NCB Capital analyses consolidation outlook for key Saudi sectors

NCB Capital, Saudi Arabia’s largest investment bank and leading GCC wealth manager, issued today a new report analysing the consolidation outlook for specific sectors in Saudi Arabia and the likelihood of Saudi companies consolidating domestically and internationally.

According to the NCB Capital report, there are many drivers for consolidation, but obstacles exist. Vertical consolidation is more likely than horizontal, with industrial sectors more likely to see the vertical form, while consumer focused sectors are more likely to undergo horizontal consolidation.

“Overall, we find that there are many compelling reasons for leading Saudi companies to take part in consolidation both domestically and internationally,” said Farouk Miah, Acting Head of Equity Research at NCB Capital. “However obstacles to this are high. These include the high family ownership of companies, access to financing, and government subsidies, which limit the incentives to consolidate.” 

NCB Capital believes that vertical consolidation is more likely than horizontal consolidation in Saudi Arabia. In many sectors, according to the report, key listed companies may find it beneficial to acquire companies further up or down on the vertical chain of their respective sector. NCB Capital believes vertical consolidation is more likely than horizontal, not particularly due to the greater benefits of this form, but rather due to the fewer obstacles it entails. 

“Horizontal consolidation is more likely in consumer areas,” added Farouk Miah. “Retail, Food & Agriculture and Insurance are key sectors in Saudi Arabia which we believe have a high likelihood of horizontal consolidation. The low margins, fragmented and highly competitive nature of the sectors, coupled with high operating costs are some of the key drivers for consolidation in these sectors.” 

However, vertical consolidation is more likely in industrial sectors. “From our analysis, we believe vertical consolidation is more likely for Saudi companies in industrial/manufacturing sectors such as Cement and Petrochemicals, as well as technology sectors such as Telecoms,” said Farouk Miah. “In these areas, we believe the control of suppliers, as well as the potential from cost synergies and revenue diversification, are key drivers for consolidation.” 

According to the NCB Capital report, many key obstacles remain present in Saudi Arabia holding back the pace of consolidation. These include a high concentration of family owned business, limited financing options, lack of know-how, and high government subsidies, which limit the incentives to consolidate.

For the petrochemical sector, firms in Saudi Arabia have undertaken aggressive investments in recent years to expand their product range and market reach. The majority of new projects are joint ventures with local or global partners. For example, SABIC formed alliances with global players such as ExxonMobil and Sinopec and SIIG formed a joint venture with Chevron Phillips Chemicals Co. Along with joint venture initiatives, producers in Saudi Arabia have in instances also acquired their foreign counterparts.

Consolidation outlook in the petrochemical sector is highlighted by the fact that SABIC and Tasnee are actively seeking M&A opportunities globally. According to news released by ICIS, SABIC is seeking opportunities (both acquisitions and joint ventures) to enhance its presence in Asia. According to the same source, Tasnee has maintained its focus on diversifying its product mix through acquisitions and/or alliances.

Globally, M&A activities in the petrochemical industry are gaining traction as firms target strategic opportunities for capacity rationalization, to create economies of scale and to move ahead in the value chain. The total value for announced deals in the chemical sector during January–April 2011 stood at USD50bn, broadly in line with the levels in 2007. A total of 293 deals were announced in 1Q11.

NCB Capital believes the outlook for overall consolidation within the KSA cement sector is limited due to the high returns and margins all companies are able to generate. This is largely off the back of the high subsidies provided by the government. Vertical consolidation is much more likely as cement companies seek different revenue sources and increase their strength in the sector.

For the Telecom sector, as a key aim of the Saudi government has been to liberalize the local telecom sector and increase competition, NCB Capital believes the sector is unlikely to see much consolidation in the short-to-medium term. However, given the limited success of new telecoms players such as Etihad Atheeb, in the long run there may be some scope of telecom companies working together. Vertical consolidation is much more likely in the telecom sector as operators look to work with technology firms specializing in growth areas such as broadband internet.

For Food & Agriculture, with global food prices remaining close to all time highs and volatility in these prices remaining present, NCB Capital believes this cost pressure will be a key driver to consolidation in the sector. The bank believes firms will look to mitigate the impact of higher raw material prices through economies of scale and exerting greater control over key suppliers.

The same applies for the retail sector, as the fragmented nature of the industry in Saudi Arabia, coupled with the low margins in this sector, is expected to incentivize companies to seek consolidation as a way to succeed. The importance of economies of scale in retail is another key driver which NCB Capital believes increases the likelihood of consolidation in the Saudi retail sector.

NCB Capital believes the Saudi banking sector is unlikely to see much consolidation activity in the future. The sector was in many ways founded on consolidation. Currently, the sector constitutes 12 domestic players and 9 foreign bank branches. The sector is dominated by four large banks holding around 61% of the banking assets, while mid-size players are also growing significantly. On the other side, small banks like Saudi Investment Bank, Saudi Hollandi Bank, Bank Aljazira and Bank Albilad are under pressure to perform. Any negative impact on the sector is not well absorbed by these small banks and results in losses in the short term. However, given the strong nature of the banking sector in Saudi Arabia and the emphasis of SAMA to promote competition, we believe consolidation is unlikely in the short-to-medium term due to restrictions from the government regulator.

Due to the large number of players in the insurance sector, NCB Capital believes achieving sustainable profitability by some of the small firms may be difficult. Hence the bank expects consolidation in the Saudi insurance sector among the small firms due to the benefits of economies of scale, cost synergies and combined market share.

Finally, NCB Capital believes the diversified nature of conglomerates and the reluctance of family owned entities to share ownership, limits the likelihood of real estate consolidation in Saudi Arabia.