IFRS-11 replaces IAS-31 July 2013

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1 IFRS-11 replaces IAS-31 This report is mainly focusing on the change in the accounting policy for the treatment of joint arrangements (JA). Since the regional and local companies have several joint arrangements so we believe it is necessary to educate the investors on the implication of the change. The new International Financial Reporting Standard (IFRS) -11 (joint arrangements) was published by International Accounting Standard Board (IASB) in May 2011 to replace IAS-31 effective from 01st Jan What has changed? Effective from 1st Jan 2013, all the companies are obligated to adopt the new accounting standard IFRS-11 in place of the old IAS-31; where, the main purpose of both of these standards is to formulate the framework to recognize joint arrangement 1 in consolidated financial statement. However, the key difference lies in the way to formulate the recognition of joint ventures. Framework to recognize joint arrangement IAS -31 Allowed the following two treatments for jointly controlled entities (JVs) in consolidation; Proportionate consolidation. Equity method accounting. In addition, accounting for jointly controlled operations 2 and assets 3 in IAS-31 required related parties to recognize (i) the assets they controlled (ii) liabilities & expenses they incurred and (iii) share of revenues. IFRS-11 IFRS-11 classification of JA is mainly based on the parties rights and obligations under a particular arrangement. According to the given information, the new standard has completely eliminated the option of proportional consolidation of JVs (which was permitted in IAS-31) with equity method (the mechanism will be explained in later stage). However, companies are required to recognize their respective (proportionate accounting; as practiced in IAS-31) shares in assets, liabilities, revenues and expenses in those arrangement falling under JO categories. Key required adjustments Before After Required adjustments Source: Deloitte & Aljazira Capital IAS31 Jointly controlled entity accounted for using the equity method IFRS11 Joint operation De-recognize the equity method investment. Recognize assets (goodwill if any) and liabilities arising from the joint operation. If the amount of net assets recognized exceeds the carrying amount (calculated using equity method investment), the excess reduces goodwill to the extent it exists, with any remaining excess recognized against retained earnings; and If the amount of net assets recognized is less than the carrying amount (calculated using equity method), the difference is recognized against retained earnings. IAS 31 Jointly controlled entity IFRS 11 accounted for using proportionate Joint venture consolidation De-recognize assets (including goodwill if any) and liabilities. Recognize equity method investment at the carrying amount of the net assets de-recognized; and Perform an impairment test and recognize the impairment loss, if any, as an adjustment of retained earnings. Source: Deloitte; IFRS in focus IASB issues new standard on joint arrangement Senior Syed Taimure Akhtar s.akhtar@aljaziracapital.com.sa Saleh AlQuati s.alquati@aljaziracapital.com.sa IFRS-11 (which superseded IAS-31) classifies JAs are those arrangements; where two or more parties have joint control. 1 Joint control (JC); agree to share the control of an arrangement and involvement of both parties are limited to make undisputed consent on a particular decision. Joint operation (JO); a joint control arrangement whereby the related parties have claims on the assets and obligation of the liabilities related to the arrangement. Joint venture (JV); where the related parties of a joint control have rights to the net assets of the arrangement. Like; the JVs of Industries Qatar (IQ) i,e. Qatar Fertilizer Company (QAFCO), Qatar Petrochemical Company (QAPCO), Qatar Fuel Additive Company (QAFAC). Separate vehicles (SV); a separate identifiable financial structure including separate legal identities or entities recognized by law, regardless of whether the entity has legal personality. 2 A joint arrangement; where, the assets and other resources of venture are used rather than the establishment of separate entity; as per IAS A joint arrangement; where, the assets are jointly controlled and have joint ownership; where the assets are dedicated to the JV; as per IAS-31.

2 Impact on the consolidated financial statement As explained earlier the new accounting standard disallowed the proportionate consolidation; hence, the related parties (having significant exposure to JVs) witnessed major impact on revenues, profitability margins, assets and liabilities. However, interestingly, the bottom line and equity remained unaffected due to equity method; but, the implication of new standard on minority interests is based on the nature of joint arrangement. Example 1: Saudi Telecommunication Company 1Q2013 financial statement Post - Equity Method (Unaudited) Pre-Equity Method (Unaudited) Revenue from services Gross profit Net income Fix assets Total liabilities Total murabahas Shareholders equity These financial indicators remained unchanged; because of the recognition of share of net profit/loss income from JVs. Source: STC 1Q2013 financial statement & Aljazira Capital # Kindly note that equity method is applied only on JVs; which is mandatory in IFRS-11. Equity method calculation It is worthy to mention that the new standard only amends the recognition of JVs; but keeps the calculation for equity method as it was explained in IAS-31; where, the following treatments are required under equity method on balance sheet; Calculate the carrying value of investment in JVs ; a new account on the balance; where value is based on the related parties interest in the respective JVs. Adjust the carrying value (opening) of investment in JVs with the share of profit/loss from respective JVs. Reduce the amount of carrying value (opening) with dividend income from these JVs. On the other hand, implication of equity method on income statement is much simple i.e. the recognition of share of profit/loss from JVs. 2

