Saudi International Petrochemical Company. SIPCHEM: Initiation Report. Research Division Company Reports December 2011

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1 SIPCHEM: Initiation Report Research Division Company Reports December 2011 Please Read Disclaimer on the Back All rights reserved, AlJAZIRA CAPITAL

2 Research Division Division Manager Abdullah Alawi a.alawi@aljaziracapital.com.sa Senior Analyst Syed Taimure Akhtar s.akhtar@aljaziracapital.com.sa Analyst Saleh Al-Quati s.alquati@aljaziracapital.com.sa Brokerage and Investment Centers Division General Manager - Brokerage Division Ala a Al-Yousef a.yousef@aljaziracapital.com.sa AGM-Head of international and institutional brokerage Luay Jawad Al-Motawa lalmutawa@aljaziracapital.com.sa Regional Manager - Central Region Sultan Al-Mutawa s.almutawa@aljaziracapital.com.sa Regional Manager - West and South Regions Abdullah Al-Misbahi a.almisbahi@aljaziracapital.com.sa Area Manager - Qassim & Eastern Province Abdullah Al-Rahit aalrahit@aljaziracapital.com.sa Aljazira Capital is a Saudi Investment Company licensed by the Capital Market Authority (CMA), License No

3 Contents Realized growth potential 1 Investment Risks 2 Valuation Summary 3 Discounted cash flows (DCF) Valuation 3 Comparative valuation 5 Weighted average valuation 5 Sensitivity Analysis 6 Valuation Under Different Scenarios 6 Company Overview 9 SIPCHEM - Subsidiaries 9 Shareholding pattern 9 Existing production flow & complexes 10 International Methanol Company (IMC) 10 International Diol Company (IDC) 10 International Gas Company (IGC) 10 International Acetyl Company (IAC) 11 International Vinyl Acetate Company (IVC) 11 Phase III expansion 12 International Polymers Company (IPC) 12 Wire & Cable Polymer Project (W&C Project) 12 Ethyl Acetate Project (EA/BA) 13 Polybutylene Terephthalate (PBT) 13 Operational integration remains crucial in future growth 14 Improving capacity utilization 14 Operational integration lead to strengthen SIPCHEM 15 Sukuk issuance & financial impact 16 9MFY11 Financial Result 17 Steady financial growth 19 Expansions & strong prices continue to nurture financial health 19 4Q FY 2011 Financial Estimates 21 Financial Statements 22 Sipchem - Income Statement (FY10-14e) 22 Sipchem - Balance Sheet (FY10-14e) 23 Sipchem - Cash Flow Statement (FY10-14e) 24 December 2011

4 Initiation KSA Petrochemical Sector December 2011 Realized growth potential Well organized production flow strengthened operational integration - SIPCHEM is enjoying the benefit of having a sophisticated production process, which allows the company to generate most of its required feedstock from in-house facilities. Acetyl complex played a crucial role in strengthening the company s operational structure; oxide (CO) and methanol from International Gas Company (IGC) and International Methanol Company (IMC), respectively, are utilized to produce acetic acid (AA) & acetate anhydride (Aan) at International Acetyl Company (IAC). Furthermore AA is further utilized as a feedstock at International Vinyl Acetate Company (IVC) to produce vinyl acetate monomer (VAM). Hence, we believe the given production flow at newly build complex played a vital role that led the company to secure a high level of economies of scale in Phase-III expansion focusing on value added products - Based on the given information, phase III will be completed in 2013, which will enable the company to produce (i) 200,000 tons of Ethylene Vinyl Acetate (EVA) & Low Density Polyethylene (LDPE) and (ii) 100,000 tons of Ethyl Acetate (EA) & Butyl Acetate (BA). In addition, phase-iii expansion will continue to nurture the existing vertical integration to attain the optimal production from existing plants; where most of the feedstock for phase-iii expansion is scheduled to be supplied by International Acetyl Company (IAC) & International Vinyl Acetate Company (IVC). Hence, we are expecting further improvement in economies of scale, going forward. Steady improvement in utilization rate will strengthen SIPCHEM - We believe the expected improvement in the company s economies of scale (as discussed earlier) will reflect positively on average utilization rate. Based on our expectations, SIPCHEM weighted average overall capacity utilization rate will reach 98% in Consequently, this will help the company (i) to strengthen its profitability margins and (ii) to increase its production. Rating: Neutral Current Price: SAR Months Price Target: SAR 20.5 Upside: 4.9% Price Chart TASI SIPCHEM (SAR) Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Key Information Reuters Code 2310.SE Bloomberg Code SIPCHEM AB Country: Saudi Arabia Sector: Petrochemical Primary Listing: TASI M-Cap: SAR mn 52 Weeks H/L: SAR 26.1/ Key Financial and Valuation Data Financials (All fig in SAR mn, unless otherwise stated) E 2012 E 2013 E 2014 E Revenues 1,993 3,144 3,264 3,415 4,162 EBITDA 1,136 1,615 1,775 1,841 2,282 Net income EPS P/E PBV EV/EBITDA Source: Company Data, AlJazira Capital * Historical prices are based on respective year end closing and for 2011 & subsequent year we have taken closing price as on 21st Dec VAM is used to produce copolymers like polyvinyl chloride acetate (PVCA), vinyl acetate-acrylic acid (VA/AA) and ethylene vinyl acetate (EVA). PVCA is used to manufacture electrical insulation of protective coverings including garments and of credit cards and swipe cards. 2. EVA has wide range of usage including biomedical engineering, hot glue sticks, top of the line soccer cleats. EVA is famously known as expanded rubber or foam rubber, where EVA foam is generally use to manufacture padding in sports equipments i.e. boxing, ski boots, and fishing rods and so on. 3. EA/BA is use to produce solvent for decaffeination of tea and coffee beans. Moreover, EA is present in daily use items i.e. confectionery, perfumes and fruits. Company Overview The company was registered in KSA on Dec and listed on TASI in The company, at present, has 366.6mn outstanding number of shares. SIPCHEM has the largest privately owned petrochemical production facility across the Kingdom. The company s principle activities are to own, establish, operate and manage industrial projects i.e. related to chemicals & petrochemical related. The company, at present, is the mainly producing methanol, Butanediol (BDO), Melaic anhydride (MAn), Tertahydrofuran (THF), CO, acetic acid, acetate anhydride and VAM. Syed Taimure Akhtar (Senior Analyst) s.akhtar@aljaziracapital.com.sa Page 1 of 25 December 2011

