Middle East Real Estate, Construction and Building Materials
17 November 2009 Coverage Change
Company Company MENA Construction & Infra Top picks Arabtec Holding (ARTC.DU),AED3.24 Buy Drake & Scull (DSI.DU),AED1.04 Buy Paving way for growth Companies featured Arabtec Holding (ARTC.DU),AED3.24 Buy 2008A 2009E 2010E Nabil Ahmed Athmane Benzerroug DB EPS (AED) 0.80 0.57 0.54 P/E (x) 7.6 5.7 5.9 Research Analyst Research Analyst EV/EBITDA (x) 4.5 3.7 3.3 (+971) 4 4283-862 (+971) 4 4283938 Drake & Scull (DSI.DU),AED1.04 Buy [email protected] [email protected] 2008A 2009E 2010E DB EPS (AED) 0.08 0.15 0.11 We initiate coverage on three MENA contractors – Buy Arabtec and DSI P/E (x) – 7.0 9.6 EV/EBITDA (x) – 4.0 4.1 We believe the MENA region offers solid growth prospects to contractors that can Orascom Construction (OCIC.CA),EGP239.40 Hold tap the infrastructure markets. Valuations of MENA contractors are inexpensive 2008A 2009E 2010E relative to EM and global peers. Our top picks are Arabtec and Drake & Scull, both DB EPS (EGP) 20.97 9.28 13.20 of which combine deep value, declining risks and an attractive diversification story. P/E (x) 18.2 25.8 18.1 EV/EBITDA (x) 16.6 14.3 10.9 Orascom Construction is a high-quality play on infrastructure and fertilizers, in our view, but the prospects appear priced in.
Global Markets Research MENA construction set for a rebound next year We believe the MENA construction industry has reached a turning point. After a 42% y-o-y fall in new awards (Dubai alone accounted for 60% of the decline), our analysis suggests that the MENA backlog has stabilized since June 2009. Several projects have been re-tendered lately, indicating that the prevailing “wait-and-see” attitude to benefit from the decline in construction costs (down 30-40% from peak) comes to an end. With project financing gradually back on track and the likely rebound in GDP growth next year, we expect 20% CAGR over 2009-12E for construction awards, and we view the industry as offering an USD280bn opportunity to civil contractors over the next three years. The long-term case for investment in MENA infrastructure remains solid Despite the collapse in regional real estate markets and in the Dubai construction industry in particular, we believe the long-term outlook for MENA infrastructure remains appealing. The region displays relatively unique characteristics, in our view: above-average population growth, historical underinvestment, strong state budget surpluses accumulated thanks to high oil prices, and governments’ will to diversify economies. We have identified Saudi Arabia and North African countries as the most attractive markets. Investors overestimating risks and neglecting mid-term potential Our coverage universe has a bias towards Dubai-based companies, which need to diversify their revenue bases to new MENA locations. This transition will take time to materialize into earnings growth. We nevertheless believe investors tend to overestimate the risks and neglect the mid-term growth potential. Our analysis suggests that stock prices of the MENA contractors and real estate developers remain highly correlated (factor of 0.95x), which we believe is increasingly unjustified, given the shift of contractors’ focus to other segments of the industry. We find good value in MENA contractors; top picks are Arabtec and DSI MENA contractors trade on 2010E P/E of 9.5x vs. for global and EM peers at respectively 15.2x and 14.6x and the risk/return combination appears attractive in our view. We initiate Arabtec and Drake & Scull as Buys, as we believe each stock combines deep value, overstated risks and an appealing transformation story over the next three years. Orascom Construction is a high-quality construction/fertilizer company, but trades at fair value, which underpins our Hold. MENA contractors are exposed to regional economic conditions, building and infrastructure spending, and availability of project financing. Project delays or cancellations and failure to recover receivables could materially affect our earnings and valuation.
Deutsche Bank AG/London All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Independent, third-party research (IR) on certain companies covered by DBSI's research is available to customers of DBSI in the United States at no cost. Customers can access IR at http://gm.db.com/IndependentResearch or by calling 1-877-208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE
LOCATED IN APPENDIX 1. MICA(P) 106/05/2009 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Table of Contents Executive Summary...... 3 Sector outlook...... 3 Valuation ...... 3 Risks ...... 3 Investment strategy ...... 4 MENA contractors have performed in line with global peers ...... 4 MENA contractors appear attractive on a global basis ...... 5 De-correlation factor to real estate has not played its role yet...... 9 Top down: play diversification stories and de-risking...... 10 Valuation: Arabtec the cheapest, OCI the most expensive...... 11 Bottom up: Buy Arabtec and Drake and Scull and Hold Orascom Construction Industries ....12 Key themes...... 14 Capturing the MENA infrastructures opportunity...... 14 MENA contractors’ margins should remain above global peers ...... 17 Working capital is expected to progressively improve...... 18 Secular growth drivers...... 21 Above-average population growth creates a strong case for infrastructure investments...... 21 Making up for the underinvestment in the yesteryears ...... 21 Planned diversification shows the intentions… ...... 22 …while higher oil prices have created the means ...... 22 Infrastructure spending is a way to support the economy in the current crisis ...... 23 GCC has one of the highest electricity consumption rates ...... 24 GCC has one of the lowest per capita availability of natural renewable water...... 25 Residential construction: opportunities remain immense...... 26 Significant investments in transport infrastructure...... 27 MENA construction industry likely to pick up again...... 29 Introduction to the MENA construction industry ...... 29 MENA project backlog stabilizing ...... 30 New orders declined 42% year-on-year, mainly due to Dubai...... 32 Cautious optimism returns to the project financing market ...... 33 New order growth of 20% projected in the next three years ...... 34 Company Profiles...... 36 Arabtec Holding...... 37 Drake & Scull ...... 59 Orascom Construction ...... 79 Appendixes ...... 102 Appendix A: country-specific opportunities ...... 103 Appendix B: The case for fertilizers ...... 120 Appendix C: Fertilizer primer ...... 132 Appendix D: Nitrogen market ...... 139
Page 2 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Executive Summary
Sector outlook Despite the collapse in regional real estate markets and in the Dubai construction industry in particular this year, we believe the long-term outlook for MENA infrastructure remains appealing. The region displays relatively unique characteristics, in our view: strong population growth, historical underinvestment in infrastructure and housing, strong state budget surpluses accumulated with high oil prices, and governments’ will to diversify economies. Most MENA countries have undertaken massive investment plans and this will pave way for growth.
According to MEED and Deutsche Bank estimates, construction awards have fallen 42% year-on-year (Dubai alone accounted for 60% of the decline), and the MENA backlog has shrunk 23% since its peak. However, we estimate the industry is set for a rebound next year. Several projects have been re-tendered lately, indicating that the prevailing “wait-and-see” attitude to benefit from the decline in construction costs (down 30-40% from peak) might come to an end. With project financing gradually back on track and the likely rebound in GDP growth next year, we expect 20% CAGR over 2009-12E for new construction awards and have identified Saudi Arabia and the North African markets as displaying the most attractive prospects. In total, we view the industry as offering an USD280bn opportunity for civil contractors over the next three years.
Our coverage universe has a bias towards Dubai-based companies, which need to diversify their revenue bases in new MENA locations. This means that the transition will take time to materialize into revenue growth and that margins are likely to decline, once the lucrative Dubai contracts are exhausted. Besides, working capital management remains an issue for MENA contractors. Nevertheless, we believe investors tend to overestimate the risks and neglect the massive mid-term growth potential. Our analysis suggests that stock prices of the MENA contractors and developers’ remain highly correlated (factor of 0.95x), which we believe is increasingly unjustified, given the shift from contractors’ to other end-markets.
We initiate coverage of Arabtec and Drake & Scull as Buys, as we believe the stocks combine deep value, overstated risks, and appealing transformation stories in the next three years. Orascom Construction Industries is a high-quality construction/fertilizer company but trades at fair value, which justifies our Hold.
Valuation MENA contractors trade at a discount to global and emerging markets peers: P/E 2010E works out at 9.5x vs. 15.2x and 14.6x respectively and EV/EBITDA at 4.6x vs. 7.4x and 7.1x respectively. We therefore believe the risk/return combination is attractive.
