Saudi Arabia Real Estate

Transcription

1 Saudi Arabia Real Estate Global Research Initiation of Coverage Equity Saudi Arabia Real Estate Sector March 22, 2011 Saudi Arabia Real Estate Saudi real estate equities are trading at a 55% discount to TASI on PBx basis versus a 4-year average discount of 48% Strong fundamentals owing to attractive demographics coupled with large undersupply of residential units, but financing is the key constraint Strong Buy - DAAR - TP:SAR11.37, Hold - EEC - TP:SAR7.20, Strong Buy - Akaria - TP:SAR30.40 Saudi real estate equities trading at a 55% PBx discount to TASI As of March 2011, TASI is trading at 2.0x PBx versus 0.9x for real estate equities at a 55% discount. Real estate average PBx needs to trade at a target of 1.1x to be inline with the historical 48% discount to TASI between 1Q07 and 4Q10. The PBx discount of Saudi real estate equities can be justified by investors preference of real asset ownership and the sector s low RoE and RoA. The market, however, is missing on the large premiums to land value reported at cost in the books of listed equities compared to their realizable fair values Attractive fundamentals, but sluggish project financing strains developments The Saudi residential market suffers from a large supply shortage, especially in the low-mid income segment. We estimate that a current shortage of 0.7mn units exist in the market and an additional 1.2mn new units will be needed by 2014, offering attractive potential for Saudi realtors. Off-plan sales are largely restricted leading to financing bottlenecks for developers who are forced to fully finance projects prior to realizing cash inflows from unit sales. Moreover, the dry credit market for real estate developers in has further substantiated the funding quandary and led to execution delays. The mortgage law is an initial step in the right direction, but not the sole solution The proposed mortgage law is critical to unlock part of the pent up demand for real estate in Saudi but it s capacity to deliver an efficient solution to the sector vulnerabilities remains feeble. Our view is devised given low base effect and limited reach owing to the disparity between the strict financial requirements expected from lenders and the wide base of inadequate borrowers. We prefer saying more credit extended to developers, which should yield better results in the short to medium term. Faisal Hasan, CFA Head of Research fhasan@global.com.kw Tel.: (965) Mostafa El-Maghraby Senior Financial Analyst melmaghraby@global.com.kw Tel.: (965) Global Investment House Initiate coverage on Saudi real estate Initiate on Dar Alarkan (DAAR) with a Strong Buy recommendation and a target price of SAR11.37, Emaar Economic City (EEC) with a Hold recommendation and a target price of SAR7.20 and Saudi Real Estate Company (Akaria) with a Strong Buy recommendation and a target price of SAR Company Target Mkt. Cap. CMP PB (x) PE (x) Price 11e 11e SAR mn SAR SAR Upside Potential Recommendation Dar Alarkan 9, % Strong Buy Emaar Economic City 5, NA % Hold Saudi Real Estate Co % Strong Buy Source: Bloomberg, Global Research

2 Real Estate Sector Table of Contents Valuation Methodology 3 Dar Alarkan Valuation 4 Emaar Economic City Valuation 5 Saudi Real Estate Company Valuation 6 MENA Peer Comparison 7 Real Estate Sector Fundamentals 10 Demographics 10 Funding 11 Mortgage Law 11 Residential Market 13 Commercial Market 13 Retail Market 14 Hospitality Market 14 Dar Alarkan 16 Emaar Economic City 27 Saudi Real Estate Company 38 Disclosures 49 March

3 Real Estate Sector Valuation Methodology We adopt a SOTP approach to arrive at a 12 month fair value target for Saudi real estate equities. We construct our valuation methodology based on the following criteria: We assign a RFR of 5.6% and MRP of 7.0%, which we believe is justified for Saudi equities given the current political turmoil in the region, along with the respective Beta and financial structure for each company to arrive at a justified WACC. When warranted, we incorporate adjustments to the project WACC based on available data on project financing and our perceived riskiness. For investment properties, we utilize a two-stage DCF approach valuing each project according to its respective credentials and discounting it at the project s WACC before arriving at a terminal reversion value based on available market capitalization rates on the fourth year of our forecast horizon. For development properties, we utilize a one-stage DCF approach extended over the life of the project. We discount each project s FCF by the relative WACC and build our assumptions for selling prices and margins based on management guidance and prevailing market trends. Where management guidance is not available on land sales, we use historical patterns and current market trends as basis to our forecasts. Individual prices and margins of land plots differ based on our assessments of factors including location, state of development and available information on comparable sales. We value land bank at historical cost based on its reported book value opting to stay on the conservative side. Market trends of listed real estate equities vary largely across MENA markets. Further, different accounting practices impede the construction of peer valuations. Accordingly, we do not incorporate relative valuations in our fair value targets. However, we conduct a relative comparison exercise to investigate multiple trends for Saudi equities versus regional peers and versus the overall Tadawul index. Risks To Valuation Execution risk is high for Saudi developers given funding constraints and can lead to diversions from our assumed delivery dates. Land sales are highly volatile and unpredictable and form a key risk factor in forecasting revenues for Saudi real estate developers. The application and the impact of the new package of laws concerning credit extension to real estate developers and the mortgage law could impact future dynamics. Political risk owing to the current upheavals across the MENA region impacts market activity and drives risk premiums higher. March

4 Real Estate Sector Dar Alarkan (DAAR) Valuation Our valuation for DAAR has yielded a SOTP fair value of SAR10.03/share. Cash flows are discounted by a WACC of 11.88%. The cost of equity has been calculated by utilizing the capital asset pricing model based on a risk free rate of 5.6%, an equity risk premium of 7% and a beta of 1. For specific projects where our judgment of the risk profile is higher, we adjust the inputs of our WACC lifting it up to a cap of 13.4%. With the company currently trading at SAR8.70/share, our fair value target provides investors with 31% upside potential. Accordingly, we issue a Strong Buy recommendation on DAAR stock. DAAR Valuation Value (SAR bn) /share % Methodology Development Sales 3, % DCF Investment Portfolio 1, % DCF / Cap. Rate Land Sales 13, % DCF Total NPV 17, Add Cash FY10 1, Add: Other Investments at Cost , Less Debt , Equity Value 12, CMP (as on March 21, 2011) 8.70 Upside Potential 31% Source: Global Research March

5 Real Estate Sector Emaar Economic City (EEC) Valuation Our valuation on EEC has yielded a SOTP fair value of SAR7.10/share. Cash flows are discounted by a WACC of 12.6%. The cost of equity has been calculated utilizing the capital asset pricing model based on a risk free rate of 5.6%, an equity risk premium of 7% and a beta of 1. For specific projects where our judgment of the risk profile is higher, we adjust the inputs of our WACC lifting it up to a cap of 14.1%. With the company currently trading at SAR6.55/share, our fair value target offers a 10% upside potential. Accordingly, we issue a Hold recommendation on EEC stock. EEC Valuation Value (SAR bn) /share % Methodology Development Sales % DCF Industrial Valley % DCF / Cap. Rate Seaport % DCF Land Sales % DCF Land Bank 3, % Cost Total NPV 5, Add Cash Add: Other Investments at Cost Less Debt NAV 6, CMP (as on March 21, 2011) 6.55 Upside Potential 10% Source: Global Research March

6 Real Estate Sector Saudi Real Estate Company (Akaria) Valuation We utilize a SOTP approach to arrive at a fair value target for Akaria. For our DCF based valuations, we arrive at a WACC of 13.9% derived from the capital asset pricing model factoring in a RFR of 5.6%, market risk premium of 7.0% and Beta of For specific projects where our judgment of the riskiness profile is higher, we adjust the inputs of our WACC lifting it up to a cap of 15.4%. Our fair value target of Akaria is SAR30.40/share implying a 34% upside potential from the current share price of SAR We, accordingly, issue a Strong Buy recommendation on the stock. Akaria Valuation Value (SAR bn) /share % Methodology Development Sales % DCF Investment Properties 1, % DCF/Cap.rate Land Bank 1, % Cost Total NPV 2, Add: Cash Add: Other Investments at Cost , Less Debt EV 3, CMP (as on March 21, 2011) Upside Potential 34% Source: Global Research March