5 Maintenance shutdown limited financial impact but normal for new plants - Based on the industry sources, the company is expected to experience shutdown for days at IVC in 4QFY11. It is noteworthy that this will be the second maintenance shutdown for the company in 2011; the first closure at IAC was recorded in 1QFY11. Based on our understanding, we believe these shutdowns are normal for new complexes in order to avoid any production glitch. We believe the financial impact of shutdown i.e. in 4QFY11 will be limited to the respective quarter. However, we cannot ignore the possible impact of these shutdowns on capacity utilization and volumetric production in Steady financial growth The company s sales revenue is expected to increase at a CAGR of 20.3%, during The growth in top line is mainly associated with the (i) steady increase in the average prices of related products at a CAGR of 8.1%, during and (ii) increase in production (net-off with in-house utilization) at a CAGR of 9.7%, during Furthermore, these factors will also lead the company s gross margins to show improvement and reach 46.8% in 2014 as compared to 42.9% in Similarly, the company s profitability is expected to increase at a CAGR of 24.5%, during ; where net profit margin is expected to reach 21.8% in 2014 as compared to 19% recorded in Investment recommendation - We used a blended approach to derive the price target for SIPCHEM. Under this valuation approach, we assigned 80% weight to DCF approach and 20% to relative valuation (EV/EBITDA metrics) and arrived at 12-month price target of SAR20.5/share. This implies the stock is offering a potential upside of 4.9% over the market price of SAR19.55/share (as of 21st Dec 2011) and trading at prospective 2012 P/E & P/BV of 10.8x and 1.2x, respectively. We, therefore, initiate our coverage on SIPCHEM with Neutral recommendation. Page 2 of 25 December 2011

6 Investment Risks Slower than expected recovery in European and US economies Since the US and European economies are major drivers of the world economies, so we cannot rule out the possible impact of any unprecedented event in these economies on the global market. Hence, slower than expected growth in these economies could lead to impact the target markets of the company, which will have a subsequent impact on the company s future growth. Delay in expansion The on-time completion of the upcoming expansion is among the vital factors for the company s future growth. In fact, our expected positive outlook of the company is mainly based on these upcoming expansions. The delay in expansion will lead us to make a subsequent downward revision in capacity utilization, which will reflect negatively on the growth of the company s future profitability margins. Exceptional movement in the average prices related products At present, the petrochemical sector as a whole, is enjoying the benefit of having higher prices of products. We, therefore, have to make the subsequent revision in the company s profitability based on any unexpected movement in the related products prices. Unexpected maintenance shutdown - Though the unexpected maintenance shutdown has no long-term impact on the company s growth but it could hit the financials of the particular period. Moreover, the financial impact of any unscheduled/unplanned shutdowns on the company is also based on the time span of the operational closure at particular plant. Page 3 of 25 December 2011

7 Valuation Summary Discounted cash flows (DCF) Valuation The following are key basic steps & assumptions we are using to value SIPCHEM on DCF: 4-years forecasted free cash flows (FCF). Terminal value calculation based on the Gordon Growth Model (GGM). o Expecting terminal growth of 3%. Using Capital Asset Pricing Model (CAPM) to calculate cost of equity. However, the CAPM calculation is based on the following variables: o Risk free rate of 3.1%, 10-years US bond yield + country risk premium of 1.25%. o Equity risk premium taken at 10.77%. o Beta of We are using Weighted Average Cost of Capital (WACC) for discounting the future FCF of the company, where the calculation of WACC is based on the following variables: o Cost of equity equivalent to CAPM o Cost of debt taken at 4.1% o Contribution from equity & debt in SIPCHEM capital structure is taken at 45% & 55%, respectively. Using the above assumptions, we have derived the company s cost of equity & WACC at 14.4% & 8.7%, respectively, and arrived at a DCF based value of SAR20.5/share for the company. Page 4 of 25 December 2011