We use DCF to value contractors, applying some company-specific assumptions (see individual company sections). We cross-check our valuation by looking at peers’ multiples.
Risks MENA contractors are exposed to regional economic conditions, building and infrastructure spending, and availability of project financing. Project delays or cancellations and failure to recover receivables could significantly affect our earnings and valuation. Besides, the MENA region is highly exposed to oil prices, which drive public spending, and to real estate markets, which account for 40% of the construction industry.
Deutsche Bank AG/London Page 3 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Investment strategy
MENA contractors have performed in line with global peers MENA contractors’ stock prices have overall rebounded since the beginning of the year, in line with the overall market rally. The recent pullback in the stock markets seems to have affected the region more than others. Looking at performances over one year, MENA contractors have been slightly underperforming global peers; YTD MENA is actually the fourth worst performer in our universe behind South Africa, Emerging Europe and China.
Figure 1: Global contractors’ stock performances over Figure 2: Global contractors’ stock performances over one and three months (DB coverage universe) six months and one year (DB coverage universe)
-9.1 MENA MENA +40.2 +19.2 +47.0 +0.0 +70.8 Turkey +16.6 Turkey +56.9 -3.5 +19.0 South Africa +12.5 South Africa +21.8 -2.6 -0.3 -9.2 China China +13.2 -6.0 +64.7 -11.2 Emerging Asia Emerging Asia +71.0 -6.0 +27.6 Emerging Europe +2.8 Emerging Europe +8.0 +3.2 +41.8 Europe +21.2 Europe +61.7 -2.6 Australia Australia +92.2 +16.7 +79.0 -7.6 Japan Japan +30.3 -3.1 +44.4 -2.8 +44.7 Global +8.0 Global +44.6
-15.0 -10.0 -5.0 +0.0 +5.0 +10.0 +15.0 +20.0 +25.0 -20.0 +0.0 +20.0 +40.0 +60.0 +80.0 +100.0 1 month 3 months YTD 1 year
Source: Deutsche Bank Source: Deutsche Bank
Even if the sudden collapse in Dubai’s construction industry has hit many regional contractors, we believe that the worse is behind and that outlook for MENA construction remains attractive, if not better than in other emerging markets.
In terms of individual stocks, Orascom Construction has been the best performer by far (+73% year to date), impressively outperforming Arabtec (+45% year to date) and Drake & Scull (+2% since its IPO in March).
Figure 3: MENA contractors’ stock performances over Figure 4: MENA contractors’ stock performances over one and three months (DB coverage universe) six months and one year (DB coverage universe)
-10.6 +45.1 Arabtec Arabtec +26.6 +96.4
-14.0 +2.0 Drake & Scull Drake & Scull +16.9 +2.0 -2.7 Orascom Orascom +73.4 Construction +14.0 Construction +42.5
-2.8 +44.7 Global contractors Global contractors +8.0 +44.6
-1.8 +20.5 MENA Fertilizers MENA Fertilizers +4.6 +16.5 +5.3 +73.2 Global Fertilizers Global Fertilizers +9.8 +17.4
-20.0 -15.0 -10.0 -5.0 +0.0 +5.0 +10.0 +15.0 +20.0 +25.0 +30.0 +0.0 +20.0 +40.0 +60.0 +80.0 +100.0 +120.0 1 month 3 months YTD 1 year
Source: Deutsche Bank Source: Deutsche Bank
Page 4 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
We believe this reflects Orascom’s more resilient profile with its very limited presence in Dubai (4% of the restated backlog vs. 51% for Arabtec and 55% for Drake & Scull) and its stronger exposure to the infrastructure segment (63% of the backlog vs. 7% for Arabtec and 19% for Drake & Scull).
We also believe that the hybrid nature of its assets (exposure to the fertilizer business) make it difficult to compare Orascom with pure MENA contractors. Nevertheless, the stock has outperformed both its contractors and fertilizers peers, suggesting that the discount to the sum-of-the-parts has significantly narrowed in the last six months.
Figure 5: Orascom Construction stock price vs. other Figure 6: Orascom Construction stock price vs. other MENA contractors* MENA fertilizer companies*
200 200.0
175 175.0
150 150.0
125 125.0
100 100.0
75 75.0
50 50.0 Jul-09 Jul-09 Apr-09 Oct-09 Jan-09 Jun-09 Jan-09 Mar-09 Mar-09 Feb-09 Sep-09 Aug-09 Sep-09 May-09 May-09
Other MENA Contractor Performance OCI Performance Other MENA Fertilizer OCI Performance
Source: Deutsche Bank, Bloomberg. * Equal weight index include Arabtec, Drake & Scull, Galfar Enfineering Source: Deutsche Bank, Bloomberg* Equal weight index include Arab Potach, Jordan Phosphate, Ma’aden and Mohammad Al Mojil Group and SAFCO
MENA contractors appear attractive on a global basis We have attempted to put MENA contractors’ valuation into a wider context and have leveraged the Deutsche Bank global coverage universe, which is wide in terms of regions and broad in terms of segments. In our sample, we have only included pure contractors or conglomerates in which the contracting division is a significant part of the valuation. Our sample includes 33 companies with a combined market cap of c.USD127bn, of which 68% is within the emerging market space (China alone is 41%).
Figure 7: Breakdown of contractors’ market cap’ by Figure 8: P/E 2010E for contractors by region (Deutsche region (Deutsche Bank coverage universe)-Nov 2009 Bank coverage universe)
25.0 Japan MENA 5% Australia 9% 20.8 10% Turkey 20.0 7% 16.3 16.7 15.4 15.3 15.5 14.6 15.2 South Africa 15.0 13.7 4%
Europe 9.5 10.0 8.3 16%
5.0
Emerging Europe 5% - Emerging Asia 3% China China Japan Global MENA Turkey Asia 41% Europe Markets Emering Europe Australia Emerging Emerging South Africa
Source: Deutsche Bank Source: Deutsche Bank. Note that Orascom Construction’s multiples are restated from the fertilizer business.
We note that differences in segment mix, business models, and local outlook make global comparisons difficult and sometimes irrelevant. However, under most metrics, MENA contractors appear to be highly discounted vs. global or emerging markets peers.
Deutsche Bank AG/London Page 5 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
MENA contractors display the highest margins in our global coverage universe. Although we see a case for slight margins contraction in the next few years, we do not believe it explains the discount vs. global peers, as suggested by relatively similar EV/ revenues ratios.
Figure 9: EBITDA margin 2010E Figure 10: EV/Revenues 2010E
120% 109% MENA 15.4%
Emerging Asia 14.7% 100%
Turkey 12.1% 80% 75% 71% 72% 70% South Africa 9.8% 65%
Emering Markets 9.1% 60% 52% 48% Global 8.2% 43% 40% 32% 33% Australia 8.0%
Europe 7.1% 20% Emerging Europe 7.1% 0% China 5.2%
Japan 5.1% China Japan Global MENA Turkey Asia Europe Markets Emering Europe Australia 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% Emerging Emerging South Africa Source: Deutsche Bank, Bloomberg consensus for Galfar and MMG. Source: Deutsche Bank, Bloomberg consensus. We exclude non construction businesses for OCI.
For the sake of comparison in the case of Orascom Construction Industries, we have also included multiples of MENA and global fertilizer companies covered by Deutsche Bank.
