SICO Research Company Update Jan-16 Feb-16 Mar-16 Mar-16 Apr-16 Apr-16 May-16 May-16 Jun-16 Jun-16 Jul-16 Jul-16 Aug-16 Aug-16 GCC Equities Transportation Price Data (SAR) Current Price 42.65 Target Price 52.00 52 wk High/Low 67.75/31.10 Ratings Short-term Long-term Risk Profile Market Data Sector Market Cap Primary Market Other Exchg Reuters Bloomberg Positive Buy Normal Transportation USD 2.14bn Saudi Arabia SGSC.SE SGS AB Equity Free Float 30% Valuation Ratio 2016E 2017E P/E x 10.5 10.3 P/BV x 2.7 2.5 EV/EBITDA x 7.9 7.7 Div Yld % 6.1 6.4 Trading Data Daily Vol (6M Avg) 0.3 Daily T/o (6M Avg USD) 3.6 Issued Shares 188.0 All in millions Relative Price Performance 160 140 120 100 80 60 40 September 08, 2016 Tadawul SGS 3Q preview and Rating upgrade Absence of one-off expenses and seasonality affect to drive YoY growth in 3Q; earnings estimate at SAR 190mn, +14% YoY Recent price decline offers good entry opportunity, rating upgraded to Buy Dividend pay-out increased in 1H16, expect FY16 dividend yield of 6%; Upgrade to Buy on price decline; TP at SAR 52/sh We upgrade our rating to Buy (previously Neutral ) for SGS with a one year FCFE based target price of SAR 52.0/sh, offering an upside of 21.9% from current levels. Our rating revision was led by the c.12% decline in stock price, since our last report on 11 July 2016. We believe that one of the key overhang on the stock is the outcome of SGS contract rate renegotiation with its principal shareholder, Saudia Airlines, which is yet to be determined (due since 4Q15 end). We understand that there has been ongoing restructuring within Saudia s management over the past 9-12 months which may have distracted them from completing the negotiations on SGS new contract pricing. However, we do not expect any downward revision in the contract rates, considering SGS increasing cost base with major portion (c.80%) of operating expenses being manpower costs, which will ideally increase in an inflationary macro environment. Nevertheless, due to limited clarity on the renegotiation, we conservatively assume current rates to remain constant till FY18 and then increase 2% till FY20. Saudia had contributed 54.4% to the company s revenue in FY14 (as disclosed in the prospectus). Exhibit 1: FCFE Valuation FCFE Valuation SAR mn Cost of Equity 10.52% Terminal Growth Rate - FY26E 3.0% Equity Value 9,819 Shares Outstanding ('000) 188.0 Target Price (SAR) 52.0 Current Price (SAR) 42.7 Upside / (Downside) (%) 21.9% During the past one month, SGS stock underperformed compared to the Tadawul All Share Index and now offers good entry point to long term investors. Exhibit 2: SGS underperforms compared to TASI 105 Restated to 100 Performance (%) 1m 3m 12m Absolute (6.3) (12.0) (34.3) Relative (3.9) (6.0) (16.4) Source: SICO Research, Bloomberg 100 95 90 Nishit Lakhotia, CFA, CAIA +973 1751 5021 Nishit.Lakhotia@sicobahrain.com www.sicobahrain.com 85 80 09-Jul 16-Jul 23-Jul 30-Jul 06-Aug 13-Aug 20-Aug 27-Aug 03-Sep SGS TASI *Note: Tadawul All Share Index (TASI) and SGS share price rebased to 100 on 09 July 2016. SICO 2016 All Rights Reserved Attention is drawn to the disclaimer and other information in the end
Exhibit 3: Peer Comparison Table Mkt Cap Company Name Country (USD mn) SGS is trading at a PE multiple of 10.5x on our FY16 EPS estimate of SAR 4.04, compared to peer group average of 19.0x. Despite being debt-free, SGS reported a strong ROE of 23.9%, substantially higher than levered comparative company s average of 13.6%. It is worth highlighting that SGS had two major one-offs in 2015, 2 month bonus pay-out of SAR 98mn after the royal decree and SAR 26mn GACA rent adjustment in 3Q15. Excluding impact of these one-offs, SGS FY15 gross margins and EBITDA margins would have been 37.8% and 35.6% respectively and ROE at 28.7%. Revenue* (USD mn) P/E FY16E (x) EV/EBITDA FY16E (x) ROE FY15 Debt to Equity* Gross Margin* EBITDA Margin* SIA Engineering Co Singapore 3,221 871 21.4 23.4 13.6% 0.03 NA 10.9% TAV Havalimanlari Turkey 1,366 1,116 7.5 5.0 27.4% 1.82 44.8% 