8 DCF Base Valuation All figures in SAR Mn, unless specified e 2012e 2013e 2014e Revenues 1,993 3,144 3,264 3,415 4,162 EBITDA 1,136 1,615 1,775 1,841 2,282 Margin (%) 57.0% 51.4% 54.4% 53.9% 54.8% EBIT 764 1,231 1,379 1,419 1,834 Margin (%) 38% 39% 42% 42% 44% Net Income Margin (%) 19% 21% 20% 20% 22% Cash from operations 375 1,534 1,508 1,620 1,961 Total assets 12,027 14,652 15,647 16,729 18,110 Shareholders' equity 4,921 5,489 6,083 6,691 7,506 Total liabilities & equity 12,027 14,652 15,647 16,729 18,110 Free Cash Flow Analysis (FCF) NOPLAT 661 1,074 1,194 1,294 1,625 Depriciation & amortization Change in net working capital (608) 82 (79) (93) (108) CAPEX (362) (809) (932) (1,148) (1,371) FCF Discount Factor PV of FCF Sum of PV of FCF 2,094 Terminal value 10,591 PV of Terminal value 8,169 Enterprise value 10,263 Add: Net debts (2,758) Total equity value 7,505 Shares (mn) DCF based value (SAR/share) 20.5 Terminal growth 3.0% WACC 8.7% Source: AlJazira Capital Page 5 of 25 December 2011

9 Comparative valuation We used EV/EBITDA to compare SIPCHEM with its peer group around the globe. Under the comparative valuation, we used the average 2011 EV/EBITDA of 6.4x for the peer group to arrive at 12-month price target of SAR20.8/share. Comparative valuation All figures in SAR Mn, unless specified Sector EV/EBITDA 6.4 Implicit enterprise value 10,367 Cash 3,637 Debt (6,395) Net worth of SIPCHEM 7,609 Shares outstanding (mn) 367 Comparative value (SAR/share) 20.8 Source: AlJazira Capital Weighted average valuation We used a blended approach to derive the price target for SIPCHEM. Under this valuation approach, we assigned 80% weight to DCF approach and 20% to relative valuation (EV/ EBITDA metrics) and arrived at 12-month price target of SAR20.5/share. This implies the stock is offering a potential upside of 4.9% over the market price of SAR19.55/share (as of 21st Dec 2011) and trading at prospective 2012 P/E & P/BV of 10.8x and 1.2x, respectively. We, therefore, initiate our coverage on SIPCHEM with Neutral recommendation. Weighted average valuation summary Fair value Weights Weighted average DCF base value % 16.4 Relative value % 4.2 Weighted average 12-month price target (SAR/share) 20.5 Source: AlJazira Capital Page 6 of 25 December 2011

10 Sensitivity Analysis The table below highlights the sensitivity of SIPCHEM weighted average 12-month price target with terminal growth & WACC. Sensitivity Analysis Terminal Growth Weighted Average Cost of Capital (WACC) 6.74% 7.74% 8.74% 9.74% 10.74% 1.00% % % % % Source: AlJazira 19.8Capital Source: AlJazira Capital Valuation Under Different Scenarios In order to examine different situations that SIPCHEM could face we have further tested our core fundamental assumptions under two possible scenarios: Bull Case and Bear Case. These scenarios illustrate how sensitive our DCF-based fair value is to changes in key fundamental variables. We chose the impact of average prices of related products, while keeping other factors constant and capacity utilization of the company s existing & upcoming complexes, while keeping the other factors constant. Scenario Analysis Price scenario SAR Bear Case - 15% -10.0% -7.5% -5.0% -2.5% DCF - Base Case 2.5% 5.0% 7.5% 10.0% Bull Case 15% Source: AlJazira Capital Page 7 of 25 December 2011

11 Scenario Analysis International Methanol Company capacity utilization SAR Bear Case - 60% 70.0% 80.0% 90.0% 100.0% DCF - Base Case 115.0% 120.0% 125.0% 130.0% Bull Case 135% Source: AlJazira Capital Scenario Analysis - International Diol Company (IDC) capacity utilization SAR Bear Case - 25% 35.0% 40.0% 45.0% 50.0% DCF - Base Case 90.0% 95.0% 100.0% 105.0% Bull Case - 115% Source: AlJazira Capital Page 8 of 25 December 2011

12 Scenario Analysis IGC, IAC and IVC capacity utilization SAR Bear Case - 40% 50.0% 55.0% 60.0% 65.0% 80.0% 85.0% 90.0% 95.0% DCF - Base Case Bull Case - 105% Source: AlJazira Capital Scenario Analysis International Polymer Company (IPC) SAR Bear Case - 15% 25.0% 30.0% 35.0% 40.0% DCF - Base Case 80.0% 85.0% 90.0% 100.0% Bull Case - 105% Source: AlJazira Capital Page 9 of 25 December 2011