Figure 11: Summary of contractors / fertilizers valuation multiples by main regions (as of 16 November 2009) Mkt Cap P/E EV/EBITDA EV/EBITA Div yield % EBITDA margin USD m 2009E 2010E 2009E 2010E 2009E 2010E 2009E 2010E 2009E 2010E Contractors
MENA 10,927 11.1 11.1 7.2 6.4 9.1 8.2 0.8 0.8 16.5 15.5 Turkey 9,377 19.7 16.3 7.9 6.2 13.1 10.4 0.1 0.2 10.8 12.1 South Africa 5,431 9.0 8.3 4.0 3.2 5.2 4.5 3.1 3.2 9.7 9.8 China 50,731 18.2 13.7 8.2 6.4 11.9 9.1 1.4 1.8 5.2 5.2 Emerging Asia 3,548 27.0 20.8 23.9 15.9 26.6 17.5 3.2 2.3 12.0 14.7 Emerging Europe 6,360 15.4 15.4 7.1 6.7 10.4 10.5 1.1 1.0 7.2 7.1 Emerging Markets 75,406 17.0 14.6 9.0 7.1 12.2 9.9 1.6 1.6 8.6 9.2 Europe 20,574 16.6 15.3 6.4 5.9 10.9 9.3 3.0 3.2 6.9 7.3 Australia 13,072 12.7 16.7 6.8 8.9 9.8 12.5 4.9 3.7 7.7 8.0 Japan 6,695 17.3 15.5 4.2 9.6 5.1 27.1 1.5 1.2 6.8 5.1 Global 115,748 16.2 15.2 7.7 7.4 10.9 12.1 2.4 2.2 7.9 8.2 Fertlizers
MENA 17,793 13.7 11.2 10.0 7.9 11.4 8.7 3.8 4.8 49.0 50.2 Global (including MENA) 72,131 22.7 12.2 12.3 7.9 16.2 9.4 2.3 3.3 33.8 36.9 Source: Deutsche Bank
Page 6 Deutsche Bank AG/London
Deutsche Bank AG/London AG/London Deutsche Bank and RealEstate,Construction 2009 17 November Figure 12: Deutsche Bank emerging markets contractors universe (prices as of 16 November 2009) Currency Rating Current Target Mkt Cap P/E EV/EBITDA EV/EBITA Div yield %P/BV EBITDA margin ND/EBITDA Price Price USD m 2009E 2010E 2009E 2010E 2009E 2010E 2009E 2010E 2009E 2010E 2009E 2010E 2009E 2010E MENA ARABTEC HOLDING AED Buy 3.24 4.5 1,055 5.7 5.9 4.0 3.7 5.5 5.1 - - 1.5 1.2 15.2 14.2 0.3 -0.3 DRAKE & SCULL AED Buy 1.04 1.3 616 7.0 9.6 4.1 4.2 4.5 4.8 - - 1.3 1.2 15.3 13.1 -3.2 -4.7 ORASCOM CONSTRUCTION EGP Hold 236 230 9,256 20.7 17.9 13.4 11.3 17.3 14.6 2.3 2.3 2.9 2.6 18.9 19.2 1.6 1.3 Average MENA 10,927 11.1 11.1 7.2 6.4 9.1 8.2 0.8 0.8 1.9 1.7 16.5 15.5 -0.4 -1.2
Turkey ALARKO HOLDING TRY Buy 3.88 5.7 585 11.4 10.4 5.1 4.3 7.7 6.2 - - 1.1 1.0 9.9 9.8 -6.6 -6.1 ENKA INSAAT USD Hold 6.25 5.9 7,589 18.1 18.5 9.3 9.1 11.2 10.9 0.3 0.3 2.0 1.8 14.6 14.4 -0.2 -0.2 TEKFEN HOLDING TRY Buy 4.66 5.8 1,163 29.6 20.1 9.2 5.3 20.3 14.1 - 0.3 1.3 1.1 7.8 12.0 -0.1 0.1 Average Turkey 9,337 19.7 16.3 7.9 6.2 13.1 10.4 0.1 0.2 1.4 1.3 10.8 12.1 -2.3 -2.1
South Africa AVENG ZAR Hold 41.11 33 2,364 9.6 8.8 4.3 3.2 6.2 4.6 2.8 3.1 1.6 1.4 8.9 9.2 -1.7 -1.9 M&R HOLDINGS LTD ZAR Hold 55.2 55 2,206 9.2 8.8 5.3 4.7 6.7 6.6 3.6 3.2 3.0 2.7 10.9 11.2 -0.3 -0.1 Building Materials MENA Construction & Infra MENAConstruction &Infra Building Materials WBHO ZAR Hold 116.23 105 861 8.1 7.4 2.3 1.8 2.7 2.2 2.9 3.2 2.7 2.1 9.4 9.1 -2.7 -2.5 Average South Africa 5,431 9.0 8.3 4.0 3.2 5.2 4.5 3.1 3.2 2.4 2.1 9.7 9.8 -1.6 -1.5
China CHINA COMM. CONSTR. CNY Hold 8.24 9.3 15,762 14.6 12.4 8.7 7.7 11.6 10.0 1.7 2.0 2.3 2.0 7.2 7.2 2.1 2.0 CHINA RAILWAY CONSTR. CNY Buy 10.9 12.4 17,352 20.8 15.4 6.7 5.0 11.4 8.4 1.2 1.6 2.3 2.0 4.0 4.0 -2.7 -2.4 CHINA RAILWAY GROUP CNY Buy 6.41 7.5 17,617 19.3 13.4 9.0 6.5 12.6 8.8 1.3 1.9 2.0 1.8 4.2 4.5 0.4 0.2 Average China 50,731 18.2 13.7 8.2 6.4 11.9 9.1 1.4 1.8 2.2 1.9 5.2 5.2 -0.1 0.0
Emerging Asia GAMUDA MYR Hold 3.1 3.3 1,841 32.2 21.9 37.3 22.0 40.2 23.0 1.9 2.9 2.0 1.9 6.8 11.0 1.6 2.6 IJM CORP MYR Buy 4.64 5.05 1,706 21.8 19.7 10.5 9.8 13.0 12.1 4.4 1.8 1.2 1.1 17.1 18.4 3.6 2.9 Average Emerging Asia 3,548 27.0 20.8 23.9 15.9 26.6 17.5 3.2 2.3 1.6 1.5 12.0 14.7 2.6 2.7
Emerging Europe BUDIMEX PLN Buy 77.7 93 715 13.9 14.3 7.8 7.6 9.0 8.7 3.6 3.5 3.1 2.8 5.7 5.2 -1.3 -1.8 PBG PLN Hold 216 220 1,080 15.2 13.8 9.6 8.8 11.2 10.2 - - 2.3 2.0 12.2 12.4 1.1 0.9 POL-AQUA PLN Sell 19.95 17 198 19.2 19.2 6.0 5.8 10.4 11.5 - - 0.8 0.8 5.9 6.0 -0.2 -0.6 POLIMEX PLN Buy 3.85 5.4 671 13.4 11.7 7.7 6.8 10.3 9.3 - - 1.6 1.4 7.3 7.4 2.0 1.4 STRABAG EUR Buy 21.78 28 3,696 15.6 17.9 4.6 4.5 11.4 12.7 1.8 1.4 0.8 0.8 5.0 4.8 0.1 -0.1 Average Emerging Europe 6,360 15.4 15.4 7.1 6.7 10.4 10.5 1.1 1.0 1.7 1.6 7.2 7.1 0.3 0.0
EM contrators average 75,406 17.0 14.6 9.0 7.1 12.2 9.9 1.6 1.6 1.9 1.7 8.6 9.2 -0.3 -0.4
Source: Deutsche Bank
Page 7 Page
Page 8 8 Page and RealEstate,Construction 2009 17 November Figure 13: Deutsche Bank mature markets contractors and global fertilizers universe (as of 12 November 2009) Currency Rating Current Target Mkt Cap P/E EV/EBITDA EV/EBITA Div yield %P/BV EBITDA margin ND/EBITDA Price Price USD m 2009E 2010E 2009E 2010E 2009E 2010E 2009E 2010E 2009E 2010E 2009E 2010E 2009E 2010E Europe AMEC PLC GBP Buy 801.5 850 4,360 16.9 14.2 6.6 5.3 7.3 5.7 2.1 2.5 2.4 2.2 9.6 10.2 -3.1 -3.1 BAUER AG EUR Hold 29.46 26 751 14.0 13.9 6.6 6.0 12.2 10.9 1.7 1.7 1.3 1.2 12.1 12.5 2.8 2.2 BILFINGER BERGER EUR Hold 51.09 51 2,703 15.8 11.7 4.5 4.4 8.0 6.6 3.9 4.3 1.3 1.5 3.8 4.7 -1.5 -1.2 HOCHTIEF EUR Buy 56.14 67 5,558 21.7 18.6 8.8 7.5 20.2 15.0 2.5 2.7 1.8 1.7 3.9 4.5 0.5 0.2 SKANSKA SEK Buy 118.2 130 7,202 14.5 18.0 5.4 6.3 7.1 8.5 4.7 4.9 2.4 2.3 4.8 4.7 -2.1 -2.4 Average Europe 20,574 16.6 15.3 6.4 5.9 10.9 9.3 3.0 3.2 1.8 1.8 6.9 7.3 -0.7 -0.9
