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1 May 214 Clinker import in Saudi cement sector overview: The Saudi cement industry has witnessed a steady growth in consumption over the last few years. The robust growth has been propelled by a rise in construction activity in the Kingdom. The residential building sector, which accounts for around 6% of cement consumption, is expected to expand at a CAGR of 8 1% 1 in the long term, supported by a rising population, changing family structure, with more emphasis on nucleus families, implementation of the mortgage law 2, new structure decided by the ministry of housing to provide developed land along with a loan to build housing units. Therefore, Clinker inventory levels for cement producers in Saudi Arabia have been depleted during due to robust demand for cement that generate a gap between supply and demand. Overall inventory levels of clinker declined from 25% of clinker production (1.9MT) in 29 to 13.4% (6.4MT) in 212. During 212, Yamamah and Saudi Cement registered the highest decline in clinker inventory. The decline in Saudi Cement s inventory was due to the sale of 2mn tons of clinker to Qassim Cement. Furthermore, the falling inventory levels add to the existing supply concerns. The government, however, has taken initiatives to offset the concerns over depleting clinker inventory levels. Therefore, a series of measures were taken to mitigate the supply concerns in the Kingdom s cement sector. In April 213, the government instructed cement factories to import 1MT of additional clinker to meet local demand and to alleviate nearterm shortage. In April 214, the Saudi cement companies reported that about 6.86 MT of clinker had been imported from the UAE and Egypt and other countries. The Minister of Commerce and Industry stated that it would monitor the companies and penalize the ones that do not adhere to the decree. In May 213, KSA s Minister of Commerce and Industry made it mandatory for cement producers to build a strategic reserve of two months of inventory at each plant, given the rising deficit in cement production. In case of a shortfall, the companies have to cover the same by importing. In addition, the government has set aside SAR 3bn, to support construction of four cement factories with a total capacity of 12MT. Figure 1: Clinker inventory levels Figure 2: Clinker inventory levels MT YTD 137.% 112.% 87.% 62.% 37.% 12.% MT Yanbu Saudi Northern Southern City Riyadh Yamama Eastern Tabuk Arabian Najran Aljouf Qassim Clinker Stock As a % of production (RHS) Clinker inventory 213 Clinker Imports 213 Source: Yamama Cements, AlJazira Capital Source: Yamama Cements, AlJazira Capital This report will discuss the most prominent deviations in the Saudi cement sector after the decision of importing clinker, margins, import statistics and opportunities in the sector to take advantage of high inventory levels. Moreover, the report includes the companies statistics shares of imported clinker and the latest developments regarding government subsidy and the expected dates of receipt. 1. NRCC prospectus dated May The implementation of the mortgage law is expected to trigger demand for housing units and, consequently, drive cement demand. Senior Analyst Talha Nazar t.nazar@aljaziracapital. Analyst Jassim AlJubran j.aljabran@aljaziracapital.com.sa 1
2 May 214 Clinker to sales ratio increasing since bottoming in 212 Clinker is formed by heating limestone and other raw materials to a very high temperature in a kiln. Clinker is ground to a powder along with gypsum to make cement. The biggest advantage of clinker is that it can be stored for a long time. Thus, clinker acts as an inventory for cement companies and 95% of inventory for cement producers consists of clinker. With lowering sales growth, clinker stock rose significantly. Starting Q3 28 (when new players entered the industry), the clinker stock as a percentage of sales kept on rising, indicating a low demand scenario. The clinker to sales ratio peaked in Q3 29 but started recovering thereafter; it improved considerably beyond 4Q 21. The ratio has considerably rose again in Q4 213 due to importing clinker and a slowdown in construction works during Q3/Q4 213, which we expect was a result of shortage of labor, due to the deadline for the violators of residence and work permits in Q3213. Figure 3: Clinker to Sales ratio elevated in 29 and Q17 Q27 Q37 Q47 Q18 Q28 Q38 Q48 Q19 Q29 Q39 Q49 Q11 Q21 Q31 Q41 Q111 Q211 Q311 Q411 Q112 Q212 Q312 