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1 CONSUMER / RETAIL 16 June 2009 Savola Group Company Overweight Price (SR) month target price# (SR) 27.1 Potential upside/downside (%) 11 Conglomerate Discount holds back valuation We believe Savola is increasingly being run as a conglomerate, engendering a Conglomerate Discount, which is artificially holding back the valuation of the company. We believe upcoming IPOs of subsidiaries should help unlock the intrinsic value of the company and hence remain overweight on the stock. Stock details Financials 52-week range H/L (SR) 38/ A 2009E 2010E 2011E CAGR % Market cap ($mn) 3,311 Revenue SR mn 13,821 16,227 17,828 19, Shares outstanding (mn) 500 EBITDA SR mn 1,011 1,548 1,726 1, Listed on exchanges Tadawul Adjusted net income* SR mn Price perform (%) 1M 3M 12M Assets SR mn 14,545 16,160 17,140 18, Absolute (16.2) (29.1) (14.2) Equity SR mn 6,389 6,722 7,144 7, Rel. to market (1.9) (0.7) 4.5 EBITDA margin % Avg daily turnover (mn) SR US$ Adj. net margin* % M Normalised ROE % M Normalised ROA % Reuters code 2050.SE Source: Company, NCBC Research estimates (as of last published report 3 Feb 2009), *Excluding one-off items (post tax) Bloomberg code Website Valuation multiples SAVOLA AB 08A 09E 10E Reported P/E (x) Adjusted P/E*(x) Reported P/B (x) Adjusted P/B* (x) EV/EBITDA (%) Div yield (%) estimates *MCap adj for MV of listed investments divided by normalized incomes less underlying dividends #Target price set on 3Feb09 at market price of SR19.10 Share price performance Jan-07 M ar-08 Jun-09 Tadawul Source: Reuters Farouk Miah f.miah@ncbc.com Savola (RHS) Please refer to the last page for important disclaimer To achieve diversified growth, Savola has adopted a fast-paced conglomerate strategy by enhancing its presence in a wide spectrum of businesses. We believe that while the conglomerate strategy has given the company balance sheet strength and a solid status to acquire new brands and businesses, it has also held back valuation Over the years, with its distinct separate business units, Savola is increasingly functioning as a conglomerate as against a unified business. This, we believe, is leading to an implicit Conglomerate Discount on the current valuation of the group, which should correct with any upcoming IPOs of Savola s businesses Savola s strategic investments are recorded at book value and flow through the income statement only as dividends. We argue that the embedded value of these businesses is significant. Savola s associates KEC, Panda, and Herfy have stated their aims to list their businesses (KEC in H2-09) providing a great catalyst to unlock value Although real estate is being treated more as a core business now, this, and various financial investments, have traditionally been seen as non-core. They are playing an increasingly significant role in Savola s performance and we believe that, despite recent losses in these businesses, Savola s overall valuation remains robust. In the long term, we believe these businesses have the potential to add significant value to the company A 28% stake in Almarai plays an important role in Savola s valuation, with 36% of Savola s current valuation coming from its investment in Almarai, increasing from 12% in 2006 but falling from a peak of 55% in February If we exclude the Almarai stake (SR4.5bn), the market currently values Savola at SR7.8bn or SR15.6 per share vs. our valuation of Savola, excluding Almarai of SR9.6bn (SR19.2 per share) indicating a 23% upside Despite the current share price providing only 11% upside to our PT of SR27.1, we highlight our bull case price target of SR33, an upside of 35%, which, amongst other things, factors in some of the value locked due to the Conglomerate Discount. We maintain our numbers and our Overweight rating as we await H1-09 results in July

