qatar national CEMENT

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1 qatar national CEMENT Strong Cash Flows key data Fair Value per Share (QAR) Closing Price (QAR) * week High / Low (QAR) 88.5/72.1 YTD / 12-month return 10.5%/7.1% Trailing P/E 8.2 Shares Outstanding (000s) 44,637 Market Cap (QAR million) 3,883 Free Float 55.70% Reuters / Bloomberg Code QANC.QA/QNCD.QD *As of November 01, Sources: Reuters and NBK Capital key metrics 2009A 2010F 2011F 2012F P/E EPS Dividend Yield 6.9% 7.0% 9.1% 9.7% EV/EBITDA RoAE 26.2% 24.5% 22.1% 20.4% RoCE 14.9% 19.4% 19.7% 19.9% EBITDA margin 31.0% 54.1% 52.9% 51.3% Net profit margin 30.8% 45.1% 44.0% 43.2% Sources: Company financials and NBK Capital forecasts QAR million 4Q2010F 1Q2011F 2010F 2011F Revenue ,109 1,143 EBITDA Source: NBK Capital Rebased Performance Nov-09 Dec-09 Mar-10 Apr-10 Jun-10 Aug-10 Oct-10 QANC Sources: MSCI, Reuters, and NBK Capital Analysts Rajat Bagchi T E. rajat.bagchi@nbkcapital.com MSCI Qatar Mariam Al-Bahar T E. mariam.albahar@nbkcapital.com Highlights 12-Month Fair Value: QAR Recommendation: Accumulate Risk Level**: 3 Reason for Report: 9M2010 Update Upward revision of the EBITDA margin raises our fair value by 19% to QAR per share with an upside potential of 15.5%, and hence we recommend Accumulate : Following a strong EBITDA margin expansion in the 9M2010 results, we have revised our margin forecast and our outlook on the Qatari cement market. Limited disclosure on operating costs led to a significant variance in the EBITDA margin during 9M2010 compared to our earlier forecasts. Following better clarity on the cost structure and the record EBITDA margin of 61% achieved in 3Q2010, we now forecast EBITDA margin contraction, albeit a much higher margin than our earlier expectations. For 4Q2010, we forecast a margin of 57.5%, leading to a FY2010 margin of 54.1%. Over the next five years, we expect an average EBITDA margin of 49.5% (our earlier assumption was 34.7%). Impressive project pipeline and minimal risks to domestic cement prices viewed favorably: We continue to remain positive on the Qatari cement sector due to the ongoing infrastructure and real estate projects undertaken by the government as well as the private sector. Additionally, we feel Qatari cement prices are competitive. The current price of ordinary Portland cement (OPC) in Qatar is USD 69 per ton which compares to a landed price of USD per ton from the United Arab Emirates (UAE) and Saudi Arabia, and stands as a hurdle to imports from these countries. On the domestic front, we forecast a tight demand supply scenario, with local cement demand pegged at million tons compared to a supply in the same range. However, conservatively we forecast nominal reductions of 2.5% for domestic cement prices over the next two years. We remain positive on the free cash flow and the dividend story: We remain positive on the free cash flow generating ability of the company considering the recent trend in margins and the overall decline in capital expenditures (capex) going forward (capex declined to QAR 9.7 million in 1H2010 compared to QAR 63.7 million in 1H2009). On last year s dividend of QAR 6 per share, the stock is currently trading at a yield of 6.9%. We expect a similar dividend this year as well, resulting in a total expected return of 22.5% for the stock based on our new fair value. Our free cash flow (FCF) analysis suggests there is still significant upside potential for the dividend yield from current levels, taking into account a notable FCF yield of 14.6% and 13.2% on forecasted free cash flows in 2010 and 2011, respectively. ** Please refer to page 11 for recommendations and risk ratings. nbkcapital. com