Q412 Q113 Q213 Q313 Q413 Q114 Clinker to Sales ratio Source: Yamama Cements, AlJazira Capital The clinker inventory level of the companies at the end of 213 stood at 14.7mn tons as compared to 6.4mn tons in 212, this is indicative of the weak performance of the sector due to decrease of cement consumption during 2H213 and import high level of clinker. Cement consumption 3 has increased from 53.3MT in 212 to 55.6MT in 213 representing only a growth of 4.3%, as against the 9% registered during and 11.3% during On April 214, clinker inventory levels have shown an increase of 281.1%YoY recording the highest level in the recent years, which was due to import 4.95MT in 213 and 1.92MT of clinker in Q1214. We believe the company with higher inventory levels might find it easy to cater to the future expected demand, unlike the case in 212 when most of the companies struggled to fulfill demand due to depleted clinker inventories. However, in some cases we might see lower profitability due to higher cost of imported clinker that adds further pressure on margins. 3. Yamamah cement statistics 2
3 May 214 Profitability mainly impacted by import clinker Cement industry in Saudi Arabia operates at the highest gross margin and net profit margin in the world. This is despite the fact that their price realization is considered one of the lowest worldwide. Saudi Arabia commands low realizations due to its subsidized cost of production, thanks to the availability of heavy fuel at cheap rates. However, the industry was caught up with an oversupply situation and average cost of production started increasing after the decree to import clinker, which resulted in margin compression during Q313 to Q114. Company () Local Cost Per Ton (SAR) Q3213 Q Q3 Q4 Q3 Q4 Q3 Q4 Q3 Q4 Yamamah Cement Saudi Cement* Qassim Cement ** Yanbu Cement Southern Province Cement Najran Cement Eastern Province Cement In fact, Saudi Arabia cement industry was unable to retain its leading cost margins, as the average cost of production increased to around SAR123/tonne in Q413 as compared to an average cost of SAR111/tonne in 212, where the companies incur the costs of shipping, transportation, insurance, customs duties and other direct expenses of imported clinker. Cement industry s gross margins hovered in the range of 52 6% during The margins, which peaked in 27, were lowest in 21 due to significantly poorer margins of Arabian Cement and Al Jouf as well as a lowerthanaverage performance by Eastern Province and Tabuk Cement. However, margins regained some of their loss and reached 54.% during 211 due to a jump in volumes and improved prices. Gross margins for the Saudi Arabian cement industry moved in the range of % over Q4213. Gross margins were adversely impacted by higher production cost, and increasing selling and marketing expenses. In addition, the margins dropped in Q413 to 5.1% from the average of 53.7% in 212. Figure 4: Gross Margins Q4 (212/13) Source: Yamama Cements, AlJazira Capital, Company reports *The company will discount the government subsidy on the cost of imported clinker when they receive it.** The company did not import clinker since % 6.% 5.% 58.2% 53.3% 59.7% 62.8% 47.7% 57.4% 53.7% 61.5% 61.% 49.4% 4.% 42.4% 3.% 29.9% 34.5% 2.% 1.%.% Yamamah Saudi Yanbu Southern Qassim Najran Eastern Gross Margins Q4212 Gross Margins Q4213 Source: Yamama Cements, AlJazira Capital, Company reports 3
4 May 214 Margins declines due to import costs and the absence of any governmental subsidy at the end of 213. Cement companies in the Kingdom benefit from higher profitability margin compared to their regional and global peers; this is primarily on account of a favorable cost structure due to access to subsidized raw materials and fuel. However, the margins in the recent quarters came under pressure due to imported clinker, price realizations being regulated by the government and the continuation of the export ban. For Example, Najran cement which is located in the Southern region has taken an additional loss of SAR 13mn in Q313, which translates into loss of SAR 138/tonne of imported clinker as compared to an industry average cost of production of around SAR 9511/tonne for cost of production. During 213, gross and net margins for cement producers stood at 51.7% and 43.5%, respectively. At 61.3%, Qassim Cement (did not import any clinker) maintains the highest gross margin level among its domestic peers, followed by Saudi Cement (58.7%) and Yamamah Cement (57.1%). While Al Jouf and Northern recorded the lowest gross margins visàvis its peers at 33.8% and 36.8% respectively. Figure 5: Trend in gross and net margins 6.