3 Example 2: Industries Qatar 1Q2013 financial statement Profit & loss statement Revenues Direct costs Notes 31-Mar2013 QR 000 Unaudited 1,666,154 1,134,758 GROSS PROFIT 531,396 Share of result of joint ventures 3 1,989,659 share of result of associates 4 18,050 Income form Investment 5 38,246 Other income, net 6 37,497 Genral and administrative expenses 41,742 selling and distributaion expenses 9,504 finance cost 14,672 PROFIT FOR THE PERIOD 2,548,930 BASIC AND DILYTED EARNINGS PER SHARE 11 4,21 Investment in JVs QAPCO QAFCO QAFAC QSIC QFA Total Investment balance as of 1 january 2012 (restated) 5,418,475 9,672,304 1,255, ,346,368 Investment during the years ,000-5,000 Net profit for the year 2,903,227 3,446, , ,001,796 Dividend received during the year 2,517, , ,569) - - 4,010 Fair value movements for the year 10,238 2, ,591 At 31 December ,814,715 12,370,907 1,165,126 5,000-19,355,748 Investment during the period Net profit for the period 762,586 1,037, , ,659 Dividend received during the period - 2,175, , ,275,100 fair value movements for the period - 2, ,859 At 31 March ,301 11,236,577 1,255,197 4, ,073,236 Balance sheet Notes 31-Mar 2013 QR 000 Unaudited ASSETS Non-current assest Property, plant and equipment 7 3,110,320 Investment properties 148,032 Interests in joint ventures 3 19,073,236 Investment in associations 4 1,483,564 Available-for-sale investment 659,173 24,474,325 Current Assets Inventories 1,370,299 Accounts reseivable and prepayments 1,362,293 Due form related parties 134,654 Held-for-trading investments 6,411 Bank balances and cash 8 6,034,096 8,907,753 TOTAL ASSETS 33,382,078 Source: Industries Qatar 1Q2013 financial report & Aljazira Capital 3

4 Recommended valuation approach We at Aljazira Capital believe that the change in policy makes the valuation of affected company more challenging; because, (as explained earlier), the companies are required to adjust their cash flows accordingly. Hence, the valuation approach should focus more on sum of the parts (SOTP) in which all the de-recognized JV (previously considered in cash flows and profitability margins) from consolidated financial statement should be valued separately. However, the biggest challenge to follow the recommended valuation approach is the low disclosure of information of these de-recognized JVs by the respective company. It should be noted that we were using the same SOTP methodology for Industries Qatar (IQ) since our initial coverage; but we update the company s each JV WACC as per the given information. Our DCF based SOTP valuation methodology for IQ (after IFRS-11) WA CC - Qapco 14.1% WA CC - Qafco 12.4% WA CC - Qafac 13.7% WA CC - Qasco 13.8% Amount in QAR 000 Qapco - Net worth Qafco - Net worth Qafac - Net worth Qasco - Net worth WACC of each JV is based on their respective capital structure; based on given information; where Qasco WACC is based on IQ since the company has not recognized Qasco as JV. In addition, we used cost equity of IQ since these JVs are not listed on exchange. Calculations are based on the cash flows and discount rate of each JV. Consolidated - Net worth Source: Aljazira Capital # It should be noted that the consolidated net worth of the company is based on SOTP-DCF based valuation; however, our 12-month price target is based on weighted average valuation technique. IFRS-11 & Aljazira Capital coverage At the time of writing this report the research universe of Aljazira Capital is based on 34 local and regional companies. However, the new standard severely impacts (i) Saudi Telecommunication Company and (ii) Industries Qatar; where significant changes are witnessed in cash flows and balance sheet. 4

5 RESEARCH DIVISION AGM - Head of Research Abdullah Alawi a.alawi@aljaziracapital.com.sa Senior Talha Nazar t.nazar@aljaziracapital.com.sa Senior Syed Taimure Akhtar s.akhtar@aljaziracapital.com.sa Saleh Al-Quati s.alquati@aljaziracapital.com.sa Jassim Al-Jubran j.aljabran@aljaziracapital.com.sa BROKERAGE AND INVESTMENT CENTERS DIVISION General Manager - Brokerage Division Ala a Al-Yousef a.yousef@aljaziracapital.com.sa Sales And Investment Centers Central Region Manger Sultan Ibrahim AL-Mutawa s.almutawa@aljaziracapital.com.sa AGM-Head of international and institutional brokerage Luay Jawad Al-Motawa lalmutawa@aljaziracapital.com.sa Area Manager - Qassim & Eastern Province Abdullah Al-Rahit aalrahit@aljaziracapital.com.sa Regional Manager - West and South Regions Abdullah Al-Misbahi a.almisbahi@aljaziracapital.com.sa RESEARCH DIVISION AlJazira Capital, the investment arm of Bank AlJazira, is a Shariaa Compliant Saudi Closed Joint Stock company and operating under the regulatory supervision of the Capital Market Authority. AlJazira Capital is licensed to conduct securities business in all securities business as authorized by CMA, including dealing, managing, arranging, advisory, and custody. AlJazira Capital is the continuation of a long success story in the Saudi Tadawul market, having occupied the market leadership position for several years. With an objective to maintain its market leadership position, AlJazira Capital is expanding its brokerage capabilities to offer further 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. 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