2 Overview of Conglomerate Discount Conglomerate Discount refers to a discount to valuation often given to a group of distinct businesses being run by one company compared to a sum-of-the-parts (SOTP) valuation when each of the businesses is valued as if they were separate independent entities. We believe this is happening to Savola where its current valuation of SR12.3bn (SR24.5 per share) is lower than the valuation that would occur if each of its independent businesses were valued separately; our sum-of-the-parts DCF valuation gives Savola a value of SR14.1bn, equating to SR28.2 per share, or an upside of 15% to the current share price (NB: This is excluding its estimated 15% stake in the Knowledge Economic City project and various other smaller realestate projects which should add another SR1-2 to this price target) Savola has a presence in a number of distinct businesses. Within the food business, it is involved in sugar, edible oils and fast-foods through its Herfy chain. It recently announced that it would be looking to get involved in the rice business too. In retail, Savola owns the supermarket chain Panda as well as a number of clothing franchises. Other business activities include the plastics division where it produces plastics for packaging of retail goods, and interests in real estate and finance. Savola s core businesses have been thoroughly analyzed and have received the attention of the markets. In this note we aim to draw attention to the increasing importance of Savola s non-core businesses as part of this Conglomerate Discount analysis and the sensitivities of their valuation to the value of the overall group. We also briefly highlight the potential of any forthcoming IPOs of Savola s core businesses as well as the increasing importance the Almarai stake has played in the overall valuation of Savola Relative importance of the non-core business Having identified food and retail as Savola s core businesses, we categorize businesses not related to food and retail as non-core. Thus, for the purpose of this note, we categorize real estate and finance as Savola s non-core businesses. Based on our SOTP valuation, our total company valuation is SR18.2bn (prior to debt/cash/minority interest adjustments, or SR14.1bn post these changes), with 15% of this coming from the non-core segments. The market currently values Savola at SR12.3bn (share price of SR24.5) indicating an upside of 15% to our current SOTP DCF price target, although we highlight we have not taken its estimated 15% stake in the Knowledge Economic City as well as various other smaller real estate projects into account in our model as we await further details on this. Within the non-core segment, we find that 34% of this 15% is from its holdings of land, 36% is from its holdings of real estate and the remaining 30% is from its investments in financial vehicles. 16 June

3 Exhibit 1: Savola valuation by business type Core (Food/Retail/Plastics) 61% Finance 30% Land 34% Non-Core 15% Core (non-controlled: Al-marai) 23% Real-estate 36% If we subtract our valuation of the non-core business (SR2.3bn once accounting for a proportionate share of debt/minority interest etc to this segment) from the current market valuation of SR12.3bn, Savola s core food and retail businesses are worth SR10bn or SR20 per share vs. our SOTP DCF core valuation of SR11.8bn or SR23.6 per share, indicating an 18% upside on the core business. What are the non-core investments? Real estate and financial investments comprise Savola s two historical non-core businesses. Below, we highlight the main characteristics of each of these businesses: Real estate 5.6% of group valuation Real estate forms 5.6% of Savola s valuation. The three main investments in Savola s real estate portfolio are: Emaar Economic City (EEC) 2.4% stake EEC is in charge of development of King Abdullah Economic City near Rabigh Total development area is 173 km 2 with the city set to cost SR300bn Project entails setting up a multipurpose city comprising six major areas: sea port, industrial, central business, recreational, residential and education city Tameer Jordanian Holding 5% stake Tameer was established in 2005 in Amman to operate in real estate development at a regional level The company was founded with a capital investment worth JD212mn, with the size of the investments it made in the Jordanian market to date exceeding JD890mn. It ranked as the 7th largest company on the Jordan stock exchange The IPO was closed for JD670mn, the largest ever recorded on the Amman Stock Exchange 16 June