% 51.5% 52.3% 53.6% 51.7% 5.5% 5.% 45.8% 46.3% 46.% 43.5% 43.3% 4.% 3.% 2.% 1.%.% Current Gross Margin Profit Margin Source: AlJazira Capital, Bloomberg Figure 6: Gross and net margins across Saudi cement companies (213) 7.% 6.% 5.% 4.% 57.1% 56.4% 58.7% 51.8% 61.3% 55.7% 54.6% 5.7% 57.1% 56.7% 41.9% 37.2% 36.8% 52.1% 29.8% 31.7% 4.5% 41.% 31.4% 54.3% 48.8% 33.8% 3.% 2.% 15.4% 17.8% 1.%.% Yamamah Saudi Qassim Yanbu Southern Eastern Northern Hail Arabian Najran Tabuk Al Jouf Gross Margin Net Margin Source: AlJazira Capital, Bloomberg We believe margins would witness an improvement in the coming quarters, as the Saudi government has taken a series of measures to mitigate the import costs concern in the cement sector by subsidizing SAR 5/ tonne of imported clinker. Furthermore, production costs are expected to decrease as most of the companies have fulfilled the requirement of importing their share of clinker, in order to adhere to the government s decree and there is no need to import more. In regards to large infrastructure projects in the coming years, the government has taken up the labor shortage issue seriously and is working towards resolving it. Therefore, we expect to see demand and margins improvement by the end of
5 May 214 Companies import most of its market share of clinker waiting for the government subsidy. Based on companies reports, the companies share of imported clinker is somewhat equivalent to 1% of their production volumes. According to the official statistics, eight cement companies had imported their full share of clinker, while four companies are on their way to importing the remaining stake; however there are three companies that did not import since 213, which are Qassim cement, City cement and Hail cement. We expect no major imports to come soon, since most companies are meeting the inventory requirement set by the government, as there is no formal decision in 214 to resume imports after recording high clinker inventory of 16 MT. For example, Saudi cement did not import clinker in 214 after completing its import obligation in 213. While companies like Yamamah and Southern have exceeded their share of imports for 213. Company Capacity (MT per year) Cement Production (MT) 213 Importing Share ( tonne) ( tonne) 213 April 214 Status Yamamah Cement Saudi Cement Eastern Cement In Progress Qassim Cement Yanbu Cement Arabian Cement Southern Cement Tabouk Cement In Progress Riyadh Cement Najran Cement City Cement Northern Cement AlJouf Cement In Progress AlSafwa Cement In Progress Hail Cement Source: Yamama Cements, AlJazira Capital, Company reports 5
6 May 214 Company Government Subsidy SAR mn Status Receiving Support Yamamah Cement 45.3 The company added SAR mn as government subsidy for the fiscal year of 213. The company has exceeded their share of import, however it has not yet received the full amount for its total imports. Saudi Cement 51.5 Eastern Cement 16.5 The company achieved its import obligation on Q4213 and the government subsidy is expected to be refelected soon. The company is on track to complete its share of the import and we expect that the government subsidy will be reflected in 2Q214. Qassim Cement Based on an official statistics, the company did not import clinker since 213. Yanbu Cement 38. Southern Cement 5. Tabouk Cement 2.7 Riyadh Cement 23.6 The company achieved its import obligation on Q1214 and the government subsidy is expected to be refelected in Q2214. The company achieved its import obligation on Q1214 and the government subsidy is expected to be refelected in Q2214. The company is on track to complete its share of the import and we expect that the government subsidy will be refleceted during 2H214 results. The company has achieved its clinker import share on Q1214 and the government subsidy is expected to be received on Q2214. Najran Cement 19.3 The company has achieved its clinker import share on Q1214 and the government subsidy is expected to be received on Q2214. City Cement Based on official statistics, the company did not import clinker since 213 Northern Cement 16.8 The company has achieved its clinker import share on Q1214 and the government subsidy is expected to be received on Q2214. AlJouf Cement 8.8 AlSafwa Cement 7.1 The company is on track to complete its share of the import and we expect that the government subsidy will be refleceted during 2H214 results. The company is on track to complete its share of the import and we expect that the government subsidy will be refleceted during 2H214 results. Hail Cement Based on official statistics, the company did not import clinker since213 Source: Yamama Cements, AlJazira Capital, Company reports 6
