EQUITIES SAUDI ARABIA February 2017 By: MENA Research Team https://www.research.hsbc.com HSBC Saudi Handbook Your guide to the Saudi market After a difficult 2016, Saudi Arabia faces an improved environment in 2017 with higher oil prices and continued progress on Vision 2030. Ultimately, we believe these reforms will improve productivity and leave Saudi Arabia stronger, even if they create near-term challenges. We believe companies with robust business models and strong management will be able to navigate this challenging time. We hope this handbook will act as a guide for your successful investment decisions. Disclaimer & Disclosures: This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it EQUITIES ● SAUDI ARABIA February 2017 Executive summary Saudi has faced its current challenges before, low oil prices and a large deficit. But the proposed solutions of reform are new, and so is the rigour through with which they are to be implemented. Our economist, Simon Williams, has been looking at the region for almost 2 decades, and this is the first time that he feels constructive on the proposals and believes the country to be taking the right path. The government has proposed two key initiatives to diversify its reliance on oil. The first is to create a sovereign wealth fund (SWF) large enough to hold strategic stakes in some of the largest organisations in the world, and the second is to reduce domestic consumption. The link to both seems to be ARAMCO. The ownership of ARAMCO would pass to the SWF and thus its listing would give the SWF the necessary firepower to make large investments. The potential listing of ARAMCO gives rise to a wide set of initiatives that also play a part in reforming the economy, such attracting FDI through the improving foreign ownership limits in Saudi along with stock market reforms and removing subsidies in the energy sector so that market pricing flows through to ARAMCO. With all of this occurring, it’s unsurprising that there is some speculation about Saudi attaining MSCI EM status, where per our calculations they would have a c2.6% (excluding ARAMCO) weighting. Whilst the event may not crystallise till 2019, the alluring valuations as highlighted by our strategists, and the wide range of stocks & sectors, means that interest in Saudi stocks should only increase. The reform process will be bumpy, especially for a government used to procrastinating and usually erring on the side of largesse to its population, but thus far the only criticism may be that of haste. The energy subsidy reforms will hit the lowest income segments the most, as will the introduction of other taxes such as a tax on sugary drinks; but having learnt lessons from the rapid increase in water tariffs the government plans to give allowances to these segments before removing subsidies. We calculate the allowances given to these segments will be larger than what is removed and will be funded by greater indirect taxes on the higher income segments. The energy reforms, taxes and government reining back spend will create uncertainty for the revenue streams for most companies. In addition, as the government brings in more incentives for the private sector to employ Saudis, margins will most likely suffer, so stocks that have the least exposure to the government are best placed. Nowhere is this more apparent than in the construction sector where delays in payments have led to a burgeoning working capital problem. Whilst the government has said it is dealing with the receivables it has also said that it wants to reduce wasteful expenditure. Hence even with the impending debt issuances we expect much volatility and uncertainty. Despite all of this, there are certain sectors like petrochemicals which are somewhat immune to the reform process, what with their feedstock prices set till 2020, or banks where the US interest rate cycle has greater influence. There are other sectors like healthcare, where the demand is so great that they will grow regardless of any stress in the system, and provide a fillip for the insurance sector. The sectors most impacted are utilities, consumers, industrials, cements and construction, but here stock picking is key, as companies will benefit from targeting areas such as the low income consumer segments, energy conservation or low income housing. 1 EQUITIES ● SAUDI ARABIA February 2017 Contents Strategy 5 Qassim Cement 91 Saudi Arabia equity strategy 6 Saudi Cement 93 Saudi Steel Pipes 95 Yamama Cement 97 Yanbu Cement 99 Economics 9 Saudi Arabia 10 Banks 21 Banks Zamil 102 22 Consumers 105 Alawwal Bank 25 Consumers 106 Alinma 27 Abdullah Al Othaim 110 Alrajhi Bank 30 Al Khaleej Training 112 Arab National Bank 33 Alhokair Tourism 114 Banque Saudi Fransi 36 Almarai 116 National Commercial Bank 39 Al-Tayyar Travel Group 119 Riyad Bank 42 Fawaz AlHokair 122 SAMBA 45 Halwani Brothers 124 Herfy Food Services 127 Chemicals 49 Jarir Marketing Co 130 Chemicals 50 Saudi Airlines Catering 132 Advanced Petrochemical 53 Saudi Company Hardware 135 Methanol Chemicals 56 Saudi Dairy & Foodstuff 138 Petro Rabigh 58 Saudi Marketing Company 140 Petrochem 61 Savola 142 SABIC 63 Shaker 145 Sahara Petrochemical 66 United Electronics Company 147 SIIG 69 United International Transport 150 SIPCHEM 72 Saudi Kayan 75 Healthcare 153 Tasnee 78 Healthcare 154 Yanbu Petrochemical 80 Al Hammadi 158 Astra Industrial Group 161 Dallah Health 164 Dr. Sulaiman Al Habib 167 Middle East Healthcare Co 168 Mouwasat Medical 170 Construction & Building Materials 83 Construction & Building Materials 84 Abdullah A.M Al-Khodari 2 88 EQUITIES ● SAUDI ARABIA February 2017 National Medical Care Co 172 Saudi Pharmaceutical 175 Industrials 179 Industrials 180 Aldrees 184 Ma’aden 186 Saudi Arabian Fertilizer 189 Saudi Ceramic Company 192 Saudi Paper 194 Insurance 197 Insurance 198 Bupa Arabia Cooperative 201 Cooperative Insurance Co 204 Real Estate 207 Real Estate 208 Dar Al Arkan 211 Emaar Economic City 214 Jabal Omar 216 Saudi Real Estate 219 Telecoms 223 Telecoms 224 Etihad Etisalat (Mobily) 227 Saudi Telecom Company 230 ZAIN KSA 233 Disclosure appendix 236 Disclaimer 240 3 Rating Curr. Abdullah AL Othaim Market Advanced Petro Chemical Al Hammadi Alinma Bank Abdullah A. M. Al-Khodari Al Khaleej Training Almarai Al Mouwasat Medical Servi Alrajhi Banking & Investm Al-Tayyar Travel Group Arab National Bank Astra Industrial Group Banque Saudi Fransi Dar Al Arkan Dallah Healthcare Etihad Etisalat(Mobily) Fawaz Abdulaziz Alhokair Halwani Brothers Herfy Food Services Jabal Omar Development Co Jarir Marketing Co Maaden Methanol Chemicals Co. National Medical Care Co National Industrialization National Petrochemical Co Rabigh Refining And Petro Qassim Cement Company Rabigh Refining And Petro Riyad Bank Sahara Petrochemical Co. Samba Financial Group Saudi Airlines Catering Saudi Arabian Fertilizer Saudi Basic Industries Co Saudi Cement Company Saudia Dairy & Foodstuff Saudi Industrial Investme Saudi International Petro Saudi Kayan Petrochemical Saudi Marketing Co Saudi Pharmaceutical Saudi Real Estate Saudi Telecom Company** Savola United Electronic Company United International Tran Yamamah Cement Company* Yanbu Cement Company* Yanbu Petrochemical Zain KSA Zamil Industries AOTHAIM AB APPC AB ALHAMMAD AB ALINMA AB ALKHODAR AB ALKHLEEJ AB ALMARAI AB MOUWASAT AB RJHI AB RJHI AB ARNB AB ASTRA AB BSFR AB ALARKAN AB DALLAH AB EEC AB ALHOKAIR AB FGB UH HERFY AB JOMAR AB JARIR AB MAADEN AB CHEMANOL AB CARE AB NIC AB PETROCH AB PETROR AB QACCO AB PETROR AB RIBL AB SPC AB SAMBA AB CATERING AB SAFCO AB SABIC AB SACCO AB SECO AB SIIG AB SIPCHEM AB KAYAN AB SMARKETI AB SPIMACO AB SRECO AB STC AB SAVOLA AB EXTRA AB BUDGET AB YACCO AB YNCCO AB YANSAB AB ZAINKSA AB ZIIC AB Buy Hold Hold Reduce Reduce Hold Hold Buy Hold Buy Reduce Hold Hold Hold Buy Buy Reduce Hold Buy Reduce Buy Hold Reduce Hold Hold Hold Buy Reduce Buy Hold Reduce Hold Hold Hold Buy Reduce Buy Buy Buy Reduce Hold Hold Reduce Hold Buy Hold Buy Buy Hold Hold Reduce Buy SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR SAR MCap (USDm) 1,247 2,461 1,176 5,828 200 211 14,826 1,928 28,885 2,031 5,426 368 7,994 1,714 1,544 4,486 1,834 450 977 17,286 3,024 12,967 230 654 2,947 2,694 2,791 1,446 2,791 8,800 1,819 11,973 1,970 8,059 77,197 2,551 1,002 2,376 1,907 3,392 372 1,279 790 34,774 5,371 270 493 1,051 1,574 8,922 1,370 501 CP TP 103.91 46.90 36.76 14.57 13.45 19.82 69.50 144.61 66.66 36.33 20.35 17.26 24.87 5.95 98.14 21.85 32.76 59.00 79.28 69.75 126.00 41.62 7.14 54.66 16.52 21.05 11.95 60.25 11.95 11.00 15.55 22.45 90.11 72.53 96.50 62.53 115.62 19.80 19.50 8.48 30.96 39.98 24.70 65.21 37.72 28.15 30.29 19.47 37.48 59.48 8.80 31.30 116.00 42.50 33.00 10.00 10.50 18.00 62.00 152.00 56.00 50.00 18.00 15.00 28.00 5.50 112.00 27.20 26.00 52.00 94.00 60.00 160.00 37.80 6.25 56.00 16.00 21.00 15.00 46.00 15.00 10.90 12.00 23.00 92.00 60.00 105.00 45.00 162.00 22.00 21.00 6.50 27.00 36.00 19.50 71.00 48.00 29.00 36.00 24.00 36.00 48.00 7.00 36.70 _______ P/E _________ 2016e 2017e 20.45 12.65 11.76 18.56 59.07 32.52 15.77 16.44 24.48 20.05 32.65 26.72 24.67 28.26 24.32 15.17 14.38 7.96 8.92 8.61 8.99 27.57 12.27 8.01 8.30 26.19 27.42 25.64 26.13 183.63 11.17 21.08 20.42 19.64 16.87 14.95 93.48 15.37 15.49 98.48 55.07 14.59 35.53 17.43 33.75 9.49 19.71 13.99 43.56 8.36 13.05 16.95 43.56 8.36 9.25 9.29 17.33 25.40 9.64 10.05 13.29 11.81 29.88 29.61 15.76 12.81 10.48 13.10 14.46 13.18 14.80 8.63 61.45 8.20 71.34 13.18 13.05 12.24 15.86 14.30 26.63 33.48 13.61 14.76 17.31 54.50 27.39 10.30 9.88 10.78 11.63 11.08 12.06 14.18 14.89 9.47 8.34 _______ P/B ________ _____ Div Yld _______ _____ EV / EBITDA ______ Sector 2016e 2017e 2016e 2017e 2016e 2017e 3.56 2.81 2% 3% 11.41 9.27 Food Products 3.10 3.56 6% 6% 10.33 12.79 Chemicals 3.22 3.05 2% 1% 32.92 21.39 Health Care Providers 1.13 1.09 3% 3% Commercial Banks 1.02 0.98 0% 0% 91.75 7.93 Construction & Engineering 1.51 1.55 5% 5% 16.12 18.44 Diversified Consumer Services 4.90 4.34 1% 1% 15.68 14.96 Food Products 5.60 4.94 1% 2% 20.80 18.11 Health Care Providers 2.23 2.04 3% 3% Commercial Banks 1.36 1.18 0% 6% 6.11 5.56 Hotels Restaurants & Leisure 0.90 0.85 5% 5% Commercial Banks 0.93 0.87 0% 0% 14.96 9.01 Conglomerates 1.02 0.94 4% 4% Commercial Banks 0.35 0.35 0% 0% 15.29 15.64 Real Estate 3.83 3.52 2% 2% 20.31 19.90 Health Care Providers 1.10 1.09 0% 0% 7.79 7.59 Wireless Telecoms 2.64 2.43 7% 1% 9.61 10.54 Multiline Retail 2.66 2.60 4% 5% 10.32 11.34 Food & Staples Retailing 4.54 4.14 4% 5% 12.82 11.41 Hotels Restaurants & Leisure 6.41 6.00 0% 0% 81.32 52.01 Real Estate 7.41 6.99 6% 5% 14.96 15.12 Multiline Retail 1.75 1.70 0% 0% 25.57 20.87 Metals & Mining 0.66 0.66 0% 6% 23.21 6.37Chemicals 2.69 2.49 1% 3% 19.23 12.90 Health Care Providers 1.34 1.22 1% 3% 12.30 9.01 Chemicals 1.60 1.52 0% 4% 11.70 9.59 Chemicals 1.28 1.20 4% 6% 17.18 11.55 Oil & Gas 3.01 2.97 9% 5% 9.52 11.45 Construction Materials 1.28 1.20 4% 6% 17.18 11.55 Oil & Gas 0.90 0.86 6% 6% Commercial Banks 1.20 1.17 3% 2% 8.47 12.92 Chemicals 1.07 1.00 4% 4% Commercial Banks 5.51 5.26 7% 8% 11.43 10.23 Commercial Services 4.11 4.24 4% 4% 20.76 20.38 Chemicals 1.75 1.67 5% 5% 8.86 7.35 Chemicals 2.93 2.89 9% 7% 8.44 9.90 Construction Materials 3.44 3.00 3% 4% 9.82 8.62 Food Products 1.21 1.12 4% 5% 11.10 9.00 Chemicals 1.23 1.13 2% 5% 14.28 6.75 Chemicals 0.98 0.91 0% 0% 10.76 8.16 Chemicals 2.22 1.97 3% 3% 11.01 10.36 Food & Staples Retailing 1.70 1.62 3% 3% 12.76 11.71 Health Care Providers 0.87 0.84 4% 0% 23.74 21.68 Real Estate 2.18 2.15 6% 7% 5.69 5.80 Diversified Telecoms 2.37 2.09 3% 0% 12.01 7.92 Food Products 1.90 1.84 0% 2% 13.15 10.95 Specialty Retail 1.84 1.65 4% 4% 4.14 4.05 Diversified Consumer Services 1.06 1.02 8% 5% 4.22 5.54Construction Materials 1.66 1.69 12% 9% 7.55 8.06Construction Materials 2.05 1.95 4% 4% 8.84 9.15 Chemicals 1.47 1.55 0% 0% 10.45 9.13 Wireless Telecoms 0.96 0.91 6% 6% 7.43 7.25 Building Products Source: Thomson Reuters Datastream, HSBC estimates, *Current prices for YACCO AB and YNCCO AB are as of close of 6 February. **Current price for Saudi Telecom Company is as of close of 8 February. All other current prices as of close of 2 February. BBG Ticker Company Name EQUITIES ● SAUDI ARABIA February 2017 4 HSBC Research coverage of Saudi companies EQUITIES ● SAUDI ARABIA February 2017 Strategy 5 EQUITIES ● SAUDI ARABIA February 2017 Saudi Arabia equity strategy Although further fiscal tightening remains a risk, there are some individual opportunities within the equity market Saudi Arabia’s recent USD17.5bn bond sale was well received and this should provide grounds for optimism Prospective financial market reforms and a potential MSCI inclusion should provide support John Lomax* Head of Global Emerging Market Equity Strategy HSBC Bank plc [email protected] +44 20 7992 3712 Kishore Muktinutalapati* Equity Strategist HSBC Securities & Capital Markets (India) Pvt Ltd [email protected] +91 80 4555 2756 Sougat Chatterjee* Associate Bangalore * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations We have an off-benchmark position in Saudi Arabia Investor concerns around Saudi Arabia were largely down to the cyclical pressures the economy was facing due to persistent lower oil prices. Lower oil revenues for the Kingdom meant tighter fiscal policy. In this context, the recent successful Eurobond sale by Saudi Arabia (the issue was c4x subscribed) provides some grounds for optimism. This was an important event from an economic perspective but is also important, and potentially very positive, for Saudi equities, with a broadly constructive impact for the Gulf as a whole, and particularly for the UAE. Further, an analysis comparing earnings/dividend yield with the bond yield shows the attractions of Saudi Arabian equities relative to other EM (for discussion see our report GEMs Equity Strategy: Why the Saudi Arabian bond issue matters, 21 October 2016). HSBC believes that oil prices will rise sufficiently to greatly ease the pressure on Saudi’s fiscal position, averaging USD60/bbl in 2017e and USD/75bbl in 2018e. Without wanting to be overly precise about either the numbers or the timing, the recent bond issue demonstrates Saudi’s ability to tap international debt markets on attractive terms. Whilst construction activity in the Kingdom is expected to continue to decline over the short term, demand should be quite strong in the long term as the government actively works to lower housing prices. The Saudi cement sector is a potential direct beneficiary of this theme (for details see HSBC report Saudi Cement, Patrick Gaffney et al, 3 November 2016). Saudi remains a strong structural story with under-penetrated markets. For instance, insurance penetration at 1.1% of GDP in Saudi remains very low compared with EM/DM peers. For the sector, our analysts forecast the gross written premium to grow at a compounded annual rate of 13.2% in 2016-2020 – with 11.0% growth in health and 19.4% in the motor insurance premiums (for details see HSBC reports Saudi Insurance: Long-term growth prospects intact, Ankur Agarwal, 13 October 2016 and Saudi Insurance: Subdued 3Q; long-term growth drivers in place, Ankur Agarwal, 14 November 2016). Even in the consumer segment, where the outlook is dim given the Government spending cuts, our analysts believe that the value segment will grow. This is mainly because we believe the government allowances to the low income segments will exceed the impact of energy price reforms and the pain of VAT and other indirect taxes (for details see HSBC report Saudi Consumers: Low income has never looked as attractive, Raj Sinha and Ankur Agarwal, 30 January 2017). 6 EQUITIES ● SAUDI ARABIA February 2017 The Kingdom also has a reform narrative that can be seen across sectors. For example, in the telecoms space, CITC (the telecom regulator), began to take serious steps towards promoting competition in 2015 when it reduced mobile termination rates (MTRs) by 40%. On 2 October 2016, the Saudi government announced two changes to the regulatory framework: the first allows all mobile operators to extend their telecom license by a further 15 years and the second – perhaps more significantly – concerns the issuing of a long-awaited unified telecom license that allows mobile operators to offer fixed services (for details see HSBC report Saudi Telecoms, Eric Chang et al, 11 October 2016). Ongoing equity market liberalisation, in particular Saudi’s ultimate inclusion in the MSCI benchmark, should dovetail with this story. On this we expect MSCI to add Saudi Arabia to the watch list in 2017 for a potential EM inclusion by 2018 and eventual implementation by 2019. Based on our simulations, we expect Saudi Arabia to have a 2.6% weighting in the MSCI EM index, making it the eleventh-largest country in the index (for discussion see our report GEMs Equity Strategy: Why the Saudi Arabian bond issue matters, 21 October 2016). Saudi equity market valuations do not look expensive compared with the FM aggregate – for instance on the IBES consensus estimated 2017e PE, Saudi currently trades at 16.4x compared with 19.6x for FM overall. Also, compared to its own history, Saudi market valuations look attractive at the current levels. On liquidity, after experiencing significant outflows since September 2014, the Saudi market has seen some moderation in the outflows over the past few months. However, the market does not appear over-owned by any standard. Overall, we retain our off-benchmark exposure to Saudi Arabia in both EM and FM country portfolios. Please find below our EM country portfolio and our views on frontier markets. HSBC Equity Strategy Recommendations Emerging markets1 Market EEMEA Czech Republic Egypt Greece Hungary Poland Qatar Russia South Africa Turkey UAE Asia China India Indonesia Korea Malaysia Philippines Taiwan Thailand Latam Brazil Mexico Chile Colombia Peru Frontier Markets Frontier markets2 HSBC Recommendation overweight neutral overweight neutral overweight underweight underweight overweight overweight neutral overweight underweight neutral overweight overweight underweight underweight underweight neutral neutral overweight overweight neutral underweight underweight overweight off benchmark MSCI EM weight (%) 16.4 0.2 0.1 0.4 0.3 1.2 0.9 4.5 7.0 1.0 0.9 70.3 26.7 8.3 2.6 14.5 2.5 1.3 12.2 2.3 13.3 7.9 3.4 1.2 0.5 0.4 0.0 HSBC weight (%) 19.4 0.2 0.4 0.4 0.5 0.3 0.4 6.0 9.2 1.0 1.2 65.3 26.7 10.0 3.4 9.0 1.5 0.3 12.2 2.3 13.8 9.0 3.4 0.6 0.0 0.8 1.5 HSBC view CEEMEA Kazakhstan Kenya Kuwait Morocco Nigeria Oman Saudi Arabia Asia Bangladesh Pakistan Sri Lanka Vietnam Latin America Argentina positive positive neutral neutral negative negative off-benchmark positive positive neutral negative positive Source: MSCI, Thomson Reuters Datastream, HSBC estimates. Notes: (1) Weights may not sum to 100% because of rounding (2) HSBC views on selected Frontier markets only 7 EQUITIES ● SAUDI ARABIA February 2017 This page has been left blank intentionally 8 EQUITIES ● SAUDI ARABIA February 2017 Economics 9 EQUITIES ● SAUDI ARABIA February 2017 Saudi Arabia Simon Williams Economist HSBC Bank plc [email protected] +44 20 7718 9563 Relief, not recovery The unexpectedly far-reaching cuts to oil production OPEC agreed in November have not materially changed our downbeat economic outlook for the Middle East, but they have brought comfort and a degree of reassurance (charts 1-2). For two years prior to the November deal, the Kingdom’s outlook had been unsettled not just by the drop in oil prices, but also by the uncertainty triggered by OPEC’s decision to stop seeking to manage energy prices by controlling supply. That strategy had promised to protect market share over the long term by allowing prices to fall to a level where higher cost producers could no longer compete. But in the near term it meant there was no level below which prices could not fall, raising fears over economic order in the Gulf and the severity of the economic adjustment that would be required. With Saudi Arabia now signalling a renewed readiness to defend prices provided others share the burden of the required production cuts, the new deal effectively reverses that stance. The abrupt shift in strategy would seem to have put a floor under the oil price (chart 3), materially reducing the risk that the level, which was below USD40/b this time last year, could face renewed downward pressure over 2017-18. That the costs of lost oil revenues were sufficient to overcome political divides and prompt Russia, Iran and Iraq to sign up to the Saudi-led production accord gives the change in strategy more substance still. We expect the improved prospects for oil price stability to bolster private and public sentiment, allowing policymakers and corporates to plan more effectively than was the case when the energy price outlook was less certain. We are also optimistic that with energy prices still far below their boom-time highs, the recent gains will not derail economic reform programmes that have gained in substance in recent months in Saudi Arabia. The stronger outlook for oil prices also puts a cap on the Kingdom’s public sector borrowing needs, potentially boosting market readiness to fund the large shortfalls that it continues to face, particularly as evidence of fiscal adjustment becomes clear. A floor to the oil price should also dampen fears that the Kingdom might be forced to devalue the currency and abandon its long-standing dollar-peg FX regimes. 1. The OPEC deal has boosted confidence in the peg…. pts pts 375 350 350 325 325 350 300 300 300 275 Sep-16 550 500 500 450 450 400 400 350 Source: Bloomberg Jan-17 USD 375 550 Dec-16 Bahrain 5 year CDS 400 600 Nov-16 USD 400 600 300 Oct-16 10 SAR 12M Forward 2.…and capped fears over the GCC’s fiscal funding requirement 275 Oct-16 Nov-16 Source: Thomson Reuters Datastream Dec-16 Jan-17 EQUITIES ● SAUDI ARABIA February 2017 Still not enough But while this offers comfort, we see little that is new. Most immediately, the wealth the Kingdom commands had always led us to argue that crisis was not on the horizon. The fiscal and current account deficits it has faced since the oil boom came to an end may have been among the largest in the world, but they followed ten years of record surpluses that had allowed it to strengthen its balance sheets substantially. Saudi Arabia’s reserves increased 18 fold before the oil boom turned sour and although they have fallen by 30% since 2014, the Kingdom had the capacity to fund 12 years of last year’s record current account shortfall or cover M0 seven times over. Similarly, even after last year’s record sovereign borrowing, public debt in Saudi Arabia was just 13% of GDP; its capacity to issue a record USD17.5bn Eurobond in October also underscored how strong its access to finance was, even before the OPEC deal was done. More importantly, we see limits to the scale of price gains the OPEC deal is likely to trigger. We had always assumed that oil prices would rise into 2017, and while we have revised our forecast assumption to USD55-60 from USD50-55 previously in light of the OPEC cuts, the increase is modest (chart 4). The impact of the higher prices on oil receipts is also set to be softened by the reduction in production required to sustain it, as well as continued gains in domestic demand. There is upside risk to our forecasts, (see Oil Insights, 11 January 2017) but OPEC’s poor track record in adhering to production cuts in a rising market, and doubts over cooperation between OPEC and Russia, give grounds for caution that supply cuts will be maintained. The likelihood of some non-conventional oil producers that shut in production when prices were uncertain could step up investment now that the outlook is more stable also suggests that energy production will prove difficult to contain, particularly given the support US president Donald Trump has promised the nation’s oil sector. The still subdued outlook for economic growth in much of the emerging world is also likely to contain gains in energy demand, particularly given the weakness of many EM currencies against the USD. Had Saudi Arabia adjusted to the weak oil price environment of the last two years, then even the modest gains in receipts we anticipate for 2017-18 might lay the ground for a pick-up in performance. However, its fixed peg currency regime and its capacity to finance the large fiscal and current account shortfalls the slump in energy prices brought mean that adjustment to the 2014 downturn has been slow and piecemeal. Indeed, for all of the discussion of reform last year, our estimates suggest that last year’s budget shortfall reached over 16% of GDP, the biggest deficit on record. 3. The OPEC deal hasn’t boosted oil prices that much USD/bbl 120 USD/bbl 120 4. Regional oil receipts will still be well below the boom-time highs GCC oil revenue USD bn 800 USD bn 800 100 100 600 600 80 80 400 400 60 60 200 200 40 40 20 20 0 2014 Source: Bloomberg 2015 OPEC meeting 2016 0 2017 Oil price 0 0 -200 -200 -400 -400 Pre-2015 2017-2018 Change Source: CEIC, HSBC 11 EQUITIES ● SAUDI ARABIA February 2017 5. 18 months into the oil slump, GCC budget deficits were still extraordinarily large Budget balance (2016e) % GDP 0 -2 -4 -6 -8 -10 -12 -14 -16 -18 -20 % GDP 0 -2 -4 -6 -8 -10 -12 -14 -16 -18 -20 Venezuela Oman Saudi Arabia Bahrain Algeria Brazil Ukraine Spain UK Nigeria Russia South Africa Kazakhstan Romania Chile Poland Hungary Turkey Czech Republic Source: HSBC, Focus Economics More adjustment to come With the deficits still so large (chart 5), the Saudi government will be required to push ahead with corrective fiscal adjustment measures, despite the improved outlook for oil prices. At a GCC level, policymakers have remained committed in their public statements and multi-year budget planning documents to introducing VAT from the start of 2018. Ahead of that, there is also a push to sharply increase unified excise duties on a range of goods including tobacco and high-sugar soft drinks. Saudi, specifically, has proposed tax increases for corporates enjoying monopoly positions in the local economy, as well as tightening the existing corporate tax net. Although there is no appetite for a shift to direct taxation, incremental measures are being introduced to boost receipts. Saudi Arabia’s 2017 budget also lays out a flat fee to be paid monthly by all expatriates living in country. The Kingdom has also signalled it will seek to boost income generated from its foreign asset stock, having doubled its annual return in 2016 despite the depletion of its holdings and the continued low rate environment. Spending to fall despite higher oil receipts The majority of the adjustments, however, will likely be delivered through cuts to spending (chart 6). Policymakers are seeking to cut subsidies on power, water and fuel in a bid to both curb current expenditure and rein in demand. After years of rapid increases, public sector wages are also being cut. For example, Saudi Arabia cut benefits and bonus payments to public employees in October 2016 for the first time and in its 2020 National Transformation Plan seeks to reduce the number of government employees by 20%. 6. It’s easy for spending to track revenue upward; harder to cut when earnings fall GCC public finances USD bn 800 USD bn 800 700 700 600 600 500 500 400 400 300 300 200 200 100 100 0 0 2006 2007 2008 2009 Expenditure Source: CEIC 12 2010 2011 2012 2013 2014 Revenue 2015 2016 EQUITIES ● SAUDI ARABIA February 2017 Capital spending has also been subject to stringent review, leading to a raft of non-core projects being cancelled and some core projects being marked down. We expect this to persist, in the context of increasingly rigorous central controls of spending by ministries. The Saudi government has established the “Office for Spending Rationalisation” within the Ministry of Finance in addition to the high powered Project Management Office to more effectively control outlays by the spending ministries. Saudi Arabia also said that it had hired PWC to review USD69bn of planned capital spending including contracts awarded to the housing, transport, health and education ministries, with a goal of finding some USD20bn in savings. The Kingdom has established a General Fiscal Unit charged with multi-year budget planning – a vital first step toward establishing a medium-term budgetary framework that might curb the impact of short-term oil revenue swings on the Kingdom’s fiscal stance. Much still to be done These and other measures are welcome steps toward rebalancing but much remains to be done (charts 7-8). Expenditure increased four-fold during the oil boom, funded by three-digit oil prices; to undo the excesses now exposed by the 50% drop in oil receipts is a multi-year process. Even allowing for significant fiscal reform and a pick-up in oil prices, we expect all Gulf governments to remain in deficit this year, with the total shortfall likely to stand at around USD175bn. Saudi Arabia’s shortfall will remain high at an average of over 7.5% of GDP. It gets harder from here The adjustment process will also prove increasingly difficult to deliver as it continues to advance. There are limits to how high the Saudi government can boost non-oil revenues, for example, in an environment where tolerance for taxation is so limited. Although the unified VAT is a significant step, the initial rate is low at just 5% and widespread exemptions are likely to be agreed as the terms are negotiated over the coming year. Corporate taxation remains very light for locally owned firms and there is no appetite for introducing tax on wealth or income. The presentation of the 2017 Saudi budget even included an explicit commitment that nationals would not pay any income tax. The proposed introduction of a levy on expatriates living in the Kingdom was set at just SAR100 a month, rising to a maximum of SAR400 in 2020. Spending will also prove difficult to adjust. Initial savings delivered by the government have focused on capital outlays where the excesses of the oil boom period were most pronounced, and easiest to reverse. From here, however, capital spending cuts will likely have a meaningful impact on long-term potential growth as well as on the provision of public services to rapidly growing populations. There is also little scope to further reduce outlays associated with high profile commitments such as the transport infrastructure projects already underway in Saudi Arabia. 13 EQUITIES ● SAUDI ARABIA February 2017 8.…as will high levels of military spending 0.6 60 0.4 40 0.2 20 02 03 04 05 06 07 08 09 10 11 12 13 14 15 Public sector employment (nationals) Source: CEIC, Bloomberg Oil price China 80 Turkey 0.8 Iran 100 % GDP 8 7 6 5 4 3 2 1 0 UK 1.0 Defence spending % GDP 16 14 12 10 8 6 4 2 0 Russia 12mma USD/bbl 120 UAE Saudi Arabia Saudi Arabia Millions 1.2 Oman 7. Public sector employment will prove difficult to curb… Source: CEIC Cutting current expenditure will prove more challenging still (charts 7-8). Saudi Arabia, though successful in curbing subsidies in some areas, was forced to reverse increases in water charges introduced in early 2016 in the face of popular opposition. Where cuts were delivered, they were significant in establishing the principle that costs would rise, but prices remained very low. As the next rounds of subsidy cuts have a more meaningful, cumulative impact on living costs, the risk that they will face resistance rises. Recognising this, Saudi Arabia plans direct transfers to compensate “low and middle income families” for the higher costs they face, boosting the probability that the adjustments will be executed, but reducing the savings that subsidy cuts will deliver. It also made clear in its 2017 budget statement that subsequent subsidy cuts would be phased in gradually, and delivered with a lag. With the public sector the dominant employer of nationals in the Kingdom, even capping spending on public sector wages will prove challenging, let alone bring outlays down. Guarantees on employment, pensions and annual wage rises, many of which were introduced after the 2011 Arab Spring, are likely to be challenging to undo. There is also little evidence of appetite for meaningful cuts to the region’s very large defence spending. The military received 21% of total budget spending in 2017, 50% more than was allocated to health and social development, and equivalent to some 8% of GDP. FX regime will compound the fiscal drag Whatever its limits, we expect the ongoing fiscal rebalancing process to be a major headwind to economic growth as lower spending and higher fees and taxes weigh on investment and consumption from the public and private sector. This fiscal dynamic will also weigh on liquidity as the contraction in public sector spending slows growth in money supply (chart 9) and large budget deficits mean government deposit growth remains weak. The region’s still substantial public sector borrowing requirement will also see governments continue to issue debt into the domestic market, adding to the liquidity squeeze and putting upward pressure on interest rates. 14 EQUITIES ● SAUDI ARABIA February 2017 9. The government has become a drain on liquidity 12m chng, GCC public sector USD bn net bank claims 70 60 50 40 30 20 10 0 -10 -20 -30 Sep-14 Feb-15 Jul-15 Dec-15 10. Private sector credit growth has fallen sharply as oil prices have fallen 12m chng, USD bn 70 60 50 40 30 20 10 0 -10 -20 -30 May-16 Source: CEIC % y-o-y GCC lending to private sector % y-o-y 18 18 14 14 10 10 6 6 2 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 2 Source: CEIC In addition to the impact of the funding squeeze (chart 10), the region’s central banks are also set to increase policy rates over the coming two years. Although weakening growth and low inflation arguably call for policy loosening, the importance of safeguarding the credibility of their dollar pegs while maintaining an open capital account saw the Kingdom hike with the Fed in December 2015 and December 2016. We expect policy rates to increase by at least 50bps over the course of 2017 as the Fed continues to tighten. Softening the monetary blow Policymakers are taking what steps they can to soften the impact of these funding pressures. Saudi Arabia, for example, has boosted its reverse repo rate in line with the Fed but left the repo on hold, narrowing the corridor to try to keep lending rates down (chart 11). After years of inactivity, it also overhauled its repo regimes at the end of last year in a bid to ease liquidity pressures, and there is scope to loosen high reserve ratio requirements. Increased borrowing from overseas will also soften the impact of the government’s deficits on local liquidity, as will confidence to make payments on arrears. Structurally, though, the combination of domestic liquidity pressures and the shift in the Fed’s policy stance means that the bias is for higher interest rates (chart 12). Weak economic growth and falling asset prices will also keep bank credit spreads under upward pressure, likely keeping the pace of private sector credit growth down. 11. Saudi Arabia has narrowed its policy corridor to offset higher rates % Saudi interest rates 12. There has been some relief, but the trend is still upward % 6 6 % 2.50 5 5 2.25 2.25 4 4 2.00 2.00 3 3 1.75 1.75 2 2 1.50 1.50 1 1 1.25 1.25 0 0 1.00 1.00 08 09 10 Source: Bloomberg 11 12 Repo 13 14 15 16 17 Reverse repo 18 0.75 2013 3M SAIBOR % 2.50 0.75 2014 2015 2016 2017 Source: Bloomberg 15 EQUITIES ● SAUDI ARABIA February 2017 13. GCC currencies have appreciated strongly, even as oil prices have slumped Index (Q2 2014=100) 180 GCC dollar pegged currencies Index (Q2 2014=100) 180 160 160 140 140 120 120 100 100 80 80 60 60 40 40 Brent JPY REER ZAR EUR GBP RUB TRY Source: Bloomberg, HSBC Weak oil, but a strong currency In addition to the fiscal squeeze and the impact of higher interest rates, economic activity will also be held back by the dollar-driven strength of the region’s currencies. While weak commodity prices saw the Russian rouble and the Nigerian naira fall substantially in value, and most EM currencies have sold against the dollar, the pegged Saudi Riyal has risen substantially in REER terms (chart 13). We expect the dollar to gain further over the first half of this year, and with the pegs set to remain in place, this will take the SAR higher still. The continued currency strength will dampen the impact of the terms of trade shock, maintaining purchasing power and keeping inflation low, but it will do so at a cost. Reserves will continue to be depleted as the fixed peg delays the rebalancing of the region’s external accounts. More immediately, the strength of the currency will undermine efforts to draw in foreign direct investment and to boost non-oil exports. The appreciation of the currency also means that domestic producers face ever stiffer competition from imported goods and local labour appears expensive against expatriate staff. Who fares best? Activity to slow, but Saudi reform is gaining pace Although we expect activity to remain weak across the Gulf, the different scale of the rebalancing challenges the region’s economies face means we see significant divergence in both the pace of likely economic growth, and the risks to our projections (charts 14-15). We take a nuanced view of the Kingdom’s economy. Most immediately, we expect the marked slowdown in growth apparent in the 2016 data to continue into 2017 (chart 18). Large payments on government arrears to contractors in the latter months of 2016 have given the economy some momentum into 2017, easing liquidity pressures and boosting sentiment (chart 16) that has also been bolstered by the OPEC deal. However, we expect this impetus to fade as the year progresses, held back by continued tightening of the underlying fiscal stance. Indeed, although the 2017 budget points to an increase in y-o-y outlays compared to last year’s spending plan, we expect the gains to be offset by increases in fees and cuts to subsidies during the course of the year. Moreover, planned 2017 expenditure of SAR890bn stands below actual outlays of SAR930bn in 2016 when the arrears payments are included in the total. 16 EQUITIES ● SAUDI ARABIA February 2017 14. Break-even oil prices underscore the divergent risks the region faces… Fiscal breakeven oil prices USD/bbl USD/bbl 15.…and how much adjustment work is still to be done USD/bbl Current account breakeven oil prices USD/bbl 30 15 15 0 0 0 0 2015 2017 Oman 2015 Oil @ 55 Source: IMF 2017 90 Qatar 30 20 UAE 40 20 Kuwait 40 Bahrain 45 Saudi Arabia 45 Algeria 60 Kuwait 60 60 Qatar 75 60 UAE 75 80 Saudi Arabia 100 80 Oman 100 Bahrain 120 Algeria 120 90 Oil @ 55 Source: IMF As the primary channel through which oil receipts feed into the domestic economy, fiscal policy is the most powerful determinant of the rhythm of economic activity in the Kingdom, and the ongoing adjustment to the 2014 slump will weigh heavily on economic growth. Upward pressure on policy rates and the government’s still substantial borrowing requirement over 2017 will also likely mean that credit creation remains slow, particularly given the questions raised by the structural reform programme. Given the long lead time, it is unlikely that plans to attract additional foreign direct investment will yield significant gains in the near term, or that structural reform measures will deliver returns over the coming year. As the dominant power in OPEC, Saudi Arabia will also bear the brunt of the oil production cuts which will see net exports remain a drag on growth. However, although the ongoing adjustment means that the near-term outlook is weak, we remain constructive on the kingdom’s longer term trajectory. We see clear signs, for example, that the fiscal adjustment programme has built traction and is gaining, not losing momentum. Excluding the arrears (much of which stem from pre-2016 spending decisions), last year’s outlays would not only have been down 16% on 2015 but would also have been close to the budget target – evidence of an unprecedented improvement in financial control. Even if the details are still a little vague, the high profile announcement in October of selective cuts to bonuses and allowances that had previously been a core part of public sector salaries shows a readiness to curb spending excesses that are too sensitive to address elsewhere in the region. The commitment to core 17.…and non-oil exports are very weak 16. Consumption is still on the slide in the Kingdom… % y-o-y % y-o-y KSA 30 25 20 15 10 5 0 -5 -10 -15 30 25 20 15 10 5 0 -5 -10 -15 2014 2015 2016 Cash withdrawals Value of point of sales transactions Source: CEIC % y-o-y 40 KSA non-oil exports % y-o-y 40 30 30 20 20 10 10 0 0 -10 -10 -20 -20 -30 -30 -40 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 -40 Source: CEIC 17 EQUITIES ● SAUDI ARABIA February 2017 18. The non-oil private sector stagnated last year % y-o-y Saudi Arabia non-oil GDP % y-o-y 8 7 6 5 4 3 2 1 0 -1 -2 8 7 6 5 4 3 2 1 0 -1 -2 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Source: CEIC capital spending projects, and the emphasis given to a more prominent role for the private sector in funding and delivering on them is also encouraging, showing a commitment to the positive goals laid out in the kingdom’s medium-term National Transformation Plan (see Why the Kingdom can and must be reformed, 17 May 2016) despite the immediate pressures for rebalancing. Progress with the privatisation programme, movement on the new bankruptcy law and on structural changes to both the labour and financial markets all suggest that a year after it was launched, the reform programme led by Mohammed bin Salman (deputy crown prince and head of the Council for Economic and Development Affairs) maintains momentum. 18 EQUITIES ● SAUDI ARABIA February 2017 Saudi Arabia: Macro framework Annual data 2008 2009 2010 2011 2012 2013 2014 2015 2016e 2017f 2018f Production, demand and employment GDP growth (% y-o-y) 8.4 1.8 7.4 10.0 5.4 2.7 3.6 3.4 0.6 0.8 1.4 Nominal GDP (USDbn) 520 430 528 670 735 745 755 654 640 666 733 GDP per capita (USD) 20,184 16,116 19,138 23,606 25,169 24,844 24,532 20,800 19,940 20,282 21,814 Private consumption (% y-o-y) 12.0 7.0 3.8 1.7 11.7 3.2 6.1 6.7 2.0 2.0 2.3 Government consumption (% y-o-y) 6.7 1.0 3.2 16.6 8.1 11.1 12.0 -8.5 -2.0 -1.0 1.0 Investment (% y-o-y) 15.1 -6.2 14.6 15.6 5.0 5.6 7.5 -1.5 -5.0 -0.2 3.5 Exports (GDP basis, % y-o-y) -4.2 -7.3 4.7 10.2 3.4 0.2 -1.8 -1.5 2.0 -2.0 0.7 Imports (GDP basis, % y-o-y) 9.7 -6.3 5.6 5.5 7.7 3.7 6.6 -8.6 -2.5 -4.0 3.0 Domestic demand (% y-o-y) 12.9 0.7 38.7 8.1 7.5 4.5 7.9 1.3 -1.2 0.6 2.3 Net exports (contribution to GDP growth, -6.5 1.0 -1.4 3.2 -0.7 -1.1 -3.0 2.2 1.6 0.3 -0.5 ppt) Industrial production (% y-o-y) 4.4 9.0 169.2 12.0 4.9 0.2 6.0 3.0 1.9 -0.5 0.3 Unemployment rate, average (%) 5.0 5.4 5.5 5.8 5.5 5.8 6.0 6.0 6.1 6.5 7.0 Population (m) 25.8 26.7 27.6 28.4 29.2 30.0 30.8 31.4 32.1 32.8 33.6 Prices and wages CPI, average (% y-o-y) CPI, eop (% y-o-y) WPI, average (% y-o-y) Money, interest rates, FX Broad money supply M3 (% y-o-y) Real private sector credit growth (% y-o-y) Policy rate, end-year (%) USD/SAR, end-year USD/SAR, average EUR/SAR, end-year EUR/SAR, average External sector Merchandise exports (USDbn) Merchandise imports (USDbn) Trade balance (USDbn) Trade balance (% GDP) Current account balance (USDbn) Current account balance (% GDP) Net FDI (USDbn) Net FDI (% GDP) International reserves (ex gold) (USDbn) Import cover (months) Gross external debt (USDbn) Gross external debt (% GDP) Short-term external debt (USDbn) Short-term external debt (% of int'l reserves) Public sector Central government balance (% GDP) Gross public sector debt (USDbn) Gross public sector debt (% GDP) 9.9 9.0 8.0 5.1 4.2 6.1 5.3 5.4 5.2 5.0 5.3 6.2 4.5 3.9 6.2 3.5 3.0 6.2 2.7 2.4 7.2 2.2 2.3 -0.4 3.6 2.8 - 3.4 1.2 - 3.4 7.9 - 17.6 18.9 1.50 3.75 3.75 5.22 5.62 10.7 -4.8 0.25 3.75 3.75 5.40 5.28 5.0 -0.6 0.25 3.75 3.75 5.02 5.18 13.3 5.7 0.25 3.75 3.75 4.87 4.87 13.9 12.6 0.25 3.75 3.75 4.94 4.94 10.9 9.1 0.25 3.75 3.75 5.17 4.97 11.9 9.5 0.25 3.75 3.75 4.53 4.89 2.6 7.5 0.50 3.75 3.75 4.08 4.12 -10.8 4.6 0.75 3.75 3.75 3.93 4.14 2.5 1.7 1.25 3.75 3.75 4.12 3.96 11.7 4.2 1.50 3.75 3.75 4.12 4.12 313.5 192.3 251.1 364.7 388.4 101.5 87.1 97.4 120.0 141.8 212.0 105.2 153.7 244.7 246.6 40.7 24.5 29.1 36.5 33.5 132.3 21.0 66.8 158.5 164.7 25.4 4.9 12.7 23.6 22.4 39.5 36.5 29.2 16.3 12.2 7.6 8.5 5.5 2.4 1.7 442.8 410.3 445.3 541.2 657.0 30.1 30.4 30.7 32.8 36.6 96.1 98.9 102.1 97.6 91.5 18.5 23.0 19.4 14.6 12.5 20.1 32.2 35.6 28.8 44.0 4.5 7.9 8.0 5.3 6.7 375.9 153.4 222.5 29.9 135.3 18.2 9.3 1.2 725.9 37.9 86.8 11.6 34.4 4.7 29.8 62.8 14.5 -5.4 60.1 16.8 4.4 44.6 8.5 11.6 36.2 5.4 13.6 22.4 3.0 6.5 16.1 2.2 342.5 202.3 192.1 210.6 214.6 158.5 155.0 147.2 150.2 154.7 184.0 47.3 44.8 60.4 59.9 24.4 7.2 7.0 9.1 8.2 73.4 -54.0 -53.4 -31.0 -30.4 9.7 -8.3 -8.3 -4.7 -4.1 10.2 9.7 8.7 8.7 8.7 1.4 1.5 1.4 1.3 1.2 732.4 616.4 545.0 492.5 447.0 33.9 30.2 27.8 24.9 22.1 87.3 91.3 113.3 132.8 153.3 11.6 14.0 17.7 19.9 20.9 35.9 37.9 39.9 41.9 43.9 4.9 6.2 7.3 8.5 9.8 -3.4 11.8 1.6 -15.0 37.9 5.8 -16.8 57.0 13.2 -8.6 -7.0 98.0 134.7 16.7 20.2 Source: Saudi Arabia Monetary Agency, Central Department of Statistics and Information (CDSI), CEIC, HSBC forecasts 19 EQUITIES ● SAUDI ARABIA February 2017 This page has been left blank intentionally 20 EQUITIES ● SAUDI ARABIA February 2017 Banks 21 EQUITIES ● SAUDI ARABIA February 2017 Banks Steep increase in US 10-year bond yields could trigger mark-tomarket losses on securities portfolios, on average 11bps of assets Liquidity eased since October 2016. Demand for loans started to ease too as government cut spending. Balance sheet contraction is a negative risk for banks’ NII growth. Saudi banks we cover trade at 11.6x/1.4x EPS/BVPS 2017e. Our relative preference is for BSF Aybek Islamov*, CFA Analyst HSBC Middle East Ltd [email protected] +971 4423 6921 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Rapid rise in US 10-year yields creates interest rate risk Banking sector earnings remain sensitive to asset quality deterioration in 2017. We think timely Government payments to projects and contractors will prevent NPL spikes in the medium term. However, our concern is that such payments may not filter through the entire corporate chain. We view SME corporate loan quality as vulnerable and in need of higher provision coverage by the banks. On the other hand, the funding position of the banks appears stronger than in 2016. Also, large repayments and lack of new originations should require less deposit growth going forward. We therefore believe banks may start to accumulate liquidity, as it was once the case back in 2008-2009. Against this backdrop, we think banking sector NIM may struggle to grow at the same rate as last year. Liquidity accumulation and lack of attractive reinvestment options should put pressure on the asset yields. Loan re-pricing in response to increased interbank rates will have a weak effect as new origination reduces. Steep increase in US 10-year bond yields can result in mark-to-market losses on available-for-sale (AFS) securities, on average 11bps of assets. US 10-year bond yields increased by c50bps to c2.4% post the presidential election outcome on 8 November. A sudden, unexpected spike in 10-year yields could increase unrealised losses on AFS securities, especially if left largely unhedged. We note two instances in the past, Q2 2013 and Q2 2015, when unexpected spikes in US 10-year bond yields of 63 and 42bp, respectively, led to unrealised losses at ANB, Riyad, Samba and NCB. The magnitude of such a loss on AFS securities is equivalent to the change in interest rate multiplied by the average duration and size of the AFS book. As we show in the table below, we estimate that banks can book unrealised losses on AFS securities as a result of a steep rise in 10-year US yields, on average 11bp of assets. 22 EQUITIES ● SAUDI ARABIA February 2017 Impact of m-t-m of AFS securities due to interest rate hike Investments (a) Weighted average duration (years) (b) Chg in interest rate (bps) ( c) Mark-to-market impact (a*b*c) -as % of assets (in bps) ANB 14,521 3.8 25 (137) (8) Alinma 1,231 3.0 25 (9) (1) Alrajhi 6,978 4.7 25 (81) (3) BSF 18,480 4.2 25 (196) (11) Riyad 24,530 4.5 25 (279) (13) NCB 122,482 3.0 25 (919) (21) Samba 35,924 4.9 25 (443) (20) Source: HSBC estimates The impact of m-t-m on AFS securities due to interest rate hike is higher compared to impact on NII. It is important to note that there should be no income statement impact due to loss on AFS securities as it is booked through equity. A potential trigger to unwind such losses is a further drawdown of deposits once USD17.5bn of October Sovereign bond proceeds are fully deployed. Under such a scenario, banks may need to sell AFS securities and will need to book m-t-m losses in their income statement. If one assumes there are no interest rate hedges in place, we estimate NCB and Samba would be the worst affected banks. We estimate a negative m-t-m impact of c20bps of average assets on both these banks. We expect the m-t-m impact to be minimal for Alinma and Alrajhi. We believe there could be downside risks if US bond yields stay elevated for the next 12 months or there is potential delay in Saudi government plans to issue further sovereign bonds due to increased US bond yields. HSBC fixed income research forecasts a 10-year bond yield of 2.5% for Q1 2017 and then reducing to 1.35% by end-2017. For more details, please refer to the report The Trump Premium: Changes to our US yield forecasts, 11 November 2016, by Steven Major. Rising risk of balance sheet contraction Loan growth decelerated in December. Customer loans increased just 3% y-o-y in 2016, and were down 1% m-o-m in December. We think a decline in sector loans in 2017 is becoming a more likely scenario as banks will see more repayments and lower new originations. The pace of deceleration is rather quick, which increases asset quality risk in the medium term. Short term loans (50% of total) were up 3% y-o-y while long term loans (31% of total) were down 1% y-o-y in 2016. SAMA bills declined 2% m-o-m and 74% y-o-y while Government bonds increased by 1% m-o-m and 107% y-o-y. Investment securities were flat m-o-m and declined by 2% in 2016. We think loan to deposit ratio will remain comfortably below the regulatory cap of 90%. Weak loan demand means that Saudi banks may end up hoarding liquid assets, which could be negative for sector NIM. What helped liquidity so far: sovereign bond placement and extension of repo term Saudi Arabia raised USD17.5bn through sovereign bond issuance in October 2016. A subsequent extension of repo facilities to 3 months from 1 week at an unchanged cost of 2% improved commercial banks’ access to emergency funding. We can’t verify however how extensively banks are using the repo window. SAMA can further ease liquidity by extending eligible collateral for domestic banks. But at the moment such measures remain unnecessary. 23 EQUITIES ● SAUDI ARABIA February 2017 Sector valuation and earnings outlook Our relative preference is for BSF. BSF tends to have a more conservative provisioning policy leading to a steeper decline in EPS at the onset of asset quality deterioration, which is why we are not more positive on the stock. This policy stance, however, tends to lead to a faster recovery thereafter. We think a q-o-q decline in NII in Q4 16 could be due to unwinding of interest rate swaps, which are one-off in nature. The stock trades at 8.5x 2017e PE – a 27% and 24% discount to Saudi and EEMEA banks, respectively. Valuation and earnings outlook. We think asset quality weakness will continue to weigh on earnings growth during 2017e. Liquidity management and loan pricing are key to NIM outlook in 2017e. Excluding Alrajhi Bank (RJHI AB, SAR63.08, Hold), we forecast EPS of banks under coverage to decline by c6% y-o-y in 2017. For Alrajhi Bank, we forecast EPS growth of 6% in 2017. 24 EQUITIES ● SAUDI ARABIA February 2017 Alawwal Bank ALAWWAL 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. SHB announced the change of its corporate identity to ‘Alawwal Bank’ in November 2016. The bank appointed Soren Nikolajsen as its managing director with effect from January 1, 2017. The bank is engaged in conventional as well as Islamic banking solutions, in addition to a wide range of investment services such as asset management and investment funds. The lender also provides brokerage services in the local and international markets through its specialised and wholly-owned subsidiary company Saudi Hollandi Capital. The bank is primarily a corporate bank with corporate loans representing c81% of total loans at end of Q3 2015. 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 Alawwal Bank reported Q4 16 net loss of SAR249m which was substantially lower than consensus of net profit of SAR373m. FY16 net income was down 47% y/y. The bank said that increase in impairment charge for credit losses is the primary driver of the net loss in Q4 16. NII was down 4% q-o-q but up 8% y-o-y. The sequential decline in NII was led by both decline in NIMs and loan book. NIMs were down 6bps q-o-q but were up 17bps y-o-y. Loans declined by 6% q-o-q and 5% y-o-y. Deposits were up 1% q-o-q but down 4% y-o-y. LDR declined to 85% in Q4 16 compared to 92% in Q3 16. Non-interest income was up 10% q-o-q but flat y-o-y. As a result, total income was flat q-o-q and up 5% y-o-y. As at 31 December 2016, total assets stood at SAR105bn, customer deposits at SAR85.4bn, and loans and advances at SAR72.7bn. The bank has 5% market share in loans, deposits and assets as of Q4 2016. The bank’s capital adequacy ratio was 16.9% at end of Q3 2016 with Tier 1 ratio of 12.9%. The bank has maintained stable NPL ratio at c1.2% as of Q3 2016 with a strong coverage ratio of 156%. Recent news 24 November 2016: The bank announced the change of its corporate identity to be ‘Alawwal Bank’ instead of ‘Saudi Hollandi Bank’ on 24th November 2016. The bank launched its new corporate identity on 27th November 2016 through its branches across the Kingdom and all of its electronic banking channels. November 2016: The bank announced the appointment of Soren Nikolajsen as managing director with effect from January 1, 2017. Soren replaces Bernd van Linder who resigned earlier in October 2016. Mr. Nikolajsen has been a Non-Executive Director at SHB since December 2013. 25 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation Financial statements Year to Core profitability (% RWAs) and leverage 12/2012a 12/2013a 12/2014a 12/2015a P&L summary (SARm) 1,372 628 5 215 2,219 -845 -140 19 1,253 0 1,253 0 0 1,253 1,253 1,624 732 -1 261 2,616 -895 -218 0 1,502 0 1,502 0 -1 1,502 1,502 1,966 864 20 332 3,182 -1,011 -346 0 1,825 0 1,825 0 -4 1,821 1,821 2,298 887 15 394 3,594 -1,159 -418 0 2,017 0 2,017 0 0 2,017 2,017 Ordinary equity HSBC ordinary equity Customer loans Debt securities holdings Customer deposits Interest earning assets Total assets Capital (%) 8,306 8,306 45,276 2,900 53,914 60,144 68,506 9,401 9,401 53,211 4,625 61,875 74,783 80,468 10,742 10,742 65,148 3,900 76,814 93,091 96,619 12,027 12,027 76,144 3,900 88,832 0 108,070 RWA (SARm) Core tier 1 Total tier 1 Total capital 63,196 12.4 12.4 17.6 75,790 11.8 11.8 18.3 89,999 11.2 11.2 15.9 101,315 11.6 11.6 15.6 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) Year to 12/2014a 12/2015a 2.1 0.0 0.3 1.2 3.8 -0.3 2.0 8.6 17.0 2.2 0.0 0.4 1.1 3.9 -0.4 2.0 9.0 18.1 2.3 0.0 0.4 1.1 3.9 -0.4 2.0 9.0 17.7 Year to 12/2012a 12/2013a 12/2014a 12/2015a 7.1 6.2 1.1 5.1 7.1 6.5 1.1 5.0 5.9 6.2 1.0 4.4 6.4 4.9 1.1 5.8 PE* Pre-provision multiple P/NAV Dividend yield (%) * Based on HSBC EPS (diluted) Price relative 26.0 60.0 55.0 50.0 45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 24.0 22.0 20.0 18.0 16.0 14.0 12.0 10.0 2014 2015 Alawwal 12/2012a 12/2013a 12/2014a 12/2015a Total income Operating expense Pre-provision profit EPS HSBC EPS DPS NAV (including goodwill) Ratios (%) 10.7 5.4 14.2 1.2 -1.8 -6.6 10.7 17.9 5.9 25.3 -0.1 0.0 -5.7 17.9 21.6 13.0 26.2 21.3 0.0 14.3 21.6 13.0 14.6 12.2 -7.7 0.0 -6.7 13.0 Cost/income ratio Bad debt charge Customer loans/deposits NPL/loan NPL/RWA Coverage ROE (including goodwill) Per share data (SAR) 38.1 0.3 84.0 1.6 1.1 152.8 15.9 34.2 0.4 86.0 1.4 1.0 161.5 17.0 31.8 0.6 84.8 1.3 0.9 160.6 18.1 32.3 0.6 85.7 1.1 0.8 166.8 17.7 EPS reported (diluted) HSBC EPS (diluted) DPS NAV NAV (including goodwill) 3.16 3.16 1.12 20.93 20.93 3.15 3.15 1.12 19.74 19.74 3.82 3.82 1.12 22.55 22.55 3.53 3.53 1.12 21.04 21.04 Year-on-year % change 26 12/2013a 2.2 0.0 0.3 1.3 3.9 -0.2 2.0 8.2 15.9 Valuation data Ratio, growth & per share analysis Year to 12/2012a 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 Source: HSBC Note: Priced at close of 02 February 2017 2016 Relative to Tadawul 2017 EQUITIES ● SAUDI ARABIA February 2017 Alinma Aybek Islamov*, CFA Analyst HSBC Middle East Ltd [email protected] +971 4423 6921 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations ALINMA AB, Reduce, TP SAR10.0 Company description Alinma was established in 2006 and is headquartered in Riyadh. The bank offers Shariahcompliant retail and corporate banking and investment services. It controls 5% of the total loan market, deposits and assets in Saudi Arabia as of the end of December 2016. As of December 2015, Alinma had a distribution network of 69 branches across Saudi Arabia. Investment thesis Cut in public sector income creates downside risks to Alinma’s deposit growth. The share of retail liabilities increased significantly at Alinma during Q2 13-Q3 16 and is the key driver of overall deposit growth. The share of retail liabilities increased to 85% as of Q3 16 compared to 75% in Q2 13. A cut in public sector income clearly creates downside risks to retail sector deposit growth. We forecast deposit growth to slow down to 3% in 2017e-18e from 20% in 2016e. Asset quality highly exposed to construction sector risk. Alinma’s asset quality is sensitive to government payments as it has a large exposure to the construction sector, 23% of loans based on IFRS reporting. In our sector report Saudi banks: Asset quality: what’s priced in and what’s not published on 6th September 2016, we estimated Alinma’s peak NPL ratio at 15%, which would be the highest amongst Saudi banks we cover. Negative risks to asset quality imply the bank will hold on to surplus capital. As a result, we see low probability of Alinma increasing the payout ratio to gear up the balance sheet and improve ROE. We forecast a dividend pay-out ratio of 45% for 2017e and 2018e compared to 46% in 2016e. Valuations. Alinma trades at 16.6x/1.1x 2017e EPS/BVPS which is a 43% premium to Saudi banks we cover on a one year forward PE basis. We estimate 2015-17e EPS CAGR of -4%. Financials We forecast Alinma to report earnings of SAR1.36bn (before zakat) in 2017, a decline of 4% over 2016e. We estimate NII growth of 9% and non-interest income growth of 5% in 2017e. We forecast loan growth to slow down to 4% in 2017e from 24% in 2016e. We look for better control on operating costs due to lower revenue and forecast opex growth of 1% in 2017e and 2018e. We estimate pre-provision income growth of 14% for 2017e and 11% in 2018e. Valuation We derive our fair value target price for Alinma using a residual income methodology, which comprises three stages. For Saudi banks, we use an inflation differential model to calculate the cost of equity. To this end, we assume the cost of equity to be the sum of the US risk-free rate (2.5%), and the inflation differential between the country and the US (3.1%) plus the equity risk premium (4.5%) multiplied by the stock beta of 1.0. We use a cost of equity of 10.1% for Alinma. 27 EQUITIES ● SAUDI ARABIA February 2017 We have a target price of SAR10.0 for Alinma. Our target price implies 31.4% downside from the current levels and therefore we have a Reduce rating on the stock. Risks Upside risks: lower-than-expected cost of risk due to better-than-expected asset quality; higher than expected dividend pay-out ratio due to surplus capital. 