13 Company Overview SIPCHEM was founded in late 1999 but started its commercial operation in 2004 with completion of methanol plant at IMC. Saudi International Petrochemical Company (SIPCHEM) successfully started commercial operation from Acetyl complexes in This led the company s total production capacity to reach at 2.2mn tons in 2010 with the addition of new products i.e. acetic acid (AA), acetate anhydride (Aan), vinyl acetate monomer (VAM). Interestingly, the current production capacity is presenting the company s uniqueness in two manners; (i) the largest private petrochemical company across the GCC region and (ii) a major exporter of acetyl products from the region. SIPCHEM - Subsidiaries At present, the company s operational structure is based on the complexes of fives subsidiaries i.e. International Methanol Company (IMC), International Diol Company (IDC), International Acetyl Company (IAC), International Vinyl Acetate Company (IVC) and International Gases Companies (IGC). In addition, the company is categorizing IGC, IAC and IVC under Acetyl complexes. Phase-1 expansion completed with the commencement of IDC in Phase-2 expansion was based on the completion of all Acetyl complexes. The company achieved this milestone in 2H10. SIPCHEM - Operational Subsidiaries 2010 Name Capacity ('000' tons/year) Product SIPCHEM Share IMC 970 Methanol 65.0% IDC 75 BDO, MAn & THF % IGC 340 CO 72.0% IAC AA & Aan 76.0% IVC 330 VAM 76.0% Source: SIPCHEM 2011 sukuk prospectus On the other hand, the company is in a process of establishing new complex under phase-3 expansion i.e. International Polymers Company (IPC), where the company holds 75% stakes. The plant is expected to come online in 2H2013. At the time of listing in 2006 SIPCHEMs share capital was recorded at SAR1.5bn In 2007, the company s share capital was recorded at SAR2bn, which was mainly due to issuance of new 50mn par in the form of bonuses. By the end of 2008, the company s share capital reached at SAR3.3bn, which was due to the issuance of 133.3mn shares at a premium of SAR5/share. Shareholding pattern The below chart shows the company s current shareholding structure as of 31st Dec 2010: Shareholding Structure Zamil Group 9.7% Ikarus Petrochemicals 8.3% Public Pension Agency 7.7% General Public 68.7% Olayan Financial Company 5.6% Source: SIPCHEM 2011 sukuk prospectus After the issuance of 33.3mn bonus shares, at present, SIPCHEMs share capital was recorded at SAR3.6bn (366.6mn SAR10/share). 4: Tertahydrofuran Page 10 of 25 December 2011

14 Existing production flow & complexes The completion of phase-2 expansion in mid 2010 led the company to run its operations in a more sophisticated manner. At present, the company s operational structure is based on five complexes (discussed in the previous section); where old plants are nurturing newly completed complexes. On the other hand, the big chunk of the output from two new plants i.e. IGC and IAC are utilized as feedstock to produce more value added products i.e. VAM. Production Flow 2010 Phase I IMC 970 KTPY m ETHANOL Mehanol Hydrogen IDC 75 KTPY BDO/THF Methanol Phase II IGC 340 KTPY CO CO Hydrogen IAC 460 KTPY AA/AAm AA IVC 330 MTPY VAM AA VAM Source: SIPCHEM 2011 sukuk prospectus International Methanol Company (IMC) IMC is the manufacturer and seller of methanol. Beside SIPCHEM, Japan-Arabia Methanol Company (JAMC) owned 35% stakes in the company. IMC is under agreement to supply 248,000 ton/year and 8,000 tons/year of methanol to IAC & IDC, respectively. The plant is using low pressure technology of ICI Chemicals & Polymers Limited (ICI), which is now owned by Johnson Matthey Plc & Methanol Casale S.A. IMC is getting 124,200 British thermal unit (btu) per day of natural gas from SIPCHEM (out of the total allocated gas from Saudi Aramco). The complex has well developed infrastructure to transport methanol to King Fahad Industrial Port (KFIP) in Jubail, through pipelines from production facilities. International Diol Company (IDC) IDC is producing & selling BDO & its derivate THF. IDC uses Universal Oil Products LLC (UOP), Huntsman & Davy process at different stages to get BDO & THF. Beside IMC the plant is getting 4,000 bbl/d of butane from Saudi Aramco. The company is under longterm marketing contract with Vinmar International Ltd, a US based group, and Will & Co., a Dutch company. International Gas Company (IGC) The complex at IGC is producing CO, which is used as a feedstock to run complex at IAC. The company is under agreement to supply 240,000 tons/year of CO to IAC, while receiving its required 41,040mmbtu of natural feedstock gas from SIPCHEM (out of the total allocated gas from Saudi Aramco). Page 11 of 25 December 2011

15 International Acetyl Company (IAC) IAC is the manufacturer & seller of AA & Aan. AA is further used to process VAM from the plant of IVC. The complex is utilizing Eastman technology to derive AA & Aan products. IAC is agreed to supply 220,000 tons/year of AA to IVC. However, the plant will also supply the designated amount of AA to IPC, once the new facility commences its operation. International Vinyl Acetate Company (IVC) IVC is using DuPont VAM production technology & Eickmeyer CO2 removal technology to produce VAM. The complex requires AA and ethylene as feedstock; where AA feedstock comes from IAC and ethylene feedstock comes from Saudi Ethylene & Propylene Co. (SEPC). Going forward, upon the completion of IPC, SIPCHEM will utilize the required portion of IVC as a feedstock to IPC. Page 12 of 25 December 2011

