co. Allianz Saudi Fransi Coop. Ins. Co. Trade Union Coop. Ins. Co. Gulf Union Coop. Ins. Co. SABB Takaful Source: Company data

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_________ Gross written premiums (SARm) __________ 2012 2011 % change 5,635 3,318 2,194 1,024 558 568 621 561 418 223

4,431 2,811 1,993 1,069 601 548 684 538 329 268

27% 18% 10% -4% -7% 4% -9% 4% 27% -17%

Market cap USDm

Average 3M trading vols USDm

773 674 592 121 163 125 403 166 138 299

4.6 6.3 8.8 2.3 4.5 6.3 5.9 2.4 3.0 3.7

Raj Sinha* Analyst HSBC Bank Middle East Ltd + 971 4423 6932 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

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Gross written premiums (SARm) 30000

Life – Protection & Savings Aviation

25000

Energy

20000

Accident/Liability

15000

Marine Engineering

10000

Property

5000

Motor Health

0 2008

2009

2010

2011

2012

2013

Source:SAMA

Even though it seems likely that the growth rate in the Saudi insurance industry will moderate, we note that Saudi Arabia remains one of the world's most underinsured nations: Industry revenues were only 1.16% of GDP in 2013, up from 0.42% in 2005. This not just a fraction of the level in the OECD countries (for example, the share is over 10% in France and 13% in the United Kingdom), but it is also among the lowest in the GCC. Even though the low level of cover in the life sector stands out, industry revenues are relatively low across all insurance segments. High population and per-capita economic growth should help continue to drive industry revenues, in our view. Moreover, even though the population is overwhelmingly young, with over 50% below the age of 20 (excluding expats), the higher age brackets appear set to experience significant growth, likely helping to drive healthcare costs and health insurance revenues. For example, we estimate 6% average annual growth to 2015e in the number of Saudis aged between 45 and 59 – about 3 times higher than that of the overall population.

Annual healthcare spending in Saudi Arabia at USD1,150 per capita is above the broader regional average, but still very low by international standards and relative to GCC peers. We expect Saudi healthcare spending to increase at a CAGR in excess of 8% over the next five years, reaching USD30bn by 2015e. Business Monitor International sees total Saudi Arabia gross insurance premiums increasing at a CAGR of 14% to 2015, driven by the health segment.

Leading players The Saudi Arabian insurance sector is regulated by the Saudi Arabian Monetary Authority. All operators are required to operate according to the principles of cooperative insurance. Collectively, they form the largest Shari'ah-compliant sector in the world. The sector is relatively fragmented, with SAMA's 2013 annual report identifying 35 companies. By far the largest player is Tawuniya, which wrote 22% of gross premiums in 2013, followed by Medgulf with a 16.4% market share and BUPA with 12.6% share. All of the ten leading companies are listed on the Tadawul stock exchange.

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The Mediterranean & Gulf Insurance & Reinsurance Co (Medgulf) MEDGULF AB; Not Rated Company description –

The Mediterranean & Gulf Insurance & Reinsurance Co (Medgulf) is a subsidiary of Medgulf Group, a leading investment group, with large finance and insurance operations in the Middle East. Medgulf operates in Saudi Arabia, Lebanon, Turkey, Jordan, UAE and the UK. Largely due to acquisitions, it provides a range of insurance and reinsurance products in the Middle East and the UK. The company was founded in October 1977 and is headquartered in Riyadh, Saudi Arabia. It is the second-largest insurance company in Saudi Arabia. Its major shareholders are Medgulf Group, with 40.5% ownership, and Saudi Investment Bank, with 19%. Medgulf offers Islamic non-life insurance and reinsurance services. Its main businesses include:  Medical insurance: The company acts as an administrator for managing and servicing the medical portfolio of group insurance plans. It also provides comprehensive health-insurance management to other health insurers (73% of GWPs in 2013).  Motor insurance: This division services and manages a large portfolio of vehicles. It also operates a network of workshops, spare part dealers and loss adjusters. The company handles claims management for those units (18% of GWPs in 2013).

222

Medgulf is backed by international reinsurance companies in the US and Europe, among them Swiss RE, Hannover RE, Lloyds of London, Gen RE, and Arab RE.

Financials The gross premium written in FY ’13 (ended 31 December 2013) was SAR4,137m, posting a 15% y-o-y increase. However, the company posted a net loss of SAR192m over FY ’13. Management attributed the loss to a 45% increase in net claims. The company ended the year with a combined ratio of 115%. Medgulf's gross written premiums for Q412 reached SAR861m vs. SAR487m in Q411. The net profit for Q412 was SAR116m, a 6.4% increase from the same period last year.

Recent news  On 1 June, 2014, Medgulf announced the renewal of its contract with Saudi Binladin Group (SBG). Medgulf provides co-operative medical insurance to SBG employees. This contract constituted over 5% of Medgulf’s revenues in FY ’13.

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Financials & valuation: Medgulf

Not Rated Valuation data


12/2010a

12/2011a

12/2012a

12/2013a

1,871 40 249 240 240 240 240

2,189 47 205 201 201 201 201

2,598 56 -234 -192 -192 -192 -192

347 952 67 0 2,931 1,094 22 0 -347 1,174

649 511 62 0 3,149 1,472 26 0 -649 1,186

1,109 558 70 0 4,084 2,232 34 0 -1,109 996

Profit & loss summary (SARm) Net earned premium Other income Operating profit PBT HSBC PBT Net profit HSBC net profit

1,792 32 253 232 232 232 232

Balance sheet summary (SARm) Cash & equivalents Investments Tangible assets Intangible assets Total assets Policy liabilities Provision for risks Gross debt Net debt Shareholder funds

217 896 57 0 3,159 1,133 20 0 -217 1,069


12/2010a

12/2011a

12/2012a

12/2013a

37.8 0.4 0.6

4.4 0.0 0.0

17.0 -0.2 -0.2

18.7 -2.0 -2.0

Y-o-y % change Net earned premium Reported PBT EPS

Year to

12/2010a

12/2011a

12/2012a

12/2013a

16.8 3.6 1.5

16.2 3.3 2.6

19.3 3.3 4.1

3.9 0.0

PE reported Price/NAV Dividend yield (%)


Issuer information Share price (SAR) Reuters (Equity) Market cap (USDm) Country Analyst

38.93 Target price (SAR) 8030.SE 1,050 Saudi Arabia NA

NA


MEDGULF AB 3,939 Insurance NR

Price relative 40

40

30

30

20

20

10

10

0 2012

0 2013 Megulf

2014 Rel to Tadawul

Source: HSBC Note: price at close of Jul 22 2014

Per share data (SAR) EPS Rep (fully diluted) EPS DPS Book value

2.32 2.32 0.60 10.69

2.40 2.40 1.00 11.74

2.01 2.01 1.60 11.86

-1.92 -1.92 0.00 9.96

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The Company for Cooperative Insurance (Tawuniya) TAWUNIYA AB; Not Rated Company description The Company for Cooperative Insurance (Tawuniya), established in 1986, is the largest company in the Saudi insurance sector. Tawuniya is focused on non-life insurance products. Medical insurance comprises the largest share of its premiums at 64% of gross premiums written in FY ‘13. Auto insurance accounts for the second largest share of premiums at 19%, followed by other property and casualty products. The central region accounted for 64% of written premiums in 2013, with the western and eastern region of Saudi accounting for 15% and 16%, respectively. Tawuniya's principal associates/investments include:  United Insurance Company, incorporated in Bahrain, via a 50% stake  Waseel Application Services Provider, incorporated in Saudi Arabia, 45% stake  Cooperative Real Estate & Investment Co, incorporated in Saudi Arabia, 33% stake  Najm insurance services, incorporated in Saudi Arabia, 8% stake

224

Tawuniya is 23.8% owned by the Saudi Public Pension Agency (PPA) and 22.8% by the Saudi General Organisation for Social Insurance (GOSI). The remaining 53% is free float.

