El-Quqa : Positive outlook on the Saudi cement sector.

Global Investment House –- Kuwait - Yamama Cement Company Equity Investment Update -  Yamama Saudi Cement Company (YSCC) ranks among the biggest cement producers in Saudi Arabia. The company derives its name from the historical name of Riyadh area. It was founded in 1961 in Riyadh city by H H Late Prince Mohammad Bin Saud Al-Kabir, with a capital of SR25mn, to produce and sell cement. The commercial production started in 1966 with a 300tpd line. With time, YSCC expanded its plant capacity by adding new production lines. Today, YSCC has clinker capacity of 2.8mtpy and cement capacity of 3.0mtpy. The company also has a paper bags unit, with a capacity to produce 30mn bags every year, for captive consumption.

The company is currently listed on the Saudi Stock Market (Tadawul), where it is heavily traded. The turnover of the YSCC stock on the Tadawul has been very high at over 201% over the last one year. The high/low prices of the stock over the last one year have been SR213 / SR64 (post the recent 2:1 bonus and 5:1 stock-split).

Source: Company's Annual Report for 2005.                                                         EPS post 2:1 bonus and 5:1 share split

Analysis of 2005 Results

The gross profit of Yamama Saudi Cement Company (YSCC) for the year 2005 increased by 24.1% to SR541.7mn from SR436.3mn in 2004. The gross profit per tonne cement sold increased by 21.4% to SR152 during the year from SR125 in the previous year, underscoring strong demand for cement in the Saudi market. Among the operating expenses, the general & administrative expenses of SR15.6mn were higher by 32.5% during the year. On the other hand, the staff and distribution expenses declined during the year. The operating profit of SR501.8mn in 2005 was higher by 25.3% over the previous year. The net profit of the company declined by 7.6% during 2005 to SR500.9mn from SR542.2mn in 2004. There was a one-time profit on disposal of investments in 2004 of SR144.8mn; after adjusting for this amount, the actual rise in the net profit in 2005 was 26.0% year-on-year. The EPS (post the recent 2:1 bonus and 5:1 stock-split) of the company fell to SR3.7 from SR4.0 reported in 2004 (actually risen to SR3.7 in 2005 from SR2.9 in 2004, after adjustment).

The company declared a cash dividend of SR30 per share (60%) during the year, the same as in the previous years.  The dividend payout ratio of the company for the year was 53.9%, higher than 49.8% in the previous year.

The total assets of the company of SR2.7bn at the end of 2005 witnessed an increase of 38.1% over the previous year-end. Trade receivables remained steady at the previous year’s level, while inventories decreased by 13.0%. There was a huge spurt in the gross fixed assets and work-in-progress during the year, in view of the ongoing capacity expansion project. On the liabilities side, the company loaned SR309.8mn from SIDF besides raising an additional SR200mn through Islamic murabahas during the year. The debt-equity ratio of the company rose to 0.45x during the year from 0.15x during the previous year.

Saudi Cement Sector Outlook

According to data currently available, projects currently under execution in the GCC amount to about $620bn. Out of these, Saudi Arabia is believed to account for about 29.3%, or $182bn worth of projects. Of these about $80bn (or over 44%) worth of projects are believed to be in the civil segment. Civil projects – covering infrastructure and property construction segments – are known to be highly cement-intensive in nature. The high proportion of the proposed investments in the civil segment points towards a steady and sustainable cement demand in the country moving forward. Thus, there is now greater visibility on the future cement demand front in the country.

On the supply side, announcements have been made by various incumbent as well as new cement companies for expansion of existing capacities and/or setting up new capacities. New clinker capacities of about 21.3mt and cement capacities of about 22.0mt are believed to be coming up in the Kingdom in the coming 2-3 years by way of expansions as well as greenfield projects.

Over the medium-term, the cement demand in Saudi Arabia is expected to be robust in view of the massive investments planned all across the country. Assuming that all the investment projects valued at $182bn announced in Saudi Arabia so far are implemented, we project a cement demand growth at a CAGR of about 12% in volume-terms during 2005-’08.

Valuation & Recommendation

In our previous Research Report on YSCC in September 2005, with which we had initiated coverage of the stock, we had arrived at a weighted average share value of SR1,275 per share (SR85 post the recent bonus and share-split), and had recommended a 'Hold' on the stock at the then prevailing price of SR1,398 (SR93 post the recent bonus and share-split). The stock has had a good run at the stock market since then, touching a high of SR213 (post the recent bonus and share-split) – a gain of about SR120 or 128% as against 38.5% in the Tadawul All Share Index (TASI) – in the six months following the release of our Report, before the Saudi stock market went for a major correction in late-February 2006. The stock has lost over SR104 (about 49%) since the end of February 2006, as against a loss of about 37% in the TASI, to close at SR109 on May 2, 2006.

The variations (actual vs. projected) in gross profit, operating profit and net profit in 2005 have been 19.0%, (-) 0.1% and 1.8% respectively. The large variation in the gross profit has largely been due to the actual gross profit per tonne being 24.3% higher than projected.

The projections for the years 2006-‘09 have been revised keeping in view the company’s 2005 and 1Q2006 performance. While we had assumed a risk-free rate of 4.66% in our earlier Report, it has been lowered to 4.625% in this Update, based on the current coupon on 10-year Saudi government bonds. We have retained the market risk premium and beta at the earlier levels, while revising the cost of debt upwards to more realistically reflect the cost of debt financing. As a result, WACC has increased to 9.50% now from 9.13% in the earlier Report.

The combination of the revised financial projections, WACC and the number of shares outstanding has now led to the DCF value of SR96, as against SR83 (SR1,250 before the bonus and share-split) arrived at in the September 2005 Report. Based on the 2006 (P) Sector P/E multiple of 21.8x, the peer valuation arrived at now is SR92,  the same as in the earlier report (SR1,373 before the bonus and share-split), which was based on a sector P/E multiple of 29.9x. The combined effect of these two has led to an upward revision in the weighted average share value of YSCC, which is now SR95, as against SR85 (SR1,275 before the bonus and share-split) arrived at in our September 2005 Report.

At the current market price of SR109 on the Tadawul, the YSCC share is quoting at a premium of 15.1% to its intrinsic value. We, therefore, recommend a ‘Reduce’ on the YSCC stock at the current price levels, downgrading it from our earlier recommendation of ‘Hold’. While the fundamentals of the company have improved vis-à-vis in our earlier report, the downgrading of the stock has resulted from the huge run-up of over 128% in the stock price in the six months post the publication of our earlier report. While the stock has lost most of its gains in recent weeks, it is still trading at a high premium to its intrinsic value.