4 Kinan International 30% stake Formed by Savola Group to carry out real estate operations; subsequently, Savola privately placed 70% of its stake in Kinan to strategic investors Main focus is on residential and mixed-use development, including a large mixed development in Jeddah with offices, hotels, a residential tower and high-end retail outlets costing around SR2.2bn. Currently Kinan has six operating hypermarket malls and six supermarket malls. Kinan s current asset base is around SR3bn and is projected to reach SR10bn by end 2011 Where does real estate fit? In many ways, a split has already occurred, with real estate now being treated more as core, which leaves the finance business in the sole non-core category. The management recently redefined its meaning of core to include real estate. It remains active in real estate, as its announcement of a 30% stake in a SR2.3bn housing project in Saudi Arabia (April ) indicates. The real estate business used to be part of the retail business line with one CEO responsible for retail, real estate, and plastics. However, recently, the Real Estate business was made into its own business line and now has its own CEO, Nidal Jamjoon, formerly CEO of Emaar, The Economic City. This indicates that Savola is taking its real estate business seriously and has hence reorganized its business lines accordingly. We believe the long term prospects of real estate in Saudi Arabia remain positive, largely due to the young population, lack of supply of affordable housing and increasing income per capita. Thus, in the future, Savola s real estate interests could prove to be a useful source of income for the group. Finance 4.3% of group valuation The financial segments of Savola equate to around 4.3% of our current SOTPDCF valuation. The three main components of Savola s financial investments include: Swicorp Company KSA 15% stake Swicorp is a leading corporate finance advisory, private equity, and investment firm focused on MENA Swicorp was founded in 1987 and is licensed by the CMA of Saudi Arabia and the Dubai Financial Service Authority of the UAE Swicorp has an extensive track record of pioneering M&A and Advisory transactions across the MENA region over the past 20 years Swicorp is a leading player in Private Equity in the MENA region and has raised nearly US$1.4bn in three private equity funds from investors since Swicorp Joussour 14% stake Swicorp Joussour is one of the three PE vehicles of Swicorp and has investor commitments totaling more than US$1bn. Swicorp Joussour Company is a Saudi Joint Stock Company launched by Swicorp capitalized at SAR2.67bn (US$712mn) 16 June

5 The company s focus is on energy and energy-intensive industries that leverage the competitive advantages of the region. Intaj Capital 49% stake A US$250mn fund focusing on sectors driven by growth in consumer demand in the MENA region Target sectors include consumer goods, retail and food and beverage Is actively making investments and sourcing future transactions. To date, it has committed over US$200mn in eight transactions Has a well balanced fund allocation policy, restricting investments of more than 25% of target commitments in a single country or a sector Where does finance fit in? The Investments in the finance business are not controlled by Savola with its key finance investments including components of the Swicorp group. This is run by Kamel Lazaar who has over 20 yrs experience in international banking and finance and prior to founding Swicorp in 1986 was a VP at Citibank and helped form SAMBA. The six MDs of the Swicorp team on average have 12+ years of banking experience and high educational qualifications, with many having worked with leading western investment banks. We feel the investments in these financial vehicles were conducted off the back of unprecedented inflows of cash into the region due to oil trading at over $125. With the oil price now significantly lower, we believe there will be limited increases in Savola s involvement in these or other financial investments. Exhibit 2: Savola SOTP valuation Non-core investments Savola stake SOTP valuation (mn) % of valuation Real-Estate 1, Emaar Economic City Tameer Jordanian Holding Kinan International Finance Swicorp Joussour Swicorp Company Intaj Capital Ltd Other Land Total non-core 2, Core : controlled Retail/Food/Plastics 11, Core : non-controlled Almarai , Total core 15, Total 18, Other factors (debt/cash/minority interest/corporate costs) (4,053) SOTP Valuation 14,127 As of our last published model in 3 Feb 2009 note 16 June

6 Savola is still committed to its core business Savola s increasing exposure to non-core businesses raises questions on its commitment to its core businesses. We believe food and retail remain Savola s key businesses. The company s recent increase in stakes in Afia Egypt (94.6% to 99.8%, worth SR65mn), Savola Foods Co. (SFC includes edible oil and sugar biz stake went from 85% to 90%, worth SR167mn) and Savola Behshahr Company Iran (Iranian oil business from 49% to 80%) validate our view. We believe food and retail are Savola s core businesses also because: On numerous occasions, Savola has divested its non-core activities; for e.g., in 2007, it sold its entire stake in Egyptian Fertilizer Company as there was no strategic fit for the business despite the fact that EFC s profits were increasing Capex - Savola announced that majority of capex will be spent on its core businesses edible oil, retail, and food and plastic Many of its non-core businesses in real estate and finance also indirectly aid the core businesses e.g. shopping malls built with preference for Panda supermarkets and private equity investments in the consumer sector 16 June

