SAUDI ARABIA REAL ESTATE SECTOR
Fertile Ground for Real Estate Developers 19 october 2009
CONTENTS • Strong Fundamental Story: Saudi Arabia’s real estate sector benefits from a very strong fundamental story driven by a large, growing and young population. The current percentage of homeownership is low,
EXECUTIVE SUMMARY 2 at c45%, with potential for significant growth. We estimate that yearly demand will increase at a rate I. MARKET OVERVIEW 3 faster than population growth, particularly once mortgages allow more people to own homes. Saudi II. STOCK OVERVIEW 8 Arabia escaped the worst of the world financial crisis, and we believe the overall economic environment is SAUDI REAL ESTATE (AKARIA) 9 solid. We consider it well-placed to benefit from strong economic (non-oil real) growth of 4.5% in 2010e DAR AL - ARKAN 24 and 4.6% in 2011e. IV. REAL ESTATE PRICES HAVE • Major Catalyst is Mortgage Law: All real estate stocks will benefit from the passing of a mortgage law, STABILISED 42 which we expect will happen in the next twelve months. Currently there is limited mortgage financing V. CONSTRUCTION COSTS HAVE available, as the lack of a regulatory framework is a major obstacle, particularly on MODERATED 44 enforcement/foreclosure. Companies like Dar Al-Arkan and Akaria are likely to benefit the most from the VI. OFFICE SPACE IN DEMAND, BUT new law, given their residential focus. We expect a very strong rally in the real estate sector when the law COULD BE REACHING RETAIL passes. OVERSUPPLY 45 VII. MORTGAGE & DEVELOPMENT • Initiating with ST/LT Buy on Akaria: Akaria is our favourite developer. It has a solid balance sheet with a FINANCING LIMITED 46 net cash position of SAR688 million, a growing recurring revenue base and potential for strong growth VIII. REGULATORY CHANGES from new development projects. Akaria's healthy mix of residential, commercial and retail properties are FAVOR INCUMBENTS 48 well-located. We particularly like its villas in the Diplomatic Quarter (which it is expanding) and its commercial space at the new Akaria Plaza in Riyadh’s Central Business District. Our LTFV of SAR33.50 per IX. DEVELOPMENT OF NEW share implies 27% upside potential. The company’s rental properties make up 40% of our value, its land CITIES 49 bank (13.8 million in total) makes up 31%, while cash and investments and the Binban project account for X. A PRIMER ON EMAAR the remaining 29%. ECONOMIC CITY AND KAEC 50 XI. DEMOGRAPHIC TRENDS • A Slightly More Cautious ST/LT Accumulate on Dar Al-Arkan: We also like Dar Al-Arkan due to i) its large land bank, which it has consistently traded at a profit, ii) its solid record of execution for its POINT TO GROWING DEMAND 55 development projects, and iii) its expanding rental portfolio. However, we are more cautious on the XII. CITY VIEWS 58 company due to lack of detailed information regarding its land bank; the operational risks we see attached APPENDIX I – MAJOR PROJECTS to its new project in Jeddah, Khozam Palace; and the financing of its SAR2.25 billion sukuk due in March IN RIYADH 65 2010 out of its cash flows, which we believe will limit the company's short-term ability to invest in land or APPENDIX II – MAJOR PROJECTS pay dividends. Our LTFV of SAR19.15 implies a 15% upside potential, and we initiate with a ST/LT IN JEDDAH 66 Accumulate recommendation.
• A Primer on Emaar EC: We have included a primer on Emaar EC, although we have not decided to initiate on the stock at this time given a great deal of uncertainty over financing and the final masterplan. We believe the economic cities, including King Abdullah Economic City (KAEC), will be a major driver of construction activity within Saudi Arabia, and Emaar EC is well-placed to take advantage of public support for new economic development. However, the company, by itself, does not have enough money or financing to build KAEC on its own, and will likely have to resort to government support, either in the form of infrastructure investment or more direct financing that could dilute current shareholders’ stakes. While we believe KAEC will be successful over the long term, this may not result in stock outperformance.
SECTOR NOTE
Companies Analysed in this Report Company Rating LTFV Price* Upside Mkt. Cap EV
ST / LT (SAR) (SAR) (SAR) (USD) (SAR) (USD) Jan Pawel Hasman Saudi Real Estate (Akaria) Buy / Buy 33.50 26.30 27% 3,156 842 2,504 668 +20 2 3332 1139 [email protected] Dar al-Arkan Acc. / Acc. 19.15 16.60 15% 17,928 4,781 25,775 6,873
Patrick Gaffney *Prices as at 18 October 2009 +20 2 3332 1080 Source: TASI, EFG-Hermes [email protected]
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FERTILE GROUND FOR REAL ESTATE DEVELOPERS 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
EXECUTIVE SUMMARY
VERY STRONG RESIDENTIAL MARKET DRIVEN BY DEMOGRAPHICS Long-term trends are very positive for the Kingdom of Saudi Arabia's (KSA) residential market. The major characteristics of the residential market are i) a young and growing population that is ii) increasingly urban and iii) characterised by a low home ownership percentage. We believe the market will also benefit from iv) a shrinking household size, as young people increasingly move out of their parents' home when they marry. We estimate annual demand of 160,000 new units each year, with unmet demand of up to 50,000 units.
OUR SHORT-TERM VIEW ON THE MARKET IS CAUTIOUSLY OPTIMISTIC We believe new residential housing targeted at the middle-income segment has strong promise in the Saudi Arabian market, given powerful pent-up demand and a growing number of young people that would like to own their own homes. We believe prices have been fairly stable over the past year, but we expect them to start to increase again in 2010e and 2011e, particularly if liquidity comes back to the market either through higher oil prices, stock market performance or mortgages. The secondary property market is very small, which means that developers and the government are the main recourse for buyers and will therefore benefit from the expected positive growth trends. Additionally, while a large number of projects have been announced, we believe a number have been delayed owing to the financial crisis and new regulations. This is likely to benefit those developers able to launch within the next year. Dar Al-Arkan, with its Al Qasr project, which launched this year, and Shams Alriyadh project, launching next, should benefit the most from strong demand in the near term.
THE STOCKS HAVE NOT DONE WELL Since the beginning of 2008, all Saudi real estate stocks have fallen. The decline accelerated after the world financial crisis in August, with a mild recovery in November and December before stocks fell again at the beginning of 2009. Although stock performance has improved since spring 2009, all are well below their early 2008 prices and all except Jabel Omar are down 40% or more.
WE INITIATE ON AKARIA AND DAR AL-ARKAN - PREFER AKARIA We are buyers of both Akaria and Dar Al-Arkan, but we prefer Akaria because of its steady recurring revenue streams and stronger balance sheet. While Dar Al-Arkan has a better track record for development and the ability to grow, it is heavily dependent on buying and selling land profitably, while Akaria’s business model is simpler and steadier. Also, we believe Dar Al-Arkan's inability to roll over its SAR2.25 billion sukuk, due to be repaid in March 2010e, has hurt its short-term ability to grow or pay dividends. Both companies trade with a high correlation to the wider KSA market, particularly Akaria, so any changes in sentiment for the overall market are likely to affect both companies significantly.
NEW MORTGAGE LAW SHOULD LIFT ALL BOATS Historically, very limited financing has been made available to homebuyers. While banks have offered mortgage-like products for some time, many are fearful of expanding without final government approval of mortgage loans. We expect the mortgage law, which has been delayed by almost a year due to the financial crisis, will benefit all real estate companies, but particularly those like Dar Al-Arkan and Akaria that target the middle-income segment of the population.
CREDIT COULD LIMIT GROWTH AT DEVELOPERS Real estate companies generally have limited access to credit from banks or from the bond market. While some have been more successful than others, namely Dar Al-Arkan, we believe banks are very risk averse when it comes to real estate companies. This negatively impacts the companies, especially when combined with the difficulty of selling off-plan. This is probably a bigger concern for Dar Al-Arkan given its heavily leveraged business model, but even Akaria’s growth plans, which we believe will need financing could be limited. We expect this will reverse in the medium term, say towards the end of 2010e, particularly if a mortgage law is passed and demand picks up.
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FERTILE GROUND FOR REAL ESTATE DEVELOPERS 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
I. MARKET OVERVIEW
ECONOMIC GROWTH REMAINS ROBUST DESPITE CRISIS Our economist believes that Saudi Arabia is in one of the strongest positions, both in the MENA region and globally, to withstand the current economic crisis and continue to support growth. We believe the government's investment programme will remain intact and will be the main driver of economic growth, as a result we expect economic activity to remain solid, resulting in real non-oil GDP growth remaining above 4.0% in both 2009e and 2010e.
ECONOMY BOLSTERED BY STRONG INVESTMENT IN INFRASTRUCTURE After years of strong oil prices and successful management of the boom, Saudi Arabia is in an extremely strong position to adopt a counter-cyclical policy. Fiscal policy will remain expansionary in the near term, and we forecast an acceleration in government spending. There is a vital need to upgrade infrastructure and increase the productive base in Saudi Arabia, and the drop in prices for raw materials and increased slack in the construction sector means the investment environment has actually improved. However, the government is the driver of investment right now, because private sector activity continues to be weak. The investment programme will predominately focus on the domestic side. Although decelerating with the fall in global asset prices, private consumption should also remain relatively supported by a marked drop in inflation. With the substantial build-up in its net foreign asset position, Saudi Arabia can easily afford the forecasted surplus in 2009e.
Figure 1: Drivers of Non-Oil Real GDP Growth Figure 2: Non-Oil and Overall GDP Growth Percentage change, Y-o-Y %, unless otherwise stated
Other Government Services 7% Non-Oil GDP Overall GDP Financial & Real Estate 6% Transport & Communication Construction 5% 6.0 Manufacturing 4% 5.0 3% 4.0 2% 3.0 1% 2.0 0% 1.0 -1% 0.0 -2% 2004 2005 2006 2007 2004 2005 2006 2007 2008 2009f 2010f 2008e 2009f 2010f
Source: SAMA, EFG-Hermes estimates Source: SAMA, IMF, and EFG-Hermes estimates
STRONG RESIDENTIAL DEMAND NOT MET BY SUPPLY There is high demand for property, especially at the lower end of the market, which is not currently being met, with unmet demand as high as 50,000 units per year, according to the government. The lack of a regulatory framework for mortgage financing means that low and middle-income households do not have access to financing to buy property. Consequently, the government has been responsible for housing many of these households, particularly at the lower end, but it has not been able to meet demand.
OUR TAKE ON CURRENT DEMAND FIGURES We estimate total KSA property demand over an economic cycle is approximately 160,000 new residential units per year. This is driven by i) new family formation (mainly marriages), ii) changes in household size (moving out of traditional houses), and iii) replacement demand. This is the underlying demand for housing, we believe it can fluctuate widely over the economic cycle. Additionally, if the mortgage law is passed, we expect demand will increase significantly as mortgages will allow more people to access the housing market.
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FERTILE GROUND FOR REAL ESTATE DEVELOPERS 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
• Marriages: We base the new demand on marriages, because we believe most young couples purchase homes around the time of their marriage. Saudi Arabia has seen an increase in marriages over the past five years, to more than 130,000 a year from less than 100,000, driven by an increasing population and improved economic conditions that have allowed men to afford marriage. We assume that 75% (or 100,000) of newly married couples will enter the housing market. It is worth bearing in mind that the percentage of people entering the housing market could increase with the mortgage law, resulting in a higher demand estimate.
• Change in household size: We also assume that some couples that previously lived in traditional homes or with family members will move out, adding another 25,000 to our demand estimate. There are about 1 million traditional houses in Saudi Arabia, about 30% of total residential units. Jizan province, on the Red Sea and abutting Yemen, has the highest percentage at 72%. Hail and Al Baha also have high percentages of traditional homes at 46% and 41%, respectively.
• Replacement demand: Our replacement demand calculation is based on 1% of current housing unit stock. This is a fairly low percentage, but we believe it is appropriate because of the relatively young age of most of the housing stock. This is likely to increase over time (say 20-30 years) to reach closer to 2-3%.
Figure 3: Housing Demand Build Up
Units Assumption From new marriages 95,000 75% of new marriages From change in hh size 25,000 Assumes gradual shift Replacement demand 40,000 1% of households Total demand 160,000 Source: EFG-Hermes estimates
SAUDI GOVERNMENT ESTIMATES DEMAND TO BE 200,000 PER YEAR In the Eighth Development Plan, the government forecasts a demand of 900,000 units over the 2005- 2010e period. To meet this expected demand, it aims to construct one million housing units during the period. The Development Plan outlines provisioning for loans to construct 90,000 units through the Real Estate Development Fund (REDF), construction of 35,000 social housing units through the Ministry of Social Affairs, and the remaining 875,000 units to be built by the private sector, with the government supporting the construction of 225,000 units.
Figure 4: Demand for Housing by Administrative Region per Eighth Development Plan
2005-2010e (1425-430h) Per Year New Replacement Unmet New Replacement Unmet Province Total Total Demand Demand Demand Demand Demand Demand Riyadh 160 20 40 220 32 4 8 44 Mecca 170 25 44 239 34 5 8.8 47.8 Medina 34 5 20 59 6.8 1 4 11.8 Qassim 20 5 12 37 4 1 2.4 7.4 Eastern 118 20 27 165 23.6 4 5.4 33 Region Jizan 30 5 30 65 6 1 6 13 Other Total 95.5 22.5 97 215 19.1 4.5 19.4 43 Total 627.5 102.5 270 1000 125.5 20.5 54 200 Source: Ministry of Economy and Planning
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FERTILE GROUND FOR REAL ESTATE DEVELOPERS 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
DEMAND SHOULD CONTINUE TO INCREASE FASTER THAN POPULATION GROWTH We expect demand will continue to increase at a gradual pace over the next twenty years due to i) the young population, ii) a move to smaller household size, iii) the replacement of older housing at a slightly faster rate than currently, and iv) growing home ownership. However, demand in each year could be volatile because of the cyclical nature of housing.
SEGMENTATION OF HOUSING DEMAND BY INCOME There is very little income data in Saudi that gives a sense of the exact size of different populations segmented by income. We assume that about a fourth of the Saudi population falls into the middle- income bracket, making between SAR7,000-15,000 per month, and demands about 40,000-50,000 homes a year, or a little more than one fourth of our total demand picture. These homes cost around SAR450,000-550,000 for apartments and SAR1.0-1.2 million for villas. We assume that the higher-end market is smaller than the middle-income market, and that prices start at SAR1 million for apartments and SAR1.5 million for villas.
LIMITED SUPPLY RESULTS IN UNMET DEMAND Saudi Arabia’s high demand for housing has not been met on the supply side, with the government forecasting unmet demand of 270,000 units during the 2005-10e period, or more than 50,000 units per year. Other sources validate this, with Dar Al-Arkan citing a similar figure for unmet demand each year until 2014a. Jones Lang LaSalle has said that it expects 380,000 units to be built between 2008 and 2012e, or about 76,000 per year, well below our demand estimate. However, up to 15% of units are unoccupied, according to Dar Al-Arkan. We attribute this large figure to greater demand at the low end of the market, but greater supply at the high end, as most developers are more interested in high-end properties, because of higher margins. This could hamper some developers if they exclusively focus on the high end. Dar Al-Arkan and Akaria have traditionally focused on middle-income and upper middle-income homebuyers, so they should weather any oversupply better than other developers.
OFFICE MARKET - SOME ROOM TO GROW The office market has been relatively solid, with high occupancy rates and increasing rents. The three major markets are Riyadh, Jeddah and Khobar. In some parts of Riyadh buildings have a low occupancy, but we have heard from real estate sources that this is because owners are waiting for one tenant to come in and take the entire space, rather than having multiple tenants. While there is a fair amount of building activity in the office sector, we believe the risk of oversupply is probably greater in the “B” class market than in the “A” market. Prices should remain fairly steady, in line with inflation.
RETAIL MARKET NEARING EXCESS SUPPLY The retail market has been very strong in recent years, although we believe it has weakened over the past year, due in part to the financial crisis and in part to the specific nature of the Saudi market. Franchise owners, such as Savola or Hokair, have developed much of the retail space and they place their own brands within these malls. Independent malls, those not associated with a retailer, are likely to have greater difficulty in renting space. Total per capita gross leasable area, GLA, is relatively low compared to other GCC countries, particularly Dubai, but room for growth is limited, in our opinion, given the much lower levels of tourism.
CONSTRUCTION MATERIAL COSTS HAVE FALLEN Prices of cement and steel, the major construction materials, have fallen considerably from their 2008 highs. We expect they will remain at current levels, albeit with some fluctuations, for the next year. There are three different trends affecting the market. Firstly, Saudi Arabia is not immune from changes in international prices for steel and cement. Although the government has been willing to halt exports in order to stabilise local prices, this has failed to dampen volatility, and we expect changes elsewhere to continue to affect the Kingdom. Secondly, there are extensive expansion plans in Saudi Arabia for both cement and steel. This new capacity should result in easier local access to these basic materials, although we expect any excess to be exported. Finally, labour costs have not historically been a major issue for construction companies, but they are likely to become a bigger part of costs as wages for labourers rise.
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FERTILE GROUND FOR REAL ESTATE DEVELOPERS 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
NEW ECONOMIC CITIES WILL DRIVE CONSTRUCTION GROWTH The Saudi Arabia General Investment Authority (SAGIA) is planning the development of four new economic cities that will drive construction growth. Each one is focused on different goals that match up with a competitiveness cluster methodology. The official goals of the cities are to i) create a million jobs, ii) house 4-5 million units, and iii) contribute more than USD150 billion to annual GDP. One city, KAEC managed by Emaar EC, has already been though an initial public offering and is publically traded. Two others, KEC and PABMEC, have announced public offerings in the near future.
NEW REGULATIONS CAUSING SHORT-TERM DELAYS - WILL BE GOOD LONG TERM The government has become much stricter with real estate companies, delaying the passage of the mortgage bill and forbidding off-plan sales without prior government approval. We believe this was partly due to the global financial crisis, which made the government wary of an expansionary real estate sector, and partly because of particular problems with a specific developer that was selling off-plan. The new regulation, together with the postponed mortgage law, has caused project delays. However, these should be temporary and we expect incumbents to benefit from the new off-plan regulation, as it will be harder for new developers to enter the market. We also believe a stronger regulatory regime will help foster demand by increasing consumer trust in real estate companies, especially those that sell off-plan and have gained government approval.
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FERTILE GROUND FOR REAL ESTATE DEVELOPERS 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
Figure 5: Map of Saudi Arabia
Riyadh Dar Al-Arkan: Shams Alriyadh Al Qasr Project Akaria: Akaria Plaza Diplomatic Quarter Medina Binban Riyadh Technology Valley Dar Al-Arkan: Others: Tilal King Abdullah Financial District Others: Al Gamra Project Knowledge Economic City Ajmakan Project
Iraq Jo rdan
Jouf Northern Border Iran Tabuk
Hail Qassim Egypt Riyadh United Arab Emirates Medina Oman
Mecca
Jeddah Eastern Sudan Province Asir
Jizan
Red Sea
Yemen
Mecca Jeddah Jabel Omar: Dar Al-Arkan : Rebuilding of Jabel Omar Khuzam Palace Shams Al-Arous Others: Akaria: Ajyad Castle Akaria Tower Jabal Khandama Development Others: Jeddah Central District Ruwais District Emaar Economic City
Source: EFG-Hermes
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FERTILE GROUND FOR REAL ESTATE DEVELOPERS 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
II. STOCK OVERVIEW
We are initiating coverage on two KSA real estate stocks, Akaria and Dar Al-Arkan. There are three other public real estate companies in the country, Emaar the Economic City (Emaar EC), Jabal Omar, and Arriyadh. While all are involved in real estate development, each one is distinct from the others.
Figure 6: Saudi Real Estate Companies
Rating LTFV Price Upside MktCap EV P/E P/B ST / LT (SAR) (SAR) (SAR) (USD) (SAR) 2008 2009e 2010e 2008 2009e 2010e Saudi Real Estate (Akaria) Buy / Buy 33.50 26.30 27% 3,156 842 2,504 27.0 28.7 23.4 1.0 1.0 1.0 Dar al-Arkan Acc. / Acc. 19.15 16.60 15% 17,928 4,781 25,775 7.6 8.0 7.7 1.5 1.3 1.1 Emaar Economic City N/R N/R 11.00 N/R 9,350 2,493 8,055 N/M N/A N/A 1.1x N/A N/A Jabal Omar N/R N/R 19.85 N/R 13,327 3,554 13,266 N/M N/A N/A 2.0x N/A N/A Arriyadh N/R N/R 13.20 N/R 1,320 352 1,147 16.7 N/A N/A 0.9x N/A N/A Note: 2008 P/Es for Emaar EC and Jabal Omar are not meaningful (NM) because of negative earnings in that year at both companies Source: Company disclosures, EFG-Hermes estimates
STOCK PERFORMANCE HAS BEEN WEAK The Real Estate Index has tracked the TASI closely. Performance has been weak since 4Q2008, although it has rebounded slightly in recent months owing to improved retail investor confidence and greater global investor risk appetite. Jabal Omar is the exception, the stock has performed better than the Index.