Australia DOWNER EDI AUD Buy 9.07 9.5 1,213 8.7 14.2 4.7 6.9 7.0 10.1 5.7 3.5 1.4 2.1 7.4 7.6 1.1 0.5 LEIGHTON HOLDINGS LTD AUD Buy 38.15 41 6,004 18.1 18.6 6.4 6.8 12.3 12.6 4.1 3.5 3.0 4.5 7.6 9.2 0.4 0.1 TRANSFIELD SERVICES AUD Hold 4.2 3.95 814 11.8 16.8 7.1 9.7 10.7 14.3 4.0 3.3 1.2 2.1 6.6 6.6 1.7 1.4 UNITED GROUP AUD Hold 13.89 13.8 1,208 11.6 15.4 7.0 8.9 8.7 11.1 6.4 4.7 1.5 2.0 5.9 6.2 1.2 1.0 WORLEYPARSONS AUD Buy 27.34 30.65 3,833 13.4 18.5 9.0 12.3 10.4 14.4 4.3 3.4 3.5 3.7 11.2 10.7 0.8 0.5 Average Australia 13,072 12.7 16.7 6.8 8.9 9.8 12.5 4.9 3.7 2.1 2.9 7.7 8.0 1.1 0.7 Building Materials MENA Construction & Infra MENAConstruction &Infra Building Materials
Japan CHIYODA JPY Hold 702 800 1,853 28.7 95.8 6.6 21.5 8.4 72.7 1.0 0.4 0.9 1.2 2.1 0.9 -13.7 -45.9 JGC JPY Buy 1733 1800 4,023 12.8 21.4 4.3 7.0 4.9 8.4 1.9 1.2 1.3 1.9 13.1 9.3 -2.5 -3.6 TOYO ENGINEERING JPY Hold 298 NA 819 10.3 9.5 1.6 0.2 1.9 0.2 1.6 2.0 0.8 0.8 5.3 5.2 -3.2 -4.1 Average Japan 6,695 17.3 15.5 4.2 9.6 5.1 27.1 1.5 1.2 1.0 1.3 6.8 5.1 -6.5 -17.9
Global contractors average 115,748 16.2 15.2 7.7 7.4 10.9 12.1 2.4 2.2 1.8 1.9 7.9 8.2 -0.8 -2.1
Middle East Fertilizers ARAB POTASH COMPANY JOD Sell 33.51 21 3,942 18.9 15.4 14.1 11.4 16.1 12.8 1.9 2.3 3.8 3.3 43.1 42.0 -0.5 -0.9 JPMC JOD Buy 17.15 23.5 1,816 9.3 8.7 5.5 4.8 5.9 5.2 3.8 4.0 2.5 2.1 32.0 31.6 -1.7 -2.2 MA'ADEN SAR Hold 17.85 17 4,403 588.2 195.6 90.8 129.5 196.7 419.0 - - 1.0 1.0 12.6 7.2 51.4 81.8 SAFCO SAR Buy 114.5 149 7,633 13.0 9.4 10.6 7.5 12.1 8.2 5.8 8.0 4.1 3.4 71.9 77.1 -1.0 -1.1 Average Middle East 17,793 13.7 11.2 10.0 7.9 11.4 8.7 3.8 4.8 3.5 2.9 49.0 50.2 -1.1 -1.4
Global ACRON USD Hold 29.25 30 1,395 16.1 8.9 8.7 5.4 10.9 6.7 0.6 1.9 1.3 1.0 15.5 18.8 3.2 2.1 K+S EUR Hold 38.8 33 9,528 48.8 16.6 20.3 9.9 32.8 12.9 0.9 2.7 3.7 3.3 7.1 14.6 2.8 1.3 ISRAEL CHEMICALS USD Hold 49.3 41 16,858 21.0 11.8 13.8 8.1 16.2 8.9 3.0 3.9 6.1 4.9 24.4 34.6 0.6 -0.1 SILVINIT USD Sell 670 500 6,156 13.9 11.5 9.5 7.6 10.4 8.4 1.5 2.2 2.9 2.3 61.1 56.0 -0.4 -0.8
Deutsche Bank AG/London Deutsche Bank URALKALI USD Sell 23.81 20 10,116 31.8 14.4 17.1 9.4 21.2 11.0 0.9 2.1 7.4 5.4 43.7 48.6 0.0 -0.3 YARA INTERNATIONAL ASA NOK Hold 199.6 170 10,285 31.3 13.0 11.1 7.1 19.8 10.2 2.4 2.5 1.9 1.7 5.3 9.0 3.0 1.7 Average Global 72,131 22.7 12.2 12.3 7.9 16.2 9.4 2.3 3.3 3.7 3.0 33.8 36.9 0.7 0.0
Source: Deutsche Bank
17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
De-correlation factor to real estate has not played its role yet Beyond global comparison, we also reviewed MENA contractors’ performances vs. regional real estate developers. Our indexes include the following stocks:
MENA contractors: Arabtec, Drake & Scull, Galfar Engineering, Mohammad Al Mojil Group, and Orascom Construction Industries.
MENA developers: We have included six UAE developers (Emaar Properties, Union Properties, RAK Properties, Aldar Properties, Sorouh Real Estate, Deyaar Development), five Saudi real estate companies (Dar Al Arkan, Emaar The Economic City, Arriyadh Development, Saudi Real Estate, Jabal Omar), two Qatari developers (Barwa Real Estate, Qatar Real Estate), two Kuwaiti (National Real Estate, Mabanee Company), one Lebanese (Solidere), and one Egyptian real estate player (Palm Hills Development). To avoid overweighting giants such as Emaar or Orascom in their respective indexes or a bias towards some specific countries, we use an equal-weight between the index components.
Figure 14: MENA contractor vs. developers’ stock Figure 15: MENA contractor vs. developers’ stock performance (Since January 2008) performance (Since January 2009)
180 160
160 140 140
120 120 100
80 100
60 80 40
20 60 Jul-09 Jul-08 Jan-09 Jan-08 Mar-09 Mar-08 Nov-08 Sep-09 Sep-08 Jul-09 May-09 May-08 Apr-09 Oct-09 Jan-09 Jun-09 Mar-09 Feb-09 Aug-09 Sep-09 May-09 MENA Contractor Index MENA RE Index MENA Contractor Index MENA RE Index
Source: Deutsche Bank, Datastream Source: Deutsche Bank, Datastream
Contractors have slightly underperformed real estate developers since the beginning of the year, although they performed almost in line over a longer period.
Nevertheless, it appears that the performances of contractors and developers are overall highly tied (correlation of 0.95x in the last two years, 0.97x in the last year). We believe this appears increasingly unjustified given:
The ability of contractors to get exposure to much more diverse segments of the construction industry; indeed, they do not participate only in the residential or commercial real estate developments but can also be involved in infrastructures or industrial projects that tend to have a counter-cycle effect.
Contractors also tend to have more broader geographical exposure than mono-country developers and are able to more easily balance the decline of one single market by the ramp-up of some others.
Even within the real estate segment, developers are exposed to property prices, while contractors tend to rely on volumes. Even if both are usually correlated, prices tend to be much more volatile than volumes over the long run.
Contractors are asset-light and the bulk of their costs is the workforce, which allows quick and easier repositioning than developers.