7 Real Estate Sector MENA peer comparison Given the significance of accounting discrepancies across different MENA countries, we believe that a peer based valuation can not be utilized as a valuation metric for real estate listed equities. Earnings based valuations are distorted by the revenue recognition method utilized. Further, the revenue mix of different companies proposes additional constraints. Different models driven by land sales, investment portfolios, development sales and construction activity impair the ability to structure a fair value judgment based on earnings metrics. Balance sheet based valuations also offer constraints to constructing a multiples based valuation because of the recognition methodology adopted in reporting land and investment properties. Saudi companies report land at the historical cost of acquisition, which, in most cases, is significantly lower than its fair market value. Security MENA Real Estate Peer Valuation Market Cap (USD mn) ROE ROA PBx PSx Talaat Moustafa Group 2, % 1.9% Palm Hills Developments SAE % 3.9% Six of October Development & Investment % 2.5% Egypt (Average) 7.6% 2.8% Mabanee Real Estate Co 1, % 7.8% Kuwait (Average) 15.7% 7.8% Barwa Real Estate Co 3, % 2.6% United Development Co % 6.0% Qatar (Average) 18.4% 4.3% Dar Al Arkan Real Estate Development 2, % 6.2% Emaar Economic City 1, % -6.4% Saudi Real Estate Co % 5.4% Arriyadh Development Co % 6.0% Saudi Arabia (Average) 3.8% 2.8% Emaar Properties PJSC 4, % 3.9% Aldar Properties PJSC 1, % -22.3% Sorouh Real Estate Co % 0.1% United Arab Emirates (Average) -37.3% -6.1% MENA Average 1.6% 2.3% Source; Bloomberg, Global Research Taking the above factors into consideration, Saudi real estate listed companies trade at a historical x PBx reflecting a 31% discount to MENA average. Within our coverage universe, DAAR is trading at a 46% discount, EEC at 38% discount and Akaria at a 36% discount to MENA average. Akaria is the only company trading in line with the Saudi real estate average PBx of 0.9x. DAAR reported a historical RoE of 10.4%, which is significantly higher than the Saudi average of 3.8%. We attribute this to DAAR s capital structure incorporating debt versus Akaria s debt free balance sheet and EEC s negative RoE. In a regional context, Saudi developers RoE is significantly lower than their regional peers, excluding the one time impact of Aldar s exceptional figure of negative 121% in 2010 driven by the company s impairments in 4Q10 on the UAE average. March

8 Real Estate Sector Investors ignore asset value appreciation Real assets have historically offered a favorable resort for Saudi investors on the back of strong fundamentals, familiarity with market dynamics and the absence of downward demand pressures. The TASI crashes of 2006 and 2008 coupled with the historical negative interest rates on bank deposits have given more credentials to real asset ownership, as investors shy away from equities, contributing to the strong cumulative appreciation in prices over the past 5 years. Based on several actual land transactions, return on land ownership in 2010 has crossed the 200% mark for land plots acquired during For residential properties, excluding the marginal slowdowns of 2009 in both rental and selling prices, the longer term trend in price movement remains to the upside. Saudi real estate equities traded at a historical PBx average discount of 48% to TASI between 1Q07 and 4Q10. Currently, TASI PBx stands at 2.0x whereas real estate equities trade at 0.9x at a 55% discount. To trade inline with the historical 48% discount, the current real estate average PBx needs to trade at a target of 1.1x. In our view, the historical discount could be justified by investors preference of real asset ownership. However, this ignores the large discounts to the value of land reported at cost in the books of listed real estate companies to the fair valuations based on realizable market prices. March

9 Real Estate Sector Real estate listed companies recorded an aggregate net income CAGR of negative 19% between underperforming TASI s 0.2% CAGR during the same period. This, coupled with the sector s under-leverage has resulted in the consistently inferior RoE as compared to the overall market. For companies under our coverage, DAAR stands out on that front with relatively higher return ratios due to its highly leveraged financial structure. In terms of price performance, Saudi listed real estate equities have significantly underperformed TASI over the past six quarters since the beginning of 3Q09 through to the end of TASI recorded an 11% appreciation while the real estate Index dropped 23% over the same period. TASI appreciation came in sync with similar movements in oil prices and the S&P500 signaling negative divergence in real estate equities. In our view, the key real characteristics and drivers of the market will not change in the short term given the current strong market fundamentals and the persistence of the undersupply of residential units. Accordingly, we believe that a re-adjustment to real estate equities discounted multiples is warranted in the medium term. For DAAR and Akaria, we see land sales as the key short term catalyst ahead of project deliveries in 2013 and For EEC, the availability of sufficient long term funding and land sales are the favorable news flow in the short term. March

10 Real Estate Sector Real Estate Sector Fundamentals Attractive Demographics The Saudi real estate market suffers from a well documented supply shortage, especially in the low-mid income housing segment. We estimate that a current shortage of 0.7mn units exists in the market while an additional 1.2mn new units will be needed by Housing demand has been escalating owing to a growing number of expatriate workers (27% of 2009 population), urbanization (82% of total population), a relatively high rate of birth amongst Saudi nationals (5 year av. 27/1,000 population) and a declining family size. Saudi demographics are highly skewed towards young population. The below 25 years age group represent 50% of the aggregate implying strong future demand for housing. Further, due to its vast geographic size, the country has a high ratio of land area per capita of 83,500 sqm and a low population density of 12 people/ sqm, which validates the programs undertaken by the government to expand outside of the historically populous cities into greenfield developments. Riyadh and Makkah districts, collectively, host 50% of the Saudi population due to the former s lively business and political activity and the latter s proximity to the tourism destinations of Makkah and Madinah in addition to high business activity in Jeddah. The large expatriate population of 6.8mn (2009 census), that has historically had low participation in property ownership on the back of strict freehold regulations, acquires a significant share of the rental market. This is mostly represented in gated compounds, shared villas or flat apartments in short to mid-rise buildings. March

11 Real Estate Sector Funding Constraints The contextual framework of the Saudi real estate sector suffers from intrinsic impediments that have created an accumulated state of disorganization. Off-plan sales are banned leading to financing bottlenecks for developers who are forced to fully finance projects prior to realizing cash inflows from unit sales. Moreover, the dry credit market for real estate developers in has further substantiated the situation. Banking credit extended to contractors and developers declined 18% in 2009 before picking up again in 9M10 but remains at a lower percentage of total credit compared to the period. Further, official figures put the contribution from the government s zero interest Real Estate Development Fund (REDF) at a marginal 8% of annual developments in the country. Mortgage Law The lack of a clear defined mortgage law has restrained affordability in the market. The current percentage of mortgage lending to total credit stands at a mere 2.8% compared to 16% in the UAE. With an average annual salary averaging at SAR36,000 for a Saudi national joining the workforce and a sluggish contribution from government grants, the disparity between the offering of luxury units and realizable pent up demand is amplified. We see this pattern continuing in the foreseeable future as the largest share of units due for delivery remain highly priced for the low-mid income bracket. According to the latest announcements, the Shura council is currently studying the draft mortgage law that is expected to be finalized within the coming few months. The law is expected to identify clear measures on foreclosures, property evacuation and title deeds along with organizing the associated role of judicial and enforcement bodies. The law is critical to unlock part of the pent up demand but we remain skeptical on it s capacity to deliver an efficient solution to the sector s vulnerabilities. Our view is devised given low base effect and limited reach owing to the disparity between the strict financial requirements expected from lenders and the wide base of inadequate borrowers. March

12 Real Estate Sector Model of Saudi Development Costs, Mortgage & Availability Input SAR Cost of un-serviced land per sqm 300 Cost of services and infrastructure works per sqm 150 Master developer design, marketing and infrastructure works mark up of 30% per sqm 135 Net cost of land per sqm 585 Land cost assuming plot size of 300 sqm 175,500 Construction cost at SAR1250/sqm 375,000 Total development cost 550,500 Monthly installment assuming 20 years, 90% financing and 8% interest rate 4,144 Required monthly salary assuming financing cap of 45% per month 9,209 Financing gap assuming average monthly salary of SAR4,000 5,209 Financing gap as percent of monthly salary 130% Source; Various Industry Sources, Global Research For a Saudi national to acquire a 20 year mortgage loan with 90% financing at an 8% interest rate for a moderate house worth SAR550,500, the minimum required monthly salary should be SAR9,209 to meet the 45% loan to income criteria needed for approval. This figure is 47% above the upper limit of the third quintile of the income band that earns a monthly salary of SAR6,250. This shrinks the addressable market significantly to less than 8% representing part of the upper two income quintiles. Accordingly, we anticipate a weak market response to the new laws as approved mortgage volumes remain low. To counter this in the short term, we prefer seeing more funding extended to developers in order to accelerate construction progress. Government New Housing Initiatives The Saudi king announced a plan to pump SAR250bn for the construction of 500,000 housing units across the kingdom. The delivery of these units could be extended for a minimum of five years given the prolonged time for the tendering, design and approval phases and also taking into account the Saudi current construction capacity of around 120,000 units per year. These units target the lower band of the population, which falls outside the addressable market for the companies under our coverage universe. Opportunities from these initiatives, however, would accrue over the long term from the added value to land plots owned by DAAR and Akaria as the surrounding infrastructure developments take place. Further, both companies can enter JV s with the government and book project management fees. March