Figure 7: Real Estate Stocks Performance Chart vs. TASI
120 Real Estate Index TASI 100 80 60 40 20 0 01-Jul-09 01-Jul-08 01-Jan-09 01-Apr-09 01-Jan-08 01-Apr-08 01-Jun-09 01-Sep-09 01-Jun-08 01-Sep-08 01-Feb-09 01-Feb-08 01-Aug-09 01-Oct-09 01-Aug-08 01-Oct-08 01-Dec-08 01-Mar-09 01-Mar-08 01-Nov-08 01-May-09 01-May-08
Source: Tadawul, EFG-Hermes estimates
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AKARIA – FROM RENTALS TO DEVELOPMENTS 19 october 2009 SAUDI ARABIA | REAL ESTATE & HOTELS
Short-Term Rec.: Buy Current Price*: SAR 26.3 Long-Term Rec. : Buy LT Fair Value : SAR 33.5
• Initiating with a ST / LT Buy Recommendation: We initiate coverage on Saudi Real Estate Co. (Akaria) with a ST/LT Buy recommendation based on i) solid, growing recurring revenues from well-located rental properties and ii) a valuable land bank throughout Saudi Arabia. We also like Akaria's move into real estate development, although it carries greater risk than the current recurring rental model. We caution that catalysts for Akaria are few and far between, and the stock will likely trade with the market for some time.
• Rentals Make Up Majority of LTFV of SAR33.50: Akaria's rental portfolio comprises 40% of our estimated LTFV of SAR33.50 per share, the largest portion of our valuation. Its land bank, for which we use a premium to book value, accounts for 31%. We value its Binban project at SAR2.07 per share, or just 6%. We estimate company’s cash and investments are worth SAR7.68 per share, or 23% of our total value.
• Growing Recurring Revenues from Rentals: We expect revenues from Akaria's rental portfolio will grow nicely over the next few years with the addition of the recently opened Akaria Plaza in Riyadh's Central Business District and new villas in Riyadh's Diplomatic Quarter. We expect a 14% growth rate in 2009e and 26% in 2010e, before falling to 10% in 2011e.
• Land Sales Volatile and Less Profitable than Rentals: Akaria also sells land, albeit not in a consistent manner, with some quarters more land-sale heavy than others. Also, gross margins on land sales at c40% are almost 20pps lower than rentals and about 10pps below Dar Al-Arkan's land sales. However, we believe Akaria’s land bank provides a way for the company to bring in cash flows when needed for development or paying dividends.
• Positive on Move into Real Estate Development, But Brings Risks: We are positive on Akaria's move into real estate development with its first major project Binban north of Riyadh. The company has other projects in the works, including the King Saudi University Science Park, which could drive earnings in the future. However, Akaria does not have experience constructing buildings and marketing full real estate development projects, and we believe this will increase risk at the company compared to its recurring rental model.
December Year End 2008a 2009e 2010e 2011e 30 Price (SAR) TASI (Rebased) Revenue 225 216 289 313 Operating Profit 110 112 141 151 EBITDA 130 131 161 172 25 Net Income 117 117 148 160 EPS (SAR) 0.98 0.97 1.23 1.33 DPS (SAR) 1.00 1.00 1.00 1.00 20 Net Debt (Cash) (711) (698) (589) (430)
P/E (x) 27.0 27.0 21.3 19.7 15 EV / EBITDA (x) 18.9 18.9 15.3 14.4 P/BV (x) 1.03 1.03 1.02 1.00 10 P/CF (x) 26.9 23.9 21.5 19.5 Div. Yield 3.8% 3.8% 3.8% 3.8% 18-Jul-09 18-Jan-09 18-Sep-09 18-Feb-09 18-Apr-09 18-Jun-09 18-Oct-09 18-Oct-08 18-Dec-08 18-Mar-09 18-Aug-09 18-Nov-08 RoAE 3.8% 3.8% 4.8% 5.1% 18-May-09 Figures in SAR million, unless otherwise stated
Estimate Changes Stock Data 2008a 2009e 2010e Last Div. Date SAR1.0 on 11 Apr 09 (SAR mn) Old New Old New Mkt. Val. / Shares (mn) SAR3,156 / 120 Revenue 225 N/A216 N/A289 Av. Mthly Liqd. (mn) SAR286 EBITDA 130 N/A131 N/A161 52-Week High / Low SAR28.80 / 16.75 EBITDA Margin 57.9% N/A 60.6% N/A 55.8% Bloomberg / Reuters SRECO AB / 4020.SE Est. Free Float 31% Net Income 117 N/A 117 N/A 148
*Prices as at18 October 2009
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AKARIA 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
EXECUTIVE SUMMARY
We initiate coverage of Saudi Real Estate Company (Akaria) with a ST/LT Buy recommendation and a LTFV of SAR33.50 per share. Akaria is distinguished by its growing recurring revenues that come from its expanding rental portfolio. It has a solid balance sheet and a stable dividend that provides a cushion to investors. In addition, its land bank of 13.8 million sqm gives us comfort. While the operations of the company are solid, the stock is highly correlated to the market, which we believe is due to low liquidity and majority ownership by the government. We believe liquidity will improve as the company becomes more transparent to investors, but this may take some time.
INVESTMENT POSITIVES
STRONG RECURRING REVENUES Akaria receives most of its revenues from its rental assets in Saudi Arabia. In 2008, 75% of its revenues were from rental and maintenance operations. We believe these rental revenues will increase as Akaria opens new rental properties such as Akaria Plaza, which is open now, and new residential units in the Diplomatic Quarter, which will likely start producing revenue in 2011e. Given a high occupancy rate in most of its buildings, we expect rents will grow at least with inflation, and should provide solid yields for the company.
LAND SALES VOLATILE, BUT CAN DRIVE GROWTH AND PROFITS Land sales from Akaria’s 13.8 million sqm land bank, while volatile, can help boost growth and cash flows for the company and provide a cushion for investors. Akaria is not as dependent on pure land sales as other companies such as Dar Al-Arkan, although land sales were 25% of total revenues in 2008, which is down significantly from about 40% in 2007. We believe this is due to weak sales in the second half of the year, but it does point to the volatility of land sales. Moreover, margins can also fluctuate – they were as high as 85% in 2005, but were just 40% in 2008. However, this is very good for cash flows, especially since most of Akaria’s 13.8 million sqm land bank was purchased a long time ago and, we believe, at low prices.
NEW PROJECTS SHOULD EXPAND SCOPE OF COMPANY We like that Akaria has expanded geographically and operationally. Its new development in Binban will likely be a mix of sales and rentals about 30 kilometres outside of Riyadh, and it is building a mixed-use office tower in Jeddah. It has also won a contract to master plan the King Saudi University Science Park, which could provide significant returns to the company, depending on its final role in the project. We believe all of these projects expand on Akaria's real estate development and management experience with fairly low risks.
STEADY DIVIDENDS, DESPITE EARNINGS VOLATILITY Akaria pays a nice dividend, and it has been stable for the past two years, despite a fall in earnings in 2008. The company paid out SAR122 million (SAR1 per share) in May 2009 for 2008 earnings, we estimate, and this was in line with the payout in 2008, which was also SAR1 per share. We believe the company will strive for a steady dividend, more so in absolute value terms than as a payout ratio. While the yield is minimal at 4%, it does provide some cushion to investors.
VERY SOLID BALANCE SHEET WITH NO DEBT The company does not have debt and carries a cash balance of SAR692 million, or SAR5.77 per share. While Akaria may have to raise debt in the future, depending on the timing of its projects, we do not expect this to be a major issue for the company, given its expected solid recurring revenues. In total, we estimate that it will spend about SAR4.2 billion on four main projects, with SAR2 billion at Akaria Tower in Jeddah and SAR1.5 billion for Binban, which will be phased over seven years. We also believe reasonable leverage may be good for investors by boosting equity returns.
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AKARIA 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
INVESTMENT RISKS
LOW LIQUIDITY AND HIGH CORRELATION WITH SAUDI MARKET Akaria’s shares are highly correlated with the Saudi stock market. In Figure 9 below, we plot the company’s share price versus the TASI, and it is difficult to separate the two. We think this likely has to do with i) low liquidity of the stock, at least compared to other real estate companies, and ii) high government ownership. We believe management is becoming more transparent with investors, and this could help increase the interest in the stock and relieve liquidity issues. However, this may take some time.
FEW CATALYSTS We do not see major catalysts for the stock, particularly after the opening of Akaria Plaza, which may have increased investor interest. Management rarely talks to investors, although that is changing, and the company is not mentioned in the press frequently. Additionally, progress on projects will likely be minimal over the next year, until new residential units in the Diplomatic Quarter open in 4Q2010e. Prior to that, we could see some announcements on Akaria Tower in Jeddah or the King Saudi University Science Park, which may boost shares in the near term.
EXECUTION RISK ON NEW PROJECTS IS HIGH We like that Akaria is expanding by building larger projects that are different from the majority of ones it has done in the past. These new projects will take different skills than previous projects. The company is also expanding geographically, which will be good in reducing its concentrated exposure to the Riyadh market, but could also increase execution risk there as well.
VALUATION LOOKS COMPELLING Akaria's valuation looks compelling at current levels, in our opinion. Our LTFV of SAR33.50 per share is based on a sum-of-the-parts valuation methodology and represents a 27% upside potential to the current share price. The majority of the company's value stems from its rental portfolio, which we believe is worth SAR13.44 per share, or 40% of the total value. The land bank is second at SAR10.31 per share (31%) using a 25% premium to book value. We estimate that the Binban project, north of Riyadh, is worth SAR2.07 per share. The remainder is composed of net cash of SAR5.73 (17%) and investments at BV of SAR195 (6%). Note that cash is 22% of the current trading price.
Akaria trades at a relatively high P/E ratio of 27.0x 2009e earnings, 21.3x 2010e and 19.7x 2011e, but we believe this is partly due to the large net cash balance. If we stripped out cash and investments in associates from its share price and investment and interest income from its earnings (using the same zakat rate), we would get P/Es of 21.2x in 2009e, 17.2x in 2010e and 15.6x in 2011e. These are still high, but we believe it is mainly due to the non-levered business model and our belief that investors do not buy Akaria for earnings, but rather for its land bank and stable revenues. The Saudi market currently trades at a P/E of around 17x 2009e and 12x 2010e.
BACKING INTO IMPLIED RENTAL PRICES AND LAND PRICES We also looked at the current price to ascertain implied values for Akaria's rental properties and land bank. We first took the current price of SAR26.30 per share, and backed out SAR5.73 per share in cash, SAR1.95 per share in investments at book value. This left SAR18.62 per share.
To find the implied rental value, we subtracted the book value of land (SAR8.23 per share), which left just SAR10.39 per share. This values the rental properties at SAR4,857 per sqm of land, or 19.2x our estimate of 2009e free cash flow.
To find the implied land bank value, we subtracted cash and investments and our estimated DCF value of its rental properties or SAR21.12 per share, which left SAR5.17 per share, or about SAR620 million for a land bank of 13.6 million sqm. This implies a price of SAR45.63 per sqm, well below the book value of cSAR80 per spm.
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AKARIA 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
I. BACKGROUND
The Saudi Real Estate Company (Akaria) is a real estate development company that was founded in 1976 and is located in Riyadh. It develops and manages residential and commercial real estate properties.
BUSINESS MODEL Akaria develops and manages real estate properties in the Kingdom of Saudi Arabia. It has a large rental portfolio of around 280,000 sqm (land, the company does not provide BUA) and has a land bank of 13.8 million sqm dispersed throughout the Kingdom. The company builds properties, mainly commercial, to add to its rental portfolio, and also sells units directly to buyers. A small portion of its revenues have historically come from land sales.
In the beginning of 2008, the company invested in a mortgage company, Dar Al Tamleek, of which it now owns 10%, which should allow it to better compete in the residential housing segment. It also has investments in related real estate and building material companies such as Knowledge Economic City and Hail Company for Cement and United Company for Glass.
MAINLY GOVERNMENT OWNERSHIP The Saudi Arabian government owns almost 70% of Akaria. Of this, the Public Investment Fund owns 64.5% and the Pension Fund owns 4.7%. We do not expect this ownership stake to change. It likely provides Akaria an incentive to continue paying regular dividends.
Figure 8: Ownership Structure of Akaria
Public Investment Fund Retirement Pension Agency Free Float
31% 64%
5%
Source: Akaria
HOW THE STOCK TRADES Akaria follows the overall stock market almost perfectly, with a correlation of 99.5% since the beginning of 2008 and a beta, as computed by Bloomberg, of 1.1. We attribute this to the company’s ownership profile.
Figure 9: Stock Trading In SAR, unless otherwise stated
60 Price (SAR) TASI (Rebased) 50
40
30
20
10 13-Jul-09 13-Jul-08 13-Apr-09 13-Jan-09 13-Apr-08 13-Jan-08 13-Jun-09 13-Sep-09 13-Feb-09 13-Jun-08 13-Sep-08 13-Feb-08 13-Aug-09 13-Oct-09 13-Mar-09 13-Aug-08 13-Oct-08 13-Dec-08 13-Mar-08 13-May-09 13-May-08 13-Nov-08
Source: EFG-Hermes
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AKARIA 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
II. PROJECT EXPECTATIONS
CURRENT RENTAL PORTFOLIO The majority of Akaria’s revenues, around 70%, stem from rental assets, and the company supplements these revenues with land sales from its land bank of 13.8 million square metres (sqm). The majority of its rentals are located in Riyadh and are a mix of commercial, retail and residential properties.
Figure 10: Commercial, Residential and Office Space, YE2008
Showrooms/ Townhomes Offices Buildings Apartments Villas Retail /Twinhomes First Commercial Centre (Akaria 1) 59 135 Second Commercial Centre (Akaria 2) 211 137 Third Commercial Centre (Akaria 3) 148 43 The Sixty Commercial Complex 129 30 The Sixty Residential & Commercial Complex 79 46 103 Eastern Buildings Complex (Olaya) 21 338 North Buildings Complex (Olaya) 25 370 Western Buildings Complex (Olaya) 8 161 Southern Buildings Complex (Olaya) 5 100 Diplomatic Quarter 122 66 132 Akaria Plaza (Under Construction) 305 19 Total 931 410 59 1194 66 132 Source: Akaria
Akaria 1, 2, 3 - These are the oldest assets that the company owns and are centrally located in Riyadh’s Business District. They are composed of 418 offices and 229 showrooms/retail areas. The company has started refurbishment of Akaria 1 and 2 in order to bring up rents and increase occupancy. Occupancies of its offices are very high, around 96%, according to management, but lower for its retail spaces at around 70%.
Figure 11: Rental Occupancy Rates, YE2008
Percentage Type of Property Occupied Residential Units in Olaya 99.72% Commercial Showrooms/Retail Shops 69.79% Office Space 96.02% Residential Units in Diplomatic Quarter 100.00% Source: Akaria
The Sixty Complexes - These are two residential and commercial complexes with 208 offices, 76 showrooms/retail locations, and 103 apartments.
Olaya Complexes - These are residential buildings of apartments in the Olaya area of Riyadh. They include 969 apartments.
Diplomatic Quarter - Akaria leased land from the government in the Diplomatic Quarter of Riyadh to build apartments and villas. It currently has 122 apartments, 66 villas and 132 townhomes for rent in the neighbourhood. It is building on another 220 land plots (we estimate this will equate to 100 villas and 240 townhouses) over the next two to three years (more below). The original lease agreement is for 99 years. Akaria does not have the right to sell these units, because the land is owned by the government.
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AKARIA 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
UPCOMING PROJECTS Akaria also has a number of projects in various stages of completion. Many of these will start construction over the next two years and will start to come online in late 2011e or 2012e.
Figure 12: Planned Projects
Stage / % Cost Expected Delivery Type of Project Land (m2)BUA Completed (SAR mn)
Akaria Plaza 97% 1Q2009 Offices & Retail c310 20,000 405,492
Design to be Akaria Tower (Jeddah) Feasibility study finished in Mixed-use 2,000 4Q2009e
Submitted designs Res. Units in Diplomatic Quarter 220 plots to municipality of Residential 420 (Riyadh) of land Olaya Residential, Res. Units north of Riyadh in In design/feasibility some 1,500 Banbaan study stage retail/commercia l
King Saud University Science In final design Expect design Commercial/ Unknown 2.2 million Park stages finished in 1Q2009 educational
Revamp Akaraia Neighbourhood and Revitalise Commercial Studying Commercial Minimal Centres (1, 2, 3)
Source: EFG-Hermes estimates
Akaria Plaza - This is a new commercial complex of three integrated buildings in Riyadh’s Central Business District. Construction is complete, and the company has started to lease out space in the building. It is composed of 305 offices and 19 retails spaces. Akaria Plaza started to add revenues to Akaria's top line in 3Q2009.
The building, with a built-up area of 72,100 sqm (59,000 sqm of office space and 13,100 of retail space) is located on approximately over 20,000 sqm of land. The building cost around SAR300 million and was expected to generate rental income of SAR60 million, according to the company when the project was announced. This equates to a gross yield of 20%. Recent price quotes have been around SAR1,200 per sqm per annum for commercial space. We expect retail prices will be around SAR2,500 per sqm per year. These prices imply rental revenues of around SAR100 million per year, if the full building is rented. We expect occupancy rates will be around 90% for retail and 80% for offices in 2010e, resulting in revenue of SAR86 million.
Figure 13: Akaria Plaza Estimated Revenues
Rent/m2/year Expected Revenue Unit Type BUA (m2) Occupancy (SAR) (SAR mn) Commercial 59,000 1,200 80% 56.6 Retail 13,100 2,500 90% 29.5 Total / Average 72,100 1,194 82% 86.1 Source: EFG-Hermes estimates
Expansion in Diplomatic Quarter - Akaria has finished design and engineering work and is in the process of qualifying contractors for this expansion of its rental unit complex in Riyadh. Construction of the 220 plots should take about 12-18 months to complete. As with the original Diplomatic Quarter units, the
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AKARIA 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
company does not have title to the land, rather it leases it in a long-term lease, and cannot sell the units. We expect these units will be completed and commence operation by 4Q2012e.
We do not know the exact mix of units (villas versus townhouses versus apartments), but we assume that half of them will be villas and half townhouses, so that the total number of units will be 340. Villas currently rent for about SAR180,000 per unit per year, and townhouses for SAR120,000. This would add SAR54 million in revenues per year once fully occupied. Given a shortage of appropriate housing for expats in Saudi Arabia and Akaria’s current occupancy rates achieved in the Diplomatic Quarter, we expect occupancy will be around 100%.
Figure 14: Diplomatic Quarter Land Plot’s Estimated Revenue
Rent/unit/year Expected Revenue Unit Type Units Occupancy (SAR) (SAR mn) Villas 100 225,000 100% 22.5 Town Homes 240 130,000 100% 31.2 Total 340 157,941 100% 53.7 Source: EFG-Hermes estimates
We believe it will cost the company about SAR1.0 million to build each villa and SAR800,000 for each townhouse. While this is fairly expensive, these will be high-end units with solid yields. This would imply a total spend, including infrastructure costs, of cSAR300 million. This compares to the cost of the original investment in 320 units (122 apartments, 66 villas, and 132 townhouses) of around SAR200 million.
Binban Residential Neighbourhood - This very large residential project located about 30-40 kilometres from Riyadh is in the design stages currently, according to management. The first phase will have about 500 units - a mix of duplexes, apartments, villas - and a small business centre. In total, the company expects to have 3,000 units on more than 2 million sqm and will likely sell some of these and keep the rest as rental properties. The final designs and contracts should be tendered in the middle of 2010e, and the first units will be finished by the beginning of 2012e. We believe these units will be targeted at middle-income buyers, given the distance of the suburb from Riyadh.
To provide an idea of how much this could add to revenues, we have made some assumptions. Akaria will target middle-income households, so we do not expect villas to cost more than SAR500,000, duplexes SAR350,000 and apartments SAR250,000. Rent for villas will likely be around SAR50,000 per year with occupancy low at first before growing. Duplexes will likely rent for SAR35,000 per year, and apartments SAR20,000 per year. If we assume that the 3,000 units are equally divided between rental and sale units, we estimate Akaria could get almost SAR550 million from sales and about SAR40 million in recurring rental revenues (assuming a 70% occupancy rate). We have not included office or retail space, which should add recurring revenues.
Figure 15: Binban Potential Revenues over Life of Development
Starting Price / Rent Percentage Sold / Expected Revenue Units per unit (SAR)* Occupancy Rate (SAR mn) For Sale Villas 500 500,000 100% 250.0 Duplexes 500 350,000 100% 175.0 Apartments 500 250,000 100% 125.0 For Sale Total (Avg. Price) 1,500 366,667 100% 550.0 For Rent (Per annum) Villas 500 50,000 80% 20.0 Duplexes 500 35,000 70% 12.3 Apartments 500 20,000 60% 6.0 For Rent Total (Avg. Price) 1,500 758,833 70% 1,138 *Starting price does not include an increase in prices, which we believe will be around 7%, slightly above inflation Source: EFG-Hermes estimates
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AKARIA 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
The company expects to spend SAR1.5 billion to develop Binban, and we believe the first phase will cost around SAR300 million, or 20% of the total, given the infrastructure investment at the early stages of the project. We include SAR73 million in our model in 2010e, SAR103 million in 2011e, and SAR132 million in 2012e. As we get more information on the project, we will incorporate it into our model.
Akaria Tower in Jeddah - Akaria has completed the feasibility study and hired Atkins, an international design team, for the preliminary design of the project. Management expects the tower, on 50,000 sqm in the Al Nahda neighbourhood, will cost approximately SAR2 billion and will take at least two years to construct. It will include a commercial complex, a hotel, and 300,000 sqm of apartments, according to the company. We do not expect the tower to start adding revenues until 2013e at the earliest. We have not included the tower in our model currently. We assume construction costs will be financed through debt or equity of some sort, but the company does not have the cash flows to build it, based on our calculations.
We do not yet know full details on the project, and therefore have included it within our land bank NAV estimate within our valuation at this point rather than valuing it separately.
Riyadh Technology Valley - Akaria is working with King Saudi University to develop a science and research and development park near the university. The university has set aside 2.2 million square metres for this project. Akaria is working with Jorung, a Singaporean industrial park consulting company, and SRI, an American non-profit science research institute. The company is finalising the master plan of the project currently. We do not yet know the role Akaria will play in the development, and we have not included it in our model or valuation. As we learn more about the project, which we believe could be profitable for the company, we will include it.
LAND BANK Akaria also has a large land bank of 13.8 million sqm, of which we estimate that 13.6 million is raw land. Some will be used for its future projects, while the company will likely sell the rest to drive short-term revenues. Land sales fluctuate widely, from SAR26 million in 2006 to SAR93 million in 2007 falling to SAR57 million in 2008. We expect land sales will fall again in 2009e to just SAR25 million, given the general economic weakness, before rebounding to SAR50 million in 2010e.
Figure 16: Akaria's Land Bank Area in square metres, unless otherwise stated
Site Situation YE2008 YE2007 1 Old Headquarter Land Buildings 1,671 1,106 2 Old Sixty Land Buildings 10,000 10,000 3 Olaya Land Buildings 235,581 323,459 4 Sixty Land #2 Buildings 9,407 9,407 5 Riyadh - Al Tukhasasi & Al Thimama Roads Investments 430,000 430,726 6 Shaeeb Al Daya Land - Al Qusaim Road Investments 600,000 648,188 7 Tukhassasi Road Extension - Cordoba Neighbourhood Investments 190,484 119,894 8 Talal Riyadh Land Investments 76,541 59,861 9 Basateen Land Investments 244,623 244,623 10 Sixty Commercial Plots Investments 2,241 2,241 11 Damman Land - West of the Industrial Area Investments 5,677,630 5,675,630 12 Damman Land - King Fahd Airport Rd. Investments 3,941,966 3,941,966 13 Jeddah Land - King Abdulaziz Rd. Investments 49,800 49,800 14 Riyadh Land - King Fahd Airport Road Investments 30,000 30,000 15 Binban Salbukh Rd. Investments 648,189 596,700 16 Land in south Binban (#13) Investments 871,597 871,597 17 Land in south Binban (#15) Investments 519,059 519,059 18 Medina - Land on Third Ring Road Investments 63,493 63,493 19 Medina - King Khaled Road Investments 157,280 20 Medina - Al Qusaim Road Investments 1,579 21 Medina - Al Qusaim Road Investments 85,572 Total 13,846,713 13,597,750 Source: Akaria
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AKARIA 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
INVESTMENTS IN REAL ESTATE SECTOR-RELATED BUSINESSES Akaria has several investments in real estate projects and building material companies. We value these at book, given our limited knowledge of their operations or financials.
Figure 17: Akaria's Investments - YE2008 In SAR million, unless otherwise stated
% Company Share Company Paid Remaining Remarks owned of B/V Saudi Company for Centre of This is a souq in Saudi in old 25.00% 150 150 0 Ma'iqaliya Riyadh near Batha
United Company for Glass 15.00% 30 30 0
Dar Al Tamleek 10.00% 100 25 75 Mortgage company 30% owned by Savola - in Kanan Co. for RE Development 2.11% 35.67 35.67 0 Medina - has SAR2.4 bn project in Knowledge Economic City 9.48% 78.65 78.65 0 Economic city located in Medina Development Co.
Hail Co. for Cement 5.00% 60 16 44
Total 454.32 335.32 119 Source: EFG-Hermes estimates
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AKARIA 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
III. FINANCIAL STATEMENT FORECASTS
After a slow 2009e, where we forecast sales and net income will fall, we look for a jump in 2010e as more rental area is added with the full opening of Akaria Plaza. We look for a positive progression of sales and earnings through our forecast period, as new rental areas are added and sales of its project in Binban start. We doubt that any of the company’s other projects will affect the income statement, although we could see some cash outflows as preliminary work is done on the Jeddah Tower.
Figure 18: Sales and Gross Margin Trends In SAR million, unless otherwise stated
450 Land Rentals Binban Gross Margin 80% 400 70% 350 60% 300 50% 250 40% 200 30% 150 100 20% 50 10% 0 0% 2004 2005 2006 2007 2008 2009e 2010e 2011e 2012e
Source: Akaria, EFG-Hermes estimates
2009E ESTIMATES We expect revenues at Akaria will fall due to fewer land sales at the company that more than offset a rise in rental revenue from the opening of Akaria Plaza. The decline in land sales results in improved gross margins for the company as a whole, because land sales have a gross margin of around 40% compared to real estate revenues at 60%-plus. We estimate SG&A will be around 6% of sales, but this will be more than made up by net other income, which is mainly profits from associated companies. These assumptions result in net income after zakat of SAR117 million, or SAR0.97 per share.
2010E ESTIMATES Rental revenue will likely benefit from the first full year of Akaria Plaza, and we expect the plaza can add SAR70 million-plus to revenues. This coupled with a rebound in land sales could lead to an almost 40% increase in total revenues to SAR289 million. We expect gross margin would fall due to a shift in the mix as well as slightly lower margins at Akaria Plaza than the older buildings (60% vs. 62%). We expect SG&A to increase to 7.6% of sales, and other income to slightly decrease to SAR20 million, given minimal insight into these revenues. These assumptions should result in net income of SAR148 million, or SAR1.13 per share, up 27% Y-o-Y.
2011E ESTIMATES We look for another increase in revenues to SAR313 million, or 8% Y-o-Y. This is driven entirely by growing rental revenues, as we believe Akaria will continue to improve its yields on its properties. We expect flat land sales revenues. Gross margin remains mostly unchanged at 56.5%, but we look for SG&A to increase to almost 9% of sales, as the company starts work on its Binban project. With flat other income, net income after zakat comes to SAR160 million, or SAR1.33 per share, up 8% Y-o-Y.
2012E ESTIMATES The addition of sales at Akaria’s project in Binban should bump revenues to above SAR400 million, or 30% above our 2011e estimate. There is a very high risk to these figures, because they depend heavily on construction progress and delivery of units, which Akaria will have some control over. Note that we expect Akaria will sell 200 units, evenly mixed between apartments, duplexes and villas, in 2012e.
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AKARIA 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
Binban will also likely have a lower gross margin than rentals or land sales, and we expect gross margin will fall to just below 54%. SG&A will likely continue to rise to c10% of sales, as the company invests in a sales force for Binban. These estimates, and flat other income, should result in net income of SAR194 million, or SAR1.61 per share.
CAPEX EXPENSES We estimate Akaria will spend about SAR4 billion on its upcoming projects. This is based on announcements by the company (for Binban and the two Akaria Plazas) and our estimates of the cost to build units in the Diplomatic Quarter. This will be spread over the next three to four years, although the company could be more measured with its spending in Binban, given that it is able to take a phased approach there.
Figure 19: Summary of Cash Flows (2007a-2012e) In SAR million, unless otherwise stated
Cash from Operations Cash from Investments Cash from Financing Net change in Cash 600 400 200 0 (200) (400) (600) (800) (1,000) 2007a 2008a 2009e 2010e 2011e 2012e
Source: Akaria, EFG-Hermes estimates
We expect Akaria will raise debt to finance its project in Jeddah, because it does not have the ability to finance it through its cash flows. At this point, because we do not have more information on when the project will start or specifics about it, we have not included it in our model and have only included the land as part of the land bank within our valuation. When the company provides more details and we feel comfortable with the start dates and potential for the project, we will add it to our model.
Separately, we have not included spending on the Riyadh Valley of Technology in our model. We do not yet know what role Akaria will play as master planner.
Figure 20: Estimated Capital Expenditures
Estimated Construction Construction Projects Total (SAR mn)Status Start Date Period Akaria Plaza - Riyadh 308 Completed 1H2006 Approx. three years Diplomatic Quarter - Riyadh 300 Qualifying contractors 1H2010 12-18 months Binban 1,500 Design stage At co. discretion Phase I (500 Units) 300 Design stage 4Q2010e Two years Akaria Tower - Jeddah 2,000 Preliminary Design Two years Total 4,108 Note: We also include maintenance capital expenditure as well as minimal expenditures on Riyadh Valley of Technology in our model Source: EFG-Hermes estimates
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AKARIA 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
IV. VALUATION
We value Akaria using both discounted cash flow (DCF) and sum-of-the-parts methodologies. We believe the best way to value the company’s rental portfolio is through a DCF analysis. The company also has a few projects, for which it will sell units. We value one of these, the Binban project, like we do for other real estate companies, using a DCF approach. However, for its land holdings we use a NAV methodology. We also include almost SAR700 million (SAR5.77 per share) in net cash and SAR234 million (SAR1.95 per share) in investments (at book value).
Figure 21: Valuation In SAR million, unless otherwise stated
Value Per Share (SAR) % of Total Rental Properties 1,615 13.45 40% Binban Project 248 2.07 6% Land Bank 1,236 10.30 31% Book Value of Investments 234 1.95 6% Net Cash (excl. ST Investments) 688 5.73 17% Total 4,020 33.50 100% Source: EFG-Hermes estimates
RENTAL PROPERTIES We use a DCF methodology to value Akaria's rental properties at SAR1.6 billion, or SAR13.45 per share. We have included the addition of Akaria Plaza and new residential units in the Diplomatic Quarter in our sales forecast. We use a WACC of 10%, in line with our assumption for other Saudi companies, and a terminal growth rate of 3%. About 76% of the value comes from the terminal value, mainly due to capital expenditure assumptions that result in negative FCF in 2011e and 2012e.
Figure 22: DCF for Rental Properties In SAR million, except for per share values
2008 2009e2010e 2011e 2012e 2013e 2014e 2015e 2016e 2017e2018e CAGR (09-18e) Recurring revenues 168 191 239 263 285 342 368 390 410 426 439 9% (excl. land sales) NOPAT 78 91 115 128 145 169 186 202 214 224 234 10% Free Cash Flow (81) 65 39 (57) (193) 127 142 155 164 173 181 11% Terminal Value 2,806 Discounted 65 35 (47) (147) 88 89 89 86 83 1,305 LTFV 1,615 LTFV per Share 13.45 Shares Outstanding 120 % from TV 76% Source: EFG-Hermes estimates
This valuation is sensitive to changes in our WACC and long-term growth rate assumptions, given the weight of terminal cash flows, as can be seen in the table below.
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AKARIA 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
Figure 23: Sensitivity Analysis In SAR, unless otherwise stated
WACC 6.6% 8.1% 9.6% 11.1% 12.6% 1.0% 19.10 14.51 11.66 9.77 8.45 2.0% 22.16 15.96 12.37 10.08 8.53 3.0% 27.16 18.18 13.45 10.61 8.76 4.0% 36.24 21.66 15.08 11.42 9.15
Terminal Growth Rate 5.0% 56.79 27.59 17.57 12.63 9.77 Source: EFG-Hermes estimates
BINBAN Our valuation for Binban of SAR248 million, or SAR2.07 per share, is also based on a DCF methodology. We assume that the company will sell 1,500 units and rent out 1,500 units. We use a 10% WACC, in line with our assumptions for other real estate developments, and a long-term growth rate of 3% for rental properties.
Figure 24: Binban Valuation by Type of Unit In SAR million, unless otherwise stated
Valuation Summary Valuation Residential for Sale - Villas 55.7 Residential for Sale - Duplexes 37.0 Residential for Sale - Apartments 22.5 Residential for Rent - Villas 84.7 Residential for Rent - Duplexes 38.1 Residential for Rent - Apartments 10.1 Total 248.3 Source: EFG-Hermes estimates
LAND BANK We value the land bank at a 25% premium to book value of SAR988 million. We use a higher premium to book for Dar Al-Arkan of 75%, but this is mainly due to a much faster turnover that results in cash earnings for the company. Akaria does not purchase much land each quarter, and it sells a relatively small amount each year. We do not believe this will change, so the value to investors is muted, somewhat, when compared to a land trader like Dar Al-Arkan which sells more than SAR1 billion in land each quarter and adds to its land bank rigorously.
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AKARIA 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
V. FINANCIAL STATMENTS
Income Statement (December Year End) In SAR million, unless otherwise stated 2008a 2009e 2010e 2011e 2012e Revenues 225.0 215.8 289.1 313.0 407.7 COGS (97.9) (87.5) (125.6) (135.2) (185.9) Gross Profit 127.1 128.3 163.5 177.8 221.7 Sales & Marketing Expenses (1.4) (1.4) (1.7) (1.9) (2.5) General & Administrative Expenses (15.2) (15.0) (20.2) (25.0) (36.7) Operating Profit 110.5 111.9 141.5 150.9 182.6
EBITDA 130.3 130.9 161.4 171.8 207.4
Other Income, Net 26.6 21.3 19.7 17.8 16.5 Net Income before Zakat 137.1 133.2 161.2 168.7 199.1 Zakat (20.1) (16.4) (13.0) (8.8) (5.4) Net Income 117 117 148 160 194 EPS 0.98 0.97 1.23 1.33 1.61 Source: Akaria, EFG-Hermes estimates
Balance Sheet (December Year End) In SAR million, unless otherwise stated
2008a 2009e 2010e 2011e 2012e Cash and Cash Equivalents 61.0 445.3 336.0 177.6 56.5 Short-Term Investments 649.9 252.9 252.9 252.9 252.9 Net Receivables 11.8 11.8 15.0 16.3 21.2 Net Inventory 1.7 3.1 4.1 4.1 5.6 Investment Land for Sale 60.3 17.9 17.9 17.9 17.9 Advance Payments and Other Receivables 16.7 10.8 14.5 15.7 20.4 Total Current Assets 801.5 741.8 640.3 484.3 374.4 Investments and Financial Assets 453.2 455.8 465.8 465.5 459.1 Projects under Construction 311.6 20.0 30.4 68.5 87.8 Net Investments 1,602 1,944 1,984 2,084 2,224 Property and Equipment, net 6.1 26.1 118.5 187.9 238.8 Total Long-term Assets 2,373 2,446 2,599 2,806 3,010 Total Assets 3,174 3,188 3,239 3,290 3,384 Rents Received in Advance 49.1 57.2 71.7 78.9 85.6 Dividends Payable 0.0 0.0 0.0 0.0 0.0 Provision for Zakat Tax 19.2 19.2 19.2 19.2 19.2 Other Credit Balances 20.6 21.2 28.8 32.1 44.6 Total Current Liabilities 88.9 97.6 119.8 130.2 149.4 End of Service Benefits 11.1 12.9 13.9 14.9 15.9 Total Liabilities 100.0 110.5 133.7 145.1 165.3 Total Net Worth 3,074 3,077 3,105 3,145 3,219 Liabilities and Net Worth 3,174 3,188 3,239 3,290 3,384 Source: Akaria, EFG-Hermes estimates
KINDLY REFER TO THE 22 IMPORTANT DISCLOSURES AND DISCLAIMERS ON BACK PAGE
AKARIA 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
Cash Flow Statement (December Year End) In SAR million, unless otherwise stated
2008a 2009e 2010e 2011e 2012e Net Profit before Zakat 137.1 133.2 148.2 159.9 193.7 Depreciation & Amortisation 19.8 19.0 19.9 20.9 24.8 Other Operating Cash Flows (17.0) (19.4) (17.7) (15.7) (14.3) Change in Working Capital (22.8) (0.5) (3.5) (2.9) (3.1) Total Operating Cash Flows 117.2 132.3 146.9 162.2 201.1 Capital Expenditures (127.2) (34.9) (102.7) (107.6) (70.2) Free Cash Flow (10.0) 97.4 44.1 54.6 130.9 Other Investing Cash Flows (426.3) 408.9 (33.5) (93.0) (132.0) Cash Flow before Financing (436.3) 506.3 10.6 (38.4) (1.1) Dividends Paid (122.1) (122.0) (120.0) (120.0) (120.0) Change in Cash (558.4) 384.3 (109.4) (158.4) (121.1) Source: Akaria, EFG-Hermes estimates
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DAR AL-ARKAN – LAND TRADER IN DISGUISE 19 october 2009 SAUDI ARABIA | REAL ESTATE & HOTELS
Short-Term Rec.: Accumulate Current Price*: SAR 16.60 Long-Term Rec. : Accumulate LT Fair Value : SAR 19.15
• A Land Trading Company Disguised as Real Estate Company: We initiate coverage on Dar Al-Arkan with a ST/LT Accumulate recommendation. We like its first-mover position in the Saudi real estate market, its ability to buy and sell land consistently at a very high profit, and real estate development operations that cater to the middle class, a poorly supplied segment. However, the stock appears close to fully valued, and earnings and valuation depend heavily on the company’s ability to buy and sell land profitably, which could become more difficult with increased competition. • Land Bank Makes Up Majority of our LTFV of SAR19.15: More than 80% of our valuation stems from the company’s land bank, which is booked at SAR15 billion (at cost) on its balance sheet, according to management. We estimate that it is comprised of between 35-50 million sqm (based on an average cost of SAR300-400 per sqm, in line with historical costs), although management does not provide the size of the land bank. We use a premium to book value of 75% in our valuation, which we believe is appropriate, given a c50% margin on land sales and a fast turnover (average life of 2.5 years). The company has been effective at profitably selling land, but future growth could be difficult if competition for land increases. • Inexpensive on a P/E Basis: Dar Al-Arkan also looks inexpensive on a P/E basis with a P/E on 2009e earnings of 8.0x and for 2010e earnings 7.7x. We believe this speaks to the company’s ability to quickly turn around land purchases and drive earnings, which is helped by a levered business model. On a P/B, the company trades at 1.3x 2009e and 1.1x 2010e. It is difficult to make comparisons with other real estate companies given very different business models and accounting methods, but Dar Al-Arkan appears to be attractively priced on a relative basis as well. • New Real Estate Projects Could Drive Earnings: Real estate sales have never been more than 30% of total sales, and in 9M2009 were just 9%. We expect this will increase, given a growing real estate portfolio (current book value of SAR1.5 billion) and the addition of Shams Alriyadh, a large project of more than 3,189 villas that will start to be sold next year. If the company reaches its target of delivering 2,500-3,000 units per year, we expect real estate sales could increase to 50% of revenues in the long term. • Sukuk Repayment Minimal Risk – But Business Model Demands Leverage: We do not believe Dar Al-Arkan will have problems financing its SAR2.25 billion sukuk due March 2010 out of cash flows and bank loans. However, this has limited its ability to pay dividends, and we believe has hurt its land purchases and even, to some extent, its investments in developments. We believe Dar Al-Arkan’s business model depends on leverage, and without it, growth will likely be limited. However, we believe the stock will perform well if the company is able to access financing in substantial amounts, which could happen in 2H2010e.
December Year End 2008a 2009e 2010e 2011e 20 Price (SAR) TASI (Rebased) Revenue 5,611 5,694 5,636 6,774 19 Operating Profit 2,644 2,442 2,526 2,936 EBITDA 2,694 2,482 2,573 3,018 18 Net Income 2,356 2,237 2,326 2,756 17 EPS (SAR) 2.18 2.07 2.15 2.55 16 DPS (SAR) 2.25 - - - Net Debt (Cash) 6919 6625 4518 3,519 15
14 P/E (x) 7.61 8.01 7.71 6.51 EV / EBITDA (x) 9.4 10.2 9.8 8.4 13 P/BV (x) 1.5 1.3 1.1 0.9 12
P/CF (x) 6.5 4.4 7.7 10.1 11 Div. Yield 14% 0% 0% 0% RoAE 21% 17% 15% 16% 18-Jul-09 18-Jan-09 18-Feb-09 18-Apr-09 18-Jun-09 18-Sep-09 18-Oct-08 18-Dec-08 18-Mar-09 18-Oct-09 18-Aug-09
Figures in SAR million, unless otherwise stated 18-Nov-08 18-May-09
Estimate Changes Stock Data 2008a 2009e 2010e Last Div. Date SAR3.0 on 20 Apr 09 (SAR mn) Old New Old New Mkt. Val. / Shares (mn) SAR17,928 / 1,080 Revenue 5,611 N/A 5,694 N/A 5,636 Av. Mthly Liqd. (mn) SAR1,369 EBITDA 2,694 N/A 2,482 N/A 2,573 52-Week High / Low SAR18.8 / 11.90 EBITDA Margin 48.0% N/A 43.6% N/A 45.7% Bloomberg / Reuters ALARKAN / 4300.SE Est. Free Float 11% Net Income 2,356 N/A 2,237 N/A 2,326
KINDLY REFER TO THE *Prices as at 18 October 2009 IMPORTANT DISCLOSURES AND 24 DISCLAIMERS ON BACK PAGE
DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
EXECUTIVE SUMMARY
We initiate coverage with a ST/LT Accumulate recommendation and a Long-Term Fair Value (LTFV) of SAR19.15 for Dar Al-Arkan, the largest publicly-traded real estate developer in Saudi Arabia. While many investors think of it is as a company that mainly builds residential units for sale, the majority of its revenue (more than 90% in 9M2009) was from land sales. It has been very effective in profitably buying and selling land, and has about SAR15 billion in land (booked at cost) on its balance sheet. It is growing its development arm. It started with small developments of 250-300 units, and has just finished a 3,000-plus unit development in south Riyadh. It is also now branching out into the redevelopment of Jeddah’s downtown. It also has a growing rental portfolio of SAR1.5 billion that will likely drive recurring revenue in the future. Dar Al-Arkan went public in December 2007 and is still 70%-owned by its founders.
INVESTMENT POSITIVES
A PROFITABLE TRADER IN LAND We view Dar Al-Arkan’s ability to build a large land bank at competitive prices as the major strength of the company. While we do not know the exact size or location of the land bank, we can see from the gross margins on its land sales (52% in 2008, 48% 9M2009) that the company has been able to purchase its land bank at good prices and then turn around and sell them profitably. We find this especially impressive, given an average life of its land bank of 2.5 years. Management has stated that its land bank has a book value of SAR15 billion, recorded at cost, including land attributable to existing projects. While we believe management has access to a wide network or sellers, there is no guarantee that future land bank purchases will be as profitable as they have been historically, particularly if competition for good land plots increases as new developers come into the market.
STRONG TRACK RECORD OF DEVELOPMENT Dar Al-Arkan has a strong development record. It has completed 20 projects over 15 years, and recently completed the construction of a large complex with more than 3,000 villas and apartments. Management targets completing 2,500-3,000 units per year, up from the current 1,000 units. While we believe this is an achievable goal in the long run and one that will result in strong earnings for the company, the company's current financial situation means that this will take some time. In our model, which extends through 2012e, we assume a much smaller amount of sales from residential units than implied by 2,500-3,000 units. Note that Dar Al-Arkan uses a network of contractors for its projects.
DAR AL-ARKAN UNIQUELY BENEFITS FROM GROWING SAUDI REAL ESTATE MARKET We believe Dar Al-Arkan is one of the best positioned companies to benefit from a growing real estate market in Saudi Arabia, given its middle-income target market and its ability to buy land at good prices in developing areas. When a new mortgage law is passed, we expect Dar Al-Arkan will benefit more than other companies, given its target market of middle-income consumers, who have unfulfilled demand for mortgages. Management has said that up to 80% of buyers of its apartment units use financing of some sort. Even for its villas, we believe the market will grow, as financing allows more people to buy larger units.
GROWING RENTAL PORTFOLIO SHOULD RESULT IN RECURRING REVENUES We expect Dar Al-Arkan’s rental portfolio, currently SAR1.5 billion, but mostly current work in progress, to drive strong recurring revenues for the company. We estimate that rental revenues will equal SAR300 million at Al Qasr by 2011e. Dar Al-Arkan has increasingly included mixed-use components in its projects, including a mall at Al Qasr and more than 3 million square metres (sqm) of built-up area (BUA) of commercial space at Shams Alriydah, and we expect it will continue to do so at its Shams Al-Arous and Qasr al-Khozam projects. This also gives the company some flexibility if it decides to sell these assets at some point in the future to free up cash, which we believe would be possible with the Al Qasr mall.
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DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
NEW, BIGGER PROJECTS SHOULD DRIVE REVENUE GROWTH Two projects in Jeddah, Qasr al-Khozam and Shams Al-Arous, still in the planning stages should drive strong revenue growth at the company going forward. In a change from its usual strategy of new developments, Dar Al-Arkan has entered into an agreement with the Jeddah Urban Redevelopment Company (JURDC, a government institution) to revitalise the Khozam Palace (Qasr al-Khozam) area, which covers 4 million sqm in central Jeddah and is expected to have a built-up area of 15 million sqm. While this project carries significant risk, from both an operational and financial perspective, we believe successful execution will result in high returns for the company. We also like that it is in partnership with
the government, which will hopefully provide more security for the company. For the second project, Shams Al-Arous, Dar Al-Arkan is planning to build 10,000 residential units in phases.
INVESTMENT RISKS
MORE FINANCING NEEDED FOR BUSINESS MODEL We believe Dar Al-Arkan’s business model needs a substantial amount of long-term financing to grow quickly and that depending solely on operating cash flows would result in slower and potentially less profitable growth. The company has announced projects that will cost more than SAR15 billion, and these are to be completed by 2016e. It also needs to replenish its land bank to the tune of about SAR2.5 billion each year to maintain its current revenue growth. While it can garner solid cash flows from its current land bank and developments, we believe it cannot sustain its current revenue figures without additional long-term financing. It has a SAR2.25 billion sukuk due in March 2010 that it has committed itself to pay off, and it has another SAR3.75 billion sukuk due in 2012, which we believe it will have to roll over. It was able to raise SAR750 million locally in May 2009, but this is a small amount, given its large investments. Until the capital markets reopen, the company will likely not pay dividends (it did not in 2009) and could face either delays at its projects or replenishing its land bank, both hurting future growth for the company.
CONCENTRATED VALUATION IN LAND BANK The greatest amount of value at Dar Al-Arkan comes from its land bank, which we estimate is worth SAR17.7 billion. While this appears reasonable to us, given historical margins of its land sales, we do not know where the land bank is located or what the cost per sqm has been. Management has said that it would like to increase its disclosure on its land bank, but it has been resistant so far for competitive reasons. We believe one potential reason is that the company benefits from buying up land around its projects through middlemen, and then selling this land at a profit when its projects are announced. It has said that historically its land bank has been located near/adjacent to its projects.
KHOZAM PALACE PROJECT PRESENTS UNIQUE OPERATIONAL RISKS Dar Al-Arkan's Khozam Palace project (also called Qasr al-Khozam) is a unique project for the company. It is an urban revitalisation project in partnership with the municipality of Jeddah. The 4 million sqm area in Jeddah is a run-down area in the centre of the city, with only 13% of the 6,000 buildings in the area considered to be in "good" condition, according to a survey conducted on behalf of the project. The government has committed to moving people from the area and demolishing the poor buildings. Dar Al- Arkan's role will be to develop the land for sale, but its 2011e start date and 2015e end-date on construction could be optimistic. Also, the SAR10 billion cost estimate is much larger than for any of its projects so far, and the financing needed for this project could be difficult to obtain. We believe its cooperation with the government, which appears very committed to the revitalisation of Jeddah and will be responsible for relocating residents, mitigates these risks somewhat.
VALUATION APPEARS COMPELLING We reach a LTFV of SAR19.15 per share based on a DCF approach for Dar Al-Arkan's current projects and using a 75% premium to book value for its land bank, which makes up the majority of our valuation. We use a premium to book value for the land bank, given that it is recorded at cost and that the company has a long history of quickly selling land profitably. The average mark-up on land has been around 100% (50% gross margin) and the average life of its land bank is just 2.5 years. We also believe land sales attributable to its Khozam Palace joint venture deserve a premium to the book value of the land there, given the good location and the likely high demand. The company also has net debt of SAR6.74 per share as of September 2009.
KINDLY REFER TO THE 26 IMPORTANT DISCLOSURES AND DISCLAIMERS ON BACK PAGE
DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
CATALYSTS A number of events could be catalysts for Dar Al-Arkan shares over the next 12 months, including a potential mortgage law, refinancing of its sukuk due in March 2010 (which has been a concern for investors), and sales launches for its projects. i) We believe Dar Al-Arkan will benefit more from a new mortgage law than any of the other publicly- traded developers. This is due to its middle-income target customers, who are expected to be the largest users of mortgage finance. Even if the number of mortgages grows gradually, the shares will likely benefit in the short term. ii) We also believe financing has been a major concern for investors in Dar Al-Arkan, and the company's ability to obtain more bank loans or another sukuk would relieve this concern and put the company on a better footing. iii) Finally, sales launches appear to have had little impact on share prices historically, although new projects could improve sentiment on the stock, in our view. Also, strong sales figures for projects like Shams Alriyadh and Khozam Palace may also be viewed positively.
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DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
I. BACKGROUND
Dar Al-Arkan was founded in 1994 and is one of the largest residential real estate developers in Saudi Arabia. It is headquartered in Riyadh and had 421 employees at the end of 2008.
The company has three main business areas
• Land development: It develops infrastructure on raw land and then sells that to third-party developers and individual buyers.
• Master-planned lifestyle communities: Dar Al-Arkan develops residential and commercial properties that it then sells. It currently has four major projects on-going: Al Qasr and Shams ar-Riyadh in Riyadh, al- Tilal in Medina, and Al Khozam Palace in Jeddah. The company has historically targeted middle-income home buyers.
• Property management: It also develops properties for future leasing. It currently has a portfolio of properties worth about SAR1.5 billion, and management expects these to start adding rental revenue in late 2009e.
STOCK PERFORMANCE The company went public in December 2007 at SAR56.00 a share, or SAR28.00 after share splits and bonus shares. The founding shareholders sold 30% of their stake, but continue to hold 70%.
Dar Al-Arkan has fallen 41% since it went public. Dar Al-Arkan has a very high correlation with TASI (the Saudi stock index) – both have fallen about 50% since Dar Al-Arkan's IPO. However, shares of Dar Al- Arkan have not tracked other real estate stocks as closely, except for Akaria, which has an almost perfect correlation with TASI. While the decline in Dar Al-Arkan’s share price has been generally in line with the performance of the Saudi market, we also believe that some of the decline can be attributable to investor concerns over funding for its projects.
We believe shares have traded mainly on sentiment over general real estate as well as specific financing concerns the company faces. Note that shares do not appear very sensitive to bonus shares, or at least the effect is short-lived, as can be seen in late October 2008 and October 2009.
Figure 25: Dar Al-Arkan Stock Price Performance vs. TASI
Price (SAR) TASI (Rebased) 20 18 16 14 12 10 18-Jul-09 18-Jan-09 18-Apr-09 18-Jun-09 18-Feb-09 18-Sep-09 18-Oct-08 18-Dec-08 18-Mar-09 18-Aug-09 18-Oct-09 18-Nov-08 18-May-09
Source: EFG-Hermes
KINDLY REFER TO THE 28 IMPORTANT DISCLOSURES AND DISCLAIMERS ON BACK PAGE
DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
II. LAND BANK AND PROJECTS
LAND BANK DRIVES EARNINGS The main driver of earnings at Dar Al-Arkan is its land bank. It represented more than 90% of total revenues and 95% of profits in 9M2009. While management does not disclose the total area it owns, we believe it could be as large as 50 million sqm, based on the book value at cost of SAR15 billion and an average cost of SAR300 per sqm, which is in line with the cost recorded on the income statement in 2008 and 9M2009. The SAR15 billion amount includes land reserved for projects, we believe. Management has stated that the land bank is sufficient for projects for the next five years and that about 40% of it is located in Riyadh, 40% in the Western Provinces (Mecca and Medina) and 20% in the Eastern Province. The company does not plan to expand beyond the five major cities (Riyadh, Jeddah, Mecca, Medina and the Dammam/Khobar conurbation).
We estimate that the company will need to spend about SAR2.5 billion a year to replenish its land bank, although the Khozam Palace project will allow it to record high land sales outside of its normal land trading operations. According to management, the average life of its land bank is approximately 2.5 years, showing good turnover. While the company has been very successful in finding good plots of land, we believe this may become more difficult as the number of competitors increases. However, Dar Al-Arkan appears to have a good network of suppliers and middle-men.
Our Buy recommendation depends heavily on Dar Al-Arkan's ability to continue to buy and sell land, but given management's solid track record, we believe it is reasonable. First, it has been able to sell land very profitably for many years, even during downturns such as in 4Q2008 or 2009. In the last three quarter, which we had expected would be weak, the company has been able to increase its land sales to SAR3.8 billion from SAR3.4 billion, or 13% higher Y-o-Y, despite very negative sentiment on real estate worldwide. Second, the company is able to take advantage of its developments in selling land. For example, we believe it buys up large pieces of land, most likely from many different sellers. It then announces a project that will use part of that land and sells the remainder after prices have gone up. Management has said that historically a sizeable portion of land sold has been near its developments. Third, Dar Al-Arkan does not focus on land in the centres of urban areas, rather it buys on the outskirts and is able to benefit from expanding urban areas. This reduces risk, because this land is usually less expensive, and the company can wait for the city area to expand and for these plots of land to become valuable.
Figure 26: Revenues and Costs of Land Sales Revenues & Costs in SAR million (LHS), estimated Price and Cost in SAR (RHS), unless otherwise stated
Revenue Costs Est'd price per sqm Est'd cost per sqm 1,600 900 1,400 800 1,200 700 600 1,000 500 800 400 600 300 400 200 200 100 0 0 1Q2008 2Q2008 3Q2008 4Q2008 1Q2009 2Q2009 3Q2009 4Q2009e
Source: Dar Al-Arkan, EFG-Hermes estimates
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DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
PROJECTS OVERVIEW Dar Al-Arkan has four projects under construction currently and just announced one more on 11 October 2009. It finished selling villas in its Ishbiliyah project in 1H2009. Of the four on-going projects, we ascribe the greatest value to Al Qasr, given the large number of units, although we believe Khozam Palace could drive future earnings at the company.
Note that we do not include Khozam Palace or Shams Al-Arous in our valuation as separate developments, given the minimal information we have on them now. They are, however, included in the value of our land bank, to which we ascribe a premium to book value.
Figure 27: Dar Al-Arkan Projects
Project Location Area (sqm) Cost Percentage End Date BUA Residential Retail (sqm) Offices Mall rental Residential Complete (sqm) Area (sqm)l (sqm) Area (sqm) Units Ishbiliyah Project Riyadh 700,00 SAR378 mn 100% 2009 c160,000 c160,000 N/A N/A N/A 420 Al Qasr Project Riyadh 813,389 SAR1.8 bn 95% 2009e 776,200 455,065 65,000 19,123 78,000 3,054 (mixed use) (mixed (mixed use); + SAR950 use), 50% YE2010e mn (mall) (mall) (mall Al Tilal - Phase Medina 2.2mn (total SAR375 mn 99% 2010e 160,000 N/A N/A N/A 500 One Project project) Shams Arriyadh Riyadh 5.0 mn SAR5.8 bn 25% YE2012e 5.0 mn 2 mn 3 mn (BUA) N/A N/A 3,189 Alriyahd Project mixed comm./retail Khozam Palace Jeddah 4.1 mn SAR 10 bn In progress 2015e 15 mn TBA TBA TBA TBA TBA Project* Shams Al-Arous Jeddah 3.0 mn SAR 7.5 bn Just 2016e TBA TBA TBA TBA TBA TBA announced *Dar Al-Arkan will only develop and sell land in Khozam Palace (or Qasr al-Khozam). It will not build all 15 mn sqm of BUA Source: Dar Al-Arkan, EFG-Hermes
OUTSOURCED CONSTRUCTION LIMITS COST VOLATILITY Dar Al-Arkan does not construct its projects, but rather it contracts the construction out to construction companies. For a project to build 3,000 units, Dar Al-Arkan could use as many as 10 contractors. The terms are usually fixed, but, given volatility in building materials prices over the past year, we believe this will change and increase construction cost volatility for the company. It also utilises Turner Construction Company for project management in a long-standing strategic agreement.
MORTGAGE AFFILIATE SHOULD HELP SALES Dar Al-Arkan helped establish Saudi Home Loans Company (SHL), the first independent Shariah-compliant mortgage provider in Saudi Arabia, and owns 15% of SHL. Other partners in the venture include Arab National Bank (ANB), Kingdom Installment Company, and the International Finance Corporation, the private sector arm of the World Bank. Currently, Dar Al-Arkan sources customers, and SHL uses ANB’s branches to service them. The affiliate was founded in 2007 with a capital of SAR2 billion and started operations in late 2008 with SAR1 billion available for loans. The company is still in launch mode based on our conversations with industry professionals.
ISHBILIYA PROJECT Overview: This 700,00 sqm project in the north of Riyadh is 100% sold, according to management. The project consists of a full community composed of 649 villas, with prices of the final phase of around SAR1.0-1.2 million per unit. The last phase consists of 166 units. Ishbiliya should have no impact on the income statement or cash flows after 2Q2009.
Prices and Costs: Dar Al-Arkan spent around SAR377.6 million, or SAR539 per sqm of land, or SAR581,000 per unit. The company expected to generate total revenues from the project of SAR523.4 million, which equates to SAR750 per sqm, or around SAR800,000 per unit.
KINDLY REFER TO THE 30 IMPORTANT DISCLOSURES AND DISCLAIMERS ON BACK PAGE
DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
Figure 28: Real Estate Units Sales, 2007-08
2007 2008 Units Sold 1,220 1,101 Revenue Recognition (SARmn) 1,321 990 SAR per Unit 1,082,932 899,524 Source: Dar Al-Arkan
AL QASR PROJECT Overview: This is a large apartment development of more than 800,000 sqm in the south of Riyadh. There will be more than 3,000 apartments in total in the development when it is finished, along with 254 villas, 19,0123 sqm of office space, 65,000 sqm of ground floor retail space, and a shopping mall with net leasable area of 78,000 sqm. Project construction was started in 2005, and Dar Al-Arkan expects it will complete commercial and residential construction by December 2009e and the mall by year-end 2010.
RESIDENTIAL Sales Start: The company started selling units in 2008, and management expects to sell all units by the end of 2009. As of September 2009, 1,194 units have been sold and 539 remain. We estimate most sales will happen in 2009e, but that 25% of the villas and 20% of the apartments will spill over into 2010e. This is later than management expects. It expects all or almost all sales will be completed in 2009. The company will keep 1,318 apartment units for rent. We do not expect it will have a problem renting these units, although we do look for occupancy to reach 90% in 2012e, from 70% in 2011e and 50% in 2010e.
Sales: We use an average price of SAR850,000 per villa and SAR475,000 per apartment unit. This results in total revenue of more than SAR900 million, with villa revenues of SAR216 million and apartments at SAR703 million.
Costs: Dar Al-Arkan is targeting total cost of SAR2.5 billion, and construction was 95% complete as of September 2009. We believe each villa costs Dar Al-Arkan around SAR650,000 to build and each apartment SAR375,000. This results in about a 22% overall margin.
COMMERCIAL AND RETAIL We assume that Dar Al-Arkan will complete Al Qasr’s commercial and mixed-use retail space in 2009e, while the mall will take until the end of 2010e. We assume occupancy will reach 85% for the mall and retail spaces and 90% for commercial offices. Our rental price estimates are based on comparable rents, with discounts for Al Qasr's location in the southern, more downscale part of town. However, rents could increase as more people move to the area and all of the units are occupied.
We estimate office space will cost around SAR134 million, or around SAR7,000 per sqm. Retail space will be less expensive at just SAR5,800 per sqm, or cSAR240 million. We believe the mall will be the most expensive to build at SAR9,000 per sqm, for a total of SAR700 million. In total, all rental properties (excluding apartments) will cost the company SAR1.1 billion.
PROJECT RISKS The major risk with Al Qasr is that the company will not be able to sell these properties or rent them out profitably. In terms of sales, only 539 units are still remaining, and the company has been successful in selling about two-thirds of its inventory. For rentals, we believe the large undersupply of middle-income housing in Saudi will stimulate demand and result in strong occupancy rates. Also, the nice designs and new construction may attract people in the area that have been unhappy with their current housing.
AL TILAL PROJECT - MEDINA Overview: Al Tilal is a 2.2 million sqm development in the south of Medina, located a 15-minute drive from the Prophet’s Mosque. Dar Al-Arkan has announced only phase one of the project, consisting of 500 units, although management had previously announced that it would build 2,000 units in total. We include just phase one in our model and valuation of the project. This will comprise 499 units. Construction of the remaining phases has not been scheduled as of yet, and there could be a change to the original plan to construct 2,000 units. We do not know the reason for the delay.
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DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
Sales: Dar Al-Arkan sold about 145 of the 499 units of phase one as of September 2009. We expect 225 units will be sold in all of 2009e, and that the remaining 274 will be sold in 2010e at around SAR900,000 per unit. We believe the delay in sales is due partly to the financial crisis, which resulted in weak demand in the Kingdom, and due to delays in connecting utilities to the units and completing delivery. Dar Al- Arkan had previously delayed some sales by pushing them to the end of the year, and it is now offering attractive financing. Customers can sign up for 25-year financing (we assume through its SHL JV), which requires a 10% down payment. We believe cash flows to Dar Al-Arkan will be unchanged – meaning that they will be received when the contract is signed.
Costs: Management has indicated that the first phase of the project (500 villas) will cost around SAR375 million, or SAR750,000 per villa. We use this assumption in our model, with about 85% of the project expenditure spent as of the end of 2008. As of September 2009, 99% of construction was complete. We do not include new costs for Al Tilal in 2010e.
Figure 29: Villa Types in Tilal
Type Size (sqm) Number Al Rowshan Villa 305 252 Al Dar Villa 334 43 Al Rouda 346 4 Al Retaj 351 24 Al Iwan 303 24 Al Nakheel 317 80 Al Aqueeq 344 16 Al Huda 360 4 Al Asima 310 36 Al Mahrousa 314 16 Total 499 Source: Dar Al-Arkan
Risks: Dar Al-Arkan has delayed delivering units at Tilal because the municipality was unable to connect utilities to the development. It had originally expected all units to be sold as of 2009e, but we do not expect this to happen. We also believe general negative sentiment on real estate in 2H2008 and 1H2009 delayed sales. However, it could also be due to relatively high prices for Medina and a smaller market there, and sales may take even longer than we forecast. If the problem has been with the product, then future sales in the project beyond phase one could be difficult without a change to the master plan.
SHAMS ALRIYADH PROJECT Overview: This is a project of 3,189 villas in the north of Riyadh stretching over 5 million square metres (sqm). Dar Al-Arkan started construction of phase one in the second half of 2009e, according to management. Each phase will consist of 250-500 villas, and Dar Al-Arkan will introduce them to the market gradually, in order not to flood the market with all 3,000 villas at the same time. The company looks to build and sell all of its units over three years and complete construction at the end of 2012e, but we assume that it will take a little over four years to sell all of the units.
Figure 30: Villa Types and Services
Villa Size Number of Service Number of Villas Services 400 sqm 1510 Hyper malls 5 600 sqm 822 Shopping centres 6 800 sqm 292 Schools 13 1000 sqm 239 Mosques 16 1200 sqm 185 Petrol stations 2 1500 sqm 141 Total 3189 Source: Dar Al-Arkan
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DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
RESIDENTIAL Sales start: Dar Al-Arkan expects to start sales in 2Q2010e, although it will not deliver these until 2011e, when it will start recognizing revenues. We estimate the company will sell around 160 units in 2010e, before increasing that to c1,000 units per year after that. Note this is in line with management’s expectations, which we believe is reasonable, given recent sales of Al Qasr and our belief that the Saudi real estate market will have improved from its weakness in 2009 by then. In September, 25% of construction was complete. Dar Al-Arkan expects to complete the project by the end of 2012e, but in our model we conservatively assume that construction and sales will continue into 1H2014e.
Pricing: Dar Al-Arkan has not yet set prices for Shams Alriyadh, but we estimate that the average price will be SAR1.45 million in 2010e, and this will increase with inflation at around 5%. This is at the high end of the middle-income segment for Saudi and higher than the average price at its other developments.
Sales: We estimate that Shams Alriyadh will contribute SAR5.1 billion in revenues from residential sales to Dar Al-Arkan’s top line and SAR1.5 billion in gross profit.
Costs: Dar Al-Arkan is targeting a total cost for the project of SAR6 billion. We assume each villa will cost SAR1.05 million, with a slight increase due to inflation over the period. Our gross margin assumption is 32%, slightly above Dar Al-Arkan’s margins at Ishbiliya given our high sales price assumptions.
COMMERCIAL Dar Al-Arkan plans to build more than 470,000 sqm of commercial and retail space in BUA of 3 million sqm. Based on progress so far, we do not expect commercial spaces will open for rentals until 2011e, and occupancy will be very low that year (we estimate around 10%) before growing to reach 85% occupancy. As with our assumptions for Al Qasr, rents are based on comparable spaces, with a discount for Shams Alriyadh.
We estimate the commercial space will cost around SAR2.4 billion, or around SAR5,000 per sqm. These are in line with our assumptions for Al Qasr. Note that the company has said that it would spend SAR5.80 billion on Shams Alriyadh, and our total cost assumption for the project is slightly higher than this at SAR5.86 billion.
PROJECT RISKS The two main risks are i) a somewhat distant location from the centre of Riyadh and ii) upper middle- income units could be oversupplied in the Saudi market. While the location is a bit far from central Riyadh (about 20km outside of the city), there are a number of developments in the same area. Limitless, The Land and Tameer are developing residential projects over a total area of almost 18 million square metres. This should create a critical mass for the area that would alleviate some buyers’ concerns over the distance. However, this does make us a bit more concerned about an oversupply of high-end units, although we are not certain how many of these projects will be completed, especially over the next three years, given the delays because of the financial crisis.
QASR KHOZAM PROJECT - JEDDAH Overview: Qasr Khozam (Khozam Palace) is a joint venture (JV) with Jeddah Development and Urban Regeneration Company (JDURC) to develop the Khozam Palace area, spread over 3.7 million sqm in central Jeddah. The JV was established on 25 April 2008. Dar Al-Arkan expects the total BUA of the project will be 15 million sqm and will include residential units, luxury hotels and shopping malls, and will be completed over five years. Dar Al-Arkan has 51% ownership of the JV. JDURC has completed its survey of privately-owned real estate in the district. The commercial value of real estate will be set and then owners will be given compensation and requested to leave within a year’s time frame, according to media reports.
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DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
Figure 31: Map of Jeddah with Khozam Palace Area Highlighted
Source: Google Earth, Dar Al-Arkan
Phases: Management said that the master plan has received preliminary approval from the municipality, but that the final approval is forthcoming. Based on this, we expect the project will be divided into four stages, with the first stage, in downtown Jeddah, in progress. The second stage will include the Al-Sabeel district. There are about 6,000 homes that the JV will have to demolish. Dar Al-Arkan plans to start construction in 4Q2010e and expects to complete the full project by 3Q2015e.
Figure 32: Khozam Palace Project
Stage sqm Al Balad (Downtown) Area 270,566 Al Sabeel Area 950,000 Khuzam Area 2,500,000 Al Nuzla Area combined *This excludes 40,000 sqm given to the Organisation of the Islamic Conference (OIC) to build its new headquarters Source: Dar Al-Arkan
Expected Revenues: It is difficult to forecasts sales for the full project, particularly without detailed figures on prices per sqm anticipated or when sales will start. We expect Dar Al-Arkan will start selling land in 2012e. We have land sales increasing to SAR6 billion in 2012e, to account for the start of Khozam. We believe the company may focus on these sales rather than traditional land sales, given the prime location and the large size of the expected BUA.
Cost: Dar Al-Arkan expects the project will cost SAR10 billion, shared with JUDRC in proportion to ownership in the JV (51:49). This money will be spent over six years, and we expect spending in the later years will be financing by sales in the earlier years. The company will not have to redevelop the whole four million sqm area, because it will keep some of the current properties intact.
Risks: We believe this project is the most risky of Dar Al-Arkan’s current projects, particularly because it is a redevelopment project with residents currently living on the land. We expect delays will be likely, given the large number of current residents that may delay leaving their homes, although some have already handed over titles to the municipality. Also, working with the government may result in bureacratic delays that the company has not faced in its newer projects. Dar Al-Arkan has never run a project like this, and it KINDLY REFER TO THE 34 IMPORTANT DISCLOSURES AND DISCLAIMERS ON BACK PAGE
DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
may find it more difficult than building new homes on virgin land. As with its other developments, it will sign up contractors for the actual construction, which we believe partially mitigates the operational risk of revitalising within a current city environment.
Figure 33: Condition of Buildings in Khozam Palace Area
Good 13% Poor 39%
Medium 48%
Source: JDURC
SHAMS AL-AROUS PROJECT Dar Al-Arkan’s latest project is Shams Al-Arous, a mixed-use project located 12km east of Jeddah. It is located on 3 million sqm of land and is expected to comprise 10,000 residential units and commercial and retail space, although the exact amount is unknown. Residential units will include a mix of villas and apartments. Infrastructure, including utility hook-ups, is already in place, according to management, and it expects to start construction at year-end 2010e. In the first of three phases, it will build 2,000 residential units, and these are expected to be completed 18 months from the start date. Revenues therefore could be partially included in 2012e, but we have not included them at this time. The total cost of the project is SAR7.5 billion, with the first phase expected to cost SAR1.5 billion. We did include an estimate for costs of SAR500 million in 2010e, SAR1 billion in 2011e, and SAR1.5 billion in 2012e.
As with Khozam Palace, we have not included Shams Al-Arous in our valuation as a separate project, given insufficient information. The land is included in the land bank calculation.
RENTAL PROPERTIES Dar Al-Arkan is building a rental portfolio composed of residential and commercial properties. We believe the company ended 3Q2009 with total rental assets of SAR1.5 billion. These properties will likely start adding revenues in 4Q2009e, and we will start to see the affect on the income statement in 2011e. The main driver of growth will be the opening of rentals in Al Qasr in 2009e, the mall in Al Qasr in 2010e, and mixed-use rentals in Shams Alriyadh in 2011e.
Figure 34: Estimated Rental Revenues, 2009-2012e In SAR million, unless otherwise stated
400 350 300 250 200 150 100 50 0 2009e 2010e 2011e 2012e
Source: EFG-Hermes estimates
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DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
III. FINANCIAL REVIEW
The company’s business model is to sell land and residential units, but the majority of its sales and revenues come from land sales.
Figure 35: Revenue, Gross Profit and Gross Figure 36: Contribution of (2008a-2012e) Profit Margin (2008a-2012e) In SAR million (LHS), unless otherwise stated In SAR million, unless otherwise stated
Revenue (LHS) 4,500 Gross Profit (LHS) Khozam Palace 4,000 Gross Profit Margin (RHS) Shams Arriyadh 3,500 Al Tilal 10,000 55% Al Qasr 3,000 8,000 50% 2,500 6,000 2,000 4,000 1,500 45% 2,000 1,000 500 0 40% 0 2009e 2010e 2011e 2012e 2008a 2009e 2010e 2011e 2012e
Source: Dar Al-Arkan, EFG-Hermes estimates Source: Dar Al-Arkan, EFG-Hermes estimates
2009E During 9M2009, total revenue declined by 2% Y-o-Y to SAR4.2 billion, of which over 90% was generated from sales of land. Gross margin for the first months fell to 46%, mainly due to decline in profitability in land sales, which had been very profitable in 2008 when real estate was booming in Saudi. We believe that the company will close 2009e with revenues of SAR5.7 billion, implying a slight increase Y-o-Y, but we expect gross profit margin will fall 5 percentage points to 46%. While SG&A cost control has been good, it represents just a nominal 2.5% of total revenues. Finance costs will also likely fall, because the company has started to capitalise interest related to projects. For 9M2009, finance expenses were just SAR115 million, compared to SAR288 million last year. After zakat, these assumptions result in net profit of SAR2.2 billion (EPS of SAR2.07) in 2009e, down just 5% despite the fall in gross margin mainly due to interest capitalisation.
2010E In 2010e, we expect the top line to decine slightly, as Dar Al-Arkan completes sales at Al Qasr and Al Tilal and records similar land sales revenue to 2009e of SAR5 billion. Gross margin grows on slightly higher land sale gross margin. We expect SG&A will fall slightly to SAR131 million, given the lack of project launches. And financing expenses should also fall due to the payback of its sukuk. These assumptions result in a 4% increase in net income to SAR2.3 billion, or SAR2.15 per share.
2011E By 2011e, land sales will continue to make up a large portion of revenues, but we should start to see a significant amount of revenues from Shams Alriyadh of SAR1.5 billion and the addition of rental revenue from Al Qasr properties. This should result in a 20% Y-o-Y growth rate in total revenues. Our gross margin assumption falls about 100 bps to 47%, because of the change in mix. SG&A will likely start to increase with the Shams Alriyadh and Khozam Palace preparations, but that should be offset by lower finance expenses due to a lower debt burden. We expect net income of SAR2.8 billion and EPS of SAR2.55.
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DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
2012E Sales jump in 2013e due to the addition of Khozam Palace land sales. We look for total revenues of SAR8 billion, SAR2 billion is from Khozam Palace, and SAR1.7 billion from Shams Alriyadh. The addition of Khozam Palace, which we believe will carry a slightly lower margin of 40%, to the mix is likely to result in another 100 bps decline in gross margin to 46%. An increase in SG&A to SAR180 million, and an increase in depreciation as rental properties at Shams Alriyadh are added, result in an EBITDA margin of 43%, down 2 percentage points from 2011e. These assumptions along with higher finance costs of SAR148 million and minority interest of SAR315 million due to the joint venture for Khozam Palace result in net income of SAR2.82 billion, up 2% Y-o-Y, and EPS of SAR2.61.
DEBT AND CASH Dar Al-Arkan had a cash position of SAR1 billion at the end of 3Q2009, up from SAR460 million in 2Q2009. Net debt in 3Q2009 reached SAR7.3 billion as the company added SAR704 million in new debt, including a SAR750 million sukuk. Its current debt-to-equity ratio is relatively high at 0.62x, as befits its business model
Although the company is able to generate strong operating cash flows (SAR2.8 billion in 2008; SAR3.3 billion in 9M2009), its needs to raise financing to continue growing strongly, particularly since it has to pay back a SAR2.25 billion sukuk in March 2010. Once the credit markets return to normality, we expect the company to raise more debt as it works to roll over its SAR3.75 billion sukuk due in 2012e.
Figure 37: Summary of Cash Flows (2008a-2012e) In SAR million, unless otherwise stated
Cash from Operations Cash from Investing 15,000 Cash from Financing Net Change in Cash 10,000
5,000
0
(5,000)
(10,000)
(15,000) 2007a 2008a 2009e 2010e 2011e 2012e
Source: Dar Al-Arkan, EFG-Hermes estimates
DIVIDENDS Dar Al-Arkan has historically paid out dividends with a high pay-out ratio that sometimes exceeded 100%. The company discontinued this practice in 2009e, although it did pay out bonus shares. We do not expect the company to return to paying dividends until it can be assured it will roll over the 2012 sukuk, and even then it will depend on construction expenses for its projects.
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DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
IV. VALUATION
We initiate coverage with a LTFV of SAR19.15 for Dar Al-Arkan using a sum-of-the-parts methodology. The main driver of value is its land bank, followed by the Al Qasr and Shams Alriyadh projects. Note that we include Khozam Palace and Shams Al-Arous projects in the land bank, because of the difficulty of valuing them without more information. These projects could result in a higher valuation, when we have a better understanding of the value drivers there.
Figure 38: Dar Al-Arkan Sum-of-the-Parts Valuation
Ownership Land (sqm)Value Value Per % of Total Methodology (SAR mn) Share (SAR) Value Al Qasr 100% 813,389 2,967 2.75 11% DCF calculation Al Tilal 100% 550,000 271 0.25 1% DCF calculation Shams Arriyadh 100% 5,059,000 1,845 1.71 7% DCF calculation 1.75x book of land for sale Land Bank 100% Unknown 22,885 21.19 82% (excl. projects) Enterprise Value 27,969 25.90 100% Net Debt 100% (7,284) (6.74) From 3Q2009 BS Equity Value 20,685 19.15 Source: EFG-Hermes estimates
On a multiples basis, Dar Al-Arkan is trading at a relatively low P/E of 8.0x on 2009e earnings and 7.7x 2010e. This is low for Saudi, which has recently traded around 17x 2009e and 12x 2010e. It is also relatively low compared to real estate companies across the region, although it is difficult to compare companies because of very different business models (some are heavy in rentals, some use off-plan sales to finance construction) and accounting standards (revenue recognition at delivery versus percentage of completion).
LAND BANK Dar Al-Arkan's land bank recorded at cost is worth SAR15 billion, according to management. We use a 75% premium to this after taking out land related to the three projects included in our valuation separately. We assume the company’s land has an average cost per sqm of SAR300, and we use this estimate to reach a book value for land (excluding the projects) of SAR13.1 billion. We then apply a 75% premium to this to reach a total value of SAR22.9 billion. Our premium is based on i) historically high gross margins for land sales at the company of around 50%, implying a 100% mark up, ii) a short life of 2.5 years for its land sales, meaning that the total SAR13 billion could be sold quickly and result in strong cash flows for the company, and iii) a substantial increase in land prices over the past three years, which has in some areas been above 100% (such as in north Jeddah), according to media reports.
AL QASR PROJECT We estimate the total value to Dar Al-Arkan of its Al Qasr project is SAR3.0 billion, or SAR2.75 per share. This represents 11% of our enterprise value. We use a DCF with a WACC of 10% and a long-term growth rate of 3%.
About 90% of Al Qasr’s value stems from rentals. Sales of villas and apartments are just 10% of the value, but that is because we assume the company has received the majority of its cash from past sales already and these represent just the remaining sales to be done in 4Q2009e and 1H2010e.
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DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
Figure 39: Al Qasr Valuation In SAR million, unless otherwise stated
Type Valuation % of Total Villas for Sale 71 2% Apartments for Sale 247 8% Residential Rentals 617 21% Office Rentals 181 6% Mall Rentals 1,047 35% Mixed-use Retail Rentals 804 27% Total 2,967 100% Source: EFG-Hermes estimates
AL TILAL Al Tilal accounts for about 1% of our estimated enterprise value, because i) it is fairly small, with just 499 units, and ii) about 145 of these units have already been sold, and we assume that the company has already received some cash to these. We use a WACC of 10%, although the project is fairly insensitive to changes in the discount rate, given a very short time frame, we expect sales will be completed next year.
SHAMS ALRIYADH Shams Alriyadh is worth SAR1.8 billion, or SAR1.71 per share, according to our analysis. We estimate that the sale of almost 3,200 villa results in a value to Dar Al-Arkan of SAR820 million, or slightly less than our estimate for the full project. The remainder stems from mixed-use commercial/retail space of 3.0 million sqm. We assume a leasable area of 472,000 sqm, based on media reports, although this could be lower than the final figure. We estimate this will be worth SAR1 billion to the company. We use a WACC of 10% for the project and a long-term growth rate of 3% for the rentals.
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DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
V. FINANCIAL STATEMENTS
Income Statement (December Year End) In SAR million, unless otherwise stated
2008a 2009e 2010e 2011e 2012e Revenue 5,611 5,694 5,636 6,774 8,018 COGS (2,766) (3,069) (2,932) (3,596) (4,365) Gross Profit 2,845 2,624 2,704 3,178 3,653 Gross Margin 51% 46% 48% 47% 46% SG&A Expenses (150) (142) (131) (160) (184) Other Operating Expenses (1) - - - - EBITDA 2,694 2,482 2,573 3,018 3,469 EBITDA Margin 48% 44% 46% 45% 43% Depreciation & Amortization (50) (40) (47) (82) (123) Operating Profit 2,644 2,442 2,526 2,936 3,347 Operating Margin 47% 43% 45% 43% 42% Finance Expenses (245) (157) (149) (120) (148) Other Income / Expenses 17 6 9 11 13 Net Income before Zakat Provision 2,417 2,290 2,386 2,827 3,211 Zakat Provision For The Year (60) (53) (60) (71) (80) Minority Interest - - - - (315) Net Income 2,356 2,237 2,326 2,756 2,815 EPS 2.18 2.07 2.15 2.55 2.61 Source: Dar Al-Arkan, EFG-Hermes estimates
Balance Sheet (December Year End) In SAR million, unless otherwise stated
2008a 2009e 2010e 2011e 2012e Cash and Cash Equivalents 716 1,714 171 271 720 Net Receivables 949 543 775 1,881 2,046 Projects Under Construction 1,269 2,600 2,404 2,393 2,362 Other Debit Balances 1,794 957 957 957 957 Total Current Assets 4,728 5,814 4,308 5,502 6,085 Fixed Assets, net 120 108 121 133 143 PUC and Investments 14,070 16,042 16,227 16,923 18,692 Other Debit Balances 1,247 1,274 1,260 1,248 1,238 Total Assets 20,164 23,239 21,917 23,807 26,159 ST Debt 1,635 2,650 900 3,750 - Accounts Payable 171 300 301 335 306 Other Credit Balances 613 615 615 615 615 Total Current liabilities 2,420 3,565 1,816 4,700 921 LT Debt 6,000 5,689 3,789 39 3,039 Other Credit Balances 8 10 11 11 12 Total Liabilities 8,427 9,265 5,617 4,751 3,972 Total Shareholder's Equity 11,736 13,974 16,300 19,056 22,187 Total Liabilities and Shareholder's Equity 20,164 23,239 21,917 23,807 26,159 Source: Dar Al-Arkan, EFG-Hermes estimates
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DAR AL-ARKAN 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
Cash Flow Statement (December Year End) In SAR million, unless otherwise stated
2008a 2009e 2010e 2011e 2012e Net Profit before Zakat 2,417 2,290 2,386 2,827 3,211 Depreciation & Amortisation 50 40 47 82 123 Other Operating Cash Flows 4 2 3 3 3 Change in Working Capital 296 1,766 (97) (1,135) (246) Total Operating Cash Flows 2,766 4,099 2,339 1,777 3,091 Capital Expenditures (3,802) (1,087) (747) (485) (483) Free Cash Flow (1,036) 3,013 1,592 1,292 2,608 Other Investing Cash Flows (1,169) (2,693) 516 (293) (1,408) Cash Flow before Financing (2,204) 320 2,107 999 1,199 Net Financing (426) 678 (3,650) (900) (750) Change in Cash (2,630) 998 (1,543) 99 449 Source: Dar Al-Arkan, EFG-Hermes estimates
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FERTILE GROUND FOR REAL ESTATE DEVELOPERS 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
IV. REAL ESTATE PRICES HAVE STABILISED
RESIDENTIAL UNIT SALE PRICES There is minimal information on real estate prices in Saudi Arabia, although some hard data and anecdotal evidence points to a relatively stable situation for real estate prices. This is partially helped by a small secondary market for housing, and we believe developers have been holding the line on prices as much as they can. Land sales are more likely to see fluctuations and anecdotal evidence points to a fall in prices for large plots of land in non-centrally located areas. Land prices within cities, particularly Jeddah, have held up, according to our industry sources, owing to a scarcity, particularly for large plots. This could change with the revitalisation of three districts in Jeddah, which will expand the universe for land within the city.
The notary publics of Riyadh and Ad Dammam report real estate transaction volumes and values, which show a continued high level of activity. The total value of contracts has fallen from the highs in 2008 but is still relatively high, particularly in Riyadh, where over a four-week period it has been about SAR6 billion. It is harder to pick out trends for average prices per sqm, which have seen significant volatility, but we do know that they have not fallen significantly.
Figure 40: Real Estate Contracts Signed in Riyadh (trailing four weeks) In SAR million, unless otherwise stated
18,000 Value of Contracts (LHS) Avg. Price per sqm 600 16,000 500 14,000 12,000 400 10,000 300 8,000 6,000 200 4,000 100 2,000 0 0 Jul-09 Jul-08 Jan-09 Apr-09 Jan-08 Apr-08 Jun-09 Sep-08 Feb-09 Jun-08 Feb-08 Aug-08 Oct-08 Dec-08 Mar-09 Dec-07 Mar-08 May-09 Nov-08 May-08 Nov-07
Source: Ministry of Justice
We saw a similar trend in Ad Damman, where transactions are steady, albeit lower, and prices have stayed relatively strong. Prices in June averaged above SAR900 per sqm, a high figure.
Figure 41: Real Estate Contracts Signed in Ad Dammam (trailing four weeks)
Value of Contracts (LHS) Avg. Price per sqm 4,000 1,000
800 3,000 600 2,000 400 1,000 200
0 0 Jul-08 Jan-09 Apr-09 Jan-08 Apr-08 Jun-09 Jun-08 Sep-08 Feb-09 Feb-08 Aug-08 Oct-08 Dec-08 Mar-09 Dec-07 Mar-08 Nov-08 May-09 Nov-07 May-08
Source: Ministry of Justice
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FERTILE GROUND FOR REAL ESTATE DEVELOPERS 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
RESIDENTIAL RENTAL PRICES The rental market remains robust, and both locals and foreigners face limited supply in our opinion. Foreigners, particularly those who want to live in residential compounds, have seen long waiting lists and rental price increases every year for several years. We expect this will continue given limited supply expansion. Locals are also facing a supply shortage, although this is more prevalent in the lower-income and middle-income segments of the market. More than 50% of households live in rented or owner- supplied units. We do not believe that additional supply, both in rentals and sales, will alleviate this, and expect rents to continue to increase.
Our economist believes that higher rents will drive inflation over the next few years. We currently forecast annual average inflation of 4.8% in 2009e, down from 9.9% in 2008. In our models, we assume that rents for compounds catering to foreigners (like Akaria’s villas in the Diplomatic Quarter) will increase above inflation. For non-compound rentals, we assume an increase in line with inflation.
Figure 42: Akaria Rental Revenues (2004-2Q2009) In SAR million, unless otherwise stated
200
150
100
50
0 2004 2005 2006 2007 2008 1Q2009 2Q2009
Source: Akaria
COMMERCIAL RENTS Office rental prices appear to have held up so far in Riyadh, but Jeddah may be facing a slightly more difficult period because of the addition of new supply. Going forwards, we expect Jeddah to recover somewhat, but that Riyadh may face greater difficulties as new supply comes on line. We believe "A” class space will hold up better than “B” class, although the two cannot be entirely segmented. Additionally, many buildings in Riyadh are either unoccupied or under-occupied, because the landlord is waiting for a single tenant to come in and take over the whole building.
In our models, we increase rental prices in line with inflation, which may be too conservative for certain projects like Akaria Plaza, a newly opened building that is centrally located in Riyadh’s CBD district. Other companies, such as Dar Al-Arkan, may face a more difficult situation, because it is building mixed-use areas near its developments in the belief that it will create its own demand.
RETAIL RENTS Retail is probably the segment most likely to face oversupply issues, in our view. According to Colliers International, a real estate research firm, existing expansion plans will result in a total of 7 million sqm of GLA in the Kingdom by 2010e, compared to 3.1 million sqm expected in Dubai. This is most likely to be a problem for independent developers that are not tied to one of the large firms (mostly family-owned) that have rights to franchise licences. These larger firms usually build malls around their franchises, and then attract smaller retailers that want the flagship stores to drive traffic. Independent developers are not able to do this as effectively, and we believe they will suffer in the case of oversupply. For the publicly-traded companies, Dar Al-Arkan, which plans to develop more than 3 million sqm of commercial and retail BUA, is likely face the greatest difficulties. However, this should be mitigated by the residential developments that will be contiguous to this area and will drive demand from the population living there. Also, the commercial and retail space in its development Al Qasr will fill a gap in the south of Riyadh, which lacks malls or quality commercial space.
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FERTILE GROUND FOR REAL ESTATE DEVELOPERS 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
V. CONSTRUCTION COSTS HAVE MODERATED
All real estate companies All real estate companies should benefit from the recent significant reduction in steel and cement prices, should benefit from the which should allow them to build units more profitably. The average price of steel in 1H2009 fell 55% Y- significant reduction in steel o-Y, although some increases in steel prices have been recorded since the beginning of the year. Cement prices prices have followed a volatile path over the past two and a half years. Prices rose in 2007 to reach a high of USD76 per ton in 4Q2007 (based on an average of prices for four major cement companies) and then fell at the beginning of 2008 before rising to a high of USD73 per ton in 3Q2008. Prices fell to a low of USD62 per ton in 4Q2008, but have increased in 2009 to between USD66-67 per ton.
The local authorities responded to the escalation of building material prices in mid-2008 by partially banning exports, although this had a much smaller impact than the dramatic decline in worldwide building material prices. We believe that similar regulatory intervention could be expected whenever cost increases are significant and hurt local Saudi buyers.
Because of the decline in construction material prices, real estate companies have been able to renegotiate contracts with construction companies. For example, Emaar EC was able to cancel a SAR1.4 billion contract with Saudi Bin Ladin Group, citing the decrease in building material costs. We have heard that other companies are doing the same. While this is positive in the short term, volatility makes it difficult for both construction companies and developers to price their products and services accurately. However, we expect this volatility will likely continue, and should result in more variable-cost contracts that will directly impact on margins for developers, rather than fixed-cost contracts that shielded developers from the worst of the price changes. The volatility is especially difficult for companies that sell on an off-plan model, because higher steel prices cause an immediate cut in realised profits.
Shortage of quality labour Securing quality labour remains another challenge for the construction process in Saudi Arabia. Increasing remains a challenge inflation, increasing living costs (mostly rent), exchange rate fluctuations and considerable improvements in the Asian economies make it more difficult to attract qualified workers to execute ambitious development plans. This effectively increases the contribution of the cost of labour to overall construction costs. We estimate that labour costs in the Kingdom have risen in 2009, albeit less than they did in 2008. The development of six new economic cities, requiring substantial amounts of manpower, may put further pressure on labour costs.
Figure 43: Average Cement Prices 1Q07-2Q09 Figure 44: Steel price USD per ton, unless otherwise stated SAR per ton, unless otherwise stated
80 6,000 76 5,000 4,000 72 3,000 68 2,000 64 1,000 60 0 Apr-08 Apr-09 Feb-08 Jun-08 Feb-09 Dec-07 Aug-08 Oct-08 Dec-08 1Q2007 2Q2007 3Q2007 4Q2007 1Q2008 2Q2008 3Q2008 4Q2008 1Q2009 2Q2009
Source: Company disclosures Source: Media reports
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FERTILE GROUND FOR REAL ESTATE DEVELOPERS 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
VI. OFFICE SPACE IN DEMAND, BUT COULD BE REACHING RETAIL OVERSUPPLY
OFFICE SPACE High-quality office space has historically been scarce, with demand always outstripping the available supply. Rapid economic growth in the Kingdom, during and after the second oil boom in 2005, gave rise to a number of new businesses and increased the demand for quality office space. In the past, lack of high standard commercial property space encouraged landlords to convert residential villas or apartments into office space. However, this practice has recently been curbed by a new law whereby no residential property may serve as a commercial outlet or office space.
The new regulation has put short-term pressure on supply in the country's main business hubs, such as Riyadh or Jeddah, and will likely result in further rent escalation. However, rents are not yet as high as in other part of the GCC region, mainly due to a limited amount of speculation on raw land prices. The existing imbalance is expected to level out with arrival of new projects specifically addressing the shortage of A class office space, such as King Abdullah Financial Centre in Riyadh.
We believe that the extent of pent up demand for quality office space gives scope for many developers to operate their properties profitably, even after the creation of high-rise office buildings encompassed in the CBDs of newly developed projects. This is especially the case in Jeddah, which has historically suffered from office space shortage. Currently, only Riyadh has a clearly laid-out, and already congested, CBD, while office space areas in Jeddah are scattered all over the city. On the other hand, Mecca and Medina look less attractive in terms of potential investment in the office space sector. Neither of these cities currently suffers from an actual shortage, as evidenced by the average rents being approximately half of those in Riyadh or Jeddah while the occupancies are moderate.
RETAIL SPACE The relative prosperity of local society makes Saudi Arabia an attractive market for internationally recognised brands and branded shopping chains. This pushes up commercial rental yields, especially in Riyadh and Jeddah where we estimate an average annual retail space rent of SAR800-1,100 per sqm, depending on the location of the outlet.
Due to poor transparency in the market, together with uncertainty surrounding many already announced projects, it is hard to accurately estimate how much new GLA will be supplied in the short term. Anecdotal evidence suggests a range of between 0.5 million to 1 million sqm of new space becoming operational by 2011e, most of which is destined for Riyadh. This is a significant amount, and may put some downward pressure on current rents or force landlords to offer more flexibility to their tenants.
Saudi Arabia ranks fifth in A.T. Kearney’s 2009 Retail Apparel Index in terms of attractiveness of potential investment in its retail industry. This is mainly due to its economic growth potential and the affluence of its residents.
Figure 45: A.T. Kearney Retail Apparel Index Ranking
2008 2009 India 2 1 Russia 3 2 China 4 3 United Arab Emirates 20 4 Saudi Arabia 7 5 Source: A.T. Kearney
The nature of the Kingdom’s retail industry is gradually changing, and more stress is being put on the entertainment aspect of the shopping experience. Newer shopping mall projects often encompass cinemas and other outlets suitable for family outings. This increases their construction costs while limiting the available net leasable area, which currently contributes to c70% of total constructed area.
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VII. MORTGAGE AND DEVELOPMENT FINANCING LIMITED
MORTGAGE LAW IN LIMBO Although the Shura Council passed a mortgage law almost a year ago, it is still under discussion by the Council of Ministers and has yet to be signed by the King. It appears that the government is wary of issuing a mortgage law currently, given the recent financial crisis.
However, we expect it to be finally issued within the next year. Once issued, we believe all real estate stocks will benefit, particularly those that focus on middle-income homebuyers such as Akaria and Dar Al- Arkan.
While banks have been offering mortgages for a few years, the amount of real estate financing to consumers is a mere 8.9% of total consumer credit, just 2.1% of total credit and around 1% of GDP. This leaves considerable room for growth. The main characteristics of these mortgages are listed below.
• Types of Mortgages: The main product used is a Shariah-compliant loan that is similar to a marked-up sale product (marabaha). Rajhi also offers musharaka (lease arrangement), erad (for real estate investment), and istisnaa (for construction financing) to its customers.
• Financing Rate: Because mortgages are Shariah-compliant, they do not carry interest rates. However, banks currently charge a fixed rate of around 4.5-4.75%. Since the agreement does not have an amortising component, the effective rate is closer to 8%.
• Terms: Tenors can be as high as 25 years (Al Rajhi). Down payments can be as low as 0%.
• Default Rates: Both Saudi Home Loans (SHL) and al Rajhi say their default rates have been very low. For SHL, this is partly due to its very short history – it has only been issuing mortgages since March 2008. For Rajhi, and we assume for other banks, it is able to keep default rates low by requiring a salary assignment.
• Early Payment: Banks will allow early payment, as with normal, amortising mortgages. However, this is somewhat at the discretion of the bank, because there is no amortising portion.
THE GOVERNMENT IS STARTING TO SUPPORT MORTGAGES FINANCIALLY The government gave preliminary approval in late May 2009 for the establishment of a real-estate financing company, expected to launch operations in 2010e, according to Okaz newspaper. The state-run Public Investment Fund, PIF, will grant a long-term loan to the new firm, provided a stake in it is owned by a public sector corporation. This, along with other financing companies that have been created with real estate developers, should help to develop the market.
Figure 46: Real Estate Financing Small Part of Total Consumer Credit In SAR billion, unless otherwise stated
Real Estate Financing % of Total Consumer Credit % of Nominal GDP
20 10.0%
15 8.0% 6.0% 10 4.0% 5 2.0% 0 0.0% 2002 2003 2004 2005 2006 1Q2007 2Q2007 3Q2007 4Q2007 1Q2008 2Q2008 3Q2008 4Q2008
Source: SAMA
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BANK CREDIT TO REAL ESTATE DEVELOPERS HAS DRIED UP… Saudi banks have historically had a low exposure to the building and construction segment (7% of total credit), and credit to the sector dried up with the onset of the financial crisis. We expect the market for bank loans will improve over time, as the real estate market improves. Real estate companies have little access to other financing methods, so are likely to have to depend heavily on bank loans; although these loans will only be available to companies with a strong track record or close ties to larger industrial groups. For example, Dar Al-Arkan, which has a strong development track record, has been able to access murabaha from banks to the tune of SAR1.6 billion, and we expect this will increase to as much as SAR2 billion as it pays off a sukuk due in March 2010e.
…AS HAS THE SUKUK MARKET The sukuk market, which has previously been a source of capital for many Saudi companies, has been very quiet for the past year. While Dar Al-Arkan was able to raise SAR750 million in a five-year term sukuk in mid-May, it is only one of two Saudi Arabian companies that have issued sukuks in 1H2009. Dar Al-Arkan will pay SIBOR +4%, up from its previous sukuks which had payments of LIBOR +2% (for a three-year term sukuk) and LIBOR +2.25% (for a five-year term sukuk). In addition, the sukuk was raised from the local market. We expect Saudi businesses will have a difficult time raising money from foreign sources for some time, given the recent Saad Al-Gossaibi problems. We believe the market for Islamic sukuks will grow, but it will take some time and have minimal impact on real estate companies as a whole.
TWO NEW IPOS ANNOUNCED IN REAL ESTATE Over the past year two economic cities, Prince Abdulaziz bin Mousaed Economic City in Hail and Knowledge Economic City in Medina, have announced their intention to issue equity to the public. Both will offer 30% of their shares via IPOs. They will follow Jabal Omar and Emaar Economic City in selling shares to the public to finance undeveloped projects. While the original announcements indicated that IPOs were imminent, these plans have been delayed and we do not now know when to expect them.
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VIII. REGULATORY CHANGES FAVOR INCUMBENTS
OFF-PLAN SALES NEED APPROVAL The Council of Ministers recently forbade off-plan real estate sales by developers without ministry approval. The new resolution was passed by the Council of Ministers on 9 March 2009. The rule covers all types of real estate sales, not just residential. Developers will have to register their properties with a special property committee that will be run by the Ministry of Commerce and Industry, SAMA, and other ministries and municipalities. The rule also requires an escrow account, into which the developer must deposit all instalments and other project financing for each property. Al Jadaan Partners, a law firm in Riyadh, sees the resolution as an interim measure until a newly planned ‘Real Estate Developments Guarantee Law’ is enacted, probably later this year.
The committee will create a register and issue licences for qualified developers. We do not know at this stage if the registry will be public, but it would be a step towards increasing transparency in the market if it were. Dubai has a similar registry that it publishes publicly. There is a possibility that the committee will also create a "special registry" that will have all sale agreements between the register and purchasers of units, according to Al Jadaan Partners. Existing developers are required to apply in order to receive a licence.
We believe large developers will have few problems complying with the new regulations, although the process could slow down some developments. We also expect most developers will receive approval for off-plan sales, as long as they can show a track record and sufficient capital for the project. Saudi Arabia is mainly an end-user market, rather than an investor market, and it should not be difficult for most large developers to comply. The regulations could, however, make it difficult for new developers without access to capital or a long track record.
RESIDENT FOREIGNERS CAN BUY HOMES Resident foreigners can buy homes in Saudi Arabia. Although access to financing is limited, Saudi Home Loans offers mortgage financing through Shariah-compliant mechanisms. The regulation, passed 9 November 2000, allows non-Saudi individuals and companies to own properties for private accommodation purposes. Real estate ownership in Mecca and Medina continues to be limited to Saudi nationals, although there are exceptions in special cases. In the two cities, foreigners are able to rent properties for a maximum of two years, subject to renewal, according to Jabal Omar.
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IX. DEVELOPMENT OF NEW CITIES
Historically, the real estate market in Saudi Arabia has been very fragmented and over 90% of housing needs were addressed by small-scale developers and individuals, with little participation of big firms active elsewhere in the region. However, the Saudi government's plan for new economic cities has changed this. The new cities are mainly being developed outside of the major population centres and planned centrally. The ambitious scheme seeks to build six new cities (four of which have reached development stage), and the government hopes they will drive future growth in the country. The projects are being developed according to a Public-Private-Partnership (PPP) framework, whereby the overall vision of the Saudi authorities is implemented by private sector companies. The Saudi Arabian General Investment Authority (SAGIA) hopes to create over a million new jobs and accommodation for 4-5 million residents in the six newly established areas by 2020. Smaller industrial areas are also being developed within existing cities, also to drive job creation.
We discuss King Abdullah Economic City (KAEC) in detail in the next section.
Figure 47: Saudi Arabian New Economic Cities
Reported Name Location Developer(s) Size (m2) Focus Investment King Abdullah Rabigh, north USD50 bn (SAR187 Emaar EC 168 mn Light industry, port, resorts Economic City of Jeddah bn)
Jizan Economic MMC (Malaysia), Heavy industries and USD30 bn (SAR112 Jizan 100 mn City Saudi Bin Ladin Group agricultural industries bn) Prince Abdulaziz Al Mal Investment USD8 bn (SAR28 Bin Mousaed Near Hail 156 mn Transportation and logistics Company bn) Economic City Knowledge Savola Group, Taiba USD6.7 bn Medina 4.8 mn Knowledge-based industries Economic City Holding SAR25 bn
Not Launched Tabuk TBA
Not Launched Ras Al Zour Mining, aluminum TBA
Note: Expected investment is from media reports and press releases - these are not EFG Hermes’ estimates Source: SAGIA, company disclosures, and media reports
JIZAN ECONOMIC CITY (JEC) NEAR JIZAN This will be located 60 kilometres northwest of Jizan City on 100 million sqm and is expected to cost USD27 billion (SAR96 billion). JEC aims to be a heavy industrial zone and facilities such as an aluminium plant are currently being built there. It will have access to 12 kilometres of coastline and a state-of-the art sea port. The city will provide accommodation to 300,000 people. MMC and the Saudi Bin Ladin Group are the land owner and master developer of the JEC Project.
PRINCE ABDULAZIZ BIN MOUSAED ECONOMIC CITY (PABMEC) NEAR HAIL Transportation and logistics hub built on 156 million sqm of land. Investment size is expected to be USD8 billion (SAR28 billion). It will create 55,000 jobs for a population of 300,000 and Al Mal Investment Company is to be the sole developer. The company has announced its intention to sell 30% of the venture to the public via an initial public offering (IPO) within the next six months.
KNOWLEDGE ECONOMIC CITY IN MEDINA This will be located on 4.8 million sqm and have a total BUA of 9 million sqm to attract SAR25 billion worth of investments. The project is expected to add 20,000 new jobs to the area and host a population of 50,000. Savola Group, Taiba Holding Company, Akaria and the government currently own more than 85% of the venture. The developer would like to undertake an IPO by the end of 2009e. It plans to sell 30% of the company to the public.
Two other economic cities are being planned for Tabuk and Ras Al Zour.
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X. A PRIMER ON EMAAR ECONOMIC CITY AND KAEC
King Abdullah Economic City (KAEC) is the largest of the economic cities, covering 168 square kilometres. It is located at the Red Sea coast around 100 kilometres north of Jeddah, and plans to accommodate two million people. Emaar EC, a publicly-traded subsidiary of UAE-based Emaar Properties, is the master developer of the project. The city will have a port able to handle up to 10 million TEUs (twenty-foot equivalent container units) annually, a light industrial zone, a resort zone, residential zone and a central business district (CBD) with a total of 3.8 million sqm of prime office and mixed-use commercial space. It is expected to be completed by 2025e. The total investment cost of the project is estimated at USD50 billion, although not all of this will be borne by Emaar EC.
SHARE PERFORMANCE Share performance has been very volatile for Emaar EC since the initial public offering, and almost none of it is because of fundamentals – the company has not consistently posted profits yet. The share performance appears to be driven by three main things: i) advance sales for smaller projects within Emaar EC, ii) corporate events such as management changes, and iii) speculation on government support towards the project.
Share performance has been highly correlated to the overall stock market and to other real estate stocks, so a positive view on the real estate sector in Saudi Arabia is likely to mean a robust performance for Emaar EC as well.
Figure 48: Emaar EC Price Performance Against TASI
15.0 Emaar EC TASI (rebased) 14.0 13.0 12.0 11.0 10.0 9.0 8.0 7.0 Jul-09 Jan-09 Apr-09 Feb-09 Jun-09 Sep-09 Oct-08 Dec-08 Mar-09 Aug-09 Nov-08 May-09
Source: TASI
STRENGTHS OF EMAAR EC
Inexpensive Land - Well-Situated KAEC is well situated on the Red Sea, not far from Jeddah, King Abdullah University of Science and Technology (KAUST), and Petro Rabigh. It has a natural port, and we expect it will be connected to the upcoming high-speed train network that the government plans to build across the Kingdom. We believe KAEC has strong potential as a resort destination from Jeddah, which is already a natural vacation spot for Saudis that want to escape from Riyadh and other cities in the hot central areas of the country during the summer. KAEC should therefore be able to tap into this market with its beach front areas and new developments, including a marina.
Government committed to KAEC success We believe the government is committed to the success of the KAEC and will help support its development. The government has stressed many times that the city will be developed solely through private investment, but we believe this is not possible in the current climate. Given that the government views its economic cities strategy as a way to create job and housing opportunities, and it has invested a great deal of time and money into them, we believe it will step in to make sure KAEC is a success. We believe any support may take the form of infrastructure spending, guarantees for debt, or pushing government wholly- or partially-owned companies to move operations into the free zone. We discuss the
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potential risks to this below, but we believe government support is positive for the development of the city - which is distinct from saying that it is good for the stock.
RISKS TO THE BUSINESS MODEL
Critical Mass May be Years Away We believe KAEC will be a success, given the government’s support, but it may be a very long time coming. KAEC is a substantial piece of land far from any population centre. It must attract both residents as well as companies to employ those residents, preferably at the same time. This could take a very long time and require government support that may not be forthcoming in the short term.
Mixed use could limit appeal of city as residential area Emaar EC is moving towards situating KAEC as a mixed-use city with both residential and industrial areas. While the light-industrial plots that the company has already built fit well with residential areas, we are concerned by announcements about large industrial projects, like an aluminium plant. Such projects may not fit with an upscale residential or resort experience, even if located some kilometres away.
Government aid may dilute shareholders We expect the government will step in to aid KAEC if the company faces financial difficulties, given the importance it attaches to the new economic cities. However, we do not know, at this point, what form this aid will take. We believe it could be a mixture of debt, equity and government subsidies to attract industries to the city. We are concerned, however, that any equity component will dilute current shareholders, while any debt portion, although possibly offered on reasonable terms, could leave Emaar EC with a high debt burden in the near term.
No Guarantee of Dividends We do not expect, nor believe it is prudent, for Emaar EC to pay dividends for many years. Investors will see no stable return on their investment for some time.
STRATEGY
Emaar EC launched sales of residential units and plots in its industrial zone in 2007. Since then, there has been a significant change in the appetite of real estate investors for high-end residential units. Owing to this change, Emaar EC has made modifications to its strategy. It is now offering land plots within some of its developments, such as in Bay La Sun, for third-party developers. It has also launched a middle-income residential housing project that is expected to have 22,000 units. We expect the next phase will include resort offerings, which can be attractive even with minimal other development around them. Separately, the company has also started to put a greater focus on attracting jobs to the development through its industrial zone. It hopes that as businesses move there, managers and other mid-level staff, who can afford homes within its developments, will move into KAEC.
Where will the people come from? Emaar EC, and the economic cities strategy generally, stands firmly behind the belief that "if you build it they will come." Supporting this is i) a very large number of young people in Saudi Arabia that are searching for good jobs, ii) lack of city housing at affordable prices, and iii) relatively close proximity to Jeddah, the second-largest city in Saudi Arabia. However, without compelling job opportunities, we believe it will be hard for Emaar EC to attract residents. While employees of KAUST and PetroRabigh are likely to find Emaar EC attractive, many will have housing provided by their employers. Even if all of them did live in Emaar EC, this would be less than 3,000 people.
Where will the money come from? We expect Emaar EC will raise funds for its development through three main sources: land sales, third- party industrials and the government. We do not believe it has the financing ability to fund the development on its own. We believe the government will support the company, particularly in regards to infrastructure developments. Emaar EC has also embarked on land sales within its developments. These sales will allow third-party developers to take some of the risk and fund new properties. Emaar EC can then use these funds to finance its infrastructure spending and its own development. Finally, we believe the infrastructure for the industrial projects is likely to be undertaken by the companies themselves. For
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example, new aluminium smelters will need to supply their own electricity, meaning that they will have to build their own power plants.
DEVELOPMENTS
Residential, Commercial and Resorts
Bay La Sun - Emaar EC's first project to launch was Bay La Sun, a residential community made up of luxury apartments, most of which targeted the high-end market. The starting price for some units was around SAR500,000. The development covers about 2.3 million sqm and was launched in September 2007. The company took a phased approach, waiting to sell a majority of units in one building before starting sales in another. Emaar EC originally expected to hand over units at the beginning of 2009, but they have been delayed. Recent press announcements have disclosed a September 2009 hand-over date, but we do not know if this has occurred.
We do not know the full expected costs of Bay La Sun, but we expect it is considerable, given the amount of infrastructure (canals, roads, bridges, etc.) that needed to be created. To give an idea of the size, Emaar EC originally signed a SAR1.4 billion contract with Saudi Bin Laden Group (SBG) to develop 16 residential towers within Bay La Sun. However, in September 2009 it cancelled these contracts citing the decline in building material prices. We expect the contract will be renegotiated without hurting the relationship with SBG, mainly because Emaar EC signed a new contract with SBG for the port the same day it cancelled the Bay La Sun contract. The new cost will probably still be more than SAR1 billion, even after the decline in steel and cement prices.
Esmerelda - Esmerelda is a townhouse and golf community in KAEC spread over 160,000 sqm. Emaar EC launched the development in mid-2008 and expects to hand over units in 2010e. The suburb consists of townhouses and villas and a golf course. At the original launch demand was high and around 95% of the units offered for sale were sold, although the exact number was not disclosed. The second phase also received a strong response. Total expected cost of the project has not been disclosed, although Emaar EC signed a SAR147 million contract for the golf course.
Hawadi - After the onset of the financial crisis, Emaar EC changed tack and launched a development targeted at middle-income homebuyers, Hawadi, which will comprise 22,000 units. Emaar EC debuted Hawadi at Jeddah Cityscape in June 2009, and it is setting prices between SAR200,000 and SAR1 million and offering owners 36 different designs. The project will extend over nine square kilometres and will accommodate 60,000 residents, although the company has released just Phase I. The development of the project will take 15 years.
Land sales – Emaar EC launched the sale of 250,000 sqm of land plots in Bay La Sun in February 2009. These land plots will be sold to third-party developers, who can then develop residential, commercial and mixed-use buildings. The developers will have to follow design guidelines from Emaar EC in order to maintain consistency with the overall plan, and they will be required to construct within a specified period. We believe these sales will be helpful in driving positive cash flows to Emaar EC and allow continued infrastructure work on the rest of the city.
Industrial zones Emaar EC has designated 63 million sqm for industrial use, both light and heavy industry. Light industry will mainly be fabricators and other small industries that will be able to take advantage of the port. The company has started to hand over some plots of land, with full services: in March, it handed over plots in the light industrial zone to investors. Phase IA covers 1.5 million metres, and the company expects to develop 4.3 million metres by 2012e. Once completed, the industrial zone within KAEC is expected to cover 63 million sqm and house 2,500 factories employing 150,000 people.
In terms of heavy industry, Emaar EC has focused on attracting companies heavily reliant on electricity supplies, such as aluminium smelters. In terms of light industry, SAGIA and Emaar EC signed a MoU with Sanofi-Aventis in April 2009 to establish an entity of the leading global pharmaceutical company in KAEC. We believe Sanofi-Aventis will use the location to supply drugs throughout the region via a manufacturing centre. With regard to heavy industry, in July 2009, Emaar EC signed an agreement with Tharawat
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Development to build two plastic and aluminium plants in the city. These plants are expected to come on line in 2011e and provide 600 job opportunities.
Sea Port KAEC will include a large sea port that will be built to provide logistical support to the industrial zones within the city. A new contract for Phase I of the port was signed in September 2009 with SBG. SBG will finance, develop and operate the port. According to Emaar EC and SBG, it is expected to cost SAR4 billion, start operations in 2012e, and have an annual capacity of 1.7 million containers. We assume that this new contract means the cancellation of Emaar EC's contract with DP World that was signed in April 2008. When the original contract was signed, an operational port was promised by 2010e, but we do not believe much progress has been made. We expect DP World may have been conflicted about building a world- class port facility near its other ports in Jeddah.
Emaar EC’s new contract with SBG probably relieves it of financing the port, but also limits its potential upside from running the port. However, we believe the trade-off is worth it, given the significant expenses associated with building a port and Emaar EC’s many other obligations within KAEC. Additionally, a working port will act as a magnet to attract businesses to the city, which will help Emaar EC sell land and developments, its core competency.
FINANCIAL RESULTS
Emaar EC has not yet realised an operating profit since it started reporting results in 2006. It started recognising revenues in 3Q2008, as it partially completed units in Phase I of the project. We do not expect the company to report positive earnings for some time, although land sales (which began in February 2009) could result in earlier-than-expected profits, depending on when Emaar EC's recognises them.
Figure 49: Income Statement, (December Year End)
December Fiscal Year End 2006a 2007a 1Q2008 2Q2008 3Q2008 4Q2008 2008a 1Q2009 2Q2009 Revenues - - - - 43.8 57.8 101.6 82.4 83.8 Cost of revenues - - - - (141.1) (80.8) (221.9) (84.2) (64.9) Gross Profit - - - - (97.3) (23.0) (120.3) (1.8) 18.9
Marketing Expenses (9.2) (41.1) (8.6) (24.1) (43.3) (13.9) (89.9) (4.4) (13.6) G & A Expenses (14.3) (128.7) (48.2) (50.7) (60.8) (29.2) (188.9) (58.2) (61.0) (54.5) Operating Profit (23.4) (169.8) (56.8) (74.8) (201.5) (66.1) (399.2) (64.3) (110.2)
EBITDA (21.1) (157.1) (50.8) (68.2) (195.3) (60.4) (374.7) (58.4) (103.6) Memo: Depreciation 2.4 12.7 5.9 6.6 6.2 5.7 24.5 (5.9) (6.5)
Marabaha income 60.3 206.7 37.8 34.6 34.8 33.5 140.6 7.7 2.8 Other Expenses (49.8) 0.0 0.0 0.0 0.0 0.0 0.0 NI before Zakat (12.9) 36.9 (19.0) (40.2) (166.7) (32.6) (258.5) (56.6) (107.4) Zakat 0.0 (10.6) (0.3) (0.3) (15.1) (17.9) (33.5) (5.8) (5.8) Net income (12.9) 26.3 (19.3) (40.4) (181.8) (50.5) (292.0) (62.3) (113.1) EPS (0.02) 0.03 (0.02)(0.05) (0.21) (0.06) (0.34) (0.07) (0.13) Source: Emaar EC
The company’s balance sheet shows a cash balance of SAR1.3 billion as of 2Q2009, although much of this was due to SAR3.4 billion raised in investments in 4Q2008, which was a reversal of the same 2007 figure. The company has recorded steady progress in construction, reporting SAR4 billion in property and equipment as of 2Q2009. This is mainly due to developments in Esmeralda and Bay La Sun, which are close to being delivered, and its industrial park, for which it started delivery this year. Further deliveries should start to show positively on the income statement over the next two years. Net income will result in an improvement in shareholder’s equity, which has fallen from SAR8.5 billion to SAR8.0 billion as of June 2009.
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Figure 50: Select Balance Sheet Accounts, (December Year End)
2006a 2007a 1Q2008 2Q2008 3Q2008 4Q2008 2008a1Q2009 2Q2009 Assets Cash and Cash Equivalents 4,574 639.8 286.3 168.3 95.7 2,219 2,219 1,625 1,295 Accounts Recievables 5.4 17.8 77.3 101.7 176.7 227.8 227.8 335.4 284.9 Total Current Assets 4,585 675.5 3,779 3,670 3,672 2,503 2,503 1,965 1,971 Investment Property 3,780 3,776 3,774 3,770 3,761 3,743 3,743 3,743 3,525 Property and Equipment 272.2 895.7 1,222 2,016 2,682 3,281 3,281 3,926 4,030 Total Assets 8,637 8,747 8,775 9,456 10,116 9,532 9,532 9,638 9,530 Liabilities Current Liabilities 180.5 263.1 309.7 1,031 1,846 1,294 1,294 1,452 1,398 Non-Current Liabilities 0.1 1.3 1.8 2.3 28.3 47.8 47.8 58.2 116.9 Total Liabilities 180.6 264.4 311.5 1,033 1,875 1,342 1,342 1,510 1,515 Total Shareholder's Equity 8,456 8,483 8,463 8,423 8,241 8,191 8,191 8,128 8,015 Total Liabilities and SHE 8,637 8,747 8,775 9,456 10,116 9,532 9,532 9,638 9,530 Source: Emaar EC
Figure 51: Selected Cash Flow Items, (December Year End)
2006 2007 1Q2008 2Q2008 3Q2008 4Q2008 2008 1Q2009 2Q2009 Cash from Operations NI before Zakat (12.9) 36.9 (19.0) (40.2) (166.7) (32.6) (258.5) (56.6) (107.4) Depreciation 2.4 12.7 5.9 6.6 6.2 5.7 24.5 5.9 6.5 Provisions & Donations 72.1 1.2 0.5 0.5 1.0 1.2 3.1 0.9 55.7 Murabaha Income (60.3) (206.7) 0.0 0.0 0.0 (140.6) (140.6) (7.7) (2.8) Development Properties (5.3) (10.5) (33.0) 15.6 176.1 248.0 406.6 195.1 17.1 Recievables (5.4) (12.4) (59.5) (24.1) (75.0) (51.3) (210.0) (107.6) 50.5 Payables 108.5 72.0 46.3 123.5 297.1 541.0 1,007.9 152.3 (26.4) Deferred Income 0.0 0.0 0.0 0.0 25.0 18.3 43.3 9.5 3.1 Zakat Paid 0.0 0.0 0.0 (10.6) 0.0 0.0 (10.6) 0.0 (33.4) Cash from Operations 99.1 (106.7) (58.8) 71.2 263.6 589.7 865.7 191.7 (37.2) Cash from Investing Capital Expenditures (274.6) (634.4) (294.7) (797.0) (839.7) (891.4) (2,823) (792.7) (296.4) Real Estate Investment (2,080) 0.0 0.0 0.0 Unlisted Investments 0.0 (3,400) 3,400 3,400 Murabaha Income 60.3 206.7 140.6 140.6 7.7 2.8 Other Investments 0.0 (4.8) (4.8) Cash from Investing (2,294) (3,828) (294.7) (797.0) (839.7) 2,645 713.1 (785.0) (293.6) Cash from Financing Short-term Loans - - - 607.9 503.4 (1,111) - - - Share Capital 6,769 ------Cash from Financing 6,769 - - 607.9 503.4 (1,111) - - -
Starting Cash Balance - 4,574.2 639.8 286.3 168.3 95.7 639.8 2,219 1,625 Change in Cash 4,574 (3,934) (353.5) (118.0) (72.6) 2,123 1,579 (593.3) (330.7) Ending Cash 4,574 639.8 286.3 168.3 95.7 2,219 2,219 1,625 1,295 Source: Emaar EC
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FERTILE GROUND FOR REAL ESTATE DEVELOPERS 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
XI. DEMOGRAPHIC TRENDS POINT TO GROWING DEMAND
Saudi Arabia's demographic profile is a fertile ground for housing development. It has a young, growing population that is increasingly urbanising, and reducing household sizes. The percentage of home ownership is low, at 45%, and even lower in the large cities.
SAUDI ARABIA HAS A YOUNG AND GROWING POPULATION. Of the total population of 27.6 million, 75% are below 35 years old, according to the 2007 census. Unlike other Gulf countries, such as the United Arab Emirates, the vast majority of the population (75%) are Saudi nationals.
Saudi Arabia’s population growth rate has slowed, but is still high at 2.7% per year, according to UN statistics. In comparison, world population growth is about 1.2% per year.
Figure 52: Saudi Population by Age Bracket (2007) In millions, unless otherwise stated
Non-Saudi Saudi 3.0 70% of population below 35 years old 2.5 2.0 1.5 1.0 0.5 0.0 0 -1 1 -4 5 -9 10 -14 15 -19 20 -24 25 -29 30 -34 35 -39 40 -44 45 -49 50 -54 55 -59 60 -64 65 -69 70 -74 75 -79 80+
Source: Central Department of Statistics and Information
54% OF SAUDI’S POPULATION IS IN RIYADH AND MECCA PROVINCES Saudi Arabia has 3.4 million households, with 54% located in two provinces: Riyadh and Mecca. Eastern Province, where most oil fields and oil workers are, has almost 500,000 households, or 14% of the total. Medina is located about 340 kilometres from Mecca, and 380 kilometres from Jeddah, and is often included within the Mecca province when discussing demand. Medina includes 7% of the total Saudi households.
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Figure 53: Saudi Households by Province (2007) In million, unless otherwise stated
1.4 Mecca and Riyadh represent 54% of all households 1.2 1.0 0.8 0.6 0.4 0.2 0.0 Asir Hail Jouf Jizan Baha Mecca Riyadh Najran Medina Qassim Tabouk Border Eastern Province Northern
Source: Central Department of Statistics and Information
URBANISATION HAS ALSO INCREASED SIGNIFICANTLY KSA's urban population has seen strong and sustained growth, reaching 81% of the population in 2005 (up from 21% in 1950) according to UN statistics. Out of the total population, almost 20 million people live in urban areas. There are five major cities with more than 750,000 inhabitants, according to the Ministry of Economy and Planning. The urban population is expected to grow faster than the rural population, to reach 86% of the total population in 2030e.
Figure 54: Urban Population in Saudi Arabia, 1950-2030e In million (LHS), unless otherwise stated
Urban Population (LHS) 40 Urban Population as % of Total (RHS) 100%
80% 30 60% 20 40% 10 20%
0 0% 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010e 2015e 2020e 2025e 2030e
Source: United Nations Department of Economic and Social Affairs, Population Division
HOUSEHOLD OWNERSHIP IS LOW Household ownership is around 45%, according to the 2004 census, but this percentage is lower in large cities such as Riyadh, where it is just 35%. Other sources peg it even lower, with the IMF estimating the homeownership rate at just 38%, and other media reports have said as low as 20%. According to the 2007 census, household ownership among Saudi households is much higher, at 62% but overall ratio for all households was not provided. We believe the current ownership may range from 30-45% if all households, including expatriate families, were included.
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Figure 55: Household Ownership (2004)
90% 80% 70% Average ownership at 45% 60% 50% 40% 30% 20% 10% 0% Asir Jouf Hail Baha Jazan Prov. Riyadh Najran Eastern Tabouk Qassim Border Makkah Madinah Northern
Source: Central Department of Statistics and Information
AVERAGE HOUSEHOLD SIZE IS SHRINKING The average size of a Saudi household has fallen from 6.1 people per household in 2004 to 5.7 in 2007. We expect this trend to continue as i) urban populations increase, ii) Saudi families move into apartments and villas and out of traditional family homes, and iii) population growth slows and children grow up. Generally, we believe the world is moving to smaller household sizes, and Saudi Arabia will be no exception.
Figure 56: Average Household Size by Province (2007)
Average household size at 5.7 individuals per household in 2007 9.0 Average household size at 6.1 individuals per household in 2003 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Asir Jouf Hail Jizan Baha Mecca Riyadh Najran Medina Qassim Tabouk Border Eastern Province Northern
Source: Central Department of Statistics and Information
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XII. CITY VIEWS
All real estate is local, and that is just as true in Saudi Arabia, where each city and region has its own demand drivers. In this section we detail the major cities in the Kingdom and their characteristics.
RIYADH The city is one of the largest urban areas in the world. It has a population of 4.6 million, which is growing at 4.2% a year, according to the High Commission for the Development of Arriyadh. The infrastructure in place is good, but not great, with a decent road system that is not overloaded. Northern expansion is mainly middle-income developments, while southern expansion inclines towards lower-income or lower middle-income. This is evidenced by Dar Al-Arkan's higher-end development, Shams Alriyadh, in the north and its lower-end project, Al Qasr, in the south. Apartments are limited (about 35% of total housing units), and demand for villas is much stronger. Per capita income in Riyadh is higher than in other cities.
Riyadh is a very large city, with an urban area of 1,000 square kilometers, and the city has historically grown out rather than up. The main characteristics of Riyadh’s housing market are: i) a young and growing population, ii) villas rather than apartments, with just 30% of residents living in apartments, iii) a very low homeownership percentage at just 35%, iv) limited financing available or utilised, and v) a fragmented real estate market, with a high percentage of people building their own house.
DEMOGRAPHICS In Riyadh province, 65% of the population is under the age of 30. Population growth is above 4% a year, meaning that its population should double every 18 years if this rate is maintained. The migration rate is 1.2% a year, according to HCDR, as Saudis and non-Saudis come to the city for work.
Figure 57: Riyadh Province Population by Age Figure 58: Riyadh Province Population by Bracket (2007) Nationality (2007)
Less Than 1 to 19 20 to 39 40 to 59 60+ Saudi Non-Saudi
18% 3% 31% 40%
69% 39%
Source: Central Department of Statistics and Information Source: Central Department of Statistics and Information
There are about 750,000 residential units in Riyadh, but only about 30% of these are apartments. The vast majority of apartment-dwellers are renters, while the majority of villa-dwellers are owners.
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FERTILE GROUND FOR REAL ESTATE DEVELOPERS 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
Figure 59: Types of Housing In Riyadh Province By Type of Tenure (2007)*
Owned Rented Other Provided by Employer
250,000 200,000 150,000 100,000 50,000 0 Apartment Villa A Floor in a Traditional Other A Floor in a Villa house Traditional House
*Includes statistics for Saudi households only Source: Central Department of Statistics and Information
FINANCING More than 50% of homes are financed through personal sources, while another 40% of financing is from loans from the Real Estate Development Fund (REDF). Only 6% of homes are financed through loans from institutions.
Figure 60: Types of Financing Used for Home Purchase (2004)
Personal Finances Loan from REDF Loan from Institution Other/Don't Know
2% 6%
51% 41%
Note: REDF = Real Estate Development Fund Source: High Commission for the Development of Arriyadh
DEMAND Using similar assumptions as for our Kingdom-wide forecasts, we believe total demand in Riyadh will average 31,750 per year. Real estate is a cyclical business, and we expect actual demand will fluctuate from year to year. This number is built up from an annual expectation of 18,000 new marriages in the city, 6,250 new units needed from changes in household size, and 7,500 in replacement demand. Riyadh's demand is 20% of total demand in the Kingdom, roughly in line with the percentage of the population.
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Figure 61: Annual Housing Demand in Riyadh
Reason of Acquisition Units From new marriages 18,000 From change in hh size 6,250 Replacement demand 7,500 Total demand 31,750 % of Total in KSA 20% 8th Development Plan 44,000 Source: Ministry of Economy and Planning, EFG-Hermes estimates
JEDDAH Jeddah is Saudi Arabia’s second largest city with a population of more than three million. It is strategically located on the Red Sea and is the gateway for pilgrims journeying to the holy cities of Mecca and Medina. The city has spread out from its central core, which was originally just 1 kilometre across 60 years ago with about 30,000 people, to 51 kilometres across north to south. This north-south expansion will be accentuated by the construction of the King Abdullah Economic City, which is about 90 km north of Jeddah.
Jeddah is similar to Riyadh in many ways, in that it has a young and growing population with a similar mix of Saudis and non-Saudis. The real estate market is slightly less fragmented than in Riyadh, mainly because of large urban renewal projects. In contrast to Riyadh, the finance capital of the Kingdom, Jeddah is a trading and (religious) tourism centre, given its historical role as a port and initial entry point for pilgrims. Jeddah’s apartment to villa split is almost the reverse of Riyadh, with apartments representing 65% of residential homes. Finally, infrastructure in Jeddah is poor, which we believe necessitates greater expenditure by developers than in Riyadh.
Note, many of the demographic statistics are for the Mecca province, of which Jeddah is the largest city.
Major characteristics of the Jeddah real estate market are: i) a young and growing population, ii) a large percentage of apartment dwellers at 65%, although villas are still the homeowners dream, iii) low percentage of home ownership at just 39% (for Mecca province), iv) poor infrastructure that puts a greater burden on developers (only 20% of the population is connected to the water mains), and v) three major urban regeneration projects in central Jeddah.
DEMOGRAPHICS 66% of Jeddah’s population of 3.4 million is under the age of 30. About 35% of the total population is non-Saudi, a higher percentage than in any other city, probably due to the high number of pilgrims that come through the province.
Figure 62: Mecca Province population by age Figure 63: Mecca Province population by bracket (2007) nationality (2007)
Less Than 1 to 19 20 to 39 40 to 59 60+ Saudi Non-Saudi
5% 18% 40% 38%
62% 37%
Source: Central Department of Statistics and Information Source: Central Department of Statistics and Information
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Apartments are more common in Jeddah than in other parts of the Kingdom. For the Mecca province as a whole, 44% of households are in apartments while the figure in Jeddah is closer to 60-65%. However, we believe villas are still in high demand in Jeddah itself, since they are seen as a symbol of upward mobility.
Figure 64: Types Of Housing In Mecca Province By Type Of Tenure (2007)*
Owned Rented Provided by Employer Other
250,000 200,000 150,000 100,000 50,000 0 Apartment Villa A Floor in a Traditional A Floor in a Other Villa house Traditional House
*Includes statistics for Saudi households only Source: Central Department of Statistics and Information
DEMAND AND SUPPLY (MAJOR DEVELOPERS AND PROJECTS) We forecast annual demand of 21,250 units in Jeddah. This represents 13% of total demand in the Kingdom. We assume new marriages will result in 9,000 new units, 6,250 units will be needed from changes in household size, and 6,000 units in replacement demand.
Figure 65: Annual Housing Demand in Jeddah
Reason of Acquisition Units From new marriages 9,000 From change in hh size 6,250 Replacement demand 6,000 Total demand 21,250 % of Total in KSA 13% 8th Development Plan 28,680 Note: We assume that 60% of demand in Mecca Province is attributable to Jeddah Source: Ministry of Economy and Planning, EFG-Hermes estimates
Jeddah has seen a great deal of real estate project announcements over the past three years as a large number of developers outside of Saudi Arabia have entered the market. There are also three major urban renewal projects that, if successful, will change the face of central Jeddah. Other major developments include: Emaar’s Jeddah Gate with Oula; Kingdom Holding’s Kingdom Tower; and Dar Al-Arkan’s Shams Al-Arous. We provide more details on major projects in Jeddah in Appendix II.
Urban Regeneration Projects The Jeddah municipality, through the Jeddah Urban Development Company, has designated three large areas in central Jeddah for redevelopment. The municipality is a partner in all three of these projects, and it will provide the companies with the land and will work to resolve any property and title issues with the current landowners. For homes that will be demolished, homeowners will be compensated, according to the size and location of the property.
The three projects are modelled on the successful redevelopment of the Solidere area in central Beirut. iv) Al Khozam Palace, a 3.72 million sqm district, is being developed by Dar Al-Arkan. v) Jeddah Central District, a 6.0 million sqm area to be master-planned by Solidere and developed by Construction Development Company Ltd. (Saudi Arabia), Siraj Capital (Saudi Arabia), Commercial Real
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Estate Company (Kuwait) and Venture Capital Bank (Bahrain). The municipality-owned Jeddah Urban Development Company is also a partner.
vi) Ruwais District, a 1.8 million sqm neighbourhood in Jeddah surrounded by Al Andalus Road from the west, Medina Road from the east, Kind Abdullah Road from the south and Palestine street from the north. The area is disorganised and its redevelopment plans assume a buyout of existing land and properties in the form of a share swap, similar to the redevelopment plans for the Jabel Omar area in Mecca. Existing properties will be cleared to make space for new infrastructure, residential and commercial buildings. Construction at the development is expected to start in 2009, with the work undertaken by Al-Ruwais Union Company for Real Estate Development.
MECCA The real estate market in Mecca is characterised by the high number of religious tourists it receives every year. The city has a permanent population of 1.7 million, and it receives more than 3 million in religious pilgrims each year. During the Hajj period, hotel and furnished apartments run at close to 100% occupancy. Note that we do not have specific demographic data on the city of Mecca. Information on the province of Mecca is included above in the section on Jeddah.
RELIGIOUS TOURISM Mecca has a population of around 1.7 million. Religious tourism is the key industry in the city of Mecca, which hosts Masjid Al Haram (the Grand Mosque) - Islam's holiest site visited by millions of pilgrims from all over the world. Hajj, the Islamic pilgrimage to Mecca that takes place once every year, is one of the pillars of Islam and must be performed by every adult Muslim at least once in a lifetime. Currently, the Hajj season attracts as many as 3 million pilgrims to Mecca each year. The local authorities are planning to extend the capacity of the Grand Mosque, to allow it to accommodate more than double in the next ten years. Aside from obligatory Hajj, Islam encourages its followers to perform Umrah, or the lesser pilgrimage, which attracts over 6 million additional pilgrims annually to Mecca and Medina.
Despite its religious significance and long history, the central areas of Mecca are relatively poorly developed and do not provide sufficient infrastructure for the growing pilgrimage traffic. A number of initiatives are therefore being undertaken to improve accommodation and communication facilities in the city. Five mega projects are currently being developed in Mecca, including that of Jebel Omar, which involves the redevelopment of the central areas of Mecca in the direct neighbourhood of the Grand Mosque.
DEMAND We estimate Meccans will demand 16,000 new units each year, or about 10% of the total demand of the Kingdom. We assume demand for 7,000 units will come from new marriages, 5,000 from changes in household size and 4,000 from replacement demand.
Figure 66: Annual Housing Demand in Mecca
Reason of Acquisition Units From new marriages 7,000 From change in hh size 5,000 Replacement demand 4,000 Total demand 16,000 % of Total in KSA 10% 8th Development Plan 19,120 Note: We assume that 35% of demand in Mecca Province is attributable to the city of Mecca Source: Ministry of Economy and Planning, EFG-Hermes estimates
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MEDINA Like Mecca, Medina is also a religious pilgrimage site, with more than half a million religious tourists each year and a permanent population of 1.3 million. The government is building the Knowledge Economic City north of Medina that will have 30,000 residential units, offices, a retail area with 1,200 shops and a theme park.
Medina is the second holiest site in Islam. Like Mecca, it is a site of pilgrimage for Umrah and half a million foreign visitors each year. It is about 200 miles from Mecca and has a population of 1.3 million.
DEMOGRAPHICS Similar to the rest of the Kingdom, about 43% of the population of the province of Medina is under the age of 20, and another 16% are between 20 and 29 years old. It’s percentage of non-Saudis, at 25%, is relatively low, which may be due to non-Muslims not being allowed to set foot in Medina.
Figure 67: Medina Population By Age Bracket Figure 68: Medina Population By Nationality (2007) (2007)
Less Than 1 to 19 20 to 39 40 to 59 60+ Saudi Non-Saudi
5% 17% 25% 43%
35% 75%
Source: Central Department of Statistics and Information Source: Central Department of Statistics and Information
The majority of people in the province live in apartments, followed by traditional houses. Just 7% live in villas, the lowest percentage for any province.
Figure 69: Types of Housing in Medina Province by Type of Tenure (2007) In units, unless otherwise stated
Owned Rented Provided by Employer Other
60,000 50,000 40,000 30,000 20,000 10,000 0 Apartment Villa A Floor in a Traditional A Floor in a Other Villa house Traditional House
*Includes statistics for Saudi households only Source: Central Department of Statistics and Information
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DEMAND We estimate total demand in Medina is 14,000 units per year, with 7,000 from marriages, 5,000 from changes in household size and 2,000 in replacement demand. This is 9% of the total demand in Saudi Arabia.
Figure 70: Annual Housing Demand in Medina
Reason of Acquisition Units From new marriages 7,000 From change in hh size 5,000 Replacement demand 2,000 Total demand 14,000 % of Total in KSA 9% 8th Development Plan 11800 Source: Ministry of Economy and Planning, EFG-Hermes estimates
EASTERN PROVINCE Three cities in the Eastern Province, Ad Damman, Khobar and Dhahran, represent one large conurbation with a population of over one million. Business in the Eastern Province is mainly oil, with both SABIC and Aramco having large plants located here. It is also very close to Bahrain, and it receives visitors from there.
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FERTILE GROUND FOR REAL ESTATE DEVELOPERS 19 october 2009 SAUDI ARABIA REAL ESTATE SECTOR
APPENDIX I – MAJOR PROJECTS IN RIYADH
Project name Developer Area Investment Construction Comment (mn m2 ) cost (bn) End Al Wasl Dubai-based Limitless 14.1 SAR45 2015e Mega mixed-use project featuring 55,000 residential units (villas, townhouses and apartments), seven five star hotels, offices, and shopping malls. Durrat Al Riyadh Dallah Albaraka 3.2 SAR3 Mixed-use project, including a five star hotel. The project was launched in March 2007. Sales started in April 2007. Ajmakan project Partnership between Saudi-based Al Shoula 1.7 SAR6 4Q2013e Mega mixed-use with residential, commercial Holding Group, UAE-based Taameer and hotel space. Holding and the Land Company for Property Development and Investment. Shams Alriyadh Dar Al-Arkan 5.0 2011e The project features residential and commercial units. Al Qasr Project Dar Al-Arkan 0.8 The project features residential and commercial units. King Abdullah Rayadah Investment Company 1.6 SAR36 Tendered for infrastructure June 2009. Financial District Information Rayadah Investment Company 0.5 SAR6.2 2Q2013e Technology & Communication Complex Al Gamra Project Al Injaz for Real Estate Development 2.5 Injaz is currently finalising the project details Company including the development plans, the timeline for sales and delivery of the plots. Rawabi Rumah Al-Shoala Group of Establishment 31 SAR27 Luxury villas, retail centres and commercial billion space. Integrated community with educational institutions, hospitals and hotels. (Al Malka) Tameer Holding 2.2 N/A Will provide 14,000 units (apartments, villas and townhouses) Source: Media reports, company disclosure, and EFG-Hermes estimates
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APPENDIX II – MAJOR PROJECTS IN JEDDAH
Project name Developer Area Investment Construction Comment (mn m2 ) cost End Jeddah Central Solidere and Jeddah Urban District Development Company Al Jawharah Damac 3.0 SAR800 2010e/2011e Damac received a licence to start infrastructure work in million February 2009. Infrastructure work is expcted to start in March 2009. Jeddah Gate Emaar Properties 0.11 SAR6 2011e (P1) 230,000 sq m of commercial space and 75,000 sqm of billion gross area for retailers. Khuzam Palace Dar Al-Arkan and Jeddah Urban 3.7 SAR580 2014e Development Company million Dubai-Jeddah Sama Dubai and Al Shaullah SAR7.23 2012e Towers billion Kingdom City Kingdom Holding 7.1 SAR100 23 million sqm of BUA. Kingdom Tower is located within billion Kingdom City. Andalusia Kinan International Company SAR143 268,000 square meters of BUA. Square Towers (Real Estate arm of Savola million Group) Lamar Towers CAYAN and Zahran Real Estate SAR2 2010e/2011e Two residential towers, offices and a mall. Investment billion Al Mutlaq Al Mutlaq Group SAR800 Business Avenue million New Rayadah Saudi Rayadah Investment 2.6 Master plan is currently with Municipality andwaiting for Project Company approval, will then tender infrastructure (August 2009). Source: Media reports, company disclosure, and EFG-Hermes estimates
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DISCLOSURES We, Jan Pawel Hasman and Patrick Gaffney, hereby certify that the views expressed in this document accurately reflect our personal views about the securities and companies that are the subject of this report. We also certify that neither we nor our spouse[s] or dependants (if relevant) hold a beneficial interest in the securities that are traded in the Tadawul stock exchange. EFG-Hermes Holding SAE hereby certifies that neither it nor any of its subsidiaries owns any of the securities that are the subject of this report.
Funds managed by EFG-Hermes Holding SAE and its subsidiaries (together and separately, "EFG-Hermes") for third parties may own the securities that are the subject of this report. EFG-Hermes may own shares in one or more of the aforementioned funds or in funds managed by third parties. The authors of this report may own shares in funds open to the public that invest in the securities mentioned in this report as part of a diversified portfolio over which they have no discretion. The Investment Banking division of EFG-Hermes may be in the process of soliciting or executing fee earning mandates for companies that are either the subject of this report or are mentioned in this report..
DISCLAIMER This Research has been sent to you as a client of one of the entities in the EFG-Hermes group. This Research must not be considered as advice nor be acted upon by you unless you have considered it in conjunction with additional advice from an EFG-Hermes entity with which you have a client agreement.
Our investment recommendations take into account both risk and expected return. We base our long-term fair value estimate on a fundamental analysis of the company's future prospects, after having taken perceived risk into consideration. We have conducted extensive research to arrive at our investment recommendations and fair value estimates for the company or companies mentioned in this report. Although the information in this report has been obtained from sources that EFG-Hermes believes to be reliable, we have not independently verified such information and it may not be accurate or complete. EFG-Hermes does not represent or warrant, either expressly or implied, the accuracy or completeness of the information or opinions contained within this report and no liability whatsoever is accepted by EFG-Hermes or any other person for any loss howsoever arising, directly or indirectly, from any use of such information or opinions or otherwise arising in connection therewith. Readers should understand that financial projections, fair value estimates and statements regarding future prospects may not be realized. All opinions and estimates included in this report constitute our judgment as of this date and are subject to change without notice. This research report is prepared for general circulation to the clients of EFG-Hermes and is intended for general information purposes only. It is not intended as an offer or solicitation or advice with respect to the purchase or sale of any security. It is not tailored to the specific investment objectives, financial situation or needs of any specific person that may receive this report. We strongly advise potential investors to seek financial guidance when determining whether an investment is appropriate to their needs.
GUIDE TO ANALYSIS EFG-Hermes investment research is based on fundamental analysis of companies and stocks, the sectors that they are exposed to, as well as the country and regional economic environment. Two investment ratings are offered for each stock, a Short-Term rating and a Long-term rating.
The Short-Term (ST) rating is based on the analyst’s best expectations on the shorter-term price movements of the stock. Short-Term is defined as any time up to six months of the rating being applied to the stock. While shorter-term drivers could include quantifiable facts and figures, the analyst may also consider non- quantifiable issues such as the analyst’s view on investor sentiment, potential news flow on the stock or the sector, or other issues which could impact share price movements.
The Long-Term (LT) rating is based on the percentage upside or percentage downside of the stock price to the analyst’s Long Term Fair Value (LTFV). Long Term is defined as any time period beyond 1 year. The LTFV is based on the analyst’s current expectations of the equity fair value of the company on a per share basis which is normally based on rigorous and fundamental long-term analysis of the company’s financial potential. Of course, any such analysis is based on the analyst’s expectations for the future and are always considered estimates.
For both the Short-Term and Long-Term ratings for any investment covered in our research, the ratings are defined by the following ranges in percentage terms:
Rating % upside (downside) Buy 25% and above Accumulate 10 to 25% Neutral (10%) to 10% Reduce (10%) to (25%) Sell (25%) or more downside
EFG-Hermes policy is to update research reports when appropriate based on material changes in a company’s financial performance, the sector outlook, the general economic outlook, or any other changes which could impact the analyst’s outlook or rating for the company. Share price volatility may cause a stock to move outside of the longer-term rating range to which the original rating was applied. In such cases, the analyst will not necessarily need to adjust the rating for the stock immediately. However, if a stock has been outside of its longer-term investment rating range consistently for 30 days or more, the analyst will be encouraged to review the rating.
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CONTACTS AND STATEMENTS Background research prepared by EFG-Hermes Holding SAE. Report prepared by EFG-Hermes Holding SAE (main office), 58 Tahrir Street, Dokki, Egypt 12311, Tel +20 2 33 32 1140 | Fax +20 2 33 36 1536 which has an issued capital of EGP 1,939,320,000.
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