16 Phase III expansion Prior to undertake phase III expansion, the company was striving to establish well integrated olefin complex. However, the company withdrew from the construction of olefin complex, which was mainly due to (i) decline of feedstock gas allocation from Ministry of petroleum and (ii) FY08-09 financial turmoil that led the project infeasible to make further progress. Hence, in order to compensate withdraw from olefin complex; the company has recently announced its phase III expansion. Based on our expectations, phase-iii expansion will remain crucial to keep the company on growth track. The company s phase-iii expansion is mainly based on three projects (i) International Polymers Company (IPC), (ii) Wire & Cable Polymer, (iii) Ethylene Acetate and (iv) Polybutylene Terephthalate. Production Flow - Post Phase III Expansion Phase II IGC 340 KTPY CO CO Hydrogen IAC 460 KTPY AA/AAm AA IVC 330 MTPY VAM AA VAM 25 KTPY W&C Phase III IPC 200KTPY EVA and LDPF ٢٥ ا لف طن سنويا W&C EVA & LDPE Source: SIPCHEM 2011 sukuk prospectus International Polymers Company (IPC) Based on the given information, the complex at IPC will have a designed capacity to produce 200,000 tons/year of EVA & LDPE and 100,000 tons/year of EA & BA. Moreover, IAC & IVC will be the major in-house feedstock provider for the company, while the company has entered in agreement with SABIC to supply ethylene feedstock. It is worthy to mention that the company has secured the long-term agreement to receive 100% ethane feedstcok gas from Saudi Aramco; where the indystry generally receive the mix of ethane & propane at 60/40 ratio. Since the company has no ethylene cracking unit so it is obvious that the feedstock gas will be supplied to SABIC concerned facility, which will supply ethylene feedstock at relatively lower cost. Wire & Cable Polymer Project (W&C Project) According to the company s 2011 Sukuk prospectus, the project is based on two production lines: 1. Medium voltage cross-linked polyethylene (XLPE) compound at a production capacity of 20,000 tons/year. XLPE is generally used as insulation material in the wire and cable industries 2. Medium voltage semi-conductive outer (insulation) and inner (conductor) shield compounds at a designed capacity of 5,000 tons/year. Semi-conductor is consisting of cross-linked compound to distribute and minimize electrical stress in power cable. It is worth mentioning that W&C project will use IPCs EVA and LDPE as a feedstock input for its operation. Page 13 of 25 December 2011

17 Ethyl Acetate Project (EA/BA) This project is focusing to produce EA and BA, with a design capacity of 100,000 tons/year. The complex requires 69,000 tons/year of AA and 56,000 tons/year of ethanol as feedstock. The complex is flexible and has the ability to produce BA, depending on demand. Polybutylene Terephthalate (PBT) The company is under exploring stage to establish PBT. The product is a thermoplastic polymer and used as an insulator in the electrical & electronic industries. PBT is utilized as an insulator in electrical and electronics industries. Page 14 of 25 December 2011

18 Operational integration remains crucial in future growth We believe the company s growth trajectory is primarily based on the successful enhancement of operational integration, which will enhance SIPCHEM ability to (i) make optimal utilization of its production facilities and (ii) attain higher economies of scale to manage cost more effectively. Improving capacity utilization The completion of the phase III expansion is expected to further enhance the company s capability to (i) increase the consumption of in-house production as a feedstock and (ii) intensify the existing operational integration. On the other hand, the new expansion will lead the company to widen its target market (with new value products) and reduce the dependence on external demand (lowering down the impact of unprecedented embargoes & duties on a particular product i.e. methanol). Moreover, we expect the upcoming expansion will further allow the company to operate on a relatively higher capacity utilization (to meet the internal & external demand). Hence, based on these possible factors, we expect the company s overall weighted average capacity to show improvement and reach at 98% in We, therefore, expect the company s production (before utilizing for feedstock) to increase at a CAGR of 6.8%, during Furthermore, we can not ignore the impact of operational shutdown at IAC in 1QFY11 and the expected operational halt in 4QFY11 at IVC for days, which will restrict YoY improvement in the company s overall utilization at 88.6% in Capacity Utilization 140% 98.0% 99% 120% 88.1% 88.6% 90.2% 91.4% 97% 100% 95% 80% 93% 60% 91% 40% 89% 20% 87% 0 85% e 2012e 2013e 2014e IMC - LHS IDL - LHS IAC - LHS IPC & EA/BA - LHS Overall Weighted Average Utilization - RHS Source: SIPCHEM financial reports & Aljazira Capital The company s production facility at IMC is expected to continue its operations at more than 100% of its designed capacity and reach at 115% in 2014, which is mainly based on the (i) increase in demand of methanol at the current pace in international market and (ii) higher utilization rate at IAC plant (80%-85% in 2014). Consequently, the increase in requirement from IAC plant will also lead the plant IGC to run on higher capacity rate in the average range of 90%-95% in The forecasted increase in production from IAC is mainly focusing to meet the external & internal requirements i.e. for IVC; where IVC is expected to run on high utilization rate in the average range of 75%-80% in Furthermore, the expected improvement in the average utilization rate at IAC and IVC is mainly due to the expected commencement of IPC and EA plants in Page 15 of 25 December 2011

