National Shipping Company of Saudi Arabia

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1 We initiate coverage on Bahri with Overweight recommendation. We believe that the expected expansions and increase in demand of VLCCs are partially priced in. Although marine shipping industry demand is expected to witness growth, market oversupply to keep the market unbalanced. New regulation by International Maritime Organization to reduce sulfur oxide emissions by 2020, is expected to result in scrapping of some old vessels. Bahri oil segment is the key growth catalyst in short-term on the back of further expansions in 2018, along with expected higher demand; whereas Bahri chemical is expected to show modest growth in revenues. Upside potential in Bahri Logistics is limited due to lack of expansion, while Bahri Dry Bulk will increase its fleet for transportation of phosphate and other minerals. We start our initiation with Overweight recommendation and PT of SAR 35.2/share, indicating a 12.5% upside potential. Although marine shipping demand and shipping rates are expected to increase; market oversupply is expected to keep the industry unbalanced: Marine shipping industry is known for its high and intense competition, which has resulted in sector consolidation in order to control supply. According to Clarksons Research (Source: Bloomberg) VLCC demand is expected to increase by 5.2%YoY and the fleet size to record 3.8% growth in They also expect 46 VLCCs to be delivered in 2018 and 34 in By 2020, all vessels operating worldwide will be required to reduce sulfur oxide emissions. This will result in scrapping of some old vessels and a reduction in the oversupply. Shipping rate is expected to witness a gradual recovery in 2018 from the current level, however the increase will be limited as the industry is already oversupplied after 2 consecutive years of 6% increase in fleet size(2016/2017). Number of vessels in service in marine shipping industry grew at CAGR of 4.25% from 11,300 vessels in 2006 to stand at 17,865 in 2017 according to Bloomberg. We expect the company to witness earning growth on the back of an expanding fleet, along with improved demand. An increase in global trade will be a key factor for the company to increase profitability: National Shipping Company of Saudi Arabia Bahri, has a solid source of demand through its partnership with Saudi Aramco, since it is the main carrier for ARAMCO (41% of total revenue in 2017). The company s total fleets currently stand at 91 vessels and is expected to reach 97 vessels by FY2020. Bahri operates in four main segments i)bahri Oil, ii)bahri Chemical, iii) Bahri Logistics and iv) Bahri Dry Bulk. Bahri Oil contributed 61.8% of revenue in FY2017, and is expected to maintain its level of contribution in FY2018. Bahri Logistics is the second largest segment with a contribution of 18.9% to total revenue in FY2017, and is expected to increase to 19.2% for FY2018. The company showed a significant decline in earnings during FY2017, due to decline in shipping rates. Bahri Oil was the only sector to show a 22.3%YoY decline in revenue. Bahri Logistics and Bahri Dry Bulk showed a growth of 22.0%YoY and 33.6%YoY respectively. Bahri Chemical showed a growth of 4.0%YoY. Gross margin for the period showed a decline of 604bps, mainly due to 11% decline in revenue. Net income for the period showed a decline of 53.4%YoY. Recommendation Overweight Current Price* (SAR) 31.3 Target Price (SAR) 35.2 Upside / (Downside) 12.5% Source: Tadawul, Prices as of 18 th of March 2018 Key Financials SARmn (unless specified) E 2019E Revenue EBITDA EBIT Net Income EPS Key Ratios SARmn (unless specified) E 2019E Gross Margin 21.8% 20.8% 20.8% Net Margin 13.2% 14.1% 14.1% P/E P/BV EV/EBITDA Dividend Yield 4.8% 5.7% 6.5% ROA 3.8% 4.1% 4.6% ROE 8.1% 8.6% 9.5% Shareholders Pattern Shareholders Pattern Holding Public Investment Fund 22.5% ARAMCO 20.0% Public 57.5% Key Market Data Market Cap (SAR) YTD % 0.41-% No. of Shares (mn) Week High week Low Source: Tadawul, Aljazira Capital Price Performance: Revenue per Vessel per Day (USD) Segment E 6600 Apr-17 May-17 Jul-17 Aug-17 Oct-17 Nov-17 Jan-18 Feb Bahri Oil* 63,500 58,600 TASI Bahri Bahri Chemical 19,200 20,200 Source: Bloomberg, Aljazira Capital 1 Bahri Logistics 1,0 146,200 Bahri Dry Bulk 53,700 49,800 *Based on the average number of vessels for the mentioned year. Waleed Al-jubayr W.aljubayr@aljaziracapital.com.sa