Deutsche Bank AG/London Page 9 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Top down: play diversification stories and de-risking Given the bias of our coverage universe towards Dubai-based contractors, we believe this flexibility will take time to materialize into earnings growth. Out of the five main contractors listed in MENA, only Orascom Construction offers the size, diversity in end-markets, and regional diversification of a true mature regional leader. We believe the company is well positioned to capture the lion’s share of the development in MENA infrastructure. These themes are nevertheless also valid for Arabtec and Drake & Scull, as we believe that both companies are pursuing similar strategies to diversify away from Dubai.
Figure 16: Restated backlog breakdown by geography Figure 17: Restated backlog breakdown by segment
100% 100%
80% 80%
60% 60%
40% 40%
20% 20%
0% 0% ARTC DSI GECS MMG OCI ARTC DSI GECS MMG OCI
Dubai Abu Dhabi Saudi Arabia Qatar Oman Egypt Algeria Others Residential Mixed use Commercial Industrial Infrastructure Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Our top-down investment strategy is based on the following themes:
Given the challenges ahead, we believe investors’ interest should focus on stocks offering deep value. We would rather play a catch-up vs. EM peers rather than buying on similar multiples, given that most MENA contractors under our coverage are currently in a transition period and will not display material earnings’ growth next year.
We would look for players with an increasing exposure to the most attractive locations and end markets. We believe that this will ultimately be the only way to replenish the backlog and ensure that the earnings growth will be back on track.
The risk profile remains a key component of our screening. Nevertheless, with liquidity progressively flowing back into the system and the Deutsche Bank economics team being relatively optimistic for next year, we would rather play higher-beta stocks. More fundamentally, we believe that MENA contractors’ specific risks (contract cancellation, receivables) have materially abated since the end of 2008, and should continue to dominate equity stories in the coming months.
Finally, we believe the ability to play a role in the likely consolidation of the sector could also offer significant development opportunities and accelerate the repositioning in strong markets and segments. Balance sheet strength and management’s will to proceed are therefore differentiating factors, in our view.
Figure 18: Summary of stock coverage towards our top-down strategy Arabtec Drake & Scull Orascom Construction
Exposure to most attractive segments Low Medium Very High Risk profile High Medium Low Likely role in consolidation Low High Medium Valuation Very Low Low High Source: Deutsche Bank
Page 10 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Valuation: Arabtec the cheapest, OCI the most expensive This section provides a comparison of valuation metrics between the five largest MENA contractors’ by market cap. We have taken our estimates for the three companies under our coverage (Arabtec, Drake & Scull and Orascom Construction) and used Bloomberg consensus estimates for Galfar Engineering and Mohammad Al Mojil Group. Note that for the sake of comparison, we consider only Orascom’s construction business in our valuation multiples (and have restated all our numbers from our estimates of the value of the fertilizer business and other peripheral assets). Beyond the usual earnings’ multiples, we have looked at EV/Backlog and EV/Backlog’s EBITDA (based on our normalized EBITDA margin assumption). We believe these ratios are a fair reflection of forward earnings.
Figure 19: EV / Restated backlog Figure 20: EV / (Backlog x normalized EBITDA margin)
80% 4.5 69% 3.9 70% 4.0
3.5 3.4 60% 2.9 2.8 49% 3.0 2.7 50% 46% 43% 2.5 40% 35% 2.0 30% 1.5 1.2 20% 18% 1.0
10% 0.5
0% - ARTC DSI GECS MMG OCI Average ARTC DSI GECS MMG OCI Average MENA MENA
Source: Deutsche Bank, Bloomberg consensus. We exclude non construction businesses for OCI. Source: Deutsche Bank, Bloomberg consensus. We exclude non construction businesses for OCI.
It appears that Orascom’s construction business is implicitly trading at a significant premium to its MENA peers, reflecting its much lower risk profile and better positioning on growth segments and locations.
Figure 21: P/E 2010E Figure 22: EV / EBITDA 2010E
16.0 15.2 8.0 14.8 7.1 7.1 14.0 7.0
12.0 6.0 5.3 9.6 10.0 9.4 9.5 5.0 4.7 4.7 7.9 8.0 4.0 3.6 5.9 2.9 6.0 3.0
4.0 2.0
2.0 1.0
- - ARTC DSI GECS MMG OCI Average Average ARTC DSI GECS MMG OCI Average Average MENA Global MENA Global
Source: Deutsche Bank, Bloomberg consensus. We exclude non construction businesses for OCI. Source: Deutsche Bank, Bloomberg consensus. We exclude non construction businesses for OCI.
The analysis of the 2010E P/E ratio provides a similar conclusion: Orascom’s construction business trades at a significant premium to its regional peer group, which is, in our view, warranted by the much better quality of the backlog, the lower risk, and the ideal positioning in the most attractive regions and segments of the industry. Nevertheless, the stock does not offer a significant discount to its global peers.
Deutsche Bank AG/London Page 11 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Conversely, Arabtec, and, to a lesser extent, Drake & Scull trade on significant discounts to the peer group (note that DSI’s P/E 2010E ex-cash would be 5.7x). In our view, this mirrors their strongest exposure to Dubai among our coverage universe.
Bottom up: Buy Arabtec and Drake and Scull and Hold Orascom Construction Industries Overall, we believe MENA contractors offer an attractive risk/reward combination, as suggested by the average 20% upside potential to our target prices. Our target prices are based on standard DCF models using company-specific assumptions (see individual company sections for details).
Figure 23: Ratings, target prices and key metrics for our MENA contractors coverage Local currency (m) unless stated Arabtec Holding Drake & Scull Orascom Construction
Currency AED AED EGP Recommendation Buy Buy Hold Current price 3.24 1.04 236 Target Price 4.50 1.30 230 Upside / (downside) 39% 25% -3% Market Cap' (local m) 3,636 2,200 52,863 Market Cap' (USD m) 990 599 9,547 Current backlog (local m) 18,933 3,130 39,922 Current backlog (USD m) 5,153 852 7,210 EV / Backlog* 21% 33% 59% EV / Backlog normalized EBIT* 1.8 2.5 5.8 P/E 2010E* 5.8 9.4 15.7 EV / EBITDA 2010E* 2.9 3.6 7.1 Source: Deutsche Bank. *Multiples restated from the fertilizer business for OCI.
Our top picks are: Arabtec Holding (Buy): We view Arabtec as the highest risk/return combination in our contractors’ universe. The company was adversely affected by Dubai’s real estate collapse, as evidenced by the 36% fall in backlog in Q1 09. We nevertheless believe the risks have materially abated since then; the backlog has stabilized at c.AED19bn (covering 2.4x revenues) and our analysis suggests that only 10% of backlog currently remains at risk vs. 62% nine months ago. Arabtec is successfully diversifying in attractive markets (Saudi Arabia, Qatar, North Africa), and this should progressively offset the Dubai decline, in our view. We also believe the worst is behind us for receivables risk, and the balance sheet has started to gradually improve. Arabtec is the least expensive stock in our contractors’ coverage globally, which does not reflect the company’s fundamentals, in our view. Besides, it offers a free option on a positive outcome regarding the Oktha Center contract and the Meydan claim, which could value add up to AED1.2 per share, according to our estimates. We initiate coverage with a Buy rating.
Drake & Scull (Buy): Drake & Scull’s equity story is relatively similar to Arabtec but with lower risks and upside potential attached. The company is a former Dubai-based MEP contractor that has started to diversify in infrastructures and international markets. MEP starts relatively late in the construction cycle and the company has been affected by limited contract cancellations so far. Despite recent contract awards, the backlog covers only 1.4x current revenues, which is the lowest level in our coverage universe. This highlights the necessity for new awards to replenish the backlog. The key attraction of Drake & Scull comes from its c.AED1bn net cash position that was raised during its recent IPO. This cash position offers a cushion against any negative surprises regarding receivables and accounts for almost 50% of the company’s market cap. More
Page 12 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
importantly, this cash-rich player status in troubled times offers an unequaled opportunity to expand by acquisition. We estimate that by spending AED500m by year-end 2010E on selected opportunities, Drake & Scull could enlarge its scope by c.50% and make a decisive step towards its AED5bn revenues mid-term target. We initiate coverage with a Buy rating.