13 Real Estate Sector Residential market Riyadh suffers from a large supply deficit in residential units with additions to apartment stock not keeping pace with the growing demand, which we estimate at 45,000 unit/an. Although the rental market softened 8-10% in 2009 owing to the mismatch in available offerings, strong signs of recovery are showing with apartment and villa prices increasing 10% and 5%, respectively in In our view, high land prices and the lack of affordable units would continue to impel new rounds of price escalation over the coming two years. In Jeddah, the key residential themes are delayed supply and the introduction of freehold units, which are showing price resilience signaling the presence of strong foreign demand for the city s properties. A high degree of land speculation coupled with the existing shortage in low-mid income supply are the main drivers of price escalation. Jeddah Municipality puts the cost of 100sqm of serviced land at 19.4x the average family income while the number of Saudi families living on rented dwellings are more than 50% of the city s population. Only 68% of the city s land bank is allotted for residential developments and the rest remains vacant leaving the city suffering from an immediate supply shortage of 283,000 units. Commercial Market We prefer Jeddah s commercial market to that of Riyadh on higher absorption of upcoming grade A supply as the city is mostly dominated by lower grade office space. A number of developments under construction in Jeddah will be offered on freehold schemes, a positive step in attracting investments in the sector and in benchmarking with regional standards. Riyadh commercial market is more saturated and runs a high vacancy rate of 26% compared to 5.5% in Jeddah. With 200,000sqm of new office space made available in 2010 and an additional 1.1mn sqm by 2013, we forecast a downward pressure in Riyadh s office selling prices and rents as tenants upgrade at competitive prices. Global Office Market Highest Vacancy Rates 2Q10 Market Percent Riga 30.0% Dubai 30.0% Fairfield 26.8% Budapest 26.1% Riyadh 26.0% Los Angeles - Inland Empire 24.7% Las Vegas 24.7% Columbia 24.1% Orange County 23.6% Cincinnati 22.6% Source; Colliers International March

14 Real Estate Sector Retail market Saudi shopping malls are of less quality and lack in-mall attractions compared to regional peers. They remain, however, a major source of leisure due to the absence of entertainment varieties in the country on the back of cultural constraints making the segment a resilient play against economic slowdowns. Current supply stands at 3.4mn sqm and an additional 1.7mn sqm is expected to be added by 2013 in the three major districts. We like the segment s short term strong fundamentals owing to attractive occupancy rates of 80-85% and resilience to downward price pressures. However, we expect rentals and yields, especially of older stock to drop significantly once new supply enters the market. Hospitality Market Saudi tourism is largely driven by religious visitors as Makkah and Madinah receive 8.5-9mn visitors annually representing 70% of aggregate arrivals. Makkah has 50,000 hotel rooms that are expected to double over the coming ten years as the city witnesses several major redevelopment plans while Madinah runs a smaller stock of 20,000 rooms. A seasonality pattern with strong fluctuations exists in the market with occupancy rates peaking during the Hajj season and the month of Ramadan but drop significantly throughout the rest of the year. March

15 Real Estate Sector Jeddah and Riyadh both suffer from undersupply of quality hotels at international standards but several developments that will be managed by recognized brands have either initiated operations or are currently in the pipelines. The hotel market runs high occupancy rates in 5-star hotels by business visitors at c.80% versus lower demand in inferior classes. Negative seasonality also exists in this segment as demand slows during summer time on the back of slowing business activity and increasing outbound travelling. Economic Cities Saudi is adopting a mega-city development model to direct future population and developments away from congested metropolitans. The developments are made on private investments under the sponsorship of the government as opposed to the state-owned and operated model of Jubail and Yanbu Industrial Cities. To date, four cities with an estimated development cost of USD69bn are under construction. The below table shows headline visionary figures provided by Saudi Arabia General Investment Authority (SAGIA). Economic City Source; SAMA,Global Research Location Area Investment Jobs Population (mn sqm) (USD bn) (000) (mn) King Abdullah Economic City Jeddah , Jazan Economic City Jizan Prince Abdulaziz Bin Musaid Economic City Hael Knowledge Economic City Madinah March

16 Dar Alarkan (DAAR) Market Data Bloomberg: Reuters: CMP (Mar 21, 2011): ALARKAN AB 4300.SE SAR8.70 O/S (mn) 1,080 Market Cap (SAR mn): 9,342 Market Cap (USDmn): 2,491 Price/EPS 2011e(x): 6.4 Price/Bv 2011e (x): 0.6 Price Performance 1-Yr High (SAR): 14.4 Low (SAR): 7.40 Average Volume: 3,286,175 1m 3m 12m Absolute (%) Relative (%) Price Performance Cash flows highly reliant on land sales till 2012 Strong Buy Target Price SAR11.37 Ability to repay the 2012 international sukuk and execution progress are the key concerns Initiate coverage with Strong Buy recommendation and TP of SAR11.37 Business model highly reliant on land sales DAAR s business model is highly reliant on land sales, forming 91% of total revenues in 2009 and 2010, with property sales making the balance. The first contribution from rental income is expected in 2011 from Alqasr residential units and Alqasr mall. Cash flow is highly reliant on land sales through to 2012 with deliveries from Shams Ariyadh and Shams Alarous to drive revenues in Sluggish performance in revenues dropped 24% y-o-y to SAR4.1bn on slower sales in both land plots and residential properties registering the lowest margins since Net income dropped 31% to SAR1.5bn in 2010 after dropping 10% in The 2012 SAR3.75bn sukuk is the upcoming liquidity challenge Real Estate Sector Management intends to repay the 2012 sukuk utilizing internal funds generated via land sales. The ability to refinance the 2012 SAR3.75bn International sukuk appears feasible, if needed The cost of refinancing remains the key challenge, in our view. Avoiding margin erosion in land sales is the key catalyst till 2012 The ability to generate short term cash flow from land sales is comforting; avoiding stressed margins is the major positive catalyst. To the downside, timely execution and the 2012 sukuk repayment are the key concerns. Initiate with a TP of SAR11.37 and a Strong Buy recommendation We value DAAR at SAR11.37/share implying a 31% upside potential over the current market price of SAR8.70. We, accordingly, issue a Strong Buy recommendation on the stock. Investment Indicators Year e 2012e 2013e 2014e Revenues (SAR mn) 5,464 4,142 4,126 4,513 10,683 7,722 Net Profit (SAR mn) 2,123 1,456 1,464 1,523 3,781 2,713 EPS (SAR mn) BVPS (SAR mn) P/E (x) P/BV (x) Source: Company Reports & Global Research March

17 Dar Alarkan Company Profile DAAR is the largest Saudi real estate listed developer. DAAR was established in 1994 specializing in land trading, property development, management and investment. In 2007, DAAR went public through floating 30% of its shares in an IPO that was 423% oversubscribed and was listed the same year on Tadawul stock exchange. Business Model DAAR is a master developer of mega projects focused on the sales of land and developed properties. The company purchases large land parcels of 1-5mn sqm and also purchases available additional land around the area designated for the project. After the design phase and the initial announcement of the master plan, DAAR realizes value added gains on sale of land parcels around the project as prices escalate yielding high margins that averaged at 49% between DAAR s property developments are tailored to the middle income bracket. Announced future developments are concentrated in Riyadh and Jeddah although the company s extensive land bank of approximately 32mn sqm is extended across several major cities in Saudi. Property sales margins have dropped sharply from 47% in 2007 to a low of 12% in 2010 due to fluctuating realizable margins between different developments. Properties in projects like Altilal and Alqasr, where a small part of the total land is developed to generate footfall and create value for the surrounding land, are sold for lower margins averaging 15-20% but DAAR realizes higher margins on land sales around these developments. Other projects designated purely for sales are sold for higher margins averaging at 35% with any higher margins realized on property sales representing exceptional deals on full buildings. Further, DAAR has a policy by which it targets a minimum of 40% margin on land sales and manages sales volume in order to avoid margin erosion. To increase its exposure to the attractive rental market, DAAR has classified units in its new developments; namely Alqasr, for that purpose. Out of the total 3,051 units in Alqasr, 1,318 are directed to generate recurring rental income. In the same direction, Alqasr Mall is 85% complete and is planned to start commercial operations in 2H11. Once completed, the mall will be the largest in Riyadh with 78,584sqm of GLA. Alqasr Mall, along with other attached retail shops in Alqasr development, will comprise the retail contribution to the rental portfolio. We like the move towards a more stable recurring income especially the exposure to the residential rental market although the contribution from DAAR s rental portfolio to the topline will remain muted compared to other sources of income. Our long term concerns over the retail segment are contained on the back of the prestigious profile of Alqasr Mall. Management indicated a target yield of more than 10% for the mall citing controlled construction costs and premium positioning. March