2 Bahri Oil Bahri Oil is the biggest segment of the company with a fleet of 49 vessels. The company signed a contract with Hyundai Samho Heavy Industries to build 10 VLCCs (Very Large Crude Carrier) for expanding its fleet size, where 8 vessels had been received by the company and the remaining will be received in 1H2018. Despite the expansion in the fleet, the decline in spot prices of shipping rates had a significant impact on the company s performance. Going forward, expansions and higher VLCC demand is expected to increase the company s profitability, as Oil demand is expected to increase by 1.3mbpd 1. We expect revenues from Bahri Oil to increase at a CAGR of 8.91% by Revenue & Gross Margin of Bahri Oil 6000 %33.0 SAR (mn) %31.0 %29.0 %27.0 %25.0 %23.0 %21.0 %19.0 %17.0 In 2015, revenue increased by 167.8% due to completion of acquisition of Vela and an increase in shipping rates. However, shipping rates started to decline in 2H2016, resulting in revenue decline of 9.3%YoY in E 2019E %15.0 Revenue (LHS) Gross Margin (RHS) VLCC Rate vs Brent Prices: Source: Company Reports, Aljazira Capital. VLCC shipping rate ended at $15K/day by the end of 2017; down from its highest point in 2015 (around $113K/day). The decline is attributed to lower VLCC demand, as the largest oil consumer such as US and China started to withdraw oil from strategic inventories. Furthermore, we expect the supply-demand balance to start to tighten during 2018 given continuing robust growth in demand and the global drawdown in stocks. According to the official statistics, US commercial crude oil inventories declined to 423.9mn barrels in 23 February-2018 from 550mn barrels in March In addition, Venezuela s oil sector and Iranian nuclear deal are at risk of US sanctions, that is likely to speed up the oil market re-balance VLCC rates are negatively correlated with oil prices, correlation (daily) stands at Since 2009, VLCC rate reached the highest point by the end of 2015, while oil prices declined significantly in the same time period. Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 VLCC rate Brent Source: Bloomberg, Aljazira Capital. Bahri Chemical: The Bahri Chemical segment is 80% owned by Bahri and 20% by SABIC and fully operated by National Chemical Carrier (NCC). NCC handle s liquid bulk chemicals, clean petroleum products and vegetable oils. In 2017, although Bahri Chemical showed a growth of 4.0%YoY in revenue, higher bunker cost was witnessed due to an increase in oil prices and resulted in weak margins and performance. We expect Bahri Chemical to witness modest and stable growth in revenues for the upcoming three years. Bahri Chemical expanded its fleet in 2016 from 26 vessels to 31 vessels and we expect the company to maintain its fleet size. The company is expected to benefit benefit from Saudi petrochemical expansions and exports in the coming years. 2 1 IEA

3 Major Expansions in Petrochemical Sector Company Capacity Commercial operation SADARA 3.2MT 1H2018 Petro Rabigh (phase 2) 5.0MT Petrochemical products, and 15MT of petroleum products 2H2018 SABIC/ARAMCO 9.0MT 2025 Bahri Logistics: Logistics has the second largest share of total revenue, with contribution of 18.9% in Bahri Logistics showed a growth of 22.0%YoY, and is expected to show growth of 4.1% in FY2018. Bahri logistics has a fleet of 6 roll-on/roll-off (ro-ro) vessels and capacity of 26,000 ton/vessel. We expect the segment s revenue to increase at CAGR of 3.74% for period Going forward, we believe segment s revenues to continue its current trajectory, at a slower rate. We believe that in order to continue its current high growth, the company needs to increase its fleet. However, we do