2 Valuation On account of the recent trend in the EBITDA margin and based on our favorable outlook on the Qatari cement market, we have revised our forecasts upward, raising the fair value of Qatar National Cement to QAR per share compared to the earlier fair value of QAR The new fair value represents an upside potential of 15.5% from the last close. Accordingly, our new recommendation for the stock is Accumulate. Since our initiation on January 19, 2010, the stock has yielded a total return of 22.3%, outperforming the MSCI Qatar Gross Index, which generated a return of 19.5% during the same period. Upward revision in the EBITDA margin leading to robust free cash flows should drive value going forward: We believe our revised forecasts for EBITDA margins should result in robust cash flows, thus acting as the main value driver for the stock. Higher EBITDA forecasts for 2011 (QAR million) compared to our earlier assumption (QAR million) led to an almost 50% increase in value generated from peer comparison (using forward EV/EBITDA multiples). A significant rise in the EBITDA margin in conjunction with minimal capex will result in average annual free cash flows of around QAR 520 million over our explicit forecast period. This in turn should result in healthy dividends, thus boosting the overall return from the stock. Solid financial position: We believe the company s strong balance sheet lends further support to our investment case. At the end of September 2010, the company had a cash balance of QAR million and total debt of QAR million. The company is expected to make major debt payments over the next months that would result in an almost net debt-free status. We expect robust future free cash flows will significantly boost the company s cash balance beyond In addition, the company owns real estate properties worth QAR 497 million (according to management estimates from the 2009 financial statements) that appear on the balance sheet at a cost of only QAR million. Figure 1 Fair Value per Share Our new 12-month fair value for Qatar National Cement is QAR Valuation Method Old New Weight Value (QAR) Weight Value (QAR) Change Discounted cash flow 80% % % Peer comparison 20% % % We ig hte d a ve ra g e fa ir va lue 100% % % Source: NBK Capital 3Q2010 Results Review Absence of Cement Import Offsets Drop in Top Line Revenue dips on account of lower cement sales volume: Qatar National Cement reported a 27.2% drop in revenue to QAR million in 3Q2010, which was 8.6% below our forecasts. This was mainly due to a 33% decline in cement sales volume to 0.78 million tons during the quarter compared to 1.16 million tons in 3Q2009. We feel the drop in volumes for both 9M2010 and 3Q2010 appears a bit exaggerated considering the company reported record sales volumes in 2009 that we believe were unsustainable going forward. According to management, the dip in sales volume was due to the general slowdown in the market and partly due to the additional supply from the competition. Margins expand significantly on lower/absence of clinker/cement imports: Limited disclosure on operating costs has led to a significant variance in the EBITDA margin compared to our forecasts. Our conservative forecast for the EBITDA margin (33% for the quarter) was based on following management guidance. The company has significantly benefitted from the absence of cement imports and lower clinker imports at comparatively cheaper prices. During the quarter, the company did not import any cement compared to a little more than 0.45 million nbkcapital. com 2

3 tons of such imports during 3Q2009. Accordingly, EBITDA significantly increased by 43.5% to QAR million during 3Q2010 compared to the same period last year, resulting in an EBITDA margin of 61% for the quarter (30.9% in 3Q2009). Net profit up: Net profit increased significantly by 73.5% to QAR million in 3Q2010, compared to the same period last year mainly due to the margin expansion discussed earlier. Figure 2 3Q2010 Financial Performance The absence of cement imports resulted in significant margin expansion during the quarter Key Financial Data Income Statement (QAR million) 9M2010 9M2009 YoY Growth 3Q2010 3Q2009 YoY Growth Cement revenue , % % Total revenue , % % EBITDA % % Net profit % % Margins (%) 9M2010 9M2009 3Q2010 3Q2009 Gross profit margin 57.9% 29.5% 65.9% 33.9% EBITDA margin 53.0% 26.4% 60.9% 30.9% Operating Highlight 9M2010 9M2009 YoY Growth 3Q2010 3Q2009 YoY Growth Cement sales volume (million tons) % % Avg. cement prices (QAR per ton) % % Sources: Company financial statements and NBK Capital Qatar Cement Sector Shielded from Regional Turmoil We continue to stay positive on the Qatari cement sector mainly due to two reasons: 1) the impressive pipeline of infrastructure projects is likely to act as a driver for cement demand in general and 2) the sector is largely insulated from the weakness in cement prices regionally (particularly the UAE) as the prevailing domestic prices do not offer any potential export opportunities for the UAE cement players. Project pipeline key to growth for the Qatari cement sector: The significant government surplus and robust economic prospects for Qatar should benefit the country s cement industry in the long run. We feel the ongoing and future government and private projects will favorably boost cement demand in the country. Qatar has lined up several high-value infrastructure and construction projects that should act as a trigger for the local cement market going forward. However, we will keep a close eye on the execution of the major infrastructure and real estate projects, as we view any potential delays as a major risk to our assumptions for the growth in cement volumes going forward. nbkcapital. com 3

