The petrochemical sector in Saudi Arabia: An understanding of the industry and review of its

Transcription

1 The petrochemical sector in Saudi Arabia: An understanding of the industry and review of its prospects, Expected including rate of investment return on opinions equity in on GCC 2 key sector players: SABIC and SAFCO. July 2009 Department شركة الكويت والشرق األوسط لإلستثمارالمالي ش.م.ك.م Kuwait and Middle East Financial Investment Company K.S.C.C

2 INTRODUCTION... 3 HIGHLIGHTS... 4 PETROCHEMICAL INDEX VS. TADAWUL... 5 PORTER S 5 FORCES ON THE PETROCHEMICAL INDUSTRY... 6 THREAT OF NEW ENTRANTS... 7 SUPPLIERS POWER... 7 THREAT OF SUBSTITUTES... 7 BUYERS POWER... 7 BUSINESS RIVALRY... 7 BASIC PRODUCTION FLOW... 9 PETROCHEMICAL... 9 FERTILIZER... 9 MACROECONOMIC OVERVIEW GROSS DOMESTIC PRODUCT & KEY GROWTH INDICATORS OIL VULNERABILITY THE GLOBAL FINANCIAL CRISIS OIL & GAS OUTLOOK MARKET DYNAMICS OIL OUTLOOK GAS OUTLOOK FEEDSTOCK COST ADVANTAGE CAPACITY AND INFRASTRUCTURES SAUDI BASIC INDUSTRIES CORPORATION (SABIC) COMPANY & BUSINESS OVERVIEW FINANCIAL PERFORMANCE & VALUATION PROJECTS, STRATEGY SAUDI ARABIAN FERTILIZER COMPANY (SAFCO) COMPANY & BUSINESS OVERVIEW FINANCIAL PERFORMANCE & VALUATION PROJECTS, STRATEGY APPENDIXES SABIC BALANCE SHEETS SABIC INCOME STATEMENTS SABIC CASH FLOW STATEMENTS SAFCO BALANCE SHEETS SAFCO INCOME STATEMENTS SAFCO CASH FLOW STATEMENTS... 29

3 INTRODUCTION As the world tries to anticipate and looks out for potential signs of recovery, attention is unavoidably drawn to basic commodities such as oil and gas whose availability and prices partly shape the world growth. This has become even more relevant to petrochemical companies in the Middle East whose competitive advantage lies in the feedstock of their activities and whose profitability is therefore highly conditioned to oil and gas prices. Among GCC countries, one in particular, thanks to its abundant natural resources, has gained prominence on the global petrochemical scene. In less than a few decades, Saudi Arabia has become the largest producer of petrochemical products in the Middle East, accounting for about 6% of the global ethylene capacity in 2007 or 7 million tonnes, up 600% from Indeed, the gulf country which possesses around 20% of the world s proven oil reserves (or billion barrels 2 ) and enjoys the fourth largest natural gas reserves in the world (258.4 trillion cubic feet 2 ) in 2008 (year end) has long provided its successful home companies with an undisputable and sustainable strategic competitive advantage. Basic chemical products prices being highly correlated with oil and gas prices, the petrochemical industry in Saudi Arabia has displayed strong growth and high profitability since But this golden growth unexpectedly stopped in H as oil prices fell dramatically from a record USD147 per barrel in July 2008 to about USD40 per barrel at 2008 year end, with most petrochemical prices going down subsequently amid worldwide equities meltdown. Though oil prices recovered higher levels in H1 2009, the global crisis has posed challenging questions regarding the expected growth and profitability of the petrochemical sector. This report provides an overall understanding of the petrochemical industry in Saudi Arabia, addresses some key factors to its prospects and presents valuation of two leading Saudi companies in their industry: Saudi Basic Industries Corporation, SABIC (petrochemicals) and Saudi Arabian Fertilizer Company, SAFCO (fertilizers). 1 Energy International Administration, Oil & Gas Journal, 2009 The petrochemical sector in Saudi Arabia P a g e 3

4 HIGHLIGHTS Saudi Arabia s economy to be impacted by the crisis, but GDP s growth expected to remain positive in FY09 thanks to government stimulus package including a USD400 billion investments and development program announced by Saudi s officials during the G20 meetings last April. Absolute feedstock competitive advantage on the back of rising oil & gas prices trend (gas prices had already risen 20% in April MoM while oil prices gained almost 50% from late December FY08 to end of June FY09) to considerably help major petrochemical companies weather the financial crisis successfully. Global ethylene capacity is expected to reach 173 millions of tonnes in 2015, up 47% from 2005 with Middle East growing almost 6 times as fast as the world average. Saudi Arabia ethylene capacity to reach 18.2 m tpa in 2013, more than double from that of 2008 levels, taking the KSA s global ethylene capacity production market share to circa 12%, with Jubail and Yanbu the focus of petrochemicals developments over the mediumterm. Middle East to become the only net ethylene derivatives exporter in 2015, growing its trade flow by circa 226% from 2005, with the Asia Pacific region growing its net trade flow (imports) to about 21 millions of tones in 2015 up 130% from 2005 driven by China s strong anticipated growth. Petrochemical market in Saudi Arabia expected to recover in H2 FY09, but magnitude and timing to depend on global recovery. Table 1 - Valuation highlights LT FV CMP (30-June-09) Upside/(Downside) Comments SABIC % SAFCO % Source: * Strong feedstock advantage * Petrochemical demand expected to recover from H1 FY09 but the magnitude of recovery will depend on global recovery * Financials heavily impacted by bad performing US subsidiary (former GE plastics) in H1 FY09 (SAR1.2 billion impairment charge booked) * Successful business model: high margin thanks to absolute cost advantage - very good cash conversion cycle - low CAPEX requirements low leverage * Fertilizer demand strong in the long run - less sensitive to economic cycle (high correlation with agricultural needs) The petrochemical sector in Saudi Arabia P a g e 4

