Company Code: 3002 Publish Date: 30-Aug-2014

Research Report: Najran Cement Company (NCC) Last price as of 28-Aug-2014: SAR 33.9 Fair Value: SAR 50.3 Expected price for the next 12 months: SAR 47.8 – 52.8

Abdulsalam Aldraibi

(48.4%) (41.0% - 55.8%)

Email :[email protected] Blog :aaldraibi.blogspot.com

Main drivers & assumptions

Overview  In the previous report of Najran Cement Company (NCC), which was published 5 months ago, the fair value of NCC stock reported to be SAR 38.1 (the market value was SAR 24.9). Since then, the stock price rallied to SAR 33.9 generating a capital gain of 36%. In this report, the stock’s fair value will be adjusted based on new factors which will be identified in this report.

Clinker capacity (m tons) Clinker operating rate Production (m tons) Cement operating rate Production (m tons) Selling price - SAR / ton Gross profit before dep. / ton Net income / ton

 In various months of this year (2014), the company was able to operate its clinker lines at an operating rate that exceeded the designed capacity of 413,000 tpa (Table-1 below shows the clinker Income statement and cement monthly production and operating rates).

2013 2014E 2015E 2016E 2017E 3.57 5.21 5.21 5.21 5.21 101% 95% 95% 95% 95% 3.42 4.71 4.71 4.71 4.71 73% 74% 100% 100% 100% 2.62 3.85 5.21 5.21 5.21 241 230 230 230 230 134

135

141

141

141

76

90

101

102

103

(SAR million)

 During the first 7 month of 2014, NCC managed to produce 2.76 million tons of clinker which counts for 95% of the designed capacity. Although, the company shut down its first production line in order to carry out scheduled maintenance during the month of May 2014.

Sales COGS profit before dep. Gross profit before dep.

632 (281) 351

885 (364) 522

1,196 (461) 735

1,196 (461) 735

1,196 (461) 735

Dep. & amort. Gross profit

(91) 259

(120) 402

(126) 609

(128) 608

(129) 606

 Despite improved sales during the second quarter of 2014, the weak sales in the first quarter in addition to the strong production of clinker during the 7 months led to a huge increase in the company's clinker inventory form 1.65 million tons at the end of 2013 to 2.82 million tons by the end of July 2014.

G&A expenses Operating income

(33) 226

(40) 362

(45) 564

(45) 562

(45) 561

Finance costs Other income (losses) Zakat Net income

(11) 2 (19) 198

(23) 18 (10) 347

(20) (16) 527

(17) (15) 531

(13) (14) 534

Future Expectations:

Growth

 It is expected that the company will produce 4.71 million of clinker during 2014 implying an operating rate of 95%.  Since the commercial operation of NCC’s 3rd line, the company was facing some difficulties in marketing the new line’s production. However, as seen in Figure-1 the company was able to increase its sales gradually from 183,000 tons in October 2013 to 330,000 tons in June 2014 by reaching into new customers in the region as well as by reaching out to the Western Region.

EPS PE Dividends Payout ratio Dividend yield

(2.0%)

75.3%

51.8%

0.7%

0.6%

1.17 29.09 0.60 51% 1.77%

2.04 16.59 1.50 73% 4.42%

3.10 10.93 2.50 81% 7.37%

3.12 10.85 3.00 96% 8.85%

3.14 10.79 3.00 95% 8.85%

Income statement ratios Sale s growth

Gross profit margin before dep. Gross profit margin Operating profit margin Net margin

3.0%

40.2%

35.1%

0.0%

0.0%

55.5%

58.9%

61.4%

61.4%

61.4%

41.0% 35.8% 31.4%

45.4% 40.9% 39.2%

50.9% 47.1% 44.1%

50.8% 47.0% 44.4%

50.7% 46.9% 44.6%

(409) (64) (236)

(131) (98) 104

670 (30) (591) 49

693 (30) (634) 29

688 (30) (634) 24

 NCC monthly sales is expected to increase to more than 400,000 tons by the end of this year (2014), and to continue at that rate during next year (2015). By doing so, the company will be the Cash flow statement (SAR million) OCF 238 333 forth largest seller among Saudi cement companies.  NCC is expected to report a net income of SAR 347 in 2014 (75% YoY growth), and SAR 527 million in 2015 (52% YoY growth).