not expect the company to increase its fleet with the current capital structure. Bahri Dry Bulk (BDB): Bahri Dry Bulk is the smallest segment with contribution of 6.0% in total revenue for FY2017 (up from 4.0%). Bahri Dry Bulk was setup by Bahri (60% holding) and ARASCO (% holding), an agricultural company. The company has a fleet of 5 vessels that has been rented to ARASCO with a capacity of 81,855 ton/vessel. The company signed a SAR 450mn contract with Hyundai Heavy Industries to build 4 bulk carriers; as the company is expected to enter new markets of phosphates and minerals. Bahri is expected to benefit from an increase in phosphate production from MADDEN, as an additional phosphate production of 5.3MT is expected to be added by 2H2018. Global dry bulk shipping is expected to show growth of 2.4% in 2018 according to Clarksons Research. The growth will be driven by iron ore (increase 3%), coal and grains (increase 2%). Gross margin declined to 21.84% for FY2017, a decline by 604bps, as higher bunker and depreciation cost pushed direct costs higher. For 2018, we expect margins to decline to 20.8% as a result of higher depreciation. Overall earnings are expected to increase due to upcoming expansion. Bunker cost (key cost element of total direct cost) is highly correlated with oil prices movement, as oil prices increased in 2017 prices of bunker fuel 380 also increased by 9.7%YoY in Higher cost and lower shipping rates pressured the margins, consequently resulting in lower earnings. In addition, the government intends to gradually reduce subsidies (bunker subsidy) on fuel starting from 2019, and to completely remove the subsidy by Total bunker subsidy as percent of net income stood at 20.5%. However, as the subsidy will be removed gradually we do not expect any strong immediate impact on the company. Furthermore, depreciation is also a key element of total direct cost, contributing 16.3% of total direct cost in We expect depreciation to increase by 15.4%YoY in 2018, attributed to higher CAPEX. Bunker Cost vs. Brent Prices Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Apr-17 May-17 Jul-17 Aug-17 Oct-17 Nov-17 Jan-18 Feb Correlation (weekly) between bunker cost and Brent prices is at Bunker cost currently at highest level since February Marine Shipping companies benefit from decline in oil prices as cost decline and shipping rates increase. Bunker Fuel 380 cst (USD/metric tonne) Brent Source: Bloomberg, Aljazira Capital. 3

4 Receivables at 24.3% of total revenue by end of FY2017. However, receivable collection is not a concern as SAR 782mn (53.0% of total receivables) is owed from Aramco ( SAR 266.1mn) and government entities: Receivables increased by 37.4% by end of 2017 and stood at SAR 1.47bn. As percentage of revenue, receivables increased to 24.3% in 2017 from 15.8% in 2016 due to decline in revenue and lower receivables turnover at 4.10x compared to 6.33x in Going forward, receivables as percentage of sales is expected to decline and turnover to increase. Aging Schedule of Receivables (SAR mn) Period Less than 6 months months More than 12 month Provisions (31.1) (32.8) 4 Net debt to EBITDA currently stands at 4.95x compared to its global peers at 4.45x. The company debt to total capital stood at 50.8% by end of Historically, the company debt to total capital has remained in the range of 45-50%. We expect the company to maintain its current capital structure at the current level. FCFF came negative in 2017 as CAPEX exceed the CFO: The Company raised its debt in order to expand its fleet and acquire Vela International in Total debt stood at SAR 10.3bn by end of Total bonds of SAR 3.9bn will be repaid by Total debt increased at a CAGR of 7.87% ( ). We expect the debt to increase, albeit at a slower rate, since the company has already allocated the needed fund for upcoming expansion. The company s current interest coverage ratio stands at 3.65x a decline from 7.43x in 2016 and 14.97x in 2015, primarily due to lower earnings and increase in finance expenses. Going forward, we expect the interest