5 PETROCHEMICAL INDEX vs. TADAWUL Petrochemical Index Vs. Tadawul Index (& Sector shares trading volume) 12,000 Volume (Million Shares) 10,000 Tadawul Index (TASI) Petrochemical Index (Rebased) 8,000 6,000 4, Million shares 2, J-08 J-08 A-08 S-08 O-08 N-08 D-08 J-09 F-09 M-09 A-09 M-09 J-09 0 Source:, TASI The petrochemical sector is of key importance in the Saudi Stock Exchange. It is, indeed, composed of 13 companies, which altogether made around USD50 billion in revenue and USD7 billion in net earnings in FY08. As of 30 June 2009 the petrochemical sector accounted for more than 30% of the total market capitalization on the Saudi Stock Exchange, tied with the banking and financial services sector. The Tadawul was not spared by the global financial crisis. From end July 2008 to end November 2008 the Tadawul Index, TASI, dropped by circa 50% to low record 4,424 driven down by the petrochemical index on concerns about plummeting oil prices, which over the same period decreased by almost 70%. As a matter of fact, Q4 FY08 was one of the worst quarters to date with companies fourth quarter s earnings literally plunging. Petrochemical heavyweight SABIC Q4 FY08 net earnings decreased by 96% QoQ to SAR0.3 billion, when fertilizer giant SAFCO Q4 FY08 net earnings dropped to SAR0.5 billion, down 71% QoQ and 28% YoY. However, from end November 2008 on until end March 2009, the TASI remained relatively stable overall, with the petrochemical index moving similarly to the TASI. End of March marked an apparent recovery for the TASI with the index going overall upward by 19% from 31 March 2009 to 30 June 2009, boosted by the petrochemical index, which over the same period recovered twice as fast (+ 41%) on the back of a USD400 billion stimulus plan (investment and development program for the government and the monetary sectors for the next five years) adopted and disclosed by the Kingdom during the G20 summits in early April. Likewise, sector volumes traded in April and May respectively increased by 18% and 44%. The petrochemical sector in Saudi Arabia P a g e 5

6 PORTER S 5 FORCES ON THE PETROCHEMICAL INDUSTRY In order to assess the attractiveness (or competitive intensity) of the Petrochemical Industry, we relied on Michael Porter s 5 forces framework. Figure 2 - Porter's 5 forces on the Petrochemical Industry Suppliers power: HIGH Threat of new entrants: LOW Petrochemical Industry Threat of substitutes: LOW Business rivalry: LOW Buyers power: LOW Source: M. Porter, The petrochemical sector in Saudi Arabia P a g e 6

7 THREAT OF NEW ENTRANTS We considered the threat of new entrants to be low because barriers to entry include high capital cost, economies of scale, distribution channels, proprietary technology, environmental regulation and geopolitical factors. Furthermore, high levels of industry expertise are needed to be competitive at all levels in the petrochemical field. In addition, fixed cost levels are high for upstream, downstream, and chemical products. It is therefore very hard for new players to enter this market. SUPPLIERS POWER Suppliers bargaining power can be considered as high since the Organization of Petroleum Exporting Countries (OPEC) controls around 50% of the world s supply of oil and owns about two thirds of the world oil reserves (EIA, 2007). This consequently gives this organization a strong influence over oil prices. OPEC s influence on oil prices can thus be considered as a threat for companies which use oil & gas as feedstock as it can exert a considerable degree of uncertainty over the company s chemical production costs. In fact, as it will be elaborated further in the section entitled The feedstock cost advantage, abundant natural resources in the Middle East countries in general (and Saudi Arabia in particular) has given the region a strategic position for key players in the petrochemical industry. THREAT OF SUBSTITUTES The threat of substitutes and new processes in the short term (next 20 years) can be regarded as low. The petrochemical industry produces materials such as plastics, synthetic rubbers, fibers and solvents which are indispensable to our everyday life products (in the form of packaging, clothes, computers, furniture, etc). Often these products generate energy savings during their use which by far outweigh the energy used to produce them. In fact, the petrochemical industry accounts for 30% of total global industrial final energy use and about 8% of world oil consumption (EIA, 2007). Besides, more than half of the energy used by the chemical industry is stored as feedstock in its product. Because of the high share of feedstock energy, the process energy efficiency using substitutes is quite limited, at least in the short term. Biomass feedstock could help to reduce CO2 emission and fossil fuel independence, but most experts argue this would be an option in the longer term, as its efficiency levels have yet to be proven competitive to oil and gas resources. BUYERS POWER Buyers can either be industrials or consumers. In both cases their power is quite limited due to the nature (necessity) of the petrochemical products. However, the continuous search for price reductions and higher margins has led more and more companies to settle their operations in Middle East countries to benefit from low cost feedstock. BUSINESS RIVALRY Due to tight regulations and high capital requirements, rivalry has been relatively low even while The petrochemical sector in Saudi Arabia P a g e 7

8 the industry has been growing quite fast (in average 2 or 3% more than countries Gross Domestic Products). Indeed, the biggest share of the market is still split between a few major companies which have extended their operations from upstream to downstream and petrochemical activities. The petrochemical sector in Saudi Stock Exchange is composed of 13 listed companies, SABIC and SAFCO respectively amounting for 89% and 2.5% of market shares in 2008 (revenues for all public petrochemical companies). The petrochemical sector in Saudi Arabia P a g e 8

9 BASIC PRODUCTION FLOW The below sections lay out the different materials and processes involved in the production of petrochemical products and fertilizers and bring out the importance and location of oil and gas feedstock s within the production chain. PETROCHEMICAL Figure 3 (page 10) shows the global framework of the petrochemical industry from inputs (feedstock) to derivatives and end markets. FERTILIZER Figure 4 displays in more details the production process of ammonia, one of the most important basic chemical serving as a core component in the production of nitrogen fertilizer and urea. Urea is the most popular and commonly used nitrogen fertilizer worldwide. Figure 4 - Ammonia & Urea Production Process Natural Gas Desulphurizer Steam Primary Carbon Urea Separation & Reformer Dioxide Synthesis Purification Air Secondary CO Shift CO2 CO & CO2 Synthesis and Urea Solution Reformer Converter Absorber Methanator Refrigerant Section Concentration Prilling Ammonia Storage Tank Granulation Urea Storage Shipping Source:, SAFCO The petrochemical sector in Saudi Arabia P a g e 9