7 Analysis of non-core valuation scenarios With its 2008 results tainted by SR676m write offs (SR242m inventory write-downs, SR162m against investments available for sale, and SR272m related to losses in KSA equity investments), a key factor to investigate for Savola is the potential for write offs in its non-core businesses. In the scenario analysis below, we look at the various fair target prices our SOTP DCF valuation gives when faced with differing levels of deterioration and improvement in the non-core business valuations. We find that a severe decline (-25%) in the valuation of its real estate and financial businesses will cut 6% off our DCF price target taking it to SR26.6. An increase (10%) in the valuation of these business plus Almarai, will increase our DCF target price by 5% to SR29.7. Stress tests We have performed a number of stress tests to analyze the impact different valuation declines and an increase in the non-core businesses will have on our DCF based price target. Scenario one: 10% fall in valuation of non-core business leads to 2% fall in PT Four major segments were tested; Almarai, Real Estate, Swicorp and related, and Others. If all the four segments were to fall in value moderately (by 10%), this would lead to a 6% fall in our sum-of-the-parts PT to SR26.6. Excluding Almarai, PT would fall only 2% at SR27.5 Exhibit 3: Moderate decline in non-core business valuations DCF Bear case Others decline by 10% Real estate decline by 10% Swicorp & related decline by 10% Almarai decline by 10% DCF Base Case Almarai increase by 10% Swicorp & related increase by 10% Real estate increase by 10% Others increase by 10% DCF Bull case 16 June

8 Scenario two: 25% fall in non-core business valuation leads to 6% fall in PT Again, four key segments were tested; Almarai, Real Estate, Swicorp and related, and Others. If Almarai falls by 20% and the remaining segments fall in value by 25% each, it would lead to a 12% fall in PT to SR24.8. Excluding Almarai, PT would fall only 6% to SR26.6. Exhibit 4: Severe decline in non-core business valuations DCF Bear case Others decline by 25% Real estate decline by 25% Swicorp & related decline by 25% Almarai decline by 20% DCF Base Case Almarai increase by 10% Swicorp & related increase by 10% Real estate increase by 10% Others increase by 10% DCF Bull case Scenario three: 50% fall in non-core business valuation leads to 11% fall in PT We again test the four key segments; Almarai, Real Estate, Swicorp and related, and Others. If Almarai falls by 25% and the remaining segments fall in value by 50%, it would lead to a 19% fall in the PT to SR22.8. Excluding Almarai, PT would fall only 11% to SR25 Exhibit 5: Extreme decline in non-core business valuations DCF Bear case Others decline by 50% Real estate decline by 50% Swicorp & related decline by 50% Almarai decline by 25% DCF Base Case Almarai increase by 10% Swicorp & related increase by 10% Real estate increase by 10% Others increase by 10% DCF Bull case 16 June

9 Scenario four: 10% increase in non-core business valuation leads to 5% increase in PT We look at the same four non-core businesses: Almarai, Real Estate, Swicorp and related, and Others. If all four were to increase in value moderately (by 10%), this would lead to a 5% increase in the PT to SR29.7. This Indicates the upside potential of non-core investments. Exhibit 6: Moderate increase in non-core business valuations DCF Bear case Others decline by 10% Real estate decline by 10% Swicorp & related decline by 10% Almarai decline by 10% DCF Base Case Almarai increase by 10% Swicorp & related increase by 10% Real estate increase by 10% Others increase by 10% DCF Bull case Importance of Almarai An important element to highlight is Savola s ownership of a 28% stake in Almarai, the GCC s leading dairy company. (Neutral Rating, PT SR158, Current Price SR148 please refer to our initiation note dated 12 May 2009 for more information on Almarai). Prior to the Almarai IPO, Savola held a 40% stake in the dairy firm with this diluted to 28% following the IPO. Almarai has outperformed the TASI by around 35% in the past 12 months with Savola outperforming the TASI by 7% in the same period. This divergence in relative performance has meant that the Almarai stake as a % of Savola s total market cap increased from 24% in March 2008 to a peak of 55% at the end of February 2009, with it currently at 36% as of June That is to say, at the end of February, more than half the valuation the market was affording to Savola was due to its stake in Almarai, as opposed to its own operations. Due to Savola s relative underperformance vs. Almarai over the past 12 months, we find that the valuation of Savola excluding the Almarai stake has fallen by 43% over the past 12 months, whereas the market cap of Savola as a whole has fallen only 34%. This means that Savola s valuation excluding the Almarai stake has fallen by 10% more than when we include the Almarai stake. Based on this analysis and on current prices, we find that if Almarai s valuation falls by 10%, Savola s would decrease by 3.7% and vice versa. This indicates the relative importance of Almarai in the Savola story. The key point from the above analysis is to highlight the relative importance of Almarai to Savola, as well as show that the market has actually discounted the valuation of the core Savola business much more than meets the eye due to the outperformance of the Almarai stake. We believe the discount on the Savola core business is too severe and thus provides an 16 June