19 Operational integration lead to strengthen SIPCHEM We believe the existing & upcoming operational integration (discussed earlier) will not only streamline the company s production-flow but also enhance the economies of scales among the operational complexes. Consequently, this will lead the company to show a strong standing, considering the ongoing economic worries and possible rise in feedstock prices, with relatively higher gross margin in the industry. Hence, we expect the company s gross profit to increase at a CAGR of 22.9%, during , which will translate into the improvement in the gross margin from 42.9% in 2010 to 46.8% in Gross Margin % 46.8% 60.0% 55.0% % 44.8% 50.0% % 42.5% 45.0% % 35.0% % 30.0% * e 2012e 2013e 2014e 25.0% Gross Profit (SAR mn) - LHS Gross Margin - RHS Source: SIPCHEM financial reports & Aljazira Capital * Decline in 2009 gross margin was mainly associated with the massive decline in the average prices of related products due to economic turmoil in 4QFY08 Page 16 of 25 December 2011

20 Sukuk issuance & financial impact SIPCHEM made a successful issuance of sukuk in 2QFY11 and raised total funds of SAR1.8bn as compared to the initial size of SAR1.5bn. The Mudarabah sukuk was issued in dominations of SAR100,000 with subject to a minimum initial subscription amount of SAR1mn. According to the company, the fund raised from sukuk will be utilized in the future expansion projects and provide an alternative source of Islamic finance. Based on the given information, the sukuk is a Floating Rate Note (FRN) for five years; where the investors are subjected to get 170 bps + SIBOR per annum. Sukuk impact on SIPCHEM Long-term debt Financial charges Debt/equity ratio Interest coverage ratio Impact Description Treated as long-term debt and impact all financial leverage ratios Higher debt leads to higher financial cost Lead to change the company's capital structure Increase the company s financial leverage Source: Aljazira Capital It is noteworthy that the fund raised through sukuk reflected directly on the company s long-term debt, which witnessed YoY increase of 32.6% and recorded at SAR5.6bn in 9MF11. This was further translated into higher financial obligations; where financial charges increased YoY by 116.2% in 9MFY11. The company s debt to equity ratio was recorded at 104.7% in 9MFY11 as compared to 89.7% in same period last year. Hence, the company witnessed a change in capital structure in 9MFY11, where the debt financing as % to total asset was recorded at 39% as compared 36% in 9MFY10. Going forward, we are not expecting any major changes in the company s capital structure. On the other hand, the company s interest coverage ratio witnessed decline, on account of higher financial charges. We believe the company will continue to face higher financial charges, which is expected to increase at a CAGR of 21.1% in However, over the period of time, the expected improvement in capacity utilization coupled with strong prices of related products will lead to dilute the impact of higher financial cost. Consequently, this will lead the company to make an improvement in interest coverage ratio, which is expected to reach at 8.8x in 2014 as compared to 7.1x recorded in According to the company s management, the fund raised through sukuk will primarily utilize to avail any opportunities; whether locally, regionally and internationally. Moreover, the fund could also use to make further vertical expansions. Page 17 of 25 December 2011

21 Financial Overview 9MFY11 Financial Result SIPCHEM 9MFY11 net profitability was recorded at SAR494.7mn (EPS: SAR1.35) as compared to the after tax profit of SAR253mn (EPS: SAR0.69) recorded in corresponding period last year. However, it is noteworthy that the company has witnessed a fall in profitability margin which was mainly associated with the higher (i) operating costs and (ii) financial cost (as discussed earlier). The increase in operating cost is mainly associated with the full year cost impact resulted in the completion of phase-ii expansion; where depreciation and G&A costs registered YoY increase of 56% & 41.7%. Income Statement: 9MFY11 All figures in SAR Mn, unless specified 9MFY10 9MFY11 YoY Change Sales 1, , % Cost of sales (646.9) (1,388.8) 114.7% Gross profit , % General & Administrative expenses (56.5) (80.0) 41.7% Income from main operation % Investment income % Financial charges (60.8) (131.3) 116.2% Net income/(expenses) of pre-operating activities (1.0) (0.0) -95.5% Other income/(expenses), net (4.3) % Income before minority interest & zakat % Minority interest (154.9) (285.2) 84.1% Income before zakat % Zakat (13.8) (18.9) 36.6% Net income % Earnings per share (SAR) Source: SIPCHEM quarterly financial statements On the other hand, the notable growth in the company s sales revenue was mainly associated with the (i) start of commercial production from phase-ii expansion and (ii) higher average prices of related products. Page 18 of 25 December 2011

22 On the other hand, the notable growth in the company s sales revenue was mainly associated with the (i) start of commercial production from phase-ii expansion and (ii) higher average prices of related products. Financial Ratios Profitability Ratios (%) 9MFY10 9MFY11 Gross Profit Margin 45.5% 41.9% Operating Margin 40.7% 38.5% Net Profit Margin 21.3% 20.7% Return on Average Assets 2.1% 3.8% Return on Average Equity 5.3% 9.7% Liquidity Ratios (x) Current Ratio Quick Ratio Turnover Ratios (x) Inventory Receivable Payable Capital Structure Debt/Equity (%) 89.7% 104.7% Interest Coverage (x) Source: SIPCHEM quarterly financial statements Page 19 of 25 December 2011