10 Figure 3 -Summary of major petrochemicals production chain Inputs Basic Building Blocks Intermediates Derivatives End Markets Titanium Dioxide Paints, Plastic, Paper Ore Phosphoric Acid Sulfuric Acid Ore Ammonia Fertilizers Agriculture Salt (Brine) Caustic Soda PVC, Aluminium, Paper, Other Chemicals Chlorine Steel, Electronics, Food, Medical Electricity Oxygen Nitrogen MTBE Gasoline Blending Natural Gas Methanol NGLS Vinyl Chloride PVC Construction, Medical Equipment Natural Packaging, Durables Polythylene Gas Liquids Alpha Olefins Ethylene Polyethylene Ethyline Oxide Ethylene Glycol Polyester fibers and plastic, Antifreeze Ethane Styrene Polystrene Packaging, Insulation Propane Synthetic Rubber Butane ABS Appliances, Automotives Acrylonitrile Propylene Acrylic Fibers Clothing Acrylic Acid Acrylates Paints, Adhesives Superabsorbants (Diapers) Propylene Oxide Polyurethanes Furniture, Automotive, Insulation Polypropylene Automotive, Consumer Products Crude Oil Refining Benzene Cumene Phenol/Acetone Polycarbonate, Epoxies, Adhesives (Nahtha/Gas Oil) Cyclohexane Nylon Automotive, Carpets, Hosiery, Cords Butadiene Fuel DMT/PTA Polyester Clothing, Contaners, Bottles (PET) Xylene Ethylene Glycol Source: HSBC, The petrochemical sector in Saudi Arabia P a g e 10

11 MACROECONOMIC OVERVIEW We will regard all GDP related issues with particular attention, as the demand for petrochemicals has been growing at around 3% above the world GDP. GROSS DOMESTIC PRODUCT & KEY GROWTH INDICATORS Table 2: Key Macroeconomic Medium-Term Indicators Saudi Arabia 2004 A 2005 A 2006 A 2007 A 2008 A 2009 E 2010 E Average Import Crude Price & WTI* (USD/B) Real GDP Growth Rate, % Population (mn) GDP/Capita (USD) 19,487 21,236 22,033 22,852 23,834 23,255 23,448 CPI Inflation (Y-o-Y % Change) Net Foreign Assets (USD Bn) Source: SAMA, IMF, BMI and *- West Texas Intermediate Since 2003, Saudi Arabia has been able to achieve strong growth thanks to high oil revenues and a relatively fast expansion of the non oil sector. As a matter of fact, since 2003 growth has averaged 4.3% with a significant and increasing contribution from the non oil sector (Table 2, Figure 5). Furthermore, net foreign assets constantly increased over the past 8 years to reach an estimated USD450 billion in 2008 (Figure 6). Besides, the issue of population growth in the Middle East has come into prominence. Indeed, the Arab population has been growing at a relatively fast pace, at an average rate of 3% per year for the past decade. This strong population increase has raised some challenging economic issues for governments in the region. The main question being that in order to grow GDP per capita in an environment where population grows at 3% per year and inflation grows at 1.5% (at least) per year; governments have to find ways to grow their GDPs by at least 5% per year to generate real GDP growth of 0.5%. As displayed in Table 2, Saudi Arabia was able to grow its GDP per capita at CAGR 5.4% from 2004 to The country s remarkable growth was accompanied by ambitious developments plans implemented by the government, which among many initiatives helped the country diversify its sources of revenues. The petrochemical sector in Saudi Arabia P a g e 11

12 Figure 5: Saudi Arabia real oil & non-oil GDP growth Figure 6: Net Foreign Assets Position 10% 8% 6% 4% 2% 0% -2% -4% Real oil GDP Real non-oil GDP Net Foreign Assets (USD Bn) Net Foreign Assets as % of GDP 100% 80% 60% 40% 20% 0% Source:, IMF Source:, SAMA Saudi Arabia is currently undergoing its 8 th five year development plan (spreading from 2005 to 2009). It marks a new phase in the development process of the kingdom of achieving long term sustainable development. Emphasis has been placed on key priorities among which are the diversification of the economic base and the improvement of the productivity and competitiveness of the national economy. Considerable attention has been given to promising areas such as strategic and manufacturing industries, the natural gas industry and information technology. Thus, oil wealth is being invested over the medium term to expand the non oil sector and boost oil production capacity to support global oil market stability (Figure 7). Figure 7: Investments breackdown from Power & water 10% Real estate 12% Petrochemicals 15% Source:, IMF Industry 5% Oil & Gas 23% Infrastructure 35% The petrochemical sector in Saudi Arabia P a g e 12

13 OIL VULNERABILITY While oil importing countries might have welcome the fall in oil prices since mid-2008, this is certainly not the case for oil exporting countries, many of which are subsequently expecting dramatic declines in their fiscal balances along with much less growth in their net foreign assets and in their GDPs. Indeed, a heavy concentration of economic activity in the hydrocarbon sector naturally tends to raise a country vulnerability to sharp drop in oil prices. Standard & Poor s recently released their oil price vulnerability index ranking 3, placing Saudi Arabia second among the countries whose overall economy can be most impacted by oil prices fluctuations. Note that fiscal outturns are logically expected to weaken in 2009, in line with falling oil prices and revenues and the government deliberate countercyclical expansionary fiscal policy (elaborated further in the global financial crisis section of our report), with total expenditure expected to rise by 16% relative to 2008 budget. The government balance should, consequently, reach a deficit of circa 7% of GDP, reversing from a 20% surplus in average over the past four years. Nevertheless, Saudi Arabia holds enough cumulated fiscal surplus to digest this deficit in the medium term. THE GLOBAL FINANCIAL CRISIS Figure 8: Saudi Arabia real GDP growth forecasts Figure 9: World & Middle East real GDP growth forecasts 5% 7% 4% 3% GDP 6% 5% 4% Middle East World 2% 3% 1% 2% 1% 0% FY08 FY09 E FY10 E FY11 E FY12 E FY13 E 0% -1% FY08 FY09 E FY10 E FY11 E FY12 E FY13 E -2% Source:, BMI Source:, IMF We do not expect Saudi Arabia to miraculously avoid the hit already taken by most countries amid the downturn. Falling oil pricing, declines in consumer spending, exports and imports should certainly undermine the Kingdom s growth. However, as pointed out by Business Monitor International, there are still grounds for positive growth in 2009 thanks to government spendings and the momentum from ongoing infrastructure projects. Furthermore, the financial framework can reasonably be considered as stable, which will encourage investments. Indeed, the Saudi government, whose net asset position has been forecasted at 170% of GDP in FY09 3, holds 3 Gulf Cooperation Council Credit Survey, Standard & Poor s, June 2009 The petrochemical sector in Saudi Arabia P a g e 13

