Positive outlook for Saudi cement: NCB Capital

NCB Capital, Saudi Arabia’s largest investment bank and leading GCC wealth manager, has published a new report highlighting the cement sector in Saudi Arabia and updating the bank’s six covered cement stocks based on the latest monthly data and recent financial results. NCB Capital believes a key positive of the sector remains the high dividends, with expected yields for 2011 around the 6-7% mark.

Although the outlook for the cement sector remains the strongest since 2007, NCB capital believes much of this is priced in with the cement sector outperforming the TASI by 26% YTD. Cement prices should remain robust, although the bank believes the recent spike is temporary and focused on the western region. Growth demand remains strong, but there is sufficient supply to meet this in the short-to-medium term.

“We believe the outlook for the listed companies is stronger than in our last sector update in March 2011, largely due to a strong pickup in construction activities which in turn is supporting demand/pricing of cement,”  said Farouk Miah, Acting Head of Equity Research at NCB Capital. “However, in part, we believe the strong pick-up in demand and prices in April/May 2011 is due to one-off reasons and will not be sustained through to the end of 2011. Additionally, we believe the recent stock outperformance of most companies has already priced in the stronger outlook scenario.”

Yamamah Cement remains the bank’s only overweight in the sector. “Although we also like Saudi and Southern, we believe their current prices factor in their positive outlook. Prospects for Eastern and Qassim remain muted, and thus we remain Neutral on these stocks. We downgrade Yanbu to Underweight off the back of an unjustified premium in valuation against peers,” added Mr. Miah.

The price targets of most companies has increased by around 5-15% off the back of an improved demand outlook coupled with excess capacity level enabling them to meet any potentially higher demand easily. This is coupled with reduced costs for many cement companies.

The cement sector performed strongly in the first quarter of 2011 driven largely by increased volumes and in part supported by stable cement prices; net income of the nine listed companies increased by 13% YoY to SR1,133 million with Arabian showing the best growth at 42 percent and Yanbu reporting the weakest, down by 18 percent. The sector’s net income margins expanded 1.3% YoY to 48.7 percent in 1Q11.

Total sales volumes for the KSA cement sector increased by 8% YoY to 12,596mn tons in 1Q11. For the nine listed stocks, total volumes increased by 9% to 9,967mn tons; sales volumes increased by 6% to 2,629mn tons for the four private cement companies in KSA. From the listed companies, Southern recorded the best growth at 27% and Qassim reporting the weakest, down by 6%.

NCB Capital believes the second quarter of 2011 will be another strong quarter for the cement sector. For the six covered stocks, the bank expects revenues to come in at SR2,095 million, up 12.9% YoY, with gross profit at SR1,165mn, up 17.7% YoY with net income expected to come in at SR1,057mn, up 14.8% YoY. Prices are set to remain stable YoY at SR240 per ton, but up 4% QoQ. The slower growth in net income is due to volatility in the other income, and hence we should ideally look at gross/operating income to have a better understanding of core earnings.

“In the backdrop of increasing construction activities, we expect KSA cement sales volumes to increase by around 16% YoY in 2Q10 and 13% for 2011,” added Farouk Miah. “Overall sales (local and export sales of cement and clinker) are expected to increase by 8% in 2Q11 and 7% in 2011. Looking at the rest of  2011, July and August are expected to be slower due to the impact of summer and Ramadan when construction activity slows in Saudi Arabia. Additionally, the start of November will also see a dip down in activity due to the Hajj festival. Thus, we believe the sales volumes in April/May will not be repeated for the next few months.”

The variance in changes to NCB Capital 2011 sales volume forecasts is significant; while volume estimates for Yamamah, Southern and Qassim have been increased by 1-11%, estimates have fallen in the range of 1-13% for Yanbu, Eastern and Saudi Cement. This variance is due to performance in 2010, location of plants and in Eastern Cement’s case, a lack of domestic clinker sales in 2011 which was present in 2010.

In terms of the spike in cement prices, NCB Capital believes the sharp increase was focused on bagged cement in the western region. “The temporary production shutdown at Yanbu due to fuel issues was largely behind the spike in prices seen in the western region,” said Farouk Miah. “In other areas, we believe prices increases have been more moderate (1-2% higher QoQ) due to cement players limiting discounts. Over the long term, given the stronger demand outlook and lower levels of excess supply, our estimates for the price of cement have increased by SR1-3 per ton.”

NCB Capital believes some confusion remains over the allotment of crude for the cement sector. The key concern is focused on supply of crude for new lines and new companies, as well as existing companies requesting higher supplies during high utilization rate periods. However, longer term, NCB Capital does not expect lack of fuel to be a source of significant concern.

For costs, the major change is the reduction for cost of cement per ton at Saudi

and Yamamah Cement. This is off the back of the efficiency gains at Saudi Cement due to exclusive use of its new lines which led to 1Q11 costs for SCC coming in SR11 per ton lower than expected. NCB Capital believes Yamamah will also benefit from its efficiency in production thus leading to SR4 per ton lower than expected costs.

The summary of company-specific ratings released include:

Saudi Cement

New production line benefits factored in

NCB Capital remains Neutral on Saudi Cement with our PT increasing to SR62. With demand outlook stronger than before, SCC should be a key beneficiary due to its high inventory/capacity levels; however, NCB Capital believe much of this is currently priced in. Its new lines continue to drive costs lower, a key strength of the stock.

Southern Cement

Capacity strength in demand growth environment

NCB Capital remain Neutral on SPCC with our PT increasing to SR73.6. With the demand outlook improving, SPCC is expected to benefit due to its high capacity and stock levels enabling it to meet any incremental domestic demand. However, NCB Capital believes much of the positive outlook is priced in at current levels.

Qassim Cement

Limited capacity holding back progress

NCB Capital remains Neutral on the stock with a PT of SR71.7. QCC’s existing high utilization rates lead to limited ability to meet incremental demand growth in KSA; we expect total YoY volume growth of only 1% against some 13% for the sector. Its low cost advantage and high dividend yield remains key strengths of the stock.

Eastern Province Cement

Lack of domestic clinker sales to hit YoY growth

NCB Capital remains Neutral on EPCC with a PT of SR49.4. With a limited capacity and low inventory, EPCC is constrained in meeting incremental demand. Additionally, YoY growth is likely to be hit in 2011 due to a lack of domestic clinker sales against high sales in 2010. Ability to export freely will be a key catalyst for the stock.

Yamamah Cement

Remains top pick in Saudi cement sector

NCB Capital remains overweight on Yamamah Cement with a PT of SR75.6. Located in Riyadh, it is ideally positioned to benefit from the 40% of total KSA cement demand expected in the central region. Its high capacity and stock levels should enable it to tap any pick-up in demand with a low cost base adding to its competitive strength

Yanbu Cement

Valuation looking expensive

NCB Capital downgraded its rating on Yanbu Cement to Underweight with a PT of SR50. Improving demand in KSA and its new line provide a good outlook for Yanbu. However, recent problems with fuel delivery, as well as a fire at its new line are concerns on the stock and could lead to short term pressure.