Financials In FY ’13 (ended 31 December 2013), gross written premiums came in at a flat SAR5,605m, down from SAR5,635m in 2012. However, premiums earned increased by 20% to reach SAR4,728m. The company posted a combined ratio of 102% for the year, and reported a net loss of SAR591m. Over 1H 2014, the company reported net income of SAR233m, citing a decrease in claims incurred and higher investment income as causes. The 1H ’14 combined ratio was 100%.

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Financials & valuation: Tawuniya



12/2010a

12/2011a

12/2012a

12/2013a

2,659 9 553 494 494 64

3,098 5 500 457 457 -9

3,951 15 356 329 329 -27

4,728 8 -686 -585 -585 -285

64

-9

-27

-285

193 3,746 147 0 5,907 2,292 1,557 0 -193 1,769

212 3,840 177 0 6,134 2,406 1,895 0 -212 2,049

390 3,937 236 0 7,095 3,033 2,445 0 -390 2,143

1,091 3,845 266 0 7,776 3,777 2,358 0 -1,091 1,641

Profit & loss summary (SARm) Net earned premium Other income Operating profit PBT HSBC PBT Net profit HSBC net profit

Balance sheet summary (SARm) Cash & equivalents Investments Tangible assets Intangible assets Total assets Policy liabilities Provision for risks Gross debt Net debt Shareholder funds


12/2010a

12/2011a

12/2012a

12/2013a

28.9 0.6 -0.8

16.5 -0.1 -1.1

27.5 -0.3 1.9

19.7 -2.8 9.5


Year to

12/2010a

12/2011a

12/2012a

12/2013a

78.0 2.8 4.0

2.4 3.0

2.3 5.3

3.0 0.0




49.60 Target price (SAR) 8010.SE 1,323 Saudi Arabia NA

NA


TAWUNIYA AB 4,960 Insurance NR

Price relative 60

60

50

50

40

40

30

30

20

20

10

10

0 2012

0 2013 Tawuniya

2014 Rel to Tadawul



0.64 0.64 2.00 17.69

-0.09 -0.09 1.50 20.49

-0.27 -0.27 2.62 21.43

-2.85 -2.85 0.00 16.41

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Malath Cooperative Insurance & Reinsurance Co (Malath) MALATH AB; Not Rated Company description Malath Cooperative Insurance & Reinsurance Company was founded in 2004 with a paid-up capital of SAR300m. The company provides a wide range of insurance products in various classes including Aviation, Energy, Engineering, Marine (cargo & hull), motor insurance, and health insurance for groups and individuals. Malath’s principal investments include:  Saudi Re for Cooperative Reinsurance with a 3.75% stake  Najm Insurance Services Company with a 7.69% stake  Sukuk issued by SEC, GACA, and Tasnee, valued at SAR70m, as well as various Sukuk funds, equity funds, and Murabaha contracts. Malath stresses the importance of a wider geographic presence over Saudi, having obtained SAMA approval to open 50 new outlets over the next few years.

226

Financials Gross premiums written in FY ’13 (ended 31 December 2013) increased 38% to SAR771m. Malath posted a net loss of SAR42m for FY ’13, down from net income of SAR30m in FY ’12. The company attributed the loss to price pressure from competition as well as a 77% increase in incurred claims, y-o-y. The company ended the year with a combined ratio of 110%. For 1H ’14 (ended 30 June 2014), the company reported losses of SAR17m. However, gross written premiums were up 52%, y-o-y. The period closed with a combined ratio of 112%.

Recent news On 3 July 2014, Malath announced an agreement with Abdullatif Jameel Insurance Agents (AJIA). The agreement stipulates that AJIA will become a distributor of Malath policies, exclusively. AJIA is affiliated with Abdullatif Jameel Co. Ltd, currently the sole distributor of Toyota cars in Saudi.

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Financials & valuation: Malath



12/2010a

12/2011a

12/2012a

12/2013a

325 21 26 23 23 18 18

398 14 23 21 21 14 14

463 17 40 37 37 30 30

662 14 -30 -30 -30 -42 -42

41 446 14 0 727 303 0 0 -41 263

44 478 15 0 807 335 0 0 -44 281

54 497 13 0 831 336 0 0 -54 323

278 375 10 0 960 443 0 0 -278 291

Profit & loss summary (SARm) Net earned premium Other income Operating profit PBT HSBC PBT Net profit HSBC net profit Balance sheet summary (SARm) Cash & equivalents Investments Tangible assets Intangible assets Total assets Policy liabilities Provision for risks Gross debt Net debt Shareholder funds


12/2010a

12/2011a

12/2012a

12/2013a

148.6 1.0 1.5

22.5 -0.1 -0.2

16.2 0.8 1.2

43.2 -1.8 -2.4


Year to

12/2010a

12/2011a

12/2012a

12/2013a

35.7 2.5 0.0

45.8 2.3 0.0

21.2 2.0 0.0

-15.4 2.2 0.0




21.50 Target price (SAR) 8020.SE 172 Saudi Arabia NA

NA


MALATH AB 645 Insurance NR

Price relative 40

40

30

30

20

20

10

10

0 2012

0 2013 Malath

2014 Rel to Tadawul



0.60 0.60 0.00 8.75

0.47 0.47 0.00 9.35

1.02 1.02 0.00 10.75

-1.39 -1.39 0.00 9.70

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228


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Telecoms

229

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Telecoms  Saudi remains at the forefront of mobile data with smart phone

penetration of more than 70%, one of the highest levels globally  Growth in major infrastructure projects and a desire to retain

control of content within Saudi is creating an attractive opportunity in ICT for STC and Mobily  We expect MVNOs to increase pricing pressure in the medium

term; data price competition is affecting the market currently

The Saudi telecom market Saudi mobile is a rare example of a market that, in terms of subscribers, has not grown since 2010 but has still grown its top line strongly thanks to excellent monetisation of mobile data. CITC, the Saudi regulator, reported that the total number of mobile subscriptions had reached around 50.9mn by the end of 2013, with a penetration rate of 170%. At the end of 2010 the numbers were reported as 51.6m with penetration of 186%. Growth is in fact mostly driven by sharp increase of data usage, now one of the highest in Emerging EMEA. As penetration slowed down, the decline in the number of subscribers was particularly rapid in 2013 driven by:  The implementation of CITC's decision regarding the regulation of the sale and activation of pre-paid SIM cards, which led service providers to deactivate a large number of unidentified SIM cards.  CITC’s decision to stop free international roaming which resulted in cancellation of a large number of SIM-cards which had been exported outside the Kingdom. 230

 The repatriation of illegal workers which led to the cancellation of a large number of prepaid SIM cards. The first two of these measures has had no impact on the revenue within the market, merely leading to a mathematical benefit to ARPU. The latter issue is expected to dampen revenue growth for a limited period although subscribers affected by these measures are likely to be amongst the lowest spending customers. Saudi Telecom Company (STC) currently has c45% market share, Mobily has c39% and Zain KSA has c16%.

Mobile broadband: key growth driver Rapid declines in smart phone prices and affordable data packages have made internet access via mobile devices easy and cheap, and we believe that by 2016, 75% of the population could be online compared to 55% at the end of 2013 (according to CITC). We believe smartphones will become the primary means of internet access in the future. Smartphone take-up has grown very quickly with smartphone penetration at more than 70%, one of the highest penetration

Hervé Drouet* Analyst HSBC Bank plc +44 20 7991 6827 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

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Saudi mobile subscribers (m) 60

200%

Saudi mobile broadband and internet penetration (%) 60% 50%

50

150%

40 30

100%

20

50%

10

40% 30% 20% 10% 0%

0

0% 2008

2009

2010

Subcribers (m)- LHS

2011

2012

2013

Penetration %- RHS

Source: CITC

levels globally. A young population and sharp increase in the number of students in the Saudi educational system should drive rapid expansion of internet usage.

Social media driving increase in data usage With a predominantly young population, and limited entertainment options, young Saudis are big users of social media. Twitter is particularly popular among the social media platforms with Saudi Arabia having the highest Twitter penetration in the world. Saudi Arabia had 2.4m active Twitter users as of March 2014, which was 40% of all active Twitter users in the Arab region. Similarly, Saudi Arabia produced 40% of all tweets in the Arab market in March 2014 (source: Arab Social Media Report).

Data pricing starts to come under pressure After a period of stability, data pricing has come under some pressure during 2013 with Zain KSA, in particular, offering unlimited-use packages. While both STC and Mobily have seen an exponential increase in data volumes in the past year both operators have invested significantly in LTE network build out and in installing fibre backbones. In contrast, Zain KSA has remained constrained in its investment for much of 2013, although the

2007

2008

2009

2010

Mobile broadband penetration

2011

2012

2013

Internet penetration

Source: CITC

agreement with the regulator to defer regulatory fees, and the successful renegotiation of its debt, should provide more headroom to invest going forward. It is therefore particularly active in the major metropolitan areas in selling data services but users requiring national data coverage will still be best served on Mobily’s network. In terms of voice services, Zain is dependent on roaming arrangements, primarily on Mobily’s network. CITC issues three MVNO licenses: In June 2013, Saudi Arabia's telecoms regulator awarded three mobile virtual network operator (MVNO) licences. The recipients were: Jawraa Consortium (Lebara), on Mobily's network; Virgin Mobile Middle East & Africa (Virgin Mobile MEA), on STC's network; and Axiom Telecom, on Zain's network (but in April 2014 CITC announced a retender for MVNO on Zain’s network, which is currently under process). CITC also prefers that MVNOs have some control over service and billing so that they can improve customer satisfaction levels in the market. Further, CITC intends that the wholesale interconnection agreement between the operator and the MVNO should be commercially negotiated rather than mandated by the regulator. We believe that STC and Mobily should be better placed in this regard than Zain KSA. Through the MVNO they can book wholesale revenues from the low cost

231


segment of the market and concentrate their marketing and acquisition efforts on the higher ARPU segments like the enterprise and post-paid segments. We believe that Zain KSA will be most negatively affected as we estimate that its customer base is biased towards the more price sensitive users. The 15% government levy on MVNO revenues should curtail the profit opportunity and prevent significant pricing pressure as a result of the MVNO entrants (please see HSBC GCC Handbook published on 4 Feb 2014 for more details).

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Etihad Etisalat (Mobily) EEC AB, Price SAR89.9, Neutral, TP SAR98 Company description Mobily is one of three mobile-phone operators in Saudi Arabia. Etisalat (UAE) is the single biggest shareholder with a 27.5% stake; the rest is held by Saudi institutions and local retail investors. The stock has a free float of c40% and a market cap of cUSD18bn. Mobily made an exceptional start in Saudi Arabia becoming EBITDA-positive in 2006 and gaining a SIM market share of more than 30% within two years of starting operations. Currently, we estimate the company has a market share of around 39% in mobile as well as starting to build a fixed-line business and a presence in what we believe will prove a lucrative opportunity in the Saudi market for information, communications and technology (ICT).

Investment thesis Mobily has been single minded in pursuing the broadband opportunity in mobile with the result that we estimate it has some 63% of the smartphone market versus an overall subscriber market share of around 40%. The overall Saudi mobile broadband market is 48% penetrated, with penetration having risen sharply in the past three years. As of 2013, 16.5 million Saudis were using internet through both fixed and mobile devices, implying a penetration rate of 55%, and the majority of these users were online via their smartphones. The rapid decline in smartphone prices, and affordable data packages have made internet access easy and cheap, and we believe that, by 2016, 75% of the population will be online.

Mobily has spent heavily on capex in recent years in order to be able to deliver these high bandwidth services and will continue to invest at a high level over the next five years to ensure it retains leadership in this lucrative sector, as well as diversifying further into the corporate services arena and fixed broad band . We believe capex will average around 18% of sales over the next 5 years but this should still leave scope for a steady increase in the dividend paying capability. Our current forecasts assume a dividend growth rate of approximately 7% CAGR over the same period. Cash flow has been negatively impacted in the past few years by negative working capital which has left the dividend uncovered. We anticipate that this situation will improve during 2014. The Saudi market structure has been attractive with a 3 player market but with the third, Zain KSA, struggling to achieve critical mass. Three new MVNO licences were awarded in mid-2013 (one was re-tendered recently) but we expect the impact will be mainly felt at the lower end of the market which is currently primarily addressed by Zain KSA. Mobily is increasingly moving into the corporate and fixed arena with its service portfolio, reducing its reliance on pure mobile service delivery. With high oil prices and sustained spending by the government in the Saudi economy, corporate activity has been rising in the Kingdom, especially in the SME sector. The Saudi government is keen to retain close control of its IT infrastructure and information management with the result that there have been major investments by Mobily in data centres in the country.

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Mobily continued to make progress with its fibre based FTTH and IPTV service in 2013 and targets connecting 250,000 buildings, thus reaching 800,000 unique residential and business subscribers by 2016.

Recent news  Recently the company saw cancellation of the IRU (Indefeasible Rights of Use) deal with Etihad Atheeb which resulted in a write-off of SAR338.7m of the net profit during the second quarter.  Mobily signed USD200m agreement with Canadian export agency, in June 2014, to acquire equipment from Alcatel-Lucent.

Financials: 2Q14 results Revenues were largely flat y-o-y at SAR5990m vs HSBCe SAR6323m. Increase in revenues for first half was on the back of increase in data revenues, both fixed and mobile. Data revenues were 39% of total revenues for the first six months vs 27% last year. FTTH covered 850 thousand homes with fiber-optic sales increasing by 89% y-o-y during the first six months. EBITDA margin for the quarter was down 4 pp y-o-y to 35% (down 1 pp q-o-q) vs HSBCe 38%. Net profit came at SAR1312m for the quarter vs HSBCe SAR1567m, down 19% y-o-y due to cancellation of IRU deal with Etihad Atheeb, leading to a write-off of SAR338.7m. Dividend of SAR1.25 per share was proposed for the quarter (SAR1.20 last year).

Valuation We value Mobily using a three-stage DCF model with a WACC of 9.9% based on a 12.5% cost of equity (risk-free rate of 3.0%, market risk premium of 9.5%, including an inflation differential of 3.5% in Saudi Arabia, and an equity beta of 1.0), as well as a 4% pre-tax cost of debt, using a debt-to-asset ratio of 30%.

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Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi Arabia stocks of 9.0%. Our target price implies a potential return of 13%, which is within the Neutral band of our model; therefore, we are reiterating our N rating. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

Risks Key downside risks include: A potentially aggressive price war with Zain KSA as it tries to achieve critical mass, STC’s aggressive build-up of its fixed network adversely affecting mobile broadband growth in the Kingdom, potential market disruption from the launch of the new MVNOs and/or additional infrastructure based competitors, failure to secure additional spectrum to facilitate continued broadband growth and failure to reverse the adverse working capital movements evident over the past three years. Key upside risks include: Faster economic growth than anticipated, less impact from the new MVNOS than expected, stronger pricing trends in mobile data and better growth in the ICT area than forecast.

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Financials & valuation: Etihad Etisalat(Mobily) Financial statements Year to


12/2014e

12/2015e

12/2016e


25,191 9,190 -2,502 6,688 67 6,755 6,755 -78 6,676 6,676

26,808 9,837 -2,935 6,902 40 6,942 6,942 -125 6,818 6,818

28,505 10,408 -3,354 7,054 38 7,092 7,092 -128 6,964 6,964

30,261 10,861 -3,612 7,249 44 7,293 7,293 -131 7,162 7,162

7,070 -5,424 -5,487 -3,619 2,226 3,754

8,199 -6,166 -6,166 -3,696 1,663 3,587

9,021 -5,131 -5,131 -4,004 114 5,187

9,778 -5,144 -5,144 -4,312 -321 5,630

9,874 25,273 14,889 1,126 50,042 11,996 11,970 10,845 26,777 36,914

9,300 27,624 15,775 2,012 52,705 12,307 12,970 10,959 29,429 38,381

8,727 29,729 17,596 3,833 56,058 12,618 14,470 10,637 31,971 39,601


Year to

12/2013a

12/2014e

12/2015e

12/2016e

3.0 8.3 2.3 10.0 2.8 5.6 5.5

2.9 7.9 2.1 9.8 2.5 5.4 6.0

2.7 7.5 2.0 9.6 2.3 7.7 6.4

2.6 7.1 2.0 9.3 2.1 8.4 6.9





Neutral

(SAR)86.96


Target price

7020.SE 17,853 40 Saudi Arabia Herve Drouet

100

100

90

90

80

80

70

70

60

60

50

50

40 2012

2013 Etihad Etisalat(Mobily)

12/2013a

2014

40 2015


Source: HSBC

12/2014e

12/2015e



Bloomberg (Equity) EEC AB Market cap (SARm) 66,959 Enterprise value (SARm) 77804 Sector Wireless Telecoms Contact 44 20 7991 6827

Price relative

10,448 20,733 15,334 1,570 46,521 11,642 10,753 9,182 23,963 33,303


1 2 . 7

(SAR)98.00

6.6 7.0 8.0 11.0 10.9

6.4 7.0 3.2 2.8 2.1

6.3 5.8 2.2 2.2 2.2

6.2 4.4 2.8 2.8 2.8

0.8 23.4 29.8 16.1 36.5 26.6

0.8 20.9 26.9 14.6 36.7 25.7

0.8 19.9 24.8 14.0 36.5 24.7

0.8 19.7 23.3 13.6 35.9 24.0

38.3 1.0 77.0

40.5 1.1 75.6

37.2 1.1 82.3

33.3 1.0 91.9

8.67 8.67 4.80 31.12

8.85 8.85 5.20 34.78

9.04 9.04 5.60 38.22

9.30 9.30 6.00 41.52


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Saudi Telecom Company STC AB, Price SAR72, OW, TP SAR71 Company description STC’s mobile monopoly ended in Saudi Arabia when licenses were awarded to Mobily in FY ’04 and Zain KSA in March’ 07. The Saudi fixed-line market was liberalised in 2007 with the award of three new fixed-line licenses. STC has a stated goal of driving long-term growth through international acquisitions although a series of costly and underperforming international acquisitions since 2007 has resulted in the company now confining its expansion ambitions to the Middle East only, particularly, we suspect, in light of its positive experience with its investments in Kuwait's VIVA (with a 26% stake), and its 100% subsidiary in Bahrain. STC also has a 35% stake in Binariang (exposure to Malaysia, India, and Indonesia); a 35% stake in Oger Telecom (exposure to Turkey and South African markets) and has recently sold out of Indonesia.

Investment thesis STC is well placed to provide highly relevant bundles that offer a clear value proposition as it is the only operator in Saudi Arabia with a pervasive presence in both fixed and wireless infrastructure. While in many other markets, active regulatory intervention has tended to undermine the advantage that this infrastructure position affords the historical incumbent operator, this is not so evident in the case of the Saudi market. As a result, STC has maintained significant advantages in operating both a fixed and mobile network. However, while STC’s domestic operation have

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improved owing to the uptake of fixed broadband products in Saudi Arabia, its international operations continue to face the dual headwinds of slow revenue growth and declining margins. STC’s Turkish investment, Turk Telekom (through Oger Telecom), faces margin pressure as a result of aggressive competition, and its operations in India and South Africa continue to operate below critical mass. Recently it changed the accounting treatment of its investment in Aircel (India) which resulted in a boost to its bottomline. Weak currencies and dollar-linked debt in STC’s overseas businesses also created translation issues during 2013. In South Africa, Cell C has to compete against the industry leaders, Vodacom and MTN, and is offering deep discounts in order to capture market share, but progress towards achieving a solidly profitable position is slow.

Recent news  In June 2014, government seized a plot of area around 1m square metre from STC which had a book value of around SAR105m  Also in June, the company raised SAR2bn via a 10 year Sukuk which is the first issuance under its newly established SAR5bn Private Placement sukuk program.  Etihad Atheeb signed an IRU agreement with STC in May which allows it to use STC’s 30 thousand ports for 15 years as an initial phase and has an option to access upto 100 thousand in future.

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Financials: 2Q14 results Service revenues for 2Q came at SAR11.7bn vs HSBCe SAR11.5bn. EBITDA for 2Q was SAR4.7bn, increase of 14% y-o-y, vs HSBCe SAR4.8bn. Net profit for the second quarter up 96% y-o-y to SAR2.8bn (HSBCe SAR3.2bn) mainly due to assets related to Axis and change in accounting of its investment in Aircel group. Q-oQ increase in net profit (SAR412m increase) was due to a) increase in revenue / operating profit b) decrease in provision for Zakat & tax. Domestic market saw huge jump in data traffic as monthly data volume over 4G network surpassed total data traffic over 2G and 3G together by 9%. FTTH customers increased 44% y-o-y during the second quarter. Enterprise business unit’s overall revenues were up 6% y-o-y during the 2Q. Dividend of SAR0.75 per share for the quarter was announced (SAR0.50 per share last year).

Valuation We use the average of a DCF and a sum of the parts model to value STC. In the DCF, we use a risk-free rate of 3.5%, a market risk premium of 9.5%, including an inflation differential of 3.5% in Saudi Arabia, and an equity beta of 1. Our weighted cost of equity for STC is 12.5% leading to a WACC of 11.8% for the stock. We assume a long-term debt-to-equity ratio of 10-90%, and we calculate a one year forward value of SAR70 per share from our DCF. Our sum of the parts model produces a valuation of SAR72, giving an average of SAR71. For the domestic operations we use our forecast for projected domestic EBITDA to which we attach a 6.0x EV/EBITDA multiple.

Under our research model for stocks without a volatility indicator the Neutral band is 5ppts above and below the hurdle rate for Saudi stocks of 9.0%. At the time we set our target price it implied a potential return which was above the Neutral band; therefore, we are Overweight on the stock. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.

Risks Downside risks: increased losses from international operations and the need to inject more equity into the operations, Zain KSA increasing competitive pressure in Saudi, leading to erosion of ARPUs for all mobile operators, regulatory developments damaging STC’s domestic and international market positions, overpayment for international acquisitions, a delay in NGN implementation, higher-thanexpected capex in international operations.

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Financials & valuation: Saudi Telecom Company Financial statements Year to


12/2014e

12/2015e

12/2016e


45,602 18,520 -7,482 11,039 47 10,561 11,316 -231 9,972 10,392

47,290 18,916 -6,599 12,317 185 12,962 12,962 -648 11,886 11,886

48,822 19,529 -6,808 12,721 301 13,606 13,606 -680 12,925 12,452

50,325 20,130 -6,987 13,143 415 14,231 14,231 -712 13,520 13,004

19,640 -7,469 -7,530 -3,998 -34,972 10,748

18,896 -7,094 -7,094 -6,000 -5,802 11,385

19,166 -7,177 -7,177 -6,285 -5,704 11,957

19,850 -7,292 -7,292 -6,564 -5,994 12,527

3,988 39,689 39,604 24,861 95,997 18,862 9,807 -15,054 62,819 39,558

3,368 40,678 45,461 30,565 102,807 19,032 9,807 -20,758 68,986 39,910

2,748 41,603 51,605 36,558 109,929 19,199 9,807 -26,752 75,426 40,199


Year to

12/2013a

12/2014e

12/2015e

12/2016e

2.9 7.2 3.4 13.9 2.5 7.6 3.1

2.7 6.7 3.2 12.1 2.3 8.0 4.2

2.5 6.2 3.0 11.6 2.1 8.5 4.4

2.3 5.7 2.8 11.1 1.9 8.9 4.6

Target price

(SAR)71.00





Overweight

(SAR)72.00


7010.SE 38,394 30 Saudi Arabia Herve Drouet

77

77

67

67

57

57

47

47

37

37

27 2012

2013 Saudi Telecom Company

12/2013a

Source: HSBC

12/2014e

12/2015e



-23.2 -11.6 -7.2 13.8 20.9

3.7 2.1 11.6 22.7 14.4

3.2 3.2 3.3 5.0 4.8

3.1 3.1 3.3 4.6 4.4

0.7 18.9 19.2 10.2 40.6 24.2

1.2 31.2 19.9 13.6 40.0 26.0

1.2 31.9 18.9 13.2 40.0 26.1

1.3 32.6 18.0 12.9 40.0 26.1

-16.1 -0.5

-23.6 -0.8

-29.5 -1.1

-34.6 -1.3

4.99 5.20 2.25 28.47

5.94 5.94 3.00 31.41

6.46 6.23 3.14 34.49

6.76 6.50 3.28 37.71


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Bloomberg (Equity) STC AB Market cap (SARm) 144,000 Enterprise value (SARm) 126522 Sector DIVERSIFIED TELECOMS Contact 44 20 7991 6827

Price relative

4,608 38,406 32,364 17,789 87,633 18,251 8,537 -9,252 56,933 39,337


1 . 4


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Zain KSA ZAINKSA AB, Not rated Company description Zain KSA is one of three mobile operators in Saudi Arabia with a market cap of around USD3bn. Zain Group (Kuwait) is the largest shareholder with a 37% stake while the rest is held by Saudi institutions and local retail investors. Company started commercial operations in 2008 and Zain KSA now has a market share of 16% with an ARPU of USD16per month. Zain KSA’s network covers 93% of the population through more than 6000 network sites. Data revenues (ex SMS & VAS) constitutes 16% of total revenues and its 4G LTE network covers around 52% of the population

Internet service revenues increased 94% y-o-y and 6% q-o-q in Q2 2014 as internet service subscribers grew by 107% y-o-y and 31% q-o-q. Internet data traffic grew by 564% y-o-y in Q2 and 64% q-o-q.

Recent news  Recently CITC announced re-tender of the MVNO license on Zain’s network, which was earlier granted to Axiom in 2013.  Also, during 2Q14 company singed a network expansion and upgrade agreements worth SAR4.5bn (USD1.2bn) with five leading global technology companies.

Financials The company had revenues of SAR6523m in 2013, up 5.7% y-o-y. This was driven by increase in revenues in internet segment and postpaid segment. EBITDA was SAR891m, implying a margin of c13.7%. Company posted a net loss of SAR-1651m in 2013. 2Q14 results

EBITDA increased by 22% y-o-y to SAR564m in the first half of 2014, implying margins of 18% vs 14% last year. Net loss was down 11% y-o-y in second quarter of 2014 due to improvements in operational efficiency, favourable judgements in legal cases and adjustments in useful life of assets.

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Financials & valuation: Zain KSA

Not Rated


Valuation data

Year to

12/2010a

12/2011a

12/2012a

12/2013a

Profit & loss summary (SARm) 5,628 331 -1,494 -1,164 -1,196 -2,358 -2,358 0 -2,358 -2,358


6,699 899 -1,710 -811 -1,114 -1,925 -1,925 0 -1,925 -1,925

6,404 879 -1,810 -932 -823 -1,749 -1,749 0 -1,749 -1,749

6,523 890 -1,840 -949 -723 -1,651 -1,651 0 -1,651 -1,651

462 -309 -307 0 42 177

-88 -311 -309 0 475 -390

-1,150 -562 -562 0 0 -1,708

229 -803 -803 0 -747 -510

21,155 4,298 2,603 702 28,055 5,600 12,509 11,807 6,129 27,353

20,253 4,059 2,432 780 26,744 4,847 17,060 16,279 4,293 25,963

19,274 4,285 4,391 2,385 27,950 3,924 14,855 12,470 8,452 25,565

18,351 4,293 3,315 1,293 26,242 3,594 11,622 10,329 6,759 24,949



(SARm)

12/2010a

12/2011a

12/2012a

12/2013a

3.8 NM 0.8 NM 1.1 1.4 0.0

3.2 23.5 0.8 NM 1.6 -3.7 0.0

3.3 24.0 0.8 NM 1.3 -15.8 0.0

3.2 23.7 0.8 NM 1.6 -5.3 0.0






Year to

(SAR)10.00


Target price


Year to

30

30

20

20

10

10

0 2012

Source: HSBC

12/2010a

12/2011a

12/2012a

12/2013a

87.4

19.0 171.9

-4.4 -2.2

1.8 1.3

0.2 -8.6 -38.5 -8.4 5.9 -20.7

0.3 -7.4 -44.8 -7.2 13.4 -12.1

0.3 -6.8 -20.7 -6.3 13.7 -14.5

0.3 -6.6 -24.4 -6.3 13.7 -14.6

1.9 35.7 0.0

3.8 18.1 0.0

1.5 14.2 -0.1

1.5 11.6 0.0

-2.18 -2.18 0.00 8.79

-1.78 -1.78 0.00 6.16

-1.62 -1.62 0.00 7.83

-1.53 -1.53 0.00 6.26


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Bloomberg (Equity) ZAINKSA AB Market cap (SARm) 10,801 Sector DIVERSIFIED TELECOMS Contact Not Rated

Price relative

0 2013 Zain KSA


1 . 4

(SAR)Not Rated


2014 Rel to Tadawul


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Utilities

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Utilities  Electricity demand fundamentals are being driven by strong

population growth  However, we see a lack of substantial catalysts to drive

profitability given the low tariffs  Solar and nuclear initiatives should keep capital requirements at

peak levels in the region while diversifying generation

Saudi Arabia utilities Middle East utilities demand has been quite strong in the past decade, usually posting high single digit numbers annually. The main driver has been population growth – expanding from 330m to 395m in the past decade. Given the abundance of fossil-based fuel in the region, ruling governments have employed subsidised tariffs that have led to further growth in demand by boosting per capita residential consumption in the area. The GCC’s strong economic performance – driven by rising commodity prices that near doubled per capita GDP to USD35,000 levels today – is the key factor behind government subsidies. However, we believe there are two main factors ahead that could limit utilities demand growth in the region in the medium term. The main factor will likely be economic, as the oil-price driven budget surplus will likely start to erode as we move into 2015. We expect countries with limited surpluses, such as Saudi Arabia, to implement measures that aim to slow domestic power and water demand, and leave as much oil

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as possible for exports. Hence, we might see price hikes for utilities in the coming quarters in the region. Another factor is the increasing power conservation campaigns in the GCC to limit excess consumption. While these are voluntary measures at this stage, given the well-aboveaverage consumption in the region, we think it is conceivable that there may be a drop in residential consumption as a result of these campaigns (National Programme in Saudi Arabia). In addition to decreasing demand, GCC governments are also pursuing ways of diversifying generation capacities – to ultimately preserve as much oil as possible for exports. The two main ways of diversifying generation capacities are solar and nuclear capacity development. Saudi Arabia has plans to develop 16 nuclear power plants in the next 20 years, which are expected to cost around USD80bn, according to the KSA Ministry of Energy. Construction of the first plant is planned to start in 2016, with initial preparations to start in 2014.

Levent Bayar* Analyst HSBC Yatrim Menkul Degerler A.S + 90 2123764617 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

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Saudi among the top electricity consumers of the world (kWh/capita)

Break-up of electricity usage in the Kingdom (%)

25,000 20,000

Industrial 20%

15,000

Others 4%

10,000

Residential 49%

5,000

Gov t. 12% Norway Canada Kuwait Finland Qatar Sweden USA Australia Bahrain UAE Japan Saudi Arabia France Germany Russia EU UK China World avg.

0

Source: World Bank data 2011

Firm demand fundamentals

Saudi Arabia is among the largest consumers of electricity in the world, with a consumption of 8,161 kWh per capita. Currently, it consumes three times the world average, and this has grown at a CAGR of 7% over the past decade against 1% growth globally. The residential segment accounts for the largest share of the total energy usage. Strong consumption in the Kingdom is underpinned by population growth. According to UN estimates, the country’s population is forecast to reach 34m by the end of the next decade, from 28m currently. The industrial segment has also seen a firm growth in its consumption trends. Thus, we believe an expanding industrial sector led by the development of petrochemical cities will likely play a pivotal role in the coming years. According to the US Energy Information Administration (EIA), Saudi Arabia’s electricity generation capacity has to increase from the present 55GW to 120GW by 2020 in order to meet the rapidly growing demand.

commercial 15% Source: Company data.

major, Saudi Electricity Company (SEC), as its costs keep increasing (but tariffs remain fixed) as it purchases more power from IPPs (to meet the growing demand) at a higher cost. Focus on non-fuel based energy sources

As discussed earlier, Saudi Arabia aims to generate electricity from its first nuclear plant by 2020 and has plans to develop 16 nuclear power plants over the next 20 years, at a cost of around USD80bn, according to the KSA Ministry of Energy. Energy efficiency norms

Air conditioning represents the lion’s share of the residential segment usage (roughly 70%). Saudi has very low standards for energy efficiency for cooling systems currently. The government is now in the process of introducing regulations for A/C use and mandatory insulation requirements for buildings. This could impact energy consumption. That said, it remains to be seen how effective the new regulations will be, and how successfully they will be implemented.

Another important factor contributing to increased consumption is the heavily subsidised electricity tariffs in the Kingdom. It has among the lowest rates globally. Based on the amount consumed, tariffs currently range between 5 and 26 halalas/kWh. That said, low tariffs have negatively impacted profitability for the utility

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Saudi Electricity Company (SEC) SECO AB, Price SAR16.20, N, TP SAR15.9 Company description

estimates, the country’s population is forecast to reach 34m by the end of the next decade, from 28m currently.

SEC is engaged in generating, transmitting and distributing electric power in the Kingdom of Saudi Arabia, either directly or through its wholly or partly owned subsidiaries. While it is currently predominantly oil and gas fired, looking forward, the company plans to build up capacity that utilises solar and nuclear power in order to decrease oil dependency, increase operational profitability, and become more environmentally friendly.

Heavy capex and high debt levels create a drag

Investment thesis

SEC plans to increase capacity by 40,000MW over the next 10 years. Based on our forecasts, capex will likely amount to SAR45-50bn each year. The company recently obtained a USD13bn interest-free loan from the Kingdom’s Ministry of Finance to fund this project. Our forecasts suggest net debt/EBITDA will average 8.0x during 201416e. We thus view the significant capex planned as a near-term negative for SEC.

Saudi’s electricity demand should continue to be powered by solid growth in the population. This underpins SEC’s robust top-line growth, while its aspirations in the renewable energy space are also a positive, in our view. However, we believe high capex plans and margin pressure owing to higher costs for power sourced from other producers warrant caution.

Margin outlook

Robust demand dynamics

Solar and deregulation are positives

Saudi Electricity Company (SEC) appears set to witness firm growth in its top line (we look for a 9% CAGR over 2013-20e) as a result of population-growth-driven power demand in Saudi Arabia. More than half of the power in the country is used by residential subscribers (49% in 2013; also the number of residential subscribers grew by 6% y-o-y last year). According to UN

With a high solar radiation of 2,550 kWh/2 per year, Saudi appears well set to obtain its goal of 41GW of solar power by 2032. We therefore see SEC’s strong aspirations in the renewable energy space as a positive. The company hopes to set up its solar farm by 2015 and plans to attract USD109bn of solar investment in order to generate a third of its electricity by 2032.

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Subsidised tariffs have impeded SEC’s profitability growth. Also, with the company sourcing power from IPPs (independent power producers) to meet demand requirements, we believe margins will have been affected by higher purchasing costs. We forecast the EBITDA margin to average 38.7% over the next three years.

Levent Bayar* Analyst HSBC Yatrim Menkul Degerler A.S + 90 2123764617 [email protected] *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations

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The company has also stated that it may split its generation, distribution and transmission businesses as the sector deregulates. We see this as a potential long-term positive for SEC, with the more profitable operations (generation and transmission) potentially being separated from the loss-making (due to subsidies) distribution business.

Financials SEC recently reported solid Q2 14 results, posting a net income of SAR3.7bn, up 143.5%. This was primarily on the back of a one-off gain of SAR6.2bn from the reversal of accounts receivable provisions. However, our concerns regarding SEC’s tight profitability window given the high costs and the regulated tariff structure persist. In the long term, we do not expect to see a strong improvement in operational figures as long as tariffs remain as they are. This is mainly because, while greater power consumption does increase power bills within the progressive tariff structure, it also forces SEC to purchase more power from IPPs at a higher cost. Combined with this, we forecast the high levels of capex will result in negative FCF in the near term.

Under our research model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate for Saudi stocks of 9%. At the time we set our target price, it implied a potential return that was within the Neutral band. We therefore rate the stock Neutral. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated.


If demand increases more quickly than expected (i.e. by more than 5% a year) and supply is unable to keep up, SEC would have to purchase a greater amount of power from IPPs, increasing costs and hurting profitability. Key upside risks include:

We believe the introduction of a tariff hike would be a key upside risk which could boost operational profitability and valuation. If SEC launches the plan of diversification of the company into three segments with the aim to improve individual business lines, it could be positive for the valuation of the company.

Valuation We use an ROE-driven PB regression methodology to value SEC. With this methodology we run a regression of HSBC EM power generators' PB and ROE values for 2014e. Our regression produces a relationship of: PB = 1.08*ROE + 1.05. Given an average 5.7% RoE for 2014e, we thus arrive at a target price of SAR15.9.

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Financials & valuation: Saudi Electricity Company Financial statements Year to


12/2014e

12/2015e

12/2016e


36,820 13,899 -12,009 1,889 0 3,036 3,036 0 3,036 3,036

40,267 15,651 -12,268 3,383 -932 3,315 3,315 0 3,315 3,315

44,418 17,195 -13,301 3,894 -932 3,824 3,824 0 3,824 3,824

48,620 18,769 -14,338 4,431 -932 4,301 4,301 0 4,301 4,301

23,791 -41,014 -41,214 -547 18,325 -18,735

17,028 -41,206 -41,206 -547 24,725 -25,365

19,757 -41,398 -41,398 -547 22,189 -22,859

27,314 -41,590 -41,590 -547 14,824 -15,468

0 267,180 32,292 3,261 301,862 135,211 100,868 97,607 59,597 160,999

0 295,278 35,097 3,118 332,765 140,436 122,914 119,796 62,874 186,820

0 322,530 39,699 4,740 364,619 151,701 139,360 134,620 66,627 205,787


Year to

12/2013a

12/2014e

12/2015e

12/2016e

3.7 9.9 1.0 22.2 1.2 -29.2 4.3

4.0 10.4 1.0 20.4 1.1 -39.0 4.3

4.2 10.8 1.0 17.7 1.1 -35.1 4.3

4.1 10.6 1.0 15.7 1.0 -23.8 4.3

Target price

(SAR)15.90





Neutral

(SAR)16.20


5110.SE 17,997 19 Saudi Arabia Levent Bayar

20

20

18

18

16

16

14

14

12

12

10

10

8 2012

2013 Saudi Electricity Company

12/2013a

Source: HSBC

12/2014e

12/2015e



9.4 -0.6 -45.5 17.7 17.7

9.4 12.6 79.1 9.2 9.2

10.3 9.9 15.1 15.4 15.4

9.5 9.2 13.8 12.5 12.5

0.3 1.8 5.5 1.2 37.7 5.1 128.2 5.2 32.6

0.3 2.5 5.7 1.5 38.9 8.4 16.8 163.8 6.2 17.4

0.3 2.5 6.2 1.5 38.7 8.8 18.4 190.5 7.0 16.5

0.2 2.5 6.6 1.5 38.6 9.1 20.1 202.0 7.2 20.3

0.73 0.73 0.70 13.64

0.80 0.80 0.70 14.30

0.92 0.92 0.70 15.09

1.03 1.03 0.70 15.99


246

Bloomberg (Equity) SECO AB Market cap (SARm) 67,499 Enterprise value (SARm) 162715 Sector ELECTRIC UTILITIES Contact +90 212 3764617

Price relative

0 237,745 31,961 4,470 272,995 132,550 77,351 72,881 56,829 132,687


1 . 9


8 2015


abc

Notes

247


Notes

248

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Disclosure appendix Analyst Certification Each analyst whose name appears as author of an individual chapter or individual chapters of this report certifies that the views about the subject security(ies) or issuer(s) or any other views or forecasts expressed in the chapter(s) of which (s)he is author accurately reflect his/her personal views and that no part of his/her compensation was, is or will be directly or indirectly related the specific recommendations(s) or view(s) contained therin: Raj Sinha, Aybek Islamov, Nicholas Paton, Patrick Gaffney, Sriharsha Pappu, Herve Drouet, Levent Bayar, Simon Williams, Razan Nasser, Vijay Sumon, John Lomax and Joaquim De Lima

Important disclosures Equities: Stock ratings and basis for financial analysis

HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its equity research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies on a 12 month time horizon; and 2) from time to time to identify short-term investment opportunities that are derived from fundamental, quantitative, technical or event-driven techniques on a 0-3 month time horizon and which may differ from our long-term investment rating. HSBC has assigned ratings for its long-term investment opportunities as described below. This report addresses only the long-term investment opportunities of the companies referred to in the report. As and when HSBC publishes a short-term trading idea the stocks to which these relate are identified on the website at www.hsbcnet.com/research. Details of these short-term investment opportunities can be found under the Reports section of this website. HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations. Investors should carefully read the definitions of the ratings used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the rating. In any case, ratings should not be used or relied on in isolation as investment advice.

Rating definitions for long-term investment opportunities Stock ratings

HSBC assigns ratings to its stocks in this sector on the following basis: For each stock we set a required rate of return calculated from the cost of equity for that stock’s domestic or, as appropriate, regional market established by our strategy team. The price target for a stock represents the value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For a stock to be classified as Overweight, the potential return, which equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated, must exceed the required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock must be expected to underperform its required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands are classified as Neutral. Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation of coverage, change of volatility status or change in price target). Notwithstanding this, and although ratings are subject to ongoing management review, expected returns will be permitted to move outside the bands as a result of normal share price fluctuations without necessarily triggering a rating change.

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*A stock will be classified as volatile if its historical volatility has exceeded 40%, if the stock has been listed for less than 12 months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However, stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility has to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.

Rating distribution for long-term investment opportunities As of 25 July 2014, the distribution of all ratings published is as follows: Overweight (Buy) 44% (31% of these provided with Investment Banking Services) Neutral (Hold)

37%

(30% of these provided with Investment Banking Services)

Underweight (Sell)

19%

(26% of these provided with Investment Banking Services)

Information regarding company share price performance and history of HSBC ratings and target prices in respect of long-term investment opportunities for the companies that are the subject of this report is available from www.hsbcnet.com/research.

HSBC & Analyst disclosures Disclosure checklist Company ABDULLAH A. M. AL-KHODARI ABDULLAH AL OTHAIM MARKETS COM AL MOUWASAT MEDICAL SERVICES C ALMARAI ALRAJHI BANKING & INVESTM ARAB NATIONAL BANK ASTRA INDUSTRIAL GROUP BANQUE SAUDI FRANSI DAR AL ARKAN ETIHAD ETISALAT (MOBILY) FAWAZ ABDULAZIZ ALHOKAIR HERFY FOOD SERVICES JABAL OMAR DEVELOPMENT COMPANY JARIR MARKETING CO MAADEN NATIONAL INDUSTRIALIZATIO NATIONAL PETROCHEMICAL CO PETR RABIGH REFINING AND PETRO RIYAD BANK SAMBA FINANCIAL GROUP SAUDI AIRLINES CATERING SAUDI ARABIAN FERTILIZER SAUDI BASIC INDUSTRIES CO SAUDI ELECTRICITY COMPANY SAUDI INDUSTRIAL INVESTME SAUDI INTERNATIONAL PETRO SAUDI KAYAN PETROCHEMICAL SAUDI PHARMACEUTICAL SAUDI TELECOM COMPANY SAVOLA YANBU CEMENT COMPANY YANBU PETROCHEMICAL ZAMIL INDUSTRIES Source: HSBC

250

Ticker

Recent price

Price Date

Disclosure

1330.SE 4001.SE 4002.SE 2280.SE 1120.SE 1080.SE 1212.SE 1050.SE 4300.SE 7020.SE 4240.SE 6002.SE 4250.SE

50.50 111.00 107.50 72.75 68.50 29.90 48.70 35.00 13.95 88.53 106.50 104.25 50.50

24-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 25-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014

4 4 4 1, 2, 4, 5, 7 7 6, 7, 11 7 6, 7, 11 11 1, 2, 4, 5 4, 7 4 1, 5

4190.SE 1211.SE 2060.SE 2002.SE 2380.SE 1010.SE 1090.SE 6004.SE 2020.SE 2010.SE 5110.SE 2250.SE 2310.SE 2350.SE 2070.SE 2050.SE 3060.SE 2290.SE 2240.SE

201.81 38.50 36.80 34.00 33.86 19.05 44.03 190.00 160.75 128.75 17.35 39.50 38.00 15.45 47.90 82.00 74.50 72.60 61.50

25-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 25-Jul-2014 24-Jul-2014 25-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 24-Jul-2014 25-Jul-2014 24-Jul-2014

4 5 2, 6, 7 5, 6, 7 5 6, 7, 11 2, 4, 6, 7, 11 4 1, 2, 5, 6, 7, 11 1, 2, 5, 6, 7, 11 1, 2, 5, 6, 7, 11 4 2, 5 5 4 2, 6, 7 4, 6, 7 4 4, 5 4, 7


1 2 3 4 5 6 7 8 9 10 11

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HSBC has managed or co-managed a public offering of securities for this company within the past 12 months. HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months. At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this company. As of 30 June 2014 HSBC beneficially owned 1% or more of a class of common equity securities of this company. As of 31 May 2014, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of investment banking services. As of 31 May 2014, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-investment banking securities-related services. As of 31 May 2014, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-securities services. A covering analyst/s has received compensation from this company in the past 12 months. A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as detailed below. A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this company, as detailed below. At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or in securities in respect of this company

HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments (including derivatives) of companies covered in HSBC Research on a principal or agency basis. Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenues. Whether, or in what time frame, an update of this analysis will be published is not determined in advance. For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research.

Additional disclosures 1

2 3

4

5

This report is dated as at 28 July 2014. All market data included in this report are dated as at close 22 July 2014, unless otherwise indicated in the report. HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner. As of 18 Jul 2014, HSBC owned a significant interest in the debt securities of the following company(ies) :ALMARAI,BANQUE SAUDI FRANSI,NATIONAL INDUSTRIALIZATIO,RIYAD BANK,SAUDI ARABIAN FERTILIZER,SAUDI BASIC INDUSTRIES CO,SAUDI ELECTRICITY COMPANY,SAUDI INTERNATIONAL PETRO,SAUDI TELECOM COMPANY,SAVOLA HSBC Saudi Arabia is acting as Financial Advisor to Saudi Arabian Mining Co (Maaden), in its rights issue

MSCI Disclaimer The MSCI sourced information is the exclusive property of Morgan Stanley Capital International Inc. (MSCI). Without prior written permission of MSCI, this information and any other MSCI intellectual property may not be reproduced, redisseminated or used to create any financial products, including any indices. This information is provided on an 'as is' basis. The user assumes the entire risk of any use made of this information. MSCI, its affiliates and any third party involved in, or related to, computing or compiling the information hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of this information. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in, or related to, computing or compiling the information have any liability for any damages of any kind. MSCI, Morgan Stanley Capital International and the MSCI indexes are services marks of MSCI and its affiliates.