18 Dar Alarkan Project Profile Altilal Altilal is DAAR s completed project in Madinah comprising 499 villas spread over 170,000sqm. The project cost was SAR375mn and was delivered in 2010 with only 48 villas remaining in DAAR s inventory. The project s land comes in as a part of a large 2.2mn sqm land owned by DAAR and is currently sold as developed land. Alqasr Alqasr is a SAR1.8bn mixed use development encompassing a land area of 813,643sqm and a BUA of 1.2mn sqm. The project comprises 1,733 residential units designated for sale, 1,318 residential units designated for rentals, 63,135 sqm of retail GLA and 20,000sqm of leasable office space. As of early 2011, the project is almost fully completed with 1,508 units already sold at an average margin of 18-25%. Investment properties have started slowly in 4Q10 and are expected to pick up pace in 1Q11. Alqasr Mall Once completed, Al-Qasr mall will be the largest in Riyadh. The mall comprises a GLA of 78,584 sqm inclusive of a 8,7800 sqm of GLA already leased to Carrefour on a 14 year lease. As of 4Q10, the mall was 85% complete and is expected to commence operations in 2H11 with management guidance on expected yields of more than 10%. Shams Ariyadh A mega project spread over 5mn sqm of land in the outskirts of Ryiadh targeting the upper middle income class. The project comprises 2,694 villas of unit size ranging between sqm, complementary retail shops and a 481,000sqm land parcel designated for sale to be developed into a 3mn sqm of commercial space. To date, 28% of the project is completed and is expected to be delivered in Management expects a 35% margin on the project entailing in a selling value of SAR8bn on an expenditure of SAR5.9bn. Shams Alarous Shams Alarous is located 12km away from Jeddah downtown on a land area of 3mn sqm with an initial BUA of 25mn sqm that has been significantly increased after the company received permission to raise the number of built up floors from four to seven. The SAR7.5bn development will be carried on several phases with the first one spanning two years and covering 20% of aggregate land. Management expects a margin of 15-20% from the project. Qasr Khozam A real estate redevelopment in Jeddah s inner city to renovate the historical site of Khozam. Khoazm company; a 51:49 JV between DAAR and Jeddah municipality with a paid up capital of SAR540 mn was formed to undertake the development of the site with expected investment requirements of SAR10bn. DAAR s revenues will come from selling the developed land plots after undertaking the infrastructure to renovate the land along with receiving management fees. Financing for the project will come under Khozam Company, which should facilitate fundraising given government involvement. To date, the master plan has been finalized and the infrastructure plan is in the process of receiving governmental approvals. Project Operations DAAR Ongoing and Future Projects Capex (SAR mn) Completed Total Units Sold to Date Delivery Alqasr Mixed 1,800 99% 3,051 1, Altilal Sales % Alqasr Mall Rental % NA NA 2011 Shams Ariyadh Sales 5,800 28% 2, Qasr Khozam Mixed 10,000 0% Shams Alarous Mixed 7,500 17% 10, Source; DAAR, Global Research March

19 Dar Alarkan Financing DAAR s outstanding debt stood at SAR7.7bn comprising SAR3.75bn of international sukuk maturing in 2012, international Islamic sukuk of SAR1.7bn maturing in 2015, local sukuk of SAR750mn maturing in 2014 and SAR1.7bn of bank loans in the form of Islamic murabaha. DAAR s coming credit crunch comes in 2012 as it needs to pay off its SAR3.75bn International sukuk. Management indicated that DAAR is will not rollover the debt and that the company intends to fully pay bondholders at maturity. The needed cash will be raised through land sales. The 2015 sukuk are priced at 10.75% versus the company s previous cost of 7.5% for the 2012 sukuk issued in July The recent downgrade by Moody s to a Ba3 from Ba2 rating could cast some doubt and perhaps increase future funding cots. Pricing in line of the previous 10.75% should significantly increase the company s average cost of debt given that the 2012 sukuk are priced at LIBOR plus 2.25%. Management affirmed to us the intention to pay off the 2012 sukuk and that there are no plans to raise any further debt except when new projects avail. We, however, prefer to assume the rollover of the amount due and factor in replacement of DAAR s 2012 debt at a similar 10.75% until further confirmation. Financial Performance Revenues registered SAR4.1bn in 2010 reflecting a 24% drop from 2009 on slower sales in both land plots and residential properties. Both segments reported their lowest margins since 2007 with land sales registering 45.6% slightly above the 40% floor acceptable margin indicated by management. Property sales from both Altilal and Alqasr yielded lower margins as well recording 12.4% down from 23.3% in 2009 and 42.3% in Due to changes in the mix of units sold, DAAR s residential margins have historically fluctuated aggressively between a high of 56.5% in 2Q08 and a low of 5.7% in 3Q10. Interest expense stood at SAR214mn up from SAR146mn the previous year on growing debt and higher financing costs, a pattern we see sustainable in the near future while net income dropped 31% to SAR1.5bn after dropping 10% the previous year. March

20 Dar Alarkan Forecast Assumptions Development sales DAAR model does not integrate off plan sales and accordingly we roll out unit sales based on scheduled completions. For 2011, we only incorporate sales from the remaining units of Alqasr and Altilal. In 2012 we factor in early sales from Shams Alarous phase 1 and Shams Ariyadh. These two projects to be the key revenue driver in We exclude Shams Alarous phase 2 and Qasr Khozam from our valuation until further clarity. Investment properties We expect 2011 to be the first year of significant revenue generation from DAAR s investment properties. We incorporate revenues from Alqasr 1,318 residential units, office space and retail as of 2Q11 and then factor in contribution from Alqasr Mall effective 3Q11. We apply a 9% yield on residential units, 6% on office space, 7-8% on street retail attached to Alqasr development and 10% on Al-Qasr mall (below management guidance of +10% yield). For occupancy rates we assume 50% for residential units in 2011 and then grow it to 99% in 2012 (in line with market trends and similar occupancy rates for Akaria). We assume 70% occupancy rate for office space and 85% for retail. Based on existent projects and our forecasted revenues, we expect contribution from this segment to hover around 4-6% of total revenues in our forecast horizon. Land Sales In our view, land sales will remain the key cash generating machine for DAAR through to 2012 on sluggish property sales in 2011 and most of We maintain a margin of 45%; slightly below historical margins factoring in pressured sales to meet capital expenditure requirements and financial commitments. We factor in the sale of 6.5mn sqm in 2011 and 5.5mn sqm in 2012 at 2010 average price of 568/sqm. Dividends We rule out any dividend payments through 2011 and 2012 as cash will be directed to servicing existing debt and capital expenditures. We expect a dividend of SAR1/share and SAR2/share in 2013 and 2014 once more cash generation takes place as Shams Alarous and Shams Ariyadh are delivered. Risks to Assumptions Based on our assumptions, DAAR remains heavily reliant on land sales for the next two years to generate the cash flow needed for project financing and the repayment of the 2012 sukuk. In case of any emerging financing needs, DAAR can resort to discounting its target gross margin on accelerate land sales and generate the needed cash flow. Further, timely execution remains a risk in spite of the company s track record. Any unaccounted for deviations from our set delivery dates would impact our valuations. Also, although we believe DAAR will successfully refinance the 2012 maturing debt, we remain cautious as to the actual refinancing terms. March

21 Dar Alarkan March

22 Dar Alarkan Valuation Our valuation on DAAR has yielded a SOTP fair value of SAR10.03/share. Cash flows are discounted by a WACC of 11.88%. The cost of equity has been calculated by utilizing the capital asset pricing model based on a risk free rate of 5.6%, an equity risk premium of 7% and a beta of 1. For specific projects where our judgment of the risk profile is higher, we adjust the inputs of our WACC lifting it to a cap of 13.4%. With the company currently trading at SAR8.70/share, our fair value target provides investors with 31% upside potential. Accordingly, we issue a Strong Buy recommendation on DAAR stock. DAAR Valuation Value (SAR bn) /share % Methodolgy Development Sales 3, % DCF Investment Portfolio 1, % DCF / Cap. Rate Land Sales 13, % DCF Total NPV 17, Add Cash FY10 1, Add: Other Investments at Cost , Less Debt , Equity Value 12, CMP (as on March 21, 2011) 8.70 Upside Potential 31% Source: Global Research March