28 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Alinma Bank Reduce Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e 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 and others Attributable profit HSBC attributable profit Balance sheet summary (SARm) 2,279 620 94 70 3,063 -1,274 -196 -122 1,470 0 1,470 -42 0 1,428 1,428 2,589 606 113 0 3,308 -1,429 -285 -180 1,415 0 1,415 -42 0 1,372 1,372 2,827 631 124 0 3,582 -1,443 -783 0 1,356 0 1,356 -41 0 1,316 1,316 2,994 690 137 0 3,820 -1,457 -985 0 1,379 0 1,379 -41 0 1,337 1,337 Ordinary equity HSBC ordinary equity Customer loans Debt securities holdings Customer deposits Interest earning assets Total assets Capital (%) 18,352 18,352 56,570 6,468 65,542 81,621 88,725 19,074 19,074 70,052 6,468 78,650 93,208 104,459 19,779 19,779 72,884 6,145 81,009 103,270 107,523 20,496 20,496 75,457 5,837 83,440 106,575 110,671 RWA (SARm) Core tier 1 Total tier 1 Total capital 82,128 0.0 22.3 22.9 101,700 0.0 18.8 19.2 105,812 0.0 18.7 19.1 109,547 0.0 18.7 19.1 Year to PE* Pre-provision multiple P/NAV Dividend yield (%) 12/2015a 12/2016e 12/2017e 12/2018e 15.2 12.1 1.2 3.4 15.8 11.5 1.1 3.0 16.4 10.1 1.1 2.8 16.2 9.2 1.1 2.9 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 14.57 10.00 1150.SE ALINMA AB 5,899 Free float Sector Country Analyst Contact 70% Commercial Banks Saudi Arabia Aybek Islamov +9714 423 6921 Price relative 25.10 23.10 21.10 19.10 17.10 15.10 13.10 11.10 9.10 2015 25.10 23.10 21.10 19.10 17.10 15.10 13.10 11.10 9.10 2016 Alinma Bank 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Ratio, growth & per share analysis Year to Note: Priced at close of 02 Feb 2017 12/2015a 12/2016e 12/2017e 12/2018e 16.9 7.5 24.7 19.0 19.0 0.0 2.3 8.0 12.1 5.1 -3.9 -3.9 -12.7 3.9 8.3 1.0 13.9 -4.1 -4.1 -6.2 3.7 6.6 1.0 10.5 1.6 1.6 1.6 3.6 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) Per share data (SAR) 41.6 0.4 86.3 0.7 0.5 0.9 0.0 175.1 7.9 43.2 0.4 89.1 0.7 0.5 0.9 0.0 174.1 7.3 40.3 1.1 90.0 1.3 0.9 1.3 0.0 136.9 6.8 38.1 1.3 90.4 1.8 1.3 1.7 0.0 133.7 6.6 EPS reported (diluted) HSBC EPS (diluted) DPS NAV NAV (including goodwill) 0.96 0.96 0.50 12.36 12.36 0.92 0.92 0.44 12.84 12.84 0.89 0.89 0.41 13.32 13.32 0.90 0.90 0.42 13.80 13.80 Y-on-y % change Total income Operating expense Pre-provision profit EPS HSBC EPS DPS NAV (including goodwill) Ratios (%) 29 EQUITIES ● SAUDI ARABIA February 2017 Alrajhi Bank Aybek Islamov*, CFA Analyst HSBC Middle East Ltd [email protected] +971 4423 6921 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations RJHI AB, Hold, TP SAR56.0 Company description Al Rajhi Bank was established in 1958 with its headquarter in Riyad. The bank provides a full range of retail and corporate banking services. The bank is mainly focussed on retail lending which comprises of 73% of its total loan book as of Q3 2016. The bank had 16% market share in loans and 17% market share in deposits, as at December 2016. As of December 2015, the bank had a distribution network of 569 branches with an employee base of 12,374. Investment thesis Loan rescheduling is negative for liquidity. We think that the cut in public sector income is likely to put lower income borrowers under pressure. We were therefore not surprised that SAMA requested banks to reschedule consumer loans. According to press reports, the regulator and banks are further looking into rescheduling of mortgage payments, which are currently not included in the calculation of debt burden ratios (DBRs). In our sector report Saudi banks: Share prices adjusting to higher retail debt ratios published on 11th October 2016, we estimated Alrajhi can see its liquidity coverage ratio (LCR) drop to 119% from 172% reported LCR due to rescheduling of loans. Retail is the key driver of funding and loan growth for Alrajhi. The share of retail liabilities increased significantly to 93% in Q3 16 from 78% in Q2 13. Corporate liabilities declined at Alrajhi during the same time period. The share of retail loans at Alrajhi stands at 73% as of Q3 16 significantly higher than the 27% on average for the other Saudi banks we cover. A cut in public sector income clearly creates downside risks to retail sector deposit and loan growth. We forecast loan growth to slow down to 4% in 2017e-18e from 9% in 2016e. Similarly, we expect deposit growth to decline to 3% in 2017e and 4% in 2018e from 7% in 2016e. We rate the stock as Hold due to its premium valuation. Alrajhi trades at 14.3x/2.0x 2017e EPS/BVPS which is a 20% premium to Saudi banks we cover on a one year forward PE basis. We estimate 2015-17e EPS CAGR of 10%. Key catalysts centre on cost of risk and retail loan spread outlook. Financials We forecast Alrajhi to report earnings of SAR8.55bn (before zakat) in 2017e, an increase of 5.5% over 2016e. We estimate NII growth of 7% and non-interest income growth of 5% in 2016e. We forecast cost of risk to increase to c120bps in 2017e and c117bps in 2018e compared to c105bps in 2016e as we believe the cut in public sector income should have a negative impact on asset quality. We look for better control on operating costs due to lower revenue and forecast opex growth of 2% in 2017e and 1% in 2018e. We estimate pre-provision income growth of 9% for 2017e and 8% in 2018e. 30 EQUITIES ● SAUDI ARABIA February 2017 Valuation We derive our fair value target price for Alrajhi using a residual income methodology, which comprises three stages. For Saudi banks, we use an inflation differential model to calculate the cost of equity. To this end, we assume the cost of equity to be the sum of the US risk-free rate (2.5%), and the inflation differential between the country and the US (3.1%) plus the equity risk premium (4.5%) multiplied by the stock beta of 1.0. We use a cost of equity of 10.1% for Alrajhi. We have a target price of SAR56.0 for Alrajhi. Our target price implies 16.0% downside from the current levels. We have a Hold rating on the stock as we expect Alrajhi to be the least negatively impacted by interest rate risk among the Saudi banking stocks we cover due to its lower share of investment securities. Risks Downside risks include lower-than-expected deposit growth and loan spreads. Higher-thanexpected drop in the volume of demand deposits leading to increasing funding costs is another downside risk. Upside risks include better than expected corporate asset quality leading to lower cost of risk. 31 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Alrajhi Banking & Investm Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e 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 and others Attributable profit HSBC attributable profit Balance sheet summary (SARm) Hold 9,959 2,567 0 1,220 13,746 -4,658 -1,958 0 7,130 0 7,130 -850 0 6,280 6,280 11,206 3,109 0 1,235 15,550 -5,007 -2,360 -75 8,108 0 8,108 -967 0 7,142 7,142 12,010 3,278 0 1,290 16,578 -5,106 -2,918 0 8,554 0 8,554 -1,020 0 7,535 7,535 12,729 3,496 0 1,347 17,572 -5,148 -2,959 0 9,465 0 9,465 -1,128 0 8,336 8,336 Ordinary equity HSBC ordinary equity Customer loans Debt securities holdings Customer deposits Interest earning assets Total assets Capital (%) 44,164 44,164 210,218 28,597 256,228 299,775 315,620 48,549 48,549 228,056 29,730 274,164 307,867 331,548 53,175 53,175 237,941 30,788 281,018 318,352 343,338 58,294 58,294 248,434 31,889 290,853 329,493 358,615 RWA (SARm) Core tier 1 Total tier 1 Total capital 236,288 19.7 19.7 20.8 250,765 20.3 20.3 21.4 262,826 21.2 21.2 22.2 275,510 22.1 22.1 23.0 Year to PE* Pre-provision multiple P/NAV Dividend yield (%) Year to 12/2016e 12/2017e 12/2018e Total income Operating expense Pre-provision profit EPS HSBC EPS DPS NAV (including goodwill) Ratios (%) 0.6 3.1 -0.7 3.2 3.2 -14.3 10.6 13.1 7.5 16.0 13.7 13.7 13.1 9.9 6.6 2.0 8.8 5.5 5.5 5.5 9.5 6.0 0.8 8.3 10.6 10.6 10.6 9.6 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) Per share data (SAR) 33.9 0.9 82.0 1.5 1.4 2.4 0.8 176.7 14.9 32.2 1.1 83.2 1.5 1.4 2.7 0.6 192.9 15.4 30.8 1.3 84.7 2.1 2.0 3.1 0.6 155.7 14.8 29.3 1.2 85.4 3.0 2.8 3.4 0.6 124.3 15.0 EPS reported (diluted) HSBC EPS (diluted) DPS NAV NAV (including goodwill) 3.86 3.86 1.50 27.18 27.18 4.39 4.39 1.70 29.88 29.88 4.64 4.64 1.79 32.72 32.72 5.13 5.13 1.98 35.87 35.87 Y-on-y % change 32 12/2017e 12/2018e 15.2 10.3 2.2 2.5 14.4 9.4 2.0 2.7 13.0 8.7 1.9 3.0 Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 66.66 56.00 1120.SE RJHI AB 28,796 Free float Sector Country Analyst Contact 45% Commercial Banks Saudi Arabia Aybek Islamov +9714 423 6921 Price relative 80.00 80.00 70.00 70.00 60.00 60.00 50.00 50.00 40.00 2015 40.00 2016 Alrajhi Banking & Investm Note: Priced at close of 02 Feb 2017 12/2015a 12/2016e 17.2 11.9 2.5 2.3 * Based on HSBC EPS (diluted) Source: HSBC Ratio, growth & per share analysis 12/2015a 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Arab National Bank Aybek Islamov*, CFA Analyst HSBC Middle East Ltd [email protected] +971 4423 6921 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations ARNB AB, Reduce, TP SAR18.0 Company description 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. ANB has 8% market share of loans and deposits, as at December 2016. 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. SAMA has issued a license for real estate finance and financial leasing activities to Arab National Bank. As of December 2015, ANB had a distribution network of 153 branches across Saudi Arabia with an employee base of 4,846. Investment thesis Asset quality remains vulnerable due to above-sector-average loan growth since 2012. We were surprised by the loan growth strength of 11% y-o-y in 2015 as it was significantly higher than peer banks. The loan growth slowed down to 0% in 2016. In our sector report Saudi banks: Asset quality: what’s priced in and what’s not published on 6th September 2016, we estimated ANB could have the second-highest peak NPL ratio of 13.5% after Alinma bank. Based on our peak NPL analysis, we believe ANB is not oversold yet. We think the main challenge for ANB will be to manage asset quality in an environment of slowing sector growth. We forecast higher bad asset charges and reduced payout ratios in our normalised earnings estimates. NPL formation is very hard to time and therefore we factor in a NPL spike in 2019 within our 5 year explicit forecast period. Such an adjustment captures the full NPL cycle in our stock valuation. We estimate cost of risk of 5% in 2019e and 1.46% in 2020e compared to 0.77% in 2016e. We forecast lower dividend payout ratio of 20% in 2019e-20e compared to 35% in 2016e. Valuation. ANB trades at 9.0x/0.8x 2017e EPS/BVPS. We estimate 2015-17e EPS CAGR of 10%. Financials We forecast ANB to report earnings of SAR2.74bn (before zakat) in 2017, a decrease of 4% over 2016e. We estimate NII growth of 10% in 2017e as we forecast NIMs to increase by 24bps in 2017e. However, we expect bad asset charges to increase 59% y-o-y in 2017e as we expect pressure on asset quality to continue in 2017e. We look for better control on operating costs due to lower revenue and forecast operating expenses to decline by 1% in 2017e. We estimate pre-provision income growth of 12% for 2017e and 6% in 2018e. Valuation We derive our fair value target price for ANB using a residual income methodology, which comprises three stages. For Saudi banks, we use an inflation differential model to calculate the cost of equity. To this end, we assume the cost of equity to be the sum of the US risk-free rate 33 EQUITIES ● SAUDI ARABIA February 2017 (2.5%), and the inflation differential between the country and the US (3.1%) plus the equity risk premium (4.5%) multiplied by the stock beta of 1.0. We use a cost of equity of 10.1% for ANB. We have a target price of SAR18.0 for ANB. Our target price implies 11.5% downside from the current levels. We have a Reduce rating on the stock as we believe the potential asset quality deterioration is not fully discounted in current valuations. Risks Upside risks: lower-than-expected funding costs leading to higher than-expected NIMs. 34 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Arab National Bank Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e 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 and others Attributable profit HSBC attributable profit Balance sheet summary (SARm) Reduce 3,845 1,286 -9 741 5,863 -2,243 -657 -6 2,956 0 2,956 -495 8 2,469 2,469 4,176 1,086 2 780 6,044 -2,253 -927 -4 2,861 0 2,861 -486 -11 2,363 2,363 4,610 1,141 10 690 6,451 -2,225 -1,521 37 2,742 0 2,742 -466 -11 2,265 2,265 4,781 1,197 10 725 6,712 -2,244 -1,595 38 2,910 0 2,910 -495 -12 2,404 2,404 Ordinary equity HSBC ordinary equity Customer loans Debt securities holdings Customer deposits Interest earning assets Total assets Capital (%) 21,344 21,344 115,144 33,239 135,687 161,920 170,421 22,717 22,717 119,464 23,471 132,973 162,675 168,531 24,033 24,033 121,219 24,914 135,632 163,832 172,506 25,430 25,430 123,556 26,449 138,345 167,255 176,616 RWA (SARm) Core tier 1 Total tier 1 Total capital 156,480 13.6 13.6 15.5 162,350 14.4 14.4 16.2 164,735 15.0 15.0 16.8 167,911 15.6 15.6 17.3 Year to PE* Pre-provision multiple P/NAV Dividend yield (%) 12/2015a 12/2016e 12/2017e 12/2018e 8.2 5.6 1.0 4.9 8.6 5.4 0.9 4.9 9.0 4.8 0.8 4.7 8.5 4.6 0.8 5.0 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 20.35 18.00 1080.SE ARNB AB 5,418 Free float Sector Country Analyst Contact 34% Commercial Banks Saudi Arabia Aybek Islamov +9714 423 6921 Price relative 36.00 36.00 31.00 31.00 26.00 26.00 21.00 21.00 16.00 16.00 11.00 2015 Arab National Bank 11.00 2016 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Ratio, growth & per share analysis Year to Note: Priced at close of 02 Feb 2017 12/2015a 12/2016e 12/2017e 12/2018e 6.4 6.5 6.4 3.7 3.7 0.0 6.4 3.1 0.4 4.8 -4.3 -4.3 0.1 6.4 6.7 -1.2 11.5 -4.1 -4.1 -4.1 5.8 4.1 0.9 5.7 6.1 6.1 6.1 5.8 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) Per share data (SAR) 38.3 0.6 84.9 1.0 0.8 1.8 0.2 224.6 11.9 37.3 0.8 89.8 1.0 0.8 1.8 0.4 231.9 10.7 34.5 1.3 89.4 2.0 1.5 2.0 0.7 130.7 9.7 33.4 1.3 89.3 2.4 1.8 2.1 0.7 117.1 9.7 EPS reported (diluted) HSBC EPS (diluted) DPS NAV NAV (including goodwill) 2.47 2.47 1.00 21.34 21.34 2.36 2.36 1.00 22.72 22.72 2.26 2.26 0.96 24.03 24.03 2.40 2.40 1.02 25.43 25.43 Y-on-y % change Total income Operating expense Pre-provision profit EPS HSBC EPS DPS NAV (including goodwill) Ratios (%) 35 EQUITIES ● SAUDI ARABIA February 2017 Banque Saudi Fransi Aybek Islamov*, CFA Analyst HSBC Middle East Ltd [email protected] +971 4423 6921 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations BSFR AB, Hold, TP SAR28.0 Company description Banque Saudi Fransi established in 1977 is among the top 5 banks in Saudi Arabian banking sector by loan market share. It controls 9% of the total assets and loans, 10% of total deposits as of December’16. 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. Investment thesis We estimate BSF to have lowest high risk loans in our coverage. We are more concerned with loans that are not directly linked to government payments. Loans to transportation, manufacturing, utilities are some of the examples. We group them as higher risk loans. We estimate BSF to have the lowest peak NPL ratio of 6.6% among Saudi banks we cover. For more details, please refer to our sector report, "Saudi banks: Asset quality: what's priced in and what's not" published on 6th September 2016. We like the conservative 2012-16 loan CAGR of 6%, which should translate into lower loan defaults going forward, in our view. We forecast loan CAGR of 0% during 2016-18e. Valuation. BSF trades at 8.3x/0.9x 2017e EPS/BVPS. We estimate 2015-17e EPS CAGR of -1%. We downgraded BSF to Hold from Buy on valuation in our sector report Saudi Banks: Selective downgrade on valuation published on 29th November 2016. Financials We forecast BSF to report earnings of SAR3.6bn (before zakat) in 2017, a decrease of 4% over 2016e. We estimate NII growth of 6% in 2017e as we expect NIMs to remain stable in 2017e. However, we expect bad asset charges to increase 151% y-o-y in 2017e as we expect pressure on asset quality to continue in 2017e. We look for better control on operating costs due to lower revenue and forecast operating expenses to remain flat y-o-y in 2017e. We estimate pre-provision income growth of 4% for 2017e and 8% in 2018e. Valuation We derive our fair value target price for BSF using a residual income methodology, which comprises three stages. For Saudi banks, we use an inflation differential model to calculate the cost of equity. To this end, we assume the cost of equity to be the sum of the US risk-free rate (2.5%), and the inflation differential between the country and the US (3.1%) plus the equity risk premium (4.5%) multiplied by the stock beta of 1.0. We use a cost of equity of 10.1% for BSF. We have a target price of SAR28.0 for BSF. Our target price implies 12.6% upside from the current levels. We have a Hold rating on the stock as we believe the potential asset quality deterioration is not fully discounted in current valuations. 36 EQUITIES ● SAUDI ARABIA February 2017 Risks Downside risks to book value include if construction-linked loans become impaired. Higherthan-expected funding cost is another downside risk. Upside risks include better-than-expected asset spreads leading to higher-than-expected net interest income growth. 37 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Banque Saudi Fransi Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e 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 and others Attributable profit HSBC attributable profit Balance sheet summary (SARm) Hold 4,055 1,328 376 532 6,291 -2,093 -181 19 4,036 0 4,036 -346 0 3,690 3,690 4,378 1,367 195 537 6,477 -2,165 -248 29 4,093 0 4,093 -351 0 3,742 3,742 4,645 1,445 60 494 6,644 -2,170 -557 8 3,924 0 3,924 -314 0 3,610 3,610 5,001 1,546 0 508 7,055 -2,218 -822 8 4,023 0 4,023 -322 0 3,701 3,701 Ordinary equity HSBC ordinary equity Customer loans Debt securities holdings Customer deposits Interest earning assets Total assets Capital (%) 26,756 26,756 123,443 28,321 141,751 179,570 183,724 29,352 29,352 133,019 24,325 146,004 184,831 196,288 31,864 31,864 131,785 25,153 146,004 194,215 198,799 34,438 34,438 132,847 28,565 147,464 198,385 202,834 RWA (SARm) Core tier 1 Total tier 1 Total capital 186,855 15.0 15.0 17.2 201,223 14.6 14.6 16.6 199,683 16.0 16.0 18.0 201,478 17.1 17.1 19.1 Year to PE* Pre-provision multiple P/NAV Dividend yield (%) 12/2015a 12/2016e 12/2017e 12/2018e 8.7 9.9 8.2 14.9 14.9 9.9 3.7 3.0 3.5 2.7 1.4 1.4 9.5 9.7 2.6 0.2 3.8 -3.5 -3.5 -4.1 8.6 6.2 2.2 8.1 2.5 2.5 2.5 8.1 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) Per share data (SAR) 33.3 0.2 87.1 0.9 0.6 1.3 -0.1 207.0 14.0 33.4 0.2 91.1 1.0 0.7 1.1 -0.2 157.5 13.3 32.7 0.4 90.3 1.3 0.9 1.1 -0.3 120.5 11.8 31.4 0.6 90.1 1.3 0.9 1.1 -0.3 128.0 11.2 EPS reported (diluted) HSBC EPS (diluted) DPS NAV NAV (including goodwill) 3.06 3.06 0.87 22.20 22.20 3.10 3.10 0.95 24.35 24.35 3.00 3.00 0.91 26.43 26.43 3.07 3.07 0.93 28.57 28.57 Y-on-y % change Total income Operating expense Pre-provision profit EPS HSBC EPS DPS NAV (including goodwill) Ratios (%) 38 12/2017e 12/2018e 8.0 7.0 1.0 3.8 8.3 6.7 0.9 3.7 8.1 6.2 0.9 3.8 Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 24.87 28.00 1050.SE BSFR AB 8,170 Free float Sector Country Analyst Contact 40% Commercial Banks Saudi Arabia Aybek Islamov +9714 423 6921 Price relative 41.00 41.00 36.00 36.00 31.00 31.00 26.00 26.00 21.00 21.00 16.00 2015 Banque Saudi Fransi Source: HSBC Year to 12/2016e 8.1 7.1 1.1 3.5 * Based on HSBC EPS (diluted) Note: Priced at close of 02 Feb 2017 Ratio, growth & per share analysis 12/2015a 16.00 2016 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 National Commercial Bank Aybek Islamov*, CFA Analyst HSBC Middle East Ltd [email protected] +971 4423 6921 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations NCB AB, Reduce, TP SAR34.0 Company description NCB was formed in 1953 as a result of the merger between two of Saudi Arabia’s largest currency houses, Saleh and Abdulaziz Kaki and the Salem bin Mahfouz Company. NCB was the first officially-recognised Saudi bank. In 1999, the shares of the bank were divided between two government institutions, the Public Investment Fund (PIF) and the General Organization for Social Insurance. NCB Group provides both conventional and Shari-ah compliant banking services to its customers. NCB has 18% market share in loans and 20% in deposits. NCB has international operations, of which the Turkish bank comprises the major part. NCB Group has branch presences in Lebanon and Bahrain in addition to representative offices in Singapore and South Korea. Investment thesis Steep increase in US 10-year bond yields creates interest rate risk for NCB. US 10-year bond yields increased by c50bps to c2.4% post the presidential election outcome on 8 November. A sudden, unexpected spike in 10-year yields could increase unrealised losses on AFS securities, especially if left largely unhedged. A potential trigger to unwind such losses is a further drawdown of deposits once USD17.5bn of October Sovereign bond proceeds are fully deployed. Under such a scenario, NCB may need to sell AFS securities and will need to book m-t-m losses in their income statement. We estimate NCB would be the most negatively affected bank with negative m-t-m impact of c21bps of average assets. Cut in public sector income creates downside risks to retail deposit growth. Similar to Alrajhi and Alinma, the share of retail liabilities increased significantly at NCB during Q2 13-Q3 16. The share of retail loans at NCB stands at 34% as of Q3 16, higher than the 27% on average for the other Saudi banks we cover. A cut in public sector income clearly creates downside risks to retail sector deposit and loan growth. We forecast a slowdown in loan growth to continue in 2017e-18e and forecast loan growth of 1-2%. Similarly, we expect deposit growth of just 1% in 2017e-18e after declining by 3% each in 2015-16. Valuation. NCB trades at 11.4x/1.5x 2017e EPS/BVPS which is a 8% premium to Saudi banks we cover on a one year forward PB basis. We estimate 2015-17e EPS CAGR of -2%. Financials We forecast NCB to report earnings of SAR8.58bn (before zakat) in 2017, a decrease of 5% over 2016e. We estimate NII growth of 6% in 2017e as we expect NIMs to remain stable in 2017e. However, we expect bad asset charges to increase 151% y-o-y in 2017e as we expect pressure on asset quality to continue in 2017e. We look for better control on operating costs due to lower revenue and forecast operating expenses to remain flat y-o-y in 2017e. We estimate pre-provision income growth of 4% for 2017e and 8% in 2018e. 39 EQUITIES ● SAUDI ARABIA February 2017 Valuation We derive our fair value target price for NCB using a residual income methodology, which comprises three stages. For Saudi banks, we use an inflation differential model to calculate the cost of equity. To this end, we assume the cost of equity to be the sum of the US risk-free rate (2.5%), and the inflation differential between the country and the US (3.1%) plus the equity risk premium (4.5%) multiplied by the stock beta of 1.0. We use a cost of equity of 10.1% for NCB. We have a target price of SAR34.0 for NCB. Our target price implies 20.4% downside from the current levels. We have a Reduce rating on the stock as we believe the potential asset quality deterioration is not fully discounted in current valuations. Risks Upside risks include better than expected asset quality leading to lower bad asset charges. 40 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: National Commercial Bank Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e 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 and others Attributable profit HSBC attributable profit Balance sheet summary (SARm) Reduce 12,778 3,336 478 893 17,486 -6,546 -1,600 -191 9,148 0 9,148 -1,265 -59 7,824 7,824 13,697 3,392 713 849 18,651 -7,045 -2,355 -200 9,051 0 9,051 -1,086 -81 7,883 7,883 13,800 3,553 342 829 18,523 -7,118 -2,773 -52 8,582 0 8,582 -1,030 -77 7,475 7,475 13,972 3,723 227 841 18,762 -7,118 -3,251 -53 8,339 0 8,339 -1,001 -75 7,263 7,263 Ordinary equity HSBC ordinary equity Customer loans Debt securities holdings Customer deposits Interest earning assets Total assets Capital (%) 48,462 48,462 252,940 134,102 323,460 409,387 449,340 53,449 53,449 261,341 110,353 313,756 410,100 444,372 58,178 58,178 264,563 117,753 316,893 410,620 455,132 62,773 62,773 270,115 124,722 320,062 424,039 465,916 RWA (SARm) Core tier 1 Total tier 1 Total capital 365,154 15.1 15.1 17.2 361,464 15.1 15.1 17.2 381,846 15.5 15.5 17.5 410,291 15.6 15.6 17.5 Year to PE* Pre-provision multiple P/NAV Dividend yield (%) 12/2015a 12/2016e 12/2017e 12/2018e 10.9 7.8 1.8 3.6 10.8 7.3 1.6 3.4 11.4 7.5 1.5 3.2 11.7 7.3 1.4 3.1 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 42.70 34.00 1180.SE NCB AB 20,995 Free float Sector Country Analyst Contact 34% Commercial Banks Saudi Arabia Aybek Islamov +9714 423 6921 Price relative 77.00 77.00 67.00 67.00 57.00 57.00 47.00 47.00 37.00 37.00 27.00 2015 27.00 2016 National Commercial Bank 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Ratio, growth & per share analysis Year to Note: Priced at close of 02 Feb 2017 12/2015a 12/2016e 12/2017e 12/2018e 7.6 3.3 10.4 2.7 2.7 6.9 7.1 6.7 7.6 6.1 0.8 0.8 -6.3 10.3 -0.7 1.0 -1.7 -5.2 -5.2 -5.2 8.8 1.3 0.0 2.1 -2.8 -2.8 -2.8 7.9 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) Per share data (SAR) 37.4 0.7 78.2 1.4 1.0 1.5 0.4 151.1 16.9 37.8 0.9 83.3 1.7 1.2 1.8 0.4 148.5 15.6 38.4 1.1 83.5 2.6 1.8 2.2 0.3 117.7 13.5 37.9 1.2 84.4 3.4 2.3 2.5 0.3 108.4 12.1 EPS reported (diluted) HSBC EPS (diluted) DPS NAV NAV (including goodwill) 3.92 3.92 1.55 24.06 24.30 3.95 3.95 1.45 26.56 26.80 3.75 3.75 1.38 28.93 29.17 3.64 3.64 1.34 31.24 31.47 Y-on-y % change Total income Operating expense Pre-provision profit EPS HSBC EPS DPS NAV (including goodwill) Ratios (%) 41 EQUITIES ● SAUDI ARABIA February 2017 Riyad Bank Aybek Islamov*, CFA Analyst HSBC Middle East Ltd [email protected] +971 4423 6921 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations RIBL AB, Hold, TP SAR10.90 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 10% in total asset, loans and deposits as of December 2016. 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 75% of the total loan book end of Q3 2016. In December 2013, SAMA issued the first license for real estate financing and lease financing to Riyad Bank. Investment thesis Low demand deposit ratio leaves bank vulnerable to funding cost increases. Riyad Bank has the lowest demand deposit ratio (c43%) amongst banks we cover. Lower share of demand deposits leaves the bank vulnerable to increasing cost of term deposit funding. Riyad Bank reported NII growth of just 2% in 2016 significantly lower than the 8% average for Saudi banks we cover. We expect pressure on funding cost to continue and forecast cost of funds to increase by c38bps to 1.5% in 2017e. We see limited impact of cut in public sector income. The share of retail liabilities, at c37%, is the lowest amongst Saudi banks we cover. The share of retail loans is also low at c25%. Therefore we see limited downside risks to loan and deposit growth due to cut in public sector income. We forecast loans to remain flat y-o-y and deposit growth of just 1% in 2017e. Valuation. Riyad Bank trades at 9.3x/0.9x 2017e EPS/BVPS. We estimate 2015-17e EPS CAGR of -3%. Financials We forecast Riyad Bank to report earnings of SAR3.78bn (before zakat) in 2017, flat y-o-y. We estimate NII growth of 7% in 2017e as forecast NIMs to increase by 15bps in 2017e. Similar to other Saudi banks, we expect pressure on asset quality and forecast bad asset charges to increase 27% y-o-y in 2017. We look for better control on operating costs due to lower revenue and forecast operating expenses to decline by 2% y-o-y in 2017e. We estimate pre-provision income growth of 5% for 2017e and 3% in 2018e. Valuation We derive our fair value target price for Riyad Bank using a residual income methodology, which comprises three stages. For Saudi banks, we use an inflation differential model to calculate the cost of equity. To this end, we assume the cost of equity to be the sum of the US risk-free rate (2.5%), and the inflation differential between the country and the US (3.1%) plus the equity risk premium (4.5%) multiplied by the stock beta of 1.0. We use a cost of equity of 10.1% for Riyad. 42 EQUITIES ● SAUDI ARABIA February 2017 We have a target price of SAR10.9 for Riyad Bank. Our target price implies 0.9% downside from the current levels and therefore we have Hold rating on the stock. Risks Upside risks include better-than-expected corporate asset quality leading to lower cost of risk. Downside risks include lower-than-expected NIM due to higher funding costs. 43 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Riyad Bank Hold Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e 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 and others Attributable profit HSBC attributable profit Balance sheet summary (SARm) 5,183 1,786 34 986 7,989 -2,927 -1,031 18 4,049 0 4,049 -250 0 3,799 3,799 5,278 1,521 30 965 7,794 -2,989 -928 -76 3,801 0 3,801 -235 0 3,566 3,566 5,668 1,553 20 760 8,001 -2,943 -1,322 48 3,784 0 3,784 -234 0 3,550 3,550 5,857 1,652 0 688 8,197 -2,971 -1,705 53 3,574 0 3,574 -221 0 3,354 3,354 Ordinary equity HSBC ordinary equity Customer loans Debt securities holdings Customer deposits Interest earning assets Total assets Capital (%) 35,245 35,245 144,674 44,552 167,090 214,375 223,316 36,721 36,721 153,769 44,396 162,077 219,866 224,798 38,190 38,190 154,054 46,037 163,698 222,175 227,955 38,863 38,863 155,114 46,848 165,335 224,824 230,332 RWA (SARm) Core tier 1 Total tier 1 Total capital 226,012 16.2 16.2 18.4 235,052 16.2 16.2 18.3 235,488 16.8 16.8 18.9 237,108 16.9 16.9 19.1 Year to PE* Pre-provision multiple P/NAV Dividend yield (%) Year to 12/2016e 12/2017e 12/2018e -0.3 4.3 -2.8 -8.5 -8.5 -4.1 2.8 -2.4 2.1 -5.1 -6.1 -6.1 -0.5 4.2 2.7 -1.5 5.3 -0.4 -0.4 -0.4 4.0 2.5 0.9 3.3 -5.5 -5.5 28.8 1.8 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) Per share data (SAR) 36.6 0.7 86.6 0.9 0.6 0.8 0.7 143.7 10.9 38.3 0.6 94.9 0.8 0.5 0.9 0.3 160.2 9.9 36.8 0.9 94.1 1.2 0.8 0.8 0.7 96.6 9.5 36.2 1.1 93.8 1.5 1.0 1.0 0.5 106.2 8.7 EPS reported (diluted) HSBC EPS (diluted) DPS NAV NAV (including goodwill) 1.27 1.27 0.70 11.75 11.75 1.19 1.19 0.70 12.24 12.24 1.18 1.18 0.69 12.73 12.73 1.12 1.12 0.89 12.95 12.95 Y-on-y % change Total income Operating expense Pre-provision profit EPS HSBC EPS DPS NAV (including goodwill) Ratios (%) 44 12/2017e 12/2018e 9.3 6.9 0.9 6.3 9.3 6.5 0.9 6.3 9.8 6.3 0.8 8.1 Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 11.00 10.90 1010.SE RIBL AB 8,767 Free float Sector Country Analyst Contact 31% Commercial Banks Saudi Arabia Aybek Islamov +9714 423 6921 Price relative 19.30 19.30 17.30 17.30 15.30 15.30 13.30 13.30 11.30 11.30 9.30 9.30 7.30 2015 7.30 2016 Riyad Bank Note: Priced at close of 02 Feb 2017 12/2015a 12/2016e 8.7 6.5 0.9 6.4 * Based on HSBC EPS (diluted) Source: HSBC Ratio, growth & per share analysis 12/2015a 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 SAMBA Aybek Islamov*, CFA Analyst HSBC Middle East Ltd [email protected] +971 4423 6921 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations SAMBA AB, Hold, TP SAR23.00 Company description Samba was established in 1980 and was branded the Saudi American bank until 2003. Samba is primarily a corporate bank. As of December 2015, Samba had a network of 72 branches. Samba has 9% market share in loans & 11% in deposits in Saudi Arabia as of the end of December 2016. 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 thennamed Crescent Commercial Bank, now known as Samba Bank Limited Pakistan. Investment thesis Higher US bond yields pose interest rate risk to investment portfolios. Similar to NCB, we estimate an increase in unrealised losses on AFS securities for Samba. We estimate negative m-t-m impact of c20bps of average assets assuming they are not hedging their interest rate risk. We believe there could be downside risks if US bond yields stay elevated for the next 12 months or there is any potential delay in Saudi government plans to issue further sovereign bonds due to increased US bond yields. Liquid balance sheet is a competitive advantage for Samba. Samba continues to maintain a very liquid balance sheet with loan to deposit ratio of 73% as at Q4 16. This forms a main competitive advantage, in our view, at a time when funding costs are rising. Samba has room to let go expensive deposits if necessary in order to defend its ROE. We forecast funding cost to increase by c40bps in 2017e and remain flat in 2018e. Valuation. Samba trades at 10.1x/1.0x 2017e EPS/BVPS. We estimate 2015-17e EPS CAGR of -2%. Financials We forecast Samba to report earnings of SAR4.96bn (before zakat) in 2017e, a decrease of 4% over 2016e. We estimate NII growth of 7% in 2017e as forecast NIMs to increase by 22bps in 2017e. We forecast cost of risk to increase to c80bps in 2017e and 2018e from a low base of c30bps in 2016e. We look for better control on operating costs due to lower revenue and forecast operating expenses to remain flat y-o-y in 2017e. We estimate pre-provision income growth of 7% for 2017e but decline by 2% in 2018e. Valuation We derive our fair value target price for Samba using a residual income methodology, which comprises three stages. For Saudi banks, we use an inflation differential model to calculate the cost of equity. To this end, we assume the cost of equity to be the sum of the US risk-free rate (2.5%), 45 EQUITIES ● SAUDI ARABIA February 2017 and the inflation differential between the country and the US (3.1%) plus the equity risk premium (4.5%) multiplied by the stock beta of 1.0. We use a cost of equity of 10.1% for Samba. We have a target price of SAR23.0 for Samba. Our target price implies 2.4% upside from the current levels and therefore we have Hold rating on the stock. Risks Downside risks include higher than expected increase in cost of risk in 2017 from a very low base of 2015 and 2016; and higher than expected funding costs leading to lower NIMs. Upside risks include higher-than-expected corporate spreads leading to better than expected NIMs. 46 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Samba Financial Group Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e 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 and others Attributable profit HSBC attributable profit Balance sheet summary (SARm) 4,663 1,683 106 1,302 7,755 -2,398 -142 0 5,214 0 5,214 -550 -2 4,662 4,662 5,519 1,537 100 885 8,041 -2,464 -398 0 5,179 0 5,179 -518 -2 4,659 4,659 5,906 1,634 90 835 8,465 -2,473 -1,028 0 4,964 0 4,964 -496 -2 4,466 4,466 5,909 1,744 10 741 8,404 -2,509 -1,061 0 4,834 0 4,834 -483 -2 4,349 4,349 Ordinary equity HSBC ordinary equity Customer loans Debt securities holdings Customer deposits Interest earning assets Total assets Capital (%) 39,117 39,117 129,819 69,705 171,396 216,417 235,243 42,006 42,006 129,116 55,992 174,824 226,569 240,955 44,775 44,775 126,793 59,046 169,579 222,017 240,582 46,950 46,950 129,230 61,540 171,275 219,143 246,751 RWA (SARm) Core tier 1 Total tier 1 Total capital 206,643 19.5 19.5 20.1 208,676 20.2 20.2 20.8 204,921 21.9 21.9 22.5 208,860 22.5 22.5 23.1 Year to PE* Pre-provision multiple P/NAV Dividend yield (%) 12/2015a 12/2016e 12/2017e 12/2018e 9.6 8.4 1.1 4.0 9.6 8.1 1.1 3.9 10.1 7.5 1.0 3.8 10.3 7.6 1.0 4.8 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 22.45 23.00 1090.SE SAMBA AB 11,881 Free float Sector Country Analyst Contact 51% Commercial Banks Saudi Arabia Aybek Islamov +9714 423 6921 Price relative 29.00 29.00 24.00 24.00 19.00 19.00 14.00 2015 14.00 2016 Samba Financial Group 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 Ratio, growth & per share analysis Year to Hold 12/2015a 12/2016e 12/2017e 12/2018e 5.0 7.4 4.0 6.7 6.7 11.0 4.1 3.7 2.8 4.1 -0.1 -0.1 -0.7 7.4 5.3 0.3 7.4 -4.1 -4.1 -4.1 6.6 -0.7 1.5 -1.6 -2.6 -2.6 28.1 4.9 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) Per share data (SAR) 30.9 0.1 75.7 0.8 0.5 1.0 0.3 181.2 12.2 30.6 0.3 73.9 1.0 0.6 1.0 0.2 154.1 11.5 29.2 0.8 74.8 1.7 1.1 1.4 0.2 125.6 10.3 29.8 0.8 75.5 2.2 1.4 1.7 0.2 123.4 9.5 EPS reported (diluted) HSBC EPS (diluted) DPS NAV NAV (including goodwill) 2.33 2.33 0.89 19.56 19.56 2.33 2.33 0.89 21.00 21.00 2.23 2.23 0.85 22.39 22.39 2.17 2.17 1.09 23.48 23.48 Y-on-y % change Total income Operating expense Pre-provision profit EPS HSBC EPS DPS NAV (including goodwill) Ratios (%) 47 EQUITIES ● SAUDI ARABIA February 2017 This page has been left blank intentionally 48 EQUITIES ● SAUDI ARABIA February 2017 Chemicals 49 EQUITIES ● SAUDI ARABIA February 2017 Chemicals Rising oil prices, comfort on feedstock pricing and improved sentiment all contributed to a strong sector performance in 2016 However, from this point onwards, we see limited value and little room for upside earnings surprises; spot product prices and oil are mostly in line with our estimates Preferred names are Sipchem on the back of strong methanol prices and SIIG due to the valuation discount vs its peers Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East [email protected] +971 4423 6924 Prateek Bhatnagar*, CFA Analyst HSBC Securities and Capital Markets (India) Pvt. Limited [email protected] +91 80 4555 2757 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations A cautious tone for 2017 The Saudi petrochemical industry was established in the 1970’s specifically to add value to cheap associated gas created by the nation’s upstream oil production, and diversify the industrial base away from oil. While Saudi chemical production grew steadily through the ‘80’s and the ‘90’s it was the move higher in global energy prices in early 2000’s that significantly raised the cost advantage enjoyed by the Saudi industry and led to torrid growth through a wave of capacity expansions. Over the last decade, the Middle East, and in particular Saudi Arabia, have 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 2000-15. However, from this point onwards, the industry faces a whole new set of challenges, with gas availability constraining new investment, new competitive challenges in the form of US shale and pressure on advantaged economics as gas prices are raised in a push to cut subsidies. While the challenges are formidable, the Saudi industry does still have excellent competitive positioning, strong cash generation and very healthy balance sheets. We enter 2017 on a more cautious note than we had in 2016. In our annual preview last year, MENA Chemicals: Oil woes, clear value January 2016, we argued that despite weakness in oil prices, uncertainty about the impact of feedstock price increases and near-term earnings volatility, there were clear fundamental value and supportive dividend yields. Since that point, oil has rallied c50%, uncertainty about feedstock pricing has been removed with the government indicating that feedstock prices will not be raised until 2020 and earnings have beaten expectations – all of which has contributed to the Saudi chemical index rallying c56% over that period. Now, when we look at the sector, particularly in light of recent performance and our expectations for product prices and oil through 2017, we see limited pockets of value. Most products have spot prices that are broadly in line with our forecasts for 2017 and we see limited room for material earnings upside, unless oil were to rally further. 50 EQUITIES ● SAUDI ARABIA February 2017 Saudi petrochemicals sector performance (indexed) Ethylene price and spreads (USD/t) 140 1300 130 1200 120 1100 800 1000 110 600 900 100 400 800 90 700 80 70 Jan-16 Apr-16 Saudi Market Global Chemicals 1000 200 600 Jul-16 Oct-16 Jan-17 Saudi Petrochemicals Source: Thomson Reuters DataStream, HSBC 500 Jan-16 Apr-16 Jul-16 Ethylene price Oct-16 0 Jan-17 Ethylene Naphtha spread (RHS) Source: Thomson Reuters DataStream Saudi Chemicals 12-month forward PE valuation 20.0x 18.0x 16.0x 14.0x 12.0x 10.0x 8.0x 6.0x Jan-10 Aug-10 Mar-11 Oct-11 May-12 Dec-12 Jul-13 Feb-14 Sep-14 Apr-15 Nov-15 Jun-16 Jan-17 Source: Thomson Reuters DataStream, Eurostat Valuations have also caught up to improved fundamentals and higher oil prices. While the median yield for the CEEMEA sector at the start of 2016 was 7.1%, that is now 4.3%. One year fwd P/E’s which were 9.6x at the start of 2016 are now 13.2x, which, given the commodity cyclical nature of the sector appears to us to represent close to full value. Chemicals price expectations for 2017 On average, our 2017 price estimates are broadly in line with spot prices. In other words we do not expect prices to rise in 2017 from current levels. Commodity chemicals outlook for 2017 Olefins: Shutdowns to spur ethylene tightness in H1’17, with c10% of Asian capacity shut from March-May. However, supply should ease in H2’17 as shutdowns normalise and new US capacity starts to come on-stream. We remain bearish on propylene and see limited upside to butadiene given poor affordability into synthetic rubber. MEG: Stronger demand, lower inventories and higher oil have taken MEG prices to higher levels in the past 18 months. With none of the new US crackers in 2017 adding any incremental MEG, we see MEG, on a relative basis, remaining undersupplied, particularly considering the lack of traction of coal-based MEG in China. 51 EQUITIES ● SAUDI ARABIA February 2017 Urea: Recent price increases reflect higher costs of Chinese anthracite coal prices, and the buying season in the Northern Hemisphere. We see no shift in medium-term fundamentals. Urea remains well supplied and after Q1’17, the urea market should return to the frail state that it was for the most part of 2016. Methanol: There are many factors attributable to the decline in methanol prices in 2016, additional US capacity, lower global gas prices, and limited demand from MTO units given challenged economics. However, the primary factor behind the low methanol price environment, was the low oil price. Methanol has fuel value and is strongly correlated to the price of oil. Post the rally in oil prices after the OPEC deal, methanol prices too have rallied, ending 2016 at USD360/ton, up c60% from their lows at the start of the year. Given the view of our Oil and Gas team that Brent will average USD60/bbl for the year, we expect the current methanol pricing environment to persist aided by higher Chinese coal prices. We are forecasting methanol prices of USD350/ton for 2017. TiO2: We remain constructive on the TiO2 market and see pricing as having troughed in early 2016 with some decent pricing momentum into 2017. TiO2 producers have announced four rounds of price increases in 2016, for a cumulative move of cUSD600/ton. Of this USD600/ton increase in prices though, only cUSD350/ton or so is as yet visible, with TiO2 contracts generally having price protection terms of 90 days on average. So, while TiO2 prices are off c20% from their lows in 2015, once all of the price increases take effect, we estimate 2017 TiO2 prices will be c35% higher than 2016 levels on average. 52 EQUITIES ● SAUDI ARABIA February 2017 Advanced Petrochemical Prateek Bhatnagar*, CFA Analyst HSBC Securities and Capital Markets (India) Pvt. Limited [email protected] +91 80 4555 2757 Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East [email protected] +971 4423 6924 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations APPC AB, Hold, TP SAR42.5 Company description APPC (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, the project started commercial operations in August 2008 and the plant was formally commissioned in November 2008. APPC 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. Its earnings have a high degree of correlation with the PP-propane spread. APPC also has a 30% stake in a Korean PHD JV with SK Gas (45%) and Kuwait’s Petrochemical Industries (25%) which has a production capacity of 600ktpa of propylene. Investment thesis Advanced Petrochemical (APPC) earns most of its profits from a single plant selling polypropylene with its feedstock price linked to Saudi propane. Due to this, earnings sensitivity to the plant operations and polypropylene prices is high. While APPC’s strong operational performance is a positive, we still have concerns about long-term propylene derivative pricing because of high US propane/propylene stocks and exports and significant propylene capacity additions in China. The stock trades at 12.8x 2017e EV/EVITDA, 5% premium to the sector. At the current price, the company valuation looks to be close to full value and we rate the stock Hold with a SAR42.5 target price. Financials APPC reported Q4 net income of SAR210m, up 11% q-o-q. The increase was primarily driven by the SAR25m gain through equity investment in SK Advanced (Korean PDH JV). Adjusted for that, the profit came in 2% below last quarter. The PP Saudi propane spread had decreased 4% q-o-q in Q4 2016. Valuation We use a DCF methodology to value APPC. Our cost of equity is 9.8% and includes a risk-free rate of 2.5%, 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 8.0%. This results in a fair value target price of SAR42.5. Our target price implies a downside of 9.4% and we have a Hold rating on the stock and not a Reduce as the contribution from Korean PDH may support earnings to some extent. 53 EQUITIES ● SAUDI ARABIA February 2017 Risks Upside risks 1. As most of APPC earnings come from a single PDH plant, its earnings are highly sensitive to the plant operational performance. Better than expected operating rate at the plant could be an upside risk 2. If the company is able to source more than contracted propylene from SATORP refinery then it will increase earnings Downside risks 1. APPC is highly leveraged to PP prices and any unexpected decrease in its price would have a negative impact on our estimates. 54 2. Crude oil prices remaining low, resulting in lower product prices 3. Lower earnings from Korean PDH JV EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Advanced Petro Chemical Financial statements Year to Valuation data 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 2,139 922 -215 707 -27 720 720 -12 708 708 2,136 743 -214 529 -26 505 505 -8 497 497 2,436 772 -220 552 -26 528 528 -8 520 520 2,449 772 -227 545 -26 521 521 -8 513 513 902 -107 -107 -533 -287 781 694 -111 -111 -590 -25 614 702 -114 -114 -590 -29 618 708 -117 -117 -590 -32 621 93 2,010 1,472 344 3,997 201 1,060 716 2,684 3,030 93 1,907 1,483 339 3,904 231 1,030 691 2,591 2,912 93 1,800 1,564 368 3,879 277 1,030 662 2,521 2,812 93 1,691 1,598 401 3,804 279 1,030 629 2,444 2,703 Year to 12/2016a 12/2017e 12/2016a 12/2017e 12/2018e 12/2019e 4.5 10.3 3.1 11.8 3.1 8.9 6.4 4.4 12.8 3.3 18.6 3.6 7.0 6.4 3.9 12.3 3.4 17.8 3.7 7.0 6.4 3.9 12.2 3.5 18.0 3.8 7.1 6.4 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 46.90 42.50 2330.SE APPC AB 2,461 62.00 57.00 52.00 47.00 42.00 37.00 32.00 27.00 22.00 2015 12/2018e 12/2019e 47% Chemicals Saudi Arabia Prateek Bhatnagar 62.00 57.00 52.00 47.00 42.00 37.00 32.00 27.00 22.00 2016 Advanced Petro Chemical Y-o-y % change Free float Sector Country Analyst Contact Price relative Ratio, growth and per share analysis Year to Hold 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) -10.0 -3.2 -4.8 1.0 -8.3 -0.2 -19.4 -25.2 -29.9 -36.6 14.1 3.9 4.3 4.5 4.5 0.5 0.0 -1.2 -1.2 -1.2 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) 0.7 22.5 27.3 18.6 43.1 33.1 34.8 26.7 0.8 126.0 0.7 17.5 18.9 13.2 34.8 24.8 28.8 26.7 0.9 100.5 0.9 19.0 20.3 14.0 31.7 22.6 30.0 26.3 0.9 106.0 0.9 19.5 20.7 14.0 31.5 22.3 30.0 25.7 0.8 112.6 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 3.99 3.99 3.00 15.11 2.53 2.53 3.00 13.17 2.64 2.64 3.00 12.81 2.61 2.61 3.00 12.42 55 EQUITIES ● SAUDI ARABIA February 2017 Methanol Chemicals Prateek Bhatnagar*, CFA Analyst HSBC Securities and Capital Markets (India) Pvt. Limited [email protected] +91 80 4555 2757 Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East [email protected] +971 4423 6924 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations CHEMANOL AB, Reduce, TP SAR6.25 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 plasticisers, 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) 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 Chemanol is able to take advantage of its methanol integration only when its plants operate at close to full capacity. However lately, the company has seen lower end market demand, meaning its plants have been working at lower than optimum rates, driving earnings lower. Given that higher Saudi feedstock gas prices are coming at a point of cyclically low methanol prices, we continue to expect weak earnings performance from Chemanol. We rate the stock Reduce. Financials Chemanol continued to post losses – SAR38m - in Q4 2016 vs SAR40m in the previous quarter. This is despite recording the final settlement of the insurance claim of SAR19m against the Para plant fire and methanol prices averaging USD288/t in Q4 2016, up 27% q-o-q. The company has been posting losses for 9 consecutive quarters now. Valuation We use a DCF methodology to value Chemanol. Our cost of equity for Chemanol is 9.0% and includes a risk-free rate of 2.5%, a market risk premium of 6% and a beta of 1.1. We use a 4% cost of debt assumption and a 30% debt weighting, which yields a WACC estimate of 7.4%. Our TP of SAR6.25 imply downside of 12.5% and we rate the stock Reduce and not Hold as we remain bearish on the end market demand of Chemanol’s products. Risks Upside risks: Methanol demand rises more than expected or the planned methanol capacity is delayed. This could result in better than expected methanol prices and therefore earnings from Chemanol. Higher than expected operating rates. 56 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Methanol Chemicals Co. Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 733 99 -177 -78 -30 -141 -141 2 -139 -139 607 72 -158 -86 -40 -98 -98 -3 -101 -101 800 253 -180 73 -40 62 62 -3 59 59 800 216 -181 35 -29 34 34 -2 32 32 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 108 -57 -56 0 -56 65 106 -80 -80 0 -46 -2 199 -82 -82 -54 -63 89 206 -84 -84 -54 -68 93 20 2,045 526 164 2,592 162 1,027 863 1,402 2,265 20 1,967 597 293 2,584 153 1,110 817 1,301 2,138 20 1,869 648 306 2,536 150 1,060 754 1,305 2,080 20 1,772 677 324 2,468 154 1,010 686 1,284 1,990 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital Reduce Year to 12/2015a 12/2016e 12/2017e 12/2018e 2.4 17.4 0.8 2.8 23.2 0.8 0.6 7.5 0.0 0.7 -0.3 0.0 2.0 6.4 0.8 14.6 0.7 10.3 6.3 1.9 7.2 0.8 26.5 0.7 10.9 6.3 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 7.14 6.25 2001.SE CHEMANOL AB 230 15.80 15.80 13.80 13.80 11.80 11.80 9.80 9.80 7.80 7.80 5.80 5.80 12/2016e 12/2017e 12/2018e Y-o-y % change Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 3.80 2016 Methanol Chemicals Co. Ratio, growth and per share analysis 12/2015a 60% Chemicals Saudi Arabia Prateek Bhatnagar Price relative 3.80 2015 Year to Free float Sector Country Analyst Contact 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 -17.1 -58.9 -209.1 -587.8 -532.8 -17.3 -27.0 31.9 250.5 0.0 -14.8 -52.4 -45.0 -45.0 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) 0.3 -3.2 -9.5 -4.2 13.5 -10.6 3.4 61.6 8.7 12.5 0.3 -4.0 -7.5 -2.3 11.9 -14.2 1.8 62.8 11.3 13.0 0.4 3.3 4.5 3.8 31.7 9.2 6.4 57.8 3.0 26.4 0.4 1.6 2.5 2.4 27.0 4.4 7.4 53.5 3.2 30.0 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value -1.16 -1.16 0.00 11.62 -0.84 -0.84 0.00 10.79 0.49 0.49 0.45 10.83 0.27 0.27 0.45 10.64 57 EQUITIES ● SAUDI ARABIA February 2017 Petro Rabigh Prateek Bhatnagar*, CFA Analyst HSBC Securities and Capital Markets (India) Pvt. Limited [email protected] +91 80 4555 2757 Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East [email protected] +971 4423 6924 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations PETROR AB, Buy, TP SAR15 Company description PetroRabigh was commissioned initially as a 325Mbbl/d basic topping refinery in 1989 and its capacity was expanded to 400Mbbl/d in 1998. It gets crude from Aramco and most of its refined products are sold domestically in Saudi Arabia but it gets Asian netback prices for them. 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 January 2008, 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 upgrade project was undertaken in order to increase the complexity of the existing refinery as well as to integrate it into a brand new world scale petrochemical complex. The refining capacity was 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. For PetroRabigh, naphtha accounts for 18% of its refining output, while fuel oil accounts for 22% of the output. These products are oversupplied and therefore have negative margins. If 40% of your product slate as a refinery loses USD5-6/bbl on average, it makes it difficult for the refinery overall to be profitable – which has been the primary challenge at Rabigh. In order to address this issue and increase profitability of the company, PetroRabigh announced in May 2014 that it wished to merge the second phase of the PetroRabigh project (Rabigh 2) that is currently under construction into the listed entity PetroRabigh. The centrepiece of Rabigh 2 is a 1.7mntpa aromatics complex that will use almost all of the existing naphtha production (c3mntpa). Investment thesis The ethane cracker expansion for Rabigh 2 was completed in March 2016, increasing the company’s ethane processing capacity by 30 mscdf (400ktpa). Growth driven by Rabigh 2 expansion has been central to our Buy investment case. We expect continuing positive news flow around Rabigh 2 and better operating performance from Rabigh 1 over the next 12-18 months to drive further share price outperformance. We think the market is putting undue emphasis on the initial start-up issues in the Ethane cracker and ignoring its long-term profit potential. Financials Petro Rabigh Q4 2016 net income came in at SAR183m as compared to a loss of SAR217m in the previous quarter. According to the company, higher feedstock (inventory revaluation) helped in earnings. Q4 2016 ended with oil at USD57/bbl as compared to USD49/bbl in Q3 2016. Refining margins helped as well with them being at USD6.74/bbl up 32% q-o-q. Rabigh Q4 sales were SAR7,488m, up 17% q-o-q. 58 EQUITIES ● SAUDI ARABIA February 2017 Valuation We use a DCF methodology to value PetroRabigh. Our cost of equity is 9.1%, comprising a risk free rate of 2.5%, 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 of 7.9%. This yields a DCF value of SAR11 per share for standalone Rabigh 1. Rabigh 2 is being executed at the list co (Petro Rabigh) level and we incorporate the value of Rabigh 2 into our estimates. Our NPV for the project is SAR5 per share, to which we apply a 20% discount to account for project delay and execution risks. We therefore add a SAR4 per share value for Rabigh 2 to our SAR11 DCF value for standalone Rabigh 1. This yields a fair value target price of SAR15, implying upside of 25.5% and we rate the stock Buy. Risks Key downside risks: Continued operational issues at its newly commissioned ethane cracker. Refining margins have been firm in H2 2016 on better demand and we expect them to remain strong. Any weakness in refining margins will present a downside risk. Any increase in marketing fees charged by Rabigh’s parent companies – Aramco and Sumitomo. 59 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Rabigh Refining And Petro Financial statements Year to Buy Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 25,514 1,413 -2,173 -760 -282 -759 -759 0 -759 -759 24,779 2,661 -2,375 286 -387 240 240 0 240 240 33,883 3,783 -2,583 1,201 -308 1,252 1,252 0 1,252 1,252 40,571 3,429 -2,347 1,083 -289 1,170 1,170 0 1,170 1,170 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 2,685 -18,130 -20,521 -438 18,282 -16,747 1,761 -1,080 -1,080 -438 -115 340 3,791 -1,101 -1,101 -657 -2,033 2,331 3,645 -1,123 -1,123 -657 -1,864 2,145 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 267 41,009 5,700 2,303 51,341 5,133 37,681 35,378 8,351 39,541 267 39,842 7,897 3,228 52,371 5,550 38,491 35,263 8,154 39,228 267 38,361 9,253 3,071 52,246 7,020 36,301 33,230 8,749 37,790 267 37,137 10,107 2,745 51,877 8,328 34,111 31,366 9,262 36,439 Year to 12/2015a 12/2016e 12/2017e 12/2018e 1.8 32.4 1.2 1.8 17.2 1.2 43.6 1.3 3.3 4.2 1.3 11.5 1.2 8.4 1.2 22.3 6.3 1.0 12.2 1.1 8.9 1.1 20.5 6.3 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) 1.3 -160.2 4.2 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 11.95 15.00 2380.SE PETROR AB 2,791 25.20 25.20 20.20 20.20 15.20 15.20 10.20 10.20 12/2016e 12/2017e 12/2018e Y-o-y % change Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) -53.0 -53.1 -203.6 -211.3 -211.3 -2.9 88.3 36.7 42.2 319.9 421.0 421.0 19.7 -9.4 -9.9 -6.5 -6.5 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) 0.8 -2.4 -8.5 -1.6 5.5 -3.0 5.0 423.6 25.0 7.6 0.6 0.7 2.9 0.5 10.7 1.2 6.9 432.5 13.3 5.0 0.9 3.1 14.8 2.4 11.2 3.5 12.3 379.8 8.8 11.4 1.1 2.9 13.0 2.2 8.5 2.7 11.9 338.7 9.1 11.6 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value -0.87 -0.87 0.50 9.53 0.27 0.27 0.50 9.31 1.43 1.43 0.75 9.99 1.34 1.34 0.75 10.57 60 5.20 2016 Rabigh Refining And Petro Ratio, growth and per share analysis 12/2015a 25% Oil & Gas Saudi Arabia Prateek Bhatnagar Price relative 5.20 2015 Year to Free float Sector Country Analyst Contact 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Petrochem Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East [email protected] +971 4423 6924 Prateek Bhatnagar*, CFA Analyst HSBC Securities and Capital Markets (India) Pvt. Limited [email protected] +91 80 4555 2757 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations PETROCH AB, Hold, TP SAR21 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), and 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. Investment thesis Petrochem’s SPC plant was shut in Q4 2016 because of a planned maintenance. However apart from that, the operational performance of the company has been very strong with more than 90% operating rates on an average in 9m 2016. However we believe that this is more than adequately reflected in the price with the share price rising more than 55% since Q4 2016, outperforming the market by 33%. The stock is currently trading at 9.6x EV/EBITDA, reflecting a c10% premium to the market. Most of Petrochem’s earnings come from its c1.2mntpa ethylene cracker. In the medium term, we remain bearish on ethylene chain due to the greenfield capacity coming online in US. We have a Hold rating on the stock. Financials Petrochem reported a loss of SAR127m in Q4 2017 vs a profit of SAR191m in Q3 2016. It was mainly due to a 60 day planned maintenance. Q4 sales were down 27% q-o-q to SAR1,163m. Valuation We use a DCF methodology to value Petrochem. Our cost of equity for Petrochem is 9.7% and includes a risk free rate of 2.5%, 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 7.9%. This yields a TP of SAR21 implying a downside of 0.2% and we therefore have a Hold rating for the company. Risks Upside risks: A sooner/higher than expected dividend announcement will reflect the confidence the management has on the company’s performance and may drive stock price. Better than expected industry operating rates and supply/demand fundamentals as all of Petrochem’s products are commodity products, whose earnings are inherently cyclical. Downside risks: As Saudi Polymers is Petrochem’s only asset, worse than expected operations would have a negative impact. Petrochem has been awarded a grace period due until 2018/19. If feedstock gas prices increase before that, it will hurt company margins. 