10 excellent opportunity to enter the stock. If we exclude the Almarai stake (SR4.5bn), the market currently values Savola at SR7.8bn or SR15.6 per share vs. our valuation of Savola, excluding Almarai of SR9.6bn (SR19.2 per share) indicating a 23% upside. Exhibit 7: Almarai stake as portion of Savola market cap (e.g. 0.5=50%) Mar-08 Jun-08 Oct-08 Feb-09 Jun-09 Potential of the IPOs As already stated earlier in this report, we believe Savola is increasingly being run as a conglomerate with distinct separate businesses which have their own CEOs. With diverse businesses in tow, it has become increasingly difficult to value Savola as a combined entity, leading to a conservative valuation for the group with a current market cap of SR12.3bn. Subsidiaries such as KEC, Panda and Herfy are expected to go public in next three years, with KEC s IPO likely in H2-09 with Herfy most likely next (the IPO was planned for Q4 2008, but delayed due to poor market conditions). We believe any IPO s of the business units will go a long way in unlocking some of the value trapped under the Conglomerate Discount phenomenon. With individual business fundamentals in focus during the IPOs, higher awareness about the strength of these businesses would help investors to value them for their own potential. The individual listings will generate greater interest and investor awareness for the spun-off entities while highlighting Savola s involvement in these businesses. The IPOs will revalue these subsidiaries to market price from the reported book value, leading to a rise in Savola s EV and thus help squeeze out the inefficiencies in valuation from the conglomerate discount. The IPO s should also lead to inflow of cash to Savola, which can be used to fund capex. However, the success of the above will depend greatly on market sentiment and general investor appetite for new IPO s 16 June

11 Valuation Our current combined DCF/Surplus ROE/Justified P/BV PT for Savola is SR27.1, indicating a 11% upside to the current share price of SR24.5. However, we maintain our Overweight rating highlighting our bull case PT of SR33, a 35% upside to the current price. Moreover, we believe Savola s implicit Conglomerate Discount is weighing down the current market price, which could be unlocked soon through IPOs of its subsidiaries as well as the potential of the non-core real estate and finance businesses. Exhibit 5: Savola - DCF bull & bear scenario analysis (SR) Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Historical price performance Current price Price target 16 June

12 Kindly send all mailing list requests to Brokerage sales Roger Yeoman (mobile) Brokerage website Corporate website / NCBC INVESTMENT RATINGS Overweight: Neutral: Underweight: Price Target: Target price represents expected returns in excess of 15% in the next 12 months Target price represents expected returns between -10% and +15% in the next 12 months Target price represents a fall in share price exceeding 10% in the next 12 months Analysts set share price targets for individual companies based on a 12 month horizon. These share price targets are subject to a range of company specific and market risks. Target prices are based on a methodology chosen by the analyst as the best predictor of the share price over the 12 month horizon OTHER DEFINITIONS NR: CS: NC: Not Rated. The investment rating has been suspended temporarily. Such suspension is in compliance with applicable regulations and/or in circumstances when NCB Capital is acting in an advisory capacity in a merger or strategic transaction involving the company and in certain other situations Coverage Suspended. NCBC has suspended coverage of this company Not Covered. NCBC does not cover this company IMPORTANT INFORMATION The authors of this document hereby certify that the views expressed in this document accurately reflect their personal views regarding the securities and companies that are the subject of this document. The authors also certify that neither they nor their respective spouses or dependants (if relevant) hold a beneficial interest in the securities that are the subject of this document. Funds managed by NCB Capital and its subsidiaries for third parties may own the securities that are the subject of this document. 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