23 Dar Alarkan Income Statement Dar Alarkan SAR mn e 2012e 2013e 2014e Revenue 5,611 5,464 4,142 4,126 4,513 10,683 7,722 Cost of revenues 2,766 2,957 2,378 2,318 2,661 6,428 4,610 Gross Profit /(Loss) 2,845 2,507 1,764 1,808 1,853 4,255 3,112 SG&A EBITDA 2,694 2,361 1,658 1,701 1,740 4,042 2,919 Depreciation & Amortization EBIT 2,671 2,321 1,618 1,652 1,688 3,983 2,858 Interest Income Interest Expenses Other income 13 (2) Income Before Zakat 2,417 2,173 1,483 1,498 1,559 3,870 2,812 Zakat Net Profit /(Loss) 2,356 2,123 1,456 1,464 1,523 3,781 2,747 P&L Appropriation Dar Alarkan Opening Retained Earnings 11,000 11,736 13,859 14,235 15,698 17,222 19,923 Dividends (1,620) - (1,080) - - (1,080) (2,160) Net profit /(loss) 2,356 2,123 1,456 1,464 1,523 3,781 2,747 Closing Retained Earnings 11,736 13,859 14,235 15,698 17,222 19,923 20,510 Source: Company Reports, Global Research March

24 Dar Alarkan Balance Sheet Dar Alarkan SAR mn e 2012e 2013e 2014e Cash & bank balances 716 2,223 1,189 1, ,144 1,276 Account receivables 2,742 1,081 2,225 1,622 1,599 3,158 2,317 Development properties & land 1, ,002 1,027 Total Current Assets 4,728 4,269 3,869 4,044 3,546 5,304 4,620 Net fixed assets 711 1,621 2,005 2,088 2,358 2,479 2,493 Development properties 13,478 16,446 16,310 16,846 17,672 18,547 18,568 Investment in Associates 1,120 1,162 1,162 1,279 1,406 1,547 1,702 Other Long Term Assets Total Non Current Assets 15,436 19,232 19,480 20,215 21,438 22,576 22,765 Total Assets 20,164 23,501 23,349 24,259 24,984 27,880 27,386 Short term debt 1,635 2,688 1,000 4, ,035 1,449 Account payables and accruals 785 1,106 1,158 1,171 1,193 1,216 1,216 Total Current Liabilities 2,420 3,794 2,158 5,354 2,055 2,251 2,665 Long term debt 6,000 5,572 6,679 2,929 5,429 5,429 3,933 Other Long Term Liabilities Total Non Current Liabilities 6,008 5,584 6,692 2,942 5,442 5,442 3,946 Total Liabilities 8,427 9,378 8,849 8,296 7,497 7,692 6,611 Share capital 7,200 10,800 10,800 10,800 10,800 10,800 10,800 Reserves 3, Retained earnings 936 2,597 2,827 4,291 5,814 8,515 9,102 Total Shareholders Equity 11,736 13,859 14,235 15,698 17,222 19,923 20,510 Minority Interest Total Liabilities & Equity 20,164 23,501 23,349 24,259 24,984 27,880 27,386 Source: Company Reports, Global Research March

25 Dar Alarkan Cash Flow Statement Dar Alarkan SAR mn e 2012e 2013e 2014e Profit /(loss) before zakat 2,417 2,173 1,483 1,498 1,559 3,870 2,812 Depreciation & Amortization Finance Income, net Zakat Paid (24) Net CFO before change WC 2,682 2,359 1,737 1,796 1,854 4,179 3,081 Account receivables & prepayments (866) 1,661 (1,143) (1,559) 841 Development properties (2,187) (2,663) 644 (999) (889) (895) (45) Account payables and accruals (221) Other adjustments (281) (131) (78) (333) (331) (398) (334) CF from Operations (874) 1,497 1,211 1, ,350 3,543 Additions to fixed assets (331) (929) (384) (82) (270) (122) (14) Other Investing Activities (1,041) (45) (177) (116) (128) (141) (155) CF from Investing (1,372) (975) (561) (199) (398) (262) (169) Change in debt 1, (605) (567) (820) 173 (1,082) Non-controlling Interest Dividends Paid (1,620) - (1,080) - - (1,080) (2,160) CF from Financing (385) 985 (1,685) (567) (820) (908) (3,242) Change in cash (2,630) 1,507 (1,035) 315 (540) Beginning cash 3, ,224 1,189 1, ,144 Ending Cash 716 2,224 1,189 1, ,144 1,276 Source: Company Reports, Global Research March

26 Dar Alarkan Ratio Analysis Dar Alarkan e 2012e 2013e 2014e Liquidity Ratios Current Ratio (x) Quick Ratio (x) Inventory Stock (Days) Receivables Outstanding (Days) Length of Operating Cycle (Days) Payables Outstanding (Days) Length of Cash Cycle (Days) Working Capital (mn) 2, ,711-1,337 1,427 2,954 1,855 Profitability Ratios Total Assets Turnover (x) Total Net Fixed Assets Turnover (x) Gross Profit Margin 50.7% 45.9% 42.6% 43.8% 41.1% 39.8% 40.3% Operating Margin 47.6% 42.5% 39.1% 40.0% 37.4% 37.3% 37.0% Net Profit Margin 42.0% 38.8% 35.1% 35.5% 33.8% 35.4% 35.6% Return on Assets 11.7% 9.0% 6.2% 6.0% 6.1% 13.6% 10.1% Return on Equity 20.1% 15.0% 10.0% 9.2% 8.7% 18.7% 13.2% Leverage Ratios Times Interest Earned (x) Debt / Equity (x) Degree of Total Leverage (x) Ratios Used for Valuation EPS (SAR) Book Value Per Share (SAR) EV/Revenue (SAR) EV/EBITDA (x) Dividend Yield 19.2% 38.3% 11.5% 0.0% 0.0% 11.5% 23.0% Market Price (SAR) Market Capitalization (SAR mn) 10,728 15,174 9,720 10,422 10,422 10,422 10,422 P/E Ratio (x) P/BV (x) Source: Company Reports, Global Research * Market price for 2011 and subsequent years as per closing prices on March 21, 2011 March

27 Real Estate Sector Emaar Economic City (EEC) Hold Target Price SAR7.20 Market Data Bloomberg: Reuters: CMP (Mar 22, 2011): EMAAR AB 4220.SE SAR6.55 O/S (mn) 850 Market Cap (SARmn): 5,568 Market Cap (USDmn): 1,485 Price/EPS 2011e(x): 5.94 Price/Bv 2011e (x): 1.14 Price Performance 1-Yr High (SAR): Low (SAR): 5.65 Average Volume: 4,289,833 1m 3m 12m Absolute (%) Relative (%) Price Performance Deteriorating cash balance, long term funding key for project revival Unique business model with one project spanning through to 2025 Negative earnings expected through to 2014 Initiate coverage with a HOLD recommendation and TP of SAR7.20 Business model highly reliant on land sales As of 4Q10, EEC cash balance stood at an alarming SAR339mn with a working capital of SAR130mn putting most operations on hold till new funds are raised. Long term funding is the key concern for operational revival in the absence of any significant cash flows from operations in the foreseeable future. Negotiations for a long term SAR2.5bn loan from the government are currently taking place. If granted, this should revive the project in the short term and act as a catalyst for the share price. Negative earnings since inception and expected through to 2014 Revenues peaked in 2009 at SAR261mn before dropping 65% in 2010 due to slowdown in development progress reflecting funding constraints. With the exception of 2007, EEC reported negative earnings since inception. Residential sales are the only source of revenue with minor contributions from the industrial valley. We expect negative earnings to drill through to 2014 until significant contributions from the seaport start to kick in the top line. A shift in strategy to land sales to generate short term cash flow Management indicated a shift in strategy moving away from residential developments to serviced land sales. This step should generate part of the needed cash flow in the short term. Recurring income from the industrial valley remains minimal while the move towards long term recurring income still requires a period of 2-3 more years. Initiate with a TP of SAR7.20 and a Hold recommendation With the company currently trading at SAR6.55/share, our fair value target provides investors with 10% upside potential. Accordingly, we issue a Hold recommendation on EEC stock. Investment Indicators Year e 2012e 2013e 2014e Revenues (SAR mn) Net Profit (SAR mn) (309) (584) (100) (114) (168) (17) EPS (SAR mn) (0.4) (0.7) (0.0) (0.1) (0.2) (0.0) BVPS (SAR mn) P/E (x) NA NA NA NA NA NA P/BV (x) Source: Company Reports & Global Research March