14 enough cash reserve to step in and rescue companies for political reasons. Furthermore, the government stimulus plans adopted to cope with the crisis will certainly bear fruits in the near term (Table 3). During the G20 summit meetings, held in London last April, Saudi Arabia adopted a USD400 billion investment and development program for the government and the monetary sectors for the next five years, comforting the country s ambition to become one of the world s ten most competitive economies by 2010 (the 10x10 plan). This was one of the largest economic initiatives prepared during the discussions of the economic recovery program for global economies. Finally, Saudi Arabia s GDP growth is expected to reach above 3% by 2013 while the world should experience a continued growth from 2010 to 2013 (Figure 9), strongly driven by emerging economies (particularly the BRIC: Brazil, Russia, India and China). Table 3: Fiscal and Monetary Policy Stimulus Measures Intervention Measures Sep-08 Oct-08 Central Bank pledges liquidity to banking sector if needed Central Bank says that banks have option to borrow up to 75% of the value of their government paper holdings but none have taken up this offer Oct-08 Repurchase rate cut by 100bps to 4.00% Oct-08 Reserve requirement cut from 13% to 10% Oct-08 Oct-08 Oct-08 Central Bank guarantees all deposits in banking sector Central Bank injects USD 3 bn into banking system USD 2.7 bn credit facility extended to low-income Saudis Nov-08 Repurchase rate cut by 100bps to 3.00% Nov-08 Reserve requirement cut from 10% to 7% Dec-08 Dec-08 Jan-09 Record-breaking USD bn budget announced Repurchase Rate but by 50bps to 2.5%, reverse repurchase rate cut by 50bps to 1.5% Public Investment fund announces it will extend project loan durations to 20 years, including a five-year grace period, from 15 years and will raise a cap on project lending to 40% of the value of the project from 30% Jan-09 Reverse repurchase rate cut by 75bps to 0.75% Apr-09 Reverse repurchase rate cut by 25bps to 0.5% Apr-09 USD400 Bn investments and development program Source: BMI, The petrochemical sector in Saudi Arabia P a g e 14

15 OIL & GAS OUTLOOK MARKET DYNAMICS With around billion barrels of proven oil reserves 4 (around one-fifth of the proven, conventional world oil reserves) and trillion cubic feet of natural gas 4 (the fourth largest natural gas reserves in the world), Saudi Arabia enjoys an enviable, unparalleled advantaged energy and feedstock position; the revenue from oil & gas in turn supporting further investments and developments. Oil & Gas prices impact petrochemical development when they are high or low. Although there can be negative impact, the energy advantage prevails under both scenarios. Scenario I: High or relatively high oil prices imply that gulf countries in general maintain a share of the market at or near current levels. However, higher oil prices may also likely negatively impact the world economy, which translates into lower petrochemical demand growth and the requirement for fewer capital expenditures. As the incremental low cost producing region, petrochemical investments in the Middle East are likely to be maintained (thanks to higher cash margins) at the expense of other regions. Scenario II: Although it might have been hard to seriously consider for many until recently, low oil prices have the negative effect of reducing the inherent advantage of gulf petrochemical producers. Nevertheless, very low oil prices would have to be sustained for an extended period of time before investment economics were adversely affected. Prices would actually have to drop considerably lower before Middle East ethane based producers had difficulty competing on a delivered polyethylene cash cost basis (cf feedstock cost advantage section). Should oil prices be sustained for a long time, the demand in petrochemical products would grow as consumers would certainly fancy lower priced products. The resulting growth in the sector would push the need for more facilities (potentially outside of the Middle East). However, one should understand that very low oil prices for a very long period of time might be unlikely to occur as OPEC countries which control around 50% of the world s supply of oil and own about two thirds of the world oil reserves would step in to influence market prices (up or down), trying to find consensus for their own benefits and the world economy. 4 Oil & Gas Journal, 2009 The petrochemical sector in Saudi Arabia P a g e 15

16 2007 Dollars per Barrel July 2009 OIL OUTLOOK Figure 10 - World Oil Prices in three price cases Reference High Price Low Price Source:, Annual Energy Outlook 2009 In its latest issue of the Annual Energy Outlook (May 2009), the Energy International Administration laid out its updated assumptions on oil prices up to 2030 based on three price scenarios depending on economic growth. As expectations for future GDP growth rates may be subject to many uncertainties, the EIA included a high economic growth case (0.5 percentage point added to the growth rate assumed for each country in the reference case) and a low economic growth case (0.5 percentage point subtracted to the growth rate assumed for each country in the reference case) in addition to the reference case. The effects of different assumptions about future oil prices are illustrated in Figure 10. In the high price case, world oil prices (in real 2007 dollars) climb from USD68 per barrel in 2006 to USD200 per barrel in 2030; in the low price case, they drop to USD50 per barrel in 2015 and remain at about this level through 2030, while oil prices rise to USD130 per barrel in 2030 in the reference case. The petrochemical sector in Saudi Arabia P a g e 16

17 2007 dollars per thousand cubic feet July 2009 GAS OUTLOOK Figure 11 - World Gas Prices in five prices cases Reference High Price Low Price Rapid technology Slow technology Source:, Annual Energy Outlook 2009 Likewise, in its Annual Energy Outlook 2009 (March 2009) natural gas prices may vary with economic growth but also with technology progress assumptions. In fact, technology improvements reduce drilling and operating costs and expand the economic recoverable resource base. Quite logically, in the rapid technology case where exploration and development costs per well decline at a faster rate, natural gas prices reach lower levels. Conversely, in the slow technology case natural gas prices reach higher levels. In the high economic growth case, natural gas consumption grows more rapidly; thus natural gas prices rise more sharply than in the reference case reaching USD8.7 (per thousand cubic feet) in In the low economic growth scenario, natural gas consumption grows more slowly; thus natural gas prices are lower than in the reference case reaching USD7.8 (per thousand cubic feet) in The petrochemical sector in Saudi Arabia P a g e 17