Orascom Construction Industries (Hold): We view OCI as a high-quality project manager with a solid track record of value creation. In our view, its construction business offers the best regional positioning in our coverage universe, with a well-balanced exposure among the most attractive end markets. Besides, the company is developing an attractive low-cost N-based fertilizer business that will significantly ramp-up over 2009-12E. The stock has enjoyed a strong rally year to date and currently trades at a significant premium to peers, which we believe is justified by its solid businesses position and its management’s impressive track record. With little upside or downside potential to our SOTP methodology, we initiate coverage with a Hold recommendation.
Deutsche Bank AG/London Page 13 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Key themes
Capturing the MENA infrastructures opportunity We forecast strong growth in MENA construction despite the Dubai collapse We believe MENA countries display relatively unique characteristics relative to many mature or other emerging markets (high population growth, underinvestment in infrastructure and housing in the yesteryears, high budget surpluses) that should offer immense opportunities for contractors. Most MENA countries have committed to massive investment plans, not only “fiscal packages” to weather the impact of the downturn, but also with a long-term view to diversify the economies from hydrocarbons.
According to MEED and Deutsche Bank estimates, the MENA backlog has started to stabilize, with 77% of projects ongoing. Year-to-date, awards are down 42%, primarily driven by the collapse in the Dubai construction industry (new contracts down 95%), which explains 60% of the decline.
Even though we view the Dubai construction market as remaining fundamentally weak in the coming years, there are ample opportunities for contractors in other MENA geographies, in our view, namely Abu Dhabi, Saudi Arabia, Qatar, Egypt, Algeria, and Libya which have undertaken massive infrastructure spending plans backed by sovereign governments and government-backed entities (for details please see individual country sections).
Overall, we forecast a rebound in the region-wide industry as from next year and forecast a 20% CAGR in construction contracts (excluding oil & gas) over 2009-12E. In total, we foresee the MENA region as offering an USD280bn market opportunity for civil contractors over the next three years.
Figure 24: MENA new constructions orders (USD m) Figure 25: New orders growth CAGR 2009-12E
120,000 MENA 20%
100,000 Libya 28%
Saudi Arabia 24% 80,000 Egypt 23%
60,000 Qatar 17% Algeria 16% 40,000 UAE (Ex. Dubai) 15%
20,000 Bahrain 15% Oman 9% - Kuwait 2% 2006 2007 2008 2009E 2010E 2011E 2012E Dubai 0% Saudi Arabia Dubai UAE (Ex. Dubai) Qatar Bahrain Oman Kuwait Algeria Egypt Libya 0% 5% 10% 15% 20% 25% 30%
Source: MEED, Deutsche Bank Source: Deutsche Bank
MENA backlog covers 1.8x contractors’ revenues, providing reasonable visibility The five largest MENA contractors (by market cap) have a combined backlog close to USD16bn. Note that all our backlog analysis exclude the Oktha Center contract (AED10bn) from Arabtec’s order book and the Durrat Al Bahrain project (AED596m) from Drake & Scull’s backlog, as we take a conservative approach to contracts.
Page 14 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 26: Restated backlog (USD m) Figure 27: Restated backlog / 2009E revenues
8,000 7,210 2.9x
2.5x 2.5x 6,000 5,153 2.1x 4,000 1.7x 1.7x 1.6x 1.4x 1.4x 1,863 2,000 1.3x 1,045 690 0.9x - OCI ARTC GECS MMG DSI 0.5x OCI ARTC GECS MMG DSI
Source: Companies data, Deutsche Bank Source: Companies data, Deutsche Bank, Bloomberg consensus for Galfar and MMG
On average, these restated backlogs cover 1.8-1.9x 2009E revenues. This ratio is above all a function of the kind of contracts and segments in which contractors are active in, but the overall level remains relatively high, providing some visibility for the next 18 months.
Contractors pursuing diversification in attractive markets In our coverage universe, Orascom Construction offers the best diversification (both current and historically) in terms of geographies and market segments
Figure 28: Restated backlog breakdown by geography Figure 29: Restated backlog breakdown by segment
100% 100%
80% 80%
60% 60%
40% 40%
20% 20%
0% 0% ARTC DSI GECS MMG OCI ARTC DSI GECS MMG OCI
Dubai Abu Dhabi Saudi Arabia Qatar Oman Egypt Algeria Others Residential Mixed use Commercial Industrial Infrastructure
Source: Companies data, Deutsche Bank Source: Companies data, Deutsche Bank
Drake & Scull and Arabtec currently have the largest exposure to Dubai (and to the UAE) and are currently pursuing diversification strategies. Orascom Construction has a very limited exposure to Dubai, while Galfar Engineering and Mohammad Al Mojil Group are essentially domestic players, primarily active in their respective countries (Oman and KSA).
Deutsche Bank AG/London Page 15 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 30: Dubai exposure (% of restated backlog) Figure 31: Real estate exposure (% of restated backlog)
60% 100% 55% 93% 51% 90% 50% 79% 80% 70% 40% 60% 30% 50% 45% 40% 20% 30% 20% 10% 12% 4% 10% 0% 0% 0% 0% 0% ARTC DSI GECS MMG OCI ARTC DSI GECS MMG OCI
Source: Companies data, Deutsche Bank Source: Companies data, Deutsche Bank
Both Arabtec and Drake & Scull have proved to be nimble-footed in adapting to the market conditions and diversify away from Dubai. For Arabtec, its concentration in Dubai has already declined from 86% in Q2 08 to 51% in Q3 09. For Drake & Scull, its concentration in Dubai has declined from 62% by year-end 2008 to 55% in Q3 09. For both companies, we estimate that their Dubai exposure will be less than 15% of the backlog by 2012E.
Backlog stabilizing and risks overall abating All our contractors under coverage have been hit by the crisis and saw some decline (by varying degrees) in their backlog in Q4 08 and Q1 09. This was a result of some contract cancellations and a lack of new orders to replenish their order books. Note that the decline was most severe for Arabtec, which saw its backlog decline roughly 51% from peak to trough compared to only 15% for Drake & Scull and 9% for Orascom Construction.
Our industry analysis suggests that with improving market conditions, projects that were put on hold earlier are being increasingly revisited by clients. Although the timing of order receipts can make the backlog appear volatile from one period to the next, we believe that the worst in terms of backlog cancellation is largely over, and we should see new orders flowing into the contractors’ books.
Indeed, since Q1 09, backlogs have largely stabilized and even increased slightly; Drake & Scull has enjoyed the strongest increase in new orders (backlog up 10% since through), followed by Arabtec (up 5%) and Orascom Construction (up 4%).
Figure 32: Backlog evolution (indexed to 100 for peak) Figure 33: : Backlog risk
120 75%
62% 100 60%
80 45% 60 30% 24% 23% 23% 40 16% 11% 13% 20 15% 10%
0 0% Peak Trough Current Peak Trough Current Peak Trough Current Q4 08 Q1 09 Q2 09 Q3 09 Q4 08 Q1 09 Q2 09 Q3 09
ARTC DSI OCI ARTC DSI
Source: Companies data, Deutsche Bank Source: Deutsche Bank
Page 16 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Using our proprietary methodology (see details in individual company sections), we estimate that the risk of cancellation in the backlog has continuously declined: from 62% in Q4 08 to 10% in Q3 09 for Arabtec and from 23% in Q4 08 to 13% in Q3 09 for Drake & Scull. For Orascom Construction, we were unable to run this analysis, given that the company does not provide its backlog details. We nevertheless believe the risk under our methodology would be relatively limited, given the segment and regional positioning of its backlog.
MENA contractors’ margins should remain above global peers MENA contractors display the highest margins globally MENA contractors are displaying the highest margins globally in our coverage universe and we believe they will remain above global and emerging markets’ average.