23 Steady financial growth Expansions & strong prices continue to nurture financial health We expect the company s sales revenue to increase at a CAGR of 20.3%, during , and reach at SAR4.2bn in The expected growth in the sales revenue is mainly based on the increase in average prices of related products and production (net-off with in-house utilization) at a CAGR of 8.1% and 9.7%, respectively, during Sales revenue growth % 21.8% 140.0% % 3.8% 4.6% 90.0% % 40.0% % -10.0% * 2011e 2012e 2013e 2014e** -60.0% Sales Revenew Million SAR - LHS Growt h- RHS Source: SIPCHEM financial reports & Aljazira Capital *Massive increase in 2010 sales revenue was mainly due to the start of commercial operation from Phase-II expansion. ** Expected increase in 2014 sales revenue is associated with expected start of operation from phase-iii expansion On the other hand, the company s bottom line is expected to increase at a CAGR of 24.5%, during On the other hand, the company s net profitability margin is expected to show improvement and reach at 21.8% in 2014 as compared to 19% in Page 20 of 25 December 2011

24 Net profitability growth, ROAA & ROAE % % 18.0% 16.0% % 12.5% 11.5% 10.6% 14.0% 12.0% % % 5.2% 5.8% 4.9% 2.8% 4.4% 4.2% 3.2% 1.2% e 2012e 2013e 2014e 8.0% 6.0% 4.0% 2.0% 0.0% Net Profitability (SAR mn) - LHS ROAA - RHS ROAE - RHS Source: SIPCHEM financial reports & Aljazira Capital We expect the improvement in net profitability will lead to further enhance the company s ROAE & ROAA, which are expected to reach at 12.8% and 5.8% in 2014, respectively. Page 21 of 25 December 2011

25 4Q FY 2011 Financial Estimates We expect the company will registered after tax profit of SAR153.6mn (EPS: SAR0.42) in 4QFY11 as compared to the net profit of SAR208.4mn (EPS: SAR0.57) in preceding quarter i.e. 3QFY11. The expected decline is mainly associated with the expected (i) QoQ decline of 16.2% in the average prices of related products and (ii) maintenance shutdown for days at VAM plant, which will lead to QoQ decline of production volume (net-off with inhouse utilization) of 6%-8%. Consequently, this will also lead a drop in the company s gross margin for 4QFY11 to 44.5% as compared to 48.2% in 3QFY11. 4Q11 Financial Estimates All figures are in SARmn, unless otherwise stated 1QFY11A 2QFY11A 3QFY11A 4QFY11e QoQ change 4QFY11/3QFY11 Sales revenue % Gross profit % EBIT % Net income % EPS (SAR) Source: SIPCHEM Quarterly financial reports & Aljazira Capital The expected maintenance shutdown will lead to evade the positive impact of improvement in the average prices of related products on the company s sales revenue in 4QFY11. However, we believe the impact of favorable prices and the better utilization rate will lead the improvement in the company s gross margin to 44.5% in 4QFY11 as compared to 39.1% recorded in 4QFY10. Consequently, we expect this will help the company to encounter with YoY higher operating and financial cost (due to sukuk) and eventually translate into YoY bottom-line growth of 22.7% as compared to 4QFY10 net profitability of SAR125.1mn (ESP: SAR0.38). Page 22 of 25 December 2011

26 Financial Statements SIPCHEM Income Statement (FY10-14e) All figures in SAR Mn, unless specified e 2012e 2013e 2014e Sales ,144 3,264 3,415 4,162 Cost of Sales (1.131) (1,807) (1,780) (1,886) (2,214) Gross Profit 861 1,336 1,484 1,529 1,948 General & Administration Expenses (97) (106) (106) (110) (114) Operating Income 764 1,231 1,379 1,419 1,834 Investment Income 8 7 (12) (15) (19) Financial Charges (1) (181) (210) (222) (231) Net Expenses of Pre-Operating Activities (3) (0) Provision of developmental cost/other expenses Income Before Minority Interest & Zakat 660 1,056 1,157 1,182 1,584 Minority Interest (238) (382) (463) (473) (634) Net Income Before Zakat Zakat (44) (26) (31) (32) (43) Net Income P&L Appropriation A/C Opening Balance ,475 2,014 Net Income of the year Transfer to Statutory Reserves (38) (65) (66) (68) (91) Dividend (333) (65) (66) (68) (91) Bonus - (333) General Reserves Directors' Remuneration (2) (2) (2) (2) (2) Ending Balance ,475 2,014 2,738 Source: SIPCHEM financial reports & Aljazira Capital Page 23 of 25 December 2011