18 FEEDSTOCK COST ADVANTAGE Abundant natural resources in Saudi Arabia have provided the petrochemical companies operating in the country with a very competitive cost structure allowing for sustainable high gross and operating margins. For instance, SAFCO, Saudi Arabia s giant fertilizer company, gets its natural gas supply from Saudi Aramco at a fixed price of USD0.75 MBTU 5 while the global natural gas prices in April stood at around USD3.5 MBTU. Besides, feedstock can account for up to 60% of total polyolefin manufacturing costs. Thus, any decrease in feedstock prices should considerably improve hydrocarbon producers margins. Feedstock prices may vary by country, although most countries in the gulf have adopted the same strategy, which is to provide feedstock at a price that gives a petrochemical producer an incentive to invest while offering a better value for the hydrocarbon producer. This advantaged feedstock cost allows gulf based producers to manufacture and deliver polyolefins at very competitive prices. As shown in Figure 12, a Saudi producer utilizing ethane/propane (alkanes cracked of petroleum) would likely deliver material to a Chinese customer at huge cost savings, even below local competition. Figure 12 - LDP Delivered Costs To China (Integrated, with Crude at USD30 per barrel) Dollars per Ton 1,000 Canada Ethane US Mixed Feed 800 West Europe Naphtha China Naphtha Saudi Ethane Feedstock Cost Variable Cost Fixed Cost Freight Duty Source:, Middle East Economic Survey (2007). 5 MBTU stands for one million BTUs and one cubic foot of natural gas produces approximately 1,000 BTUs The petrochemical sector in Saudi Arabia P a g e 18

19 Capacity (millions of tonnes) July 2009 CAPACITY AND INFRASTRUCTURES Feedstock availability coupled with high oil & gas prices for the past years (until end 2008) have enabled Saudi petrochemical prices to achieve very high cash margins. Petrochemical companies ability to be profitable has therefore been largely dependent on the country s feedstock capacity. Growing feedstock capacities in the Middle East In 2008, the total petrochemical production of MENA countries reached about 85 million tonnes, that is about two third of the global production. Ethylene is a critical feedstock to the petrochemical industry both in terms of volume produced (circa 120 millions of tonnes globally in 2005) and number of end market products it may generate from automotives, packaging and synthetic rubbers to medical equipments (for a more exhaustive list please refer to Figure 3). Global ethylene capacity is expected to reach 173 millions of tonnes in 2015, up 47% from 2005 when the Middle East capacity should grow by 300% over the same decade, taking its global market share of ethylene to around 19% in 2015 (Figure 13). Furthermore, comforting its position as the most dynamic petrochemical region in the world, the Middle East is anticipated to become the only net exporter of ethylene in the world in 2015, significantly growing its trade flow by 226% from 2005 (Figure 14). Besides, we note that Asia Pacific should considerably increase its demand of ethylene driven by China s strong growth to reach a net trade flow (import) of about 21 millions of tonnes in 2015, up 130% from 2005 (Figure 14). Figure 13 - Global Ethylene Capacity Trend Source:, Parpinelli Tecnon Middle East China Rest of Asia Japan Europe North America Others The petrochemical sector in Saudi Arabia P a g e 19

20 Net Trade (Mn of tonnes Ethylene Equivalent) July 2009 Figure 14 - Changing Trade Flow Pattern of Ethylene Derivatives 30 Exporter Middle East is the only net exporter 20 Middle East is the primary exporter Asia-Pacific Western Europe Middle East Importer North America transactions from net export to net importer North America Source:, CMAI Saudi Arabia, the heavyweight in the MENA petrochemical industry As for Saudi Arabia, whose total production capacity accounts for more than half of MENA s, domestic ethylene capacity in 2013 is forecasted to be almost double that of 2008 levels, at 18.2m tpa, with Jubail and Yanbu the focus of petrochemicals developments over the medium-term (Table 4). Table 4: Saudi Arabia ethylene capacity & global market share (actual/ forecast) 2008A 2013 E Saudi Arabia ethylene capacity (m tpa) Saudi Arabia global market share of ethylene capacity 6% 12% Source:, BMI, March 2009 The petrochemical sector in Saudi Arabia P a g e 20

21 SAR July 2009 Saudi Basic Industries Corporation (SABIC) Listing : Tadawul Sector : Petrochemical Industries CMP (30 Jun - 09) : SAR62.75 Upside/ (Downside) : 12% LTFV Opinion Key Performance Indicators : SAR70.58 : Undervalued in'million'sar unless otherwise indicated (Dec year end) FY08 A FY09 E FY10 E FY11 E Revenues 150,810 90, , ,925 EBITDA 46,643 28,222 39,108 43,446 Net Profit 22,030 9,038 15,221 20,201 Gross Profit Margin 30.3% 29.5% 34.0% 36.0% Operating Margin 24.3% 19.3% 26.0% 28.0% Net Profit Margin 14.6% 10.0% 14.3% 16.2% ROE 15.7% 6.0% 9.7% 11.8% EPS (SAR) EPS growth -18.5% -59.0% 68.4% 32.7% P/E BVPS (SAR) P/BV Dividend Yield 1.7% 2.9% 4.4% 5.3% EV/EBITDA Debt/Equity 63.2% 60.7% 58.1% 49.6% Net Debt 74,091 57,816 55,999 53,739 Source:, SABIC financial statements Figure 15 - SABIC rebased to Petrochemical Index (& company shares trading volume) J-08 J-08 A-08 S-08 O-08 N-08 D-08 J-09 F-09 M-09 A-09 M-09 J-09 Source:, TADAWUL Volume (Million Shares) SABIC (SAR) Petrochemical Index (Rebased) Million shares Figure 16 - SABIC shareholding structure Public Investment Fund 70.0% Source:, Zawya Free Float 30.0% The petrochemical sector in Saudi Arabia P a g e 21

22 COMPANY & BUSINESS OVERVIEW The Saudi Basic Industries Corporation (SABIC) was established by a royal decree in 1976 to produce chemicals, polymers and fertilizers, benefiting from oil and gas competitive feedstock thanks to the country s abundant natural resources. Constantly growing organically and through acquisitions, SABIC has become a heavyweight in the petrochemical sector. In 2008, SABIC s revenues topped about SAR151 billion, net profit SAR22 billion with a production of more than 56 million metric tonnes, up 60% YoY. Best known for being one of the world largest petrochemical companies, the Saudi Arabia based company has also grown and diversified its activities to become the largest steel producer in the Middle East. As a truly global company, SABIC currently employs more than 33,000 people in more than 100 countries over six continents. As on 30 June 2009, the company s market capitalization was SAR188.2 billion, which is more than 60% of the petrochemical sector s combined capitalizations in the Tadawul. FINANCIAL PERFORMANCE & VALUATION SABIC revenues continuously grew at CAGR 24.4% over the past three years, reaching about SAR151 billion in FY08 with a net profit of SAR22 billion, down 18.5% YoY though. SABIC s growth was strongly supported by increasing demand for petrochemicals along with soaring oil and gas prices and successful acquisitions. Nevertheless, non exempt from the global turmoil, the company s financial performance started weakening in the last fiscal year fourth quarter. Indeed, Q4 FY08 revenues plunged 39% YoY and net earnings came at SAR0.3 billion, down 96% QoQ due to lower petrochemical fundamentals (for both volumes and prices per unit). Besides, SABIC surprisingly disclosed a net loss of SAR0.9 billion in Q1 FY09 due to SAR1.2 billion impairment on its goodwill related to its US subsidiary Sabic Innovative Plastic (formerly GE Plastics). We note that Q1 FY09 normalized net earnings (from this exceptional write off) are still positive at SAR0.2 billion but lower than most analysts expectations. Despite the fact that we expect SABIC growth to be considerably haltered in FY09 (down 40% YoY) we still believe SABIC prospects are strong due to (i) an anticipated recovery of the petrochemical demands from H2 FY09, FY10 on and (ii) strong cash margin thanks to sustained low feedstock costs (gas prices already went up 16% in April) which should help the company weather the crisis. Our weighted Discounted Cash flows (Free Cash Flow to the Firm) and Relative Valuation models resulted in a Long Term Fair Value of SAR70.58, up 12% from the stock price as on 30 June 2009 (Table 5). Table 5 - SABIC Valuation in SAR LTFV Weight Weighted Value DCF - FCFF % Relative valuation % Hybrid valuation The petrochemical sector in Saudi Arabia P a g e 22

23 GROWTH July 2009 Table 6 - Sensitivity analysis of fair value (SAR) to WACC and Growth WACC % 10.21% 11.21% 12.21% 13.21% 1.0% % % % % PROJECTS, STRATEGY As a move to cope with the current financial crisis SABIC decided to keep costs minimal. Along with other cost cutting measures, SABIC innovative Plastics announced last February it would be cutting around 100 jobs. This company, which was purchased from GE about 2 years ago forced SABIC to book a SAR1.2 billion in their Q1 FY09 financials. SABIC could, however, still be involved in some inorganic growth transactions, as Prince Saud Bin Abdullah Bin Thenayan Al Saud, the company s chairman told Alarabiya TV in May 2009: The economic crisis had some negative as well as some positive effects, and it could be a chance for some new acquisitions. Furthermore, SABIC and Spichem announced in May 2009 their cooperation on projects in order to create synergies after the downturn somehow hit their profitability. Under a memorandum of understanding, SABIC agreed it will crack ethane feedstock to provide Sipchem; in return, Sipchem will provide SABIC with carbon monoxide. Furthermore, within the framework of its strategy to become the preferred world leader in chemicals, SABIC has engaged in multiple expansion and development projects, among which are key projects in the Asia Pacific region whose demand for petrochemicals is bound to increase (Figure 14 in section Capacity, Infrastructures).Thus, in January 2008 SABIC signed a contract with China Petroleum & Chemical Corporation to set up a plant in Tianjin, China. Likewise, in April 2008 SABIC announced its plans for a petrochemical project in India. Besides SABIC also signed a joint venture agreement with Ma aden (Saudi Arabian Mining company) in 2007 for a phosphate project. The petrochemical sector in Saudi Arabia P a g e 23

24 SAR July 2009 Saudi Arabian Fertilizer Company (SAFCO) Listing : Tadawul Sector : Petrochemical Industries CMP (30 Jun - 09) : SAR Upside/ (Downside) : 24% LTFV Opinion Key Performance Indicators : SAR : Undervalued in'million'sar unless otherwise indicated (Dec year end) FY08 A FY09 E FY10 E FY11 E Revenues 5,243 3,408 4,430 5,095 EBITDA 4,594 2,481 3,600 4,044 Net Profit 4,280 2,353 3,389 3,839 Gross Profit Margin 83.7% 69.0% 79.0% 78.0% Operating Margin 80.8% 64.0% 74.5% 73.5% Net Profit Margin 81.6% 69.0% 76.5% 75.3% ROE 60.9% 30.5% 38.6% 37.5% EPS (SAR) EPS growth 55.0% -45.0% 44.1% 13.3% P/E BVPS (SAR) P/BV Dividend Yield 10.6% 4.6% 6.6% 7.4% EV/EBITDA Debt/Equity 7.3% 8.1% 7.3% 8.3% Net Debt -2,102-1,735-4,229-3,758 Source:, Financial Statements Figure 17 - SAFCO rebased to Petrochemical Index (& company shares trading volume) Volume (Million Shares) J-08 J-08 A-08 S-08 O-08 N-08 D-08 J-09 F-09 M-09 A-09 M-09 J-09 Source:, TADAWUL SAFCO (SAR) Petrochemical Index (Rebased) Million shares Figure 18 - Share ownership of SAFCO Free Float 43% Source:, Zawya SABIC 43% General Organization for Social Insurance 14% The petrochemical sector in Saudi Arabia P a g e 24

