El-Quqa : Positive outlook on the UAE cement sector. However, we recommend a “SELL” on Gulf Cement stock on valuation considerations
Company Background
Global Investment House – Kuwait – Equity Results Research report on Gulf Cement Company stock- <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />December2005- Gulf Cement Company (GCC), Ras Al Khaimah, UAE, was incorporated as a public shareholding company in 1977. It is the biggest cement company in the UAE, with a current clinker capacity of 1.3 million tones (mt) and cement capacity of 2.5mt. It enjoys excellent locational advantages, being just across the road from the Mina Al Saqr port in Ras Al Khaimah. This gives it cost advantages in the case of both imports and exports. The company produces various types of cement, such as ordinary portland cement, sulphate resisting cement and moderate sulphate resisting cement. GCC is planning to expand its clinker capacity by 2.4mt, to be commissioned by the middle of 2006.
The company is currently listed in the Kuwait Stock Exchange and Abu Dhabi Securities Market. The stock turnover of the company has been 38.7% on the KSE and 82.3% on the ADSM in the year to December 2005. The high/low prices of the stock over the last one year have been KD1.400/0.650 on the KSE, while on the ADSM the range has been AED17.70/8.50.
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Analysis of 3rd Quarter 2005 Results
The sales revenue for GCC increased by 21.5% y-o-y during the quarter to AED173.6mn, taking the total for the first three quarters up by 26.4% y-o-y to AED470.3mn. The cost of sales of AED112.8mn, on the other hand, was higher by 14.9% y-o-y, with the total for the first three quarters going up by 26.3% y-o-y to AED320.0mn. The raw material costs were higher by 39.7% y-o-y during the quarter, whereas the total for the first three quarters was up by 37.6% y-o-y. The higher growth in the raw material expenses in the two periods was on account of higher imports of clinker and cement by the company.
On the operating expenses side, the general & administrative expenses increased by 51.2% y-o-y during 3Q2005, with the total for the first three quarters going up by 82.6%. It was primarily on account of a YTD increase of 118.0% y-o-y in the other administrative expenses – mainly expenses incurred on Letters of Credits, and some commissions paid. On the other hand, the selling expenses decreased by 70.1% y-o-y during 3Q2005, with the total for the first three quarters declining by 44.9%. The operating profit was higher by 36.6% y-o-y in the 3Q, while the rise was 26.8% y-o-y in the nine month period of 2005. The finance costs of the company more than doubled in the quarter, while the total finance costs were higher by about 5 times y-o-y in the first three quarters of the year. This was due to higher interest outgo on working capital during the period.
The company had sizeable gains – both booked as well as notional – from its investment portfolio during the 3Q/YTD period. The adjustment in the fair value of the financial assets gave it AED47.4mn in the quarter (up almost 9 times y-o-y), whereas these adjustments amounted to AED99.4mn (up almost 4 times y-o-y) during the nine month period. In addition to this, there were hefty profits on trading and available-for-sale investment portfolios in the two periods.
The net profit of the company of AED119.2mn increased by 133.4% y-o-y during 3Q2005, with the total for the first three quarters of AED350.2mn going up by 140.8%. The EPS of the company rose by 128.6% to AED0.96 in the first nine months of 2005, from AED0.42 in the first nine months of 2004.
The total assets of the company of AED1.4bn at the end of September 2005 were up 76.5% during YTD. While there was an increase of 35.5% in the receivables (138 average receivable-days at the end of September 2005, higher than 117 days in December 2004), inventories increased by 21.1% (56 average inventory-days at the end of September 2005, down from 70 days at the end of December 2004) during YTD. The biggest change, however, was in the trading investments whose fair value rose by 175.8% since end of 2004. On the liabilities side, there was a rise in the payables of 55.2% YTD at the end of September 2005 (66 average payable-days at the end of September 2005, higher than 54 days at the end of December 2004), and a YTD increase of 24.8% in the bank borrowings to AED67.3mn at the end of September 2005. The paid-up share capital increased to AED365.2mn, thanks to a 20% bonus issue and 15% rights issue during YTD. The rights were issued at a premium of AED3 per share, which resulted in an inflow of AED142.9mn into the share premium account.
UAE Cement Sector Outlook
According to MEED Projects, projects currently under execution in the GCC, Iran and Iraq are in excess of $697bn. Out of these, UAE is believed to account for about 32%, or $224bn worth of projects. Out of an amount of $294bn proposed to be invested in construction projects all across the GCC (over the next 3-4 years), UAE is believed to account for about 60%, or about $177bn. Assuming that all the investment projects valued at $177bn announced in UAE so far are implemented, we project a cement demand growth at a CAGR of over 25% in volume-terms during 2005-’09.
On the supply side, announcements have been made by various incumbent as well as new cement companies for expansion of existing capacities and/or setting up new capacities. New clinker capacities of about 10.9mt and cement capacities of about 16.9mt are believed to be coming up in the UAE in the coming 2-3 years – by way of expansions as well as greenfield projects.
Valuation & Recommendation
In our previous Research Report on GCC in October 2004, with which we had initiated coverage of the stock, we had arrived at a weighted average share value of KD0.740 (AED9.26) per share, and had recommended a 'Buy' on the stock at the then prevailing price of AED7.05. The stock has since then had a good run at the stock markets, touching a high/low of KD1.400/KD0.530 (AED17.70/AED7.00) over the 14 months since our Report was released, thereby, justifying our 'Buy' recommendation.
The positive newsflows favorably impacting the UAE cement sector, as well as the excellent YTD performance of GCC have prompted us to revisit our earlier projections. We have accordingly revised our projections for sales, gross profit, operating profit and net profit for 2005 to AED627.1mn, AED234.4mn, AED191.7mn and AED464.5mn respectively, to better reflect the company's first 9 months results this year.
Besides the changes in the projections, we have also made a change in the risk-free rate and cost of debt from that assumed in our earlier Report. The combination of the revised financial projections and WACC has led to a downward revision in the DCF value of GCC to AED7.67 (KD0.613) now, from AED9.70 (KD0.776) in the October 2004 Report. Based on the Sector P/E multiple of 13.9x (up from 10.7x at the time of the earlier Report), the peer valuation too has increased now to AED17.70 from AED7.48 earlier. The combined effect of these two has led to a marginal upward revision in the weighted average share value of GCC, which is now AED9.67 (KD0.774), as against AED9.26 (KD0.740) in our October 2004 Report. Besides the high capital expenditure expected to be incurred on the company’s on-going capacity expansion project, other factors adversely impacting the valuation of the company now include a 38% hike in the paid-up capital of the company, thanks to bonus and rights issues during 2005, and higher risk-free rate and cost of debt than that assumed in our October 2004 Report.
At the current market price of AED15.00 on the ADSM and KD1.120 on the KSE, the GCC share is quoting at a premium of 55.1% and 44.7% to its intrinsic value at the respective stock exchanges. The scrip has gained 100.0% on the KSE and 111.3% on the ADSM since the release of our October 2004 Report (72.3% and 76.5% in the last one year on the two exchanges). We, therefore, downgrade our recommendation on the GCC stock to 'Sell'.