4 Figure 3 Pipeline for Selected Infrastructure and Real Estate Projects in Qatar Qatar boasts an impressive pipeline of infrastructure and real estate projects Contract Value USD million Airpo rts NDIA - New Doha International Airport 11,000 NDIA - Passenger Terminal Complex 820 NDIA - Concourse C Superstructure 750 NDIA - Expansion of NDIA - Phase NDIA - Airfield Paving And Road Tunnel 493 NDIA - UtilitySystems Package 401 NDIA - Catering Facility 284 NDIA - Emiri Terminal, Parking Structure and Mosque 246 NDIA - Midfield Area Access System 212 NDIA - Airline Support Facilities 199 Po rts Ashghal - Al Ruwais Port 215 Ro a ds Ashghal - Doha Expressway - F Ring Road (Phase 12) 4,700 Ashghal - Lusail Expressway 687 Ashghal - North Road - Al Khor to Ruwais (Phase 3) 600 Ashghal - North Road - Duhail to Al Khor (Phase 2) 600 Ashghal - North Road - Al Zubara to Ushairej (Phase 4) 500 Re a l Esta te Pro je c ts DOHALAND - Musheired 5,500 Lusail Development 5,500 Arcapital/Al Imtiaz - Sidra Development 3,500 Al Waab City 3,200 Qatar Entertainment City 3,000 Qatar Foundation - Sidra Medical and Research Center 2,300 BARWA - Ain Khalid Commercial Avenue 1,700 Qatari Diar - Doha Convention Center and Tower (DCCT) 1,500 Qatari Diar Real Estate Investment Company - Fox Hills 1,200 Barwa Al Khor Company - Barwa Al Khor - Phase 1 1,400 Barwa Real Estate Company - Barwa City 1,360 Barwa Real Estate Company - Barwa Financial District 1,360 Source: Zawya Projects We expect a minimal downside to domestic cement prices: We believe the Qatari cement sector is largely insulated from the turmoil in the regional cement market. We weigh the risks related to domestic cement pricing, taking into consideration possible imports from Saudi Arabia and the UAE. The Qatari cement sector is extremely competitive in terms of pricing in the Gulf Cooperation Council (GCC) context since the current ordinary Portland cement (OPC) bulk price of around USD 69 per ton compares to a landed price of USD from the UAE and Saudi Arabia, which makes any possible imports from these countries unviable. In contrast to the weakness in cement prices in the regional markets and the steep decline in cement prices in the UAE during the recent past, cement prices in Qatar have remained firm during the current year. The prevailing price for OPC bulk is QAR 250 per ton (USD 69 per ton) and has remained the same for the last four years. We have seen price correction in almost all the cement markets within the GCC, ranging from 10% in Saudi Arabia and Oman to more than 50% in the UAE. However, that has not been the case with Qatar. On the domestic front, we estimate a tight demand supply scenario with domestic cement demand pegged at million tons compared to an effective supply in the same range. However, on a conservative basis, we forecast a nominal reduction of 2.5% in domestic cement prices over the next two years and that prices will remain at those levels for the rest of the forecast period. nbkcapital. com 4

5 Figure 4 Opportunities Across the Current Flow of Cement Across the GCC* QATAR Capacity: mtpa Domestic Price: USD 68/ton Transport from UAE: USD15/ton UAE Capacity: 33.8mtpa Domestic Price: USD 52-58/ ton Transport from RAK to AUH/DXB USD5-10/ton We see minimal risks to domestic cement prices in Qatar IRAQ Active Capacity: 3mtpa Domestic Price: USD / ton Saudi Arabia Capacity: 48mtpa Domestic Price : USD 60/ton Prominent Cement Exporter Freight to MENA USD 10-30/ton Selling Price FOB: USD 40-50/ton SUDAN / OTHER AFRICAN REGIONS Sudan Capacity: 1mtpa (6mtpa by 2011) Sudan Cement Import 09: 2.35million tons Sudan Cement Consumption 09: 3.3million tons Domestic Market Price: USD / ton Freight UAE to Khartoum+ Clearance: USD /ton OMAN Capacity: mtpa Domestic Price USD 70-72/ ton Transport from UAE USD 5-10/ton Indicates potential supply opportunities from Saudi Arabia Indicates the exports markets pursued by the UAE cement manufacturers *Data for Sudan is from the CEMEX report on the Sudan cement industry; the government of Sudan has currently fixed a minimum price of USD 60 per ton, and data for Iraq was reported by the United States Agency for International Development (USAID) as of November 25, Source: MEED and NBK Capital. Revised Revenue Forecasts The last quarter for the company is seasonally one of the stronger quarters of the year. Hence, contrary to the trend in cement sales volume during 9M2010, we expect a pickup in volumes during 4Q2010 compared to 3Q2010 (0.78 million tons) and for the volumes to reach the levels of 2Q2010 (0.97 million tons). To add to that, better average cement prices should ensure higher revenue for the company in the next quarter compared to our earlier forecasts. We now forecast total revenue of QAR million for 4Q2010 compared to our earlier forecast of QAR 263 million. Figure 5 Cement Revenue Old vs. New Forecasts We expect a pickup in cement sales volume during 4Q2010 New Forecast Old Forecast 4Q2010 4Q2010 Total cement sales volume (million tons) Average domestic cement price (QAR per ton) Total cement revenue (QAR million) Source: NBK Capital nbkcapital. com 5