25 COMPANY & BUSINESS OVERVIEW The Saudi Arabian Fertilizer Company (SAFCO), the first petrochemical company in Saudi Arabia, was established in 1965 by a royal decree. SAFCO s products include urea (since 1970), ammonia (since 1970), sulfuric acid (since 1972) and melamine (since 1984). They are mostly used in the agricultural industry but may as well supply other industries (Figure 4 in section Basic production flow ). The company s products are sold domestically but also widely exported to Asia, North America, South America, Australia and Europe. SAFCO, which has grown organically to become the leading manufacturer and exporter of fertilizers in the Gulf region, generated revenues of SAR5.2 billion in FY08, up 49% YoY, with 4.8 million metric tonnes produced. SAFCO is currently 43% owned by SABIC, which may give it the opportunity to benefit from potential synergies in certain business areas (such as sales, marketing, R&D). As on 30 June 2009, the company s market capitalization was SAR28.4 billion. FINANCIAL PERFORMANCE & VALUATION Despite the financial crisis SAFCO s revenues in FY08 reached a five year high SAR5.2 billion with net earnings at SAR4.3 billion, up 94% YoY. This is explained by strong fertilizers demand for the first three quarters of FY08 along with outstanding gross profit margins (84% in FY08) due to an exceptional feedstock cost advantage. As a matter of fact, SAFCO is supplied in natural gas through Saudi Aramco at a fixed price of USD0.75 MBTU (as a comparison, in April 2009 natural gas prices stood at about USD3.5 MBTU). However, SAFCO revenues for Q1 FY09 dropped to SAR739.4 million on lower fertilizer prices worldwide, down 10% QoQ while net earnings fell to SAR524.5 million, down 27.5% YoY. In spite of the current economic situation, we believe the fertilizer industry, which shows less sensitivity to cyclical effects, along with the company s efficient business model (low leverage, high free cash flow generation due to absolute feedstock advantage, low conversation cycle and low CAPEX requirements) provide the company with bullish prospects. Our weighted Discounted Cash flows (Free Cash Flow to the Firm) and Relative Valuation models resulted in a Long Term Fair Value of SAR140.21, a potential upside of 24% from the stock price as on 30 June 2009 (Table 7). Table 7 - SAFCO Valuation in SAR LTF value Weight Weighted Value DCF - FCFF % Relative valuation % Hybrid valuation The petrochemical sector in Saudi Arabia P a g e 25

26 GROWTH July 2009 Table 8 - Sensitivity analysis of fair value (SAR) to WACC and Growth WACC % 11.93% 12.93% 13.93% 14.93% 1.0% % % % % PROJECTS, STRATEGY In July 2008 SAFCO announced the signature of an agreement with Hadeed to construct a 50/50 owned facility in Jubail Industrial City for the production of flat steel products with an annual capacity of 1.7 million metric tonnes. In addition to this project, the facility should rely on the quantity of gas allocated to SAFCO plant in Dammam, which was closed by the end of Q3 FY08. During the construction phase of the flat products facility, SAFCO reached agreement with SABIC affiliate, the Saudi Methanol Company (AR-RAZI) to make use of the above referenced gas quantity to produce methanol for SAFCO for an interim period until the completion of the flat steel products project, scheduled for a period estimate. The petrochemical sector in Saudi Arabia P a g e 26

27 APPENDIXES SABIC BALANCE SHEETS in "000" SAR FY05 A FY06 A FY07 A FY08 A FY09 E FY10 E FY11 E Cash & Cash Equivalents 28,172,569 39,556,764 45,876,795 51,027,586 63,960,610 72,961,812 72,151,044 Net Receivables 17,465,830 20,759,432 30,122,511 20,067,638 16,036,087 18,625,991 21,445,396 Other Current Assets 10,642,446 13,658,245 22,305,959 24,359,750 12,768,466 15,066,790 17,628,144 Total Current Assets 56,280,845 73,974,441 98,305,265 95,454,974 92,765, ,654, ,224,584 PP&E 66,096,734 79,970, ,113, ,440, ,598, ,335, ,858,951 Intangibles and Others 14,572,901 12,643,757 32,312,242 34,864,838 34,552,186 36,088,592 39,026,662 Total non Current Assets 80,669,635 92,614, ,425, ,305, ,150, ,423, ,885,613 Total Assets 136,950, ,588, ,731, ,759, ,915, ,078, ,110,197 ST Debt 6,703,959 6,128,796 4,671,224 4,288,816 4,384,740 4,445,100 4,176,090 Payables 7,781,718 11,065,422 16,732,412 10,426,809 9,412,327 10,588,295 12,193,804 Other Current Liabilities 7,461,439 7,747,658 12,279,002 11,864,382 7,336,133 8,456,437 9,594,212 Total Current Liabilities 21,947,116 24,941,876 33,682,638 26,580,007 21,133,200 23,489,832 25,964,106 LT Debt 23,017,180 33,611,628 75,437,595 88,367,462 90,491,980 94,334,900 88,625,910 Other LT Liabilities 6,764,647 7,545,079 10,114,576 10,170,907 10,272,616 11,136,278 11,299,878 Total non Current Liabilities 29,781,827 41,156,707 85,552,171 98,538, ,764, ,471,178 99,925,788 Total Liabilities 51,728,943 66,098, ,234, ,118, ,897, ,961, ,889,893 Minority Interest 22,880,920 27,607,078 43,342,241 43,709,139 47,331,206 51,568,726 56,753,193 Total Equity 85,221, ,490, ,496, ,641, ,138, ,117, ,220,303 SABIC INCOME STATEMENTS in "000" SAR FY05 A FY06 A FY07 A FY08A FY09 E FY10 E FY11 E Sales 78,253,536 86,327, ,204, ,809,596 90,485, ,924, ,663,332 Gross profit 33,084,330 35,228,022 47,950,176 45,763,281 26,693,298 36,302,886 44,972,869 Operating Profit 29,169,978 30,886,120 41,046,523 36,591,289 17,473,188 27,761,030 34,978,898 EBITDA 35,700,701 37,005,356 48,652,533 46,643,288 28,221,927 39,107,700 43,446,250 Net Profit 19,159,685 20,293,942 27,022,272 22,029,843 9,038,302 15,220,975 20,200,535 The petrochemical sector in Saudi Arabia P a g e 27