61 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: National Petrochemical Co Financial statements Year to Hold Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 7,304 2,584 -822 1,763 -156 1,611 1,611 -125 907 907 5,510 1,953 -802 1,151 -195 967 967 -104 513 513 6,783 2,311 -863 1,447 -116 1,331 1,331 -143 722 722 7,413 2,512 -896 1,617 -97 1,520 1,520 -163 825 825 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 2,608 -210 -291 0 -2,549 2,378 2,049 -248 -248 0 -1,831 1,790 1,747 -251 -251 -384 -1,112 1,496 2,087 -254 -254 -432 -1,401 1,833 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 0 17,066 5,245 3,035 22,360 956 13,055 10,020 5,802 18,320 0 16,512 5,359 3,522 21,920 967 11,710 8,189 6,315 17,382 0 15,899 5,428 3,255 21,376 997 10,332 7,077 6,653 17,075 0 15,258 5,634 3,278 20,941 1,015 8,954 5,676 7,046 16,599 Year to 12/2015a 12/2016e 12/2017e 12/2018e 3.3 9.4 1.3 11.1 1.7 16.6 0.0 4.1 11.7 1.3 19.7 1.6 12.2 0.0 3.3 9.6 1.3 14.0 1.5 9.9 3.8 2.9 8.6 1.3 12.2 1.4 11.5 4.3 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 21.05 21.00 2002.SE PETROCH AB 2,694 29.30 29.30 24.30 24.30 19.30 19.30 14.30 14.30 12/2016e 12/2017e 12/2018e Y-o-y % change Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) Source: HSBC Note: Priced at close of 02 Feb 2017 -7.1 10.9 17.1 20.7 17.1 -24.6 -24.4 -34.7 -40.0 -43.5 23.1 18.3 25.8 37.7 40.9 9.3 8.7 11.7 14.2 14.2 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) 0.4 8.6 17.0 7.3 35.4 24.1 16.6 120.7 3.9 26.0 0.3 5.8 8.5 4.7 35.4 20.9 10.0 89.4 4.2 25.0 0.4 7.5 11.1 6.0 34.1 21.3 19.9 71.0 3.1 24.7 0.4 8.6 12.0 6.8 33.9 21.8 26.0 52.1 2.3 36.8 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 1.89 1.89 0.00 12.09 1.07 1.07 0.00 13.16 1.51 1.51 0.80 13.86 1.72 1.72 0.90 14.68 62 9.30 2016 National Petrochemical Co Ratio, growth and per share analysis 12/2015a 17% Chemicals Saudi Arabia Sriharsha Pappu 971 4 4236924 Price relative 9.30 2015 Year to Free float Sector Country Analyst Contact 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 SABIC Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East [email protected] +971 4423 6924 Prateek Bhatnagar*, CFA Analyst HSBC Securities and Capital Markets (India) Pvt. Limited [email protected] +91 80 4555 2757 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations SABIC AB, Buy, TP SAR105 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 fertilisers and steel, and is one of the largest nitrogen fertiliser producers in the Middle East, although its steel and fertiliser business are small in the context of the company (5% and 3% of its sales, respectively, in 2014). SABIC, unlike the other petrochemical companies in the region, has a global footprint with significant assets outside MENA, primarily in Europe owing to its acquisitions of GE Plastics (in 2007), Hunstsman’s petrochemical assets in the UK (in 2006), and DSM’s European base chemical assets (in 2002). SABIC was created in 1976 by royal decree to add value to Saudi Arabia’s hydrocarbon resources, especially the natural gas associated with the kingdom’s oil production, most of which was previously flared off. The Saudi government is the largest shareholder in the company with a 70% stake. Investment thesis SABIC’s recent dividend cut – from an annual payout of SAR5.5 per share to SAR4 per share, was disappointing and took the market by surprise. In light of the three growth projects that the company is working on – the US cracker JV with Exxon, the Oil to Chemicals project JV with Aramco and the Coal to Olefins project with Shenhua in China – all of which combined could cost up to USD50bn, management chose to cut the dividend and preserve optionality for growth. We believe that the dividend cut was unnecessary given the strength of the balance sheet and cash generation. However, despite the declining payout, the company’s chemicals business continues to remain resilient with strong Q4 2016 earnings. SABIC has a first quartile global cost position, generates a 6.3% FCF yield, and offers a USD-denominated 5.2% dividend yield on 2017e. We see the yield as sustainable, given limited capex and lack of leverage (net debt/EBITDA of 0.1x). We therefore remain positive on the company. Financials SABIC reported Q4 2016 net income of SAR4.55bn, down c13% on a q-o-q basis and 3% lower than consensus expectations. There was another impairment of Ibn Rushd of which SABIC's share is SAR330m, so net of that, recurring numbers were 2% lower q-o-q. Sales and gross profit remain broadly flat. The company in its release said that lower equity income and affiliate income (Kayan) was the main reason for lower results q-o-q. Valuation We use a DCF methodology to value SABIC. Our cost of equity is 9.7%, comprising a risk-free rate of 2.5%, a market risk premium of 6% and a beta of 1.2. We use a cost of debt of 4% and a 30% debt weight to get to our WACC of 7.9%. This yields a price target of SAR105. Our target price implies upside of 8.8% and we rate the stock Buy and not Hold as we see strong growth/return potential in the company and its earnings resilience. Earnings resilience can be highlighted by the fact that despite a c50% drop in oil price, gross earnings in chemicals in 2016 dropped only 10% vs 2014 levels. 63 EQUITIES ● SAUDI ARABIA February 2017 Risks Downside risks: Potential M&A: any low return or high cost acquisition that does not add to the long-term value constitutes a downside risk. The company has ethylene capacity of over 10m tons and is therefore highly levered to spreads. Any unexpected decline in ethylene demand or better supply can therefore strain earnings. A further increase in Saudi gas prices could impact profitability. 64 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi Basic Industries Co Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 149,167 43,809 -15,372 28,437 -291 29,518 29,518 -2,100 18,784 18,784 133,415 42,131 -15,420 26,710 -287 28,223 28,223 -2,822 18,373 18,373 162,371 51,105 -16,227 34,878 -255 35,303 35,303 -1,589 22,594 22,594 167,069 50,476 -16,685 33,791 -260 34,211 34,211 -1,539 21,724 21,724 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 53,269 -18,029 -12,392 -16,471 -6,221 35,732 39,316 -18,029 -18,029 -15,000 741 19,487 42,845 -18,972 -18,972 -15,000 2,248 23,193 47,787 -19,965 -19,965 -15,000 -1,874 27,141 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 16,325 177,990 116,886 68,394 327,928 45,406 72,642 4,248 162,023 197,402 16,325 180,599 98,138 52,429 311,787 41,117 57,418 4,989 165,396 201,516 16,325 183,344 95,237 39,062 311,632 44,486 46,299 7,237 172,990 211,358 16,325 186,624 85,266 26,553 304,942 45,455 31,916 5,363 179,714 216,208 Year to 12/2015a 12/2016e 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 (diluted) HSBC EPS (diluted) DPS Book value 12/2016e 12/2017e 12/2018e 2.5 8.5 1.9 15.4 1.8 9.7 5.7 2.8 8.9 1.9 15.8 1.8 5.3 5.2 2.3 7.4 1.8 12.8 1.7 6.3 5.2 2.2 7.4 1.7 13.3 1.6 7.4 5.2 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 96.50 105.00 2010.SE SABIC AB 77,197 12/2017e 12/2018e Free float Sector Country Analyst Contact 30% Chemicals Saudi Arabia Sriharsha Pappu 971 4 4236924 Price relative 132.00 122.00 112.00 102.00 92.00 82.00 72.00 62.00 52.00 2015 132.00 122.00 112.00 102.00 92.00 82.00 72.00 62.00 52.00 2016 Saudi Basic Industries Co Y-o-y % change Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 12/2015a EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) Ratio, growth and per share analysis Year to Buy 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 -21.1 -16.6 -24.6 -23.6 -19.5 -10.6 -3.8 -6.1 -4.4 -2.2 21.7 21.3 30.6 25.1 23.0 2.9 -1.2 -3.1 -3.1 -3.9 0.7 13.1 11.6 8.6 29.4 19.1 150.6 2.0 0.1 1254.1 0.7 12.1 11.2 8.4 31.6 20.0 146.8 2.3 0.1 788.0 0.8 16.1 13.4 11.2 31.5 21.5 200.7 3.3 0.1 592.0 0.8 15.1 12.3 10.9 30.2 20.2 194.1 2.4 0.1 891.1 6.26 6.26 5.50 54.01 6.12 6.12 5.00 55.13 7.53 7.53 5.00 57.66 7.24 7.24 5.00 59.90 65 EQUITIES ● SAUDI ARABIA February 2017 Sahara Petrochemical Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East [email protected] +971 4423 6924 Prateek Bhatnagar*, CFA Analyst HSBC Securities and Capital Markets (India) Pvt. Limited [email protected] +91 80 4555 2757 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations SPC AB, Reduce, TP SAR12 Company description Sahara was incorporated as a Saudi joint stock company in 2004 and went public in July 2004. It carried out a successful rights issue in August 2009, raising SAR1.03bn in equity to fund new projects. Sahara has stakes in multiple projects in Saudi via JVs, which provide it with growth options. Sahara has investments in four chemical projects: The Al-Waha Petrochemical Company: Al Waha is an integrated polypropylene plant with a capacity of 450ktpa. Sahara has a 75% stake in the project and consolidates Al Waha in its financials. The plant was completed in Q4 2009. Saudi Ethylene and Polyethylene Company (SEPC): SEPC is an integrated ethylene cracker with a capacity of c1mtpa of ethylene and 800ktpa of derivatives. SEPC is a joint venture between Tasnee and the Sahara Olefins Company, with Sahara having an effective stake of c24% in the company. The acrylic acid project: Sahara has a c32.3% stake in the Saudi Acrylics Monomer Company (SAMC), an integrated acrylic acid project with a nameplate capacity of c250ktpa. Sahara & Maaden Petrochemicals Company (SAMAPCO): A 50:50 JV between Sahara and Maaden, the plant comprises a caustic soda unit (245ktpa) and an ethylene dichloride unit (300ktpa). Investment thesis The improvement in operations is positive, however, we believe it is already reflected in the stock price. Since Q4 2016, it has been the best performing stock in our Saudi chemicals coverage – increasing 75% and at current levels valuations look rich. We remain bearish on the outlook for propylene prices, which is the primary product chain that Sahara is exposed to and therefore we have a Reduce rating on the stock. Financials Sahara posted healthy results in Q4 2016 with net income of SAR160m up c50% q-o-q. The company cited better volumes from Al-Waha, and SEPC cracker for the improvement Also there were lower losses in SAMAPCO q-o-q mainly due to the improvement of caustic soda selling prices. Valuation We use a DCF methodology to value Sahara. Our cost of equity is 9.7% and includes a risk-free rate of 2.5%, a market risk premium of 6% and a beta of 1.2. We use a 4% cost of debt assumption and a 30% debt weighting, which yields a WACC estimate of 7.9%. This yields a target price of SAR12 implying a downside of 22.8%. As such, we rate the stock Reduce. 66 EQUITIES ● SAUDI ARABIA February 2017 Sahara: Net income (SARm) improvement 200 Sahara: 12 month forward PE 22 150 20 100 18 16 50 14 0 12 (50) 10 8 (100) Jan-15 Jun-15 Nov-15 Apr-16 Sep-16 Feb-17 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 12 12 13 13 14 14 15 15 16 16 Source: Company data Source: Thomson Reuters DataStream Risks Upside risks: 1. Sahara’s new plants, Chlorvinyls and the acrylics are ramping up operations currently and have been generating losses since start-up. We expect their performance to improve gradually however better than expected operations can be an upside risk to the company. 2. SEPC is a naphtha cracker and highly levered to ethylene spreads, while we expect that ethylene cycle as peaked, a better than expected margins are an upside risk. 3. Operating performance at the Al-Waha plant has improved over the last few quarters after a disappointing start-up period. An even better than expected performance at the facility will be a upside risk. 67 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Sahara Petrochemical Co. Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Reduce 1,424 369 -192 176 -91 124 124 -37 43 43 1,782 641 -228 413 -71 549 549 -54 394 394 2,251 427 -196 231 -147 328 328 -32 269 269 2,598 516 -196 321 -178 409 409 -40 323 323 482 -332 -609 -373 260 -45 255 -140 -140 -197 -72 282 -228 -140 -140 -132 276 -165 -58 -168 -168 -154 134 0 30 3,613 2,033 1,382 8,491 93 2,034 652 5,499 4,200 30 3,557 2,009 1,261 8,599 97 1,840 580 5,695 4,238 30 3,501 2,073 1,028 8,830 121 1,884 856 5,832 4,455 30 3,473 1,889 704 8,864 130 1,693 990 6,002 4,558 Year to 12/2015a 12/2016e 12/2017e 12/2018e 3.9 15.1 1.3 158.0 1.2 -0.9 3.2 3.0 8.5 1.3 17.3 1.2 5.8 2.9 2.5 12.9 1.2 25.4 1.2 -3.5 1.9 2.1 10.6 1.2 21.1 1.1 0.0 2.3 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2016e 18.10 16.10 16.10 14.10 14.10 12.10 12.10 10.10 10.10 8.10 8.10 12/2018e Y-o-y % change -25.0 -17.1 -28.7 -74.3 -89.0 25.1 74.0 134.2 343.3 811.6 26.3 -33.4 -44.0 -40.3 -31.7 15.4 21.0 38.7 24.8 20.2 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) 0.3 2.9 0.8 1.8 25.9 12.4 4.0 10.7 1.8 73.9 0.4 8.8 7.0 6.5 36.0 23.2 9.0 9.1 0.9 44.0 0.5 4.8 4.7 4.9 19.0 10.3 2.9 13.1 2.0 0.6 6.4 5.5 6.0 19.9 12.4 2.9 14.7 1.9 0.10 0.10 0.50 12.53 0.90 0.90 0.45 12.98 0.61 0.61 0.30 13.29 0.74 0.74 0.35 13.68 68 Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 6.10 2016 Sahara Petrochemical Co. 12/2017e 33% Chemicals Saudi Arabia Sriharsha Pappu 971 4 4236924 18.10 Ratio, growth and per share analysis 12/2015a Free float Sector Country Analyst Contact Price relative 6.10 2015 Year to 15.55 12.00 2260.SE SPC AB 1,819 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 SIIG Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East [email protected] +971 4423 6924 Prateek Bhatnagar*, CFA Analyst HSBC Securities and Capital Markets (India) Pvt. Limited [email protected] +91 80 4555 2757 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations SIIG AB, Buy, TP SAR22 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). Investment thesis SIIG is a value-unlocking story. It comprises two parts – a 50% stake in the listed National Petrochemical Company (PETROCH AB, Hold, TP SAR21) and ‘legacy’ assets – Saudi Chevron Phillips (SCP) and Jubail Chevron Phillips (JCP). The value of SIIG’s 50% stake in Petrochem now accounts for 62% of SIIG’s market cap, putting its debt-free SCP/JCP businesses on 9.5x annualised 2016 ytd earnings – a discount to the sector median multiple for similar businesses at 12-14x. We think most of this valuation discount can be attributed to a holding company discount for SIIG’s stake in Petrochem – as there are currently limited options for SIIG to monetise its stake. However, once Petrochem starts paying a dividend, which we expect in 2017e, this valuation discount should close. Financials SIIG declared a dividend of SAR0.5 per share for 2016. The company had cut its div from SAR1 to 0 in 2015, citing tough environment. They also recently decided to impair their downstream Nylon project (PCC), which has been losing money since startup in 2015 at cSAR150m a year and has been a drag on company profitability. They're impairing asset value from SAR 1.5bn to 190m, and taking it to equity through retained earnings. This should cut future depreciation expenses by cSAR65m, so should help the P&L from that project going forward. SIIG reported Q4 net profit of SAR19m, down from SAR163m in the previous quarter. A decline in profits was expected due to a complete planned shutdown at Petrochem during the quarter (SIIG’s portion of Petrochem reported SAR64m loss vs SAR96m profit in Q3 2016). PCC too reported higher losses SAR56m vs SAR42m previously. However SIIG’s legacy assets SCP/JCP contributed higher profits SAR154vs SAR116m in Q3 2016. 69 EQUITIES ● SAUDI ARABIA February 2017 Valuation We use a sum-of-the-parts methodology to value SIIG due to the large Petrochem stake. We use a PE multiple of 14.0x, in line with the average PE for our MENA chemicals universe, to value the ex- Petrochem businesses. To this we add the value of SIIG’s 50% stake in Petrochem, by using our SAR21 target price for Petrochem. This yields a sum-of-the-parts valuation for SIIG of SAR22 per share. Our TP implies upside of 11.1% and we rate the stock Buy. We have a Buy rating and not Hold as we see potential catalysts from better Petrochem operations and its legacy SCP/JCP assets when styrene recovers. Risks Downside risks 70 1. Current high margins are being driven partly by high operating rates at SPC in our view. Unplanned shutdowns at Saudi Polymers would have a negative impact. 2. Lower than expected styrene/gasoline margins. 3. Lower than expected dividends from National Petrochem. EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi Industrial Investme Financial statements Year to Buy Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 7,304 2,572 -822 1,750 -152 1,922 1,922 -162 727 727 5,510 1,944 -802 1,142 -183 1,346 1,346 -137 602 602 6,783 2,311 -847 1,464 -89 1,892 1,892 -109 1,032 1,032 7,413 2,512 -857 1,655 -65 2,214 2,214 -128 1,230 1,230 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 2,558 -211 -29 -450 -2,022 2,326 2,683 -235 -47 -338 -2,299 2,438 1,962 -238 16 -450 -1,528 1,714 2,250 -241 66 -450 -1,866 1,999 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 0 20,277 5,392 3,146 26,534 1,072 12,925 9,779 7,089 21,451 0 19,898 5,608 4,100 26,371 1,381 11,580 7,480 7,353 20,024 0 19,542 6,013 4,250 26,420 1,477 10,202 5,952 7,935 19,828 0 19,233 6,637 4,738 26,735 1,533 8,824 4,086 8,715 19,598 Year to 12/2015a 12/2016e 12/2017e 12/2018e 3.2 9.0 1.1 12.3 1.3 17.2 0.0 3.9 11.1 1.1 14.8 1.2 17.3 3.8 3.1 9.0 1.0 8.6 1.1 11.5 5.1 2.7 7.9 1.0 7.2 1.0 12.7 5.1 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2016e 27.50 22.50 22.50 17.50 17.50 12.50 12.50 12/2018e Y-o-y % change 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) -7.1 10.9 17.2 0.0 -22.0 -24.6 -24.4 -34.7 -30.0 -17.2 23.1 18.8 28.2 40.5 71.4 9.3 8.7 13.0 17.1 19.2 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) 0.3 7.3 10.5 7.2 35.2 24.0 16.9 78.3 3.8 26.2 0.3 4.9 8.3 5.2 35.3 20.7 10.6 56.0 3.8 35.9 0.3 6.9 13.5 7.1 34.1 21.6 25.9 40.5 2.6 33.0 0.4 7.9 14.8 8.1 33.9 22.3 38.7 25.0 1.6 55.1 1.62 1.62 0.00 15.75 1.34 1.34 0.75 16.34 2.29 2.29 1.00 17.63 2.73 2.73 1.00 19.37 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 7.50 2016 Saudi Industrial Investme 12/2017e 80% Chemicals Saudi Arabia Sriharsha Pappu 971 4 4236924 27.50 Ratio, growth and per share analysis 12/2015a Free float Sector Country Analyst Contact Price relative 7.50 2015 Year to 19.80 22.00 2250.SE SIIG AB 2,376 71 EQUITIES ● SAUDI ARABIA February 2017 SIPCHEM Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East [email protected] +971 4423 6924 Prateek Bhatnagar*, CFA Analyst HSBC Securities and Capital Markets (India) Pvt. Limited [email protected] +91 80 4555 2757 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations SIPCHEM AB, Buy, TP SAR21 Company description 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 is best thought of as an integrated petrochemical company with three phases, of which phases I and II are fully operational, while the phase III EVA/LDPE project has not yet started commercial operations. 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. 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 (commercial operations started in Q2 2015) and a 63ktpa Polybutylene Terephthalate (PBT) plant (started commercial operations in Q2 2015). Investment thesis We continue to like Sipchem due to our outlook on methanol. At its core, Sipchem remains a play on methanol prices. Methanol is the company’s most profitable product and methanol prices provide the basis of the pricing for most of its downstream products. Lower methanol prices in 2016 impacted company profitability. However post the rally in oil prices after the OPEC deal, methanol prices too have rallied, ending 2016 at USD360/ton, up c60% from their lows at the start of the year. We expect to see the current methanol pricing environment persist, aided by a higher oil price and Chinese coal prices. Strong methanol price bodes well for Sipchem and therefore we remain positive on the company. Financials Sipchem Q4 2016 earnings were SAR52.3m vs a loss of SAR59m in Q3 2016. Sales were cSAR910m, up 33% q-o-q mainly due to higher methanol price and lower shutdowns. Methanol prices averaged USD288/t in Q4 2016, up 27% q-o-q. Current prices are close to USD350/t up 22% from Q4 2016 average. There were also no shutdowns in Q4 2016 as compared to Q3 2016 (SAR17m impact). Valuation We use a DCF methodology to value Sipchem. Our cost of equity for Sipchem is 9.0%, comprising a risk-free rate of 2.5%, 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 7.8%. This yields a price target of SAR21. Our TP implies upside of 7.7% and we rate the stock Buy and not Hold as the company's earnings are highly correlated to methanol prices as it is the 72 EQUITIES ● SAUDI ARABIA February 2017 most profitable part of the business. Methanol prices are currently at USD355/t up c50% vs 2016 average. We are constructive regarding methanol prices (see GEM Chems - Commodity chemicals outlook, Jan 2017 for details). Also the company has lower capex needs going forward, which should contribute to higher cash generation. Risks Downside risks 1. A continued recurrence of one-off charges may result in lower earnings for the company. 2. Lower than expected contribution from EVA/LDPE plant due to operational issues. 3. Sipchem’s plants have a high degree of integration; although this helps the company move down the value chain, it also implies that any operational issues at its upstream plants could also impact its downstream units and is a key downside risk. 73 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi International Petro Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 3,514 1,277 -687 590 -231 369 369 -30 287 287 3,254 1,035 -620 415 -253 201 201 -58 116 116 5,169 2,123 -754 1,369 -185 1,224 1,224 -61 872 872 5,278 2,051 -776 1,275 -158 1,156 1,156 -58 824 824 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 1,205 -978 -978 -458 641 -34 1,151 -513 -513 -110 -239 327 1,830 -528 -528 -367 -554 1,056 2,130 -544 -544 -367 -878 1,370 161 13,323 3,561 2,125 17,045 1,087 8,087 5,962 5,812 13,833 161 13,216 2,354 1,019 15,730 1,102 6,742 5,723 5,819 13,610 161 12,990 2,530 559 15,681 1,445 5,728 5,169 6,324 13,677 161 12,758 2,350 352 15,269 1,551 4,643 4,291 6,781 13,367 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital Buy Year to 12/2015a 12/2016e 12/2017e 12/2018e 4.3 11.7 1.1 24.9 1.2 -0.4 3.1 4.5 14.3 1.1 61.5 1.2 3.6 1.5 2.8 6.8 1.0 8.2 1.1 11.5 5.1 2.6 6.6 1.0 8.7 1.1 14.8 5.1 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 19.50 21.00 2310.SE SIPCHEM AB 1,907 37.00 37.00 32.00 32.00 27.00 27.00 22.00 22.00 17.00 17.00 12.00 12.00 12/2016e 12/2017e 12/2018e Y-o-y % change -13.6 -26.8 -50.0 -60.8 -52.6 -7.4 -19.0 -29.7 -45.4 -59.5 58.9 105.1 230.1 508.2 649.5 2.1 -3.4 -6.9 -5.5 -5.5 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) 0.3 4.0 4.9 2.9 36.3 16.8 5.5 77.4 4.7 20.2 0.2 2.1 2.0 1.9 31.8 12.7 4.1 74.1 5.5 20.1 0.4 9.5 14.4 8.5 41.1 26.5 11.5 62.0 2.4 35.4 0.4 9.0 12.6 8.1 38.9 24.2 13.0 48.2 2.1 49.6 0.78 0.78 0.60 15.85 0.32 0.32 0.30 15.87 2.38 2.38 1.00 17.25 2.25 2.25 1.00 18.49 74 Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 7.00 2016 Saudi International Petro Ratio, growth and per share analysis 12/2015a 66% Chemicals Saudi Arabia Sriharsha Pappu 971 4 4236924 Price relative 7.00 2015 Year to Free float Sector Country Analyst Contact 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Saudi Kayan Prateek Bhatnagar*, CFA Analyst HSBC Securities and Capital Markets (India) Pvt. Limited [email protected] +91 80 4555 2757 Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East [email protected] +971 4423 6924 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations KAYAN AB, Reduce, TP SAR6.5 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 products 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. Investment thesis Saudi Kayan’s share price has increased more than 63% since Q4 2016, outperforming the broader market by 40%. This improvement is driven by better earnings with Kayan posting an annual profit in 2016 - for the first time since starting operations. The strong results have been driven by: 1) improving polycarbonate market where Kayan has 260 ktpa capacity and 2) benefits from 130 ktpa extra ethane allocation – which have cut Kayan’s feedstock cost by more than SAR150m per year on our estimates. However, we believe both of these drivers have already been extensively discussed in the past, are well known and are now in the price. However Kayan has the heaviest feedstock slate of all of the new Saudi crackers and its raw material cost is linked to oil. The company is enjoying higher margins due to the depressed oil prices; however the HSBC oil team expects the crude price to increase to USD60/bbl in 2017 and USD75/bbl in 2018, significantly above spot levels, which will increase Kayan’s feedstock cost and hurt its margins going forward. We therefore have a Reduce rating on the stock. Financials Saudi Kayan Q4 net income decreased 34% q-o-q to SAR103.7m. Operating profit was down only 6% sequentially so most of the decline in net income was due to higher financial charges. Valuation We use a DCF methodology to value Kayan. Our cost of equity is 10.0% and includes a risk free rate of 2.5%, a market risk premium of 6% and a beta of 1.25. We use a 6% cost of debt assumption and a 60% debt weighting, which yields a WACC estimate of 7.5%. This yields a TP of SAR6.5 which implies downside of 23.3% and we therefore have a Reduce rating on the company. 75 EQUITIES ● SAUDI ARABIA February 2017 Risks Upside risks 76 1. If polycarbonate demand growth exceeds our expectations, resulting in higher margins than anticipated, it may result in higher earnings. 2. If the company is allocated extra ethane in the future, it could increase earnings. 3. According to the notification in January 2016, Kayan buys ethane at old prices until Q2 2017. If the deadline in postponed, it could present an upside risk. 4. Better than expected operational performance can improve earnings and is an upside risk in our view. EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi Kayan Petrochemical Financial statements Year to Reduce Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 7,976 1,884 -2,477 -594 -574 -1,160 -1,160 -83 -1,243 -1,243 8,498 3,376 -2,377 999 -752 248 248 -70 178 178 10,615 4,274 -2,480 1,794 -758 1,038 1,038 -73 965 965 11,420 4,357 -2,542 1,815 -668 1,149 1,149 -69 1,081 1,081 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 2,750 -602 -602 0 -2,187 2,134 2,558 -903 -903 0 -1,655 1,653 2,617 -1,151 -1,151 0 -1,466 1,464 3,282 -1,179 -1,179 0 -2,103 2,101 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 0 36,048 6,025 1,720 42,073 2,411 26,984 25,264 12,806 37,942 0 34,573 5,343 1,221 39,916 2,229 24,830 23,609 12,984 36,465 0 33,244 5,342 163 38,585 2,458 22,305 22,143 13,949 35,964 0 31,881 4,737 -907 36,618 2,583 19,133 20,040 15,030 34,942 Year to 12/2015a 12/2016e 12/2017e 12/2018e 4.8 20.2 1.0 4.3 10.8 1.0 71.3 1.0 13.0 0.0 3.3 8.2 1.0 13.2 0.9 11.5 0.0 2.9 7.5 0.9 11.8 0.8 16.5 0.0 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2016e 12/2018e Y-o-y % change Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 25% Chemicals Saudi Arabia Prateek Bhatnagar 15.30 13.30 13.30 11.30 11.30 9.30 9.30 7.30 7.30 5.30 5.30 3.30 2016 Saudi Kayan Petrochemical 12/2017e Free float Sector Country Analyst Contact 15.30 Ratio, growth and per share analysis 12/2015a 8.48 6.50 2350.SE KAYAN AB 3,392 Price relative 3.30 2015 Year to 1.0 16.8 0.0 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 -31.5 -34.0 -215.2 -3669.2 6.5 79.2 24.9 26.6 79.5 317.8 441.4 7.6 2.0 1.2 10.7 11.9 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) 0.2 -1.6 -9.3 -1.4 23.6 -7.4 3.3 197.3 13.4 10.9 0.2 1.9 1.4 1.8 39.7 11.8 4.5 181.8 7.0 10.8 0.3 4.6 7.2 4.3 40.3 16.9 5.6 158.7 5.2 11.8 0.3 4.8 7.5 4.5 38.2 15.9 6.5 133.3 4.6 16.4 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value -0.83 -0.83 0.00 8.54 0.12 0.12 0.00 8.66 0.64 0.64 0.00 9.30 0.72 0.72 0.00 10.02 77 EQUITIES ● SAUDI ARABIA February 2017 Tasnee Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East [email protected] +971 4423 6924 Prateek Bhatnagar*, CFA Analyst HSBC Securities and Capital Markets (India) Pvt. Limited [email protected] +91 80 4555 2757 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations NIC AB, Hold, TP SAR16 Company description 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. 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). The manufacturing business consists of a number of small scale battery, packaging and services businesses and accounts for c15% of Tasnee’s revenue. Investment thesis We remain constructive on the TiO2 market and see pricing as having troughed in early 2016 with some decent pricing momentum into 2017e. However the stock price, we believe, is adequately reflecting the pricing momentum – having almost doubled from the lows seen in early 2016. It is currently trading at 8.9x 2017e EV/EBITDA – in line with the sector average. We have a Hold rating on the stock. Financials Tasnee reported net Q4 2016 income of SAR123.4m, broadly flat q-o-q, 33% higher than consensus expectations. Q4 operating profit up increased 38% q-o-q but net income remained flat because of increased zakat provisions. The company said that the general and administrative expenses decreased sequentially. Q4 sales too remained broadly flat (+2%) sequentially to SAR3.95bn thus the improvement in operating profit was margin-driven. Valuation We use a DCF methodology to value Tasnee. Our cost of equity is 10%, comprising a risk-free rate of 2.5%, 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 tax rate than the Saudi domestic businesses – which results in a WACC of 8.4%. This yields a target price of SAR16. Our TP implies a downside of 3.1% and we have a Hold rating on the stock. Risks Upside risks: Better than expected realisation on the proposed TiO2 price increases is an upside risk. Better than expected performance in Tasnee’s acrylics business Downside risks: Tasnee has a large exposure to TiO2 markets and a weaker-than-expected margin recovery is a downside risk. Tasnee is also highly levered with net debt to EBITDA of 4.7x on our 2017e; a further increase in Saudi interbank rates would meaningfully impact earnings. 78 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: National Industrializatio Financial statements Year to Key forecast drivers 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 15,090 1,317 -1,774 -456 -614 -1,329 -1,329 -317 -1,427 -1,427 15,246 3,331 -2,033 1,298 -780 830 830 -50 327 327 17,342 4,570 -1,877 2,693 -673 2,182 2,182 -131 1,164 1,164 18,792 5,075 -1,877 3,198 -636 2,723 2,723 -163 1,491 1,491 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 2,333 -2,174 -1,665 -671 2,978 30 1,841 -1,479 -1,479 -134 -228 50 3,062 -1,693 -1,693 -334 -1,034 1,208 3,803 -1,693 -1,693 -435 -1,675 1,949 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 3,015 26,405 13,013 3,748 45,119 4,592 26,352 22,604 8,045 34,094 3,015 25,851 13,355 3,794 44,907 3,915 26,170 22,376 8,239 34,512 3,015 25,667 13,085 2,544 44,453 4,029 23,886 21,342 9,069 35,194 3,015 25,484 13,199 1,935 44,383 4,118 21,602 19,667 10,125 35,645 Ratio, growth and per share analysis Year to Hold 12/2015a 12/2016e 12/2017e 12/2018e Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) -19.7 -70.3 -116.5 -159.1 -225.9 1.0 152.9 13.7 37.2 107.5 162.7 255.6 8.4 11.0 18.7 24.8 28.0 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) 0.4 -1.6 -14.5 -1.9 8.7 -3.0 2.1 163.6 17.2 10.3 0.4 3.6 4.0 3.4 21.8 8.5 4.3 154.7 6.7 8.2 0.5 7.3 13.5 6.0 26.4 15.5 6.8 131.9 4.7 14.3 0.5 8.5 15.5 7.1 27.0 17.0 8.0 107.4 3.9 19.3 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value -2.13 -2.13 0.00 12.03 0.49 0.49 0.20 12.32 1.74 1.74 0.50 13.56 2.23 2.23 0.65 15.14 Y-o-y % change Year to 12/2015a 12/2016e 12/2017e 12/2018e 1,092 1,186 1,122 618 897 1,031 1,031 532 1,044 1,105 1,105 709 1,192 1,179 1,179 886 Polypropylene (USD/t) LDPE (USD/t) HDPE (USD/t) Acrylic Acid (USD/t) Valuation data Year to 12/2015a 12/2016e 12/2017e 12/2018e 2.7 30.8 1.2 2.7 12.3 1.2 33.7 1.3 0.3 1.2 2.4 9.0 1.2 9.5 1.2 6.1 3.0 2.2 8.1 1.2 7.4 1.1 9.1 3.9 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) 1.4 0.2 0.0 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 16.52 16.00 2060.SE NIC AB 2,947 Free float Sector Country Analyst Contact 80% Chemicals Saudi Arabia Sriharsha Pappu 971 4 4236924 Price relative 30.40 30.40 25.40 25.40 20.40 20.40 15.40 15.40 10.40 10.40 5.40 2015 5.40 2016 National Industrializatio 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 79 EQUITIES ● SAUDI ARABIA February 2017 Yanbu Petrochemical Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East [email protected] +971 4423 6924 Prateek Bhatnagar*, CFA Analyst HSBC Securities and Capital Markets (India) Pvt. Limited [email protected] +91 80 4555 2757 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations YANSAB AB, Hold, TP SAR48 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 Yansab is a single-project company and is structurally growth constrained. The company is highly cash-generative – with all available cash flow directed towards paying dividends to majority shareholder SABIC (and, by association, minority shareholders). We see it as a strong cash-generation story, but think earnings potential and cash generation under current oil prices are largely reflected in the share price. We rate the stock Hold with a SAR48 target price. Financials Yansab reported Q4 2016 net income of SAR603m, broadly flat q-o-q and in line with consensus estimates. Q4 2016 operating profit of SAR619m was down 6% q-o-q so there was some tailwind from lower finance charges. Sales of SAR1849 were up 7% q-o-q. Yansab's product prices had increased 4.2% q-o-q in Q4 2016 while spreads decreased 4% q-o-q. Valuation We use a DDM to value Yansab. We think this method is appropriate based on our view that Yansab will pay out all of its earnings as dividends in the medium term, with the amount of dividends paid driving the value of the stock. We use a dividend discount factor of 6.8%, derived from the market implied discount rate for Saudi Arabian Fertilizer (SAFCO, 2020.SE, SAR72.53, Hold, TP SAR60) as the companies have comparable structures and we believe that the longrun dividend payout of each company should be discounted at the same rate. This yields a fair value target price of SAR48 per share. Our TP implies downside of 19.3% and we rate the stock Hold and not Reduce because of the healthy earnings outlook and strong cash generation potential . Yansab has high exposure to MEG (35% of the capacity) and its prices are 40% higher currently vs 2016 average. Risks Upside risks: Better than expected product prices/spreads is a key upside risk to our rating and product price. Higher than expected oil price environment can result in higher product prices. Better than expected operational performance. Downside risks: Yansab is a single project company and therefore highly sensitive to any shutdowns. Any production problems would hurt Yansab’s earnings. If the Saudi feedstock prices and utility prices are increased again, it can be a downside risk for our estimates. 80 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Yanbu Petrochemical Financial statements Year to Hold Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 6,911 2,660 -1,120 1,540 -182 1,384 1,384 -176 1,207 1,207 6,999 3,665 -1,076 2,590 -133 2,527 2,527 -167 2,360 2,360 7,793 3,369 -1,159 2,210 105 2,366 2,366 -118 2,247 2,247 7,905 3,205 -1,176 2,029 187 2,266 2,266 -113 2,152 2,152 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 3,431 -794 -808 -1,404 -1,220 2,382 3,300 -205 -205 -1,406 -1,689 3,025 3,296 -310 -310 -1,406 -1,580 2,936 3,330 -420 -420 -1,688 -1,222 2,860 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 80 14,560 6,328 3,413 20,968 1,556 4,060 647 15,352 15,999 80 13,689 6,423 3,669 20,193 1,260 2,628 -1,041 16,305 15,264 80 12,841 7,033 3,816 19,954 1,612 1,195 -2,621 17,147 14,526 80 12,084 7,353 4,043 19,518 1,706 200 -3,843 17,612 13,769 Year to 12/2015a 12/2016e 12/2017e 12/2018e 4.9 12.8 2.1 27.7 2.2 7.1 3.4 4.6 8.8 2.1 14.2 2.1 9.0 4.2 4.0 9.2 2.1 14.9 2.0 8.8 4.2 3.7 9.2 2.2 15.5 1.9 8.5 5.0 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 59.48 48.00 2290.SE YANSAB AB 8,922 79.00 79.00 69.00 69.00 59.00 59.00 49.00 49.00 39.00 39.00 29.00 29.00 Yanbu Petrochemical Ratio, growth and per share analysis 12/2015a 12/2016e 12/2017e 12/2018e Y-o-y % change 40% Chemicals Saudi Arabia Sriharsha Pappu 971 4 4236924 Price relative 19.00 2015 Year to Free float Sector Country Analyst Contact 19.00 2016 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) -27.3 -35.6 -45.8 -47.4 -51.3 1.3 37.8 68.1 82.6 95.4 11.4 -8.1 -14.6 -6.4 -4.8 1.4 -4.9 -8.2 -4.2 -4.2 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) 0.4 8.0 7.8 6.3 38.5 22.3 14.6 4.2 0.2 530.0 0.4 15.5 14.9 12.1 52.4 37.0 27.7 -6.4 -0.3 0.5 14.1 13.4 10.7 43.2 28.4 0.6 13.6 12.4 10.0 40.5 25.7 -15.3 -0.8 -21.8 -1.2 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 2.15 2.15 2.00 27.29 4.19 4.19 2.50 28.99 4.00 4.00 2.50 30.48 3.83 3.83 3.00 31.31 81 EQUITIES ● SAUDI ARABIA February 2017 This page has been left blank intentionally 82 EQUITIES ● SAUDI ARABIA February 2017 Construction & Building Materials 83 EQUITIES ● SAUDI ARABIA February 2017 Construction & Building Materials Saudi is in the process of adjusting to lower oil revenues and construction has seen some of the largest cuts to spending Contractors have fared worst, while the cement names started to feel the pain in 4Q2015; suppliers are yet to see much negative impact We rate Zamil and Yamama Buy but remain cautious on the remaining stocks. We have a Hold on Yanbu and Reduce ratings on SACCO, QACCO and Al Khodari Nicholas Paton* Analyst HSBC Bank Middle East [email protected] +971 4423 6923 Patrick Gaffney*, CFA Analyst HSBC Bank Middle East [email protected] +971 4423 6204 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Is it time to invest in Saudi construction or building materials? The Saudi construction market is made up of mostly private or foreign firms, so few of these companies trade on the stock exchange. However, there are a few, most of which have large contracts to the government or quasi-governmental organisations. Margins for these companies have suffered over the past few years on the back of higher labour costs. Outside construction companies, there are a large number of companies that supply building materials that are publicly traded. In particular, 15 cement companies are listed on the Saudi stock market. The government requires companies that receive a fuel allocation (which the cement companies do) to list publicly. The cement companies benefit from low costs (with EBITDA margins above 50%) and have seen many years of growing demand, although 2016 was the first year that demand dropped by our records (which go back to 2002). All of the construction and building materials faced a difficult 2016 given a shrinking government budget, higher costs, and late payments. We are aware that cyclical sectors tend to rally even before the trough in earnings and, having been negative on the Saudi contractors and suppliers since oil prices began falling in September 2014, we do not want to miss the inflection point. In fact, the stocks have already rallied from their lows of 2016, making valuations looks much more expensive given weak earnings. We believe the rally is going to prove difficult to support for a few reasons: 84 Persistently low oil prices. The GCC is in the process of a delicate and complicated rebalancing to bring its spending in line with its significantly-lower oil revenue line and this is most pronounced in Saudi. We believe weak oil revenues will make it difficult for Saudi to pay sums already due to construction companies, and also to generate new construction awards. This is a particular problem for construction contractors for which the cash cycle for contractors is front and back loaded. Without prepayments on new projects and final handover payments for work already completed, the sector is likely to face major challenges that should eventually trickle down to suppliers too. EQUITIES ● SAUDI ARABIA February 2017 Sectoral issues. The legal, bureaucratic and regulatory characteristics of the market are such that contractors are currently structurally disadvantaged in the region. Put simply, contractors in the region have an obligation to continue building, even when their customers are not paying. Creating a more equitable system would avoid the violent swings in contractor company earnings and valuations. Building materials companies are in a comparatively better position. Excess capacity. This is an issue for the cement players, which have built up a clinker inventory of 6 months of sales. Capacity has expanded significantly over the past few years: 9m since 2008. This equates to a 19% increase in capacity. This doesn’t include another 1m tons that have been mothballed at Saudi Cement. Valuations. From a multiples perspective the sector is currently expensive, with many construction companies having negative earnings and cement companies with falling profits (albeit still positive ones). It is worth noting that our estimates for the construction companies assume a recovery in new orders that may yet prove overambitious. Saudi cash construction spending (USDbn) Capital spending (USDbn) Current spending (USDbn) Brent Crude (USD/bbl)- RHS Source: CEIC, Thomson Reuters Datastream Complete Execution 2020 0 2019 0 2018 20 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 50 2017 40 100 2016 60 150 2015 80 200 2014 250 Steep decline in spending expected 2013 100 2012 300 100 90 80 70 60 50 40 30 20 10 - 2011 120 2010 350 2009 Saudi government spending (USDbn) Pre Execution Source: MEED Projects Saudi continues to face challenges in its construction industry In 2014 the GCC exited a period of incredible revenue and spending growth that has led to a tough hangover in the construction sector. We had anticipated that capital spending would bear the brunt of the spending declines, which has indeed been the case, but had not anticipated the cuts to current spending, including salaries and benefits for government employees. The latter development is reflective of the scale of the problem for the GCC, which is most pronounced in Saudi Arabia. In 2014 Saudi’s overall capital spending was USD100bn, with roughly USD58bn being spent in the construction sector, according to MEED Projects estimates. With oil revenues materially lower in Saudi, and current spending significantly more difficult to cut, it is clear why construction has needed to bear the brunt of the spending cuts. New awards were first to see the cuts, falling 23% in 2014, 1% in 2015 and 53% in 2016, while the expected cash spending (according to MEED Project’s analysis) is only expected to fall in 2017 due to the lag between order award and the cash payment being made. In reality, payments have already fallen dramatically as Saudi has sought to conserve cash by whatever means possible. What the data above shows is that even when payments restart, they will be at an underlying level lower than we have been used to in the past few years. 85 EQUITIES ● SAUDI ARABIA February 2017 A roadmap to recovery: it’s mostly about the oil price Saudi is experiencing a reduction in revenues of around USD100bn with oil at USD50 versus oil at USD75. To balance budgets, the majority of the GCC needs oil to rise above USD60 bbl, while Saudi is likely somewhere closer to USD80 bbl. With weakness in current spending carrying higher risk than capital spending, we believe Saudi will continue to see limited new awards and cash conservation until oil recovers further. Fiscal balance breakeven oil price (USD bbl) 120 100 80 60 40 20 Kuwait Oman 2015 Qatar 2016e Saudi Arabia United Arab Emirates 2017e Source: IMF What would we need to see to become more positive on Saudi construction sector Although payments for completed work appear to be trickling into the system now, it is a long way short of providing the boost required to generate upside for the GCC contractors we have under coverage. In the past 18 months Arabtec, Drake and Scull and Al Khodari have faced severe and sustained revenue pressures. Critically we see 3 major issues that are currently unresolved: 86 1. Cash. Customers need to settle the bills for work that has already been performed. The recent announcement from Saudi that it paid SAR40bn of back payments is welcomed but more is needed to drive a rebound in the sector. We estimate that up to SAR375bn or USD100bn, is due in total, and significant inroads are needed for the sector to become attractive for contractor companies. We note that contractors typically work on gross margins of around 10%, so a 10% haircut on 2 years of sales will wipe out the gross profit for that period. At this point however, most contractors would be happy at even this sub-optimal outcome. 2. New orders. GCC new awards have declined for the past two years, and are now 45% below their peak in 2014. In the normal course of business the pre-payments for such awards offset other cash requirements and ease stress on the balance sheet. The current cash conservation environment has put extra emphasis on these cash prepayments at a time when new awards are particularly scarce. A convincing recovery in margin awards should help spark a rebound in the sector. 3. Sector reform. Contractors are typically asset-light. Their manpower is largely transient and physical assets largely project-specific and often leased. The value of a contractor is in its brand, reputation and certification to execute certain projects. Cash management for a contractor is critical, because gross margins are typically low at 10-15% (in good times), and working capital/sales is ordinarily between 20% and 50% of sales (or much higher in bad times like those currently). Being unable to collect cash from customers is a problem. The GCC market is different to others − while it is still necessary to pay suppliers and repay project finance, there are inadequate structures to make customers pay. This is compounded by performance bonds which force a contractor to continue to work even when customers do not EQUITIES ● SAUDI ARABIA February 2017 pay. Worse still, bureaucracy is opaque making it difficult to identify where cash payments are being held up, who is responsible and what needs to be remedied. For the cement players, we need to see a pickup in contract awards and housing. There is little correlation between Saudi budgets and cement demand, and we believe that cement demand lags construction awards. Local volume sales in Saudi (millions of tons) 70 25% 20% 15% 10% 5% 0% -5% -10% -15% 60 50 40 30 20 10 0 2019e 2018e 2017e 2016e 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 Volume Growth Source: Yamama, HSBC estimates Prices are falling because of excess supply and an inventory build-up. As we mentioned above, clinker inventories equal to around 6 months of sales. With the higher capacity, coming on line, we do not expect this pricing pressure to fall. Clinker inventory and prices 30.0 260 25.0 250 240 20.0 230 15.0 220 10.0 210 5.0 200 0.0 190 3Q2016 2Q2016 1Q2016 4Q2015 3Q2015 2Q2015 1Q2015 4Q2014 3Q2014 2Q2014 1Q2014 4Q2013 3Q2013 2Q2013 1Q2013 4Q2012 3Q2012 2Q2012 1Q2012 4Q2011 3Q2011 2Q2011 1Q2011 Clinker Inventory (tons, m) Prices (SAR/ton, RHS) Source: Company data, Yamama, HSBC calculations 87 EQUITIES ● SAUDI ARABIA February 2017 Abdullah A.M Al-Khodari Nicholas Paton*, CFA Senior Research Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6923 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations ALKHODAR AB, Reduce, TP SAR 10.5 Company description Abdullah A. M. Al-Khodari Sons Company was established in 1966 and publicly listed in September 2010. Its businesses include the construction of roads and 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 Backlog decline should continue in 2017 due to low level of awards Al Khodari’s qoq backlog growth has been negative for eight quarters now, and in absolute terms has declined 43% from its recent high of SAR5,027m in 1Q15. New awards have been weak with just SAR214m during 2016, and down 86% from the SAR1,512m booked in 2015. We expect backlog to remain at slightly lower levels in 2017 and 2018 compared to 2016, but that is on the back of the assumption that it manages to win new awards of approximately SAR700m annually to make up for the revenues realised each year. Business mix has shifted towards private company work The company has moved from government projects to diversify into private sector and housing projects, focusing on executing these and getting paid on time in return. Even so, a few of these projects could still be impacted by the general spending slowdown. The company is also looking to execute relatively smaller and fast-track projects (like the SAR100mn Maaden project which will still have the same revenues compared to a bigger and longer time period projects). Segmental Revenue evolution (SARbn) Segmental backlog evolution (SARbn) 2.0 5.0 4.0 1.5 3.0 1.0 2.0 0.5 1.0 0.0 2012 2013 2014 Water & Power Environmental Industrial & infra Source: Company data, HSBC estimates 88 2015 2016 2017E 2018E O&M Services Roads, Rails & Bridges Buildings 0.0 2012 2013 2014 Water & Power Environmental Industrial & infra Source: Company data, HSBC estimates 2015 2016 2017E 2018E O&M Services Roads, Rails & Bridges Buildings EQUITIES ● SAUDI ARABIA February 2017 Reform is a key milestone to generate value in the sector Fawwaz Al Khodari, the CEO, is part of the national contractor’s committee that highlights to the government the issues impacting the contractors. In a recent interview, Fahad al-Hammadi, chief of the National Contractors’ Committee said the Saudi government is expected to pay up to 80% of the total amount due to contractors during the remaining few weeks of this year by disbursing another SAR100bn besides the SAR40bn already paid by the government (source: The National, 26 Nov 2016). We think reforms in the sector are necessary going forward to make the payment process quicker and free of bureaucratic hurdles. Financials 4Q results were poor but better than our estimates. Revenues of SAR201mn were 23% above our SAR163mn estimate. Gross profit was SAR-6.8mn, better than our SAR-24.4mn estimate, EBIT SAR-19.9mn versus our SAR-33.1mn estimate and the company made a loss at the net income level of SAR-32.1 slightly better than our SAR-39.2mn estimate. The company won new awards worth SAR65.5mn during 4Q compared to our SAR60mn estimate and ended with a backlog of SAR2,853m, down 27% yoy. The company attributed the loss to lower revenue growth due to slow progress on the ongoing projects, a decline in new project awards and an extended slowdown in the construction sector which in turn impacted the Gross profit. The numbers were negatively affected impacted by an increase in financial charges, a decrease in other income and an increase in zakat expenses. This was counteracted by lower direct costs mainly due to a reduction in manpower and depreciation costs and a decrease in SG&A costs (mainly due to the savings in manpower costs and resource optimization). Valuation We value Al-Khodari using a DCF methodology. We have assumed a cost of debt of 6.8%. We use a risk-free rate of 2.5%, an equity risk premium of 7.0%, an inflation differential of 2.0% and a beta of 1.2 giving us a 12.9% cost of equity. Using a long-term debt-to-equity ratio of 70:30 we arrive at a WACC of 8.6%. We assume a terminal growth rate of 2.5%. We have a Reduce rating and our DCF based target price is SAR10.5 which implies downside of 21.9%. Our Reduce rating reflects the uncertainty facing GCC contractors, which makes equity value very volatile (the NPV of cash flows is close to the level of debt) and the lack of a solution to cash conservation issues, new awards and reform in the market. Key upside risks Construction and project awards remain lumpy by nature; therefore in the event Al-Khodari wins several high margin contracts in the near future, it should report better earnings than we expect, representing an upside risk. We expect working capital to remain high until the end of next year. In the event the company starts collecting its receivables faster, this would generate large cash flows, which represents upside risk to our thesis. A recovery in the price of crude oil will help stimulate the spending activities of the government which accounts for around 80% of the construction market in the country, and thus could positively impact the new projects awards to the company as well 89 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Abdullah A. M. Al-Khodari Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Reduce 1,570 194 -160 35 -46 37 37 -3 34 34 992 15 -135 -119 -48 -124 -124 -2 -126 -126 854 138 -91 47 -41 31 31 -1 31 31 971 136 -81 55 -35 50 50 -1 48 48 166 -103 41 -27 -200 16 386 -41 -41 -27 -328 302 367 -51 -51 0 -316 290 157 -58 -58 0 -99 70 0 443 2,783 93 3,249 1,165 1,105 1,012 890 1,968 0 350 2,560 420 2,933 1,002 1,105 684 737 1,488 0 310 2,452 736 2,785 823 1,105 368 767 1,203 0 288 2,565 835 2,876 865 1,105 269 816 1,152 Year to 12/2015a 12/2016e 12/2017e 12/2018e 1.1 8.9 0.9 21.3 0.8 2.1 3.7 1.4 91.8 0.9 1.3 7.9 0.9 24.5 1.0 39.9 0.0 1.0 7.3 0.9 15.5 0.9 9.6 0.0 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 13.45 10.50 1330.SE ALKHODAR AB 200 12/2016e 33.60 28.60 28.60 23.60 23.60 18.60 18.60 13.60 13.60 8.60 8.60 12/2018e Y-o-y % change Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) -9.6 -7.1 -45.8 -64.6 -66.9 -36.8 -92.1 -443.2 -437.4 -458.6 -14.0 798.6 13.7 -1.5 17.5 57.6 57.6 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) 0.8 1.5 3.8 2.4 12.4 2.2 4.3 113.7 5.2 16.4 0.6 -7.0 -15.5 -2.5 1.6 -12.0 0.3 92.8 44.5 56.4 0.6 3.4 4.1 2.5 16.2 5.5 3.3 48.0 2.7 99.7 0.8 4.6 6.1 2.9 14.0 5.7 3.9 33.0 2.0 58.5 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 0.63 0.63 0.50 16.74 -2.26 -2.26 0.00 13.21 0.55 0.55 0.00 13.76 0.87 0.87 0.00 14.62 90 3.60 2016 Abdullah A. M. Al-Khodari 12/2017e 40% Construction & Engineering Saudi Arabia Nicholas Paton, CFA +971 4 423 6923 33.60 Ratio, growth and per share analysis 12/2015a Free float Sector Country Analyst Contact Price relative 3.60 2015 Year to 1.0 41.5 0.0 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Qassim Cement Patrick Gaffney*, CFA Analyst HSBC Bank Middle East Ltd. [email protected] +971 4423 6204 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations QACCO AB, Reduce, TP SAR46 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 3.4mtpa. 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 Reduce rating on Qassim is our belief that the downside risks to our estimates are high. We have already lowered our 2017e and 2018e revenue estimates as we are looking for slightly worse overall market volumes. At the same time if the company faces lower margins or weaker prices, then there are risks to earnings and dividends, and shares would likely suffer. Financials Qassim cement reported earnings for 4Q bang in line with our expectations at SAR89m. This is down 37% yoy but up 26% from the seasonally weak 3Q. Revenues were worse than expected at SAR185m (we had SAR192m), but gross profit of SAR96m was ahead of our SAR94m estimate due to higher gross margin at 52% (we were looking for 49%). However, operating profit of SAR86.5m was a bit worse than our SAR88.1m forecast due to SG&A coming in higher. The company said sales volumes and prices fell due to lower demand for cement. Also, it stated that COGS rose on higher power and fuel prices, although it appears the increase wasn't as high as we expected. Overall, the significant year-over-year decline was expected and there are few surprises in the numbers. Valuation We use an EV/EBITDA multiple of 9.5x (unchanged) on 2018e EBITDA and discount that back by one year using WACC. This reaches an equity value of SAR46 per share. We use a risk free rate of 2.5%, an inflation differential of 4%, an ERP of 6% and a beta of 0.85. We assume a cost of debt of 4% and a debt:equity ratio of 10:90 (all unchanged). This results in a WACC of 10.8%. This is the same as we use in our Saudi property coverage as well. We then subtract net debt and minorities (very limited for any company) to reach an equity value. Our target price of SAR46 implies 23.7% downside and we maintain our Reduce rating on the stock. Risks Upside risks include higher mid-term demand than we expect, higher prices, or lower fuel chargebacks by the government for exports. 91 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Qassim Cement Company Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Reduce 1,024 678 -76 601 0 627 627 -41 586 586 859 491 -72 420 0 445 445 -29 415 415 786 402 -70 332 0 342 342 -22 320 320 744 360 -67 293 0 303 303 -20 283 283 656 -41 45 -683 35 548 497 -43 -43 -495 48 400 418 -39 -39 -297 -78 346 354 -37 -37 -271 -44 287 0 963 1,150 790 2,113 135 0 -790 1,884 1,188 0 934 1,100 742 2,034 136 0 -742 1,804 1,156 0 904 1,153 820 2,057 136 0 -820 1,826 1,101 0 874 1,195 864 2,068 136 0 -864 1,838 1,068 Year to 12/2015a 12/2016e 12/2017e 12/2018e 4.5 6.8 3.9 9.2 2.9 10.1 12.4 5.4 9.5 4.0 13.1 3.0 7.4 9.1 5.9 11.5 4.2 17.0 3.0 6.4 5.5 6.1 12.7 4.3 19.2 3.0 5.3 5.0 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2016e 102.00 92.00 92.00 82.00 82.00 72.00 72.00 62.00 62.00 52.00 52.00 12/2018e 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 (diluted) HSBC EPS (diluted) DPS Book value 92 42.00 2016 Qassim Cement Company 12/2017e Source: HSBC Note: Priced at close of 02 Feb 2017 3.9 2.8 4.5 4.8 4.1 -16.1 -27.5 -30.2 -29.2 -29.2 -8.5 -18.3 -20.8 -23.0 -23.0 -5.4 -10.5 -12.0 -11.6 -11.6 0.8 46.4 30.4 27.3 66.2 58.7 0.7 33.4 22.5 20.0 57.2 48.8 0.7 27.5 17.6 15.6 51.1 42.3 0.7 25.2 15.4 13.7 48.4 39.3 -41.9 -1.2 -41.1 -1.5 -44.9 -2.0 -47.0 -2.4 6.5 6.5 7.5 20.9 4.6 4.6 5.5 20.0 3.6 3.6 3.3 20.3 3.1 3.1 3.0 20.4 75% Construction Materials Saudi Arabia Patrick Gaffney, CFA +971 4423 6204 102.00 Ratio, growth and per share analysis 12/2015a Free float Sector Country Analyst Contact Price relative 42.00 2015 Year to 60.25 46.00 3040.SE QACCO AB 1,446 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Saudi Cement Patrick Gaffney*, CFA Analyst HSBC Bank Middle East Ltd. [email protected] +971 4423 6204 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations SACCO, Reduce, TP SAR45 Company description Located in the eastern region, Saudi Cement (SCC) was established in 1955. SCC operates two cement plants, 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 on to the ships at 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 10mtpa. SCC’s cement is of a specialized nature that is well suited to being used as a finishing material as well as for normal uses. This uniqueness means that it is sought after from across the region. Investment thesis We are Reduce on Saudi Cement as we believe that the downside risks to our volumes and pricing are high. We specifically believe that there is more room for downside to our EBITDA margins, given the surprising strength in 2016. This will result in a fall in earnings and eventually dividends which will make the stock less attractive for the investor. Financials Saudi Cement reported 4Q earnings at SAR187m which were below our estimate of SAR198m, driven mostly by lower sales and non-operational expenses. Sales of SAR397m, 6% below our estimate and down 18% yoy. Gross profit of SAR221m was in line, though, meaning that gross margin remained high at 55.7%. Operating profit came in at SAR195m, just below our SAR198m forecast. The company said that the decline was due to lower sales and higher fuel prices, which was expected. Overall, these results were a bit worse than we thought despite a still high gross margin. Valuation We use a one-year forward EV/EBITDA multiple of 9.5x (unchanged) on 2018e EBITDA and discount that back by one-year using WACC. This reaches an equity value of SAR45 per share. We use a risk free rate of 2.5%, an inflation differential of 4%, an ERP of 6% and a beta of 0.85. We assume a cost of debt of 4% and a debt:equity ratio of 10:90 (all unchanged). This results in a WACC of 10.8%. This is the same as we use in our Saudi property coverage as well. We then subtract net debt and minorities (very limited for any company) to reach an equity value. Our target price of SAR45 implies 28.0% downside and we maintain our Reduce rating on the stock. Risks Upside risks include higher mid-term demand than we expect, higher prices, or lower fuel chargebacks by the government for exports. Additionally, SACCO’s margins have held up much better than for any other company. If it can sustain this, earnings will be significantly better than we expected. 