Figure 34: 2010E EBITDA Margins by region Figure 35: 2010E EBITDA Margins by MENA player
25.0% 23.3% MENA 15.4%
Emerging Asia 14.7% 20.0% Turkey 12.1%
South Africa 9.8% 15.4% 15.0% 14.2% 13.7% Emering Markets 9.1% 13.1% 12.7% Global 8.2%
Australia 8.0% 10.0% 8.2%
Europe 7.1%
Emerging Europe 7.1% 5.0%
China 5.2%
Japan 5.1% 0.0% ARTC DSI GECS MMG OCI Average Average 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% MENA Global Source: Deutsche Bank for contractors under coverage. Bloomberg consensus for Galfar and MMG. Source: Deutsche Bank for contractors under coverage, Bloomberg consensus for Galfar and MMG
Margins have only slightly declined vs. 2007 peaks Historical data show that MENA contractors’ margins have slightly eroded in the last few years. However, if we limited our focus on our three companies under coverage (Arabtec, Drake & Scull and Orascom Construction), the result would be margins as very close to 2007 levels.
Figure 36: Historical EBITDA margins for MENA Figure 37: Historical and current EBITDA margins for contractors MENA contractors under coverage
35.0% ARTC 30.0%
25.0% DSI 20.0%
15.0% OCI 10.0%
5.0% Average
0.0% ARTC DSI GECS MMG OCI Average 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% 20.0%
2006 2007 2008 H1 2009 9m 09 2008 2007 2006
Source: Companies data, Deutsche Bank Source: Companies data, Deutsche Bank
Indeed, EBITDA margins somewhat stabilized in 9m 09 and were higher than 2008 margins. We believe it stems from the execution of high-priced contracts in the backlog but also from the decline in the cost of raw materials by 30-40% since the peak.
Deutsche Bank AG/London Page 17 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Opportunities in new countries to offset for the decline in high-margin Dubai contracts We acknowledge the two main potential negatives for contractors’ margins:
High-margin contracts, awarded in 2007-08 during the construction boom (especially in Dubai) should come to an end.
Increasing competition in other MENA locations as most Dubai contractors try to reposition themselves in more attractive geographies. However, we believe these negatives should be mitigated by several key elements:
Barriers to entry in new locations remain strong. It is necessary that contractors build customer relationships, learn how to deal in new legal and business environments, and have the capacity to deliver in local projects. Although we overall believe that Abu Dhabi is an accessible market for most Dubai contractors, we believe Saudi is much more complex (visa, etc.). Moreover, we believe that technical expertise and track record are strong differentiating factors.
The shift of the business mix to infrastructures should allow better margins not worse ones. Therefore, we believe there is an opportunity for contractors’ increasing presence in this new segment to capture higher returns.
Figure 38: EBITDA margins forecasts Figure 39: Typical EBITDA margin by segment
20.0% 25% 18.0% 15-25% 16.0% 20% 14.0% 12-20% 12.0% 15% 10.0%
8.0% 5-15% 10% 6.0% 4.0% 2.0% 5% 0.0% ARTC DSI OCI Average 0% Infrastructure Residential / Commercial Industrial 2006 2007 2008 2009E 2010E 2011E
Source: Companies data, Deutsche Bank Source: Deutsche Bank
Overall, we have forecasted a modest decline in EBITDA margins in the next couple of years, and we expect them to return to around 13-14% (vs. 14-15% currently). This is more conservative than the companies’ guidance, as none of the players under our coverage is seeing any meaningful changes in profitability in their current backlogs, or in the new projects they are currently pricing.
Working capital is expected to progressively improve Significant sudden increase in working capital for most MENA contractors We believe contractors operate in a cyclical industry and that they should have a light capital- intensive business model, should get customers’ pre-payment and negative working capital. However, the MENA business culture has historically been very modestly focused on cash management (a trend that is valid across industries), and, as a result, contractors are displaying relatively poor capital discipline compared to their global peers.
In MENA countries, the typical contractor payment scheme would require a 10% bullet payment at the start of the project and then billing as construction progresses, with payment due 90 days after the end of each month.
Page 18 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
MENA contractors saw a significant increase in working capital in 2009, after they enjoyed relatively favourable conditions in 2007-2008. This was primarily due to a common significant increase in receivables, but the explanations are diverse:
For Arabtec and Drake & Scull, the increase primarily stemmed from Dubai developers that have delayed or frozen payments to contractors in an attempt to adjust to the cyclical slump.
In the case of Orascom Construction, this was more the result of a shift in the business mix towards the public sector (higher portion of government-driven infrastructure projects), which are on average paying later than private customers.
Figure 40: Working capital requirement (USD m) Figure 41: Working capital requirement / sales
400 25%
20% 300 15% 200 10%
100 5%
- 0% -5% (100) 2006 2007 2008 2006 2007 2008 2006 2007 2008 2006 2007 2008 2006 2007 2008 2006 2007 2008 -10% 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E (200) -15% ARTC DSI OCI ARTC DSI OCI (300) -20%
-25%
Source: Deutsche Bank Source: Deutsche Bank
Many contractors cover the receivables risk back to back by delaying payment to suppliers. However, in the wake of the liquidity crunch, we presume that the liquidity situation of the contractor’s suppliers was tight, and as a result contractors paid the suppliers to ensure continuity of the project. As a result, the working capital/sales ratio increased substantially for the contractors that lead to a strain on working capital.
Figure 42: Receivables (days of sales) Figure 43: Payables (days of sales)
260 260
230 230
200 200
170 170
140 140
110 110
80 80 2006 2007 2008 2006 2007 2008 2006 2007 2008 2006 2007 2008 2006 2007 2008 2006 2007 2008 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E
ARTC DSI OCI ARTC DSI OCI
Source: Deutsche Bank Source: Deutsche Bank
This issue is particularly critical for Arabtec, which has been forced to borrow short-term funds at a high cost in Q4 08, and ended the quarter with c.AED500m net debt in the books (vs. c.AED270m net cash in Q3 08). The company has shifted to medium-term debt since then and the balance sheet has improved slightly.
Deutsche Bank AG/London Page 19 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Drake & Scull has also seen a significant increase in working capital since the beginning of the year. However, the AED1bn net cash position (thanks to AED1.2bn raised through its recent IPO) has offered some cushion. Nevertheless, DSI has the highest level of working capital requirement / revenues ratio in our coverage universe, and we believe this could be improved.
Finally, we believe Orascom Construction’s case is somehow different, since the increase in the working capital requirement stems from a shift in the business mix. The WCR/sales ratio is the lowest in our coverage universe and is clearly manageable in our view.
Gradual improvement expected for Dubai contractors Given that UAE contractors, especially Arabtec, receive a significant portion of work from Dubai government-owned/backed developers, some implicit support is considered, and we believe the risk of not being paid by the master-developers should not be overstated. However, the key question remains: When will contractors be paid and how much? We believe it is likely some of the developers will try to settle their payables at a lower rate. In terms of timing, we believe the second tranche of the USD20bn federal bonds will provide a much needed liquidity to Dubai. A significant portion of that amount is expected to support the real estate sector, therefore the developers. The first USD10bn bond last February triggered some payment to contractors (namely from Nakheel). Since then, developers are paying but with delays. We expect the second USD10bn injection to act as a potential catalyst for better cash collection for contractors. Our estimates assume only a modest improvement between now and the end of the year and a subsequent return to normalcy in 2011 and 2012. Nevertheless, we believe that the worst is currently behind us.
Figure 44: Net debt / EBITDA Figure 45: Gearing
4.0 80% 3.0 60% 2.0
1.0 40%
- 20% (1.0) 0%
(2.0) 2006 2007 2008 2006 2007 2008 2006 2007 2008 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E (3.0) -20% 2006 2007 2008 2006 2007 2008 2006 2007 2008
(4.0) ARTC DSI OCI 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E -40% (5.0) -60% ARTC DSI OCI (6.0)
(7.0) -80%
Source: Deutsche Bank Source: Deutsche Bank
Page 20 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Secular growth drivers
Above-average population growth creates a strong case for infrastructure investments The demand for infrastructure is closely related with population growth. Between 2003 and 2008, population in the MENA countries grew 3.4% annually, one of the fastest rates in the world (Qatar is highest at 8.9% and Algeria is lowest at 1.3%), which creates pressure on the existing infrastructure stock. This growth compares favourably with the annual population increase of developing Asia at 1.2% and other industrialized countries at 0.5-0.6%.