coverage ratio to decline in 2018 due to higher finance expenses. The Federal Reserve is expected to increase interest rate three times by total a 75bps in 2018, accordingly higher SAIBOR rate would add more pressure on the company s profitability. Net debt/ebitda stands at 4.95x, higher than its global peers at 4.45x. However, we expect net debt/ebitda to decline to 4.64x in 2018, due to improvement in earnings. We initiate Bahri with an Overweight recommendation and PT of SAR 35.2/share, indicating upside potential of 12.5%. We believe the positive outlook is partially priced in: Bahri is currently trading at P/E of 15.42x (P/BV of 1.30x)and forward P/E of 14.90x (P/BV of 1.21x) compared to market P/E of 16.38x. We believe that the upcoming expansions and growth in revenue are mostly priced in. The company announced that it will sell part of its holding in Petredec Ltd. (holding of 30.3%). The company reclassified SAR 251mn of its holding as held for trading investment which we expect to sell at capital gain in 2018 and improve the company net debt position. Higher than expected increase in shipping rates and expansion in Bahri chemical and Bahri Logistics are the main upside risk to valuation. On the other hand, down side risk include continued pressure on shipping rates, delay in announced expansion and higher financing cost. In addition, geopolitical issues in the region is the main concern for the company. Our valuation is based on 5-year DCF, a 2.0% terminal growth and a 2-year weekly beta of 1.15 (Bloomberg). WACC is taken at 9.1%; we have arrived at a PT of SAR 34.6/share indicating upside potential of 10.5%. Summary of Financial Statements: Income Statement E 2019E Sales 6,805,921 6,045,835 6,196,744 7,104,329 YoY Growth -9% -11% 2% 15% Gross Profit 1,917,786 1,320,681 1,287,019 1,477,974 Operating Profit 1,805,263 1,125,209 1,128,542 1,317,912 Net profit 1,741, , ,896 1,000,850 EPS Balance Sheet E 2019E Cash and Cash equivalents 2,079,993 1,190,441 1,365,277 2,264,260 Trade receivables 1,091,606 1,474,988 1,426,918 1,343,948 Other Current Assets 661, , , ,075 Total Current Assets 3,832,645 3,629,374 3,516,642 4,358,284 Fixed Assets 13,661,896 14,746,536 15,513,098 15,204,783 Share in Associated Company 1,123, ,161 1,042,155 1,267,309 Other Non-Current Assets 2,238,743 1,811,512 1,513,125 1,066,623 Total Non-Current Assets 17,024,487 17,553,209 18,068,378 17,538,714 Total Assets 20,857,132 21,182,583 21,585,020 21,896,998 Current Liabilities 2,0,995 2,014,500 1,911,857 1,876,656 non-current Liabilities 8,729,0 9,250,052 9,461,906 9,537,543 Share Holder Equity 10,087,097 9,918,031 10,211,256 10,482,799 Total Equity and Liabilities 20,857,132 21,182,583 21,585,020 21,896,998

5 RESEARCH DIVISION Head of Research Talha Nazar Waleed Al-jubayr Sultan Al Kadi, CAIA Muhanad Al-Odan Jassim Al-Jubran BROKERAGE AND INVESTMENT CENTERS DIVISION General Manager Brokerage Services & sales Alaa Al-Yousef AGM-Head of Sales And Investment Centers Central Region Sultan Ibrahim AL-Mutawa AGM-Head of international and institutional brokerage Luay Jawad Al-Motawa AGM-Head of Qassim & Eastern Province Abdullah Al-Rahit AGM- Head of Western and Southern Region Investment Centers Mansour Hamad Al-shuaibi RESEARCH DIVISION AlJazira Capital, the investment arm of Bank AlJazira, is a Shariaa Compliant Saudi Closed Joint Stock company and operating under the regulatory supervision of the Capital Market Authority. AlJazira Capital is licensed to conduct securities business in all securities business as authorized by CMA, including dealing, managing, arranging, advisory, and custody. AlJazira Capital is the continuation of a long success story in the Saudi Tadawul market, having occupied the market leadership position for several years. With an objective to maintain its market leadership position, AlJazira Capital is expanding its brokerage capabilities to offer further 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. 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. 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