28 Emaar Economic City Company Profile EEC is a Saudi joint stock company established in 2006 with a share capital of SR8.5bn and was made public the same year through floating 30% of its shares. The purpose for incorporating EEC is the development of King Abdullah Economic City (KAEC) project under the expertise of Emaar Properties PJSC and SAGIA s patronage. Land Acquisition At inception, an in kind contribution of 37mn sqm was made by Dayem Modern Company in exchange of SAR1.7bn at a value of SAR46/sqm. EEC further acquired another 6mn sqm from the same company for a consideration of SAR300mn at SAR48/sqm. The other 125mn sqm was purchased from quasi government agencies at a value of SAR14/sqm bringing the overall weighted average price of the 168mn sqm project land to SAR22/sqm. Business Model EEC s business model is focused on the full development of King Abdulla Economic City; a mixed use development spread over 168mn sqm of land located in Rabigh, close to Jeddah. The project comprises several developments that collectively create a new urban community to attract new business ventures and drive population density away from the older overpopulated city of Jeddah. Due to the nature of the project, large sunk costs were required to develop basic amenities of the unserviced land. The initial plan was to complete the project in four phases with the first phase planned for completion in This plan has highly missed its target due to delivery delays and lack of investor interest on the back of the financial crises and execution delays. Phase one encompasses the development of 10% of the total land area including the infrastructural works along with residential and industrial developments. To facilitate the flow of investments to the project, SAGIA has established direct presence in the city aiming at minimizing red tape. Further, to encourage foreign investments, KAEC was the first development in Saudi to be granted the right of non-national freehold ownership. March

29 Emaar Economic City Residential Developments The initial plan was to develop the residential, resorts and CBD areas to generate cash flow at the project s early life via property sales. The company incurred SAR712mn of development capital expenditures in seven projects, mostly catered to the upper-middle to high end segments while construction in the first middle income project will start in These projects offer a collective 1,048 units of which only 611 were sold at the end of Several other projects were scheduled to commence construction but were put on hold due to funding problems and weak demand. We anticipate additional capital requirement of SAR333mn through to 2013 to complete the existing projects. Further, EEC is offering 103 serviced land plots of 2,500 sqm each for sale in the high end Esmeralda development. Project Name Source; EEC, Global Research Industrial Valley The industrial valley comprises 30% of KAEC land bank and was initially designated to be developed and leased on long term contracts to generate recurring income. Due to the hefty capital requirements and the slow movement of tenants, cash generation form this segment has been significantly subdued with a revenue contribution of SAR2mn in Current leased industrial land stands at 319,000 sqm expected to reach 1mn sqm by 2012 representing 75% of phase one originally planed land. Management has indicated that EEC is currently considering the sale of 2mn sqm of land in the valley to generate cash flow. Further, management has also pointed that EEC awaits the approval of a long term loan in the realm of SAR300mn from the Saudi Industrial Development Fund (SIDF). Although the longer term capital requirements appear to us much higher than this figure, we believe that this loan, if granted, will help accelerate progress in the pending infrastructural works needed to facilitate tenant movement. Seaport Total Units Delivery EEC Property Developments Sales Capex (SAR mn) to e Remaining Ongoing Projects Marina Marina Marina Beach Beach Town Homes SOD Villas Mid Income Total Ongoing 1, Land Plots Designated For Sale Esmeralda Plots Total Land Plots KAEC seaport is the first to be fully financed by the private sector in Saudi and is ultimately planned to cover 13mn sqm of land and handle 20mn TEU s. Port Development Company (PDC); a 49:51 JV was formed between EEC and Saudi Bin Laden Group for the development, finance and operation of the seaport. Based on management guidance, phase one should start operations in 2012 with a handling capacity of 600,000 TEU and increase to 1.9mn TEU by PDC revenue generation will come in the form of a 33% operating fees along with royalty fees from other terminal operators in addition to the regular utility fees. Given the current funding crunch that EEC is going through, we are under the impression that negotiations could take place and eventually change the structure of the JV or the scheduled operations start date. March

30 Emaar Economic City Financing Since raising the initial SAR2.6bn of IPO proceeds and the founders seed contribution of SAR4.3bn in 2006, no new financing of any kind was tapped. As of the end of 2010, this aggregate amount was fully channeled into infrastructure works and property developments that have not generated any significant cash flow to support operations. At the end of 2010, EEC balance sheet reported an alarming cash balance of SAR339mn and a working capital of SAR130mn on current assets of SAR1.6bn inclusive of SAR1.1bn of development properties. On top of bank s reluctance to lend to the sector, we believe that the nature of the project has exacerbated the situation due to its large requirements of sunk capital expenditures at the early stage of its prolonged life and the lack of visibility on demand prospects. In our view, the long term anticipated government loan of SAR2.5bn is EEC s best bet as we do not see any change in bank s appetite to lend to the company in the short term given current prospects. We factor in SAR3.5bn of loans to be channeled to EEC between 2011 and Based on our estimated required expenditures, we believe this amount of funding is merely sufficient to bridge the needed funding gap for the company and pull it out of the current status quo in order to start realizing returns on its investments incurred over the past five years. Financial Performance In line with Saudi real estate companies, EEC recognizes revenue from development sales based on the percentage of completion method. With the exception of minor contributions from leases in the industrial valley, all revenues generated between were from unit sales. Revenues peaked in 2009 at SAR261mn before dropping a significant 65% to SAR91mn in 2010 reflecting funding bottlenecks and the associated slowdown in development progress. EEC contained its SG&A expenses by 35% in 2010 to SAR185mn compared to SAR283mn in 2009, excluding depreciation expense. The company created provisions of SAR54mn in 2009 against residential property maintenance and SAR283mn as a fair value impairment against assets held for disposal. Collectively, this has led to an operating loss of SAR305mn and SAR590mn in 2009 and 2010, respectively. With the exception of the 2007 net gain of SAR26mn realized on the back of SAR207mn interest income, EEC has reported consecutive losses amounting to a collective SAR1.2bn since inception through to March

31 Emaar Economic City Forecast Assumptions Development sales We rule out any additional projects in the development properties segment until we receive confirmed assurance from management as we do not see any further demand formulating in the near future. For 2011, we set sale prices between SAR5,000/sqm up to SAR12,000/sqm based on management guidance on actual realized sales and our perception of every project s prospects. We further factor in a movement of current unsold inventory of property developments over the period spanning 2011 through to Industrial Valley For industrial leases, we assume SAR14/sqm/a. and add 25% service charge to arrive at an aggregate rental of SAR17.5/sqm/a. We further factor in a 2% annual growth in rents. Based on management guidance, we build our assumptions on 750,000 sqm of available lease land in KAEC industrial valley in 2011 and grow the number to 1mn sqm in the following year before leaping further to 2mn sqm by Seaport We factor in revenues from the seaport in We believe that this should be the first significant year of recurring income generation for EEC provided the project is delivered as scheduled. We estimate a revenue of SAR400/TEU in line with 2010 realizable prices and maintain the same growth rate of 2% as in industrial valley valuation. Land Sales Based on the company s change in strategic direction from developing property twords the shorter cash generation cycle of land sales, management has indicated that 103 plots of land are designated for sale in Esmiralda development. We account for a plot size of 2,500sqm and factor in a selling price of SAR1,750/ sqm based on the premium location of these land plots and the developed golf course and available facilities around them. To date, contracts for the sale of 13 plots have been signed in 2010 and we assume all remaining plots will be sold by For the 2mn sqm of unserviced land designated for sale in the industrial valley (Plan to be approved), we assume a selling price of SAR250/sqm based on the lower ban of guidance received from management. We believe this price is justified given the value added from nearby dwellings and facilities. Land Bank We lack specific guidance on the actual development magnitude, specifically in terms of the seaport and its delivery phases. Accordingly, we exclude only the 10% of land, equivalent to 16.8mn sqm, to be used in phase 1 as indicated by EEC s initial plan and value the remaining land bank at cost. Risks to Assumptions In our view, once funding is made available to EEC, especially in the magnitude of SAR5bn as indicated by management, the stock price could rally swiftly and we could revisit our assumptions based on the new capital structure. Further, given the nature of land sales, we believe that any acceleration in sales would be perceived as a positive catalyst. To the downside, a prolonged delay before funding availability and further execution risks in the form of construction delays are our major concerns. March

32 Emaar Economic City March

33 Emaar Economic City Valuation Our valuation on EEC has yielded a SOTP fair value of SAR7.10/share. Cash flows are discounted by a WACC of 12.6%. The cost of equity has been calculated utilizing the capital asset pricing model based on a risk free rate of 5.6%, an equity risk premium of 7% and a beta of 1. For specific projects where our judgment of the risk profile is higher, we adjust the inputs of our WACC lifting it to a cap of 14.1%. With the company currently trading at SAR6.55/share, our fair value target provides investors with 10% upside potential. Accordingly, we issue a Hold recommendation on EEC stock. EEC Valuation Value (SAR bn) /share % Methodology Development Sales % DCF Industrial Valley % DCF / Cap. Rate Seaport % DCF Land Sales % DCF Land Bank 3, % Cost Total NPV 5, Add Cash Add: Other Investments at Cost Less Debt NAV 6, CMP (as on March 21, 2011) 6.55 Upside Potential 10% Source: Global Research March

34 Emaar Economic City Income Statment Emaar Economic City SAR mn e 2012e 2013e 2014e Revenue Cost of revenues (222) (191) (155) (368) (463) (436) (444) Gross Profit /(loss) (120) 69 (64) SG&A (254) (283) (185) (155) (149) (278) (223) EBITDA (375) (214) (249) (6) (17) (19) 143 Depreciation & Amortization (24) (37) (58) (59) (57) (65) (72) Provisions & Impairments - (54) (283) EBIT (399) (305) (590) (64) (74) (84) 71 Interest Income Interest Expenses (25) (50) (88) (88) Other income Income Before Zakat (259) (292) (578) (81) (100) (158) (5) Zakat (34) (17) (6) (19) (14) (10) (10) Net Profit /(Loss) (292) (309) (584) (100) (114) (168) (16) P&L Appropriation Emaar Economic City Opening Retained Earnings (17) (309) (618) (1,202) (1,302) (1,416) (1,583) Dividends Net profit /(loss) (292) (309) (584) (100) (114) (168) (16) Closing Retained Earnings (309) (618) (1,202) (1,302) (1,416) (1,583) (1,599) Source: Company Reports, Global Research March

35 Emaar Economic City Balance Sheet Emaar Economic City SAR mn e 2012e 2013e 2014e Cash & bank balances 2, , Account receivables Development properties ,103 1,042 1,058 1,330 1,327 Other Current Assets Total Current Assets 2,503 1,773 1,572 1,517 1,883 3,249 2,155 Net Fixed Assets 7,024 7,315 6,884 7,727 9,010 9,987 10,331 Other Long Term Assets Total Non Current Assets 7,029 7,394 7,109 7,986 9,308 10,330 10,725 Assets classified as held for disposal Total Assets 9,532 9,305 8,885 9,708 11,395 13,783 13,084 Short term debt Account payables and accruals 1,294 1,298 1,442 1,292 2,083 3,127 2,431 Total Current Liabilities 1,294 1,298 1,442 1,292 2,083 3,127 2,431 Long term debt ,000 2,000 3,500 3,500 Other long term liabilities Total Non Current Liabilities ,159 2,169 3,681 3,693 Total Liabilities 1,342 1,423 1,587 2,451 4,253 6,808 6,124 Share capital 8,500 8,500 8,500 8,500 8,500 8,500 8,500 Retained earnings (loss) (309) (618) (1,202) (1,244) (1,358) (1,525) (1,541) Total Shareholders Equity 8,191 7,882 7,298 7,256 7,142 6,975 6,959 Total Liabilities & Equity 9,532 9,305 8,885 9,708 11,395 13,783 13,084 Source: Company Reports, Global Research March

36 Emaar Economic City Cash Flow Statement Emaar Economic City SAR mn e 2012e 2013e 2014e Profit /(loss) before zakat (259) (292) (578) (81) (100) (158) (5) Depreciation (59) (57) (65) (72) Provisions & Impairments Other Adjustments (138) (9) (14) Net CFO before change in assets & Liabilities (372) (209) (251) 59 (78) (120) (41) Account receivables & prepayments (210) (173) (329) (112) (40) (59) (33) Development properties 407 (234) (17) (271) 2 Account payables and accruals 1, (150) 791 1,044 (696) Zakat (11) (33) (13) (19) (14) (10) (10) CF from Operations 822 (626) (350) (161) (819) Additions to fixed assets (2,823) (684) (170) (843) (1,282) (978) (344) Other Investing Activities 3,536 (59) (28) (20) CF from Investing 713 (743) (198) (863) (1,256) (928) (305) Debt Raised 1, ,000 1,000 1,500 - Debt Repayment (1,330) Issue of share capital CF from Financing ,000 1,000 1,500 - Change in cash 1,536 (1,369) (548) (24) 309 1,036 (1,125) Beginning cash 640 2, ,579 Ending Cash 2, , Source: Company Reports, Global Research March

37 Emaar Economic City Ratio Analysis Emaar Economic City e 2012e 2013e 2014e Liquidity Ratios Current Ratio (x) Quick Ratio (x) Inventory Stock (Days) Receivables Outstanding (Days) Length of Operating Cycle (Days) Payables Outstanding (Days) 2, , , , , , ,997.1 Length of Cash Cycle (Days) (1,310.2) (1,918.1) (2,942.0) (1,122.4) (1,476.9) (2,446.7) (1,835.3) Working Capital (mn) 1, (994) (186) Profitability Ratios Total Assets Turnover (x) Total Net Fixed Assets Turnover (x) Gross Profit Margin -118% 27% -70% 29% 22% 37% 45% Operating Margin -393% -117% -649% -1% -12% -12% 9% Net Profit Margin -288% -119% -642% -8% -19% -24% -2% Return on Assets -3% -3% -7% 0% -1% -1% 0% Return on Equity -4% -4% -8% -1% -2% -2% 0% Leverage Ratios Times Interest Earned (x) (0.2) (1.5) (1.0) 0.8 Debt / Equity (x) Degree of Total Leverage (x) (1.4) (0.2) (5.5) Ratios Used for Valuation EPS (SAR) (0.3) (0.4) (0.7) (0.0) (0.1) (0.2) (0.0) Book Value Per Share (SAR) EV/Revenue (SAR) EV/EBITDA (x) NA NA NA NA NA 59.5 Dividend Yield 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Market Price (SAR) Market Capitalization (SAR mn) 7,608 8,160 6,035 5,568 5,568 5,568 5,568 P/E Ratio (x) NA NA NA NA NA NA NA P/BV (x) Source: Company Reports & Global Research * Market price for 2011 and subsequent years as per closing prices on March 21, 2011 March

38 Saudi Real Estate Company (Akaria) Real Estate Sector Strong Buy Target Price SAR30.40 Market Data Bloomberg: SRECO AB Reuters: 4020.SE CMP (Mar 22, 2011): SAR22.75 O/S (mn) 120 Market Cap (SARmn): 2,730 Market Cap (USDmn): 728 Price/EPS 2011e(x): 27.8 Price/Bv 2011e (x): 0.9 Price Performance 1-Yr High (SAR): 26.8 Low (SAR): 21.0 Average Volume: 172,541 1m 3m 12m Absolute (%) Relative (%) Price Performance A pure play on the attractive Riyadh rental market Solid balance sheet and government support key to Binban project financing Visible rental earnings with land sales a key positive catalyst Initiate with a Strong Buy recommendation and TP of SAR30.40 Pure play on the attractive Riyadh rental market A pure play on Riyadh rental market with a high portfolio exposure of 52% to the attractive residential market, our favorite segment in the Saudi market. Akaria s portfolio is also exposed to the office and retail markets representing 34% and 14%, respectively of the companies investment portfolio. Value of land bank significantly higher than book value Akaraia has a land bank of 13.6mn sqm located in several locations across Saudi. The majority of these land plots were acquired several years ago and have significantly appreciated in value, in line with the market. Akaria s first property sales project to start delivery in 2014 To leverage on its under-utilized land bank, Akaria will launch it s first development project that is fully designated for sales in the area of Binban. Construction is expected to start in 2H10 after receiving municipality approvals expected in 1H10 with the first phase to be delivered in Sustainable rental revenues, land sales a positive catalyst Revenues grew 152% in 2010 at SAR432bn driven by the sale of the Basateen land plot for SAR223mn at a 62% gross margin. Net income stood at SAR180mn, a 95% y-o-y growth with a net margin of 42% down from 54% in Looking forward, we do not incorporate land sales in our forecasts, which leaves a large room for upside earnings surprises Initiate with a target price of SAR30.40 and Strong Buy recommendation We value Akaria at a fair value target of SAR30.40/share implying a 34% upside potential from the current share price of SAR Accordingly, we issue a Strong Buy recommendation on the stock. Investment Indicators Year e 2012e 2013e 2014e Revenues (SAR mn) Net Profit (SAR mn) EPS (SAR mn) BVPS (SAR mn) P/E (x) P/BV (x) Source: Company Reports & Global Research March