49.6% BBA Aviation PLC UK 3,375 2,130 16.3 11.8 5.1% 0.24 18.6% 9.6% Flughafen Wien AG Austria 2,358 726 15.9 8.2 10.2% 0.48 NA 42.4% Grupo Aeroportuario Mexico 2,526 284 26.4 16.0 20.7% 0.80 81.4% 50.6% Save SpA Italy 977 173 24.9 13.4 13.8% 1.22 NA 44.3% Saudi 2,138 677 10.5 7.9 23.9% - 33.0% 29.3% Weighted Avg ex SGS 2,304 1,021 19.0 14.1 13.6% 0.56 45.4% 29.4% *Note: Revenue, leverage and Margin data for FY15. Data as on 07 September 2016 Source: SICO Research, Bloomberg, Company Data Expect YoY growth in 3Q due to absence of one-off relating to GACA rent in 3Q15 We estimate SGS 3Q16 earnings at SAR 190mn, up 14% YoY, led by revenue growth estimate of 12% YoY. Despite we projecting a lower recurring gross margin of 33.5% (36.6% in 2Q16) in 3Q15, earnings is expected to grow 14% YoY during the quarter due to the fact that 3Q15 earnings were adversely impacted by a one-off expense of SAR 26.2mn, incurred from retrospective adjustment of increased GACA rent. Our analysis suggests a 12% YoY increase in the company s 3Q16 top line to SAR 740mn, driven by a shift of seasonality with less number of Ramadan days falling in 3Q16 compared to 3Q15. However, on a QoQ basis, the company s 3Q net profit is expected to decline 3.3% from SAR 197mn in 2Q16, despite a 6.9% QoQ of estimated growth in revenues. This is due to the hiring of temporary high cost labour to meet higher demand during Hajj season at the Jeddah and Medina airport. In addition, providing ground services at Jeddah Airport is relatively more expensive compared to other airports in the Kingdom. As a result, we expect the company s 3Q16 gross margin to decline to 33.5% from 36.6% QoQ. Recall, SGS reported 13% YoY growth in 2Q16 earnings at SAR 197mn, outperforming our estimates by 11%. The company also posted 13% YoY growth in 2Q16 revenues to SAR 692mn, ahead of our forecast by 6%. Exhibit 4: SGS 3Q16 earnings estimates (SAR mn) SAR mn 3Q16E 2Q16 3Q15 YoY QoQ Revenue 740 692 661 12.0% 6.9% Gross Profit 248 253 221 12.4% -2.1% Gross Margin 33.5% 36.6% 33.4% Operating Profit 196 201 171 14.6% -2.3% Operating Margin 26.5% 29.0% 25.9% Net Profit 190 197 167 14.0% -3.3% Net Margin 26.8% 28.4% 25.3% Expect FY16 dividend at SAR 2.6/sh, offers a yield of 6% SGS paid a quarterly dividend of SAR 0.65/sh in 1H16, higher than FY15 quarterly average of SAR 0.51/sh. We expect the company to maintain its current dividend run rate with FY16 dividend of SAR 489mn (SAR 2.60/sh), translating into a yield of 6.1% at current levels. 2
SGS reported strong liquid asset balance of SAR 832.9mn (cash of SAR 481.8mn and SAR 351.1mn of investment in money market) by 2Q16 end, compared to SAR 779.4mn of cash by FY15 end, sufficient to fund a capex of SAR 100/120mn (our FY16 estimate). We expect the company to generate FCF/sh of SAR 3.54 and SAR 3.61 in FY16 and FY17 respectively, leaving sufficient headroom for higher dividends compared to our DPS forecasts of SAR 2.60 and SAR 2.75. Exhibit 5: FCF/sh vs DPS/sh (SAR) 5.00 4.00 3.38 3.54 3.61 3.95 3.00 2.00 1.00 2.04 2.60 2.75 3.00 - FY15E FY16E FY17E FY18E FCF/sh DPS/sh Earnings estimates marginally revised downwards despite higher top-line We have slightly revised our earnings estimate downwards by 0.8% and 1.1% for FY16 and FY17 respectively. The decline in our forecasts was due to our cautious view on SGS rate renegotiation with Saudia (expecting no increase in FY16 and FY17 versus 2% and 3% rate hike expectation in FY16 and FY17 respectively previously. However, our FY16 and FY17 revenue forecast have been revised upwards to SAR 2.8bn and SAR 3.0bn respectively, attributed to increasing traffic of international airlines in the erstwhile domestic airports where SGS is primarily sole ground services provider. Exhibit 6: Revised estimates (SAR mn) New Estimates Old Estimates % Change FY16 FY17 FY16 FY17 FY16 FY17 Revenue 2,810 2,982 2,766 2,891 1.6% 3.1% Operating Profit 786 788 782 804 0.6% -2.0% Net Profit 760 780 767 788-0.8% -1.1% Increasing competition in the sector, although not a major threat Swissport