27 SIPCHEM Balance Sheet (FY10-14e) All figures in SAR Mn, unless specified e 2012e 2013e 2014e Assets Current Assets Cash and Equivalents 1,621 3,637 3,978 4,201 4,508 Inventories A/R, P. Payment & R/A Total Current Assets 2,426 4,606 5,061 5,413 5,868 Non-Current Assets Investments Securities Plant & Property-Net 9,506 9,781 10,318 11,045 11,969 Project Development Cost Intangible Assets Other Assets Total Non-Current Assets 9,601 10,046 10,586 11,316 12,243 Total Assets 12,027 14,652 15,647 16,729 18,110 Liabilities and Equities Current Liabilities Trade Creditors Short term advances to shareholders Short term loans Current Portion of Long term loans Current Portion of Capital Lease Total Current Liabilities 857 1,158 1,197 1,239 1,283 Non-Current Liabilities Long-Term Debt 4,202 5,673 5,729 5,787 5,845 End-Of-Service Indemnities Obligation Under Capital Lease Sub-Ordinate Loans From Minority Shareholders Fair Value of Interest Rate Swap Total Non-Current Liabilities 5,156 6,662 6,713 6,767 6,822 Total Liabilities 6,013 7,820 7,911 8,006 8,104 Shareholders' Equity Share Capital 3,333 3,667 3,667 3,667 3,667 Reserves for the result of sales of sahers in Sub Statutory Reserves ,047 1,115 1,206 General Reserves Retained earnings ,475 2,014 2,738 Change in Fair Value of Interest Rate Swap (140) (154) (154) (154) (154) Total Equity 4,921 5,489 6,083 6,691 7,506 Minority Interest 1,092 1,344 1,653 2,033 2,500 Total Shareholders' Equity & Minority Interest 6,014 6,833 7,736 8,724 10,006 Total Liab. Shareholders' Equity & Minority Interest 12,027 14,652 15,647 16,729 18,110 Source: SIPCHEM financial reports & Aljazira Capital Page 24 of 25 December 2011

28 SIPCHEM - Cash Flow Statement (FY10-14e) All figures in SAR Mn, unless specified e 2012e 2013e 2014e Profit before zakat Depreciation Other operating cash flows Financial cost Zakat paid (69) (26) (31) (32) (43) Change in working capital (535) 82 (79) (93) (108) Net Cash from operating activities 375 1,534 1,508 1,620 1,961 Investing Activities Purchase of plant & property (360) (809) (932) (1,148) (1,371) Other investing cash flows (1) (4) (7) Cash Flows from Investing Activities (306) (798) (933) (1,151) (1,378) Financing Activities Long-Term financing 104 1, Dividend & directors's remuneration paid (336) (67) (68) (70) (93) Other financing cash flows (48) (123) (222) (233) (241) Cash Flows from Financing Activities (280) 1,281 (234) (245) (276) Increase/Decrease in Cash (211) 2, Cash beginning balance 1,831 1,621 3,637 3,978 4,201 Cash Ending Balance 1,621 3,637 3,978 4,201 4,508 Source: SIPCHEM financial reports & Aljazira Capital Page 25 of 25 December 2011

29 COMPANY PROFILE 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 value-added 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 10% 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 10% 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 +/- 10% 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. For further queries about our special services, contact us at the toll free number

30 Disclaimer The purpose of producing this report is to present a general view on the company/economic sector/economic subject under research, and not to recommend a buy/sell/hold for any security or any other assets. Based on that, this report does not take into consideration the specific financial position of every investor and/or his/her risk appetite in relation to investing in the security or any other assets, and hence, may not be suitable for all clients depending on their financial position and their ability and willingness to undertake risks. It is advised that every potential investor seek professional advice from several sources concerning investment decision and should study the impact of such decisions on his/her financial/legal/tax position and other concerns before getting into such investments or liquidate them partially or fully. The market of stocks, bonds, macroeconomic or microeconomic are of a volatile nature and could witness sudden changes without any prior warning, therefore, the investor in securities or other assets might face some unexpected risks and fluctuations. All the information, views and expectations and fair values or target prices contained in this report have been compiled or arrived at by AlJazira Capital from sources believed to be reliable, but AlJazira Capital has not independently verified the contents obtained from these sources and such information may be condensed or incomplete. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on the fairness, accuracy, completeness or correctness of the information and opinions contained in this report. AlJazira Capital shall not be liable for any loss as that may arise from the use of this report or its contents or otherwise arising in connection therewith. The past performance of any investment is not an indicator of future performance. Any financial projections, fair value estimates or price targets and statements regarding future prospects contained in this document may not be realized. The value of the security or any other assets or the return from them might increase or decrease. Any change in currency rates may have a positive or negative impact on the value/return on the stock or securities mentioned in the report. The investor might get an amount less than the amount invested in some cases. Some stocks or securities maybe, by nature, of low volume/trades or may become like that unexpectedly in special circumstances and this might increase the risk on the investor. Some fees might be levied on some investments in securities. This report has been written by professional employees in AlJazira Capital, and they undertake that neither them, nor their wives or children hold positions directly in any listed shares or securities contained in this report during the time of publication of this report. This report has been produced independently and separately and no party (in-house or outside) who might have interest whether direct or indirect have seen the contents of this report. It should be also noted that the Research Division of AlJazira Capital had no information at the time of issuing this report regarding any conflict of interest between the company/companies mentioned in this report and any members of the board / executives / employees of AlJazira Capital or any of Bank AlJazira Group companies. No part of this document may be reproduced whether inside or outside the Kingdom of Saudi Arabia without the written permission of AlJazira Capital. Persons who receive this document should make themselves aware, of and adhere to, any such restrictions. By accepting this document, the recipient agrees to be bound by the foregoing limitations. Asset Management Brokerage Corporate Finance Custody Advisory Head Office: Madinah Road, Mosadia P.O. Box: 6277, Jeddah 21442, Saudi Arabia Tel: Fax: