Saudi Basic Industries Corp After an upbeat Q3, expect good performance in Q4; Raise TP to SAR103/sh.

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1 Vol mn RSI10 Petrochemicals Industrial SABIC AB: Saudi Arabia US$78.87bn 21% US$83.39mn Market cap Free float Avg. daily volume Target price % over current Current price as at 11/6/2017 Research Department Pritish K. Devassy, CFA Tel , Existing rating Neutral Underweight Neutral Overweight Performance Earnings Price Close MAV50 MAV10 10/16 01/17 05/17 08/17 Source: Bloomberg Relative to TADAWUL FF (RHS) (SARbn) e 2018e Rev Rev growth -5.8% 7.8% 1.0% Gross Profit Gross margin 33.5% 34.1% 33.8% EBITDA EBITDA margin 31.7% 29.3% 29.2% Net Profit Net margin 12.6% 13.1% 13.6% EPS DPS Payout ratio 68% 69% 72% EV/EBITDA 7.7x 7.8x 7.7x P/E 16.9x 15.2x 14.4x Source: Company data, Al Rajhi Capital After an upbeat Q3, expect good performance in Q4; Raise TP to SAR103/sh. SABIC reported Q3 net profit at SAR5.7bn, much higher than consensus estimate of SAR4.3bn. The beat was observed across all key line items. Despite this, the stock price rose only ~1% post the results announcement given lower initial disclosures, as the key question was on the sustainability of the performance. Post the release of detailed financials, we believe that bulk of the operating profit beat was infact helped by healthy petchem demand which SABIC capitalized on, as the product prices also picked up by mid quarter, helped by various factors including externalities in US, stockpiling in Asia etc. With SAR39.7bn revenue, much above consensus and also the highest quarterly revenue since early-2015, the top-line beat together with operating leverage drove higher profitability. SADAF acquisition benefit on bottom-line is only partial in Q3 and full benefit will be seen in Q4 which also could see improving metals and polymers prices. Commercialization of other projects expected by next quarter may also give a fillip to Q4 earnings. On the other hand, as oil price increases, the feedstock costs could also increase and newer projects may take more time to reach full production. Post Q3 results, we revised our estimates upwards and consequently increased our target price to SAR103/share based on average of relative valuation (7.2x EV/EBITDA, 20% discount to MSCI chemical peers, similar to historical trend) and DCF. Due to limited upside, we remain Neutral. Figure 1 Q3 results (In SARmn) 2Q16 2Q17 3Q17 y/y q/q ARCe Revenue 33,314 35,049 39,650 19% 13% 33,851 Gross Profit 10,956 10,785 14,110 29% 31% 10,959 margin 33% 31% 36% 32% Op. profit 7,636 5,428 8,560 12% 58% 5,601 margin 23% 15% 22% 17% Net profit 5,224 3,706 5,790 11% 56% 3,658 margin 16% 11% 15% 11% Source: Company data, Al Rajhi Capital Analysis of Q3 financials: Usually, the diversified presence for SABIC across geographies implies steady operating rates throughout the year. However, operating rates in the last two quarters were much lower than usual. This did not get much attention, because post the IFRS restatement revenue had been stated gross of fees (implies a boost of 7-8%). So, though revenue was in-line with past trends, the operating rates were lower as compared to the past. As per our analysis, the operating rates were less than 110% in Q1 and Q as compared to 130% in the past. Moreover, despite lower operating rates in Q1 and Q2 this year, the operating profit was similar to past levels this was due to high product prices in Q1. In Q2, the profit was weak because of some shutdowns but this did not raise a flag as weak numbers were expected. In case of Q3, SABIC was able to capitalize on better demand. For example, Sharq was supposed to be shut-down for maintenance. However we believe that did not go through as planned as the company decided to cater to the increased demand in Asia post the US cyclones Please see penultimate page for additional important disclosures. Al Rajhi Capital (Al Rajhi) is a foreign broker-dealer unregistered in the USA. Al Rajhi research is prepared by research analysts who are not registered in the USA. Al Rajhi research is distributed in the USA pursuant to Rule 15a-6 of the Securities Exchange Act of 1934 solely by Rosenblatt Securities, an SEC registered and FINRA-member broker-dealer.