6 In line with our view on the sector, we now expect cement volumes to increase by 4.7% year-on-year to 3.94 million tons in In general, we forecast cement sales volume to grow at a five-year compound annual growth rate (CAGR) of 2.2% to reach 4.2 million tons in Figure 6 Trend in Cement Sales Volume We expect moderate growth in sales volume going forward f 2011f 2012f 2013f 2014f Cement sales volume (miilion tons) Source: NBK Capital According to management guidance, we now expect the company to sell in the range of 17,000 to 20,000 tons per day ( million tons per annum) of sand over the forecast period. Our revised forecast for the sand sales volume is lower than our earlier forecasts of 20,000 to 28,000 tons per day. We have forecasted a gradual increase in the sales volume going forward and hence expect capacity utilization to rise from 40% in 2010 to 50% in 2015 (we had earlier forecasted 70% capacity utilization by the end of 2014). We expect no changes in sand prices from our earlier assumptions and, taking cues from management, accordingly maintain the price at QAR 22 per ton. In general, we forecast total revenue from the sand business to increase at a five-year CAGR of 4.6% from QAR million in 2010 to QAR 132 million in We expect revenue from the sand business to contribute an average of 10.6% of the total revenue over the forecast period. nbkcapital. com 6

7 Figure 7 Trends in Total Revenue We expect a moderate increase in total revenue going forward f 2011f 2012f 2013f 2014f Cement revenue (QAR billion) Total revenue (QAR billion) Sources: Company financial statements and NBK Capital Lower EBITDA Going Forward The EBITDA paradox for Qatar National cement is worth a closer look. At full capacity utilization, the current clinker capacity of 3.6 million tons should result in around 3.8 million tons of cement production. Assuming all of that cement is sold, this will result in an optimal sales volume for the company whereby the company maximizes its margins. All other factors remaining the same, the company will continue to generate its highest EBITDA margin when Qatar National Cement entirely depends on its own clinker production. Any additional clinker purchases/imports will hurt the margins. This is exactly what we expect going forward since an increase in cement sales volume will come at the expense of the EBITDA margin. We now expect the company to import around 300,000 to 400,000 tons of clinker annually during the period , lower than our earlier assumptions of 400,000 to 600,000 tons annually for the same period. nbkcapital. com 7

8 Figure 8 Trends in EBITDA and the EBITDA Margin 54.1% 52.9% 51.3% 49.2% 47.7% We expect the EBITDA margins to contract from 2010 onwards mainly due to higher clinker imports 30.5% 31.0% % 23.3% f 2011f 2012f 2013f 2014f EBITDA (QAR million) EBITDA margin (%) Sources: Company financial statements and NBK Capital Debt Likely To Decrease Qatar National Cement had piled up a significant amount of debt over the last few years to fund capacity expansion. The company has spent a whopping QAR 1.83 billion in the last five years related to capacity expansion. Accordingly, debt increased manifold from QAR 20 million in 2004 to QAR million at the end of 2008, thus increasing the debt-to-equity ratio from 0.02 to 0.53 during the same period. However, the company paid back QAR million during At the end of 9M2010, the company s total debt stood at QAR million while the cash balance was QAR million. The company has scheduled payments lined up over the next two years and should pay back its entire long-term debt by the end of Robust cash flows are likely to come in handy toward making these payments, and we believe the company is in a strong financial position to honor them. As a result, we expect the company to be debt free on a net debt basis in the near term. High Free Cash Flow is Likely to Lead to Attractive Dividend Payouts Given that management is not contemplating any increase in capacity in the foreseeable future, we expect the company to generate healthy free cash flows going forward, which should play a significant role in boosting the dividend yields going forward. We expect payout ratios to increase from 2011 onwards and reach 80% by On last year s dividend of QAR 6 per share, the stock is currently trading at a yield of 6.9%. We expect a similar dividend this year as well. Our free cash flow analysis suggests there is still a significant upside potential for the dividend yield from current levels, taking into account a notable free cash flow yield of 14.6% and 13.2% on forecasted free cash flows in 2010 and 2011, respectively. nbkcapital. com 8

9 Figure 9 Trends in Free Cash Flows and Dividend Payout Our free cash flow analysis suggests a significant upside potential for the dividend yield from current levels f 2011f 2012f 2013f 2014f all figures in QAR millions, otherwise stated Free Cash Flow from Operations Cash Dividends FCFO / Net Profit (%) -124% 108% 114% 102% 99% 96% 96% Dividend Cover (x) Dividend Payout Ratio (%) 65% 57% 54% 70% 75% 80% 80% Free Cash Flow Yield (%) -14.7% 13.0% 14.6% 13.2% 12.8% 12.1% 11.7% Cash Dividend Yield (%) 6.9% 6.9% 7.0% 9.1% 9.7% 10.0% 9.8% Sources: Company financial statements and NBK Capital Revised Forecasts for 2010 Figure 10 Higher Margins Leading to Better Results We have revised our 2010 forecasts upward Income Statement (QAR million) 2010 Forecast Old New Change Revenue 1,188 1, % Cost of sales % Gross profit % Selling and general & admin. expenses % EBITDA % EBITDA margin 33.2% 54.1% EBIT % Net profit after tax % Source: NBK Capital nbkcapital. com 9

10 FINANCIAL STATEMENTS Income Statement (QAR Thousands) Historical Forecast Fiscal Year Ends December Total Revenue 1,412,993 1,519,125 1,109,314 1,142,777 1,163,419 1,171,137 1,180,174 Cost of Revenue 1,047, , , , , , ,571 Gross Profit 365, , , , , , ,604 Selling/General/Admin. Expenses 36,312 53,278 53,394 55,908 59,273 61,833 63,684 Depreciation/Amortization 85, , , , , , ,360 Ope ra ting Inc o me 243, , , , , , ,559 Interest/Invest Income - Non-Operating 98,983 36,421 13,096 14,154 22,099 27,240 31,267 Other net 94,487 90,488 31,328 31,428 33,990 36,513 38,541 Net Income before Taxes 413, , , , , , ,311 Provision for Income Taxes ,815 12,898 12,897 12,484 12,208 Net Income after Taxes 413, , , , , , ,103 Balance Sheet (QAR Thousands) Fiscal Year Ends December ASSETS Cash and Short-Term Investments 4,554 54,275 68, , , , ,605 Total Receivables, Net 267, , , , , , ,423 Total Inventory 492, , , , , , ,620 Total Current Assets 770, , , ,927 1,153,690 1,271,812 1,423,648 Property/Plant/Equipment, Total - Net 1,790,478 1,790,026 1,685,860 1,614,025 1,546,688 1,483,617 1,425,182 Long-Term Investments 260, , , , , , ,920 Other Long-Term Assets, Total 31,427 15,085 13,607 12,130 10,652 9,174 7,696 TOTAL ASSETS 2,853,137 2,526,160 2,531,577 2,737,626 2,906,450 2,962,522 3,057,446 LIABILITIES & EQUITY Historical Forecast Accounts Payable 330, ,356 99, , , , ,216 Short-Term Debt 553, , , , , , ,097 Total Current Liabilities 884, , , , , , ,313 Other Liabilities 5,764 7,329 7,500 8,500 9,500 10,500 11,500 Total Liabilities 1,210, , , , , , ,813 Total Equity 1,642,527 1,922,945 2,154,879 2,387,524 2,538,402 2,648,018 2,734,632 TOTAL LIABILITIES AND EQUITY 2,853,137 2,526,160 2,531,577 2,737,626 2,906,450 2,962,522 3,057,446 Cash Flow (QAR Thousands) Historical Forecast Fiscal Year Ends December Cash from Operating Activities 123, , , , , , ,065 Cash from Investing Activities (507,788) (22,446) (1,284) (9,205) (7,465) (8,958) (12,430) Cash from Financing Activities 182, ,735 (498,362) (308,411) (344,227) (439,096) (388,893) Net Change in Cash (202,357) 792,617 (27,552) 306, , , ,741 Sources: Company financials and NBK Capital nbkcapital. com 10

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13 KUWAIT DUBAI ISTANBUL CAIRO