39 Saudi Real Estate Company Company Profile Akaria was established in 1976 and was listed on Tadawul Stock Exchange in Akaria has a paid up capital of SAR1.2bn and is 64.5% owned by the Saudi Public Investment Fund, which is 100% owned by the government of Saudi Arabia. Business Model Akaria business model relies purely on developing investment properties to generate long term recurring income. The company is a clear play on Riyadh rental market with a high exposure of 52% to the residential market, our favorite segment in the Saudi real estate market. Akaria s portfolio is also exposed to the office and retail markets representing 34% and 14% of the companies investment portfolio. Akaria has a large land bank of 13.6mn sqm located in several locations across Saudi. The majority of these land plots were acquired several years ago and have significantly appreciated in value, in line with the prevailing market trend. To leverage on its under-utilized land bank, Akaria is in the process of launching a project in the area of Binban on the road connecting Riyadh with Qassim. The project will be fully directed to property sales and construction is expected to commission in 2H10 after receiving municipality approvals expected in 1H10. The more stable recurring rent and rent related revenues reported a 10% CAGR between 2006 and 2010 with a stable margin of 62-63%. Occupancy rates in residential properties are significantly high at 99% across most projects. Commercial occupancy rates hover at 60-65%, in line with the market trend in Riyadh office market while retail occupancy rates are relatively higher at 75% as Akaria s retail exposure is mostly in the form of small street shops servicing residential communities. Management indicated the company has no plans to build or operate malls and would prefer to retain the current form of exposure to the retail segment. Land sales have fluctuated aggressively as Akaria adopts an opportunistic approach in selling land plots especially in the absence of urgent financing requirements. March

40 Saudi Real Estate Company Project Profile Akaria Commercial Complex 1, 2 & 3 Three commercial complexes encompassing 424 office units and 295 retail units. The project is relatively old with an occupancy rate of around 65% as of the end of Al-Steen Center Encompasses 206 office units, 76 retail units and 103 residential units. Office and retail units run occupancy rates of 65-75%, respectively while residential units are 99% occupied. The project is also relatively old and realizes the lowest lease rates in Akaria s portfolio. Olaya Towers A large complex of 59 residential towers comprising 969 units. The project is located in a premium location in Riyadh and targets middle income expatriates. Akaria Project Breakdown 4Q10 Existing Projects Office Units Retail Residential Villas Duplex Occupancy Akaria Commercial Complex Al-Steen Center Olaya % Diplomatic Quarters % Akaria Plaza % Total , % New Projects Office Units Retail Residential Villas Duplex Occupancy Diplomatic Quarters NA Source; Akaria, Global Research 80% Diplomatic Quarters 1 & 2 Diplomatic Quarters 1 is a high end residential development comprising 122 apartments, 66 villas and 132 duplex units. Akaria is currently in the process of developing Diplomatic Quarters 2, which should encompass 292 separate villas once fully operative by Akaria Plaza Akaria s latest addition to its investment portfolio. The project is high end commercial development comprising 305 office units and 19 retail units. Akaria Plaza currently runs an occupancy rate of 70%. Binban Project Akaria is awaiting government approvals expected in 1H11 to commence construction in the project. The Binban development is the first and only project designated for sales by Akaria. Binban is scheduled to be completed in three phases over a 2mn sqm plot of land and is expected to cost SAR4bn. Phase 1, which comprises only 10% of the project is planned to be delivered by Akaria Land Bank 4Q10 Location Size (sqm) Status Old Company HQ Building Land 1,671 Built Old Al-Steen Commercial 10,000 Built Olya 238,538 Built Al-Steen 2 9,325 Built Takhsosi & Thamama Rd. 430,727 Investment Shoeib Al-Dayaa Quasim Rd. 596,700 Investment Tilal Ariyadh 48,735 Investment West Industrial Zone - Damam 5,677,630 Investment Airport Rd. - Damam 3,941,966 Investment King Abdulaziz Rd. - Jeddah 49,800 Investment King Fahd Rd. 30,000 Investment Salbokh Binban Rd. 648,189 Investment South Binban Plot # ,597 Investment South Binban Plot # ,059 Investment Third Ring Rd. - Madinah 63,493 Investment King Khaled Rd. - Madinah 157,280 Investment Qasim Rd. - Madinah 1,578 Investment Qasim Rd. - Madinah 85,572 Investment Qordoba Plot # 26 1,919 Investment Qordoba 56,694 Investment Narges Plot # 20 25,570 Investment South Akik 25,500 Investment Total 13,655,079 Source; Akaria, Global Research March

41 Saudi Real Estate Company Financing Akaria has a clean balance sheet with zero debt on its accounts. To date, the company has been successful in meeting required funds internally or through equity financing as in After the full delivery of Akaria Plaza in 2010, the SAR4bn Binban project remains the sole capital intensive requirement for Akaria in the coming 5 years. Based on our discussions with management, the project will be financed via internal equity and bank loans. Akaria relies heavily on the ownership of the Public Investment Fund in raising the needed debt financing for the project and management has specified that they have received guarantees for securing the needed funds at favorable rates. Until further clarification is available, we factor in a 75:25 debt to equity project financing over the period spanning 2011 through to 2015 and assume partial liquidation of the investment portfolio. Financial Performance Akaria reported 2010 revenues of SAR432bn reflecting a 152% y-o-y growth driven by the sale of the Basateen land plot for SAR223mn at a 62% gross margin. Rental revenues increased 60% to SAR204mn on recognition of rentals from Akaria Plaza reporting a gross margin of 83% compared to 81% on SAR128mn in Service charges and other rent related activities stood at SAR4.7mn. Akaria realized an impairment loss of SAR37mn against long term financial investments and the suspension of its Akaria Tower in Jeddah. EBIT came in at SAR199mn with an associated margin of 46% reflecting a 740bps decline from 2009 margin. Zakat payments doubled to SAR30mn from SAR15mn in 2009 resulting in a net income of SAR180mn, a 95% y-o-y growth with a net margin of 42% down from 54% in March

42 Saudi Real Estate Company Forecast Assumptions Development sales Based on our discussions with management, Akaria is highly confident in the progress of the Binban project although little details were provided. We factor in sales from phase 1 in 2014 and then phases 2 and 3 through to We incorporate a selling price of SAR5,500/sqm in 2014 and inflate it 2% annually afterwards in line with our long term assumptions for the Saudi market. Investment Properties For commercial properties we have assumed an occupancy rate of 60-65% for Akaria commercial complexes 1,2 & 3 and for Alsteen commercial. For Akaria Plaza we factored in 75% occupancy rate in line with management guidance for 2011 and maintained it at the same rate going forward. Annual rental prices per annum vary between SAR500-1,000/sqm. For retail properties, we assume an occupancy of 75% across all properties, which is below market average of 80-85% but in line with Akaria s historical realized averages. For residential properties, we apply 8% yield on older properties as Akaria does not increase its rents annually in line with market patterns and we adjust the yield upwards to arrive at a 10% capitalization rate in We factor in rental revenues from the 292 villas of Diplomatic Quarters as of 2H13 and set our annual rentals for the project at SAR300/sqm. Land Bank We value Akaria s land bank at 2010 book value. Although land sales have a significant impact on earnings fluctuations, we exclude any land sales from our forecasts since Akaria does not have a specified sales plan or annual target. The company sold the Basateen land in 2010, which was not identified for sale as was the case for Cordoba and Tilal Ariyadh land plots that are sitting in the company s current assets as land identified for sale since Dividends With the exception of the needed financing for the Binban project, Akaria has no other significant capital commitments in the medium term. Accordingly, we maintain an annual dividend of SAR1/share throughout our forecast horizon. Risks to Assumptions For Binban project, our key concern is the lack of transparency on receipt of the approvals to start construction and the impact this would have on delivery dates. Financing for the project is another concern although we see Akaria s strong balance sheet and ties with the Public Investment Fund as positives on that front. Fluctuations in investment properties are low and our assumptions are aligned with Akaria s historical patterns and market trends. To the upside, the key risk we note is the size and impact of land sales on Akaria s earnings, cash flows and expected dividends. March

43 Saudi Real Estate Company March