28 SABIC CASH FLOW STATEMENTS in "000" SAR FY05 A FY06 A FY07 A FY08A FY09 E FY10 E FY11 E Cash Flow from operations 33,135,996 34,734,906 46,655,309 46,229,845 41,782,740 34,567,933 37,769,890 Cash Flow from investing activities (10,626,649) (17,867,006) (73,703,935) (29,806,609) (24,163,965) (19,873,661) (19,135,971) Cash Flow from financing activities (17,581,909) (5,483,705) 33,520,656 (11,272,445) (4,685,751) (5,693,070) (19,444,687) (Decrease) increase in cash & cash equivalents 4,927,438 11,384,195 6,472,030 5,150,791 12,933,024 9,001,202 (810,768) Cash Flow at year - end 28,172,569 39,556,764 45,876,794 51,027,586 63,960,610 72,961,812 72,151,044 SAFCO BALANCE SHEETS in "000" SAR FY05 A FY06 A FY07 A FY08 A FY09 E FY10 E FY11 E Cash & Cash Equivalents 304, ,238 1,572,063 3,917,745 3,310,877 5,987,075 5,771,091 Net Receivables 441, , , , , , ,785 Other Current Assets 367, , , , , , ,127 Total Current Assets 1,113,587 1,555,284 2,832,550 5,138,695 4,184,520 7,084,252 7,018,002 PP&E 3,922,873 4,025,640 3,811,597 3,457,565 3,407,565 3,359,826 3,357,565 Intangibles and Others 1,170,865 1,093,095 1,509,279 1,253,777 1,374,360 1,499,233 1,911,313 Total non Current Assets 5,093,738 5,118,735 5,320,876 4,711,342 4,781,925 4,859,059 5,268,878 Total Assets 6,207,325 6,674,019 8,153,426 9,850,037 8,966,445 11,943,310 12,286,881 ST Debt - 176, , , , , ,625 Payables 250, , , , , , ,199 Other Current Liabilities 101,717 96, , Total Current Liabilities 352, , , , , , ,824 LT Debt 695,000 1,063, , , , , ,875 Other LT Liabilities 371, , , , , , ,988 Total non Current Liabilities 1,066,638 1,470,664 1,334,381 1,023,231 1,081,283 1,276,724 1,446,863 Total Liabilities 1,419,257 1,934,642 2,139,089 1,816,077 1,575,724 1,757,800 2,012,687 Equity 4,788,068 4,739,377 6,014,337 8,033,960 7,390,721 10,185,510 10,274,193 The petrochemical sector in Saudi Arabia P a g e 28

29 SAFCO INCOME STATEMENTS in "000" SAR FY05 A FY06 A FY07 A FY08A FY09 E FY10 E FY11 E Sales 1,823,985 1,831,252 3,516,028 5,242,632 3,407,711 4,430,024 5,094,528 Gross profit 1,074,666 1,090,249 2,294,474 4,388,701 2,351,320 3,973,732 4,202,985 Operating Profit 981, ,450 2,127,414 4,234,781 2,180,935 3,300,368 3,744,478 EBITDA 1,177,835 1,182,652 2,470,576 4,593,652 2,480,935 3,600,368 4,044,478 Net Profit 1,108,308 1,151,324 2,209,226 4,279,788 2,352,612 3,388,965 3,838,513 SAFCO CASH FLOW STATEMENTS FY05 A FY06 A FY07 A FY08A FY09 E FY10 E FY11 E Cash Flow from operations 922,659 1,004,992 2,397,134 4,269,285 2,420,413 3,634,576 1,123,023 Cash Flow from investing activities (782,791) 138,232 45, ,789 (5,000) 40, ,000 Cash Flow from financing activities (211,259) (853,125) (1,465,179) (2,048,392) (3,022,281) (998,378) (1,454,007) (Decrease) increase in cash & cash equivalents (71,391) 290, ,825 2,345,682 (606,868) 2,676,198 (215,984) Cash Flow at year - end 304, ,238 1,572,063 3,917,745 3,310,877 5,987,075 5,771,091 The petrochemical sector in Saudi Arabia P a g e 29

30 This report is being provided for informational purposes only and on the condition that it will not form a primary basis for any investment decision. This report is not an offer to buy or sell any of the securities that may be referred to herein. In no event will KMEFIC be liable for any loss occurring from investment decisions made based on the recommendation here-enclosed. Past performance is not necessarily a guide to future performance. Investors should make their own decision on whether or not to buy or sell the securities covered herein based upon their specific investment goals and in consultation with their financial advisor. KMEFIC has no obligation to update, modify or amend this report or to otherwise make any notification or announcement thereof in the event that any matter stated herein, or any opinion, projection, forecast or estimate set forth herein, changes or subsequently becomes inaccurate. The inclusion of any opinions/estimates does not necessarily imply a recommendation or endorse the views expressed within them. Many areas of the report contain opinions and/or analysis that represent the involved analysts' views; neither the analysts nor KMEFIC shall be in any way liable for their opinions expressed in the report. KMEFIC may or may not have ownership or interest in companies mentioned in this report. This report has been prepared and issued by the Research Kuwait & Middle East Financial Investment Co. S.A.K. (KMEFIC), a licensed Kuwaiti investment company regulated by the Central Bank of Kuwait. KMEFIC prepared this report using publicly available information, internal data, and other sources considered reliable; however, KMEFIC makes no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability with respect to the report or the information, analysis, opinions, or related graphics contained on the report for any purpose. While great care has been taken to ensure that the facts stated are accurate, neither KMEFIC nor any of its employees shall be in any way responsible for the contents. Neither this document nor any of its contents may be distributed in any jurisdiction where its distribution is restricted by law. Neither this document nor its content may be copied, transmitted or distributed without the prior written consent of KMEFIC. Additional information on the contents of this report is available on request. The petrochemical sector in Saudi Arabia P a g e 30