7 May 214 To sum up, we believe with the current inventory level, the sector is well set to cater the demand boom that the Kingdom is seeing in the coming years. The recent dispatch numbers although are not according to our expectation ( For four months 214, dispatches showed a decline of 4.3%Y/Y) primarily due the labor shortage. However with the current inventory level, and the steps by the government to ease the labor shortage along with strong demand the industry looks set to cater the future mega projects. We believe the sector will feel the impact of the fall in dispatches for short term; however our long term view of the sector still remains intact. We believe if the current weakness in dispatches impacts the sector stock prices negatively, it can be treated as an opportunity to enter the sector. Yamama Cement Najran Cement Souhtern Cement Saudi Cement Co J u n 13 J u l 13 A u g 13 S e p 13 O c t 13 N o v 13 D e c 13 J a n 14 F e b 14 M a r 14 A p r 14 Arabian Cement Yanbu Cement J u n 13 J u l 13 A u g 13 S e p 13 O c t 13 N o v 13 D e c 13 J a n 14 F e b 14 M a r 14 A p r 14 7
8 May 214 & Change Yamama Cement Eastern Cement % 5% 4% 3% 2% 1% % 4% 3% 2% Apr13 May13 % 1% 2% 3% 4% 5% Apr13 May13 1% % 1% 2% Qassim Cement Najran Cement 45 4% 35 6% % 2% 1% % 1% 2% 3% % 2% % 2% 4% Apr13 May13 4% Apr13 May13 6% Souhtern Cement Saudi Cement Co Apr13 May13 5% 4% 3% 2% 1% % 1% 2% 3% 4% 1, Apr13 May13 4% 3% 2% 1% % 1% 2% 3% Arabian Cement Yanbu Cement % 5% 4% 3% 2% 1% % 1% 2% % 5% 4% 3% 2% 1% % 1% 2% 3% 4% Apr13 May13 3% Apr13 May13 5% Source: Yamamah Cement Company, AlJazira Research 8
9 RESEARCH DIVISION AGM Head of Research Abdullah Alawi Senior Analyst Talha Nazar Senior Analyst Syed Taimure Akhtar Analyst Saleh AlQuati Analyst Sultan Al Kadi Analyst Jassim AlJubran BROKERAGE AND INVESTMENT CENTERS DIVISION General manager brokerage services and sales Ala a AlYousef a.yousef@aljaziracapital.com.sa AGMHead of Sales And Investment Centers Central Region Sultan Ibrahim ALMutawa s.almutawa@aljaziracapital.com.sa AGMHead of international and institutional brokerage Luay Jawad AlMotawa lalmutawa@aljaziracapital.com.sa AGMHead of Qassim & Eastern Province Abdullah AlRahit aalrahit@aljaziracapital.com.sa AGM Head of Western and Southern Region Investment Centers & ADC Brokerage Abdullah Q. AlMisbani a.almisbahi@aljaziracapital.com.sa AGM Head of Institutional Brokerage Samer Al Joauni s.aljoauni@aljaziracapital.com.sa RESEARCH DIVISION AlJazira Capital, the investment arm of Bank AlJazira, is a Shariaa Compliant Saudi Closed Joint Stock company and operating under the regulatory supervision of the Capital Market Authority. AlJazira Capital is licensed to conduct securities business in all securities business as authorized by CMA, including dealing, managing, arranging, advisory, and custody. AlJazira Capital is the continuation of a long success story in the Saudi Tadawul market, having occupied the market leadership position for several years. With an objective to maintain its market leadership position, AlJazira Capital is expanding its brokerage capabilities to offer further valueadded services, brokerage across MENA and International markets, as well as offering a full suite of securities business. RATING TERMINOLOGY 1. Overweight: This rating implies that the stock is currently trading at a discount to its 12 months price target. Stocks rated Overweight will typically provide an upside potential of over 1% from the current price levels over next twelve months. 2. Underweight: This rating implies that the stock is currently trading at a premium to its 12 months price target. Stocks rated Underweight would typically decline by over 1% from the current price levels over next twelve months. 3. Neutral: The rating implies that the stock is trading in the proximate range of its 12 months price target. Stocks rated Neutral is expected to stagnate within +/ 1% range from the current price levels over next twelve months. 4. Suspension of rating or rating on hold (SR/RH): This basically implies suspension of a rating pending further analysis of a material change in the fundamentals of the company. 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