93 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi Cement Company Financial statements Year to Reduce Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 1,932 1,183 -219 964 -12 968 968 -24 944 944 1,803 1,150 -214 936 -13 937 937 -23 913 913 1,678 959 -208 751 -11 749 749 -19 730 730 1,561 833 -211 622 -10 621 621 -16 606 606 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 1,168 -110 -105 -862 -200 944 1,046 -90 -82 -849 -116 931 993 -84 -82 -694 -217 900 916 -78 -76 -575 -265 828 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 0 3,015 1,416 383 4,514 274 720 337 3,256 3,774 0 2,886 1,435 454 4,402 151 675 221 3,269 3,717 0 2,763 1,531 596 4,372 159 600 4 3,306 3,538 0 2,629 1,624 786 4,329 161 525 -261 3,336 3,306 Year to 12/2015a 12/2016e 12/2017e 12/2018e 5.1 8.3 2.6 10.1 2.9 10.0 8.8 5.4 8.4 2.6 10.5 2.9 9.8 9.2 5.7 9.9 2.7 13.1 2.9 9.5 7.3 5.9 11.1 2.8 15.8 2.9 8.7 6.0 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2016e 110.00 100.00 100.00 90.00 90.00 80.00 80.00 70.00 70.00 60.00 60.00 50.00 50.00 12/2018e Y-o-y % change -4.6 -11.0 -14.2 -12.9 -12.2 -6.7 -2.8 -2.9 -3.3 -3.3 -6.9 -16.6 -19.8 -20.0 -20.0 -7.0 -13.1 -17.2 -17.1 -17.1 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) 0.5 24.4 29.2 21.2 61.2 49.9 98.1 10.4 0.3 346.6 0.5 24.4 28.0 20.8 63.8 51.9 90.7 6.8 0.2 473.3 0.5 20.2 22.2 16.9 57.1 44.7 86.5 0.1 0.0 - 0.5 17.7 18.2 14.2 53.3 39.8 86.0 -7.8 -0.3 - 6.2 6.2 5.5 21.3 6.0 6.0 5.8 21.4 4.8 4.8 4.5 21.6 4.0 4.0 3.8 21.8 94 Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 40.00 2016 Saudi Cement Company 12/2017e 67% Construction Materials Saudi Arabia Patrick Gaffney, CFA +971 4423 6204 110.00 Ratio, growth and per share analysis 12/2015a Free float Sector Country Analyst Contact Price relative 40.00 2015 Year to 62.53 45.00 3030.SE SACCO AB 2,551 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Saudi Steel Pipes SSP AB, Not rated Company description Founded in 1980, Saud Steel Pipes Company was the first manufacturer for steel pipes in the Kingdom and still the leading Saudi companies in welded steel pipes. The current annual production of the company is 240,000 metric tons of steel pipes with sizes ranging from (1/2 - 20) inches, produced by 4 production lines. The customer list of the company includes oil and gas companies: such as Aramco (Saudi Arabia), ADNOC (UAE), PDO (Oman), KOC (Kuwait) and Qatar Petroleum. The company has a broad base of clients in the construction sector for purposes such as fence manufacturing, scaffolding, fire-fighting systems, lighting poles and traffic lights. Financials SPP reported a net loss of SAR65.6m in 4Q2016 compared to a SAR1.3m net loss in 4Q2015. The higher loss was due to conversion to IFRS accounting standards. This necessitated a number of revaluations and revisions. Investments in associated companies fell SAR35m due to revaluation along with a loss of SAR7.7m in 4Q. Out of service assets were excluded and written-down in the quarter, added an SAR 6.6m loss. Depreciation expense grew by SAR 3.5m, while provision for projects increased SAR 3m. On a quarter-over-quarter basis, net profit fell from SAR5.8m; this was mainly due to the IFRS conversion mentioned above. For the full year, the net loss was SAR46m, with EBIT down 90% to SAR 4.3m and revenues fell 26.4% to SAR627m. Recent News 22 February 2016: The company announced that it had agreed to buy a 30 percent stake in its joint venture Titanium & Steel Manufacturing (TSM Arabia) from its South Korean partner TSM Tech Co. 9 June 2016: SSP announced the appointment of Khalid AlRabea as chairman of the board. 21 December 2016: It announced signing a contract with ARAMCO for the supply of pipes built into the lining of oil and gas wells with a maximum value of SAR 106m. 95 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi Steel Pipes Co. Financial statements Year to Valuation data 12/2013a 12/2014a 12/2015a 12/2016a Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT Taxation Net profit Cash flow summary (SARm) 839 107 24 83 -2 79 0 79 858 78 32 45 -5 23 0 23 852 81 40 41 -7 30 0 30 627 49 45 4 -10 -46 0 -46 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 46 -20 -222 -77 252 26 103 -20 -81 0 -53 83 159 -14 -58 -51 -49 145 76 -10 -54 0 -11 66 18 664 519 37 1,344 96 415 378 785 1,307 16 715 542 6 1,399 182 363 357 803 1,393 13 610 408 6 1,282 144 314 308 777 1,276 9 640 373 17 1,228 145 309 292 727 1,211 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital Ratio, growth and per share analysis Year to Not rated 12/2013a 12/2014a 12/2015a 12/2016a Year to 15.6 33.3 44.4 48.0 2.2 -27.5 -45.4 -70.7 -0.7 3.9 -9.7 28.1 -26.4 -39.6 -89.6 -253.4 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) 0.6 6.1 10.1 5.9 12.8 7.9 59.7 0.5 3.5 0.1 0.6 1.7 2.9 1.7 9.1 9.9 15.2 0.4 4.6 0.2 0.7 2.3 3.8 2.3 9.5 5.3 11.6 0.4 3.8 0.5 0.7 -3.8 -6.3 -3.7 7.8 4.8 4.8 0.4 6.0 0.2 EPS Rep (diluted) DPS Book value 1.57 1.51 15.4 0.58 0 15.7 0.66 1 15.2 -0.91 0 15.3 96 12/2014a 12/2015a 12/2016a 1.5 11.6 0.95 12.0 1.2 2.1 8.1 1.5 16.0 0.89 40.9 1.2 6.7 0 1.5 15.4 0.98 31.9 1.2 11.6 5.3 2 25.5 1.03 N/A 1.2 5.3 0 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Reuters (Equity) Market cap (USDm) Free float Country 18.9 1320.SA 257 27.5 Saudi Arabia Free float Bloomberg (Equity) Market cap (SARm) Enterprise value (SARm) Sector 33 SSP AB 964 1,239 Industrials Price relative 50 50 40 40 30 30 20 20 10 10 0 2014 0 2015 Saudi Steel Pipes Y-o-y % change Revenue EBITDA Operating profit PBT Ratios (%) 12/2013a EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) Source: HSBC Note: Priced at close of 02 Feb 2017 2016 2017 Rel to Tadawul EQUITIES ● SAUDI ARABIA February 2017 Yamama Cement Patrick Gaffney*, CFA Analyst HSBC Bank Middle East Ltd. [email protected] +971 4423 6204 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations YACCO AB, Buy, TP SAR24 Company description Located in the central region, Yamama Cement is the Kingdom’s fourth-largest cement producer, with a capacity of 6.4mtpa. The company holds a 33% stake in Cement Product Industry Co. Ltd. (CPI), which produces cement bags (among other things). Investment thesis The 4Q results for Yamama were disappointing and we do not expect earnings to improve much in the next few years. We look for sales to fall 6% in 2017e and 4% in 2018e before rising again in 2019e. This is based on a small construction project pipeline. However, we believe that the Vision 2030 projects should result in greater construction, especially around infrastructure. The government initiatives around housing should also lead to more house building and increased demand for cement. The Ministry of Housing just announced an agreement with Emaar (EMAAR UH; CP AED7.5; Buy) to build 10,000 units in Riyadh on February 5, 2017. We had also pushed out our assumption on fuel cost increases to 2019e based on government guidance. It appears that the government will link fuel prices to “international” prices starting in 2019e. This will eventually hurt gross margin, but in the short term the company has a reprieve. We think that this bad news is priced in, and investors should understand fairly well the trajectory of earnings over the next few years. The stock price more than reflects this and we have a Buy rating on the stock. Financials Yamama reported weak 4Q2016 figures with net income of SAR43m, well below our SAR73m estimate and down 72% yoy. Sales of SAR233m were below our estimates of SAR257m and down 34% yoy and the company attributed it to lower demand in the domestic market. Gross profit of SAR74m and operating profit of SAR60m were down 63% and 68% respectively. They were below our forecasts of SAR93m and SAR77m, respectively. The decline in gross profit was on the back of an increase in the price of fuel and an increase in the depreciation of fixed assets. Valuation We use a one-year forward EV/EBITDA multiple of 9.5x (unchanged) on 2019e EBITDA and discount that back by two years using WACC. We use a risk free rate of 2.5%, an inflation differential of 4%, an ERP of 6% and a beta of 0.85. We assume a cost of debt of 4% and a debt:equity ratio of 10:90 (all unchanged). This results in a WACC of 10.8%. This is the same as we use in our Saudi property coverage as well. To this we subtract the value of the land minus the value of the new plant construction, but add dividends paid in 2017e and 2018e and net cash to reach an equity value of SAR24 per share. Our target price of SAR24 implies 23.3% upside and we reiterate our Buy rating on the stock. Risks Downside risks include new capacity operating earlier-than-expected, further price reductions and increases in fuel costs greater than we anticipate. Additional capacity in the market could push for greater discounting and hurt profitability and/or market share. 97 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Yamama Cement Company Financial statements Year to Valuation data 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 1,125 692 -278 414 0 392 392 -26 366 366 1,056 618 -278 340 -4 358 358 -19 338 338 1,009 567 -282 285 -4 305 305 -16 289 289 1,040 537 -285 252 -4 273 273 -15 259 259 473 -381 -143 -298 175 92 683 -1,000 -1,000 -201 519 -339 625 -1,500 -1,500 -204 1,078 -899 549 -1,000 -1,000 -206 656 -476 59 1,991 1,400 506 3,974 100 0 -506 3,726 2,843 59 2,713 1,314 488 4,610 100 500 12 3,863 3,499 59 3,931 1,682 909 6,196 100 2,000 1,091 3,948 4,662 59 4,646 2,026 1,253 7,254 106 3,000 1,747 4,001 5,372 Year to 12/2016a 12/2017e 12/2018e 12/2019e 12/2018e 12/2019e 3.2 5.5 1.0 11.6 1.0 -9.9 5.1 4.5 8.0 1.0 13.6 1.0 -26.3 5.2 5.0 9.6 1.0 15.2 1.0 -13.9 5.2 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) -14.2 -22.0 -40.4 -42.2 -42.9 -6.1 -10.7 -17.9 -8.7 -7.6 -4.4 -8.3 -16.2 -14.6 -14.6 3.0 -5.2 -11.6 -10.5 -10.5 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) 0.4 14.4 9.9 9.2 61.5 36.8 0.3 10.2 8.9 8.0 58.5 32.2 160.6 0.3 0.0 5624.8 0.2 6.7 7.4 5.4 56.1 28.2 147.2 27.6 1.9 57.3 0.2 4.8 6.5 3.9 51.7 24.2 139.6 43.7 3.3 31.4 1.7 1.7 1.0 19.1 1.4 1.4 1.0 19.5 1.3 1.3 1.0 19.8 -13.6 -0.7 1.8 1.8 1.5 18.4 19.47 24.00 3020.SE YACCO AB 1,051 Free float Sector Country Analyst Contact 78% Construction Materials Saudi Arabia Patrick Gaffney, CFA +971 4423 6204 Price relative 56.00 51.00 46.00 41.00 36.00 31.00 26.00 21.00 16.00 11.00 2015 Source: HSBC Note: Priced at close of 06 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 98 12/2017e 2.6 4.2 1.0 10.8 1.1 2.7 7.7 56.00 51.00 46.00 41.00 36.00 31.00 26.00 21.00 16.00 11.00 2016 Yamama Cement Company Y-o-y % change EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 12/2016a EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) Ratio, growth and per share analysis Year to Buy 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Yanbu Cement Patrick Gaffney*, CFA Analyst HSBC Bank Middle East Ltd. [email protected] +971 4423 6204 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations YNCCO AB, Hold, TP SAR36 Company description Located in the western region, Yanbu Cement has recently become one of the largest producers in terms of capacity after adding a fifth production line in 2011and securing fuel allocation from Aramco in 2012, bringing total capacity to 6mtpa. The company holds a 60% stake in Yanbu Al Shuaiba Paper Products Company, a bag producer. Investment thesis The 4Q results for Yanbu were weak and we do not expect earnings to improve either. We continue to look for earnings to deteriorate over the next few years, on the back of weaker demand and prices. This is driven by a weak construction environment. However, Yanbu is positioned well as the largest player in the Western region, and it actually performed well in 4Q (sales were up 7% compared to the market declining 21%). This was mainly because of discounting, but shows that the company can compete effectively. Also, as Vision 2030 and housing construction comes through, Yanbu will likely take a solid share of any additional cement demand. We had also pushed out our assumption on fuel cost increases to 2019e based on government guidance. It appears that the government will link fuel prices to “international” prices starting in 2019e. This will eventually hurt gross margin, but in the short term the company has a reprieve. However, YACCO’s share price has fallen 7.5% since the beginning of the year, and we believe that risks are more evenly weighted now. While demand will be weak, this is well understood by the market, and news around government housing and infrastructure projects may boost demand for cement. Financials Yanbu reported weak figures for 4Q2016 with net income of SAR100m, compared to our SAR130m estimate. While revenues were disappointing, it appears that non-operating expenses were a big part of the miss coming in at SAR27m, compared to our estimate of SAR8m. Revenues of SAR303m were 11% below our estimate. This miss was driven by very low prices. In fact, they came in at just SAR152/ton, down 27% qoq. At the same time, volumes were quite strong, surprisingly. This may mean that the company tried to push through some older inventory (which fell about 10% in December) at fire-sale rates. Despite this, gross margin came in at 45% (we had 43%), again speaking to getting rid of old inventories. Valuation We use a one-year forward EV/EBITDA multiple of 9.5x (unchanged) on 2019e EBITDA and discount that back by two years using WACC. To this we subtract net debt, but add dividends paid in 2017e and 2018e. This reaches an equity value of SAR34 per share. We use a risk-free rate of 2.5%, an inflation differential of 4%, an ERP of 6% and a beta of 0.85. We assume a cost of debt of 4% and a debt:equity ratio of 10:90 (all unchanged). This results in a WACC of 10.8%. This is the same as we use in our Saudi property coverage as well. 99 EQUITIES ● SAUDI ARABIA February 2017 Our target price of SAR36 implies 3.9% downside and we maintain our Hold rating on the stock. We believe that the potential upside from new infrastructure and housing construction is equally weighted with downside risks related to demand or higher fuel prices. Risks Upside risks include higher mid-term demand than we expect, higher prices, or lower fuel chargebacks by the government for exports. Downside risks include weaker demand or greater capacity that continue to push down Yanbu sales more than we currently estimate. Fuel prices may also come in higher than we assume in our model. 100 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Yanbu Cement Company Financial statements Year to Valuation data 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Hold 1,286 791 -222 569 -6 547 547 -14 530 530 1,205 730 -220 510 -5 505 505 -13 489 489 1,169 689 -219 470 -3 467 467 -12 452 452 1,175 620 -218 402 3 405 405 -10 392 392 764 -281 -281 -706 229 478 728 -60 -60 -548 -120 668 739 -58 -58 -475 -206 681 613 -59 -59 -392 -162 554 0 3,165 863 111 4,028 130 212 101 3,528 3,787 0 3,006 906 189 3,912 111 170 -19 3,469 3,612 0 2,845 1,048 395 3,893 112 170 -225 3,447 3,386 0 2,685 1,221 557 3,907 123 170 -387 3,447 3,227 Year to 12/2016a 12/2017e 12/2018e 12/2019e 4.7 7.6 1.6 11.1 1.7 8.1 12.0 4.9 8.1 1.6 12.1 1.7 11.3 9.3 4.9 8.2 1.7 13.1 1.7 11.5 8.0 4.7 8.9 1.7 15.1 1.7 9.4 6.6 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2017e 70.00 60.00 60.00 50.00 50.00 40.00 40.00 30.00 30.00 12/2019e Y-o-y % change 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 06 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) -20.3 -23.6 -31.1 -33.4 -34.1 -6.3 -7.6 -10.3 -7.7 -7.6 -3.0 -5.6 -7.9 -7.5 -7.6 0.5 -10.0 -14.4 -13.2 -13.3 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) 0.3 14.7 14.7 13.1 61.5 44.2 138.9 2.8 0.1 757.3 0.3 13.4 14.0 12.5 60.6 42.3 137.9 -0.5 0.0 0.3 13.1 13.1 11.7 58.9 40.2 223.8 -6.5 -0.3 0.4 11.9 11.4 10.1 52.8 34.2 -11.1 -0.6 3.4 3.4 4.5 22.4 3.1 3.1 3.5 22.0 2.9 2.9 3.0 21.9 2.5 2.5 2.5 21.9 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 20.00 2016 Yanbu Cement Company 12/2018e 59% Construction Materials Saudi Arabia Patrick Gaffney, CFA +971 4423 6204 70.00 Ratio, growth and per share analysis 12/2016a Free float Sector Country Analyst Contact Price relative 20.00 2015 Year to 37.48 36.00 3060.SE YNCCO AB 1,574 101 EQUITIES ● SAUDI ARABIA February 2017 Zamil Nicholas Paton*, CFA Senior Research Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6923 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations ZIIC AB, Buy, TP SAR36.7 Company description Zamil Industrial Investment Company is engaged in the development of solutions for use in the construction industry. Zamil implements its engineering through a range of products: pre-engineered steel buildings, steel structures, air conditioning and climate control systems designed for a range of commercial, industrial and residential applications, telecom and transmission towers, process equipment, precast concrete building products, fiberglass, Rockwool and engineered plastic foam insulations, and solar power projects. Zamil also offers installation and erection services. It operates manufacturing facilities in Saudi Arabia, United Arab Emirates, Egypt, India, Vietnam and Italy. Investment thesis Well placed in the Saudi construction market We like Zamil as it is well placed as a local Saudi supplier of energy efficient consumerfocussed products. Saudi Arabia accounted for 83% of Zamil’s revenues in 2016, which is the most challenging market in the GCC. However Zamil is a supplier, rather than a contractor, and does more sales direct to end-users than a contractors would. The company therefore side steps several issues that the contractors in the GCC are facing, which is reflected in the company’s healthier balance sheet and recent profitability. We expect Zamil to continue to benefit from structural growth in housing-related spending due to its expertise in pre-engineered steel buildings and various structural steel products specifically for that market. Housing spending is a major focus for the Saudi administration. Trading at attractive multiples compared to 5-year history Zamil is trading at attractive valuations compared to its historical multiples, it is currently trading at a one year forward consensus PE of 7.4x versus its 5 year average PE of 8.9x. On one year forward EV/sales, it is currently trading at 0.65x versus a 5 year average of 0.80x. Steel and AC segment to partially benefit from consumer exposure We expect Zamil to benefit from its exposure to the consumer segment as industrial activity is at a low ebb driven by falling government spending. Zamil’s air conditioning segment contributes 45% of group revenues (2016), with a high proportion of consumer exposure. The Steel segment contributes 48% to group revenues (2016), and we think Zamil stands to benefit from housing-related spending due to its expertise in pre-engineered steel buildings and various structural steel products. 102 EQUITIES ● SAUDI ARABIA February 2017 Segmental revenue evolution (SARbn) Segmental EBIT (SARbn) 0.5 7.0 6.0 0.4 5.0 4.0 0.3 3.0 0.2 2.0 0.1 1.0 0.0 0.0 2012 2013 2014 2015 2016 2017E 2018E Air Conditioner Industry Steel Industry Glass & Fibreglass Source: Company data, HSBC estimates 2012 2013 2014 2015 2016 2017E 2018E Air Conditioner Industry Steel Industry Glass & Fibreglass Source: Company data, HSBC estimates Financials 4Q results were a slight beat on net income but due to better margins on weaker than expected revenues. 4Q revenues of SAR1,199m was 17% below our SAR1,436m estimate due to lower than expected sales of core products in AC and Steel sector. The company has attributed this to project delays in Saudi. Gross profit of SAR349mn (29% margin) was 10% ahead of our SAR319m (22% margin), EBIT of SAR89m (7.4% margin) was in-line with our estimate and net income of SAR59m (4.9% margin) was 5% ahead of our estimate of SAR56m (3.9% margin). The increase in gross margins is mainly due to better than expected margins in steel and AC sector. The increase in net profit was aided by higher other income and non-controlling interests and due to a reduction in impairment loss. Valuation We value Zamil using a DCF methodology. We use a risk-free rate of 2.5%, an equity risk premium of 7.0%, an inflation differential of 2.0% and a beta of 1.1 (unchanged), giving us a 12.2% cost of equity. We use a cost of debt of 4.8%. Using a long-term debt-to-equity ratio of 50:50 we arrive at a WACC of 8.5%. Our terminal growth assumption is 2.5% and we have a DCF-based target price of SAR36.7, which implies upside of 17.3%. We believe the situation for Saudi suppliers is somewhere near a trough and with a large increase in construction spending needed to complete the Vision 2030 we see upside potential for our estimates and therefore rate the stock a Buy. Downside risks Large-scale cancellation of projects by the government due to low oil prices could lead to lower demand Continued weakness in steel prices could lead to further erosion in steel segment margins Additional subsidy cuts may lead to lower operating margins 103 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Zamil Industries Buy Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 5,491 572 -161 410 -74 303 303 -26 263 263 5,188 497 -160 337 -88 258 258 -39 198 198 5,674 523 -156 367 -91 279 279 -31 225 225 6,017 549 -158 391 -91 303 303 -33 244 244 515 -146 -146 -120 -200 295 520 -130 -130 -120 -182 302 305 -170 -170 -120 76 44 383 -181 -181 -120 8 112 81 1,800 4,313 353 6,446 1,545 2,397 2,044 1,879 4,295 81 1,776 4,277 535 6,389 1,460 2,397 1,862 1,957 4,138 81 1,790 4,551 460 6,681 1,597 2,397 1,938 2,063 4,366 81 1,813 4,790 451 6,946 1,693 2,397 1,946 2,187 4,540 Year to 12/2015a 12/2016e 12/2017e 12/2018e 0.7 6.6 0.9 7.1 1.0 16.8 6.4 0.7 7.4 0.9 9.5 1.0 16.5 6.4 0.7 7.3 0.9 8.3 0.9 2.4 6.4 0.6 7.0 0.8 7.7 0.9 6.0 6.7 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2016e 73.00 63.00 63.00 53.00 53.00 43.00 43.00 33.00 33.00 23.00 23.00 12/2018e Y-o-y % change 0.7 1.6 0.8 -5.9 0.5 -5.5 -13.1 -17.9 -14.7 -24.6 9.4 5.2 8.7 8.2 13.6 6.0 5.0 6.6 8.5 8.5 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) 1.3 8.7 14.5 5.4 10.4 7.5 7.7 95.2 3.6 25.2 1.2 6.8 10.3 4.6 9.6 6.5 5.6 82.9 3.7 27.9 1.3 7.7 11.2 5.0 9.2 6.5 5.8 81.6 3.7 15.7 1.4 7.8 11.5 5.2 9.1 6.5 6.0 77.1 3.5 19.7 4.38 4.38 2.00 31.32 3.31 3.31 2.00 32.62 3.75 3.75 2.00 34.38 4.07 4.07 2.10 36.45 104 Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 13.00 2016 Zamil Industries 12/2017e 75% Building Products Saudi Arabia Nicholas Paton, CFA +971 4 423 6923 73.00 Ratio, growth and per share analysis 12/2015a Free float Sector Country Analyst Contact Price relative 13.00 2015 Year to 31.30 36.70 2240.SE ZIIC AB 501 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Consumers 105 EQUITIES ● SAUDI ARABIA February 2017 Consumers Consumers are trading down but still consuming The largest set of reforms will be in energy prices, where prices could move to US levels but still leave the low income segments better off Companies need to move away from aggressive promotions to ensuring they have the appropriate product mix Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 Ankur Agarwal*, CFA Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6558 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Second round of reforms While a large number of consumer-related companies are listed on the stock market, these companies vary between operating in a fragmented market (ie food retail) to those that almost dominate a particular sub-segment (ie fresh milk & branded apparel). While consumption of most goods falls below the European average, which together with population growth ought to point to structural drivers, the consumer companies face a challenging environment. Over the past few years as oil prices have declined the government has cut budgets and is now working to remove benefits and subsidies. As the government implements these various measures, consumer patterns will change as their income reduces. Following the last round of subsidy reforms, one key trend that management of companies have discussed and we have observed in the numbers reported is that the Saudi consumer is trading down. We also note that discretionary spending like that on apparel has seen a significant drop while in the case of staples retailing consumers are going for less expensive options. However, the income segments are affected differently by these measures; we estimate that by 2020 the lower income household segments are impacted by 17% but allowances mean that they are net beneficiaries to the tune of SAR1,536 per month whereas the high income segments are impacted by SAR3,787 a month (which is 11% of their household income) even after allowances and the middle segments are broadly unaffected. With various government initiatives to increase the number of Saudis employed, we believe that the household income for the bottom two quintiles of the household income segment will see growth from SA119bn in 2015 to SAR151bn in 2020. These measures to increase participation of Saudis in the workforce will affect the consumer stocks in a few ways: Costs will go up for the companies as they either pay an expat levy or hire more Saudis at higher wages (government rebates notwithstanding) Smaller stores will falter as their costs go up and they do not have scale to compete The number of consumers will increase but their purchasing power will be at the low end Impact of new reforms on income quintiles (SAR per month, 2020) Income quintiles Low - 1st 2nd 3rd 4th High - 5th Utility & fuel costs 615 1,013 1,767 2,340 3,363 VAT 63 93 133 164 211 Indirect taxes 82 113 154 178 213 Source: HSBC estimates based on fiscal balance programme published by Saudi government as part of Vision 2030 106 Allowances 2,295 2,295 1,913 1,148 0 Net impact 1,536 1,075 -142 -1,534 -3,787 EQUITIES ● SAUDI ARABIA February 2017 In our note, Age of austerity, 29 Sep 2016, we had talked about the possibility of further subsidy reforms and other direct measures from the Saudi government to cut down the budget deficit. According to the budget document published on 22 Dec 2016, the government estimates the 2017 deficit to drop to SAR198bn (from SAR297bn in 2016) mainly driven by the increase in oil revenues. However, the budgeted expenditure for the year still remains above the levels in 2016 – SAR890bn vs. SAR825bn spent during 2016. To cut down the deficit further in the medium term, the Saudi government has come out with a set of measures, including a second round of subsidy cuts, a new expat levy, VAT (value added tax) and excise tax on certain items. According to our calculations these measures will lead to additional monthly expenditure of SAR618 to SAR2,100 for the average Saudi household between 2017 and 2020 – 4% to 13% of total average household income. Within this we see a varying impact for different income groups. Timeline for planned implementation of reforms -Value aaded taxes (VAT) -Link industrial electricity prices to international benchmarks 2019 -Link residential electricity prices to international benchmarks -Household allowance -Q2 - Excise tax on harmful substances -Q3 - Expat levy 2018 2017 2017-2020: link gasoline and diesel prices to international benchmarks -Gradually link water prices to international benchmarks -Gradually link all unpegged products to reach reference prices (except for butane, propane & natural gas) Source: Saudi fiscal balance program However on the flip side the government is also planning to support low income Saudi households through allowances. With these allowances the net impact on average Saudi household will be very limited. We calculate it to be 1% of their current average household income. But then, we do see stark differences between income groups. On one hand, the two lowest income quintiles will gain excess income of 8-25% of their current household income, the middle income quintile will have almost no impact, while the two high income quintiles will see a burden of 5-6% of their average household income. Saudi budget deficit (2017e, SARbn) and impact of government reforms 200 160 36 120 80 46 20 30 198 20 16 5 30 25 1 40 35 20 16 10 9 Allowances Subsidy cuts phase II-2018e Subsidy cuts phase I-2018e Expat levy -2018e Allowance/ wage cut White land tax Excise tax -2018e VAT -2018e Allowances Budget deficit 2017e Subsidy cuts phase II-2017e Subsidy cuts phase I-2017e Allowance/ wage cut White land tax Excise tax -2Q17e Expat levy -3Q17e 0 Source: Fiscal balance programme, Saudi budget, HSBC estimates 107 EQUITIES ● SAUDI ARABIA February 2017 Household allowances to limit the negative impact of subsidy cuts The Saudi government believes that by removing subsidies and compensating for it through allowances but just for the lower income segments it will first of all reduce wasteful usage of resources and secondly limit the government benefits mechanism only to the most deserving. Household allowance per month (SAR) 80 3,000 70 2,500 1,000 20 500 10 0 2017e 2018e 1st-low 2nd 3rd 0 2017e 2018e 2019e 2020e Source: Saudi fiscal balance programme *Note: the chart shows the range with dashed line referring to higher end of government estimates 1,148 971 30 794 794 662 397 1,500 40 1,942 1,942 1,618 1,412 1,412 1,177 2,000 50 706 60 2,295 2,295 1,913 Household allowance budget (SARbn) 2019e 4th 2020e 5th-high Source: HSBC estimates based on fiscal balance programme published by Saudi government as part of Vision 2030 Although the government has not announced the exact amount of allowances it plans to give to each income group, we do have a broad understanding of the total amount of spending the Saudi government plans to make to fund these allowances. As per the fiscal balance program document, Saudi households in the two lowest quintiles will get the full benefit of these allowances, which will gradually decrease for the third and fourth quintiles. The government will not provide any allowance for households in the highest income quintile group (those having a monthly household income above SAR20,160). Based on the total budget for household allowance, and given the guidance from government on the broad breakdown of allowances among the income group quintiles, we estimate that the two lowest income quintiles will get SAR2,295 per month as an allowance by 2020. Excess cash for lower income groups: 40% of the population, the two lowest income quintiles will get excess cash which will more than compensate for the direct impact of subsidy 2019e 4th 2020e 5th-high Source: HSBC estimates based on fiscal balance program document 1,243 589 1,148 589 844 367 403 -3,439 -4,000 -2,506 -4,861 -1,773 -986 -678 -581 -1,212 -2,143 -731 -1,061 -1,501 -1,534 -3,000 -3,787 -4,000 108 6 -142 -2,000 -2,532 -3,000 2017e 2018e 1st-low 2nd 3rd -1,000 -913 -434 -1,359 -105 -371 -849 -2,000 1,000 0 0 -1,000 Change in income (SAR/month) for Saudi household quintiles If utility tariffs are increased to US levels 2,000 1,536 1,075 1,377 1,014 80 112 1,000 548 338 2,000 1,021 746 Change in income (SAR/month) for Saudi household quintiles If utility tariffs are increased to UAE levels -5,000 2017e 2018e 1st-low 2nd 3rd 2019e 4th 2020e 5th-high Source: HSBC estimates based on fiscal balance program document EQUITIES ● SAUDI ARABIA February 2017 cuts and taxes. Should utility tariffs be raised to UAE levels, the lowest income quintile as per our calculation can get excess cash of SAR1,536 per month per household by 2020. However this does not mean that one should expect a boom in discretionary spend. We believe that prices of goods and services in Saudi will also increase due to the indirect impact, the most significant of which, the expat tax, we discuss subsequently. For the highest income group quintile we estimate an 11% (14% if tariffs are raised to US levels) negative impact on their household income due to higher tariffs and taxes. Percentage change in income for Saudi household quintiles If utility tariffs are increased to UAE levels Percentage change in income for Saudi household quintiles If utility tariffs are increased to US levels 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% 2017e 1st-low 2018e 2nd 3rd 2019e 4th 2020e 5th-high Source: HSBC estimates based on fiscal balance program document 2017e 1st-low 2018e 2nd 3rd 2019e 4th 2020e 5th-high Source: HSBC estimates based on fiscal balance program document There is still no clarity regarding when new utility tariff structures will be implemented in 2017 and what exactly will be the new rates. However, the document released by the government on the fiscal balance programme suggests the potential savings from the new utility tariffs to be SAR29bn in 2017 which it estimates will reach SAR171bn by 2020. If we use UAE-tariff rates, the potential savings for the government will be lower as per our calculations, however, if we use US rates, the savings will be higher. The key takeaway is that, in either case (UAE or US tariffs), the lowest two income group quintiles will be better off due to household allowances. Potential savings for Saudi government from new electricity, water and fuel tariffs (SARbn) Savings from new energy and water price reform –as per fiscal balance program HSBC estimate for savings from new energy and water price reform at UAE rates HSBC estimate for savings from new energy and water price reform at US rates 2017e 29 36 70 2018e 77 46 85 2019e 104 86 131 2020e 171 129 181 Source: Fiscal balance program document and HSBC estimates 109 EQUITIES ● SAUDI ARABIA February 2017 Abdullah Al Othaim Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations AOTHAIM AB, Buy, TP SAR116 Company description Al Othaim is the second largest grocery retail in Saudi in terms of market share. The company operates over 160 stores in Saudi and also has presence in Egypt. Al Othaim operates supermarkets, hypermarkets, convenience stores and wholesale stores in over 30 cities in the kingdom. The group has strong presence in the Central region of the kingdom with very little exposure to Western region. Investment thesis With Saudi consumers trading down especially following the salary/allowance cuts, Al Othaim has seen strong revenue growth as it has gained market share from competition and traditional grocery retailers. In 4Q16 the group reported 24% sales growth while for the full year 2016 it was 19%. We expect that in such a tough environment, retailers like Al Othaim should continue to benefit due to their value proposition and value brand perception. Higher volumes leading to more supplier rebates: Despite operating in such a tough environment, where there is strong price competition and consumers are cutting spending, Al Othaim’s margins dropped by just 20bps during FY16 (compared to 1pp drop for Saudi Marketing and Panda swinging to operating losses). We believe that higher volumes are leading to more supplier rebates for Al Othaim supporting margins and also helping the group to invest further in prices. Financials Al Othaim reported strong sales growth of 24% YoY during 4Q16. Operating income came in at SAR102m, up 20% YoY while net income was up 6% YoY. We estimate the pace of revenue growth from market share gains and expansion to continue for Al Othaim in the medium term and estimate revenue CAGR of 13% between 2016 and 2019 for the group. Although, margins will face headwinds from subsidy cuts and the need to invest more in prices, we believe that over the longer term, the group should benefit from increasing scale and market share gains. Valuation Our DCF model uses a WACC of 8.9% is derived from a cost of equity of 10.2% (ERP of 5.5%, RfR of 5.2% based on the sum of the US 10-year bond yield of 2.4% and the historical SaudiUS inflation differential of 2.8%), a debt-equity ratio of 25:75, beta of 0.9 and cost of debt of 5% (all unchanged). Our DCF generates a target price of SAR116. Our SAR116 target price implies FY18e PE of 15x and upside of 11.6%. We believe the company’s focus on the low- to midincome segment bodes well for future growth as the consumer trades down and hence we have a Buy rating on the stock. Risks Key downside risks: Lower rental income from its malls due to potential increase in retail real estate vacancy rates in Saudi. A slower-than-forecast shift to organised retail in Saudi from traditional retailers, increased competition and introduction of discount stores by competitors, which could attract Al Othaim's target demographic of low to middle-income customers. 110 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Abdullah AL Othaim Market Financial statements Year to Valuation data 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Buy 7,172 389 -155 234 -23 243 243 -12 229 229 8,368 454 -188 266 -16 381 381 -11 370 370 9,356 531 -214 317 -7 349 349 -10 339 339 10,451 612 -251 361 -5 396 396 -12 385 385 390 -502 -502 -90 203 -128 630 -418 -57 -129 -444 100 590 -374 -374 -119 -97 199 757 -314 -314 -135 -309 425 11 1,574 1,289 361 3,557 1,370 804 443 1,313 1,144 11 1,804 1,886 804 4,165 1,625 804 0 1,665 1,272 11 1,965 2,109 902 4,582 1,822 804 -98 1,886 1,362 11 2,027 2,466 1,210 5,035 2,026 804 -406 2,136 1,268 Year to 12/2016a 12/2017e 12/2018e 12/2019e 0.6 11.4 3.9 20.4 3.6 -3.2 1.9 0.5 9.3 3.3 12.6 2.8 2.4 2.8 0.4 7.7 3.0 13.8 2.5 4.8 2.5 0.4 6.1 2.9 12.1 2.2 10.3 2.9 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 103.91 116.00 4001.SE AOTHAIM AB 1,245 136.00 136.00 116.00 116.00 96.00 96.00 76.00 76.00 12/2017e 12/2018e 12/2019e Y-o-y % change 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 18.8 14.7 11.6 3.6 0.6 16.7 16.9 13.6 56.9 61.6 11.8 16.8 19.2 -8.3 -8.3 11.7 15.2 13.7 13.5 13.5 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) 7.3 22.6 18.4 7.6 5.4 3.3 17.2 33.8 1.1 87.9 6.9 21.4 24.8 10.0 5.4 3.2 28.9 0.0 0.0 7.1 23.4 19.1 7.9 5.7 3.4 77.5 -5.2 -0.2 7.9 26.6 19.1 8.1 5.9 3.5 124.6 -19.0 -0.7 5.08 5.08 2.00 29.18 8.21 8.21 2.87 37.01 7.53 7.53 2.64 41.90 8.55 8.55 2.99 47.46 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 56.00 2016 Abdullah AL Othaim Market Ratio, growth and per share analysis 12/2016a 49% Food Products Saudi Arabia Raj Sinha +971 4423 6932 Price relative 56.00 2015 Year to Free float Sector Country Analyst Contact 111 EQUITIES ● SAUDI ARABIA February 2017 Al Khaleej Training Ankur Agarwal*, CFA Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6558 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations ALKHLEEJ AB, Hold, TP SAR 18.00 Company description Founded in 1992 by Al Khaleej Computers and Electronic Equipment and Mr. Alwaleed Aldryaan, Al Khaleej is a leading company in training and education. It provides training courses in Information Technology, English Language, Administrative Training and others and recently has migrated to schools business. Currently, the three largest shareholders are also founders, with a combined share of 28.71%. The company has one of the highest proportions of free-float shares in the market. Investment thesis While the legacy business of Al Khaleej training is significantly affected by the current macro backdrop in Saudi, it is investing in the schools business which overtime will result in a more predictable earnings stream, margins and a higher return on capital employed. However the transition will be complete by 2020. Schools business will be a major value driver for Khaleej and which we believe has the potential to contribute 37% of the total revenue in 2019e versus 11% currently. The training business and the preparatory course programme has been in a structural decline both in terms of revenue and margins in 2015 and we believe that this trend is unlikely to reverse substantially in the near term. Financials Al Khaleej reported 4Q2016 results which were better than expected at the topline and profit levels. Reporting revenue of SAR167m, was down 7.2% y-o-y while 8.2% above HSBC’s estimate of SAR154m, while the overall decrease in y-o-y sales is due to a decrease in the educational sector. Reported gross profit came at SAR49.5m with a margin of 29.6%, down 12% y-o-y and 15.8% above HSBC’s estimate of SAR42.7m at a margin of 27.7%. EBIT reported was 9.4% lower than last year coming in at SAR22.4m and above HSBC’s estimate of SAR19.4m (at an implied margin of 12.6%). Net income for the quarter was SAR19.4m, a 10% decline y-o-y and 31% above HSBC’s estimate. Valuation Our DCF uses a WACC of 9.76%, based on 3:7 debt-equity ratio, CoD of 5%, CoE of 10.8% (based on a RfR of 5.2% (US10Y + Saudi/US inflation differential), an ERP of 5.5%, and beta of 1 .2) (all unchanged). Our target price of SAR18 implies downside of 9.2% from the current stock price and we maintain a Hold rating on Al Khaleej considering the uncertainty around the revenue trajectory of the legacy training business. Key risks Key downside risks: 1) delays in school construction and 2) a faster-than-expected decline in the preparatory course programme. Key upside risks: 1) stronger-than-expected growth and margins in training business and 2) a faster-than-expected ramp up in schools. 112 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Al Khaleej Training Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 726 101 -18 82 -9 75 75 -2 70 70 618 75 -26 48 -16 42 42 -2 40 40 663 68 -25 43 -17 26 26 -1 24 24 730 71 -26 45 -20 25 25 -1 24 24 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) -25 -119 50 -28 103 -161 79 -70 30 -40 22 3 46 -58 -18 -40 52 -15 32 -29 -9 -40 37 0 35 617 459 26 1,130 131 416 390 526 928 35 661 510 103 1,225 126 516 412 526 950 35 693 506 92 1,253 129 556 464 510 987 35 696 509 74 1,260 131 576 502 494 1,009 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 12/2015a 12/2016e 12/2017e 12/2015a 12/2016e 12/2017e 12/2018e 1.6 11.8 1.3 11.3 1.5 -20.2 5.0 2.0 16.2 1.3 20.1 1.5 0.3 5.0 1.9 18.5 1.3 32.8 1.6 -1.9 5.0 1.8 18.2 1.3 33.5 1.6 0.0 5.0 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 19.82 18.00 4290.SE ALKHLEEJ AB 212 Free float Sector Country Analyst Contact 78% Diversified Consumer Services Saudi Arabia Ankur Agarwal, CFA Price relative 66.00 66.00 56.00 56.00 46.00 46.00 36.00 36.00 26.00 26.00 16.00 16.00 Al Khaleej Training 12/2018e 6.00 2016 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Y-o-y % change Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 0.3 -10.8 -14.8 -18.5 -17.6 -15.0 -25.7 -41.1 -44.5 -43.8 7.3 -8.8 -11.3 -37.9 -38.6 10.2 4.5 5.0 -2.2 -2.2 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) 0.8 11.4 13.9 7.9 13.8 11.3 10.6 72.5 3.9 0.7 7.7 7.5 4.7 12.1 7.8 4.8 76.6 5.5 19.1 0.7 6.8 4.7 3.4 10.3 6.5 4.0 88.8 6.8 9.9 0.7 6.9 4.7 3.5 9.8 6.2 3.6 98.8 7.0 6.3 1.76 1.76 1.00 13.16 0.99 0.99 1.00 13.15 0.61 0.61 1.00 12.76 0.59 0.59 1.00 12.35 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value Year to 6.00 2015 Ratio, growth and per share analysis Year to Hold Note: Priced at close of 02 Feb 2017 113 EQUITIES ● SAUDI ARABIA February 2017 Alhokair Tourism AATD AB, Not rated Company description The company was started in 1975 to invest in the sectors of entertainment and hospitality under the leadership of Sheikh Abdulmohsin Alhokair. The group has expanded to include 70 entertainment centres and 34 hotels in Saudi Arabia and the United Arab Emirates. The total area of the entertainment group is 882,226 sqm in Saudi Arabia and the UAE. The Group owns 34 hotels inside the Kingdom, including prominent global brands such as Holiday Inn, Hilton Garden Inn and Accor. The company also has 70 recreational centres that have around 8 million visitors annually. The company employs 4,100 people. Financials Net profit in 4Q16 was SAR 20.2m, a 36.7% decrease, from SAR 30.9m in 4Q15. This was mainly due to decreased hotel demand from individuals and businesses in the Umrah (lesser pilgrimage) season. The company was also affected by the decrease in related companies profits as well as the increase in financing costs driven by higher SAIBOR. This was partially offset by lower rents on its hotel and entertainment locations. On a quarter-over-quarter basis, net profit fell 65.4% mainly due to the seasonality of the business as the previous quarter included: Eid al-Ftr, Eid al-Adha and the school summer vacation. For the full year, net profit dropped 22% yoy to SAR148m, EBIT was SAR 141.1m down by 17.4 and revenues fell 3.4% to SAR679m. Recent News 21 November 2016 - The company announced that its Park Inn by Radisson Hotel in AlJubail is 40% complete and is expected to be completed in the second half of 2017. Its Radisson Blue Hotel in AlKhobar project has been delivered to the contractor and is expected to be completed in 4Q 2018. 12 December 2016 - The company announced signing with Marriott for a hotel and resort in AlKhobar. Construction& development will be done by Mazen AlSaeed Holding Co. and then rented to AlHokair Group for 17 years. The costs of construction and development will be incurred by Mazen AlSaeed Holding Co. 2 February 2017 - The company announced dividends of SAR 0.65 for the second half of 2016. 114 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Abdulmohsen Alhokair Group Financial statements Year to Valuation data 12/2013a 12/2014a 12/2015a 12/2016a Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT Taxation Net profit Cash flow summary (SARm) 880 268 98 169 9 198 3 9 952 286 104 182 12 201 5 12 1,146 296 125 171 10 194 4 10 1,174 284 143 141 17 151 3 17 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 196 -169 -239 -69 52 27 294 -254 -119 0 64 40 321 -297 -271 -138 74 24 190 -216 -193 -105 135 -26 39 739 329 135 1,215 164 251 116 759 1,080 39 899 268 57 1,302 177 316 259 749 1,245 0 1,065 281 38 1,459 253 390 352 762 1,421 0 1,131 383 75 1,616 222 525 450 804 1,541 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital Ratio, growth and per share analysis Year to Not rated 12/2013a 12/2014a 12/2015a 12/2016a Year to 14.2 8.5 11.0 8.0 8.1 6.8 7.5 1.5 20.4 3.4 -6.2 -3.5 2.4 -4.1 -17.4 -22.4 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) 0.8 18.1 25.8 16.1 30.4 19.3 -18.0 0.2 0.4 0.2 0.8 15.8 26.2 15.1 30.1 19.1 -15.0 0.3 0.9 0.2 0.8 13.4 24.9 13.0 25.8 14.9 16.4 0.5 1.2 0.1 0.8 9.6 18.4 9.1 24.2 12.0 8.4 0.6 1.6 -0.1 EPS Rep (diluted) DPS Book value 3.6 1.3 13.8 3.6 0.0 13.6 3.5 2.5 13.9 2.7 1.9 14.6 12/2014a 12/2015a 12/2016a 2.7 8.8 2.2 10.1 2.6 1.4 3.5 2.5 8.3 1.9 10.1 2.7 2.0 0.0 2.1 8.0 1.7 10.5 2.6 1.2 6.9 2.0 8.3 1.5 13.5 2.5 -1.3 5.3 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Reuters (Equity) Market cap (USDm) Free float Country 36.12 1820.SA 530 69% Saudi Arabia Bloomberg (Equity) Market cap (SARm) Enterprise value (SARm) Sector AATD AB 1,987 2,437 Tourism Price relative 120 120 100 100 80 80 60 60 40 40 20 20 0 2014 0 2015 AlHokair Y-o-y % change Revenue EBITDA Operating profit PBT Ratios (%) 12/2013a EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) 2016 2017 Rel To Tadawul Source: HSBC Note: Priced at close of 02 Feb 2017 115 EQUITIES ● SAUDI ARABIA February 2017 Almarai Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations ALMARAI AB, Hold, TP SAR62 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, Egypt and Jordan. As of 2016, 63% 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 Despite the moderate revenue growth and strong margin gains from lower raw material prices during 2016, we maintain our Hold rating on Almarai. Although we acknowledge that Almarai’s dairy and poultry divisions have good structural growth potential in Saudi Arabia, we see increasing pressure on the group’s margins from higher costs related to subsidy reforms and requirements to imports feed. Import tariffs benefit the government more: Saudi government has raised import tariffs for both frozen poultry and long life dairy products (finished) in 1Q17 which could support growth via market share gains for Almarai. While import tariffs help local producers, they also provide an opportunity for the government to introduce initiatives that are effectively indirect taxes, such as levies on expat workers to increase proportion of Saudis employed, which would not necessarily be applicable to imports. Margins improvement is not sustainable: Almarai reported a 90bps operating margin improvement in 2016 driven by lower raw material costs and improving efficiencies. We think these are difficult to sustain: the group will have to import all of its feed requirement by 2019, which it estimates will lead to cSAR200m additional costs per annum; raw material prices will increase as inventories fall; there will be further cuts in energy subsidies later in the year. We see downside risk to sales growth: We believe that Almarai’s 2017 top-line is facing headwinds: devaluation of EGP will continue to drag sales growth till 3Q; cheese and butter sales were down 9% in 4Q16, indicating a significant drop in discretionary spending in Saudi, a trend we believe will continue in 2017; and gains in long life dairy in 4Q were due to new products which will cycle out in 2017. Financials Almarai reported 0.7% growth in revenue mainly driven by growth in long life milk and poultry divisions. Stable raw material prices led to gains in operating margins and operating profit for the quarter was up 15.6%. However, higher financial charges and FX movement limited earnings growth for the quarter to 1%. We estimate revenue growth of 7% for the group with 60bps drop in operating margins for 2017 driven by higher costs related to import tariffs and further subsidy cuts. 116 EQUITIES ● SAUDI ARABIA February 2017 Valuation Our DCF model uses a WACC of 8.6% derived from CoE of 10.2% (ERP of 5.5%, an RfR of 5.2% based on the sum of the US 10-year bond yield of 2.4% and the historical Saudi-US inflation differential of 2.8%), a CoD of 5%, beta of 0.9 and a debt equity ratio of 30:70. Our DCF generates a fair value target price of SAR62. Our SAR62 target price implies FY18e PE of 20x and downside of 10.8%. Although we see structural growth potential for Almarai in dairy and a turnaround in poultry, there is risk in terms of pressure on margins from a cut in subsidies and the requirement to import feed. Furthermore, the stock trades at a FY18e PE of 22x, a 40% premium to Saudi consumer peers. Hence, we maintain our Hold rating. Risks Key downside risks: Almarai imports 60% of its animal feed and all of its ingredients for cheese, butter and fruit juice, from Europe; hence, changes in the EUR/USD exchange rate affect profit margins. There is currently no insurance on the company’s livestock. An epidemic in one farm could have a material impact. Key upside risks: Currently there are restrictions on pricing of fresh dairy in Saudi. Following the cut in subsidies, if the government removes price restrictions, this would be positive for Almarai. Improving performance in poultry division will also have a positive impact. 117 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Almarai Hold Financial statements Year to Valuation data 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 14,699 4,337 -1,795 2,542 -385 2,157 2,157 -74 2,080 2,080 15,776 4,555 -1,922 2,633 -300 2,334 2,334 -77 2,254 2,254 17,287 4,921 -2,011 2,910 -300 2,610 2,610 -85 2,522 2,522 19,010 5,347 -2,110 3,237 -300 2,937 2,937 -95 2,840 2,840 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 4,394 -4,451 -4,900 -720 1,546 -609 4,363 -3,104 -3,104 -789 176 929 4,691 -3,093 -3,093 -883 -55 1,268 5,063 -3,246 -3,246 -994 -139 1,488 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 931 21,138 5,462 730 29,023 3,309 13,319 12,589 11,336 23,492 931 22,705 6,537 1,554 31,665 3,484 14,319 12,765 12,801 25,136 931 24,212 7,207 1,609 33,841 4,017 14,319 12,710 14,440 26,723 931 25,813 7,878 1,749 36,113 4,441 14,319 12,571 16,286 28,432 Year to 12/2016a 12/2017e 12/2018e 12/2019e 4.6 15.7 2.9 26.7 4.9 -1.1 1.3 4.3 15.0 2.7 24.7 4.3 1.7 1.4 3.9 13.8 2.5 22.0 3.9 2.3 1.6 3.6 12.7 2.4 19.6 3.4 2.7 1.8 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 69.50 62.00 2280.SE ALMARAI AB 14,825 86.00 86.00 76.00 76.00 66.00 66.00 56.00 56.00 46.00 46.00 12/2017e 12/2018e 12/2019e Y-o-y % change Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) Source: HSBC Note: Priced at close of 02 Feb 2017 6.6 12.6 12.4 15.7 8.6 7.3 5.0 3.6 8.2 8.3 9.6 8.0 10.5 11.9 11.9 10.0 8.7 11.2 12.5 12.6 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) 0.7 11.0 19.2 8.7 29.5 17.3 11.3 107.1 2.9 34.9 0.6 10.5 18.7 8.4 28.9 16.7 15.2 96.5 2.8 34.2 0.7 10.9 18.5 8.6 28.5 16.8 16.4 85.5 2.6 36.9 0.7 11.4 18.5 9.0 28.1 17.0 17.8 75.2 2.4 40.3 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 2.60 2.60 0.90 14.17 2.82 2.82 0.99 16.00 3.15 3.15 1.10 18.05 3.55 3.55 1.24 20.36 118 36.00 2016 Almarai Ratio, growth and per share analysis 12/2016a 26% Food Products Saudi Arabia Raj Sinha +971 4423 6932 Price relative 36.00 2015 Year to Free float Sector Country Analyst Contact 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Al-Tayyar Travel Group Ankur Agarwal*, CFA Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6558 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations ALTAYYAR AB, Buy, TP SAR50.00 Company description Founded in1980, Al-Tayyar Travel Group (ATG) provides travel and tourism services in Saudi Arabia and across several locations around the world. ATG was founded by Dr. Nasser Al Tayyar, who now controls (directly and indirectly) a 29.72% stake in the company. The company’s main activity is air travel reservation and ticketing, in which it retains a leading market share of ~32% (at 4x the second largest player). ATG is also involved in land and naval transportation, travel insurance, customs clearance, car rental, and has recently expanded into hospitality. Investment thesis ATG is the leader in the air travel industry with a market share of ~32%. It is a diversifying away from the legacy ticketing business which is mostly B-2-B (45% of it is the government while 19% was corporate in 2015) and will be adversely affected by a period of fiscal restraint in Saudi Arabia. We expect it to be challenging for the legacy business (ex - hospitality) to maintain the historical growth rate in the absence of any large client additions, but we are positive on the medium- to long-term potential of the investments in religious tourism and the online travel space. The group’s incremental capex, especially since 2013, is primarily directed towards hospitality assets in Makkah, which will make Al Tayyar a meaningful player in the high potential religious tourism market. Religious tourism is also a focus area in the Saudi government’s Vision 2030. Additionally, the company has also balanced its investments in the hospitality segment with its foray in the capital light but scalable online travel space by acquiring Almosafer, which it will supplement through its own OTA platform, Tajawal. Even if Al Tayyar captures c5% of the online travel space in the MENA region by 2020, it will translate into an additional USD1bn in revenues for the company. In addition to the online airline ticketing space, Al Tayyar had ~20% (pre-deal) stake in Careem, a leading car booking service in the MENA region which recently completed a round of funding from Saudi Telecom Company (STC AB, Hold, CP SAR66.75) of SAR375m which valued the business at USD1.0 billion according to a statement by STC on the Tadawul website. Overall while near-term earnings may remain subdued and working capital requirements may increase in the short term but the valuation looks extremely attractive relative to Saudi consumer peers and the company’s historical valuation. Even if we do not factor in any growth in the travel and tour and hospitality division beyond 2017, and no renewal of MOHE along with gross margin decline, there is still potential upside from current levels. A large client addition could be a catalyst for the stock. Financials Altayyar 4Q16 results came ahead in terms of topline but below expectations in terms of net profit. The reported revenue came at SAR2,036m, down 6.8% y-o-y and 3.1% above HSBC’s estimate of SAR1,974m. Gross profit for the quarter came in at SAR314m (gross margin of 15.4%), 25% decline y-y and 3.1% below HSBC’s estimate of SAR324m (gross margin expectation of 16.4%). 4Q Net income reported by company of SAR145m, (down 33% y-o-y and 119 EQUITIES ● SAUDI ARABIA February 2017 excluding a one off gain of SAR10m, down 37%) was 9.2% below the HSBC estimate of SAR159.7m. Cash flow from operations was SAR367m in 4Q versus SAR 290m in 3Q and -SAR571m in 1H FY16 which meant that it ended 2017 with net cash of SAR172m versus a net debt level of 65m at the end of 9M 2016 and net cash levels of SAR550m at the end of 2015. Valuation Our DCF uses a WACC of 9.6%, based on 2:3 debt-equity ratio, CoD of 5%, CoE of 12.6% (based on a RfR of 5.2% (US10Y + Saudi/US inflation differential), an ERP of 5.5%, and beta of 1.35) (all unchanged). Our target price of SAR50 implies upside of 37.6% from the current stock price and we have a Buy rating on Al Tayyar. Key risks Key downside risks: 1) a further slowdown in government revenues, 2) a higher than expected decline in margins, 3) delays in the completion of religious tourism infrastructure, 4) a further sell down by founder, Nasser Al Tayyar. 120 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Al-Tayyar Travel Group Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 8,631 1,373 -91 1,281 -2 1,205 1,267 -36 1,162 1,222 7,979 1,137 -110 1,027 -8 884 987 -38 840 940 7,780 1,130 -158 972 -35 887 887 -27 854 854 8,546 1,234 -167 1,067 -33 974 974 -29 937 937 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 1,403 -181 -1,438 0 938 1,293 -442 -412 -292 0 966 -718 1,124 -443 -1,019 -419 -201 717 1,071 -477 -1,076 -419 330 638 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 290 4,575 3,409 2,009 8,424 2,823 1,448 -561 3,971 3,443 290 4,877 3,342 1,276 9,576 2,092 1,681 405 5,615 5,141 290 5,162 3,254 1,367 10,238 2,005 1,571 204 6,469 5,335 290 5,472 2,997 926 10,779 2,131 1,460 534 6,987 5,702 12/2015a 12/2016e 12/2017e 12/2015a 12/2016e 12/2017e 12/2018e 0.8 5.0 2.0 5.9 1.8 17.4 0.0 0.9 6.1 1.3 7.9 1.4 -11.0 0.0 0.8 5.5 1.2 8.9 1.2 11.8 5.5 0.7 4.9 1.1 8.1 1.1 11.5 6.1 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 36.33 50.00 1810.SE ALTAYYAR AB 2,024 Free float Sector Country Analyst Contact 58% Hotels Restaurants & Leisure Saudi Arabia Ankur Agarwal, CFA Price relative 113.00 113.00 93.00 93.00 73.00 73.00 53.00 53.00 33.00 33.00 13.00 2016 Al-Tayyar Travel Group 12/2018e 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Y-o-y % change Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) Year to 13.00 2015 Ratio, growth and per share analysis Year to Buy 11.9 11.1 9.0 3.0 8.6 -7.6 -17.1 -19.8 -26.6 -25.3 -2.5 -0.6 -5.3 0.4 -10.7 9.9 9.2 9.7 9.8 9.8 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) 3.6 51.3 35.9 16.2 15.9 14.8 584.9 -14.0 -0.4 1.9 22.9 19.6 9.9 14.3 12.9 137.1 7.2 0.4 1.5 18.0 14.1 9.1 14.5 12.5 32.3 3.1 0.2 550.8 1.5 18.8 13.9 9.4 14.4 12.5 37.9 7.6 0.4 200.4 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 5.81 6.11 0.00 19.86 4.08 4.56 0.00 26.78 4.07 4.07 2.00 30.85 4.47 4.47 2.20 33.33 Note: Priced at close of 02 Feb 2017 121 EQUITIES ● SAUDI ARABIA February 2017 Fawaz AlHokair Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations ALHOKAIR AB, Reduce, TP SAR26 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 2,072 stores, including c1,542 in Saudi Arabia, with a total retail space of c584k sq m. Apart from Saudi Arabia, Alhokair has a presence in North Africa, Central Asia and North America. Investment thesis With increasing pressure on their disposable incomes, Saudi consumers are trading down. We believe that rather than going for extended promotions (like the one Alhokair ran during the last quarter), companies should focus more on moving to the value segment. However, Alhokair has a limited presence in the value segment and is mostly focused on the premium brand category. Although the group has now got the license to sell “Lefties”, a value-brand from Inditex (ITX SM, Buy, EUR31.07), we believe that it will take time to establish this new brand in Saudi. New store openings are slowing down: Over the last five years, Alhokair’s selling space in Saudi has grown at c15% CAGR which has driven strong sales growth. However, over the last year, this space growth has fallen to just 2% as the company had to shut down 131 stores due to weak performance. Furthermore, Alhokair’s stretched balance sheet and debt covenants will limit future store additions for the group – guidance is just 3% space growth in Saudi over the next year. Financials Fawaz Alhokair reported net income of SAR40.5m, down 56% y-o-y for December ending third quarter FY2017. Operating profit for the quarter was down 44% while revenues were down 1.7% YoY. Management pointed to additional mark downs for weaker margins. Following the disposal of Blanco and considering the slowdown in Saudi, we estimate Alhokair’s revenue growth will slow down to just 2% in FY18. Although we estimates margins to improve driven by lower inventory losses, we see potential headwinds from slower sales and potential store closures. Valuation We value Alhokair using a DCF model. We derive our WACC of 9.0% using a cost of equity of 10.7%, a debt to equity ratio of 30:70, a beta of 1 (Bloomberg), cost of debt of 5% and terminal growth of 1%. Our DCF generates a fair value target price of SAR26. Our SAR26 target price implies a FY18e PE of 12x and downside of 20.6%. We see risk to the group’s earnings from discretionary spending cuts hence maintain our Reduce rating. Risks Key upside risks: Stronger-than-expected improvement in margins and a smaller-than-estimated impact from the opening of Saudi retail to foreign players. 122 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Fawaz Abdulaziz Alhokair Financial statements Year to Valuation data 03/2016a 03/2017e 03/2018e 03/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Reduce 7,277 1,009 -335 674 -122 605 605 7 616 616 6,751 901 -352 548 -168 416 416 -46 326 326 6,880 948 -325 623 -157 508 508 -41 471 471 7,152 1,040 -317 723 -137 630 630 -50 583 583 721 -652 -667 -473 398 -24 838 -169 -169 -98 -197 669 714 -275 -275 -141 -341 439 759 -286 -286 -291 -332 473 0 3,320 3,830 500 7,468 1,235 3,628 3,128 2,608 5,415 0 3,172 3,849 696 7,340 834 3,627 2,931 2,837 5,491 0 3,165 4,232 1,037 7,715 884 3,627 2,590 3,166 5,476 0 3,177 4,276 969 7,772 1,052 3,227 2,258 3,457 5,432 Year to 03/2016a 03/2017e 03/2018e 03/2019e 1.3 9.6 1.8 11.2 2.6 -0.4 6.9 1.4 10.5 1.7 21.1 2.4 10.2 1.4 1.3 9.7 1.7 14.6 2.2 6.7 2.0 1.2 8.5 1.6 11.8 2.0 7.2 4.2 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 32.76 26.00 4240.SE ALHOKAIR AB 1,837 130.00 130.00 110.00 110.00 90.00 90.00 70.00 70.00 50.00 50.00 30.00 30.00 03/2017e 10.00 2016 Fawaz Abdulaziz Alhokair Ratio, growth and per share analysis 03/2016a 03/2018e 03/2019e Y-o-y % change 30% Multiline Retail Saudi Arabia Raj Sinha +971 4423 6932 Price relative 10.00 2015 Year to Free float Sector Country Analyst Contact 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 5.5 -11.1 -20.3 -24.3 -20.1 -7.2 -10.7 -18.7 -31.3 -47.0 1.9 5.2 13.6 22.1 44.2 4.0 9.8 16.0 24.0 23.8 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) 1.4 13.3 24.7 8.6 13.9 9.3 8.3 120.0 3.1 23.0 1.2 8.9 12.0 5.0 13.3 8.1 5.4 101.8 3.3 28.6 1.3 10.4 15.7 6.2 13.8 9.0 6.0 80.8 2.7 27.6 1.3 12.2 17.6 7.5 14.5 10.1 7.6 64.7 2.2 33.6 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 2.93 2.93 2.25 12.42 1.55 1.55 0.47 13.51 2.24 2.24 0.67 15.08 2.77 2.77 1.39 16.46 123 EQUITIES ● SAUDI ARABIA February 2017 Halwani Brothers Ankur Agarwal*, CFA Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6558 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations HB AB, Hold, TP SAR52.00 Company description Halwani Brothers is one of the earliest food producers in the Kingdom of Saudi Arabia and has come a long way from a single store in Jeddah in 1952. It currently produces and distributes a range of products, with a total of 400 SKUs split across 4 broad food categories in Saudi Arabia and Egypt: Confectionary: which includes products like halawa, maamoul, and ice cream Sauces, condiments and spreads: includes jams, tahina, olives, pickles, ketchup Processed meat: chilled and frozen Other segments: including packaging, dairy, juice, sambousa, and catering Halwani has 10 factories in KSA and 6 in Egypt, in addition to 2 packaging materials factories. Halwani markets its products under several brand names such as Halwani Bros, Al Nakhla, Mokhtarat, Top, Freshy, Thini, and others. Investment thesis Halwani Brothers is a dominant player in the processed meat category in Egypt (with a more than 50% market share in the combined frozen/chilled meat category) and in sesame-based products in Saudi Arabia (with a c50% market share). The group’s geographical sales split in 2015 was 47% Egypt, 40% from Saudi Arabia, and 13% from exports. Egypt central bank floated the EGP following which the currency depreciated more than 100%. This impacted Halwani’s valuations and resulted in a one-time charge of SAR58m in Q4 2016. We believe the depreciation will lead to a decline in Egypt sales of approximately 25% in 2017, and any recovery in sesame prices will bring down the margin of Saudi sales. While the business is defensive with a premium positioning in niche food categories, we believe that at the current stock price, the stock is in the fair value zone. Financials Halwani Bros. posted a weak set of Q4 2016 numbers. It reported revenue of SAR215m, a decline of 18% y-o-y and 19% lower than HSBC’s estimate of SAR267m. Gross profit for the quarter came at SAR74.9m (at 34.8% margin), 10% lower than Q4 2015 (31.7% margin) and 8.2% lower than HSBC’s estimate (30.6% margin); the higher margin was attributed to an increase in profit from the decrease in raw materials prices and price increases on products. Reported EBIT of SAR25.7m (12.0% margin) was 30.9% below last year (14.2% margin) and 36.8% below HSBC’s estimate of SAR40.7m (15.3% margin). The company attributed the decline in margin to a higher selling & distribution expense, and an increase in depreciation which were partly offset by the reversal of a provision for doubtful debt. The company reported a net loss of SAR15.7m Q4 2016 versus Q4 2015 reported net income of SAR38.7m, but above HSBC’s estimate of a net loss of SAR20.2m owing to the reversal of income tax in a subsidiary company as a result of the realised forex losses. 124 EQUITIES ● SAUDI ARABIA February 2017 Valuation Our DCF uses a WACC of 9.0%, based on a 3:7 debt-equity ratio, CoD of 5%, CoE of 10.7% (based on a RfR of 5.2% (US10Y + Saudi/US inflation differential), an ERP of 5.5%, and beta of 1) (all unchanged). Our target price of SAR52 implies downside of 11.9% from the current stock price. We have a Hold rating on the stock following the devaluation of EGP. Key risks Key downside risks: 1) we have factored in a stabilisation of sesame prices at the current levels based on trends in sesame production and demand. However, an uptick in sesame prices may mean a deviation from our margin assumptions. 2) Further depreciation of EGP Key upside risks: Stronger than expected growth in Egypt, appreciation of EGP 125 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Halwani Brothers Hold Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 1,075 173 -25 149 -12 147 136 -32 115 108 1,039 188 -41 147 -15 80 132 -32 48 83 959 167 -43 124 -9 115 115 -29 86 86 1,066 183 -43 140 -9 131 131 -32 98 98 124 -142 -110 -57 97 -32 55 -65 22 -71 82 38 159 -43 -71 -71 -45 113 114 -43 -72 -86 15 68 0 637 452 52 1,088 172 222 170 657 865 0 661 473 57 1,133 154 309 252 633 923 0 661 451 73 1,112 146 280 207 648 893 0 661 445 28 1,106 157 251 222 660 920 Year to 12/2015a 12/2016e 12/2017e 12/2018e 1.7 10.7 2.1 15.6 2.6 -1.9 4.2 1.9 10.3 2.1 20.4 2.7 2.2 4.2 2.0 11.3 2.1 19.6 2.6 6.7 5.1 1.8 10.4 2.1 17.1 2.6 4.0 5.1 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2016e 105.00 95.00 95.00 85.00 85.00 75.00 75.00 65.00 65.00 55.00 55.00 45.00 45.00 Halwani Brothers 12/2017e 12/2018e Y-o-y % change 1.0 8.5 10.8 9.4 20.5 -3.3 8.4 -1.3 -45.8 -23.5 -7.7 -11.1 -15.3 44.3 4.0 11.2 9.4 12.6 13.8 14.7 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) 1.4 14.7 17.0 11.4 16.1 13.8 14.0 25.9 1.0 73.0 1.2 9.8 12.8 5.0 18.1 14.1 12.6 39.8 1.3 21.7 1.1 10.2 13.4 8.3 17.4 13.0 17.8 32.0 1.2 76.5 1.2 11.6 15.1 9.5 17.1 13.1 19.7 33.6 1.2 51.1 4.03 3.78 2.50 23.00 1.66 2.89 2.50 22.16 3.00 3.00 3.00 22.67 3.45 3.45 3.00 23.11 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 126 Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 44% Food & Staples Retailing Saudi Arabia Ankur Agarwal, CFA 105.00 Ratio, growth and per share analysis 12/2015a Free float Sector Country Analyst Contact Price relative 35.00 2015 Year to 59.00 52.00 6001.SE HB AB 450 35.00 2016 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Herfy Food Services Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations HERFY AB, Buy, TP SAR94 Company description Herfy is one of the largest players in the Saudi fast food market with interests in rusk production, meat processing and bakeries. It also has franchised fast food outlets in Bahrain, Kuwait and the UAE. The fast food operations contributed c86% of Herfy’s revenue in 2016. As of end 2016, Herfy operated c340 fast food outlets, one of the largest such groups in the Kingdom. Investment thesis Despite the recent weakness in sales growth, we continue to like Herfy and see it as one of the best propositions for investors in Saudi considering the current environment. Herfy trades at a discount to Saudi consumer peers in terms of 2018e PE. We think it should trade at a premium for the following reasons: 1) Herfy is already operating in an openly competitive and fragmented market where international players are already present – hence easing of foreign investment norms in Saudi would have only a limited impact; 2) Herfy’s product positioning is in the value segment, which should prove beneficial as consumer discretionary spending moves towards value as a result of subsidy reforms; 3) the company has a vertically integrated operating model that helps it operate at a high margin and price products more competitively; 4) among Saudi consumer companies, Herfy is one of the least dependent on government subsidies. Further subsidy reforms will have only a limited impact on group costs; 5) Herfy’s expansion plan is strong and the group’s recent openings, once mature, should start to contribute to strong revenue growth in the coming quarters. Financials Herfy has reported preliminary 4Q16 numbers. The company reported net income of SAR55.3m, up 22% during 4Q16. Operating profit came in at SAR58m, up 26% while revenues for the quarter came in at SAR280m, up 2.7% YoY. Management pointed to lower raw material costs for the strong margin gains. Herfy opened 10 new outlets in 4Q 2016 and 36 new outlets for full year 2016. We estimate revenue CAGR of 10% for the group between 2015 and 2018 driven by strong expansion. We believe that margins should remain stable despite the headwinds from subsidy reforms and discretionary spending cuts as the group gains from its vertically integrated operating model and stable raw material prices. Valuation We value Herfy using a DCF model. The WACC of 9.1% is derived from a cost of equity of 10.2% (ERP of 5.5%, RfR of 5.2% based on the sum of the US 10-year bond yield of 2.4% and the historical Saudi-US inflation differential of 2.8%), debt-equity ratio of 20:80, beta of 0.9, a terminal growth rate of 2% and cost of debt of 5%. This leads to a target price of SAR94. Our SAR94 target price implies a FY17e PE of 16x and 18.6% upside. We see Herfy as among the best-placed Saudi consumer stocks to tackle the double impact of subsidy cuts and growing competition from easier foreign investment in the Saudi retail sector. Considering future new opening plans and the large number of outlets opened in 2016 that are yet to operate at a mature level, we see strong potential for the group in the medium term in terms of earnings growth. Hence we have a Buy rating on the stock. 127 EQUITIES ● SAUDI ARABIA February 2017 Risks Key downside risks: delays in new outlet openings, higher-than-expected growth in raw material prices leading to lower margins, or a drop in Saudi consumer confidence. 128 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Herfy Food Services Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 1,077 288 -80 208 -4 207 207 -4 203 203 1,185 312 -89 222 -11 221 221 -4 217 217 1,341 356 -101 256 -17 250 250 -5 245 245 1,456 393 -113 281 -22 271 271 -5 266 266 275 -289 -273 -145 130 -17 288 -210 -210 -147 69 68 325 -230 -230 -165 71 84 362 -190 -190 -179 7 160 0 937 252 23 1,189 169 284 261 735 997 0 1,058 309 54 1,367 176 384 330 806 1,136 0 1,188 370 83 1,558 188 484 401 886 1,287 0 1,265 390 76 1,655 199 484 408 972 1,380 12/2015a 12/2016e 12/2017e 12/2015a 12/2016e 12/2017e 12/2018e 3.6 13.6 3.9 18.1 5.0 -0.5 3.7 3.4 12.8 3.5 16.9 4.5 1.8 4.0 3.0 11.4 3.2 14.9 4.1 2.3 4.5 2.8 10.3 2.9 13.8 3.8 4.4 4.9 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 79.28 94.00 6002.SE HERFY AB 976 Free float Sector Country Analyst Contact 31% Hotels Restaurants & Leisure Saudi Arabia Raj Sinha +971 4423 6932 Price relative 132.00 132.00 112.00 112.00 92.00 92.00 72.00 72.00 Herfy Food Services 12/2018e 52.00 2016 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Y-o-y % change Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) Year to 52.00 2015 Ratio, growth and per share analysis Year to Buy 18.3 15.9 7.5 -1.1 -1.5 10.1 8.0 6.9 7.1 7.1 13.1 14.3 14.9 12.9 12.9 8.6 10.5 9.8 8.5 8.5 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) 1.2 22.6 28.7 18.7 26.8 19.3 75.8 35.5 0.9 105.0 1.1 20.5 28.2 17.0 26.3 18.8 28.1 41.0 1.1 87.1 1.1 20.7 29.0 16.8 26.6 19.1 21.3 45.3 1.1 81.0 1.1 20.6 28.6 16.5 27.0 19.3 18.1 42.0 1.0 88.9 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 4.39 4.39 2.96 15.92 4.70 4.70 3.17 17.45 5.30 5.30 3.58 19.17 5.75 5.75 3.88 21.04 Note: Priced at close of 02 Feb 2017 129 EQUITIES ● SAUDI ARABIA February 2017 Jarir Marketing Co Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations JARIR AB, Buy, TP SAR160 Company description Jarir is one of the largest electronics retailers in Saudi. 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-2016, the company operated 45 showrooms. Apart from Saudi Arabia, Jarir has outlets in Qatar, the UAE and Kuwait, and has real estate investments in Egypt. Investment thesis Jarir reported 17.7% y-o-y sales growth in Q4 following four quarters of falling sales, driven by strong smartphone sales as the retailer gained significant market share from smaller retailers as many of the smaller mobile phone retailers had to shut down due to the implementation of the 100% Saudisation rule for the sector along with a general slowdown in the kingdom. We see this trend to continue in the medium term. Our analysis of other markets, eg Russia, indicates that during times of downturn as consumers trade down and cut spending, retailers with scale gain market share over smaller players. We believe that Jarir is able adapt its product portfolio to changing trends and may well generate higher margins on unbranded electronic products which have much lower prices than branded products. Driven by these factors we see strong revenue growth for the group in the medium term despite the potential discretionary spending cuts by Saudi consumers. Financials Jarir reported sales growth of 17.7% YoY in 4Q16 driven by strong smartphone sales. Operating income came in at SAR210m, up 6% YoY and the weakness in margins was due to a shift in sales mix. Earnings for the quarter were up 3% YoY. We estimate c5% revenue growth for the group in the medium term driven by new openings and market share gains in Saudi smartphone retail. Despite the headwinds in the form of subsidy cuts, shift in product mix and expat levies, we estimate margins to remain stable as the group gains from increasing scale and efficiency improvements. Valuation Our fair value target price for Jarir is DCF-based. We assume a WACC of 8.6%, which is derived from a cost of equity of 10.2%, debt-equity ratio of 30:70, beta of 0.9, terminal growth rate of 2.5%, and cost of debt of 5% (all unchanged). Our DCF valuation generates a fair value target price of SAR160. Our SAR160 target price implies a FY18e PE of 18.5x and upside of 27.0%. We maintain our Buy rating on Jarir. Risks Downside risks: Slowdown in discretionary spending in Saudi. The opening of the Saudi retail and wholesale markets to 100% foreign ownership could also pose a downside risk. 130 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Jarir Marketing Co Financial statements Year to Valuation data 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Buy 6,123 748 -43 705 -4 751 751 -13 738 738 6,390 743 -50 693 5 751 751 -19 732 732 6,696 793 -56 738 3 796 796 -20 776 776 7,116 836 -62 774 5 837 837 -21 817 817 948 -127 -172 -639 -73 733 757 -168 -168 -622 50 553 784 -179 -179 -660 -60 589 823 -188 -188 -694 -52 619 0 1,269 1,340 158 2,637 1,107 0 -158 1,530 1,344 0 1,387 1,330 108 2,745 1,122 0 -108 1,622 1,487 0 1,510 1,435 168 2,973 1,196 0 -168 1,777 1,581 0 1,636 1,552 220 3,216 1,282 0 -220 1,933 1,686 Year to 12/2016a 12/2017e 12/2018e 12/2019e 1.8 15.0 8.3 15.4 7.4 6.5 5.6 1.8 15.1 7.6 15.5 7.0 4.9 5.5 1.7 14.1 7.1 14.6 6.4 5.2 5.8 1.6 13.3 6.6 13.9 5.9 5.5 6.1 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2017e 212.00 162.00 162.00 112.00 112.00 Jarir Marketing Co 12/2018e 12/2019e Y-o-y % change 43% Multiline Retail Saudi Arabia Raj Sinha +971 4423 6932 212.00 Ratio, growth and per share analysis 12/2016a Free float Sector Country Analyst Contact Price relative 62.00 2015 Year to 126.00 160.00 4190.SE JARIR AB 3,024 62.00 2016 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) -4.0 -11.0 -12.9 -11.8 -10.9 4.4 -0.6 -1.7 -0.1 -0.8 4.8 6.8 6.4 6.1 6.1 6.3 5.4 4.9 5.2 5.2 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) 4.5 50.6 48.7 29.2 12.2 11.5 179.1 -10.3 -0.2 4.5 47.7 46.4 27.2 11.6 10.8 4.4 46.9 45.7 27.2 11.8 11.0 4.4 46.2 44.0 26.4 11.7 10.9 -6.6 -0.1 -9.5 -0.2 -11.4 -0.3 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 8.20 8.20 7.10 16.99 8.13 8.13 6.91 18.03 8.63 8.63 7.33 19.74 9.07 9.07 7.71 21.48 131 EQUITIES ● SAUDI ARABIA February 2017 Saudi Airlines Catering Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations CATERING AB, Hold, TP SAR92 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), and provides lounge services at airports and on the ground catering services to both companies and religious travellers. Investment thesis Although we see robust growth for the group in the near term from fleet expansion at Saudi Arabian Airlines, we believe that the margins of Saudi Airlines Catering will remain under pressure. Furthermore, with the cuts in discretionary spending in Saudi, we believe that per flight revenues could see some drop for the group. Cuts in government spending is an overhang: We estimate a 10pp drop in SACC’s long-term operating margins from 2020e as we believe it is at risk of significant cuts, as Saudia (which contributes over 60% of SACC’s revenues) is likely to renew the contract in 2019 at lower price terms. Hence we estimate 2020e earnings to drop to 2016 levels. Furthermore, with potential subsidy reforms to come in the next few years we see cuts in discretionary spending in Saudi which in our opinion will lead to slower growth for SACC. Diversifying is understandable but new divisions will not contribute enough: To mitigate single customer risk the company is attempting to diversify, unfortunately nothing is as lucrative as the current catering deal with Saudia. There is growth in Skysales and business lounges but some of the other contracts signed recently are small: a three-year deal with Al Bayraq Airlines for inflight catering and retail for SAR81m, renewal of the in-flight catering contract with Oman Air and a two-year contract for security services for SAR12m with Saudi Airlines Cargo. Dividends still a positive: The company continues to have strong enough cash flow to support a dividend yield of 6.8% in 2016, which we believe can be sustained given a net cash position. Financials Saudi Catering reported preliminary 4Q16 results. The company reported net income of SAR105m, down 45% for the quarter 4Q16. Operating income came in at SAR103m, down 44% y-o-y while net revenue came in at SAR535m, down 4% YoY. Management pointed out that in the base period 4Q15 the company had released SAR20m provision for rent which did not come through in the current quarter. Among the divisions, in-flight catering revenues were down 7%, non-airline revenues were down 6% and retail revenues were up 10%. For the medium term between 2015 and 2018 we estimate revenue CAGR of c8% with stable margins as the group gains from fleet expansion at Saudi Arabian Airlines and through new non-airline contracts. Valuation We value SACC using a DCF model. The WACC of 9.1% is derived from a cost of equity of 10.2%, a debt-equity ratio of 30:70, beta of 0.9, terminal growth of 2%, cost of debt of 5%. Our 132 EQUITIES ● SAUDI ARABIA February 2017 DCF generates a fair value target price of SAR92. Our SAR92 target price implies FY17e PE of 11x and upside of 2.1%. Although we see strong medium-term growth potential for the group from fleet expansion at Saudi Arabian Airlines, we believe that the margins will remain under pressure. Further, we estimate a 10pp drop in SACC’s long-term operating margins from 2020e as we believe it is at risk of significant cuts, as Saudia (which contributes over 60% of SACC’s revenues) is likely to renew the contract in 2019 at lower price terms. Hence we estimate 2020e earnings to drop to 2016 levels. Furthermore, with potential subsidy reforms to come in the next few years we see cuts in discretionary spending in Saudi which in our opinion will lead to slower growth for SACC. Hence we have a Hold rating on the stock. Risks Key downside risks include: Around 60% of the company’s revenues come 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 for SACC is dependent on Saudia’s fleet expansion. If the fleet expansion is below expectations it could lead to lower revenues for SACC. Since air travel is a discretionary expenditure, a drop in consumer confidence could negatively affect our top-line forecast for SACC. Key upside risks include: We currently estimate SACC’s operating margins to drop to 18% in 2020e from the current level of 28% as we believe that Saudia will significantly alter the terms of contract when it is up for renewal. A scenario where such a move does not happen would imply a higher valuation for SACC. 133 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi Airlines Catering Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Hold 2,261 694 -25 669 0 699 699 -42 657 657 2,261 619 -38 580 0 588 588 -32 556 556 2,458 697 -44 653 0 662 662 -36 626 626 2,748 806 -49 757 0 766 766 -42 724 724 581 -292 -292 -564 167 261 521 -147 -147 -533 191 334 686 -147 -147 -563 61 493 779 -151 -151 -651 66 576 0 513 1,335 509 1,848 527 0 -509 1,318 812 0 621 1,247 318 1,868 525 0 -318 1,341 1,026 0 725 1,223 257 1,948 541 0 -257 1,404 1,150 0 826 1,214 191 2,041 561 0 -191 1,477 1,288 Year to 12/2015a 12/2016e 12/2017e 12/2018e 3.0 9.9 8.5 11.2 5.6 3.5 7.6 3.1 11.4 6.9 13.3 5.5 4.5 7.2 2.9 10.2 6.2 11.8 5.3 6.7 7.6 2.6 8.9 5.6 10.2 5.0 7.8 8.8 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 90.11 92.00 6004.SE CATERING AB 1,968 205.00 205.00 185.00 185.00 165.00 165.00 145.00 145.00 125.00 125.00 105.00 105.00 85.00 85.00 Saudi Airlines Catering Ratio, growth and per share analysis 12/2015a 12/2016e 12/2017e 12/2018e 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 (diluted) HSBC EPS (diluted) DPS Book value 134 Source: HSBC Note: Priced at close of 02 Feb 2017 5.8 6.4 5.6 6.8 8.1 0.0 -10.8 -13.3 -15.8 -15.4 8.7 12.7 12.6 12.6 12.6 11.8 15.6 15.8 15.8 15.8 3.3 92.2 51.6 35.9 30.7 29.6 2.5 59.7 41.8 29.9 27.4 25.7 2.3 56.8 45.6 32.8 28.4 26.6 2.3 58.7 50.3 36.3 29.3 27.5 -38.6 -0.7 -23.7 -0.5 -18.3 -0.4 -13.0 -0.2 8.01 8.01 6.88 16.08 6.78 6.78 6.50 16.35 7.63 7.63 6.86 17.12 8.83 8.83 7.94 18.01 30% Commercial Services Saudi Arabia Raj Sinha +971 4423 6932 Price relative 65.00 2015 Year to Free float Sector Country Analyst Contact 65.00 2016 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Saudi Company Hardware Ankur Agarwal*, CFA Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6558 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations SCH AB, Buy, TP SAR107.00 Company description Founded in 1984, Saudi Company for Hardware (SACO) is one of the largest retailers providing home improvement products in Saudi Arabia, with a product portfolio encompassing housewares, electrical appliances, furniture, power tools, building material, sporting equipment, and automotive and plumbing accessories, among other categories (numbering at over 45,000 SKUs). The company currently has 26 stores in 14 cities around Saudi (2 of which are franchisees), with formats varying in size from 2,000-24,500 sqm (SACO World), with ~12m visitors in 2014 to the company’s then 23 stores (company’s estimate). Aside from retail, the company has a small wholesale component (~1.4% of 2014 revenues), which sells the same tools and equipment to contractors. Investment thesis We view SACO as a high quality retailer whose format lends itself to greater product mix flexibility. SACO’s product portfolio is relatively resilient to the deflationary trends faced by other discretionary retailers, especially those in the electronics category. SACO continued its outperformance in Q4 2016 with revenue/ earnings growth of 9.2%/9.5% respectively, compared to average 4Q16 revenue/earnings growth of 6.5% / -5.0% respectively by other listed Saudi consumer companies (ex-Savola). LFL for the company increased by 5.5% in spite of the decrease in average basket size. LFL for 2016 was limited to a decline of 1.6% confirming that its target consumer segment was less impacted by the austerity measures in Saudi. The addition of 2 new stores along with operating efficiency meant that sales were flat while recurring earnings were up 3.1% in 2016. SACO's cash flow from operations in 2016 more than tripled on the back of a reduction in inventory days from 213 days in 2015 to 176 days in 2016 (versus our expectation of 195 days) which resulted in a Net Debt reduction from SAR172m in 2015 to SAR21m in 2016 (or SAR6.3/share). After this sharp improvement we now forecast a modest reduction in inventory days from 176 in 2016 to 170 by 2020. We expect ~15% area addition in 2017 followed by ~11.3% in 2018 to offset a benign LFL trajectory and allow SACO to gain market share especially from the unorganized/sub-scale retailers in the home-improvement space. We believe that the current PE valuation of 15.4x in 2017e with 3.7% dividend is reasonable for a strong retail franchise focused on the value segment in Saudi. SACO trades at a 28% discount to global peers (average PE 2017e of 21.4x) in spite of similar medium-term growth prospects and ROE profile. Our revised target price implies a target valuation of 18.7x for FY17e EPS, which we believe is reasonable in the context of an HSBC EPS 2016-18e CAGR of 11% and an average ROE of 25.6% in 2017- 2018e. Financials SACO’s Q4 2016 top line/earnings were ahead of our estimates .The increase was attributed to the ramp-up of the 2 new stores opened during 2016 and the inclusion of Medscan from the date of the acquisition. SACO’s 4Q revenue SAR384m was up 9.2% y-o-y and 4.1% above HSBC’s estimate of SAR369m. EBIT during the quarter increased to SAR46m up 28.9% y-o-y 135 EQUITIES ● SAUDI ARABIA February 2017 and 37.9% above HSBC estimate of SAR33m, mainly as SG&A expenses and financial charges saw a decline. Net income at SAR41m was up 9.2% y-o-y on the reported net income last year (which included a SAR4.57m one-off insurance claim impact) and 34.7% higher than our estimate of SAR31m. Medscan added ~SAR1.9m to the top line (or an additional 0.5% in topline growth) and SAR181,000 to net income (or an additional 0.48% in net income growth). Valuation Our DCF uses a WACC of 8.71%, based on 7:13 debt-equity ratio, CoD of 5%, CoE of 10.7% (based on a RfR of 5.2% (US10Y + Saudi/US inflation differential), an ERP of 5.5%, and beta of 1) (all unchanged). This leads to a target price of SAR107 (unchanged). Our target price of SAR107 implies upside of 16.6% from the current stock price. We have a Buy rating on SACO considering the strong long-term potential of the group. Key risks Key downside risks: 1) Potential slowdown in like for like sales due to sharper-than-expected decline in consumer spending; 2) Slower pace of expansion or sales ramp-up in new stores 136 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi Company Hardware Financial statements Year to Key forecast drivers 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 1,324 172 -33 139 -5 136 135 -10 126 125 1,509 192 -41 150 -3 149 149 -11 138 138 1,724 218 -46 172 -5 168 168 -13 155 155 1,919 242 -53 189 -8 182 182 -14 169 169 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 287 -69 -227 -36 -151 192 157 -65 -63 -79 -15 91 159 -83 38 -89 11 74 184 -82 -50 -96 -8 101 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 0 241 645 55 894 307 76 21 511 524 0 262 719 69 990 345 76 6 569 567 0 298 914 178 1,220 389 196 18 635 645 0 324 1,030 216 1,362 428 226 9 708 709 Ratio, growth and per share analysis Year to 12/2016a 12/2017e 12/2018e 12/2019e 3.7 6.4 5.4 1.4 3.1 14.0 11.3 8.2 9.0 10.2 14.2 13.5 14.2 13.0 13.0 11.3 11.2 9.9 8.6 8.6 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 (diluted) HSBC EPS (diluted) DPS Book value Buy 2.3 22.5 25.8 14.8 13.0 10.5 33.9 4.2 0.1 1348.8 2.8 25.5 25.5 14.9 12.7 10.0 67.9 1.1 0.0 2460.2 2.8 26.2 25.8 14.5 12.6 10.0 43.1 2.8 0.1 902.4 2.8 25.8 25.1 13.6 12.6 9.8 30.9 1.3 0.0 1962.1 5.26 5.20 3.00 21.28 5.73 5.73 3.30 23.70 6.47 6.47 3.70 26.48 7.03 7.03 4.00 29.51 Year to Avg. area (sqm) Area growth (%) Store count (ex. Franchisees) Sales density (SAR/sqm) SAR/sqm growth (%) 12/2016a 12/2017e 12/2018e 12/2019e 141,236 9 26 9,204 -1 158,150 12 30 9,066 -2 178,765 13 35 9,202 2 193,727 8 38 9,478 3 Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e 1.7 12.8 4.2 17.6 4.3 8.8 3.3 1.5 11.4 3.9 16.0 3.9 4.2 3.6 1.3 10.1 3.4 14.1 3.5 3.4 4.0 1.1 9.1 3.1 13.0 3.1 4.6 4.4 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 91.73 107.00 4008.SE SCH AB 586 Free float Sector Country Analyst Contact 30% Specialty Retail Saudi Arabia Ankur Agarwal, CFA Price relative 160.00 160.00 140.00 140.00 120.00 120.00 100.00 100.00 80.00 80.00 60.00 60.00 40.00 2015 40.00 2016 Saudi Company Hardware 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 137 EQUITIES ● SAUDI ARABIA February 2017 Saudi Dairy & Foodstuff Ankur Agarwal*, CFA Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6558 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations SADAFCO AB, Buy, TP SAR162.00 Company description Saudia Dairy and Foodstuff Company (SADAFCO) was founded in 1976 and operates primarily in the imported dairy processing segment (dairy products accounted for 85% of total sales in FY2016). The company relies on its flagship brand “Saudia,” which has strong recall in the domestic market. SADAFCO’s products include long life milk, powdered milk, flavoured milk, ice cream, cheese, and other products (tomato paste, ketchup, frozen French fries and potato chips). SADAFCO has a presence in other countries in the MENA region, but Saudi Arabia is the dominant country, contributing 92.7% of the company’s revenues. Among other markets, Qatar was the largest, contributing 2.5% of total revenue in FY 2016. Investment thesis We favour SADAFCO given its revenue as a staples/dairy producer is largely inelastic to the current macro backdrop in Saudi. SADAFCO’s cost competitiveness versus the more water and energy intensive fresh dairy increases on the back of subsidy cuts, in our view. SADAFCO’s earnings in the first 9 months of FY17 (April-September 2016) rose 26% due to raw material tailwinds, which has resulted in significant gross margin expansion. Average gross margin of 40.9% in 9M FY17 was the highest for seven years. Skimmed milk powder prices have increased 14% since the end of 3Q 2016, but we believe that margin strength relative to last year may persist longer for SADAFCO than these milk powder prices suggest. This depends on how long SADAFCO has locked in raw material prices. We conservatively assume SADAFCO’s gross margin declines by 211bps y-y in 4Q FY17 and declines by around 274bps in FY18 (versus FY17 average levels). The valuation for SADAFCO, a defensive company with a solid balance sheet (SAR13/share of net cash) and a steady earnings growth, is compelling. It currently trades at 13.1x FY18, a 40% discount to Almarai. Financials As the company’s reported 3Q FY17 results sales remained subdued (down-7.9%) owing to intense competition, gross margin remained at elevated levels (gross profit up 4.7%, 39.4% in 3Q FY17 versus 34.6% in 3Q FY16). Selling and distribution expenses for the quarter increased by 17.3% which the company attributed to an aggressive pricing and discounting campaign adopted by competitors which meant that operating income at SAR72m was flat versus last year. Net income for 3Q at SAR68.9m was flat (though up 26.2% YTD) which means that it is on track to achieve our full-year net income estimate of SAR289m which will imply a net income of SAR61m in 4Q FY17 (versus ~SAR80m in 4Q FY16). Valuation Our DCF-based target price of SAR162 is derived using a WACC of 9.12% based on a cost of debt of 5%, CoE of 10.15% and a debt: equity ratio of 1:4. Our CoE assumption is underpinned by a riskfree rate of 5.2% (US10Y + Saudi/US inflation differential), an ERP of 5.5%, and an estimated beta of 1.35 (all unchanged). This implies upside of 38.9% and hence we have a Buy rating. Key risks Key downside risks: reversal in commodity prices and shifts in the competitive landscape. 138 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudia Dairy & Foodstuff Financial statements Year to Valuation data 03/2016a 03/2017e 03/2018e 03/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Buy 1,983 358 -82 276 0 276 276 -15 260 260 1,864 382 -83 299 7 310 307 -21 289 285 2,069 381 -82 299 12 311 311 -22 288 288 2,303 416 -81 335 13 348 348 -26 321 321 362 -68 -67 -114 -180 296 425 -75 -75 -130 -220 347 316 -79 -79 -146 -91 237 350 -81 -81 -163 -106 269 0 577 813 246 1,391 194 0 -246 1,092 950 0 569 973 466 1,542 186 0 -466 1,251 890 0 566 1,132 557 1,698 195 0 -557 1,393 945 0 566 1,303 664 1,869 204 0 -664 1,551 1,001 Year to 03/2016a 03/2017e 03/2018e 03/2019e 1.8 9.9 3.7 14.6 3.5 7.8 3.4 1.8 8.7 3.7 13.3 3.0 9.1 3.9 1.6 8.5 3.4 13.1 2.7 6.3 4.3 1.4 7.5 3.1 11.8 2.4 7.1 4.7 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 116.62 162.00 2270.SE SADAFCO AB 1,010 209.00 209.00 189.00 189.00 169.00 169.00 149.00 149.00 129.00 129.00 109.00 109.00 03/2017e 03/2018e 03/2019e Y-o-y % change 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 9.7 57.7 77.2 79.6 84.4 -6.0 6.7 8.5 12.3 9.8 11.0 -0.3 0.0 0.2 1.1 11.3 9.4 12.0 11.9 11.3 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) 2.1 27.1 25.5 20.1 18.0 13.9 2.0 30.4 24.3 19.3 20.5 16.1 2.3 30.3 21.8 17.2 18.4 14.5 2.4 31.9 21.8 17.4 18.1 14.5 -22.5 -0.7 -37.2 -1.2 -39.9 -1.5 -42.7 -1.6 8.01 7.99 4.00 33.61 8.89 8.78 4.50 38.49 8.87 8.87 5.00 42.86 9.87 9.87 5.50 47.73 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 89.00 2016 Saudia Dairy & Foodstuff Ratio, growth and per share analysis 03/2016a 51% Food Products Saudi Arabia Ankur Agarwal, CFA Price relative 89.00 2015 Year to Free float Sector Country Analyst Contact 139 EQUITIES ● SAUDI ARABIA February 2017 Saudi Marketing Company Ankur Agarwal*, CFA Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6558 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations SMARKETI AB, Hold, TP SAR27.00 Company description Saudi Marketing Co (a.k.a Farm) operates food retail stores and indoor entertainment centres in Saudi Arabia, as well as a shopping mall in Lebanon. Established in 1978, Farm opened its first retail outlet (Farm Superstore 1) in Dammam in October 1979. It was founded by the Alaswad family which continues to retain a 66.5% stake in the company. The company currently operates 64 supermarkets, and 10 indoor entertainment centres under its ‘Adventure World’ brand. The company also owns Beirut Mall in Lebanon, which hosts over 50 tenants in an area of over 50,000 m2. Investment thesis Saudi Marketing ended the year on the positive side with revenue going up 3.5% for the year, mostly on the back of new stores, but the top line growth slowed dramatically compared to 9% in 2015 and 11% in 2014 driven by a mid-single digit decline in LFL growth. We view Saudi Marketing as a long-term beneficiary of the consolidation theme in the food retail market, helped by its aggressive store expansion plan, which the management confirms remains in place in spite of the current slowdown in the market. However the key challenge for Farm will be dealing with aggressive competition from Savola, the largest retail player in the market, and Othaim a strong player in the Central region where FARM has been adding some stores. Additionally in the environment of consumers trading down, FARM may be affected more than the value segment retailers given its positioning as a middle to upper middle income retailer. Financials Farm reported Q4 2016 results coming below our estimates of the top and bottom line. Revenue for the quarter came at SAR491m, 7.5% below HSBC estimate of SAR531m. The company reported gross profit of SAR102.8m (at margin of 20.9%), 15.6% lower than HSBC’s estimate of SAR121.7m (at a margin of 22.9%). EBIT came at SAR20.7m, 40% below our estimate at SAR35m. The EBIT margin in Q4 2016 came at 4.2%, 230bps lower than HSBC’s estimate of 6.5%. Net income for Q4 2016 was SAR16.8m, 47% below HSBC’s estimate of SAR31.7m. Valuation Our DCF valuation uses a WACC assumption of 9.0% based on a 3:7 debt-to-equity ratio, CoD assumption of 5.0% and a CoE assumption of 10.7% (all unchanged). Our target price of SAR27 implies a valuation of 10.67x FY17 EPS and downside of 12.8%. Although we see continuing pressure on like-for-like growth of the company in the medium term, the stock trades at a discount to Saudi consumer peers. Hence we maintain our Hold rating. Key risks Key upside risks: Stronger-than-expected like for like growth as a result of strategic shifts in store locations and potential regulatory changes leading to market consolidation. Key downside risks: Any delay in new store openings and intensifying competition in Saudi food retail. 140 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi Marketing Co Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Hold 1,898 164 -38 127 -7 114 119 -3 110 116 1,971 159 -41 119 -8 111 110 -3 108 107 2,109 171 -45 126 -8 117 117 -3 114 114 2,320 194 -51 143 -9 134 134 -4 130 130 29 -128 18 -53 151 -102 186 -146 -146 -35 -5 39 168 -153 -123 -35 20 15 186 -162 -132 -35 11 24 1 720 583 17 1,311 320 385 369 554 967 1 825 607 22 1,441 376 385 364 627 1,035 1 933 634 31 1,576 403 415 384 706 1,135 1 1,044 687 51 1,740 441 445 395 800 1,240 Year to 12/2015a 12/2016e 12/2017e 12/2018e 0.9 10.7 1.8 12.0 2.5 -7.4 2.5 0.9 11.0 1.7 13.0 2.2 2.8 2.5 0.8 10.3 1.6 12.2 2.0 1.1 2.5 0.8 9.2 1.4 10.7 1.7 1.7 2.8 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 30.96 27.00 4006.SE SMARKETI AB 371 101.00 101.00 81.00 81.00 61.00 61.00 41.00 41.00 Saudi Marketing Co Ratio, growth and per share analysis 12/2015a 12/2016e 12/2017e 12/2018e Y-o-y % change 21.00 2016 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 9.0 15.6 13.0 4.5 14.3 3.8 -3.3 -6.5 -2.6 -8.1 7.0 7.5 6.1 5.8 6.6 10.0 13.4 13.5 13.9 13.9 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) 2.2 14.4 22.1 9.8 8.7 6.7 22.4 66.4 2.2 7.8 2.0 11.5 18.1 8.4 8.1 6.0 18.8 57.9 2.3 51.1 1.9 11.3 17.1 8.1 8.1 6.0 20.2 54.3 2.2 43.8 2.0 11.7 17.2 8.4 8.4 6.2 21.2 49.2 2.0 47.1 2.45 2.58 0.78 12.32 2.39 2.37 0.78 13.93 2.53 2.53 0.78 15.68 2.88 2.88 0.86 17.79 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 30% Food & Staples Retailing Saudi Arabia Ankur Agarwal, CFA Price relative 21.00 2015 Year to Free float Sector Country Analyst Contact 141 EQUITIES ● SAUDI ARABIA February 2017 Savola Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations SAVOLA AB, Buy, TP SAR48 Company description Savola is one of the largest business conglomerates in Saudi Arabia. The group’s main presence is in food production and grocery retail. In addition, the group also has a host of other strategic investments in various industries across MENA and Central Asia. Savola’s food division has three key products: edible oil, refined sugar and pasta. The division has a presence across GCC, Iran, North Africa and Turkey. As of 2016, the foods division accounted for 47% of the company’s revenues. The retail arm (Panda) contributed 53% of revenues in 2016 and is the largest organised food retailer in Saudi. Panda operates 163 supermarkets, 66 hypermarkets and 181 convenience stores, with a total selling space of 752,784sq m across Saudi Arabia and the UAE as of 2016 end. Investment thesis Inventory write-offs, FX losses and a weak operational performance at its grocery retail division, Panda led the group to report losses in 2016. We believe that most of the kitchen sinking is done during the year and 2017 should see some improvement in terms of operational performance with a new management team in place. Although we believe that Panda will not see a sudden improvement in performance we have Buy rating on the stock. Savola’s foods division has started showing signs of recovery, as seen during the last two quarters which we believe should support the group performance. Furthermore, the stake sale in the Egyptian sugar business should also help the group in the near term in our opinion. With Savola’s stake in its listed associates alone being valued more than the company’s market capitalisation, the market is ascribing no value for its core operations, which we believe is unwarranted. We believe Savola’s valuation is not justified as core operations are still profitable (we estimate they will contribute SAR324m profits in 2017e). Financials The company reported a SAR964m net loss for the quarter compared to a SAR515m net profit in 4Q15. The group has taken gross impairments and inventory write-down of SAR951m which had a net impact of SAR860m. Excluding the impairment, inventory write-downs and one-off gains, the company reported net income of SAR74m. The company reported an operating loss of SAR176m compared with a SAR378m operating profit in 4Q15. Net revenues for the quarter came in at SAR6.25bn, down 0.2% YoY. We estimate weakness in Savola’s retail division to continue in 2017 while the foods division, despite a strong operational performance will see slow growth in SAR-terms due to FX movements. However, in terms of margins we forecast a recovery for the retail division as many under-performing stores have now been closed. 142 EQUITIES ● SAUDI ARABIA February 2017 Valuation We use a DCF methodology to value Savola’s core subsidiaries and take the market value of its listed associates. We assume a WACC of 9.1% derived from a cost of equity of 10.7% (based on an ERP of 5.5% and RfR of 5.2%), a cost of debt of 5.5%, a debt-equity ratio of 30:70, beta of 1 and a terminal growth rate of 2.5%. To this we add associates, which we value using the market capitalisation for the listed ones (in case they are covered by HSBC, we use the lowest of market capitalisation and target market capitalisation). Based on this, we arrive at a fair value target price of SAR48. Our SAR48 target price implies upside of 27.3% from the current price. We believe that a turnaround at Panda will take time, while revenue growth at the foods division will remain under pressure from FX woes. However, Savola’s current stock price implies no value for the group’s core operations as the market value of the listed associates is more that the group’s market capitalisation. Hence, we have a Buy rating on the stock. Risks Key downside risks: Continuing weakness in the consumer sentiment in Saudi leading to weaker-than-expected like-for like sales growth in the food retail division. The inability of the group to turn around its small format stores. Continuing weakness in sugar prices and the potential dumping of sugar also are downside risks to our valuation. 143 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Savola Buy Financial statements Year to Valuation data 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 25,008 1,577 -743 835 -567 -306 -306 -139 -451 -451 25,381 2,361 -784 1,577 -218 1,358 1,358 -136 1,163 1,163 26,871 2,871 -826 2,045 -220 1,825 1,825 -183 1,553 1,553 28,541 3,169 -885 2,284 -221 2,063 2,063 -206 1,746 1,746 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 2,444 -1,482 -741 -667 -137 634 777 -1,142 -890 0 332 255 1,926 -1,344 -1,029 -534 -143 1,411 1,629 -1,427 -1,074 -873 539 1,157 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 662 6,822 7,766 1,320 23,826 5,313 8,705 7,386 8,491 8,616 662 7,179 9,329 1,987 26,334 5,599 9,705 7,718 9,655 9,584 662 7,697 9,283 2,184 27,540 5,642 9,759 7,575 10,674 9,815 662 8,239 9,330 1,693 28,952 6,023 9,807 8,114 11,547 10,515 Year to 12/2016a 12/2017e 12/2018e 12/2019e 0.8 12.0 2.2 0.7 7.9 2.0 17.4 2.1 2.3 0.0 0.7 6.2 1.8 13.0 1.9 13.7 2.6 0.6 5.5 1.7 11.6 1.7 12.2 4.3 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) 2.4 5.5 3.3 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 37.72 48.00 2050.SE SAVOLA AB 5,382 82.00 82.00 72.00 72.00 62.00 62.00 52.00 52.00 42.00 42.00 32.00 32.00 12/2017e 12/2018e 12/2019e 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 (diluted) HSBC EPS (diluted) DPS Book value 144 22.00 2016 Savola Ratio, growth and per share analysis 12/2016a Source: HSBC Note: Priced at close of 02 Feb 2017 -0.5 -37.8 -56.3 -114.9 -125.2 1.5 49.7 88.8 5.9 21.6 29.7 34.4 33.5 6.2 10.4 11.7 13.0 12.4 2.6 12.4 -4.7 1.5 6.3 3.3 2.8 80.7 4.7 33.1 2.8 15.6 12.8 5.7 9.3 6.2 10.8 74.4 3.3 10.1 2.8 19.0 15.3 6.8 10.7 7.6 13.1 66.0 2.6 25.4 2.8 20.2 15.7 7.3 11.1 8.0 14.3 65.1 2.6 20.1 -0.85 -0.85 1.25 15.90 2.18 2.18 0.00 18.08 2.91 2.91 1.00 19.99 3.27 3.27 1.63 21.62 56% Food Products Saudi Arabia Raj Sinha +971 4423 6932 Price relative 22.00 2015 Year to Free float Sector Country Analyst Contact 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Shaker SHAKER AB, 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: 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 Shaker reported a net loss of SAR 29.9m in 4Q, compared with a net loss of SAR 17.8m in 4Q15. The greater loss was due to lower revenues, down 16.6% yoy, one-off expenses of SAR6.8m for consulting fees and restructuring and a loss in a related company of SAR 4.9m (which had a net profit of SAR 1.4m in 4Q15). However, operating profit was up 15.8% on lower COGS. On a quarter-over-quarter basis, the net loss was down from a net profit SAR 2.4m, on the back of lower sales (-22.1%) and an increase of SAR 6.7m in sales and distribution expenses. For the full year, net profit dropped 65.2% yoy to SAR 48m, EBIT was SAR 50m down by 45.6% and revenues fell 12.9% to SAR 1,643m. Recent News 12 May 2016: The company announced Mr. Abdulelah Abunayan as board chairman. 1 November 2016: It announced a dividend of SAR 0.75 for the first 9 months of 2016. 22 December 2016: Shaker signed a 3 year extension deal with LG Electronics to be the exclusive vendor of LGV air conditioners. 145 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Al Hassan Ghazi Ibrahim Shaker Co. Financial statements Year to Valuation data 12/2013a 12/2014a 12/2015a 12/2016a Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT Taxation Net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 1,741 226 30 196 -19 178 8 125 1,557 122 12 110 -14 482 7 437 1,887 102 14 91 -17 134 8 137 1,643 63 14 50 -30 49 5 48 88 -32 -38 0 -36 56 -94 -72 -86 -175 262 -166 -57 -38 -37 0 99 -95 -83 -24 -22 -47 122 -107 0 301 1,176 89 1,489 220 445 356 790 1,400 10 223 1,291 65 2,028 411 656 591 926 1,963 39 258 1,579 85 2,431 558 758 673 1,075 2,346 39 257 1,527 55 2,401 408 880 825 1,071 2,346 Ratio, growth and per share analysis Year to 12/2013a 12/2014a 12/2015a 12/2016a Year to Revenue EBITDA Operating profit PBT Ratios (%) 0.2 -16.1 -18.1 -21.0 -10.6 -46.0 -43.8 170.8 21.2 -16.8 -17.0 -72.2 -12.9 -38.2 -45.6 -63.4 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) 1.2 8.9 15.8 8.4 13.0 11.3 -11.9 0.5 1.6 0.2 0.8 22.3 47.2 21.5 7.8 7.1 -8.7 0.6 4.8 -0.3 0.8 5.8 12.7 5.6 5.4 4.8 -6.0 0.6 6.6 -0.1 0.7 2.0 4.5 2.0 3.8 3.0 -2.1 0.8 13.1 -0.1 EPS Rep (diluted) DPS Book value 3.6 0.0 17.1 12.5 0.0 17.1 3.9 0.0 17.1 0.8 0.8 17.0 12/2013a 12/2014a 12/2015a 12/2016a 1.1 8.2 1.3 4.6 1.0 5.4 0.0 1.2 15.3 1.3 1.3 1.0 5.4 0.0 1.0 18.3 1.3 4.2 1.0 5.4 0.0 1.1 29.6 0.8 21.7 1.0 0.0 4.6 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Reuters (Equity) Market cap (USDm) Free float Country 16.47 1214.SA 277 64.3 Saudi Arabia Bloomberg (Equity) Market cap (SARm) Enterprise value (SARm) Sector SHAKER AB 1,038 1,863 Industrials Price relative 60 60 50 50 40 40 30 30 20 20 10 10 0 2014 0 2015 Shaker Group Y-o-y % change 146 Not rated Source: HSBC Note: Priced at close of 02 Feb 2017 2016 2017 Rel to Tadawul EQUITIES ● SAUDI ARABIA February 2017 United Electronics Company Ankur Agarwal*, CFA Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6558 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations EXTRA AB, Hold, TP SAR29.00 Company description Extra opened its first store in 2003 and now has 42 stores. The company has a presence in 24 cities overall and a major presence in Riyadh, where it operates 8 stores. The company also has a presence in both Bahrain and Oman. It is one of the largest consumer electronics and white goods 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. The company operates multiple store formats, ranging in space from 1,000m2 to 5,000m2. It has 4 stores with an area of 4,500m2 or more (Class A), 4 stores with areas in the range of 3,500-4,500m2 (Class B), 15 stores with areas in the range of 2,000-3,000m2 (Class D); the remaining stores have areas of less than 2,000 m2 (Class D). As per the latest reported data, Extra’s sales mix is heavily weighted towards the audio-visual category (50% of revenue, with gross margins in the range of 15%-18%), followed by white goods and home appliances (25% of revenues, with gross margins in the range of 25%-26%); the remaining revenues are derived from the digital segment , including personal computers (PCs) and smartphones (with gross margins in the range of 10-12%). Recent trends in sales and margins, suggest that the mix may have shifted towards lower-margin items. Al Fowzan Holding Company and AbdulAziz Al Saghir Investments Company, the key shareholders at listing, continue to be the major shareholders with 45.42% and 14.93% stakes, respectively. Investment thesis The company reported better than expected results in 4Q 2016 on the back of market share gains. Extra’s Q4 FY16 sales rose 8.8% on the back of higher sales in the mobile and electronics segment. We believe the shift from unorganised to organised retail was especially pronounced in the mobile phone category as the government 100% saudised the sector in 2016. But on the back of further cuts in subsidies (utilities and fuel prices) in addition to the subsidy cuts and allowance cuts announced in 2016, we expect consumer spending to remain subdued in 2017, especially for the high value discretionary category. However, continued market share gains from the unorganised sector should result in more resilient LFL growth for the listed names including Extra. We have a Hold rating on the stock because the valuation risk-reward is not compelling enough at current levels and we see better value elsewhere in Saudi retail space. Financials Extra reported higher than expected revenue growth and margin expansion in 4Q which meant that earnings were significantly ahead of our expectations. 4Q revenue of SAR1, 386m in Q4 2016 was up 8.8% y-y and 13% higher than HSBC estimates. Extra attributed this increase to higher mobile and consumer electronics sales. Gross profit for the period was SAR212m (margin of 15.3%), 20% higher y-o-y and 27% higher than HSBC estimate of SAR167m (margin of 13.6%), the increase coming from higher sales and improved margins on some products. Extra reported EBIT margin of 3.2% (EBIT of SAR44.1m) higher than HSBC estimate of 1.4% (EBIT of SAR16.8m) for the quarter and 160bps higher than 3Q 2016. 147 EQUITIES ● SAUDI ARABIA February 2017 Reported 4Q net income came in at SAR27.5m (versus SAR9m in 4QFY15) and HSBC’s estimate of SAR14.2m. The reported net income also includes an impairment loss of SAR15.6m. Valuation Our DCF-based valuation suggests a fair-value DCF target price of SAR29.0. We use a WACC of 10.9% based on RFR of 5.2%, COD of 5%, ERP of 5.5%, beta of 1.2, COE of 11.8% and debt to equity of 15% (all unchanged). This implies limited upside of 3.0% from current levels. We maintain our Hold rating on the stock because the valuation risk-reward is not compelling enough at current levels and we see better value elsewhere in the Saudi retail space. Key risks Upside risks: 1) More store openings: We assume 3 store openings in both 2017 and 2018. A higher rate could grow sales faster than we currently assume. The company added 1 store in 2016. 2) Higher LFL growth: A better-than-expected LFL trajectory than we currently expect (LFL declines of 2% and 1.5% in 2017-18e) would mean an upside risk to our estimates. Downside risks: 1) Margin trajectory deviation: Our gross margin assumption for 2017 is 15.87% which is 30bps above 2016 levels; any deviation below our assumption owing to product mix or any other issues will mean a downside risk to our estimates. 148 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: United Electronic Company Financial statements Year to Valuation data 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Hold 3,752 68 -44 24 -2 5 22 -3 2 19 3,876 79 -43 36 3 38 38 -1 37 37 4,016 90 -47 43 1 44 44 -2 42 42 4,320 119 -50 68 1 69 69 -2 67 67 109 -45 -46 0 -64 50 133 -83 -83 -18 -32 50 101 -87 -87 -18 4 14 131 -92 -92 -36 -4 40 0 462 770 100 1,251 665 0 -100 532 467 0 502 866 133 1,386 781 0 -133 551 454 0 542 874 128 1,435 806 0 -128 576 482 0 584 919 132 1,521 861 0 -132 606 510 Year to 12/2016a 12/2017e 12/2018e 12/2019e 0.2 13.1 1.9 54.4 1.9 5.1 0.0 0.2 10.9 1.9 27.3 1.8 5.1 1.8 0.2 9.7 1.8 23.9 1.8 1.4 1.8 0.2 7.2 1.7 15.1 1.7 4.0 3.6 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2017e 106.40 86.40 86.40 66.40 66.40 46.40 46.40 26.40 26.40 6.40 2016 United Electronic Company 12/2018e 12/2019e Y-o-y % change 38% Specialty Retail Saudi Arabia Ankur Agarwal, CFA 106.40 Ratio, growth and per share analysis 12/2016a Free float Sector Country Analyst Contact Price relative 6.40 2015 Year to 28.15 29.00 4003.SE EXTRA AB 270 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 0.2 -33.0 -57.2 -91.1 -61.5 3.3 15.8 51.9 709.1 99.0 3.6 13.7 19.8 14.3 14.3 7.6 32.6 59.3 58.1 58.1 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) 7.5 2.1 3.5 0.2 1.8 0.6 38.1 -18.8 -1.5 8.4 7.5 6.8 2.6 2.0 0.9 8.6 8.9 7.5 2.9 2.2 1.1 8.7 13.3 11.3 4.5 2.8 1.6 -24.0 -1.7 -22.3 -1.4 -21.8 -1.1 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 0.06 0.52 0.00 14.78 1.03 1.03 0.50 15.31 1.17 1.17 0.50 15.99 1.86 1.86 1.00 16.84 149 EQUITIES ● SAUDI ARABIA February 2017 United International Transport Ankur Agarwal*, CFA Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6558 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations BUDGET AB, Buy, TP SAR36.00 Company description Established in 1978 by Abdulelah Zahid, United International Transportation Co. (Budget KSA) is the market leader in the car rental and fleet management industry in Saudi Arabia. The company has been operating under a franchise agreement with Avis-Budget USA. The franchise agreement fees averaged 1.24% in 2010-2014 (was 1.4% of Budget KSA’s revenue in 2014). Budget KSA -as of 2016 end- operated a combined rental and leasing fleet of over 30,543 vehicles, and had a presence in over 101 branches in the Kingdom (spread over 14 cities, as well as 11 airports). Apart from car rental and fleet management services, Budget KSA also engages in pre-owned car sales and is seeking to expand into logistic services through a JV with Barloworld Logistics of South Africa. We have not factored into our model any impact from the foray in the logistics business which could be a potential source of upside to our estimates. The company’s main segments are short-term rentals (Rent-A-Car operations, largely B2C) and long-term leases (fleet management, B2B). While the company started as a Rent-A-Car shop, longterm leasing and fleet management growth has been outpacing short-term rentals, accounting for 62.9% of revenues and 62.8% of the fleet in 2016, up from 56.5% and 59.4%, respectively, in 2015. Investment thesis While we acknowledge the slowdown especially in the short rental segment, from a longer term perspective Budget Saudi remains a best-in-class car rental and fleet management company, with a dominant market share in the Kingdom. Budget Saudi’s long term growth potential, its profitability and leverage metrics compare extremely favourably with global peers (refer to our initiation note: Steady growth at a reasonable price). We believe that Saudisation will further shift market share towards larger players with scale advantage like Budget, and that would mitigate slowdown in the overall market. We like Budget in spite of its B2B exposure given that it has a well-diversified customer base with no significant single client concentration. Its exposure to the government is indirect through clients in the oil and gas and construction and is limited to 18% of sales (2015). While in the short term the rental business is likely be impacted by the consumer trading down, Budget plans to ramp up the value segment offering branded as Payless which will allow it to capture market share even from the most “value conscious customer”. Financials 4Q16 sales of SAR214m were down 6%y-y, 10% below HSBC estimate of SAR238m. The decline in revenue was due to the weakness in the short rental business while long term leasing continued to grow. Gross profit at SAR32.7 was lower than HSBC estimate of SAR37.9m EBIT ex-gains came in at SAR9.7m (at margin of 4.5%), down 29.5% y-y and 31.1% below HSBC estimate of SAR14.1m (at margin expectation of 5.9%), this included a bad debt provision of SAR3.6m ex of which the EBIT was 5.6% below our estimate. Reported net income came at SAR35.2m, 27.3% lower than last year and 12.5% lower than HSBC estimate of SAR40.2m but adjusting for the bad debt provisions net income was 3.4% lower than our estimate. Overall for the 2016 Budget Saudi’s revenue at SAR867m is down 1% y-o-y while its net income, adjusting for bad debt provisions (SAR8.6m this year versus SAR3.9m last year) and a one-off impairment on SAR6.6m on its investment in its associate, is down 1.6%. 150 EQUITIES ● SAUDI ARABIA February 2017 Valuation Our DCF uses a WACC of 8.2%, based on 2:3 debt-equity ratio, CoD of 5%, CoE of 10.37% (based on a RfR of 5.2% (US10Y + Saudi/US inflation differential), an ERP of 5.5%, and beta of 0.94) (all unchanged). Our target price of SAR36 implies upside of 19% from the current stock price and we have a Buy rating as we believe Saudisation and the launch of the new value segment “Payless” should further shift market share towards Budget, and that should compensate for any slowdown in the overall market. Key risks Key downside risks: 1) A significant decline in car prices may have an adverse, short-term impact on the P&L in terms of lower gain on sale of vehicles. 2) A prolonged period of lower oil prices may impact long-term leases as it would slow the Saudi economy, reducing corporate demand for logistic services and therefore impacting the revenues of Budget’s long-term leasing segment. 151 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: United International Tran Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 876 566 -358 208 -16 195 187 -6 189 182 890 576 -373 203 -17 187 185 -6 181 179 940 606 -387 219 -25 194 194 -7 187 187 1,000 647 -407 240 -31 209 209 -8 201 201 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 432 -507 -521 -69 -9 57 379 -379 -259 -76 -69 145 408 -567 -447 -75 72 3 425 -508 -388 -85 -9 95 0 1,499 178 22 1,703 151 650 628 902 1,503 0 1,505 414 211 1,945 170 770 559 1,005 1,538 0 1,685 474 259 2,185 178 890 631 1,117 1,722 0 1,786 616 388 2,429 186 1,010 622 1,233 1,829 12/2017e 12/2018e Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital Ratio, growth and per share analysis Year to 12/2015a 12/2016e Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 15.6 13.1 10.2 9.8 8.2 1.7 1.7 -2.5 -3.9 -1.2 5.6 5.2 8.1 3.7 4.3 6.4 6.7 9.6 7.5 7.5 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) 0.6 13.9 21.5 12.6 64.7 23.7 34.4 69.6 1.11 68.8 0.6 12.9 18.8 10.9 64.7 22.8 33.1 55.7 0.97 67.8 0.6 12.9 17.6 10.2 64.5 23.3 24.3 56.5 1.04 64.6 0.6 13.0 17.1 10.0 64.7 24.0 20.6 50.5 0.96 68.3 3.09 2.98 1.25 14.78 2.97 2.94 1.25 16.47 3.07 3.07 1.23 18.31 3.30 3.30 1.40 20.21 152 Year to 12/2015a 12/2016e 12/2017e 12/2018e 2.80 4.33 1.63 10.2 2.1 3.1 4.1 2.68 4.14 1.55 10.3 1.8 7.9 4.1 2.61 4.05 1.42 9.9 1.7 0.1 4.0 2.44 3.78 1.34 9.2 1.5 5.2 4.6 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 30.29 36.00 4260.SE BUDGET AB 493 Free float Sector Country Analyst Contact 65% Diversified Consumer Services Saudi Arabia Ankur Agarwal, CFA Price relative 58.00 53.00 48.00 43.00 38.00 33.00 28.00 23.00 18.00 2015 58.00 53.00 48.00 43.00 38.00 33.00 28.00 23.00 18.00 2016 United International Tran Source: HSBC Y-o-y % change EPS Rep (diluted) HSBC EPS (diluted) DPS Book value Buy Note: Priced at close of 02 Feb 2017 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Healthcare 153 EQUITIES ● SAUDI ARABIA February 2017 Healthcare SAR120bn (USD32bn) per annum opportunity by 2030 from potential implementation of mandatory private medical insurance Privatisation of government facilities could lead to more earnings for private players from O&M contracts… …however, encouraging the public sector to compete with the private sector could yield poor results Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Investment thesis Saudi Arabia currently spends over SAR130bn per annum on healthcare (including pharma), with government spending at cSAR100bn and private sector spending at cSAR35bn. However the spending levels in Saudi ten years back, during 2005, were less than one-third of what they are now. Based on the current trajectory, with the growth in population, ageing and general increase in healthcare service charges, we see total spending on health rising to cSAR300bn pa by 2030e. Even then this would not be sufficient to improve healthcare infrastructure in the country as the public sector continues to face issues stemming from a lack of efficiency. The Vision 2030 document targets private medical insurance for all, which would lead to even higher usage (as those with private insurance tend to go to the doctor more often). In this case we estimate total spending to increase to SAR314bn pa, with private hospitals accounting for SAR142bn (from SAR23bn currently) by 2030 – a six fold increase in 15 years. From Vision 2030, the two key takeaways we see for healthcare sector in Saudi are: The plan to increase private medical insurance in Saudi The plan for public hospitals to compete against the private sector Healthcare spending pa in Saudi (SARbn) 350 Private hospitals Others 314 300 Number of insured people in Saudi (m) 50 Saudi Expats 40 15.7 250 30 200 133 150 20 28.4 100 50 142 42 23 0 2005 2015 Source: World Bank WDI, UN, MoH and HSBC estimates 154 10 0 2030e 6.5 1.9 2010 Source: CCHI and HSBC estimates 8.8 3.1 2015 2030e EQUITIES ● SAUDI ARABIA February 2017 Impact of potential mandatory health insurance in Saudi In our note Saudi Hospitals – Insurance: the next leg of growth, 29 August 2014, we looked at the significant opportunity for the Saudi healthcare sector from a potential widening of the insurance net within the Kingdom. With Vision 2030 alluding to a widening of the insurance net in Saudi, we look at the implications of mandatory private health insurance being implemented by 2030. We see a SAR120bn per annum additional revenue, or SAR142bn total revenues per annum opportunity for private hospitals (excluding pharma) should mandatory health insurance come through in Saudi by 2030. This would mean a six-fold increase in private hospital revenues in a matter of just 15 years. The main drivers of this growth would be: Substantial increase in the number of insured Saudi nationals – from just 3m in 2015 to 28m by 2030 (assuming 2% per annum growth in the population of Saudi nationals). Shift to private hospitals from government ones – our calculations show that currently over 60% of patient flow in Saudi is into government hospitals and c70% of hospital/healthcare spending is made in the public sector. With government plans to cut investments in healthcare through the public sector, we believe most of the growth will now come through private operators. Saudi nationals starting to use private hospitals more – with potentially all Saudi nationals coming within the health insurance net, we believe that by 2030, a larger share will start using private hospitals in preference to government ones. From the current level of just c27% Saudis visiting private hospitals, we estimate this to rise to over 66% once they have health insurance. Increasing healthcare use levels among insured population – generally we see at least a doubling in the use of healthcare services once a person is covered by health insurance. However we assume just a 50% increase in Saudi, to remain conservative. The main problem the government could face while implementing mandatory private health insurance in the country is that the current healthcare infrastructure may not be able to take care of the increased patient flow that tends to be seen following the implementation of health insurance. However given the time frame of 15 years that we assume, we think this could be achieved. For comparison, both Dubai and Abu Dhabi have been able to achieve mandatory health insurance for a population of three million people in just two years. Share of inpatients and outpatients visiting public and private hospitals in Saudi (2014) Percentage of people insured in Saudi 100% 100% 8% 11% 80% 43% 43% 33% 80% 60% 60% 40% 92% 89% 40% 57% 57% 67% 20% 20% Public I/P Private Public O/P Private Population O/P Expat I/P Saudi Source: Ministry of Health (MoH) Saudi-base Expats Total-new 2030e 2028e 2026e 2024e 2022e 2020e 2018e 2016e 2014 0% 2012 2010 0% Saudi-new Total-base Source: CCHI and HSBC estimates 155 EQUITIES ● SAUDI ARABIA February 2017 Hospital spending in Saudi – potential from implementation of mandatory insurance Insured in private -2015 Saudi Expat Total Private Private inpatients outpatients 753,207 27,264,868 579,273 20,888,849 1,332,480 48,153,717 Uninsured in public -2015 Saudi Expat Total Public Public inpatients outpatients 1,959,931 77,732,691 248,997 6,946,257 2,208,928 84,678,948 Total -2015 Saudi Expat Total Insured IP/ insured OP/ insured 3,115,067 8,798,504 11,913,571 0.24 0.07 0.11 8.75 2.37 4.04 IP spend (SARm) 6,026 4,634 10,660 Uninsured 18,001,520 1,672,048 19,673,568 IP/ uninsured 0.11 0.15 0.11 OP/ uninsured 4.32 4.15 4.30 IP spend (SARm) 23,519 2,988 26,507 OP spend Total spend (SARm) (SARm) 29,150 52,669 2,605 5,593 31,755 58,262 Inpatients Outpatients Population IP/ person OP/ person 2,713,138 104,997,559 828,270 27,835,106 3,541,408 132,832,665 21,116,587 10,470,553 31,587,139 IP spend (SARm) 29,545 7,622 37,167 OP spend Total spend (SARm) (SARm) 35,966 65,511 7,827 15,449 43,793 80,960 IP spend (SARm) 48,666 21,928 70,594 OP spend Total spend (SARm) (SARm) 52,311 100,976 19,116 41,044 71,427 142,021 IP spend (SARm) 25,323 3,217 28,540 OP spend Total spend (SARm) (SARm) 31,385 56,708 2,805 6,022 34,190 62,730 IP spend (SARm) 73,989 25,145 99,134 OP spend Total spend (SARm) (SARm) 83,696 157,685 21,921 47,066 105,617 204,751 0.13 0.08 0.11 4.97 2.66 4.21 OP spend Total spend (SARm) (SARm) 6,816 12,842 5,222 9,856 12,038 22,698 Private-2030 - new hospitals Inpatients Outpatients Saudi Expat Total 4,519,926 155,470,306 2,036,604 56,815,035 6,556,530 212,285,342 Public-2030 - 20% growth to fill hospitals Inpatients Outpatients Saudi Expat Total 2,351,917 93,279,229 298,796 8,335,508 2,650,714 101,614,738 Mandatory insurance scenario by 2030 Saudi Expat Total Inpatients Outpatients Population 6,871,843 248,749,535 2,335,400 65,150,544 9,207,243 313,900,079 28,420,145 15,682,526 44,102,671 IP/ person OP/ person 0.24 0.15 0.21 8.75 4.15 7.12 Source: MoH and HSBC estimates Corporatisation of public hospitals Apart from plans to increase health insurance penetration, Saudi’s Vision 2030 also outlines plans for the public sector to compete against the private sector. Although details are scant, this could play out in the following ways: 156 The government could sell, ie, privatise, the hospitals it currently runs – this would present a good opportunity for incumbent private operators to expand faster and gain further market share. The government could give operations and management contracts (O&M contracts) for its hospitals to private players – some of the hospitals we cover already generate some revenues from such contracts, which are high margin – such a move could bring in more revenues – we estimate a potential SAR3bn in additional revenues from O&M contracts. The public facilities could be given a set budget and asked to be profitable or at least to break even, but importantly, would be able to compete against the private sector in all elements of healthcare. We do not advocate this route, and draw parallels with Brazil to explain why. EQUITIES ● SAUDI ARABIA February 2017 Lessons from the experience in Brazil Brazil’s case is different from other EMs, as despite disproportionally high healthcare spending versus its median age, the country still lags most of its peers in terms of healthcare services. What went wrong in Brazil can be looked at as an example of what not to do in Saudi. As in Saudi, the private sector in Brazil plays a central role in the provisioning of healthcare services. In addition the government has encouraged public facilities to be run by the private sector, something that Saudi is now planning. Private healthcare facilities − including simple medical offices and diagnostic centres, all the way up to hospitals – accounted for c74% of all healthcare facilities in the country in 2013. In terms of beds the proportion is lower at 27% but increases to 64% if we include publicly held beds run by the private sector. The public contribution to healthcare spending of 47% is well below the global average of 59.7%, according to the World Bank. And this is despite public healthcare spending in Brazil having increased from 2.8% of GDP in 1996 to 4.1% in 2011, which compares to an increase of only 70bps from 4.1% to 4.8% for the private sector. The rapid increase in spend by the public sector and the high out-of-pocket expenditure indicates shortfalls in government strategy, in our view. The first policy shortfall is that despite the relevance of the private sector, regulation and public policies do not very clearly define the role of the private sector in the overall healthcare system. Hence it is common to observe some overlap between public and private healthcare provision, leading to competition and, potentially, poor allocation of resources. For example, states with a higher penetration of hospital beds per capita in the private sector tend also to have higher penetration in the public sector. This lack of coordination, combined with a still-low level of public funding, in part explains the lack of adequate healthcare for some segments of the population, most noticeably the poorest families living in the most remote regions. The second shortfall has been to neglect the provision for more complicated care. The burden of chronic ailments is more substantial now than it was some 20 years ago but the public healthcare sector has not adapted to these changes. This means the task of providing complicated care is picked up by the private sector; thus the government pays a lot more for procedures that could be performed in the public sector, with no efficiency gains. We believe Saudi can learn from the experience in Brazil. In our opinion, the focus should remain on tertiary healthcare, with primary and secondary care moved to the private players. The burden on the population would also fall as mandatory insurance is rolled out in the Kingdom. Median age of population (year, x axis) versus healthcare spending as a % of GDP (y axis) – correlation of 75% – Brazil has significantly higher spend 14% Private hospital bed penetration (x-axis) vs public hospital bed penetration (y-axis) in different Brazilian states – build-out by both segments has been similar with few outliers 3.5 12% France 10% Brazil South Africa Germany UK 1.5 Poland Russia 6% South Africa - private India Malaysia Saudi 4% 2% Private and public similar 2.5 2.0 Spain 8% 3.0 Outliers 1.0 China Thailand 0.5 0.0 UAE 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 0% 20 25 30 Source: World Bank WDI, UN estimates 35 40 45 50 Source: Brazilian Ministry of Health 157 EQUITIES ● SAUDI ARABIA February 2017 Al Hammadi Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations ALHAMMAD AB, Hold, TP SAR33 Company description Al Hammadi Development & Investment Co. (Al Hammadi) owns and operates two hospitals in Riyadh at Olaya and Suweidi. Established in 1985, the group currently has a total capacity of 720 beds. Al Hammadi started commercial operations at its Al Suweidi Hospital only during the second half of 2015 and plans to open Al Nuzha Hospital in 2017. Al Nuzha Hospital has a planned capacity of 600 beds in total, bringing the total capacity of the group to 1,320 beds. The company also plans to add 64 new outpatient clinics at Al Nuzha, which would take the total number of clinics to 202. Investment thesis Although we see strong long-term growth potential for Hammadi due to the expansion plans, we maintain our Hold rating on the stock for the following reasons: It will take time for Olaya to return to normal operating levels: Following a fire, Hammadi’s key hospital in Olaya was closed between February 2016 and August 2016. Although 4Q16 numbers indicate that Olaya hospital has started contributing to the group performance, we believe it will be some time before it starts operating at historical levels. Government contracts and receivables remain an issue: Hammadi’s trade receivables as of 2016 end (calculated based on reported cash-flow statements) indicate receivable days of close to 300.The group has significant exposure to government contracts (c30% of revenues) and, in our opinion, the delays in payments from the government are leading to the high receivable levels. We believe Hammadi’s margins are at risk here also, as the company may either try to get the payments at a discount or move away from the government contracts, which for it are higher margin than those for insurance patients (the opposite for other hospital operators). Financials Hammadi reported 16% revenue growth with a significant drop in operating margins during 4Q16. The reopening of Olaya hospital in August 2016 had a positive impact on the group’s top line. However, given that the reopening should have doubled capacity, the revenue growth rate of 16% reported suggests neither of the two hospitals are running at full capacity. Net income for the quarter came in at SAR10.7m, down 70% y-o-y. Management pointed to bad debt provisions for weaker operating margins. Considering the strong expansion plan and potential improvement in existing hospitals, we estimate Hammadi’s revenues to double by 2019 from current (2016) levels. However we estimate margins to remain under pressure for the group due to its significant exposure to government contracts. Valuation We value Hammadi using a DCF methodology. The WACC of 8.6% is derived from a risk-free rate of 5.2% (sum of US 10 year bond yield of 2.4% and inflation differential of 2.8% (the historical differential between Saudi and the US)), ERP of 5.4%, beta of 0.9, cost of debt of 5% and debt equity ratio of 30:70%. This yields a target price of SAR33. 158 EQUITIES ● SAUDI ARABIA February 2017 Our target price of SAR33 implies a 2018e PE of 20x and 10.2% downside from the current share price and we rate the stock Hold. Despite the risks related to company’s receivables due to its exposure to government contracts, we have a Hold rating on Hammadi considering the strong long-term potential from the opening of a new hospital in Nuzha in 2017, which will add c40% bed capacity. Risks Downside risks include: Further delays in the opening of new hospitals, concentration risk in Riyadh, higher-than-expected wage growth. Upside risks include: If the group is able to improve its client mix without sacrificing its margins, valuation should also improve. Better than expected margin performance despite opening of new Nuzha hospital. Faster than expected recovery in Olaya hospital. 159 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Al Hammadi Hold Financial statements Year to Valuation data 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 606 151 -53 98 -14 86 86 -11 75 75 765 230 -64 165 -23 144 144 -9 136 136 1,052 304 -80 225 -20 207 207 -12 194 194 1,346 358 -79 280 -17 265 265 -16 250 250 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 151 -109 -109 -90 239 17 230 -46 -46 -60 -74 152 304 -63 -63 -90 -85 209 358 -67 -67 -129 -44 258 0 1,610 492 51 2,103 97 626 575 1,371 1,956 0 1,592 596 125 2,188 106 626 501 1,446 1,957 0 1,575 736 210 2,311 125 626 416 1,551 1,976 0 1,564 888 254 2,451 145 626 371 1,671 2,052 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital Year to 12/2016a 12/2017e 12/2018e 12/2019e 8.2 32.8 2.5 58.8 3.2 0.4 2.0 6.4 21.3 2.5 32.4 3.0 3.5 1.4 4.6 15.8 2.4 22.6 2.8 4.7 2.0 3.5 13.3 2.3 17.6 2.6 5.9 2.9 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 36.76 33.00 4007.SE ALHAMMAD AB 1,171 61.00 61.00 51.00 51.00 41.00 41.00 31.00 31.00 12/2017e 12/2018e 12/2019e Y-o-y % change 8.0 -17.8 -36.0 -43.0 -47.2 26.2 51.6 68.4 68.4 81.6 37.6 32.5 35.9 43.4 43.4 28.0 17.8 24.5 28.3 28.3 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) 0.3 4.6 5.4 3.7 25.0 16.2 10.6 42.0 3.8 26.3 0.4 7.9 9.6 6.3 30.0 21.6 10.0 34.6 2.2 45.9 0.5 10.7 13.0 8.6 28.9 21.3 15.2 26.8 1.4 73.2 0.7 13.0 15.5 10.5 26.6 20.8 21.5 22.2 1.0 96.5 0.62 0.62 0.75 11.42 1.13 1.13 0.50 12.05 1.62 1.62 0.75 12.92 2.08 2.08 1.08 13.93 160 Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 21.00 2016 Al Hammadi Ratio, growth and per share analysis 12/2016a 30% Health Care Providers Saudi Arabia Raj Sinha +971 4423 6932 Price relative 21.00 2015 Year to Free float Sector Country Analyst Contact 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Astra Industrial Group Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations ASTRA AB, Hold, TP SAR15 Company description Astra Industrial Group has three main business segments: pharmaceuticals represented by the Tabuk Pharma, specialty chemicals represented by Astra Polymer Compounding & Astrachem, and finally, steel & power industries represented by the International Building Systems Factory, Al Tanmiya Steel and Astra Energy. The group also has some presence in limestone mining through Astra Mining. Investment thesis Through its diversified segments and revenue streams, we believe Astra is an attractive collection of companies. However for the medium term we see headwinds for the group earnings and hence have a Hold rating on the stock. Tabuk Pharma, which contributes almost half of group sales, is the second largest domestic pharma company. However over the last few quarters the division’s net income margins have been under pressure, which we believe is caused by FX depreciation for key export markets. We expect profitability to remain under pressure in the near term as we do not see any improvement in FX rates for markets such as Egypt and Sudan. Risk from spending cuts and Pfizer’s licence in Saudi: Government ambitions to cut spending could lead to public tenders where prices are pushed down further. Furthermore, the Saudi government recently gave approval for Pfizer to start manufacturing and operations in the Kingdom by 2017. Tabuk currently has an agreement to sell 12 Pfizer generic products in Saudi. Although the existing deal may not come under threat, the possibility of similar deals in the future is now low, putting the group’s long-term potential at risk if other foreign pharma companies enter the Saudi market. Still a market with low generics penetration: It is difficult to forecast what the pharma market will look like in the next decade. However, with the penetration of generics relatively low at c20% and with regulation that favours companies with the largest sales force, one would expect the government to attempt to change the laws to address these issues with a view to creating more jobs. This suggests an environment of higher volumes but lower margins for generic companies. To that end, Tabuk’s proposed expansion to increase capacity as a key driver of medium-term growth (the new facility in Dammam, which has lines for injectable, liquid and semisolid drugs, should be fully operational this year) is in our opinion a good move. Problems at the Iraqi steel plant continue, with no visibility on when it will reopen: we believe that even if the plant re-opens, it will take time to ramp up and become profitable. Financials Astra’s reported preliminary 4Q16 numbers comprised the following: net income for the quarter was SAR3m compared to a SAR65m loss in base period of 4Q15. The company reported operating loss of SAR21m compared to SAR50m loss in 4Q15. Net revenues for the quarter came in at SAR405m, down 4% y-o-y. However gross profits were up 41% during the quarter. 161 EQUITIES ● SAUDI ARABIA February 2017 Management said that gross profit in the pharma division improved while there were lower losses in the power and steel division. We estimate revenue growth remains weak for the group in the medium term, partly due to the FX impact, especially in its export markets. However we see improving margins for the group as loss making steel operations is either revived or sold off. Valuation We value Astra using a DCF methodology. Our DCF uses a WACC of 9.3% derived from a cost of equity of 11.2% using a risk-free rate of 5.2%, an equity risk premium of 5.5% and beta of 1.09, cost of debt of 5% and debt to equity of 30:70. This leads to our fair value target price of SAR15. Our target price of SAR15 implies downside of 13.1% and a FY17e PE of 10.6x. We have a Hold rating on Astra as we believe that the losses from its steel unit in Iraq and FX issues with its pharma exports mean a full recovery will take time. Risks Downside risks to our investment view include increased competition in the Saudi generic pharmaceuticals’ market and reduced demand for products in the chemicals division. Upside risks to our investment view include complete closure of Iraqi steel division and a faster-than-expected recovery in the pharma division. 162 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Astra Industrial Group Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Hold 1,756 109 -109 0 -54 -103 -103 0 6 6 1,791 166 -121 44 -76 -46 -46 0 50 50 1,840 265 -123 142 -78 74 74 0 113 113 1,931 324 -126 198 -77 151 151 0 166 166 -30 -157 -136 -60 135 -29 67 -161 -161 0 58 -80 201 -147 -147 0 -92 44 256 -154 -154 -83 -117 72 55 1,396 2,227 283 3,679 925 1,327 1,044 1,428 2,470 55 1,436 2,220 233 3,713 900 1,335 1,102 1,478 2,578 55 1,460 2,309 325 3,825 900 1,335 1,010 1,590 2,599 55 1,488 2,447 442 3,992 984 1,335 893 1,674 2,565 Year to 12/2015a 12/2016e 12/2017e 12/2018e 1.4 22.3 1.0 213.3 1.0 -2.1 4.3 1.4 15.0 1.0 27.6 0.9 -5.8 0.0 1.3 9.0 0.9 12.3 0.9 3.2 0.0 1.2 7.0 0.9 8.3 0.8 5.2 6.0 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2016e 34.30 29.30 29.30 24.30 24.30 19.30 19.30 14.30 14.30 Astra Industrial Group 12/2017e 12/2018e 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 (diluted) HSBC EPS (diluted) DPS Book value 39% Conglomerates Saudi Arabia Raj Sinha +971 4423 6932 34.30 Ratio, growth and per share analysis 12/2015a Free float Sector Country Analyst Contact Price relative 9.30 2015 Year to 17.26 15.00 1212.SE ASTRA AB 368 9.30 2016 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 -8.5 -38.5 -100.0 -1148.9 -94.1 2.0 52.4 2.7 59.8 218.5 674.2 124.7 5.0 22.1 39.6 104.3 47.9 0.7 0.0 0.4 -1.3 6.2 0.0 2.0 73.1 9.6 0.7 1.8 3.4 0.8 9.3 2.5 2.2 74.6 6.6 6.0 0.7 5.5 7.3 4.0 14.4 7.7 3.4 63.5 3.8 19.9 0.7 7.7 10.2 5.8 16.8 10.2 4.2 53.3 2.8 28.7 0.08 0.08 0.75 17.85 0.63 0.63 0.00 18.47 1.41 1.41 0.00 19.88 2.08 2.08 1.04 20.92 163 EQUITIES ● SAUDI ARABIA February 2017 Dallah Health Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations DALLAH AB, Buy, TP SAR112 Company description Founded in 1987, Dallah Healthcare owns and operates a single hospital in north Riyadh with 448 beds while also offering its management services to other healthcare providers. Furthermore, Dallah has a pharma division that is responsible for the wholesale of pharmaceutical, herbal and cosmetic products. Investment thesis Our investment case for Dallah is based on the following factors: Strong expansion plan to complement the increasing usage levels in Saudi: Dallah has in place one of the strongest expansion plans among EM hospitals, with an announced capacity addition pipeline that should double the number of beds over the next five years, and a land bank to do more. We estimate the group has close to 1,000 beds and more than 700 clinics by end of 2021. Furthermore, Dallah also has a 30% stake in Mohammed Rashid Al Fagih hospital in Riyadh, which is planned to come online in 2017 with 308 beds. Increasing insurance patients: Another factor which we believe is leading to stronger gains for Dallah is the growing contribution from the insurance group, who are more likely to go to a private hospital than those who pay their own way. The share of revenues from insurance patients has increased from 41% in 2011 to close to 50% now. We believe this points to increasing take-up in insurance in Saudi, which is leading to higher usage of hospitals among the population, in turn leading to stronger volumes for private hospital groups. We expect this trend to continue, benefiting companies such as Dallah in the longer term. Strong margin gains: Dallah’s hospital division has been reporting strong margin gains over the last six quarters. Although part of this is driven by maturing assets, we believe improving contract terms and increasing patient traffic is also helping. We expect this trend to continue in the medium term. However, despite this we estimate margins come under pressure in 2017 due to significant green-field expansion projects. Financials In 4Q16 Dallah reported strong revenue growth of 14% y-o-y driven by higher volumes and better contract terms. However margins were down 2.2pp due to losses in the pharma division, excluding which margins were up. Net income for the quarter came in at SAR52m, down 5% yo-y partly due to write-offs. Driven by strong expansion plans, we estimate Dallah’s revenues double by 2019 compared to 2016 levels. Although for the next three years we estimate margins remain under pressure due to significant expansion projects, we believe strong traffic and improving contract terms should support long-term margin gains for the group. 164 EQUITIES ● SAUDI ARABIA February 2017 Valuation We value Dallah using a DCF methodology. The WACC of 8.6% is derived from a risk-free rate of 5.2%, ERP of 5.4%, beta of 0.9, cost of debt of 5% and debt equity ratio of 30:70%. This yields a target price of SAR112. Our TP of SAR112 implies a 2018e PE of 20x and 14.1% upside from the current share price; we have a Buy rating considering the strong expansion pipeline of the group and growing focus towards brownfield expansion in the longer term. Risks Downside risks include: The new hospital coming on line in 2017 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; any acceleration in the Saudisation timetable from government would be negative. 165 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Dallah Healthcare Financial statements Year to Valuation data 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Buy 1,163 290 -58 232 -2 240 240 -14 226 226 1,382 309 -73 236 -8 238 238 -17 222 222 1,884 418 -81 337 -11 353 353 -23 330 330 2,394 501 -90 411 -31 409 409 -29 380 380 279 -317 -248 -89 -5 -43 256 -425 -425 -89 272 -140 295 -282 -282 -118 112 103 376 -297 -297 -118 70 145 0 1,404 620 187 2,245 148 481 295 1,511 1,689 0 1,755 653 149 2,630 165 716 567 1,644 2,094 0 1,955 795 137 2,972 196 816 678 1,856 2,418 0 2,162 1,184 367 3,568 229 1,116 748 2,119 2,750 Year to 12/2016a 12/2017e 12/2018e 12/2019e 5.1 20.4 3.5 25.7 3.8 -0.8 1.5 4.5 20.0 2.9 26.2 3.5 -2.5 1.5 3.3 15.0 2.6 17.6 3.1 1.8 2.0 2.7 12.7 2.3 15.3 2.7 2.6 2.0 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2017e 140.00 120.00 120.00 100.00 100.00 80.00 80.00 60.00 60.00 Dallah Healthcare 12/2018e 12/2019e Y-o-y % change Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 18.8 6.8 1.7 -0.7 -1.9 36.3 35.3 42.7 48.0 48.9 27.1 19.8 22.1 16.0 15.2 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) 0.7 13.8 15.6 10.7 24.9 20.0 160.1 19.5 1.0 94.7 0.7 11.6 14.0 9.4 22.4 17.1 39.3 34.5 1.8 45.1 0.8 14.0 18.9 12.1 22.2 17.9 38.8 36.5 1.6 43.5 0.9 14.8 19.1 12.5 20.9 17.2 16.4 35.3 1.5 50.2 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 3.83 3.83 1.50 25.61 3.76 3.76 1.50 27.87 5.59 5.59 2.00 31.46 6.45 6.45 2.00 35.91 166 Source: HSBC Note: Priced at close of 02 Feb 2017 17.9 30.7 37.9 37.3 36.8 43% Health Care Providers Saudi Arabia Raj Sinha +971 4423 6932 140.00 Ratio, growth and per share analysis 12/2016a Free float Sector Country Analyst Contact Price relative 40.00 2015 Year to 98.14 112.00 4004.SE DALLAH AB 1,550 40.00 2016 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Dr. Sulaiman Al Habib Not listed Company description Established in 1995 in Riyadh, Sulaiman Al Habib Medical Group (HMG) is currently the largest private hospital group in Riyadh with close to 1,000 beds at its three hospitals in the city. The group currently has a capacity of over 1,300 beds and operates hospitals and clinics in Riyadh, Qassim, Dubai and Bahrain. SHMG has plans to increase bed capacity to over 2,200 beds in the medium term with new facilities being constructed in Khobar, Jubail and Riyadh. HMG also has a presence in Dubai. Expansion plans: The group plans to add a 400-bed, 290-clinic hospital in Khobar over an area of 290k sqm. The key project of the group is, however, the Dr. Sulaiman Al-Habib Medical City in Riyadh which will house 700 beds, 400 clinics and 170 emergency and intensive care beds. Furthermore, the group also plans to add a new hospital in Jubail which will be in 1.85msq ft area. We have not included a financial summary because Dr Sulaiman Al Habib Medical Group is a private company. 167 EQUITIES ● SAUDI ARABIA February 2017 Middle East Healthcare Co MEH AB, Not rated Company description Established in 2004, Middle East Healthcare Company (MEHACO) is the largest listed private hospital in Saudi Arabia both in terms of revenues and beds. The group currently operates four hospitals under the Saudi German hospital brand name in Jeddah, Riyadh, Medinah and Aseer (Khamis Mushait) and c800 beds and c300 outpatient clinics across the Kingdom. MEHACO recently opened a 150-bed hospital in Hail in which it has a 32.3% stake and it plans to open a new 150-bed hospital in Dammam by 2018. The company also provides operations and management support to Saudi German Hospitals in Dubai (UAE), Cairo (Egypt) and Sanaa (Yemen). Financials MEHACO reported 4Q16 revenue of SAR405m, down 3.3% y-o-y, which according to management, in their results release on the Tadawul website, was mainly due to a shift in client mix. Net income for the quarter came in at SAR87.6m, down 14% y-o-y with operating profit dropping 11.6% y-o-y. Management pointed to higher staff costs related to expansions and higher interest charges for the significant drop in earnings. For the full year 2016, the group reported revenue growth of 5.3% y-o-y; however earnings were down 7.3% y-o-y with operating margins dropping by 2.8pp y-o-y. Recent news 7 February 2017: MEHACO announced in a public statement that the Saudi German Hospital Hail will open on 16 February 2017 and start receiving patients the following day. This hospital is owned by the National Hail Company for Healthcare, of which MEHACO owns 32.33%. This will add 30 outpatient clinics and 150 beds to MEHACO’s total. Total revenue is expected to grow 2.5% in 2017e according to the statement, while MEHACO’s share in the operating loss is expected to be SAR7.5m for the year. The financial impact will start in 1Q2017. 1 February 2017: In a TV interview, MEHACO’s CEO guided that the company plans to expand its operations in Saudi and said that more details on it will be revealed soon (source: Al Arabiya TV). 21 September 2016: MEHACO wins the management supervision contract Batterjee Medical City in Alexandria, Egypt. Operations are scheduled to start at the medical city by end-2019. 168 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Middle East Healthcare Co Financial statements Year to Valuation data 12/2013a 12/2014a 12/2015a 12/2016a Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 828 180 -43 137 -1 140 140 -4 137 137 1,399 358 -45 313 -4 332 332 -1 332 332 1,535 430 -52 378 -4 390 390 0 390 390 1,616 412 -59 354 -11 359 359 0 362 362 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 114 -162 -162 -20 77 -52 329 -123 -123 -92 -93 183 176 -115 -115 -166 86 45 232 -140 -140 -184 65 75 0 853 734 44 1,588 344 173 129 906 1,200 0 932 846 136 1,778 283 172 36 1,140 1,359 0 995 1,062 56 2,057 311 178 122 1,353 1,690 0 1,076 1,432 155 2,509 390 343 188 1,537 1,963 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital Not Rated Year to 12/2013a 12/2014a 12/2015a 12/2016a 8.0 36.7 5.5 46.8 7.1 0.3 4.7 18.4 4.9 19.3 5.6 1.4 4.3 15.3 3.9 16.5 4.7 2.6 4.1 16.0 3.4 17.7 4.2 2.9 EV/sales EV/EBITDA EV/IC PE* PB Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) 69.75 NR 4009.SE MEH AB 1,710 30% Health Care Providers Saudi Arabia Price relative 79.00 79.00 74.00 74.00 69.00 69.00 64.00 64.00 59.00 59.00 54.00 54.00 49.00 49.00 44.00 2015 44.00 2016 Middle East Healthcare Co 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Ratio, growth and per share analysis Year to Market cap (USDm) Free float Sector Country 12/2013a 12/2014a 12/2015a 12/2016a Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 52.8 61.3 88.6 96.8 121.3 68.9 99.2 128.9 137.1 142.0 9.7 20.3 20.8 17.4 17.6 5.3 -4.2 -6.5 -8.0 -7.3 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) 0.9 13.9 18.1 11.0 21.7 16.5 157.2 13.5 0.7 88.7 1.1 24.4 32.5 19.7 25.6 22.4 86.6 3.0 0.1 915.5 1.0 24.8 31.3 20.3 28.1 24.6 96.3 8.7 0.3 143.8 0.9 19.4 25.0 15.7 25.5 21.9 36.4 11.8 0.5 123.5 1.49 1.49 0.21 9.84 3.61 3.61 1.00 12.38 4.24 4.24 1.80 14.70 3.93 3.93 2.00 16.70 Note: Priced at close of 02 Feb 2017 Y-o-y % change EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 169 EQUITIES ● SAUDI ARABIA February 2017 Mouwasat Medical Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations MOUWASAT AB, Buy, TP SAR152 Company description Mouwasat is one of the largest hospital operators in Saudi Arabia, currently operating five hospitals with more than 800 beds and over 230 outpatient clinics. The group has a strong presence in Eastern cities of the Kingdom; however it opened its first hospital in Riyadh in 2014. Mouwasat has a strong corporate client base with companies like Saudi Aramco, Saudi Electricity Company and SABIC utilising its services. Investment thesis We believe Mouwasat is one of the largest beneficiaries of the strong growth potential in the Saudi private healthcare sector as it is one of the largest players. Mouwasat has a very strong expansion plan, which should see it expand its inpatient bed capacity by more than 50% by 2020 with plans to add a 300-bed hospital in Khobar in 2019 and add 170 beds in Madinah. During 2016 it added 100 beds to its portfolio through brownfield expansion in Jubail, equivalent to a 12% increase in bed capacity. Mouwasat has also been able to generate strong organic growth from increasing the number of patients treated at existing facilities as well as improving the tariff/case mix. We see this trend continuing, complementing the group’s expansion plans. In addition, in the long term, we see the potential for strong improvement in group margin as Mouwasat starts focusing more on brownfield expansion and as the Riyadh hospital matures. Financials Mouwasat reported strong 36% revenue growth in 4Q16 driven by improving performance at its Riyadh hospital. Operating profit for the quarter was up 33% and net income was up 34% y-o-y. Mouwasat had reported record revenue growth in 3Q and 4Q 2016. We expect the group to continue to see strong revenue growth in the medium term from improving traffic and addition of new beds. We estimate revenue CAGR of c13% between 2016 and 2019 with stable operating margins as the group’s new capacity matures. Valuation We value Mouwasat using a DCF methodology. The WACC of 8.6% is derived from a risk-free rate of 5.2%, ERP of 5.4%, beta of 0.9, cost of debt of 5% and debt equity ratio of 30:70%. This yields a target price of SAR152, which implies a 2018e PE of 21x and 5.1% upside from the current share price: we rate the stock Buy as we see strong margin gains for the group in the medium term from improving profitability in Riyadh while the long-term potential is among the best in Saudi, in our view due to its capacity expansion pipeline. Risks Downside risks include: There is a possibility that 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 also put pressure on margins as Saudis are more expensive to employ. 170 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Al Mouwasat Medical Services Financial statements Year to Valuation data 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Buy 1,240 362 -76 287 -7 295 295 -22 256 256 1,398 417 -81 336 -9 342 342 -25 297 297 1,610 504 -100 404 -9 410 410 -30 358 358 1,852 594 -114 480 -9 486 486 -36 425 425 275 -223 -223 -100 -51 36 355 -238 -238 -125 8 102 423 -274 -274 -150 1 134 499 -185 -185 -212 -102 299 17 1,383 659 132 2,119 242 447 315 1,292 1,685 17 1,540 714 124 2,330 262 447 323 1,464 1,885 17 1,714 798 124 2,589 291 447 323 1,672 2,115 17 1,785 997 225 2,858 323 447 222 1,885 2,251 Year to 12/2016a 12/2017e 12/2018e 12/2019e 6.1 20.8 4.5 28.2 5.6 0.5 1.4 5.4 18.1 4.0 24.3 4.9 1.4 1.7 4.7 15.0 3.6 20.2 4.3 1.9 2.1 4.0 12.5 3.3 17.0 3.8 4.1 2.9 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 144.61 152.00 4002.SE MOUWASAT AB 1,926 204.00 204.00 184.00 184.00 164.00 164.00 144.00 144.00 124.00 124.00 104.00 104.00 12/2017e 12/2018e 12/2019e Y-o-y % change 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 17.6 26.1 22.1 23.1 22.5 12.7 15.0 17.0 16.0 16.2 15.2 21.0 20.5 20.2 20.5 15.0 17.8 18.7 18.4 18.6 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) 0.8 16.9 21.1 14.0 29.2 23.1 49.7 22.8 0.9 87.3 0.8 17.4 21.6 14.6 29.8 24.0 46.6 20.6 0.8 110.0 0.8 18.7 22.8 15.8 31.3 25.1 56.4 18.0 0.6 130.8 0.8 20.3 23.9 16.8 32.1 25.9 66.4 10.9 0.4 225.2 5.12 5.12 2.00 25.84 5.95 5.95 2.50 29.28 7.16 7.16 3.00 33.45 8.49 8.49 4.25 37.70 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 84.00 2016 Al Mouwasat Medical Servi Ratio, growth and per share analysis 12/2016a 44% Health Care Providers Saudi Arabia Raj Sinha +971 4423 6932 Price relative 84.00 2015 Year to Free float Sector Country Analyst Contact 171 EQUITIES ● SAUDI ARABIA February 2017 National Medical Care Co Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations CARE AB, Hold, TP SAR56 Company description National Medical Care Co (NMCC) was established in 2003 as a joint-stock company. NMCC operates two hospitals in Riyadh – Riyadh Care Hospital and National Hospital. The company was initially owned by GOSI (General Organization for Social Insurance). NMCC currently has inpatient bed capacity of close to 600 beds. Investment thesis Although upward revision of some contract terms in the first half of 2016 led to strong revenue growth for NMCC, the company has been seeing significant weakness over the past two quarters. We believe the key reason for this is the loss of traffic in its GOSI contracts which is for blue collar accident cases and forms close to 25% of group revenues. With the construction sector slowing down, this contract may continue to face risk in terms of traffic in our opinion. The drop in sales has also led to weaker margins for the group recently. Hence we see limited potential for earnings growth in the near term and we have a Hold rating on the stock. Furthermore, in 4Q16 NMCC booked SAR47m provision for “anticipated objections” on their medical claims to clients, as well as a SAR10m bad debt provision and SAR20m loss on receivables. Along with Hammadi, NMCC has significant exposure to government contracts, which we believe could negatively impact group margins in the medium term. Financials NMCC reported a net loss of SAR71m in 4Q16 compared to SAR35m net profit in 4Q15; and operating loss of SAR47.7m in the quarter compared to operating profit of SAR33.7m in 4Q15. Gross profit for the quarter came in at SAR4m, down 92% y-o-y. Revenue for the quarter was at SAR221m, down 14% y-o-y. Management said that SAR20m losses were related to settlements with two clients, SAR10m was related to provision for doubtful debts to some government agencies and SAR46.8m was related to provisions for anticipated objections on medical claims to some clients. Excluding the impact of these one-off items, the company reported net loss of SAR6m. Despite the recent weakness in revenues we see strong long-term potential for NMCC due to its expansion plans. We estimate revenue CAGR of 13% for the group between 2016 and 2019. We believe group margins will normalise in the medium term. Valuation We value NMCC using a DCF methodology. The WACC of 8.6% is derived from a risk-free rate of 5.2%, beta of 0.9, cost of debt of 5% and an ERP of 5.4%. We assume a long-term debt to equity ratio of 30:70%. This yields a target price of SAR56. Our target price of SAR56 implies a 2018e PE of 15x. NMCC continues to trade at a 20% discount to Saudi hospital peers. However with implied upside of 2.5% to our target price, we have a Hold rating on the stock considering the risk to earnings from potential loss of revenues related to blue collar workers. Furthermore, the group continues to face problems with government receivables, although the quantum has come down slightly. 172 EQUITIES ● SAUDI ARABIA February 2017 Risks Key downside risks include: Further delays in getting payments from government and higher than expected pressure on margins as the company starts capacity expansion. Key upside risks include: Recovery in patient traffic can lead to a strong improvement in revenues and margins. If the group is able to improve its client mix without sacrificing its margins, valuation should also improve. 173 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: National Medical Care Co Financial statements Year to Valuation data 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 901 135 -59 77 -5 83 83 -14 69 69 1,064 211 -62 149 -7 157 157 -16 141 141 1,248 257 -71 187 -11 191 191 -19 172 172 1,330 275 -67 208 -13 210 210 -20 190 190 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 98 -90 -90 -34 25 18 115 -160 -160 -70 114 -59 255 -125 -125 -86 -44 115 220 -106 -106 -95 -19 99 0 688 900 217 1,588 306 369 151 913 1,064 0 785 1,051 253 1,836 334 519 266 983 1,249 0 840 1,117 297 1,956 369 519 221 1,069 1,290 0 879 1,186 316 2,065 383 519 203 1,164 1,366 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital Hold Year to 12/2016a 12/2017e 12/2018e 12/2019e 2.9 19.3 2.5 35.6 2.7 0.7 1.4 2.6 12.9 2.2 17.5 2.5 -2.4 2.9 2.1 10.4 2.1 14.3 2.3 4.7 3.5 2.0 9.7 1.9 12.9 2.1 4.0 3.9 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2017e 104.00 94.00 94.00 84.00 84.00 74.00 74.00 64.00 64.00 54.00 54.00 44.00 44.00 12/2019e Y-o-y % change 2.5 -27.7 -40.3 -41.6 -47.2 18.1 55.6 93.6 89.6 103.8 17.3 22.2 25.6 21.6 22.1 6.6 6.9 11.4 10.2 10.6 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) 0.9 6.1 7.6 4.9 15.0 8.5 26.9 16.6 1.1 65.0 0.9 11.5 14.8 8.6 19.8 14.0 30.8 27.1 1.3 43.4 1.0 13.2 16.7 9.6 20.6 15.0 23.2 20.7 0.9 115.2 1.0 14.2 17.0 10.0 20.7 15.6 21.2 17.4 0.7 108.6 1.54 1.54 0.75 20.35 3.14 3.14 1.57 21.91 3.83 3.83 1.91 23.83 4.23 4.23 2.12 25.94 174 Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 34.00 2016 National Medical Care Co 12/2018e 30% Health Care Providers Saudi Arabia Raj Sinha +971 4423 6932 104.00 Ratio, growth and per share analysis 12/2016a Free float Sector Country Analyst Contact Price relative 34.00 2015 Year to 54.66 56.00 4005.SE CARE AB 655 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Saudi Pharmaceutical Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Limited [email protected] +971 4423 6932 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations SPIMACO AB, Hold, TP SAR36 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 and began operations in 1990 with six 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 its earlier deals were structured so that it manufactures products for the 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 seen strong revenue growth for most of the year (except 4Q16), as it benefited from sales of a Herceptin-based cancer drug from Roche. Although the impact of this deal with Roche will cycle out in 2017, the company should see robust growth in the medium term. Qassim Medical: In May 2016, SPIMACO increased its stake in Qassim Medical and now owns a 57% stake in the group. Qassim operates a 100-bed hospital and has space to raise capacity to 200 beds. We currently do not estimate any returns from this investment as we do not have full clarity on the operations. However, we believe it could be a strong catalyst and could potentially add SAR3/share to our valuation. But risks remain – spending cuts and big pharma: Spending cuts can lead to a squeeze on margins for government tenders (14% of sales) which can put pressure on SPIMACO earnings. Although near-term spending cuts can lead to the government preferring cheaper generics over originals in tenders, benefiting local players, we see a risk of government supporting multinational pharmas to set up manufacturing in Saudi and altering the pricing differential mechanism that exists for generics (whereby companies that are first to register generics are allowed better pricing). Such a move could lead to more competition and potential margin erosion for SPIMACO. GSK (through a JV) and Sanofi already have plants in Saudi, with Pfizer recently getting a licence to start operation in 2017. Financials SPIMACO reported net income of SAR212m in 4Q16, compared to a SAR9m loss in the same quarter last year. However, SPIMACO's numbers include two one-offs during the quarter – capital gains of SAR248m and FX losses of SAR58m. Excluding the impact of one-offs, net income was SAR22m. The company reported operating loss of SAR7.6m (SAR50m ex. one off FX losses) compared to SAR102m operating profit in 4Q15. Gross profits were down 13.5% for the quarter. Net revenues for the quarter was SAR458m, down 12% y-o-y. Management pointed to weaker sales, higher administrative costs partly related to acquired Al Qassim Medical and losses in associates for the weak numbers. 175 EQUITIES ● SAUDI ARABIA February 2017 We estimate robust revenue growth for the group in the medium term (revenue CAGR of 6% 2015-18e) with steady operating margins. Although subsidy cuts and weaker government tenders could negatively impact earnings, we believe growing dividends from petchem associates could be supportive. Valuation We value SPIMACO using a DCF with a WACC of 9.6%, CoE of 10.7%, ERP of 5.5%, RfR 5.2%, debt equity ratio of 20:80 and cost of debt of 5%. Our DCF generates a target price of SAR36, implying 2017e PE of 13x. SPIMACO trades at a core PE of 10x on our 2017 estimates. Our target price implies downside of 10.0% to the current share price and we rate the stock Hold. Despite the risk on margins due to multinational pharmaceuticals setting up a manufacturing base in Saudi and directly competing with local players, we have a Hold rating on SPIMACO, considering the structural growth potential in the long term for pharmaceuticals in Saudi from ageing demographics and SPIMACO being the market leader benefitting from this. Risks Key downside risks include: (1) increased competition in the generic pharmaceuticals market; (2) inability to gain first entrant registration for off-patent drugs, which would likely reduce margins for the company. Key upside risks include: (1) if the company decided to divest its non-core assets and distribute the proceeds to shareholders; (2) the ramp-up in operating expenses, leading to much better sales than expected. 176 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi Pharmaceutical Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 Hold 1,705 287 -31 256 -3 370 370 0 351 351 1,911 328 -40 289 0 326 326 0 302 302 1,987 350 -45 305 0 360 360 0 335 335 2,066 426 -103 322 0 381 381 0 355 355 -41 -194 35 -180 172 -249 165 -296 -296 -121 259 -144 291 -99 -99 -168 -95 162 366 -103 -103 -178 -121 230 71 846 1,971 251 3,806 608 301 51 2,677 2,029 61 1,112 1,898 -8 3,989 649 301 310 2,826 2,430 53 1,174 2,059 87 4,205 662 301 215 2,958 2,537 48 1,179 2,247 208 4,393 675 301 94 3,098 2,592 Year to 12/2015a 12/2016e 12/2017e 12/2018e 2.3 13.7 1.9 13.7 1.8 -6.4 3.7 2.2 12.8 1.7 15.9 1.7 -3.7 2.5 2.1 11.7 1.6 14.3 1.6 4.1 3.5 1.9 9.4 1.5 13.6 1.6 5.9 3.7 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 39.98 36.00 2070.SE SPIMACO AB 1,283 49.00 49.00 44.00 44.00 39.00 39.00 34.00 34.00 29.00 29.00 24.00 24.00 Saudi Pharmaceutical Ratio, growth and per share analysis 12/2015a 12/2016e 12/2017e 12/2018e Y-o-y % change Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 62% Health Care Providers Saudi Arabia Raj Sinha +971 4423 6932 Price relative 19.00 2015 Year to Free float Sector Country Analyst Contact 19.00 2016 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 15.0 6.9 7.8 10.5 13.0 12.1 14.2 12.6 -12.0 -13.9 4.0 6.6 5.7 10.4 10.9 3.9 21.7 5.6 5.8 5.9 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) 0.9 14.0 11.5 9.3 16.9 15.0 101.6 1.9 0.2 0.9 13.4 11.0 8.4 17.2 15.1 0.8 12.6 11.6 8.8 17.6 15.3 0.8 12.8 11.7 8.9 20.6 15.6 10.6 0.9 53.2 7.0 0.6 135.7 2.9 0.2 389.7 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 2.93 2.93 1.50 22.31 2.52 2.52 1.01 23.55 2.79 2.79 1.40 24.65 2.96 2.96 1.48 25.82 177 EQUITIES ● SAUDI ARABIA February 2017 This page has been left blank intentionally 178 EQUITIES ● SAUDI ARABIA February 2017 Industrials 179 EQUITIES ● SAUDI ARABIA February 2017 Industrials Saudi’s electrical infrastructure system faces extreme demands and its capacity is hydrocarbon-dominated Recent initiatives open the door to liberalisation, while focusing on efficiency and diversification of the generation capacity Value creation and success will depend entirely on the details of the move towards market prices for electricity and input fuels Nicholas Paton*, CFA Senior Research Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6923 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations A state of flux in the electricity market The Kingdom’s electricity system has extreme characteristics The Saudi electricity market represents some of the largest and most difficult challenges for the Kingdom over the next 15 years: 1. Extremely high per capita consumption. Saudi Arabia is among the largest consumers of electricity in the world, with a consumption of 8,161 kWh/capita. Currently, it consumes three times the world average. Solution: According to World Bank data, transmission and distribution (T&D) losses in Saudi Arabia are low at only 7% of capacity output. Therefore the efficiency focus needs to be on the consumer, and this is addressed in the FBP2020 document with initiatives to move to higher efficiency electrical components and to reduce unnecessary usage. It should be noted that savings at the end consumer are particularly valuable as they are grossed up by the transmission loss factor as a saving on the electricity required to be generated. For instance with Saudi’s level of T&D losses, a 10kW saving at the consumer would result in a 10.8kW lower capacity requirement. An example given in the FBP2020 includes an expected reduction in the cost of lighting of 73%. 2. High growth in consumption. Consumption grew at 7% CAGR over the past decade against 3% growth globally (Source: Enerdata). Residential demand accounts for the largest share of total energy usage and growth here is driven by high 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 firm growth in its consumption trends. Thus an expanding industrial sector led by the development of petrochemical cities should 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 rapid demand growth. Solution: Saudi has plans to grow its generating capacity by 2% between 2015 and 2040 (from 70GW to 120 GW) and is simultaneously pushing efficiency measures which will help reduce the requirement for additional generation capacity. 180 EQUITIES ● SAUDI ARABIA February 2017 Energy consumption by segment (2015) Growth in energy consumed (10 year CAGR - 2006-2015) 14% 12% 12% 8% 6% 6% 50% 14% Industry 2% 16% Others 4% 4% 1% Source: Saudi Electricity Company 3. Others Industry Residential 0% Government Government 16% 4% Commeric al Commeric al 9% 10% Residential Source: Saudi Electricity Company Hydrocarbon dominated generation. Oil represents two thirds of the Kingdom’s input fuel for power generation and gas represents most of the remainder. Saudi’s power generation mix is therefore unusual and in urgent need of diversification towards other generation technologies. Solution: Saudi is embarking on an ambitious expansion into nuclear and renewable energy, targeting 9.5GW of renewable generation by 2030. This, combined with addressing consumption growth should limit the additional hydrocarbon-related capacity expansion required. Electricity generation split (%) by fuel type in 2015 %* Gas 3% 20% 30% Crude HFO Diesel Electricity generation split (%) in 2030 11% Renewable Non-renewable 39% Source: Saudi Electricity Company.* 2015 data. % arrived based on fuel consumed 97% Source: Saudi Vision 2030, HSBC estimates. % arrived based on capacity A delicate rebalancing is under way, but we expect accelerated reform from here Saudi’s Vision 2030 and the more recent Fiscal Balance Program 2020 document include various targets that are likely to have far-reaching implications for the Kingdom’s electricity market. The driver for the change is the same as that for other sectors: to balance the Saudi budget in an environment of sustained lower oil prices. The changes are designed to capture the most value for the Kingdom’s resources by capturing the best price for petrochemical resources and decreasing the consumption of those same resources. Decreased consumption can be achieved either by increasing the efficiency of the system or by using different technologies for generating the power. Both have been addressed in the government’s initiatives. The steps have moved towards liberalisation (unbundling of transmission, generation and distribution) and free market prices, while mitigating the negative effect on the most 181 EQUITIES ● SAUDI ARABIA February 2017 vulnerable consumers and industries. On the whole we believe the Saudi administration has achieved this, although the coming reform will significantly accelerate previous cost-saving initiatives and the impact will be less easy to mitigate for the lowest income users. Recent announcements raise expected costs savings from SAR38m to SAR209m in 2020 In the recent Fiscal Balance Program 2020 (FBP2020), published as a follow-up to the Vision 2030 document in 2016, the Saudi administration details plans to ramp up cost savings from Electricity and Water market reforms, from SAR38m in 2020 under the “first phase” of the programme to SAR209m in 2020 from the combined “first phase” and “new” energy reforms. During 2016 the government implemented what it termed a “marginal correction” in electricity prices, which we outline in the chart below. These hikes increased the electrical tariff for Saudi Electricity Company by 23% y-o-y we estimate, on a weighted average basis. With global market prices (ex GCC) for electricity still around USc10-15/kWh and more than 150% above Saudi’s, there remains some considerable way to go. The FBP2020 document states the guiding principle for the 2017-20 period is for a phased increase in prices towards international market prices with compensation for affected consumers, industrial support and Energy Efficiency programmes. By 2020, the target is for all products is to reach 100% of the reference prices. Global electricity market prices (USc/kWh) Source: Saudi Electricity Company and HSBC estimates Italy Germany UK China US France Others Industry New price Weighted avg Old price Government Commeric al Residential 25.0 20.0 15.0 10.0 5.0 0.0 18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 - South Africa 30.0 Canada 35.0 Saudi 2016 new vs old price tariff changes (SAR halala/KwH) Source: Statista. Note: 2015 prices used. Post reform prices for Saudi Renewables generation will feature in the Kingdom’s plans FBP2020 includes explicit targets for generation capacity Saudi, like other GCC countries, is pursuing ways of diversifying its generation capacity. The two main ways of diversifying generation capacities are solar and nuclear capacity development. The region’s biggest concentrated solar power plant (CSP), Shams 1, became operational in March 2013 and there are plans to introduce both CSP and photovoltaic (PV) type power plants to increase renewable capacity generation. Saudi Arabia recently launched the construction of a 600 MW Integrated Solar Combined Cycle gas power plant project in Dubai. This project would integrate a parabolic trough CSP unit of about 500 MW. Nuclear, however is likely to form the bulk of the renewables generation capacity. 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. In fact nearly all countries in the GCC have some form of development targeted at introducing nuclear capacity into their generation mix. In the UAE, Barakah Nuclear Power Plant unit 1 and 2 are currently under construction, due to become operational in 2017. The ultimate plan is to reach 4x1400MW of capacity by 2020. Construction of the first plant is planned to start in 2016. 