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Disclaimer * Legal entities as at 30 May 2014 Issuer of report ‘UAE’ HSBC Bank Middle East Limited, Dubai; ‘HK’ The Hongkong and Shanghai Banking Corporation Limited, HSBC Bank Middle East Ltd Hong Kong; ‘TW’ HSBC Securities (Taiwan) Corporation Limited; 'CA' HSBC Bank Canada, Toronto; HSBC PO Box 502601 Bank, Paris Branch; HSBC France; ‘DE’ HSBC Trinkaus & Burkhardt AG, Düsseldorf; 000 HSBC Bank (RR), Dubai UAE Moscow; ‘IN’ HSBC Securities and Capital Markets (India) Private Limited, Mumbai; ‘JP’ HSBC Securities (Japan) Limited, Tokyo; ‘EG’ HSBC Securities Egypt SAE, Cairo; ‘CN’ HSBC Investment Bank Asia Limited, Telephone: +971 4 3904722 Beijing Representative Office; The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch; The Fax: +971 4 4267397 Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch; The Hongkong and Shanghai Website: www.research.hsbc.com Banking Corporation Limited, Seoul Branch; HSBC Securities (South Africa) (Pty) Ltd, Johannesburg; HSBC Bank plc, London, Madrid, Milan, Stockholm, Tel Aviv; ‘US’ HSBC Securities (USA) Inc, New York; HSBC Yatirim Menkul Degerler AS, Istanbul; HSBC México, SA, Institución de Banca Múltiple, Grupo Financiero HSBC; HSBC Bank Brasil SA – Banco Múltiplo; HSBC Bank Australia Limited; HSBC Bank Argentina SA; HSBC Saudi Arabia Limited; The Hongkong and Shanghai Banking Corporation Limited, New Zealand Branch incorporated in Hong Kong SAR; The Hongkong and Shanghai Banking Corporation Limited, Bangkok Branch In the UAE this document has been approved by HSBC Bank Middle East Ltd (“HBME”) for the information of its customers and those of its affiliates only. HSBC Securities (USA) Inc. accepts responsibility for the content of this research report prepared by its non-US foreign affiliate. All U.S. persons receiving and/or accessing this report and wishing to effect transactions in any security discussed herein should do so with HSBC Securities (USA) Inc. in the United States and not with its non-US foreign affiliate, the issuer of this report. In the UK this report may only be distributed to persons of a kind described in Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005. The protections afforded by the UK regulatory regime are available only to those dealing with a representative of HSBC Bank plc in the UK. It is not intended for Private Customers in the UK. If this research is received by a customer of an affiliate of HSBC, its provision to the recipient is subject to the terms of business in place between the recipient and such affiliate. In Australia, this publication has been distributed by The Hongkong and Shanghai Banking Corporation Limited (ABN 65 117 925 970, AFSL 301737) for the general information of its “wholesale” customers (as defined in the Corporations Act 2001). Where distributed to retail customers, this research is distributed by HSBC Bank Australia Limited (AFSL No. 232595). These respective entities make no representations that the products or services mentioned in this document are available to persons in Australia or are necessarily suitable for any particular person or appropriate in accordance with local law. No consideration has been given to the particular investment objectives, financial situation or particular needs of any recipient. This publication is distributed in New Zealand by The Hongkong and Shanghai Banking Corporation Limited, New Zealand Branch incorporated in Hong Kong SAR. This publication has been distributed in Japan by HSBC Securities (Japan) Limited. It may not be further distributed, in whole or in part, for any purpose. In Hong Kong, this document has been distributed by The Hongkong and Shanghai Banking Corporation Limited in the conduct of its Hong Kong regulated business for the information of its institutional and professional customers; it is not intended for and should not be distributed to retail customers in Hong Kong. The Hongkong and Shanghai Banking Corporation Limited makes no representations that the products or services mentioned in this document are available to persons in Hong Kong or are necessarily suitable for any particular person or appropriate in accordance with local law. All inquiries by such recipients must be directed to The Hongkong and Shanghai Banking Corporation Limited. In Singapore, this publication is distributed by The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch for the general information of institutional investors or other persons specified in Sections 274 and 304 of the Securities and Futures Act (Chapter 289) (“SFA”) and accredited investors and other persons in accordance with the conditions specified in Sections 275 and 305 of the SFA. This publication is not a prospectus as defined in the SFA. It may not be further distributed in whole or in part for any purpose. The Hongkong and Shanghai Banking Corporation Limited Singapore Branch is regulated by the Monetary Authority of Singapore. Recipients in Singapore should contact a "Hongkong and Shanghai Banking Corporation Limited, Singapore Branch" representative in respect of any matters arising from, or in connection with this report. 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The opinions contained within the report are based upon publicly available information at the time of publication and are subject to change without notice. Past performance is not necessarily a guide to future performance. The value of any investment or income may go down as well as up and you may not get back the full amount invested. Where an investment is denominated in a currency other than the local currency of the recipient of the research report, changes in the exchange rates may have an adverse effect on the value, price or income of that investment. In case of investments for which there is no recognised market it may be difficult for investors to sell their investments or to obtain reliable information about its value or the extent of the risk to which it is exposed. HSBC Bank Middle East Ltd is registered in Jersey, Channel Islands, is authorised and regulated by the Jersey Financial Services Commission. 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MENA Research Team

Raj Sinha* Head of EEMEA equity research HSBC Bank Middle East Limited, Dubai +971 4 423 6932 [email protected]


Ammash Aljuraid* Analyst HSBC Saudi Arabia Limited +966 11 299 2105 [email protected]

Sriharsha Pappu* Analyst HSBC Bank Middle East Limited, Dubai +971 4 423 6924 [email protected]

Sagar Kumar* Analyst HSBC Saudi Arabia Limited +966 11 299 2104 [email protected]

Vikram Viswanathan* Analyst HSBC Bank Middle East Limited, Dubai +971 4 423 6931 [email protected]

Yazeed M Alturki* Analyst HSBC Saudi Arabia Limited +966 11 299 2260 [email protected]

Nicholas Paton* Analyst HSBC Bank Middle East Limited, Dubai +971 4423 6923 [email protected]

Telecom Herve Drouet* Analyst HSBC Bank Plc +44 20 7991 6827 [email protected]

Simon Williams Chief Economist, Middle East and North Africa HSBC Bank Middle East Limited, Dubai +971 4 423 6925 [email protected] Rana Nasser Senior Economist, Middle East and North Africa HSBC Bank Middle East Limited, Dubai +971 4423 6928 [email protected] Egypt Shirin Panicker* Analyst HSBC Securities, Egypt, S.A.E. +202 2529 8439 [email protected]

Saudi Arabia A guide to the market

Equities

United Arab Emirates Aybek Islamov* Analyst HSBC Bank Middle East Limited, Dubai +971 4 423 6921 [email protected]

Saudi Arabia

Saudi Arabia Patrick Gaffney*, CFA Analyst HSBC Saudi Arabia Limited +966 11 299 2100 [email protected]

After moves towards increased accessibility over the past seven years, the Saudi Arabian cabinet has now authorised the Capital Market Authority to allow foreign institutions to trade stocks on the Saudi stock market, paving the way for potentially a complete opening of the market in 2015 We believe valuations should see a positive effect from the potential inclusion of the stocks in various equity indices, which could follow soon after the opening of the market

Oilfield services Peter Hitchens* Analyst HSBC Bank plc +44 20 7991 6822 [email protected]

In this report we provide a macro overview of the market, and look at this new opportunity from an equity strategy, industry sector and stock perspective

Utilities Levent Bayar* Analyst HSBC Yatirim Menkul Degerler A.S. +90 212 3764617 [email protected] Equity Strategy John Lomax* Head of Equity Strategy, GEMs HSBC Bank plc, London +44 20 7992 3712 [email protected]

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.

By the MENA Research Team

Issuer of report: HSBC Bank Middle East Limited, Dubai

July 2014

Disclosures and Disclaimer This report must be read with the disclosures and analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

Saudi Arabia a Guide to the Market by HSBC

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