Month Capacity ('000 tons) Clinker Production ('000 tons) Operating rate Capacity ('000 tons) Cement Production ('000 tons) Operating rate

ICF FCF Net change in cash

Table-1: Monthly clinker and cement production during the last 12 months Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul 2013 2013 2013 2013 2013 2014 2014 2014 2014 2014 2014 2014 240 240 413 413 413 413 413 413 413 413 413 413 354 375 414 441 304 465 436 381 264 332 414 465 148% 156% 100% 107% 74% 113% 106% 92% 64% 80% 100% 113% 252 123 49%

252 188 75%

434 203 47%

434 162 37%

434 169 39%

434 202 47%

434 230 53%

434 277 64%

434 285 66%

434 323 74%

434 342 79%

434 156 36%

Disclaimer: The purpose of preparing this report is to provide an overview of the company, and not to make a recommendation to buy or sell or keep the shares. This report does not take into account the financial circumstances of each investor, so it is advisable to take the advice of financial and legal advisors before making any financial decision based on this report. I do not bear any responsibility for any direct or indirect material or moral loss that may occur due to the use of this report or any part thereof. Copyright: No part of this document may be reproduced without a written permission from me personally.

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Company Code: 3002 Publish Date: 30-Aug-2014

Research Report: Najran Cement Company Fair Value:

 The fair value is increased to SAR 50.3 implying a 48.4% upside potential as a result of the following factors:  A decline in NCC’s operating risk that is associated with the ability to operate clinker production lines at high rate. Certainly, the company was able to operate at 95% of the designed capacity during the first 7 months of 2014; furthermore, NCC managed to increase its clinker inventory to 2.8 million tons by July 2014, accounting for ~15% of all Saudi cement companies’ inventory.  A decline in NCC’s marketing risk that is associated with the ability to sell its production. In fact, the company was able to reach into new customers and new markets such as the western region market.  An increase in government and private sector spending on infrastructure, residential, and other development projects which will increase the demand for cement in general.  An increase in the investors’ risk tolerance which is reflected in the multiple expansion in the Saudi Stock Market.  NCC was able to get an additional financing in 2014 that is repayable starting from mid 2019. Having this financing decreases NCC’s liquidity risk; additionally, it will enable NCC to increase its dividends to SAR 1.5 in 2014 and SAR 2.5 in 2015.  The fair value is derived using DCF valuation with the following assumptions: 1) growth rate of 2.5% 2) WACC of 8.5%.  Based on 2015 forecasted net income and current market price, the company is trading at a 2015 forward PE of 10.93x and a 2015 dividend yield of 7.4%, compared to a current PE of 19.2x and a dividend yield of 4.4% for the Saudi cement sector.  When NCC stock price reaches the fair value of SAR 50.3, it will be trading at a 2015 forward PE of 16.2x and an expected dividend yield of 5.0%, which still makes NCC stock attractive for long term investors.

tons

Figuer-1: Najran Cement Sales

500,000

100% 76%

400,000 63% 300,000

48%

80% 60%

332,000 330,000

50% 274,000

200,000

76%

68%

297,000

39% 40%

207,000 215,000

Ramadan and Eid-al-Fitr holiday

169,000

100,000 -

20% 0%

Jan'14

Feb'14 Mar'14 Apr'14 May'14 Jun'14 Capacity

tons 5,500,000

Jul'14

Aug'14 Sep'14

Sales

Oct'14 Nov'14 Dec'14

Operating Rate

Figuer-2: Monthly Sales of All Cement Companies* 2009

5,000,000

2010

4,500,000

4,000,000

2011

3,500,000

2012

3,000,000

2013

Ramadan and Eid-al-Fitr Holiday for the year 2014

2,500,000

2014

2,000,000 Jan

Feb

Mar

Apr

May

Jun

July

Aug

Sep

Oct

Nov

Dec

*Excluding City Cement Disclaimer: The purpose of preparing this report is to provide an overview of the company, and not to make a recommendation to buy or sell or keep the shares. This report does not take into account the financial circumstances of each investor, so it is advisable to take the advice of financial and legal advisors before making any financial decision based on this report. I do not bear any responsibility for any direct or indirect material or moral loss that may occur due to the use of this report or any part thereof. Copyright: No part of this document may be reproduced without a written permission from me personally.

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