182 EQUITIES ● SAUDI ARABIA February 2017 Liberalisation is the longer-term aim Privatisation would fit with the strategy with other state assets The Vision2030 document from 2016 also mentions potential privatisation of state-owned assets in the utility and other sectors. In a previous move, SEC was set to be split into four power generation companies by year-end 2016 in an effort to increase efficiency; however according to Reuters (8 May 2016), the newly formed Energy Ministry is considering revamping the plan with alternative/complementary additions; there are no further details available currently. We believe privatisation and liberalisation of the utilities market would be value accretive for the sector longer term. However the details of any restructuring, including the financial terms for the various elements of the system will be critical to assess the valuation of the assets. We believe methodology similar to Qatar’s, whereby the generation company sells power to an unlisted government entity with a long-term off take agreement, would be the fastest way to implement a privatisation and liberalisation strategy, as it would improve market liberalisation and profitability for SEC. Liberalisation of tariffs without full sector privatisation (i.e. regional and segmental breakdown) could result in bill collection problems – similar to the liberalisation process in Turkey – as households and struggling commercial consumers could delay payments in the absence of government support. Among the three business lines, we see transmission as being the most difficult to privatise due to the challenging geography of the Kingdom, with its vast deserts and sparse rural population in some areas. The implementation of a licence-free solar capacities model (Turkey) or local mobile diesel generators (Oman - Dhofar region) could help ease the process. 183 EQUITIES ● SAUDI ARABIA February 2017 Aldrees ALDREES AB, Not rated Company description Listed in 2006, Aldrees owns, leases, and operates through its own brand fuel stations across Saudi Arabia. The company also has a transportation fleet, through its ‘Naqil’ subsidiary. As of 4Q 2016, the company had 473 petrol stations across Saudi Arabia. Of these, 267 petrol stations are in the Central region, and 104 are in the Eastern region, with 54 stations located on highways. The company mostly rents the properties on which it operates, with 458 petrol stations rented. The company has a 5% market share in the fragmented petrol station market, making it the largest organised player. On the transportation side, the company had 1,285 trucks as of the end of 2016. The segment serves companies in the petrochemical industry, mining and food logistics, among others. Financials The company’s net profit in 4Q16 fell to SAR15.3m, from SAR33m in 4Q15 (-53.4%) driven by a weaker transportation sector due to declining prices and demand from cement and petrochemical factories. Costs of sales and operations also increased on the back of higher fuel, electricity and water prices for the transportation and petrol sectors. On a q-o-q basis, net profit fell 17.3% mainly due to the increase in cost of sales, as mentioned above. For the full year, net profit dropped 36.8% y-o-y to SAR91m, EBIT was SAR104.5m, down 28.8% and revenues increased 50.3% to SAR3,461m. Recent news 17 January 2017: Aldrees announced a dividend distribution of SAR40m, equating to SAR1.0 per share for the year 2016. The company also distributed one bonus share for every four shares held. 19 October 2016: The company issued a statement to announce that it had signed a contract with Ma’aden Waad AlShamal for Phosphate Company for the transportation of molten sulphur and phosphoric acid with a total value of as much as SAR597m. 184 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Aldrees Petroleum and Transport Services Financial statements Year to Valuation data 12/2013a 12/2014a 12/2015a 12/2016a Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT Taxation Net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 1,983 172 -63 109 -10 105 -3 102 2,144 204 -65 138 -12 129 -5 124 2,303 215 -69 147 -10 149 -5 144 3,461 150 -180 -177 -60 100 -30 175 -115 -124 -60 15 60 139 -78 -33 -80 -42 61 213 -143 -141 -80 30 70 0 697 361 29 1,089 237 300 270 518 1,060 0 743 421 35 1.205 266 315 280 580 1,170 0 736 501 18 1,259 294 273 255 643 1,241 0 806 732 39 1,557 549 303 264 653 1,518 179 68 105 -14 94 -3 91 Ratio, growth and per share analysis Year to 12/2013a 12/2014a 12/2015a 12/2016a Year to 5.8 4.9 4.1 7.6 8.2 18.4 26.6 22.6 7.4 5.8 6.1 15.9 50.3 -16.7 -28.6 -36.9 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) 2.5 12.9 19.6 9.3 8.7 5.5 17.5 0.5 1.6 0.1 2.5 14.4 21.3 10.3 9.5 6.5 17.6 0.5 1.4 0.2 2.6 16.0 22.4 11.4 9.4 6.4 21.6 0.4 1.2 0.2 1.3 6.0 13.9 5.8 5.2 3.0 12.8 0.4 1.5 0.1 EPS Rep (diluted) DPS Book value 2.6 1.5 13.0 3.1 2.0 14.5 3.6 2.0 16.1 2.3 1.6 16.3 12/2013a 12/2014a 12/2015a 12/2016a 0.9 9.9 1.6 14.4 2.8 -2.0 4.1 0.8 8.3 1.4 11.9 2.5 4.1 5.4 0.7 7.9 1.4 10.3 2.3 4.1 5.4 0.5 9.5 1.1 16.0 2.3 4.8 4.4 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Reuters (Equity) Market cap (SARm) Free float Country 36.75 4200.SE 1,470 88.2 Saudi Arabia Bloomberg (Equity) Market cap (USDm) Enterprise value (SARm) Sector ALDREES AB 392 1,695 Oil & Gas Price relative 80 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 2014 0 2015 Aldress Petroleum Y-o-y % change Revenue EBITDA Operating profit PBT Ratios (%) Not rated 2016 2017 Rel to Tadawul Source: HSBC Note: Priced at close of 02 Feb 2017 185 EQUITIES ● SAUDI ARABIA February 2017 Ma’aden Nicholas Paton*, CFA Senior Research Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6923 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations MAADEN AB, Hold, TP SAR37.8 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 away from the Kingdom’s traditional oil and petrochemicals sectors. 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. Ma'aden's main projects are gold, phosphate, aluminium and infrastructure. The gold business has been operational since the inception of the company. The existing phosphate fertiliser project is a joint venture with SABIC owning 30%. The Waad Al Shamal project is owned 60%, 25% and 15% by Ma’aden, MOSAIC and SABIC, respectively. Ma’aden’s aluminium project is a joint venture with Alcoa owning a 25.5% stake. On December 7, 2016 Ma’aden announced it is developing a third phosphate plant that will eventually add a further 3m tonnes per year of production capacity and is subject to feasibility studies. Investment thesis Ma’aden is a long-term story as most of its projects have only recently become fully operational and the Waad Al Shamal plant is only due to come onstream at the end of 2017. We believe the Saudi Government will continue to support the venture with whatever resources are necessary and that this resolve is likely only to be strengthened by the lower oil prices seen over the past three years. Positive newsflow has helped push the stock higher. The raft of newsflow in 2016 on Ma’aden has been largely positive, with the development of the Jaguar Land Rover (JLR) deal, the Ad-Duwayhi mine being commissioned during 2Q16 and the commercial commissioning of the alumina refinery in October. The stock has performed well as a result, rallying close to 50% from its low on 30 September 2016. The announcement of the third phosphate plant – which we view as adverse for the company’s cash flow – has not impacted the stock price. We still see significant uncertainty on how the government’s Vision 2030 and the Saudi National Transformation Plan will be reconciled with Ma’aden commercial production of basic resources. Ma’aden plans to build its third phosphate fertilisers plant. Ma’aden announced on 7 December 2016 that is developing a third plant which will eventually add a further 3m tonnes per year of production capacity. The company estimates the new plant will cost approximately SAR24bn and expects full capacity to be reached in 2024. This project is subject to the completion of feasibility studies. As we wrote in the most recent Fertile Crescent note, 21 November 2016, there is oversupply for most fertiliser products in the near to medium future that will not be helped by Ma’aden's second DAP plant, due to come onstream in two years. We have previously highlighted the potential of the NTP and Vision 2030 projects to have an effect on Ma’aden's equity valuation, as the company is close to becoming cash flow positive with the current business scope. Ma’aden to supply aluminium for the Range Rover Sport models. On 2 November 2016, at the company’s investor day, Ma’aden announced that it had been selected to provide rolled 186 EQUITIES ● SAUDI ARABIA February 2017 aluminium product to JLR for its new Range Rover Sport model. The company appeared reasonably confident that it can sell a meaningful portion of its overall rolled product to JLR at some point in the future. This is clearly very good news. In our report on 24 May 2016 (Uncertainty dominates), we noted Ma’aden’s rolled product could completely displace the GCC can-stock production, creating significant price competition, and that JLR had decided not to build a manufacturing plant in the Kingdom. Although there are likely to be challenging economics in delivering material quantities of high grade and “lifed” aluminium product to the UK while maintaining profitability, at least there is now a final customer for the product. High level of group debt is being addressed. At the recent 4Q earnings call Ma’aden said it is looking to shift some of its debt to fixed rate, as the majority is currently floating and SIBORbased. SIBOR rates rose from 1.8% at the start of 2016 to as high as 2.5% in November, creating a significant additional burden on Ma’aden’s SAR55.8bn debt pile. Financials 4Q results were below our estimates. 4Q sales were SAR2,371m, 11.7% below our SAR2,684m estimate. Gross profit of SAR498m is 14.1% below our estimate, EBIT of SAR225m is 37.4% below our estimate, and net income of SAR16m (post minorities) is 84% below our estimate. Looking by division, volumes of product sold were all in line with our estimate (+/- 4%) with the exception of Ammonia, where the company sold 0.204m tonnes of product, which was 57% ahead of our estimate. The company cites weak fertiliser and aluminium prices as the reason for the weak results. SG&A, which had been the big positive surprise 1Q16 (7.9% of sales, versus 9.0% for FY15) slipped back to 9.0% of sales 4Q16. The rise in SIBOR caused a 140% increase in the finance expense, from SAR110m 4Q15 to SAR265m 4Q16, which the company, at its recent Capital Markets Day, said that it needs to tackle. Valuation We value Ma’aden using a DCF-based sum-of-the-parts (SOP) valuation i.e. we value each part using a DCF methodology, taking account of the debt allocated to each individual project and Ma’aden’s stake in it, and then summing the separate divisions. We have assumed a cost of debt of 3.9% to reflect current corporate bond yields in Saudi. We use a risk free rate of 2.5%, an equity risk premium of 7.0%, an inflation differential of 2.0% and beta of 1.1 across the different business units, giving us a 11.9% cost of equity. Using a long-term debt-to-equity ratio of 60:40 we arrive at a uniform WACC of 7.1%. We assume a terminal growth rate of 2.5% for Ma’aden’s phosphate, Wa'ad Al Shamal, and aluminium projects, and 1.0% terminal growth rate for gold. Based on the sum of- the parts for the valuation of each project, we arrive at a fair value target price of SAR37.8 per share. Our target price implies 9.2% downside and we rate the stock Hold despite having downside to our price target as we believe Ma’aden is likely to continue to see support from shareholders and share price resilience given its high-profile position as one of the three pillars of the Saudi economy. Risks Downside risks include: A further reduction in the subsidies on natural gas and other input commodities. Ma’aden could struggle to export DAP when the Wa’ad Al Shamal project comes on line. Weaker than expected demand for Ma’aden’s key products: DAP, aluminium, gold and ammonia. Upside risks include: An increase in the scope of Ma’aden’s business, complemented by a state subsidy for the new end products, as part of the National Transformation Plan. Improvement in commodity prices. 187 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Ma’aden Hold Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 10,956 3,657 -2,353 1,305 -415 854 854 -46 605 605 9,820 3,791 -2,482 1,309 -684 572 572 -29 494 494 12,061 4,674 -2,447 2,227 -1,289 1,006 1,006 -25 883 883 15,452 5,974 -3,721 2,253 -1,276 1,073 1,073 -27 941 941 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 2,993 -13,431 -13,431 0 8,153 -10,853 840 -8,151 -8,151 0 8,010 -7,995 4,306 -3,691 -3,691 0 605 -674 5,727 -1,855 -1,855 0 -2,691 2,595 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 372 77,085 11,110 4,308 89,378 8,072 45,399 41,091 27,298 76,187 317 82,809 16,406 6,146 100,342 8,609 55,246 49,100 27,792 84,777 269 84,100 14,165 3,381 99,345 8,790 53,086 49,705 28,675 86,363 229 82,275 15,146 3,125 98,460 9,807 50,139 47,014 29,617 84,718 Year to 12/2015a 12/2016e 12/2017e 12/2018e 8.1 24.3 1.2 80.4 1.8 -22.7 0.0 9.9 25.6 1.1 98.5 1.7 -16.7 0.0 8.1 20.9 1.1 55.1 1.7 -1.4 0.0 6.1 15.9 1.1 51.7 1.6 5.4 0.0 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 41.62 37.80 1211.SE MAADEN AB 12,967 59.00 59.00 54.00 54.00 49.00 49.00 44.00 44.00 39.00 39.00 34.00 34.00 29.00 29.00 12/2016e 12/2017e 12/2018e Y-o-y % change Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 1.5 2.0 -34.7 -52.0 -55.4 -10.4 3.7 0.3 -33.0 -18.4 22.8 23.3 70.1 75.9 78.8 28.1 27.8 1.2 6.6 6.6 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) 0.2 1.8 2.2 1.4 33.4 11.9 8.8 116.1 11.2 7.3 0.1 1.6 1.8 1.4 38.6 13.3 5.5 136.6 13.0 1.7 0.1 2.6 3.1 2.3 38.7 18.5 3.6 134.6 10.6 8.7 0.2 2.6 3.2 2.4 38.7 14.6 4.7 123.8 7.9 12.2 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 0.52 0.52 0.00 23.36 0.42 0.42 0.00 23.79 0.76 0.76 0.00 24.54 0.81 0.81 0.00 25.35 188 24.00 2016 Maaden Ratio, growth and per share analysis 12/2015a 34% Metals & Mining Saudi Arabia Nicholas Paton, CFA +971 4 423 6923 Price relative 24.00 2015 Year to Free float Sector Country Analyst Contact 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Saudi Arabian Fertilizer Nicholas Paton*, CFA Senior Research Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6923 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations SAFCO AB, Hold, TP SAR60.0 Company description Saudi Arabia Fertilizers Company (SAFCO) is a petrochemical company that manufactures Urea and Ammonia at plants located in Dammam, with an annual production capacity of 2.6mt of urea and 2.3mt of ammonia. It also produces Sulphuric acid and Melamine. SAFCO holds a 50% equity interest in National Chemical Fertilizers Company, a 3.7% stake in Arabian Industrial Fibers Company, and a 1.69% stake in Yanbu National Petrochemicals Company. Investment thesis Dividend looks sustainable. Over the past ten years, the company has paid out roughly 100% of earnings in dividends, and its share price has broadly tracked those dividend payments. We believe SAFCO will broadly retain this dividend policy, which is likely to see a moderate decrease in net cash over the coming periods. Ibn Al-Baytar unlikely to change the growth profile. On 14 November 2016, SAFCO announced it was to buy Saudi Basic Industries Co (SABIC)’s 50% stake in Ibn Al-Baytar. We believe the primary rationale for the deal is to rationalise cross holdings. SAFCO’s financials do not offer much clarity as to the exact break down of the associate income and valuation, but we assume the majority of the associates’ book value is Ibn Al-Baytar. Likewise, we assume the majority of the 2016 SAR52.9m associate income that SAFCO booked is Ibn Al Baytar. Based on publicly available information from SABIC, we understand Ibn Al-Baytar has the capacity to produce, per annum: 500kt of ammonia, 400kt of ammonium phosphates, 485kt of carbon dioxide, 100kt of superphosphate and 500kt of urea. Like SAFCO, Ibn Al-Baytar does not have the gas allocation to expand production and therefore it does not have the ability to grow volumes. Financials 4Q results were better than we had estimated. 4Q sales of SAR765.3m was 15% higher than our estimate of SAR666.9m. Gross profit of SAR310.9m was 38% ahead of our estimate, EBIT of SAR290.4m was 37% ahead and net income of SAR284.5m was 16% ahead. However, the results were down materially y-o-y – by 25% at the net income level – due to lower product prices and higher feedstock costs. Urea prices have been a little stronger recently due to the increase in coal prices in China, which has lifted prices across the market. Valuation Unlike our DCF- or PE multiple-based valuations for the other fertiliser companies, we use a target dividend yield method to value SAFCO as historically, it has traded in line with the movement of its dividend. Due to the company having no growth in volumes (because it is unable to get any additional allocation of gas supplies) and its paying out c100% of earnings, this seems logical. So therefore we forecast SAFCO’s dividend and establish a target dividend yield, paying attention to the stock's history and where the Saudi market trades. The Saudi market is currently trading at an average 2017e dividend yield of 3.3% vs SAFCO on 4.2%. Given SAFCO's high valuation on metrics such as PE and EV/EBITDA relative to other Saudi listed stocks, we do not believe its yield is likely to fall to the market level. However, we believe the stock can trade on a 5.0% dividend yield 189 EQUITIES ● SAUDI ARABIA February 2017 as it has done historically. At a 2017e 5.0% dividend yield SAFCO would trade at SAR60, which is our target price and which implies downside of 17.3%. We maintain our Hold rating. As the chart below shows, SAFCO is running down its cash levels at this level of payout. However it is doing so very slowly and against a backdrop of Urea prices that may have troughed; hence we rate the company a Hold rather than Reduce. SAFCO dividend payout and gross cash position 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 - 160% 140% 120% 100% 80% 60% 40% 20% 0% 2008 2009 2010 2011 2012 Cash (SARm) 2013 2014 2015 2016e 2017e Payout - RHS Source: Company data and HSBC estimates Risks Downside risks: lower than expected fertiliser prices and lower than expected operating rates. A dividend cut would likely catalyse a prompt negative reaction in the stock. Upside risks: Higher than expected fertiliser prices and higher than expected operating rates. Increases in the dividend. 190 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi Arabian Fertilizer Financial statements Year to Hold Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 3,547 2,415 -401 2,014 0 2,196 2,196 -66 2,130 2,130 2,758 1,334 -433 901 0 1,038 1,038 -27 1,011 1,011 2,873 1,361 -451 911 0 1,048 1,048 -27 1,020 1,020 2,875 1,286 -449 837 0 974 974 -25 948 948 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 2,654 -779 -779 -2,242 180 1,828 1,522 -233 -233 -1,250 71 1,252 1,352 -240 -240 -1,250 138 1,076 1,397 -240 -240 -1,250 194 1,020 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 0 5,173 2,815 1,460 9,012 750 0 -1,460 7,596 5,779 0 5,083 2,506 1,389 8,714 689 0 -1,389 7,358 5,511 0 4,875 2,415 1,251 8,513 718 0 -1,251 7,128 5,321 0 4,668 2,221 1,057 8,212 719 0 -1,057 6,826 5,113 Year to 12/2015a 12/2016e 12/2017e 12/2018e 10.0 20.8 5.0 29.9 4.1 4.3 4.1 9.7 20.4 5.2 29.6 4.2 3.7 4.1 9.7 21.6 5.4 31.9 4.4 3.5 4.1 Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 72.53 60.00 2020.SE SAFCO AB 8,059 12/2017e 12/2018e Free float Sector Country Analyst Contact 35% Chemicals Saudi Arabia Nicholas Paton, CFA +971 4 423 6923 Price relative 140.00 130.00 120.00 110.00 100.00 90.00 80.00 70.00 60.00 50.00 2015 140.00 130.00 120.00 110.00 100.00 90.00 80.00 70.00 60.00 50.00 2016 Saudi Arabian Fertilizer Y-o-y % change 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) -20.4 -27.4 -31.9 -32.5 -32.9 -22.3 -44.7 -55.2 -52.7 -52.5 4.2 2.0 1.0 0.9 0.9 0.1 -5.5 -8.1 -7.1 -7.1 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) 0.6 34.6 27.6 23.8 68.1 56.8 0.5 15.6 13.5 11.4 48.4 32.7 0.5 16.4 14.1 11.8 47.4 31.7 0.6 15.6 13.6 11.3 44.7 29.1 -19.2 -0.6 -18.9 -1.0 -17.6 -0.9 -15.5 -0.8 5.11 5.11 6.00 18.23 2.43 2.43 3.00 17.66 2.45 2.45 3.00 17.11 2.28 2.28 3.00 16.38 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 12/2016e 7.8 11.5 4.8 14.2 4.0 6.3 8.3 * Based on HSBC EPS (diluted) Ratio, growth and per share analysis Year to 12/2015a EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) 191 EQUITIES ● SAUDI ARABIA February 2017 Saudi Ceramic Company SCERCO AB, 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 tile, 2.5m pieces of sanitary ware, 10m pieces of ceramic road markers and 5m pieces of tile accessories. 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 Saudi Ceramic reported a 4Q16 net loss of SAR6m, down from a net profit of SAR55.7m in 4Q15, mainly due to a decrease in projects and falling selling prices as the company chose to retain market share. This resulted in lower margins overall. On a q-o-q basis, net loss was better as sales increased, helping margins. Also, the company had a SAR25m provision for its investment in Ceramic Pipes Company in 3Q16. For the full year, net profit dropped 91.3% y-o-y to SAR 24.5m, EBIT was SAR86.7m down 68.7% and revenues fell 21.3% to SAR1,304m. Recent News 2 October 2016: The company announced it had set aside SAR25m as provision against impairment of assets at its associate company Ceramic Pipes Company (CPC). 3 October 2016: Saudi Ceramics announced it had appointed Hamad Al Sheikh as the new CEO to replace Ali Al-Naim. Mr. Al Sheikh has a Masters business Management and was previously the deputy head of the Saudi Commission for Tourism and National Heritage. 29 December 2016: The company announced a dividend for 2016 of SAR1.0 per share for a total distribution of SAR 50m. 192 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi Ceramic Co. Financial statements Year to Valuation data 12/2013a 12/2014a 12/2015a 12/2016a Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT Taxation Net profit Cash flow summary (SARm) Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity 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 1,601 472 140 331 12 322 0 309 1,621 441 160 281 9 325 0 310 1,658 453 167 286 8 323 0 284 1,304 265 176 90 13 47 0 25 482 -376 -372 0 -30 106 389 -239 -261 0 13 150 380 -201 -193 0 60 179 124 -123 -133 0 -51 1 0 1,806 922 42 2,806 350 874 832 1,521 2,764 0 1,880 1,032 70 3,017 343 887 816 1,715 2,947 0 1,914 1,263 186 3,259 342 946 761 1,898 3,074 0 1,862 1,205 24 3,101 510 692 668 1,823 3,077 Ratio, growth and per share analysis Year to Not rated 12/2013a 12/2014a 12/2015a 12/2016a Year to 10.6 21.9 28.4 23.4 1.3 -6.5 -15.2 0.9 2.3 2.8 1.9 -0.8 -21.4 -41.4 -68.7 -85.4 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) 0.6 11.2 20.3 11 29.5 20.7 -38.8 0.5 1.8 0.6 0.6 10.5 18.1 10.3 27.2 17.3 -50.7 0.5 1.9 0.5 0.5 9.2 15 8.7 27.3 17.3 -55.7 0.4 1.7 0.5 0.4 0.8 1.3 0.8 20.3 6.9 -22.1 0.4 2.5 0.2 EPS Rep (diluted) DPS Book value 8.3 0.0 40.6 8.3 0.0 45.8 7.6 0.0 38.0 0.5 0.0 36.5 12/2014a 12/2015a 12/2016a 1.4 4.6 0.8 3.9 0.8 6.6 0.0 1.3 4.9 0.7 3.9 0.7 9.4 0.0 1.3 4.8 0.7 4.2 0.8 8.4 0.0 1.7 8.2 0.7 65.3 0.9 0.0 0.0 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Reuters (Equity) Market cap (USDm) Free float Country 31.98 2040.SA 426 83.8 Saudi Arabia Bloomberg (Equity) Market cap (SARm) Enterprise value (SARm) Sector SCERCO AB 1,599 2,174 Industrials Price relative 120 120 100 100 80 80 60 60 40 40 20 20 0 2014 0 2015 Saudi Ceramic Y-o-y % change Revenue EBITDA Operating profit PBT Ratios (%) 12/2013a EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) 2016 2017 Rel to Tadawul Source: HSBC Note: Priced at close of 02 Feb 2017 193 EQUITIES ● SAUDI ARABIA February 2017 Saudi Paper SPM AB, Not rated Company description Saudi Paper Manufacturing Company was established in 1989. It is engaged in the production and distribution of a range of paper products and tissue paper, as well as collecting, filtering and pressing solid waste paper, carton, plastic, metal and glass. The company uses virgin pulp, blended-fibres and de-inked papers as raw materials. It offers its products under brand names such as Manadeel, Excellence, Mouchoir, Zaman, City, Pure and Weekend. The company is active in local and international markets and runs paper collection and recycling operations through its wholly owned subsidiaries in the United Arab Emirates, Morocco, Bahrain, Jordan and Algeria, including Saudi Paper Converting Company, Saudi Paper Recycling Company, Al Madar Paper Trading Company and Saudi Investment and Industrial Development Company, among others. Financials SPM reported a loss of SAR33.1m for 4Q16 compared to a SAR44.4m loss in 4Q15. The decrease in losses was due to lower raw materials costs and sales and marketing costs. On a q-o-q basis, net loss increased 59.4% from SAR20.8m mainly due to the increase in marketing expense. For the full year, net loss dropped 48% y-o-y to SAR66.2m, while EBIT was a negative SAR24.8m and revenues fell 20.5% to SAR477m. Recent News 24 January 2016: SPM announced it had signed a contract with a consulting company to improve efficiency and return the company to profitability. 19 October 2016: SPM announced the relocation of a subsidiary’s production line from Jeddah to Dammam. The process will take six months and will lower annual costs by SAR4m. 15 November 2016: Hassan Asseri was appointed as CEO. He has more than 20 years’ experience working for ARAMCO and IBM and has a Masters in product development from The University of Tulsa. 194 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi Paper Manufacturing Co Financial statements Year to Valuation data 12/2013a 12/2014a 12/2015a 12/2016a Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT Taxation Net profit Cash flow summary (SARm) 820 109 50 59 27 35 3 32 758 105 50 55 33 28 2 25 601 12 55 -43 36 -125 1 -127 477 20 45 -25 32 -64 1 -66 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 77 -10 -9 56 -99 67 127 -66 -55 0 -82 61 23 0 -24 0 16 23 132 0 20 0 164 132 23 931 786 35 1,751 140 948 913 677 1,716 23 1,016 657 24 1,709 134 868 844 658 1,685 27 984 678 39 1,713 249 904 865 528 1,674 24 914 497 27 1,460 227 742 715 461 1,433 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital Ratio, growth and per share analysis Year to Not rated 12/2013a 12/2014a 12/2015a 12/2016a Year to 3.3 -29.2 -42.2 -66.7 -7.6 -2.5 -6.9 -20.0 -20.7 -88.9 -178.9 -545.9 -20.5 -72.6 -42.7 -48.5 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) 0.5 1.8 4.6 1.8 13.3 7.2 -4.1 1.3 8.4 0.1 0.4 1.5 3.8 1.5 13.8 7.2 -3.2 1.3 8.0 0.1 0.4 -7.6 -24.1 -7.4 1.9 -7.2 -0.3 1.6 74.4 0.0 0.3 -4.6 -14.4 -4.5 4.2 -5.2 -0.6 1.6 35.6 0.2 EPS Rep (diluted) DPS Book value 0.7 1.3 18.1 0.6 0.0 14.6 -2.5 0.0 11.7 -1.3 0.0 10.2 12/2014a 12/2015a 12/2016a 1.4 10.5 0.7 14.5 0.6 14.7 12.3 1.5 10.9 0.7 18.1 0.7 13.4 0.0 1.9 95.4 0.7 NA 0.9 5.0 0.0 2.4 57.2 0.8 NA 1.0 28.9 0.0 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Reuters (Equity) Market cap (SARm) Free float Country 10.15 2300.SE 122 100 Saudi Arabia Bloomberg (Equity) Market cap (USDm) Enterprise value (SARm) Sector SPM AB 457 1,145 Industrials Price relative 60 60 50 50 40 40 30 30 20 20 10 10 0 2014 0 2015 Saudi Paper Y-o-y % change Revenue EBITDA Operating profit PBT Ratios (%) 12/2013a EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) 2016 2017 Rel to Tadawul Source: HSBC Note: Priced at close of 02 Feb 2017 195 EQUITIES ● SAUDI ARABIA February 2017 This page has been left blank intentionally 196 EQUITIES ● SAUDI ARABIA February 2017 Insurance 197 EQUITIES ● SAUDI ARABIA February 2017 Insurance Long-term drivers in place given the enforcement gap in both the health and motor segments Regulatory push to increase enforcement even though short-term growth has been impacted by the consumer trading down Larger players with the requisite scale and balance sheet set to continue to gain market share Ankur Agarwal*, CFA Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6558 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Insurance Sector penetration still very low In the Islamic world, religious guidelines are often interpreted as being at odds with conventional insurance; therefore, Shariah compliant variants like Takaful and Islamic cooperative insurance have been growing at a rapid rate. The reluctance towards conventional insurance in the Islamic world stems from the belief that it involves Riba (interest or usury), Al-Maisir (gambling) and AlGharar (uncertainty), all of which are not permissible in Islam. The insurance contract contains gharar because, when a claim is not made, one party (insurance company) may acquire all the profits (premium) gained whereas the other party (participant) may not obtain any profit whatsoever. This is addressed in Islamic insurance by apportioning a percentage of the operating profit to the policyholders. While Takaful is the most dominant form in countries like Malaysia, Indonesia, Pakistan and Algeria, Islamic Cooperative Insurance is the most prevalent model in Saudi Arabia. Saudi Arabia has a model of Islamic insurance (cooperative insurance) that differs slightly from the traditional Takaful model in the following ways: The cooperative model does not require a segregation of ownership of policyholder funds from the shareholder funds. In Islamic cooperative insurance the operator is required to pay any claim that is incurred. The total claimed amount can exceed the value of the premium, which forces the company to use shareholders – similar to conventional insurance. However in the Takaful model, while the claimed amount is paid from the underwriting fund, in the case of a shortfall, whether under a profit sharing or agency contract (through the funds of the shareholders), the operator should provide an interest-free loan to cover the deficiency. In the case of both the Islamic Cooperative model and Takaful, the insurer pays Tabarru (donations). However while in the Cooperation model the underwriting surplus is shared between the policyholder and the shareholder, this is not true for all the Takaful models. For example in the Wakala model any underwriting surplus is distributed back to the policyholders (whereas in the Mudaraba model it is shared between the shareholder and the policyholder). Most companies in Saudi Arabia, including Bupa and Tawuniya, follow the Islamic Cooperative Insurance model (only four out of the 35 insurance and reinsurance listed entities have adopted 198 EQUITIES ● SAUDI ARABIA February 2017 the traditional Takaful model).The cooperative insurance model in Saudi Arabia calls for 10% of the operating profit from underwriting activities to be accrued to policyholders (and typically gets distributed as dividends or otherwise discounted from future premiums). Operating activities include both the traditional insurance business and the investment of working capital; further down the P&L for companies on the cooperative model, companies also have a second source of investment income from the investment of regulatory capital and any excess shareholder equity held to meet rating agencies’ requirements or otherwise to provide an additional buffer in the case of underwriting losses or pick-ups in net written premiums growth. Penetration remains low The Saudi insurance market has witnessed strong growth in the past few years, with a gross written premium (GWP) CAGR in 2009-16 of 21% across all segments. In spite of this rapid growth, insurance penetration in Saudi remains low compared with EM/DM peers and we believe there is scope for this to increase, driven by regulation to bridge the enforcement gap in the motor/health segment, as well as further mandates to insure additional segments of the population. Insurance penetration in Saudi (GWPs as a percentage of GDP) at 1.5% is even lower than other countries with a predominantly Takaful/Islamic insurance model like Malaysia, where this ratio stood at 1.7% in 2015. Saudi is underpenetrated relative to EM/DM GWP as a percentage of GDP US Premiums as a % of GDP 4% Canada Venezuela Switzerland Germany France 3% South Af rica Spain UK 2% Keny a 1% Japan Portugal Australia Namibia Italy Brazil Morocco Malay sia Colombia Ireland United Arab Emirates China Saudi Arabia Hong Kong Russia Tanzania Mexico India Indonesia Nigeria 0% 0.1 1 10 100 GDP per capita USD 1000 Source: Sigma Significant enforcement gap in the health and motor segment We believe the key means of driving higher insurance penetration in Saudi is to bridge the current enforcement gap in motor and health. Increasing the ambit of mandated insurance in health to cover Saudis in the public sector is another driver, especially as Saudi is looking to increase the share of the private sector in the healthcare space. There are currently 2.5m Saudis in the private sector who are yet to be insured (44% enforcement gap) while the enforcement gap in motor stands at close to 52%. We expect this gap to narrow by 2020 (to 19% in health and 13% in the motor insurance segment). We believe growth in the sector will come from bridging the enforcement gaps and strict regulatory monitoring. We forecast health GWP CAGR for 2015-20e at 8%, while in motor we expect 19% for the same period. However, the Council for Cooperative Health Insurance (CCHI) has taken steps to bridge the gap with policies like Unified health insurance, to be implemented in three phases, the third of which is due for completion by April 2017. CCHI will likely leverage the GOSI database to compare the number of Saudis insured with the employment data of Saudis in the private sector. In motor insurance, there are plans to ensure that the motor registration renewal (currently done every three years) and the insurance period overlap, making it easier to enforce compliance. 199 EQUITIES ● SAUDI ARABIA February 2017 Performance in FY2016 Growth in the sector moderated in 2016. The overall insurance sector was up around 1% for the full year 2016 (health was down 3.2% in the first nine months of 2016, while motor was up 13.9%) with the top-five players posting GWP growth of 5.4%, accounting for 63.4% of the total insurance GWP, or representing 63.4% market share. The top-two players reported GWP growth of 7.5%; they represent 43.5% of the market and increased market share by 260bps in 2016. While the reported profitability in the sector improved significantly, mostly helped by a lower loss ratio – which declined 1.4% from 79% in FY2015 to 77.6% during the year – and higher income from investment. This profitability of smaller players whose GWP actually declined (leading indicator of Net earned premium) is not sustainable in our view. Overall out of the 33 companies in the sector, 15 still have a combined ratio above 100% or were unprofitable. The top-two players still account for more than 56% of total profits. 15 Companies reported a combined ratio of more than 100% on average in last 4 quarters 180% 160% 140% 120% 100% 80% 60% 40% 8012-SA 8180-SA 8130-SA 8240-SA 8290-SA 8280-SA 8060-SA 8250-SA TAWUNIYA BUPA 8270-SA 8200-SA 8070-SA 8230-SA 8170-SA 8310-SA 8150-SA 8050-SA 8160-SA 8190-SA 8040-SA 8300-SA 8100-SA 8030-SA 8110-SA 8120-SA 8260-SA 8080-SA 8020-SA 8140-SA 8011-SA 8312-SA 8311-SA 20% Source: Factset, Company data SAMA suspended the ability of five insurers to issue motor insurance due to non-compliance SAMA, the insurance regulatory authority, has in the past three months suspended the ability of five insurers – Arabian Shield Cooperative Insurance, Malath Cooperative Co, MedGulf, Allied Cooperative Insurance Group and United Cooperative Assurance Co., (with a combined market share of close to 30%) – to issue motor insurance because of non-compliance. This should benefit the larger players like Tawuniya, which are better managed and well capitalised. SAMA subsequently lifted the ban on Malath Cooperative Co and Allied Cooperative Insurance Group. We believe market share increases will come mostly from gains from smaller players that would likely struggle in a more regulated environment, and also bearing in mind the relative preference of governmental organisations for using other government-owned entities: for example, Tawuniya is 47%-owned by government organisations and is one of the best players in the market, which should make it a preferred choice for government-run organisations as the government will indirectly earn from these agreements. Tough macro backdrop resulted in growth moderation The Saudi insurance sector was affected by the difficult macro backdrop in 2016. In the health segment in particular – mainly a B2B business – consumers traded down, and smaller players especially were affected by the slowdown in job additions during the year. Motor segment GWP continued to grow in double digits during the year driven by an increase in pricing. 200 EQUITIES ● SAUDI ARABIA February 2017 Bupa Arabia Cooperative Ankur Agarwal*, CFA Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6558 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations BUPA AB, Buy, TP SAR148.00 Company description Incorporated in 1997 as a JV between Bupa Group and Nazer Group, and listed in 2008, Bupa Arabia specialises in cooperative health insurance. The company has been outgrowing the market, with market share of 42.5% in 2016, from 18% in 2009. Bupa Arabia is associated through a franchise agreement with Bupa International, which retains a 26% stake in the company through Bupa Investments Overseas. It employs over 1,000 employees in Saudi. Aside from its insurance activities, the company plans to become a healthcare provider at some stage, in line with other Bupa associates around the world. In 2014, Bupa became the largest health insurance player in the Saudi market and maintained its lead in 2016. Other major shareholders include Nazer Holding Group at 9.00%, Hulol Albaramij Al Haditha at 9.00% and Asas Healthcare at 8.25% – all entities owned by the Nazer family. Investment thesis We continue to see Bupa as a major beneficiary of enforcement of the coverage gap in Saudi, along with consolidation in the health insurance segment. We highlight Bupa Arabia is the only insurer in Saudi that has consistently increased market share since 2012, as well as maintaining pricing discipline; this has meant its combined ratio improved 134bps in 2012-16 even though it more than doubled its market share in the health insurance market to ~42.5% as at end-2016. We expect a GWP CAGR of 14% in 2015-20e (versus health insurance sector growth of 8%), translating to a market share gain of around 11.5% in that period, of which Bupa had already captured 3.9% in FY2016. We see Bupa as a major beneficiary of consolidation in the health insurance segment and expect market share gains to continue during 2016-20e on the back of consolidation in the growing health insurance segment, as its balance sheet strength and scale gives it leverage over smaller players. Another catalyst for profitability growth will be the improvement of returns from investments. Bupa had a conservative investment portfolio in 2015 as was highlighted in our initiation report (Saudi Insurance sector 29 June 2016). It recorded a solid jump in its investment income of 7x in FY2016 versus FY2015, reflecting the increase in yields and an enhanced focus on maximising returns on its investment. Financials Bupa Saudi's 4Q results missed our expectations due to a subdued GWP trajectory and a higher than expected increase in loss ratio. GWP declined by 1% in the quarter to SAR1,086m and was 14% below our expectation of SAR1,263m. Net earned premium at SAR1,984m was up 10% y-o-y, and 5.3% below our estimate of SAR2,095m. Loss ratio increased to 84% from 79.3% the same period last year and was 280bps higher than our estimate of 81.1%. Expense ratio, at 8.6%, was lower than our 9.3% estimate. For the full year 2016, GWP at SAR7,938m was up 8.3% (versus our expectation of SAR8,115m or an increase of 10.7%) and Net income before Zakat at SAR630.7m was down 2.23% – 3.4% lower than our expectation of SAR653m. 201 EQUITIES ● SAUDI ARABIA February 2017 Valuation Our TP of SAR148, implying upside of 16.8%, is based on the residual income method, which we believe is suitable for capturing the significant growth in the Saudi insurance sector. Our TP implies a target multiple of 4.57x 2017e BVPS, which we believe to be fair in the context of an EPS CAGR of 19.9% in 2016- 20e and an average ROE of 31% during the same period. Our SAR148 TP implies 16.8% upside and we rate the stock Buy as we believe that Bupa, the largest health insurer, is well placed to leverage the structural growth story in the health insurance sub-sector. Key assumptions underlying our valuation: COE of 10.7%, based on an RfR of 5.2% An ERP of 5.5% and a beta of 1.0 Terminal growth rate of 2.5%. Key risks Key downside risks: The introduction of a state health insurance: while we do not account for any policy expansions on the mandated coverage in our estimates, the introduction of a state insurer to increase coverage among Saudis, especially in the public sector but potentially also in the private sector, may adversely affect the growth prospects of Bupa. Further downside risks include: 202 Stricter solvency requirements from SAMA may affect returns More aggressive competition Non-renewal of a major contract EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Bupa Arabia Cooperative Financial statements Year to Buy Per share data (SAR) 12/2015a 12/2016e 12/2017e 12/2018e P&L summary (SARm) Gross written premium Net earned premium PBT (reported) Total tax Net reported profit HSBC net profit Balance sheet summary (SARm) 7,328 6,739 645 -27 619 633 8,115 7,780 653 -31 622 622 9,164 8,589 788 -61 727 727 10,829 9,938 956 -74 882 882 Total investments Total assets Technical reserves Total liabilities Shareholders' funds Average invested capital Equity 4,971 6,153 3,945 4,487 1,667 1,359 1,667 5,672 7,179 4,534 5,056 2,124 1,895 2,124 7,031 8,684 5,389 5,994 2,690 2,407 2,690 8,641 10,518 6,604 7,310 3,209 2,949 3,209 Year to EPS reported (diluted) HSBC EPS (diluted) DPS NAV TNAV 12/2015a 12/2016e 12/2017e 12/2018e 7.73 7.92 2.00 20.8 19.6 7.78 7.78 2.01 26.6 25.3 9.09 9.09 4.55 33.6 32.4 11.03 11.03 6.62 40.1 38.9 12/2015a 12/2016e 12/2017e 12/2018e 16.4 16.0 6.5 46% 3.9 1.6% 16.3 16.3 5.0 33% 3.9 1.6% 13.9 13.9 3.9 30% 2.0 3.6% 11.5 11.5 3.3 30% 1.7 5.2% Valuation data Year to PE reported* PE (HSBC)* Price / TNAV ROE Dividend cover Dividend Yield * Based on diluted shares Ratios & growth Year to 12/2015a 12/2016e 12/2017e 12/2018e 27.7 46.7 114.1 102.3 113.0 119.3 10.7 15.4 1.2 0.5 -1.8 0.5 24.1 12.9 10.4 20.8 17.0 17.0 126.1 19.3 18.2 15.7 21.3 21.3 21.3 45.5 18.7 89.6 77.3 12.2 58.5 91.9 79.8 12.1 58.3 91.6 79.7 11.9 62.7 91.1 79.3 11.8 66.5 Y-o-y % change Gross written Premium Net earned Premium Reported PBT EPS reported HSBC EPS DPS Total investments Ratios (%) Combined ratio Loss ratio Expense ratio Reserve ratio Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 126.75 148.00 8210.SE BUPA AB 2,704 Free float Sector Country Analyst Contact 71% Insurance Saudi Arabia Ankur Agarwal, CFA Price relative 200.00 200.00 180.00 180.00 160.00 160.00 140.00 140.00 120.00 120.00 100.00 100.00 80.00 80.00 60.00 2015 60.00 2016 Bupa Arabia Cooperative 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 203 EQUITIES ● SAUDI ARABIA February 2017 Cooperative Insurance Co Ankur Agarwal*, CFA Analyst HSBC Bank Middle East Limited [email protected] +971 4423 6558 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations TAWUNIYA AB, Buy, TP SAR128.00 Company description The Company for Cooperative Insurance (Tawuniya) is the largest company in the Saudi insurance sector with a 21% market share of the gross written premium across categories in 2015. It was established in 1986 (originally known as the National Company for Cooperative insurance) as a national insurer to provide an impetus to Islamic insurance in the Kingdom. Tawuniya has a presence in three major insurance segments: health comprises the largest share of its premiums, at 65% of gross premiums written in FY15; motor accounts for 17% of group GWP, with the remainder composed of other property and casualty products. The central region accounted for 64% of written premiums, with the western and eastern regions of Saudi accounting for 15% and 16%, respectively in 2015. 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. Investment thesis We are positive on Tawuniya, the largest insurance player in Saudi and a beneficiary of the enforcement gap in the health (65% of GWP in 2016) and motor (19% of GWP in 2016) segments. Tawuniya’s 4Q profitability was higher than we expected due to a lower expense ratio that offset a higher than expected loss ratio. SAMA suspended the ability of five insurers in Q4 2016 (with a market share of close to 30%) to issue motor insurance because of noncompliance, potentially benefiting the larger players like Tawuniya, which are better managed and well capitalised. It could also set a precedent for future operations. We forecast Tawuniya’s motor market share increases 377bps by 2020 versus the 2015 level of 12% market share) on the back of stricter rules for pricing and operating in the market. Tawuniya recently added the health insurance contract from Saudi Airline Company which adds 5% to group GWP and 7.7% to health GWP. The regulator’s focus on bridging the enforcement gap in the health and motor sub-segments, where Tawuniya has leading positions, should support its growth trajectory. Financials Tawuniya’s 4Q results were ahead of our expectations in terms of profitability even though gross written premium (GWP) and net earned premium (NEP) were marginally below our estimates. 4Q FY16 GWP of SAR2,997m was up 8.4% y-y but 3.7% below HSBC estimate of SAR3,114m. Net earned premium of SAR1,740m in 4Q FY16 was up 9.4% y-o-y and 2.9% lower than our estimate of SAR1,793m. Claims incurred in 4Q FY16 at SAR1,300m (at 74.7% loss ratio) were up 14.7% on Q4 2015 (last year claims were restated upwards, which imply a 71.3% loss ratio for 4Q FY15) and 2.6% higher than our estimate of SAR1,267m (we expected a 70.7% loss ratio). 4Q FY16 net profit before tax came in at SAR212m versus SAR99.5m in 4Q FY15 – 46.2% higher than our SAR145m. Overall in 2016, while GWP growth was 6.8%, profitability growth was 22%. In addition to gaining market share in the motor and health segments, the company reduced its expense ratio by 362bps, which was a key driver of profitability in 2016. 204 EQUITIES ● SAUDI ARABIA February 2017 Valuation Our SAR128 target price is based on the residual income method, which we believe is suitable for capturing the growth story of the Saudi insurance sector. Our SAR128 TP implies 13.4% upside and we rate the stock Buy, as we think the regulator’s focus on bridging the enforcement gap in the health and motor sub-segments, where Tawuniya has leading positions, should support its growth trajectory,. Our TP implies a target multiple of 3.88x 2017e BVPS, which we believe to be fair in the context of an EPS CAGR of 15.0% in 2016-20e, and an average ROE of 27% during the same period. Key assumptions underlying our valuation: COE of 11.0%, based on an RfR of 5.2%; ERP of 5.5% a beta of 1.06 and a terminal growth rate of 2.5%. Key risks Downside risks: The investment income ratio (investment income/NEPs) averaged 4.4% in the last six years, which may be at risk if the money market returns are not as high going forward; adverse portfolio performance can have a material impact on our thesis. The introduction of a state health insurance. Stricter solvency requirements from SAMA may affect returns. 205 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Cooperative Insurance Co Financial statements Year to Per share data (SAR) 12/2016a 12/2017e 12/2018e 12/2019e P&L summary (SARm) Gross written premium Net earned premium PBT (reported) Total tax Net reported profit HSBC Net Profit Balance sheet summary (SARm) Total investments Total assets Technical reserves Total liabilities Shareholders' funds Average invested capital Equity Buy 8,055 6,841 801 -74 727 727 9,577 7,824 824 -64 760 760 11,180 9,342 992 -76 915 915 12,977 10,968 1,175 -91 1,084 1,084 6,946 13,476 5,716 10,554 2,922 2,616 2,922 7,920 14,632 6,394 11,330 3,302 3,112 3,302 9,010 16,014 7,143 12,300 3,714 3,508 3,714 10,151 17,510 7,972 13,362 4,148 3,931 4,148 Year to EPS reported (diluted) HSBC EPS (diluted) DPS NAV TNAV 12/2016a 12/2017e 12/2018e 12/2019e 7.27 7.27 1.00 29.22 29.22 7.60 7.60 3.80 33.02 33.02 9.15 9.15 5.03 37.14 37.14 10.84 10.84 6.51 41.48 41.48 12/2016a 12/2017e 12/2018e 12/2019e 15.5 15.5 3.9 28% 7.3 0.9% 14.9 14.9 3.4 24% 2.0 3.4% 12.3 12.3 3.0 26% 1.8 4.5% 10.4 10.4 2.7 28% 1.7 5.8% Valuation data Year to PE reported* PE (HSBC)* Price / TNAV ROE Dividend cover Dividend Yield * Based on diluted shares Ratios & growth Year to 12/2016a 12/2017e 12/2018e 12/2019e Gross Written premium Net earned premium Reported PBT EPS (reported) HSBC EPS DPS Total investments Ratios (%) 6.8 20.8 24.7 21.5 21.5 -31.0 11.6 18.9 14.4 2.9 4.6 4.6 280.2 14.0 16.7 19.4 20.4 20.4 20.4 32.4 13.8 16.1 17.4 18.5 18.5 18.5 29.3 12.7 Combined ratio Loss ratio Expense ratio Reserve ratio 88.5 74.6 13.9 83.6 89.5 74.8 14.6 81.7 89.2 74.9 14.3 76.5 89.1 75.0 14.1 72.7 Y-o-y % change Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 112.89 128.00 8010.SE TAWUNIYA AB 3,013 53% Insurance Saudi Arabia Ankur Agarwal, CFA Price relative 276.00 276.00 226.00 226.00 176.00 176.00 126.00 126.00 76.00 2015 76.00 2016 Cooperative Insurance Co Source: HSBC Note: Priced at close of 02 Feb 2017 206 Free float Sector Country Analyst Contact 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Real Estate 207 EQUITIES ● SAUDI ARABIA February 2017 Real Estate Government initiatives provide long-term support, but near term may not be as effective New land fees will impact companies negatively in the short term, but result in increased housing construction long term We are worried about very large supply additions for retail, office and hospitality, especially in Riyadh Patrick Gaffney*, CFA Analyst HSBC Bank Middle East Ltd. [email protected] +971 4423 6204 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Government efforts to revive sector are weak The Saudi residential housing market has suffered for many years from an undersupply of units – as many as 500,000. Much of this has been due to relatively high costs, driven mostly by high land costs. Land in the Kingdom has historically been seen as a store of value, and because there are no carrying costs, many landowners have sat on large plots of land in the cities. In the past few years, the government has started to rectify this, both by trying to stimulate the market and by imposing fees on undeveloped plots of land within urban areas. The property market in is very fragmented. Publicly listed real estate companies in Saudi Arabia focus mostly on the residential sector, but make up a small portion of total home construction. They also have large land banks and may suffer from these new land fees. They are generally not as involved in other sectors (retail, office, hospitality), but are making some inroads into these. However, as we discuss below, these sectors are facing excess capacity, so investments may not be as profitable. Below we summarise our recent report, Saudi real estate: Uncertainty remains – hurting sector published 17 January 2017 While Vision 2030 includes discussion of the importance of stimulating the housing sector, the nearterm effect of these initiatives may be a weak market. There are three major initiatives that should, over time, result in a much stronger housing market. First, the government is working to stimulate private development by offering partnerships and incentives to local and international developers. Historically the government has directly built units, which has been slow and somewhat ineffective. It seems much more committed now and has created an independent business unit in the ministry to drive public-private partnerships (PPP). It currently (as of February 2017) is undertaking or assessing projects that could consist of as much as 180,000 housing units. Recently, the Ministry of Housing announced an agreement with Emaar Middle East, 61%-owned by Emaar Properties (EMAAR UH; Buy; AED7.25). Second, the government wants to stimulate the mortgage market by raising loan-to-value (LTV) limits and guaranteeing loans directly. We think higher LTVs are incrementally positive, although there is limited liquidity in the banking system plus mismatched duration (banks have limited long-term funding). Over time, as the mortgage market develops and banks build liquidity, this could be very effective. In the near term, though, it is likely to be somewhat ineffective. 208 EQUITIES ● SAUDI ARABIA February 2017 Third, the implementation of the new land fees on undeveloped land should ultimately result in a more balanced property market. Until recently, land has made up a significant portion of the cost of building a home (50% or even more in some cases), despite a large amount of undeveloped land in cities. The new land fees have already started to lower land prices (not good for companies with large land banks), and this will likely continue through the implementation process. Right now the government has identified the plots included in phase 1, and will start to value these and send bills to land owners, who will have a year to pay the fees. Until the actual bills arrive, we think the land market will continue to be in stasis. Added to this, the implementation of new fees on expat workers by the Saudi government will raise prices on construction, despite the government’s intention to lower residential property prices. Residential Over the past few years supply additions have not been significant and we do not expect this to change much either. According to JLL, only 48,000 homes are to be built in Riyadh by 2018e (which is a quarter of the Saudi population). Jeddah accounts for even fewer, at 27,000 homes. These represent just 1% of the housing supply in these cities. Prices and rents for both apartments and villas in Riyadh fell slightly in Q4 2016 as well as over the past year. The fall in rents was worse, down 4% y-o-y for both apartments and villas. This is likely because of a weaker economy and reduced government spending. We could see further softening in prices and rentals in the short term on the back of this. . In Jeddah, sales prices for apartments were down 7% y-o-y and villas were down by 12%. Rents were more stable, with apartments (+1% y-o-y) holding up better than villas (-3%). We expect downward pressure on prices in the medium term given the introduction of new reforms in Saudi and the white land tax encouraging more development. Residential supply (000s of units) Retail capacity (000s of sqm) 1,200 2,500 1,000 2,000 800 1,500 600 1,000 400 500 200 - - 2012 2013 Riyadh Source: JLL, Q4 2016 2014 2015 2016 2017f 2018f 2012 Jeddah 2013 Riyadh 2014 2015 2016 2017f 2018f Jeddah Source: JLL, Q4 2016 Retail Retail supply additions in 2016 were relatively subdued in both Riyadh and Jeddah, with Riyadh seeing an additional 90,000 sqm of GLA in 2016. However, JLL estimates capacity will increase from 1.5m sqm at YE2016 to 1.8m sqm at the end of 2018e – a 32% increase in two years. Jeddah should see a similarly high increase in capacity, of 30%, over the same period to 1.5m sqm, according to JLL. This will result in increased vacancy rates putting downward pressure on rental rates. Pricing in retail in Riyadh has started to decline after remaining robust over the past few years. In Q4, JLL reported that Riyadh rents at super regional shopping centres fell 1% (-2% y-o-y), while regional centres were flat (both q-o-q and y-o-y). Jeddah rent declines were worse, with super regional mall rents falling 2% in 4Q (-3% y-o-y), although community centre rents were flat (-2% y-o-y). However, because of additional capacity we could see a decrease in rents over 209 EQUITIES ● SAUDI ARABIA February 2017 time. Vacancy rates rose to 9% (from 7% at 3Q) for Riyadh but reached 10% (from 7% in Q2) for Jeddah in Q4. These vacancies are mostly concentrated in shopping centres that are situated in less prime locations and are an indication of increasing capacity in the market. Office Riyadh had few supply additions in 2016, with none in the third quarter, while Jeddah saw the completion of several office buildings. According to JLL, capacity is set to increase by 24% from 4Q2016 to 2018e in Riyadh, and 19% over the same period in Jeddah. If the government converts some of the office space in King Abdullah Financial District (KAFD) into other types of space, this may improve the market. However, JLL believes there is “shadow” supply from companies that have laid off employees that will eventually release additional excess space into the market. Office rents have until now remained stable in both Riyadh and Jeddah, but, as with retail, we think this is unlikely to last because of the rising capacity. Riyadh office rents rose just 1% y-o-y in 4Q according to JLL, while they fell 1% in Jeddah. Vacancies have also started to increase, especially in Riyadh, and we would expect higher vacancies and lower rental rates. Currently vacancy rates are around 6% in Jeddah but 13% in Riyadh. Office supply (000s of sqm) Hotel rooms (number of rooms) 3,500 25,000 3,000 20,000 2,500 2,000 15,000 1,500 10,000 1,000 5,000 500 - 2012 2013 Riyadh Source: JLL, Q4 2016 2014 2015 2016 2017f 2018f 2012 Jeddah 2013 Riyadh 2014 2015 2016 2017f 2018f Jeddah Source: JLL, Q4 2016 Hospitality The number of rooms added in 2016 in both Riyadh and Jeddah has been minimal. This was primarily due to construction delays and administrative challenges that pushed the pipeline to future years. JLL estimates capacity increasing 68% from YE2016 to YE2018e in Riyadh and 34% in Jeddah over the same period. Again, there has been downward pressure on hotel performance in Riyadh because of a heavy dependence on business travellers. The occupancy rate declined by 6 percentage points to 54% and average daily rates fell 7% to USD211 y-o-y in the year to November 2016. Supply additions will bring further pressure in the short to medium term. In Jeddah, occupancy rates have declined by 7% compared to the previous year, to 68%. However, average daily rates increased 4% over the past year, likely because of an increase in domestic demand as Saudis start to vacation within the Kingdom. 210 EQUITIES ● SAUDI ARABIA February 2017 Dar Al Arkan Patrick Gaffney*, CFA Analyst HSBC Bank Middle East Ltd. [email protected] +971 4423 6204 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations ALARKAN AB, Hold, TP SAR5.5 Company description Dar Al Arkan (DAAR) is one of the largest 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 We continue to have doubts about Dar Al Arkan’s business model given the weakness in the land market because of the lengthy implementation of the white land fees. Land sales make up 90% of Dar Al Arkan revenues, and this will continue to be the case because the company has not been successful in diversifying away from land, with little inventory of residential units and very slow progress at the Shams Arriyadh project. Moreover, it may be difficult to diversify much without greater liquidity. The company had cash of SAR582m as of Q4 2016, down from 3Q because it repaid a SAR1.25bn sukuk at the end of 2016. Although we continue to look for cash to build through the year and the company to end 2017 with a solid cash balance, it may not be enough to build a significant number of homes. We are also concerned about potential land fees that the company might have to pay. Although much of the land bank (it has around 32m sqm) for Dar Al Arkan is unlikely to be subject to land tax, some of it could, which would hurt the balance sheet further. However, we are not more negative on the stock, because it appears inexpensive, trading at just 0.3x price-to-book value, with that book value recording all land at cost. Once we move through these uncertainties over the land fees, the land market could pick up and revenues jump. This would likely only happen if land prices fell significantly (25-50%), so margins might be hurt, but cash would come back to the company. Financials Dar Al Arkan reported 4Q earnings of SAR37m, down 23% y-o-y and compared to our estimate of SAR32m. Revenues came in at SAR411m for the quarter, down 2% y-o-y and below our estimate of SAR427m. This was because of lower land sales in the quarter. Gross profit of SAR171m was slightly less than our estimate of SAR174m, while operating profit of SAR122m was above our SAR116m estimate, helped by lower SG&A than we expected. Gross profit and operating profit were down 6% and 11% y-o-y respectively. Gross margin at 41.5% was 160bps lower than same quarter last year but 70bps above our estimate. Valuation We value the company’s rental stream and land/residential sales using a DCF methodology, resulting in a value of SAR5.5. The terminal value continues to be the main driver of valuation for the company, representing about 75% of the enterprise value. We estimate a cost of equity of 12.5% based on a risk-free rate of 2.5%, a country risk premium of 6%, and an inflation 211 EQUITIES ● SAUDI ARABIA February 2017 differential of 4.0%. With a 6% cost of debt, this results in a WACC of 10.5%. We assume a 3% terminal growth rate for rental properties. We then add the value of the residual land, which we calculate using a SAR500 price per sqm and discount by 60% to account for the timing of sales. We also add the land for Shams Al Arous and Shams Arriyadh valued at SAR1,500 per sqm, and we apply a 55% discount, slightly less than the discount for the other land bank because of the greater likelihood of it being sold more quickly. Our SAR5.5 target price implies 7.6% downside and we rate the stock Hold as it appears inexpensive, trading at just 0.3x price-to-book value, with that book value recording all land at cost. Once we move through these uncertainties over the land fees, the land market could pick up and revenues jump. This would likely only happen if land prices fell significantly (25-50%), so margins might be hurt, but cash would come back to the company. Risks Downside risks to our rating include new land fees and further cuts in government budgets that may hurt rental revenues and share performance. Banks may also not fund mortgages at the rates they have done previously, limiting home sales. Upside risks include faster land sales, the company speeding up the Shams Arriyadh project, subsidised home purchases within the company’s projects by the government, or lower land fees leading to rising land prices and helping revenues. 212 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Dar Al Arkan Hold Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit 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 (SARm) Tangible fixed assets Current assets Cash & others Total assets Gross debt Net debt Shareholders' funds Invested capital 2,211 779 -40 739 -385 368 368 -9 359 359 1,887 631 -37 594 -352 252 252 -6 245 245 1,746 564 -36 528 -288 240 240 -6 234 234 1,859 631 -35 597 -295 302 302 -8 294 294 491 -1 845 -450 0 -5 461 1,079 -17 1,373 232 0 -1,284 1,021 896 -19 1,160 -67 0 -828 872 604 -20 873 -161 0 -443 578 20,167 4,362 1,001 25,305 6,293 5,292 17,927 22,442 19,867 3,731 1,160 24,386 5,168 4,007 18,172 21,392 19,899 3,928 1,989 24,615 5,168 3,179 18,406 20,798 20,025 4,101 2,431 24,914 5,168 2,736 18,701 20,650 Ratio, growth and per share analysis Year to 12/2015a 12/2016e 12/2017e 12/2018e Revenue EBITDA EBIT PBT HSBC EPS Ratios (%) -27.6 -26.6 -27.5 -37.5 -37.5 -14.7 -19.0 -19.7 -31.7 -31.7 -7.5 -10.6 -11.0 -4.5 -4.5 6.5 11.9 13.0 25.6 25.6 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) 0.1 3.4 2.0 2.8 35.2 33.4 2.0 29.5 6.8 9.3 0.1 2.8 1.4 2.4 33.4 31.5 1.8 22.1 6.4 26.9 0.1 2.6 1.3 2.1 32.3 30.3 2.0 17.3 5.6 28.2 0.1 2.9 1.6 2.3 34.0 32.1 2.1 14.6 4.3 22.1 EPS Rep (diluted) HSBC EPS DPS NAV (Book Value) NAV (adjusted) 0.3 0.3 0.0 16.6 26.1 0.2 0.2 0.0 16.8 25.2 0.2 0.2 0.0 17.0 24.5 0.3 0.3 0.0 17.3 24.8 Y-o-y % change Year to 12/2015a 12/2016e 12/2017e 12/2018e 0.4 0.2 17.9 8.2 0.0 0.4 0.2 26.2 18.1 0.0 0.3 0.2 27.4 15.5 0.0 0.3 0.2 21.8 10.3 0.0 Price to NAV (BV) Price to NAV (adj) PE* FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 5.95 5.50 4300.SE ALARKAN AB 1,714 Free float Sector Country Analyst Contact 71% Real Estate Saudi Arabia Patrick Gaffney, CFA +971 4423 6204 Price relative 11.60 10.60 9.60 8.60 7.60 6.60 5.60 4.60 3.60 2015 11.60 10.60 9.60 8.60 7.60 6.60 5.60 4.60 3.60 2016 Dar Al Arkan 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 213 EQUITIES ● SAUDI ARABIA February 2017 Emaar Economic City EMAAR AB, Not rated Company description Emaar, The Economic City (EEC), was established in 2006 by Dubai-based Emaar PJSC and other prominent investors. The company leads the planning and development of the King Abdullah Economic City (KAEC), situated along the Red Sea coast, between major shipping routes connecting Europe, Africa and Asia, and north of Jeddah. KAEC is spread over 168m sqm and will be an investment and lifestyle destination intended to help drive economic growth in Saudi Arabia. The city is to be fully developed by 2035. KAEC will have a sea port, an industrial zone, a central business district, an educational zone, resorts and a residential area. The initial phase of the port has been completed with a current capacity of c2.5m TEU (twenty foot equivalent units). The industrial zone will encompass c63m sqm 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. Currently, the majority of revenues at the company come from the sale of plots and apartments and villas in KAEC and in providing certain ancillary services such as hospitality, education and lease. Finally, the company is a 50% owner in the port. Financials Emaar Economic City reported 4Q2016 net income of SAR128m compared with SAR158m in 4Q2015, and reported gross profit of SAR293m vs. SAR177m in Q4 2015. According to the company the 19% decrease in earnings y-o-y was due to a combination of: decreasing industrial and residential land sales, reversal of land contributed to a government body free of charge during the comparable quarter, increase in selling & marketing expenses due to more launches and promotional events and an increase in general & administration expenses. The increase in gross margin over the last year was due to change in infrastructure cost estimate of industrial and residential lands. Recent news 22 January 2017: The company announced it had signed two contracts for a total of SAR50.5m for infrastructure in KAEC. 8 November 2016: Emaar EC signed a memorandum of understanding (MOU) with the Ministry of Housing to allow citizens who have applied to Ministry programmes promoting home buying to buy from current housing projects in KAEC. The MOU is for one year. 7 September 2016: Emaar EC announced its ports subsidiary (50% owned) had signed a Murabaha loan worth SAR2.7bn. This is for phase 2 of the port, which will expand its capacity to 5 million containers annually, along with 600,000 cars and 4 million tons of products. The loan duration is 14 years. 214 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Emaar Economic City Financial statements Year to Valuation data 12/2012a 12/2013a 12/2014a 12/2015a Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit 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 Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 545 177 -47 131 0 194 194 0 189 189 833 359 -41 319 0 304 304 0 273 273 1,064 437 -66 371 0 386 386 -27 380 380 1,045 400 -90 310 0 330 330 -29 303 303 -330 -186 1,862 0 0 -516 97 -568 -594 0 27 -471 1,487 -1,180 -2,963 0 716 316 28 -1,352 -1,492 0 1,350 -1,324 8,154 4,953 4,106 13,884 0 5,168 1,061 7,570 9,778 8,421 4,711 3,034 14,346 29 5,304 2,270 7,837 11,313 9,377 5,413 2,886 16,206 753 6,131 3,246 8,215 13,321 10,713 5,596 2,912 18,038 0 7,100 4,188 8,517 15,126 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 (diluted) HSBC EPS DPS Book Value 12/2012a 12/2013a 12/2014a 12/2015a 29.5 90.7 1.6 78.0 2.0 -3.5 0.0 19.3 44.7 1.4 54.2 1.9 -3.2 0.0 15.1 36.8 1.2 38.6 1.8 2.1 0.0 15.4 40.2 1.1 48.3 1.7 -9.0 0.0 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Reuters (Equity) Market cap (USDm) Free float Country 17.39 4220.SE 3,942 55.8 Saudi Arabia Bloomberg (Equity) Market cap (SARm) EV (SARm) Sector EMAAR AB 14,782 16,058 Real Estate 25 25 20 20 15 15 10 10 5 5 0 2014 12/2012a 12/2013a 12/2014a 12/2015a 25.8 62.0 104.0 119.3 129.0 52.9 103.0 144.3 56.7 44.3 27.7 21.5 16.4 26.9 39.0 -1.8 -8.5 -16.6 -14.6 -20.3 0.1 1.9 2.5 1.4 32.5 23.9 0.1 2.4 3.5 1.9 43.1 38.3 0.1 2.9 4.6 2.3 41.0 34.9 0.1 2.0 3.6 1.7 38.2 29.6 0.1 6.0 -0.3 0.3 6.3 0.0 0.4 7.4 0.5 0.5 10.5 0.0 0.2 0.2 0.0 8.9 0.3 0.3 0.0 9.2 0.5 0.5 0.0 9.7 0.4 0.4 0.0 10.0 Y-o-y % change Revenue EBITDA EBIT PBT HSBC EPS Ratios (%) Year to EV/sales EV/EBITDA EV/IC PE* P/Book value FCF yield (%) Dividend yield (%) Price relative Ratio, growth and per share analysis Year to Not rated 0 2015 Emaar Economic City 2016 2017 Rel to Tadawul Source: HSBC Note: Priced at close of 02 Feb 2017 215 EQUITIES ● SAUDI ARABIA February 2017 Jabal Omar Patrick Gaffney*, CFA Analyst HSBC Bank Middle East Ltd. [email protected] +971 4423 6204 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations JOMAR AB, Reduce, TP SAR60 Company description Jabal Omar Development Company was set up to invest in projects located in the Holy city of Makkah where it is headquartered. The project is spread over a 230,000sqm area with 2m sqm of built-up area (BUA). The project will include 38 residential/hotel towers with 11,445 hotel and living quarter units, 204 villas for sale, a mosque of 14,000sqm, and retail podiums with 163,500sqm of GLA. Although there have been delays in the delivery of the hotels, the company has already delivered Hilton Suites, Hyatt Regency, Marriott and Conrad and expects to roll out the rest of the hotels over the next few years. The project is located next to the Grand Mosque, which is a competitive advantage for the company and is one of the most prime locations in the world. Investment thesis Jabal Omar continues to be an interesting company but the project has been delayed significantly – both in construction and execution – and the delays continue. The company released good results in December for 4Q2016 (as it is on the Islamic Hijri calendar), but this was only because of the delivery of c55 villas at an average price of SAR18m, which resulted in high revenues and profits for the quarter. These 55 units were leased out for a year at a 2% fee as per the agreement between JOMAR and Al Bilad Capital. We believe the company is more aggressively trying to market its units in order to raise cash, but given the weak macroeconomic environment, we think it will only be partially successful. We expect far fewer villas to be delivered in 2017-20. The construction progress has remained slow and we do not expect any more hotel rooms to be added in 2017. With the replacement of the contractors for the phase 4 project, we expect further delays, while the phase 5 project has not yet been tendered out. The stock appears expensive given very high execution risks and a poor track record to date. However, the company should benefit from the government’s push to increase religious tourism. The government has recently made moves to return the number of Hajj visas issued to their 2012 level (ie before the government started construction on the expansion of the Holy Mosque, which is now complete). This should increase occupancies and rates and start to turn to profit (segment profits were negative for hotels in 2016). Financials The company announced 1Q2017 net profit of SAR79m, up from a loss of SAR76m last year. It attributed this to higher sales, which were SAR311m. This is a slow start to the year: we look for 2017e revenue of SAR1.9bn and net profit of SAR693m. Gross margin of 49% was also below our expectation of 56% for the year. We do not have a breakout of revenues from villas, retail and hospitality yet, but when we do we will be looking to see if the hotel business has turned profitable on a segment level (which was not the case in FY2016). Note the company uses the Islamic Hijri year. 216 EQUITIES ● SAUDI ARABIA February 2017 Valuation We value Jabal Omar using a discounted cash flow model for Phases 1-4 of the project (SAR28.3 per share) and add the remaining land value (SAR41.1 per share). We take the average price of land at cSAR500,000 per sqm. We apply a 5% discount to reflect the difficulty in selling large plots of land and the time it takes to develop the land. We then subtract net debt of SAR9.2 per share to arrive at an equity value of SAR60 per share. In our DCF valuation, we estimate a cost of equity of 12.5% based on a risk-free rate of 2.5%, a country risk premium of 6%, and an inflation differential of 4.0%. Coupled with a cost of debt of 6%, this leads to a WACC of 10.2%. This results in a cost of equity of 13.1%. Our terminal growth rate is 4.5%. Our target price of SAR60 results in downside of 14.0% and we rate the stock Reduce as we believe that risks over execution and the profitability of the hotels outweigh the long-term profitability of the project. Risks Upside risks include: Greater government focus on religious tourism, specifically issuing more Hajj and Omra visas, which will drive up occupancy and room rates. The company could enter into more agreements, like its deal with Al Bilad Capital, to buy units and then rent them out for the buyer. This would help build cash flows in the near term. Faster deliveries of hotels would also boost earnings. 217 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Jabal Omar Development Co Financial statements Year to Valuation data 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 1,480 896 -150 746 -155 615 615 -5 609 609 1,879 1,369 -405 964 -253 711 711 -18 693 693 3,663 2,800 -630 2,170 -363 1,807 1,807 -45 1,762 1,762 4,188 2,779 -702 2,077 -499 1,578 1,578 -39 1,538 1,538 Cash flow from operations Capex FCF enterprise Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 934 -2,058 -879 -2,057 0 564 -1,034 1,025 -2,163 -887 -2,163 0 1,139 -1,140 2,323 -1,668 1,016 -1,668 0 -655 654 2,178 -553 2,122 -553 0 -1,625 1,624 Tangible fixed assets Current assets Cash & others Total assets Gross debt Net debt Shareholders' funds Invested capital 19,430 2,241 1,782 22,611 10,435 8,653 10,108 17,832 18,389 990 568 23,118 10,359 9,791 10,802 16,866 16,607 1,229 837 24,395 9,973 9,137 12,564 15,155 15,988 2,818 2,461 25,834 9,973 7,512 9,375 14,599 Year to 12/2016a 12/2017e 12/2018e 12/2019e 89.9 207.0 254.3 396.9 562.9 26.9 52.8 29.2 15.7 13.8 95.0 104.5 125.1 154.1 154.1 14.3 -0.8 -4.3 -12.7 -12.7 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) 0.1 4.3 6.3 3.6 60.5 50.4 5.8 85.6 9.7 10.8 0.1 5.4 6.6 4.1 72.9 51.3 5.4 90.6 7.2 10.5 0.2 13.2 15.1 8.9 76.4 59.2 7.7 72.7 3.3 25.4 0.3 13.6 14.0 8.1 66.4 49.6 5.6 80.1 2.7 29.0 EPS Rep (diluted) HSBC EPS DPS NAV (Book Value) NAV (adjusted) 0.7 0.7 0.0 10.9 77.4 0.7 0.7 0.0 11.6 91.4 1.9 1.9 0.0 13.5 122.2 1.7 1.7 0.0 10.1 132.9 Y-o-y % change Revenue EBITDA EBIT PBT HSBC EPS Ratios (%) 218 12/2017e 12/2018e 12/2019e 6.4 0.9 106.4 -1.6 0.0 6.0 0.8 93.5 -1.9 0.0 5.2 0.6 36.8 1.1 0.0 6.9 0.5 42.1 2.8 0.0 * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 69.75 60.00 4250.SE JOMAR AB 17,286 Free float Sector Country Analyst Contact 91% Real Estate Saudi Arabia Patrick Gaffney, CFA +971 4423 6204 Price relative 96.00 96.00 86.00 86.00 76.00 76.00 66.00 66.00 56.00 56.00 46.00 46.00 36.00 2016 Jabal Omar Development Co Ratio, growth and per share analysis 12/2016a Price to NAV (BV) Price to NAV (adj) PE* FCF yield (%) Dividend yield (%) 36.00 2015 Year to Reduce Source: HSBC Note: Priced at close of 02 Feb 2017 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 Saudi Real Estate Patrick Gaffney*, CFA Analyst HSBC Bank Middle East Ltd. [email protected] +971 4423 6204 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations SRECO AB, Reduce, TP SAR19.5 Company description Saudi Real Estate Company (SRECO) was founded in 1976 and is based in Riyadh. It owns, develops, leases and sells residential and commercial real estate and sometimes sells land from its large land bank. The company has c603,000sqm of leasable space, mainly from residential (more than 50% of GLA) and office (c40%), with retail making up the rest. It also has a large land bank of c20m sqm, which it can monetise by developing or selling. Investment thesis We have a Reduce rating on SRECO because of our view that the company’s expansion plans are too aggressive given its track record in building, limited balance sheet and potential for land fees to hit net income. The scale of these expansions is significant – management wants to spend SAR5.5bn on its projects over the next few years. It has specifically announced four hotels and a project comprising 68 new units in the diplomatic quarter (DQ) to be built at a total cost of SAR67m, and a compound in the Nargis area encompassing 161 residential units at a cost of SAR226m. We estimate a yield of c11%, or SAR55m. For the remaining cSAR5bn the company says it plans to spend, there have been no updates since the 2015 annual report. In our view, the balance sheet continues to look too small to fund these expansions – net debt was already SAR2.65bn for a net debt-to-equity ratio of 0.79x. Moreover, given its large land bank, SRECO could be hit by large land fees. We estimate the fees could be at least SAR16m but could go up to as much as SAR41m. Overall, until we have more confidence in SRECO’s expansion plans (through successful execution) and more land sales to fund this, we believe a Reduce rating is appropriate. Financials Saudi Real Estate reported 4Q2016 net income of SAR26m, down 11% y-o-y and 47% below our estimate of SAR49m. Sales of SAR90m were up 23% y-o-y and in line with our estimate. Gross profit was lower than expected at SAR61m, below our estimate of SAR69m. The company was helped by higher rental income (up SAR6bn) and the sale of land for SAR9.4m (this happens rarely – the last was in 2014 – but usually in 4Q). However, net income was down for the year on the back of higher interest income, as the company has taken on more debt. Overall, the results were disappointing on a gross profit level; but our negative view is due to the expansion plans, the impact of which we see in the higher debt balance and resulting higher net interest expenses, driving down net income. Valuation We use a DCF approach to value SRECO's current projects (SAR26.3 per share) and add the value of the remaining land bank at a 35% discount to cost (SAR9.6 per share) plus short-term investments. Most of these are held in money market funds, although it also owns Hail Cement (HCC AB; not covered). This goes to SAR4.7 per share. We then subtract net debt to reach at a target price of SAR19.5. 219 EQUITIES ● SAUDI ARABIA February 2017 For our WACC calculation, we estimate a cost of equity of 12.5% based on a risk-free rate of 2.5%, a country risk premium of 6%, and an inflation differential of 4.0%. With a 6% cost of debt, this results in a WACC of 10.5%. We assume a terminal growth rate of 2.5%. Our SAR19.5 target price represents 21.2% downside from the current share price and we rate the stock Reduce. Risks Upside risks 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 the company would benefit. 220 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi Real Estate Reduce Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 279 196 -30 166 -36 166 166 -18 148 148 315 232 -30 202 -83 122 122 -10 111 111 339 249 -32 217 -119 98 98 -10 89 89 349 256 -34 223 -149 73 73 -10 64 64 Cash flow from operations Capex FCF enterprise Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 252 -3 276 -1,885 -120 1,757 239 88 -181 25 -766 -121 793 -58 121 -57 179 -18 0 -104 60 104 -59 191 -18 0 -87 42 Tangible fixed assets Current assets Cash & others Total assets Gross debt Net debt Shareholders' funds Invested capital 4,635 1,117 863 6,328 2,616 1,753 3,426 4,603 4,779 830 576 6,838 3,121 2,545 3,424 4,741 4,772 936 679 6,930 3,121 2,442 3,512 4,733 4,763 1,017 766 6,994 3,121 2,355 3,576 4,717 Ratio, growth and per share analysis Year to 12/2015a 12/2016e 12/2017e 12/2018e Revenue EBITDA EBIT PBT HSBC EPS Ratios (%) -18.3 -24.0 -27.5 -43.1 -47.1 13.1 18.7 21.9 -26.8 -24.6 7.4 7.4 7.7 -19.1 -20.4 3.0 2.8 2.3 -25.5 -28.1 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) 0.1 4.3 4.3 2.9 70.1 59.4 5.4 51.2 9.0 14.4 0.1 4.0 3.2 1.7 73.6 64.0 2.8 74.3 11.0 3.5 0.1 4.1 2.6 1.3 73.7 64.2 2.1 69.5 9.8 5.0 0.1 4.1 1.8 0.9 73.5 63.8 1.7 65.8 9.2 4.4 EPS Rep (diluted) HSBC EPS DPS NAV (Book Value) NAV (adjusted) 1.2 1.2 1.0 28.5 43.5 0.9 0.9 1.0 28.5 39.9 0.7 0.7 0.0 29.3 40.6 0.5 0.5 0.0 29.8 41.2 Y-o-y % change Year to 12/2015a 12/2016e 12/2017e 12/2018e 0.9 0.6 20.1 8.1 4.0 0.9 0.6 26.6 -2.0 4.0 0.8 0.6 33.5 2.0 0.0 0.8 0.6 46.6 1.4 0.0 Price to NAV (BV) Price to NAV (adj) PE* FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 24.70 19.50 4020.SE SRECO AB 790 Free float Sector Country Analyst Contact 100% Real Estate Saudi Arabia Patrick Gaffney, CFA +971 4423 6204 Price relative 46.00 46.00 41.00 41.00 36.00 36.00 31.00 31.00 26.00 26.00 21.00 21.00 16.00 16.00 11.00 2015 11.00 2016 Saudi Real Estate 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 221 EQUITIES ● SAUDI ARABIA February 2017 This page has been left blank intentionally 222 EQUITIES ● SAUDI ARABIA February 2017 Telecoms 223 EQUITIES ● SAUDI ARABIA February 2017 Telecoms Subscriber identification efforts were particularly disruptive in 2016 Regulatory framework and competitive landscape are improving Mobily best positioned to benefit from a unified telecom license Eric Chang* Analyst HSBC Bank Middle East Ltd. [email protected] +971 4 423 6554 Herve Drouet* Analyst HSBC Bank plc [email protected] +44 20 7991 6827 Nikhil Mishra* EEMEA Telecoms Associate Bangalore * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations The Saudi Telecom Market STC is the only integrated player in Saudi with a strong presence in both fixed line and mobile. In fixed line, it is by far the biggest player, with little competition and in mobile, it is the largest player having captured almost half (48%, as of Q3 16, source: Zain) of market share. STC is followed by Mobily (26%) and Zain (22%), while the remainder (4%) is netted by MVNOs. Mobile broadband has been a key growth driver Rapid declines in smart phone prices and affordable data packages have made internet access via mobile devices easy and cheap. According to CITC data, internet users have been growing steadily in the region, with the figure standing at 24m currently (Q3 16). This implies an internet penetration of 75%. The growth has been driven by social networking applications, video on demand and gaming. The amount of data traffic has exploded in the recent years as telecom operators offered higher speeds and larger data packages to the customers. According to CISCO, mobile data traffic in Saudi Arabia will grow 7-fold from 2015 to 2020, a CAGR of 48%. 2017 investment themes Data monetisation and dividend sustainability We view data usage and monetisation as critical to drive revenue and profitability growth, given the high subscriber penetration levels in most markets. As smartphones become increasingly affordable, consumer adoption will increase, driving data consumption. We view data monetisation as a function of individual markets and operators. We expect the markets with tiered data tariff structures to be the main beneficiaries. Operators will be in a better position to capitalise on data take-up if they have better spectrum and can drive ARPU through usage differentiation. Saudi Arabia presents these characteristics. In this regard, CITC (Communications and Information Technology Commission, Saudi Arabia’s telecom regulator) has asked all operators to remove unlimited packages, which should be beneficial for the industry. We see significant improvement in the regulatory framework and competitive landscape. From a regulatory perspective, the key change is the government’s decision to introduce a unified telecom licence. In time, this will allow Mobily and Zain KSA to compete with STC on an equal footing and sell fixed and mobile solutions to the lucrative corporate segment as well as residential customers. We also note that in the past two years the regulator has taken steps in earnest to encourage competition in the mobile segment by slashing mobile termination rates by 60%. We believe competition should gradually become rational. Both Mobily and Zain KSA need to improve profitability and repair their balance sheets. A price war at this juncture would not be helpful. 224 EQUITIES ● SAUDI ARABIA February 2017 A cleaner subscriber base During the first three quarters of 2016, all telecom operators directed their retail sales staff towards regulatory compliance (fingerprinting, verifying and uploading customer identity cards) instead of selling products and services. This impacted their subscriber base and profitability. But now the subscriber base is much cleaner for all and the increased regulatory requirements should improve customer stickiness. The unified telecoms licence is a potential game-changer In our opinion, the unified telecom licence is the most significant decision taken by regulator in recent times. As the only operator with a fixed and mobile licenses, STC stands to lose the most. A unified licence will allow Mobily and Zain KSA to offer fixed services in addition to their current offering. We think Mobily is best positioned to benefit from the unified licence. The company should be able to monetise its fixed network infrastructure (which is sizeable compared to Zain KSA). Mobily had in the past tried to secure a fixed line licence but was turned down by the regulator. Now, it can leverage its existing fibre network to provide fixed line services and be an effective competitor to STC in the government and enterprise customer segment. Nevertheless, given the stressed balance sheet, we see only a slow ramp-up in the fixed line market. Over the medium term, we do not expect any material difference for Zain KSA. We think a proprietary, alternative fixed infrastructure is out of the equation. Zain KSA still needs to invest in its mobile infrastructure (it has under-invested relative to Mobily). In addition, high leverage would limit the funding available. The alternative would be to rent capacity, in which case there would be a cap on profitability. In October 2016 Zain signed an open ended Letter of Intent with Dawiyat Telecom, a wholly owned subsidiary of Saudi Electricity Company (SEC), to utilise SEC’s 51,000 km fibre-optic network. Other players could benefit from a unified licence. Atheeb Telecom (7040.SE, Not Rated) is a small fixed line services provider, using primarily WiMax technology. A unified licence will enable Atheeb to offer mobile services on a stand-alone basis or on a bundled plan to highvalue customers. 225 EQUITIES ● SAUDI ARABIA February 2017 Mobile subscriptions and penetration 60 188% 186% 182% 170% 171% 168% 50 153% 40 30 52 54 53 51 53 2010 2011 2012 2013 2014 53 49 2015 Q3 2016 20 10 0 Total subscriptions (m) - LHS 200% 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% Penetration % - RHS Source: CITC Mobile data subscriptions and penetration 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 105.9% 94.5% 20.2 20.0 42.1% 9.7% 7.1 8.1 2.7 4.3 4.2 4.6 2010 2011 2012 2013 78.8% 60.0% 40.0% 9.7 Standard Mobile Subscriptions - LHS 100.0% 80.0% 12.7 47.6% 39.6% 120.0% 9.1 13.2 12.6 2015 Q3 2016 20.0% 0.0% 2014 Dedicated Mobile Data Subscriptions - LHS Mobile BB Teledensity % - RHS Source: CITC Internet users and penetration 30 64% 25 20 54% 41% 69% 75% 70% 55% 60% 47% 50% 15 40% 10 5 11 14 2010 2011 16 17 22 20 24 10% 0% 2012 Internet users (m) - LHS 226 30% 20% 0 Source: CITC 80% 2013 2014 2015 Penetration % - RHS Q3 2016 EQUITIES ● SAUDI ARABIA February 2017 Etihad Etisalat (Mobily) Eric Chang* Analyst HSBC Bank Middle East Ltd. [email protected] +971 4 423 6554 Herve Drouet* Analyst HSBC Bank plc [email protected] +44 20 7991 6827 Nikhil Mishra* EEMEA Telecoms Associate Bangalore * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations EEC AB, Buy, TP SAR27.20 Company description Mobily is a mobile operator focused on Saudi Arabia. It was established in 2004, shortly after the Etisalat-led consortium won a GSM and 3G license (for SAR 13bn). The company got off to a strong start. Within a year of its inception, it had listed on the Saudi Exchange and built a 3G network with 79% population coverage at launch. From the outset, Mobily decided that network investments as well as clever marketing would be key to its commercial success. 1m subscribers joined Mobily within 90 days of launch. By the end of 2006, the start-up had achieved a 30% subscriber share, a threshold it has defended since. Despite the launch of Zain KSA (the third entrant) in 2008, Mobily’s market share did not fall below the high 30s. Commercial success led to a series of financial milestones. Mobily was EBITDA-positive in Q4 2005. It was profitable by Q1 2006 and started generating cash flow in Q3 2006. From its experience in the UAE, Etisalat knew data’s potential: the UAE was the first country in the Middle East to roll-out a 3G network. Accordingly, Mobily built a network based on 3G specifications. In 2008, it rolled out a 3.5G network, a first in Saudi Arabia, which attracted broadband internet subscribers. It also built a fibre optic network and acquired Bayanat al-Oula for its data services licence. In 2012, as growth in mobile voice services slowed, Mobily shifted its focus towards the Information and Communication Technologies (ICT) segment. It began directly challenging the incumbent STC on the Enterprise client segment. With this transition, the company pursued ambitious financial targets and aggressive accounting policies. The strategy unravelled and accounting problems were disclosed in Q3 2014. The problem was revenue recognition related to: i) one of its promotional programmes as well as ii) to non-readiness of FTTH (Fibre-To-The-Home) ports related to a lease contract signed with one of its approved distributors. The restatements were significant. Cumulatively, SAR 3.8bn of profits were restated from the 2013 and 2014 financials. The market reaction was unequivocal and Mobily’s share price lost two-thirds of its value. Subsequently, company overhauled its management and started a restructuring process that is still ongoing. Investment thesis We think Mobily’s debt load and low profitability are not insurmountable challenges. Management has been effective with cost control and negotiations with various stakeholders. It now needs to show its mettle with revenue growth. The company has lost market share in the last two years and it needs to at least stem the decline if not reverse it. However, we think the company is more likely to focus on improving its ARPU growth (better for profitability) rather than improving market share to drive up revenue. In addition, a unified licence will open up new revenue streams; but it is difficult to quantify the profit potential as terms and conditions have yet to be publicised. Recently (9 January 2017), the company appointed Ahmed Abdelsalam Abdelrahman as its new CEO following the resignation of Ahmad Farroukh. 227 EQUITIES ● SAUDI ARABIA February 2017 Financials Q4 results were, as expected, lacklustre. Revenues dropped 17% y-o-y to SAR 2,908m and were 2% below our estimates. Mobily reported EBITDA of SAR 954m (-14% y-o-y) which were 6% ahead of our expectation. The operator reported a net loss of SAR71m (HSBCe net loss of SAR84m) Valuation We value Mobily on a DCF. We use a WACC of 8.1%, based on following assumptions: cost of equity of 9.4%, risk-free rate of 2.5% and equity risk premium of 7%. We use a beta of 1 and long-term growth rate of 2%. Our target price of SAR27.20 implies 24.5% upside and we rate the stock Buy: the regulatory environment and competitive landscape are improving and we think the unified licence will open up new revenue and profit streams that are as yet difficult to quantify as terms and conditions have yet to be publicised. Risks Downside risks: Zain KSA pursuing market share instead of profitability. Failure to secure additional spectrum to facilitate continued broadband growth. 228 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Etihad Etisalat(Mobily) Financial statements Year to Buy Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 14,424 2,941 -3,625 -684 -240 -924 -924 -169 -1,093 -1,093 12,644 3,959 -3,769 190 -467 -277 -277 61 -216 -216 12,990 4,130 -3,511 619 -525 94 94 -2 92 92 14,657 4,938 -3,543 1,395 -558 837 837 -21 816 816 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 5,233 -3,573 -3,585 0 -1,402 1,251 1,689 -5,112 -5,110 0 1,521 -3,829 3,591 -3,551 -3,551 0 487 -487 4,749 -3,801 -3,801 0 -369 369 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 9,493 24,466 8,398 1,748 42,376 12,541 14,275 12,527 15,559 28,069 8,976 24,049 7,595 746 40,639 10,499 14,795 14,049 15,343 29,374 8,658 24,408 7,841 755 40,926 10,199 15,290 14,535 15,435 29,953 8,347 24,976 8,409 831 41,751 10,502 14,997 14,166 16,251 30,399 Year to 12/2015a 12/2016e 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 (diluted) HSBC EPS (diluted) DPS Book value 12/2017e 12/2018e 2.4 7.8 1.1 nm 1.1 -22.8 0.0 2.4 7.6 1.0 183.6 1.1 -2.9 0.0 2.1 6.3 1.0 20.6 1.0 2.2 0.0 Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2017e 12/2018e 21.85 27.20 7020.SE EEC AB 4,486 Free float Sector Country Analyst Contact 61% Wireless Telecoms Saudi Arabia Eric Chang +971 4 423 6554 Price relative 52.00 47.00 42.00 37.00 32.00 27.00 22.00 17.00 12.00 2015 Etihad Etisalat(Mobily) Y-o-y % change Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 12/2016e 2.0 10.0 1.0 nm 1.1 7.4 0.0 * Based on HSBC EPS (diluted) Ratio, growth and per share analysis Year to 12/2015a EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) 52.00 47.00 42.00 37.00 32.00 27.00 22.00 17.00 12.00 2016 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 3.1 5.9 -12.3 34.6 2.7 4.3 225.5 12.8 19.6 125.3 790.4 790.4 0.5 -0.3 -6.8 -1.5 20.4 -4.7 12.2 80.5 4.3 41.8 0.4 2.0 -1.4 0.5 31.3 1.5 8.5 91.6 3.5 12.0 0.4 3.1 0.6 1.5 31.8 4.8 7.9 94.2 3.5 24.7 0.5 5.5 5.1 3.3 33.7 9.5 8.8 87.2 2.9 33.5 -1.42 -1.42 0.00 20.21 -0.28 -0.28 0.00 19.93 0.12 0.12 0.00 20.05 1.06 1.06 0.00 21.10 229 EQUITIES ● SAUDI ARABIA February 2017 Saudi Telecom Company Eric Chang* Analyst HSBC Bank Middle East Ltd. [email protected] +971 4 423 6554 Herve Drouet* Analyst HSBC Bank plc [email protected] +44 20 7991 6827 Nikhil Mishra* EEMEA Telecoms Associate Bangalore * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations STC AB, Hold, TP SAR71.00 Company description Saudi Telecom Company (STC) is the incumbent telecom operator in Saudi Arabia where it remains the only integrated telecom company. Liberalisation of the Saudi telecoms market took place in stages. In 2004, the regulator CITC awarded the second mobile licence to Mobily. The fixed-line market was liberalised in 2007 with the award of three new fixed-line licences. Despite the competitive pressure from market liberalisation, STC was late in seeking international diversification. STC deployed capital by acquiring minority stakes, with mixed results. Currently, it is limiting its expansion ambitions to the Middle East. Its subsidiaries in Kuwait and Bahrain have performed well despite being the third entrant in small markets. The rationalisation of STC’s international operations has resulted in a positive impact both on its financials and investor sentiment. In terms of revenue contribution, Saudi Arabia represents 90% of the group while Kuwait and Bahrain contribute the balance. Domestic operations remain the key driver as the size of the Kuwaiti and Bahraini markets limits upside potential. Investment thesis STC is currently by far the biggest telecom operator in Saudi Arabia – it has the highest market share in the mobile segment and is the dominant player in the fixed line segment. Broadband, especially mobile, has been the driver of growth for telecoms in the region. STC’s leadership in Saudi Arabia has been a key competitive advantage as it was a net beneficiary of data growth. This has translated to high cash generation and a solid balance sheet. We still think its high cash balance will lead – over time – to increased dividend pay-out. But in light of deteriorating financial performance, de-regulation of the Saudi telecoms market and challenging economic conditions, we think STC may be more prudent with its financial resources. Moreover, STC’s trade receivables have nearly doubled, from SAR8.2bn (63 days) in Q4 2014 to SAR18.5bn (140 days) in Q4 2016. We think this could be related to STC’s government-related accounts and highlight the possibility of receivables write-downs. Financials Revenues declined 9% y-o-y to SAR12bn driven mainly by weak mobile revenues in Saudi. EBITDA continued its downward trend with a 4% drop y-o-y. As a result, net profit was lower by SAR200m y-o-y. The incumbent maintained its dividend of SAR1/per share in line with expectations. The key concern, however, is the sharp jump in trade receivables. We highlighted this issue and the possibility of a receivables write-down in our report Saudi Telecoms: 2016, a year of regulatory upheaval, 06 December 2016. Valuation We continue to value STC on an equal weighting of DCF (cSAR75.00/share) and a multiplesbased SOTP (cSAR67.00/share). DCF: We use a WACC of 6.2%: risk-free rate of 2.5%, equity risk premium of 7%, beta of 0.73 and long-term growth rate of 2%. Sum-of-the-parts: Our sum-of-the-parts valuation is based on the following: 230 EQUITIES ● SAUDI ARABIA February 2017 We value the core Saudi operations on a 5.5x 2017e EBITDA. We incorporate the Viva Kuwait (VIVA KK, KWD0.89, Reduce) stake at our target price of KWD0.74. We value Viva Bahrain at 4x 2017e EBITDA given that it is the most recent entrant in the country We assign no value for STC’s 35% stake in Oger Telecom We value Maxis (MAXIS MK, MYR 6.01, Reduce) at HSBC’s target price of MYR5.15. This is based on a cost of equity of 6.5% (a risk-free rate of 4%, a risk premium of 3.5% and a beta of 0.7x and a terminal growth of 0.5%). STC SOTP SARm Saudi Arabia Viva Kuwait Viva Bahrain Subsidiaries Oger Telecom Maxis Associates EBITDA 2017e 19,471 1,598 520 EV /EBITDA 5.5x 4.0x % stake 100.0% 51.8% 100.0% 35.0% 16.2% EV 107,091 2,357 2,079 111,527 0 5,308 5,308 EV 116,835 Debt Cash Minority's share in net debt Net debt 5,881 -24,858 1,566 -17,410 Equity value Issued shares (m) FV (SAR) 134,245 2,000.0 67.12 % of EV 91.7% 2.0% 1.8% 0.0% 4.5% Source: HSBC estimates Our target price of SAR71 implies 8.9% upside to the closing price as of 8 February 2017. We maintain a Hold rating due to weakening profitability and increasing trade receivables. STC’s trade receivables have nearly doubled from SAR8.2bn (63 days) in Q4 2014 to SAR18.5bn (140 days) in Q4 2016. This could be related to STC’s government-related accounts and highlight the possibility of receivables write-downs. Risks Upside risks: Higher dividend in Q4 2016. Conditions for the unified telecom licence are too onerous for Mobily and Zain KSA to compete with STC. Viva Kuwait focusing on profitability instead of market share. Oger Telecom (of which STC owns 35%) solving its debt problem in an equity accretive manner. Downside risks: We highlight the possibility of receivables write-downs. One should pay close attention to the evolution of trade receivable days and watch for any signs of further deterioration. STC’s trade receivable have nearly doubled from SAR8.2bn (63 days) in Q4 2014 to SAR18.5bn (140 days) in Q4 2016. We think this could be related to STC’s governmentrelated accounts. In addition, an extended period of low oil prices would have a deeper impact on the Saudi economy and telecom spending. Higher competition in the mobile segment (from Zain KSA and the MVNOs) and in the ICT segment (Mobily). A further cut in termination rates in Saudi Arabia would impact revenue and margins as STC is the leading operator in the country. Given its significant net cash position, STC may indulge in dilutive M&A activity; however we believe the possibility is lower as the company seems to have learnt from past experience. 231 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Saudi Telecom Company Financial statements Year to Hold Valuation data 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 51,845 18,256 -8,063 10,193 561 9,510 9,803 -751 8,539 9,583 52,952 18,213 -8,595 9,618 175 9,870 9,081 -789 8,835 8,835 55,456 18,538 -8,368 10,170 283 10,797 9,934 -863 9,686 9,686 57,567 18,848 -8,364 10,484 233 11,215 10,318 -897 10,070 10,070 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 19,606 -10,561 -11,424 -8,031 1,157 8,855 17,000 -10,100 -10,100 -8,375 1,624 6,287 16,818 -10,371 -10,371 -8,875 3,498 5,868 17,773 -10,608 -10,608 -9,375 3,356 6,502 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 4,394 43,023 46,899 24,858 101,854 34,899 5,881 -18,976 59,743 34,559 4,194 44,728 46,425 21,834 102,851 36,468 4,481 -17,353 60,571 37,044 4,383 46,542 41,415 16,936 100,187 34,517 3,081 -13,854 61,258 40,886 4,790 48,379 38,272 12,498 99,787 34,629 2,000 -10,498 61,827 44,314 Year to 12/2016a 12/2017e 12/2018e 12/2019e 2.0 5.7 3.0 13.6 2.2 7.2 6.1 2.0 5.8 2.8 14.8 2.2 5.1 6.5 2.0 5.9 2.7 13.5 2.1 4.8 6.9 1.9 5.9 2.5 13.0 2.1 5.3 7.3 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 12/2017e 107.00 97.00 97.00 87.00 87.00 77.00 77.00 67.00 67.00 57.00 57.00 12/2019e Y-o-y % change 2.4 -5.4 -14.0 -9.3 -8.4 2.1 -0.2 -5.6 3.8 -7.8 4.7 1.8 5.7 9.4 9.6 3.8 1.7 3.1 3.9 4.0 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) 1.5 30.7 15.9 9.0 35.2 19.7 1.5 28.1 14.7 9.0 34.4 18.2 1.4 25.9 15.9 9.9 33.4 18.3 1.4 23.7 16.4 10.4 32.7 18.2 -31.1 -1.0 -28.0 -1.0 -22.1 -0.7 -16.6 -0.6 4.27 4.79 4.00 29.87 4.42 4.42 4.25 30.29 4.84 4.84 4.50 30.63 5.03 5.03 4.75 30.91 232 Source: HSBC Note: Priced at close of 08 Feb 2017 Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) EPS Rep (diluted) HSBC EPS (diluted) DPS Book value 47.00 2016 Saudi Telecom Company 12/2018e 16% Diversified Telecoms Saudi Arabia Eric Chang +971 4 423 6554 107.00 Ratio, growth and per share analysis 12/2016a Free float Sector Country Analyst Contact Price relative 47.00 2015 Year to 65.21 71.00 7010.SE STC AB 34,774 2017 Rel to TADAWUL ALL SHARE INDEX EQUITIES ● SAUDI ARABIA February 2017 ZAIN KSA Eric Chang* Analyst HSBC Bank Middle East Ltd. [email protected] +971 4 423 6554 Herve Drouet* Analyst HSBC Bank plc [email protected] +44 20 7991 6827 Nikhil Mishra* EEMEA Telecoms Associate Bangalore * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations ZAINKSA AB, Reduce, TP SAR7.00 Company description In 2007, Zain Group led a group of Saudi partners (including Almarai, ALMARAI AB; SAR69.50, Hold) to bid for the third mobile licence in Saudi Arabia. The consortium won by paying SAR22.9bn (USD6.1bn) for the licence, double the amount Mobily paid for its licence. Zain Group is the largest shareholder in Zain KSA, holding a 37% stake, while a Saudi consortium owns 21% and the remaining 42% is free float. In February 2008, Zain KSA was listed on the Saudi stock exchange, Tadawul. The same year, in August, the company launched its commercial operations, breaking the duopoly of STC and Mobily. Zain KSA is the smallest of the three mobile network operators in Saudi Arabia and holds a market share of around 22% (as of Q3 2016, source: Zain). It serves around 10.5m customers through a network of more than 8,000 sites. Investment thesis Our negative view on the stock is based on the premise that Zain KSA’s debt load is not sustainable and will likely require another recapitalisation – through a rights issue or debt swap. In either case, minority investors would be diluted by half. We have previously argued that proceeds from the mobile tower sale would not be sufficient to significantly deleverage the company. On 11 November (Zain Group expects to finalize Saudi tower sale in first-half of 2017: CEO), Reuters reported that Zain Group expects the Saudi tower sale to conclude in the first half of 2017 and generate proceeds in excess of USD500m (SAR1.9bn). In our initiation report (Recapitalisation and dilution seem unavoidable, 25 July 2016), we estimated the tower sale could generate SAR4.2-5.6bn. We think this news validates our thesis on dilution risks as net debt in Q3 2016 stood at SAR 13.8bn. Although the unified licence brings new revenue opportunities, we think upside to profitability will be limited. Zain KSA’s cumulative capex in the past five years is one sixth of Mobily’s and it needs to ramp-up to avoid network congestions and retain customers. However, high leverage may limit investments and Zain KSA would need to rent capacity. Financials Q4 16 results were ahead of our expectations. Revenues increased by 8% y-o-y (+10% q-o-q) to SAR1,801m (above HSBCe SAR1648m). EBITDA jumped by 21% y-o-y (+1% q-o-q) to SAR490m, in line with our estimates. We note a q-o-q deterioration of EBITDA margins to 27% (Q3 16: 30%). Saudi’s third mobile operator halved its net loss to SAR135m on the back of higher EBITDA and lower amortisation expenses resulting from extension of its licence. We were expecting a net loss of SAR196m. Valuation We value Zain KSA on a DCF. We use a WACC of 9.3% based on following assumptions: cost of equity of 13.0%, risk-free rate of 2.5% and equity risk premium of 7%. Our target price of SAR7.00 implies 20.5% downside and we rate the stock Reduce rating based on our belief that the company may need to raise further capital given its current balance sheet structure. 233 EQUITIES ● SAUDI ARABIA February 2017 Risks Upside risks: Greater penetration of the government and corporate customer segment: Zain KSA’s growing customer base has been price-sensitive consumers (lower income expats, Saudi youths). The government and corporate segment are generally high-value customers, which would allow the operator to expand margins. Greater mobile broadband usage could be a catalyst for ARPU increases. As usage increases, customers will start to see the value of data and may be more inclined to pay for it. 234 EQUITIES ● SAUDI ARABIA February 2017 Financials & valuation: Zain KSA Reduce Financial statements Year to Valuation data 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (SARm) Revenue EBITDA Depreciation & amortisation Operating profit/EBIT Net interest PBT HSBC PBT Taxation Net profit HSBC net profit Cash flow summary (SARm) 6,741 1,629 -1,770 -141 -831 -972 -972 0 -972 -972 6,774 1,800 -1,474 326 -971 -645 -645 0 -645 -645 6,872 2,129 -1,272 856 -1,048 -191 -191 0 -191 -191 7,323 2,336 -1,374 962 -1,045 -82 -82 0 -82 -82 Cash flow from operations Capex Cash flow from investment Dividends Change in net debt FCF equity Balance sheet summary (SARm) 2,099 -1,582 -1,582 0 213 -314 3,570 -1,541 -1,541 0 -192 1,058 2,003 -1,571 -1,571 0 616 -616 2,487 -1,672 -1,672 0 229 -229 Intangible fixed assets Tangible fixed assets Current assets Cash & others Total assets Operating liabilities Gross debt Net debt Shareholders' funds Invested capital 16,813 5,007 4,096 1,378 26,048 6,135 15,362 13,983 4,552 18,403 16,102 6,250 3,353 1,056 25,817 7,471 14,847 13,791 3,499 17,178 15,736 6,915 2,282 138 25,045 7,191 14,546 14,407 3,308 17,603 15,391 7,558 1,883 -300 24,944 7,383 14,336 14,636 3,226 17,750 Year to 12/2015a 12/2016e 12/2017e 12/2018e 2.8 11.7 1.0 2.8 10.5 1.1 2.8 9.1 1.1 2.7 8.4 1.1 1.1 -6.3 0.0 1.5 21.1 0.0 1.6 -12.3 0.0 1.6 -4.6 0.0 EV/sales EV/EBITDA EV/IC PE* PB FCF yield (%) Dividend yield (%) * Based on HSBC EPS (diluted) Issuer information Share price (SAR) Target price (SAR) Reuters (Equity) Bloomberg (Equity) Market cap (USDm) 8.80 7.00 7030.SE ZAINKSA AB 1,370 14.50 14.50 12.50 12.50 10.50 10.50 8.50 8.50 6.50 6.50 12/2016e 12/2017e 12/2018e Y-o-y % change Revenue EBITDA Operating profit PBT HSBC EPS Ratios (%) 4.50 2016 Zain KSA Ratio, growth and per share analysis 12/2015a 42% Wireless Telecoms Saudi Arabia Eric Chang +971 4 423 6554 Price relative 4.50 2015 Year to Free float Sector Country Analyst Contact 2017 Rel to TADAWUL ALL SHARE INDEX Source: HSBC Note: Priced at close of 02 Feb 2017 8.0 48.1 0.5 10.5 1.5 18.3 162.8 6.6 9.7 12.4 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) 0.4 4.6 -19.4 -0.5 24.2 -2.1 2.0 307.2 8.6 15.0 0.4 7.2 -16.0 1.4 26.6 4.8 1.9 394.1 7.7 25.9 0.4 8.6 -5.6 3.5 31.0 12.5 2.0 435.6 6.8 13.9 0.4 9.2 -2.5 3.9 31.9 13.1 2.2 453.8 6.3 17.0 EPS Rep (diluted) HSBC EPS (diluted) DPS Book value -1.67 -1.67 0.00 7.80 -1.10 -1.10 0.00 5.99 -0.33 -0.33 0.00 5.67 -0.14 -0.14 0.00 5.53 235 EQUITIES ● SAUDI ARABIA February 2017 Disclosure appendix Analyst Certification Each analyst whose name appears as author of an individual section or individual sections of this report certifies that the views about the subject security(ies) or issuer(s) or any other views or forecasts expressed in the section(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 to the specific recommendation(s) or view(s) contained therein: Raj Sinha, Aybek Islamov, Sriharsha Pappu, Prateek Bhatnagar, Ankur Agarwal, CFA, Nicholas Paton, CFA, Patrick Gaffney, CFA, Eric Chang, Herve Drouet, Nigel Fletcher, John Lomax, Kishore Muktinutalapati, Simon Williams and Razan Nasser, CFA Important disclosures Equities: Stock ratings and basis for financial analysis HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations and that investors utilise various disciplines and investment horizons when making investment decisions. Ratings should not be used or relied on in isolation as investment advice. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations and therefore investors should carefully read the definitions of the ratings used in each research report. Further, investors should carefully read the entire research report and not infer its contents from the rating because research reports contain more complete information concerning the analysts' views and the basis for the rating. From 23rd March 2015 HSBC has assigned ratings on the following basis: The target price is based on the analyst’s assessment of the stock’s actual current value, although we expect it to take six to 12 months for the market price to reflect this. When the target price is more than 20% above the current share price, the stock will be classified as a Buy; when it is between 5% and 20% above the current share price, the stock may be classified as a Buy or a Hold; when it is between 5% below and 5% above the current share price, the stock will be classified as a Hold; when it is between 5% and 20% below the current share price, the stock may be classified as a Hold or a Reduce; and when it is more than 20% below the current share price, the stock will be classified as a Reduce. Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation or resumption of coverage, change in target price or estimates). Upside/Downside is the percentage difference between the target price and the share price. Prior to this date, HSBC’s rating structure was applied 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 target price for a stock represented the value the analyst expected the stock to reach over our performance horizon. The performance horizon was 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, had to exceed the required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock was expected to underperform its required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands were classified as Neutral. *A stock was classified as volatile if its historical volatility had exceeded 40%, if the stock had been listed for less than 12 months (unless it was in an industry or sector where volatility is low) or if the analyst expected significant volatility. However, stocks which we did not consider volatile may in fact also have behaved in such a way. Historical volatility was 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 had to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change. 236 EQUITIES ● SAUDI ARABIA February 2017 Rating distribution for long-term investment opportunities As of 10 February 2017, the distribution of all independent ratings published by HSBC is as follows: Buy 45% ( 25% of these provided with Investment Banking Services ) Hold 40% ( 27% of these provided with Investment Banking Services ) Sell 15% ( 17% of these provided with Investment Banking Services ) For the purposes of the distribution above the following mapping structure is used during the transition from the previous to current rating models: under our previous model, Overweight = Buy, Neutral = Hold and Underweight = Sell; under our current model Buy = Buy, Hold = Hold and Reduce = Sell. For rating definitions under both models, please see “Stock ratings and basis for financial analysis” above. For the distribution of non-independent ratings published by HSBC, please see the disclosure page available at http://www.hsbcnet.com/gbm/financial-regulation/investment-recommendations-disclosures. 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. To view a list of all the independent fundamental ratings disseminated by HSBC during the preceding 12-month period, please see the disclosure page available at www.research.hsbc.com/A/Disclosures. HSBC & Analyst disclosures Disclosure checklist Company ABDULLAH A. M. AL-KHODARI AL KHALEEJ TRAINING AL MOUWASAT MEDICAL SERVICES C AL-TAYYAR TRAVEL GROUP ALINMA BANK ALMARAI ALRAJHI BANKING AND INVESTMENT ARAB NATIONAL BANK ASTRA INDUSTRIAL GROUP BANQUE SAUDI FRANSI BUPA ARABIA COOPERATIVE COOPERATIVE INSURANCE CO DAR AL ARKAN FAWAZ ABDULAZIZ ALHOKAIR HALWANI BROTHERS HERFY FOOD SERVICES JABAL OMAR DEVELOPMENT COMPANY JARIR MARKETING CO MAADEN NATIONAL COMMERCIAL BANK NATIONAL INDUSTRIALIZATIO NATIONAL MEDICAL CARE CO RIYAD BANK SAHARA PETROCHEMICAL CO. SAMBA FINANCIAL GROUP SAUDI AIRLINES CATERING SAUDI ARABIAN FERTILIZER SAUDI BASIC INDUSTRIES CO SAUDI COMPANY HARDWARE SAUDI INDUSTRIAL INVESTME SAUDI INTERNATIONAL PETRO SAUDI PHARMACEUTICAL SAUDIA DAIRY AND FOODSTUFF CO SAVOLA UNITED ELECTRONIC COMPANY UNITED INTERNATIONAL TRANSPORT YANBU CEMENT COMPANY ZAMIL INDUSTRIES Ticker Recent price Price date Disclosure 1330.SE 4290.SE 4002.SE 1810.SE 1150.SE 2280.SE 1120.SE 1080.SE 1212.SE 1050.SE 8210.SE 8010.SE 4300.SE 4240.SE 6001.SE 6002.SE 4250.SE 13.06 18.99 136.99 35.77 14.48 67.50 65.02 19.90 16.75 24.50 127.62 107.45 5.82 31.09 56.95 76.21 67.24 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 4 7, 12 4, 12 5, 12 12 2, 5, 7 7 6 7 6 12 12 6 7 7 4, 12 2 4190.SE 1211.SE 1180.SE 2060.SE 4005.SE 1010.SE 2260.SE 1090.SE 6004.SE 2020.SE 2010.SE 4008.SE 2250.SE 2310.SE 2070.SE 2270.SE 2050.SE 4003.SE 4260.SE 3060.SE 2240.SE 128.40 41.54 40.92 15.76 51.74 10.80 15.00 20.77 85.65 70.69 96.10 96.52 19.89 18.19 39.83 116.00 38.40 28.44 29.05 37.30 29.77 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 09 Feb 2017 12 2 2, 6 4, 7 12 6, 7 7, 12 6, 7 4, 7 6, 7 6, 7 4, 12 12 6, 7 4 4, 12 4, 6, 7, 12 4 7, 12 4 4, 7, 12 Source: HSBC 1 HSBC has managed or co-managed a public offering of securities for this company within the past 12 months. 237 EQUITIES ● SAUDI ARABIA February 2017 2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months. 3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this company. 4 As of 31 January 2017 HSBC beneficially owned 1% or more of a class of common equity securities of this company. 5 As of 31 December 2016, 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. 6 As of 31 December 2016, 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. 7 As of 31 December 2016, 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. 8 A covering analyst/s has received compensation from this company in the past 12 months. 9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as detailed below. 10 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. 11 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 12 As of 07 February 2017, HSBC beneficially held a net long position of more than 0.5% of this company’s total issued share capital, calculated according to the SSR methodology. 13 As of 15 December 2016, HSBC beneficially held a net short position of more than 0.5% of this company’s total issued share capital, calculated according to the SSR methodology. HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments, both equity and debt (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, sales & trading, and principal trading revenues. Whether, or in what time frame, an update of this analysis will be published is not determined in advance. Economic sanctions imposed by the EU and OFAC prohibit transacting or dealing in new debt or equity of Russian SSI entities. This report does not constitute advice in relation to any securities issued by Russian SSI entities on or after July 16 2014 and as such, this report should not be construed as an inducement to transact in any sanctioned securities. 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. In order to find out more about the proprietary models used to produce this report, please contact the authoring analyst. Additional disclosures 1. This report is dated as at 13 February 2017. 2. All market data included in this report are dated as at close 02 February 2017, unless a different date and/or a specific time of day is indicated in the report. 3. 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, Principal Trading, and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner. 4. You are not permitted to use, for reference, any data in this document for the purpose of (i) determining the interest payable, or other sums due, under loan agreements or under other financial contracts or instruments, (ii) determining the price at which a financial instrument may be bought or sold or traded or redeemed, or the value of a financial instrument, and/or (iii) measuring the performance of a financial instrument. 238 EQUITIES ● SAUDI ARABIA February 2017 5. As of 03 Feb 2017 HSBC owned a significant interest in the debt securities of the following company(ies): ADVANCED PETRO CHEMICAL C, ALMARAI, BANQUE SAUDI FRANSI, NATIONAL INDUSTRIALIZATIO, RIYAD BANK, SAUDI ARABIAN FERTILIZER, SAUDI BASIC INDUSTRIES CO, SAUDI INTERNATIONAL PETRO, SAUDI TELECOM COMPANY, SAVOLA 6. HSBC are acting as advisor to SABIC in the proposed disposal of Ibn Al-Baytar to SAFCO. Production & distribution disclosures 1. This report was produced and signed off by the author on 10 Feb 2017 12:31 GMT. 2. 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MCI (P) 094/06/2016, MCI (P) 085/06/2016 and MCI (P) 062/02/2017 [549895] 240 Issuer of report: HSBC Bank Middle East Ltd PO Box 502601 Dubai UAE Telephone: +971 4390 4722 Fax: +971 4426 7397 Website: www.research.hsbc.com Main contributors Raj Sinha* Head of EEMEA Equity Research HSBC Bank Middle East Ltd [email protected] +971 4423 6932 Sriharsha Pappu*, CFA Analyst HSBC Bank Middle East Ltd [email protected] +971 4423 6924 Patrick Gaffney*, CFA Analyst HSBC Bank Middle East Ltd [email protected] +971 4423 6204 Aybek Islamov* Analyst HSBC Bank Middle East Ltd [email protected] +971 4423 6921 Ankur Agarwal*, CFA Analyst HSBC Bank Middle East Ltd [email protected] +971 4423 6558 Nigel Fletcher* Analyst HSBC Bank Middle East Ltd [email protected] +971 4423 6862 Nicholas Paton*, CFA Analyst HSBC Bank Middle East Ltd [email protected] +971 4423 6923 Eric H Y Chang* Analyst HSBC Bank Middle East Ltd [email protected] +971 4423 6554 Prateek Bhatnagar* Analyst HSBC Securities and Capital Markets (India) Private Limited [email protected] +91 80 4555 2757 John Lomax* Head of Equity Strategy, GEMs HSBC Bank plc [email protected] +44 20 7992 3712 Simon Williams Chief Economist, CEEMEA HSBC Bank plc [email protected] +44 20 7718 9563 Kishore Muktinutalapati* Equity Strategist HSBC Securities and Capital Markets (India) Private Limited [email protected] +91 80 4555 2756 Razan Nasser Economist, Middle East and North Africa HSBC Bank Middle East Ltd [email protected] +971 4423 6925 *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.
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