was awarded the second ground services license in Saudi Arabia in April 2015, to operate from three international airports- Jeddah, Riyadh and Damman. However, by June 2016, the company had commenced its operations at only two airports, offering services to Jazeera Airways in Jeddah and Riyadh and Scoot in Jeddah. Although we expect Swissport to initially establish itself in the three major airports, it does have plans to further expand its services to other domestic airports in the Kingdom. In the near term we do not expect any major threat to SGS from Swissport, which will still remain a much smaller player compared to SGS pan Saudi presence across 27 airports. In addition, some of the kingdom s domestic airports opened up for international flights, which has increased traffic of non- Saudi based airlines into these airports and SGS is benefitting from such traffic as it has monopoly in most of these airports. Another factor to be considered is airport privatisation initiatives being undertaken by Saudi government, which may grant non-exclusive ground services licenses at particular airports, as part of the BOT contracts. 3
Again, due to SGS dominant presence across Saudi Arabia, investment in airport infrastructure and existing relationship with all major airlines operating in the Kingdom, the company will continue to hold an edge over other smaller competitors. 4
Financials Income Statement (Consolidated) Revenue 2,541 2,810 2,982 Cost of Goods Sold (1,703) (1,807) (1,970) Gross Profit 837 1,002 1,012 Selling, General and Admin. (242) (244) (255) EBITDA 779 937 941 Operating Profit 630 786 788 Other Income 50 35 35 Net Interest Income (1) 6 7 Tax (23) (40) (20) Minority Interest 0 0 0 Net Profit 621 760 780 Cash Flow Statement (Consolidated) Net profit before Zakat 644 800 800 Depreciation 149 151 154 Other Adjustments 11 (18) 4 Working Capital Changes (140) (159) (143) Cashflow from Operations 665 775 814 Capital Expenditure (28) (110) (134) Other Investing Activities 24 0 0 Cashflow from Investing (3) (110) (134) Debt Raised/Repaid 0 0 0 Dividend (402) (462) (509) Other Financing Activities 0 (350) 0 Cashflow from Financing (402) (812) (509) Net Chg in Cash 260 (148) 170 Note: The above statements may not match the published cash flow statements due to adjustments made by us. Balance Sheet (Consolidated) Cash & Short Term Deposits 779 632 802 Other Current Assets 986 1,182 1,342 Investments 0 0 0 Net Fixed Assets 473 470 485 Net Intangible Assets 934 896 861 Other Non-Current Assets 76 103 134 Total Assets 3,249 3,634 3,975 Current Liabilities 280 316 333 Total Debt 0 0 0 Other Liabilities 0 0 0 Total Liabilities 545 632 703 Minority Interest 0 0 0 Share Capital 1,880 1,880 1,880 Reserves & Surplus 824 1,122 1,392 Shareholders Funds 2,704 3,002 3,272 Total Equity & Liabilities 3,249 3,634 3,975 Key Ratios (Consolidated) EPS 3.30 4.04 4.15 EPS Growth (%) (5.5) 22.4 2.5 Gross Margin (%) 33.0 35.7 33.9 EBITDA Margin (%) 30.7 33.4 31.6 EBITDA Growth (%) 0.0 20.3 0.4 Net Margin (%) 25.8 28.0 27.2 ROAE (%) 23.9 26.7 24.9 ROAA (%) 21.2 22.9 21.3 Debt/Equity (%) 0.0 0.0 0.0 Valuation Ratios PER (x) 12.9 10.5 10.3 PBV (x) 3.0 2.7 2.5 Dividend Yield (%) 4.8 6.1 6.4 EV/EBITDA (x) 9.9 7.9 7.7 Source: Company, SICO Research, Bloomberg 5
25-Jun-15 25-Jul-15 25-Aug-15 25-Sep-15 25-Oct-15 25-Nov-15 25-Dec-15 25-Jan-16 25-Feb-16 25-Mar-16 25-Apr-16 25-May-16 25-Jun-16 25-Jul-16 25-Aug-16 SICO RESEARCH Price, Target Price and Rating Change History Chart of (SGS AB) Date Closing Target RatingInitiation Price Price 80.0 25-Jun-15 51.52 74.00 B X 75.0 5-Aug-15 65.87 71.00 N 70.0 28-Oct-15 55.08 62.00 N 65.0 2-Feb-16 38.49 56.00 B 60.0 21-Feb-16 40.74 50.00 B 55.0 11-Jul-16 47.72 52.00 N 50.0 7-Sep-16 42.65 52.00 B 45.0 40.0 35.0 30.0 B N N B B N B Closing Price Target Price B=Buy, A=Add, N=Neutral, R=Reduce, S=Sell, U/R = Under Review Securities & Investment Company BSC Analyst Stock Rating Definitions * Note:- Under old methodology, up until 20 th Feb 2016, we had 5 categories of LT rating. Sell (<-25%), Reduce (-10 to -25%), Neutral (-10% to +10%), Add (+10% to +25%), Buy (>+25%). The LT rating was independent of Risk Profile. Time horizon Short term Long term SICO Research issues a Short term outlook if the analyst feels that there are factors which might affect the short-term performance of the stock during the immediate six months after issuing a rating. This might be due to both quantitative and qualitative factors which the analyst think can affect the stock price. SICO Research s Long-term rating is based on the Target Price calculated by the analyst. The Target Price is arrived at using both fundamental and/or comparative valuation methods based on the Financial models developed by analysts incorporating current expectations and analyst's assumptions. Target price for a stock is calculated one year forward from the valuation date Recommendation (Short term) Positive Analyst expect positive triggers in the short term which might affect current price positively (> 10%) Neutral Analyst does not expect any short term triggers/events (+/- 10%) Negative Analyst expect negative triggers in the short term which might affect current price adversely (< 10%) Recommendation (Long term)* Buy If Risk profile is High Target price estimate offers 20%+ return from the current share price. If Risk profile is Normal Target price estimate offers 15%+ return from the current share price. Neutral If Risk profile is High Target Price estimate offers 0% to 20% return from the current share price. If Risk profile is Normal Target Price estimate offers 5% to 15% return from the current share price Sell If Risk profile is High Target price estimate offers less than 0% return from the current share price. If Risk profile is Normal Target price estimate offers less than 5% return from the current share price. Risk High Stock volatility (360 days standard deviation) exceeds 2x of S&P GCC market volatility Normal Stock volatility (360 days standard deviation) lower than 2x of S&P GCC market volatility 6
Contact Details NOTES BMB Centre, 1st Floor P.O Box 1331, Diplomatic Area Manama Kingdom of Bahrain Investment Research research@sicobahrain.com Head of Research Nishit Lakhotia, CFA, CAIA Tel: (Direct) +973 17515021 Brokerage Fadhel Makhlooq Tel: (Direct): +973 17515202 Visit us at www.sicobahrain.com Disclaimer This report does not constitute or form part of, and should not be construed as, any offer for sale or subscription of, or any invitation to offer to buy or subscribe for any securities. The information and opinions contained in this report have been compiled or arrived at from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness and are subject to change without notice. Investors must make their own investment decisions. Past performance is not necessarily a guide to future performance. Nothing in this report should be construed as investment or financial advice or as an advice to buy or sell the securities of the company referred to in this report. SICO and/or its clients may have positions in or options on the securities mentioned in this report or any related investments, may affect transactions or may buy, sell or offer to buy or sell such securities or any related investments. The analyst(s) who is (are) responsible for producing the report certifies(y) that he (she) or any of their close relative have no beneficial ownership in the company s stock at the time of publishing the report. Any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report. Additional information on the contents of this report is available on request. Among stocks under our coverage, Ahli United Bank and National Bank of Bahrain owns 11.9% and 12.5% respectively in SICO. SICO does market making in Aluminum Bahrain (ALBA) and Zain Bahrain s shares. Copyright Notice Securities and Investment Company 2016. This report is being supplied to the recipient for information and not for circulation and may not be reproduced, redistributed or passed on to any other person or published, in whole or in part. 7