2 which resulted in temporary closure of U.S. refineries. Platts also reported stock piling due to holiday week and anticipation of plant closures globally. Thus despite lower average prices for products in Q3 relative to Q1, the sales were skewed, more on the dates when prices were high leading to an upbeat top-line performance. Confirming our view, SABIC commented that it saw an increase in both price and volume (while the average price of petchem products was clearly lower in the quarter). Key question are these operating rates sustainable? We believe the Q3 performance may be sustainable in Q4 as demand is still healthy, however, the high level of operating rates could thereafter decrease from Q We tweak our numbers to reflect a higher level of utilization in Q4 at 130% and 122.5% on an average for 2018 and beyond. Also, there are other projects which are picking up gradually. The benefit is likely to be more at net profit level as post the SADAF deal the minority is to be lower (see below). Bottom-line gets a boost from the recent acquisition of 50% stake in SADAF: SABIC has completed the acquisition of the remaining 50% stake (from Shell) in Jubail-based Saudi Petrochemical Company (SADAF) for US$820mn on August 16, SADAF JV produces Ethylene, Styrene, EDC and MTBE with total production capacity of more than 4mn tpa. Despite the acquisition being at ~1% of market cap, we believe that the annual incremental earnings from SADAF deal could be ~US$340mn (~SAR1,270mn), before debt servicing in 2018, which would be 8% of our 2017E earnings before interest costs. This probably implies that the debt level of SADAF is significant. In Q3 we saw minority interest reduce by around SAR300mn as compared to average minority income deducted from consolidated earnings mostly to do with SADAF. We believe that the impact of SADAF deal would be higher in Q4 due to full quarter impact compared to Q3. Grasim acquisition unlikely to impact valuation much although establishes strong distribution and supply chain network in India for SABIC. At the end of September 2017, ET announced that SABIC may acquire Grasim Industries fertilizer biz, which is low-margin government regulated business in India, for ~INR32bn (SAR2bn). Despite Grasim having urea capacity similar to that of SAFCO, the profit earned is much lower because of both SABIC s low cost feedstock and working capital requirements for Grasim. Based on company filings, the annual profit (~SAR150mn) of Grasim s fertilizer segment is much smaller than that (SAR1.5bn) of SAFCO, subsidiary of SABIC. Consequently, we believe that this acquisition would have limited impact on SABIC s valuation, although on a positive side, we believe that SABIC can capitalize on distribution network and supply chain in India through this acquisition as India is one of SABIC s largest markets for fertilizers. We believe that this acquisition is a part of the company s strategy to invest in successful ventures, which are smaller and less risky through optimum use of its huge pile of cash / ST investments worth SAR57bn. Capacity expansion / Acquisitions: The company currently has a gross debt to asset ratio of 16%, lower than peer average and also has a cash balance, at 19% of market cap. The company s RoE has been declining and the company is looking at major projects which can boost its earnings. The key projects, identified in our previous reports, are as below: Polycarbonate plant in China: The company expects its SAR 6.38 billion polycarbonate complex to start operations by The new complex will have an annual production capacity of 0.26 mt. It will be constructed in the Tianjin Binhai New Area, China, and is expected to be financed from SABIC's internal resources as well as other credit facilities. It will allow SABIC to supply polycarbonate as feedstock to the company's other plants in China and the Pacific region. OTC project: SABIC and Aramco have received bids for consultancy work on their $20 billion oil-to-chemicals joint venture project (Source: Reuters). Aramco expects a final decision on the project by the end of the year. The contract for the development is likely to be awarded early next year, while commissioning of the complex is scheduled for late Disclosures Please refer to the important disclosures at the back of this report. 2

3 11/25/ /25/2014 1/25/2015 2/25/2015 3/25/2015 4/25/2015 5/25/2015 6/25/2015 7/25/2015 8/25/2015 9/25/ /25/ /25/ /25/2015 1/25/2016 2/25/2016 3/25/2016 4/25/2016 5/25/2016 6/25/2016 7/25/2016 8/25/2016 9/25/ /25/ /25/ /25/2016 1/25/2017 2/25/2017 3/25/2017 4/25/2017 5/25/2017 6/25/2017 7/25/2017 8/25/2017 9/25/ /25/2017 Petchem complex in Texas: SABIC said it is carrying out further studies, including technical and commercial estimations, before making an investment decision sometime in It did not give an estimated cost of the project, but expects an ethane cracker with an expected capacity of 1.8 million tonnes per year. Other investments: As per Reuters, the CEO expressed that the company was looking to make other U.S. investments between US$3bn and US$6bn. Integration of fertilizers: The company is also considering integrating three fertilizer related affiliates, SAFCO, Ibn Baytar and Al-Bayroni, which are located next to each other in Jubail, eastern Saudi Arabia. For this reason SAFCO was carrying out a feasibility study to buy SABIC s 50% stake in Ibn Baytar. Dividends likely to improve in H SABIC is likely to announce SAR2.5/share DPS for H2 2017, taking the full year DPS to SAR4.5/share (implying a 12m forward dividend per share of SAR5). Changes in our estimates. We revised our top-line and bottom line estimates higher to factor in SADAF deal, upcoming commercialization of projects such as Ibn Sina (likely in Q4) and the Methacrylate Project (2018), improved utilization at synthetic rubber plant (running at full capacity in Q3 in our view), higher operating rates and latest price deck. Consequently, our 2018 EBITDA at SAR44.3bn, is around 7% higher than our earlier estimates. Valuation. Post stellar Q3 performance and revision of our estimates, we increased our TP to SAR103/share based on equal mix of DCF and relative valuation but remain Neutral on SABIC given low upside. The stock is currently trading at an EV/EBITDA of 7.7x 2018E EBITDA maintaining its discount compared to global peers (see Figure 2). The long-term direction for the stock would depend on the outcome of the large projects such as a) CTO plant in China, b) Oil to chemicals JV with Aramco in Saudi c) Petchem complex in Texas d) other acquisitions that the company intends to do. These are not yet added in our model. Figure 2 SABIC 12m forward EV/EBITDA multiples trade at a discount to MSCI Chemical peers 12.0x 10.0x 8.0x 6.0x 4.0x 2.0x 0.0x SABIC MSCI World Chemical Index Source: Company data, Al Rajhi Capital, Bloomberg Risks. Key upside triggers are associated with faster than expected successful commercial launch of its above mentioned future expansion projects and increase in product spreads. SABIC is most likely to be included in MSCI EM Index, generating additional global interest in the stock once Saudi Arabia upgrades to Emerging market list, which could eliminate part of the discount compared to global peers provided disclosures improve. Downside risks include weak oil & thereby significant decline in petchem product prices, unplanned plant shutdowns and any further unexpected revision in the subsidized feedstock prices. Disclosures Please refer to the important disclosures at the back of this report. 3

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