Figure 46: Annual Population growth 2003-2008 Figure 47: Population growth 2009-2030E
10.0% 5.0% 8.9%
8.0% 4.0% 6.3% 6.0% 3.0% 4.0% 3.4% 2.5% 2.4% 2.1% 1.9% 1.9% 2.0% 2.0% 1.3% 1.2% 0.6% 0.6% 0.5% 0.0% 1.0% Libya Qatar Egypt Oman Kuwait Algeria 0.0% Bahrain Asia Asia Newly Euro Area Euro Qatar Bahrain Kuwait Saudi UAE Libya Egypt Algeria MENA World Developing MENA Avg. Saudi Arabia Saudi
G7 Countries G7 Industrialized Arabia Avg. Avg. MENA Others 2011-2020 2009-30
Source: Economist Intelligence Unit, United Nations Source: EIU, US Census Bureau
Furthermore, the population is young (with 50%+ below the age of 30), which creates a strong case for future growth. According to EIU, the annual MENA population is expected to increase 2.6% annually in 2011-2020E and 2.3% annually during 2009-2030E (vs. 1.0% for the world, source: US Census Bureau). Along with the population growth, other favourable demographic trends such as urbanization, industrialization, and a decline in the average size of households should further necessitate the case for infrastructure (housing, roads, ports, power, and water) investments.
Making up for the underinvestment in the yesteryears In all the MENA countries, investment in infrastructure has not kept pace with GDP growth. In absence of exact data, we used gross fixed capital formation/GDP as a proxy for infrastructure investments. In the past five to 10 years, MENA GFCF/GDP was at 19.4% and 20.1%, respectively, vs. 25% for the other emerging markets. In addition, almost all the MENA government have committed substantial sums (USD400bn in Saudi Arabia, USD220bn in Libya, USD150bn in Algeria) for infrastructure developments. We believe MENA countries will continue to invest in the future, sooner than later to catch up with the underinvestment in the yesteryears, as well as to lay the foundation stone for future growth.
Deutsche Bank AG/London Page 21 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 48: GFCF/GDP for MENA countries Figure 49: GFCF/GDP – MENA, emerging markets
44% 30% 39%
34% 25.4% 26% 25.0% 25.0% 29%
24%
19% 22% 20.1% 20.5% 14% 19.4%
9% 18% UAE India Libya Brazil Qatar China Korea Egypt South Saudi Oman Arabia Russia Kuwait Algeria Bahrain Thailand Malaysia Singapore Hongkong 14% MENA Other emerging markets MENA Avg. Other Emerging Market Avg
Average (10 year) Average (5 year) Average (10 year) Average (5 year) Average (3 year)
Source: United Nations Source: United Nations
Planned diversification shows the intentions… Hydrocarbons remain the pillar of MENA economies; however, hydrocarbon resources are finite resources and will likely be exhausted over time.
Figure 50: Hydrocarbon’s contribution to nominal GDP Figure 51: Hydrocarbon’s contribution to government revenue and exports
70.0% 100% 94% 95% 89% 90% 62% 85% 82% 60.0% 56% 80% 80% 55% 76% 51% 80% 67% 50.0% 60% 60% 40.0% 37% 43% 29% 30.0% 40%
20.0% 20%
10.0% 0% 0.0% Kuwait KSA Bahrain UAE Oman Qatar Qatar Kuwait KSA Oman UAE Bahrain % Govt. Revenue % Exports
Source: Haver Analytics, Deutsche Bank Source: Haver Analytics, Deutsche Bank
The highly capital-intensive, hydrocarbon sector accounts for only 3% of the GCC’s workforce, and the MENA economies have some of the highest population growth rates in the world with population structures highly skewed to young people (roughly 50% people born after 1987). According to Ithmar Capital estimates, it will be necessary to create 90 million jobs over the next 20 years, particularly for the young population. In keeping with their future needs, many of the MENA countries have embarked on extensive diversification plans (Abu Dhabi Vision 2030, Qatar National Vision 2030, Oman’s “The Future Vision 2020” are a few such examples) to include more industry and services in the GDP. This has created a stupendous need for developing adequate infrastructure, namely new cities, roads, airports, telecommunication infrastructure, ports, airports, energy and water treatment plants, and other associated social infrastructure. …while higher oil prices have created the means The strong increase in average crude oil prices during 2002-2008 (from an average USD26/bbl to an average USD100/bbl) has led to substantial liquidity for the MENA countries. As a result, their current account balances swelled considerably over the years, and according to the International Monetary Fund, the current account balances increased from USD31bn in 2002 to USD369bn in 2008.
Page 22 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 52: OPEC spot crude oil price (USD/bbl) Figure 53: C/A balance for MENA countries (USD bn)
120 400 100 369 100
320 80 72 265 258 66 64 65 240 211 57 60
41 160 40 31 110 26 81 68 80 20 31 14 0 0 2002 2003 2004 2005 2006 2007 2008 2009F 2010F 2002 2003 2004 2005 2006 2007 2008 2009F 2010F
Source: EIA, Deutsche Bank Source: IMF, Deutsche Bank
Although forecasted lower crude prices in 2009E and 2010E (Deutsche Bank estimate) could mean that the financial muscle is not as strong as it was, we note that these countries are sitting on huge reserves that, if required, can be tapped to fund infrastructure investments. Note that according to Sovereign Wealth Fund Institute, as of year-end 2008, UAE had the largest SWF assets of USD739bn followed by Saudi Arabia at USD436bn.
Figure 54: SWF Assets by country – 2008 (USD bn) Figure 55: MENA FX Reserves (USD bn)
800 739 200
700 160 600
500 436 120 400
300 80 203 200 40 100 65 65 47 14 8 0 UAE Saudi Kuwait Libya Qatar Algeria Bahrain Oman 0 Arabia 2002 2003 2004 2005 2006 2007 2008 2009F 2010F
Source: SWF Institute Source: Deutsche Bank * includes 6 GCC countries and Egypt
Infrastructure spending is a way to support the economy in the current crisis Government-sponsored infrastructure is usually countercyclical and benefits during an economic slowdown. As economies slow down, government spending increases to support the economy. In the recent global slowdown, the situation was not different, as sovereign governments announced billions of dollars of stimulus plans. In total, as of March 2009, USD2.2tr of stimulus packages was announced, accounting for 3.5% of world’s GDP. Although specific details of each stimulus plan are not always clear, almost all the countries mentioned that a significant portion of the stimulus package has been allocated for infrastructure. It is worth noting that KSA has the largest package as a percentage of GDP.
Deutsche Bank AG/London Page 23 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 56: G20 fiscal stimulus as a % of GDP
8
7 2010 6 2009 5 4 3 2 1 0 Ita SA UK Ind US Tur Chi Fra Bra Kor Jap Ger Aus Rus Spa Can Mex Indo KSA
Source: IMF, Deutsche Bank, *Estimated cost of discretionary measures relative to 2007 baseline
GCC has one of the highest electricity consumption rates The GCC region already has one of the highest electricity consumption rates in the world, primarily because of its extreme climatic conditions. The GCC average stands at 11,350Kwh vs. the emerging markets average of 4,838 and the OECD average of 8,600. North Africa (Libya, Algeria and Egypt) has a much lower rate of 1,834Kwh.
Figure 57: Per capita electricity consumption (Kwh) Figure 58: Growth in MENA electricity demand (Twh)
18,000 450 16,000
14,000 360 12,000 10,000 270 8,000 6,000 180 4,000 90 2,000 - 0
UAE Saudi Iran UAE Kuwait Iraq Qatar Other Egypt Algeria Libya Other Libya Qatar Egypt Oman Kuwait Algeria
Bahrain Arabia Middle North
GCC Avg. East Africa OECD Avg. OECD Saudi Arabia Saudi
Other EM Avg. 2003 2030 North Africa Avg.
Source: UNDP Source: World Energy Outlook 2005
Furthermore, according to the International Energy Association, MENA electricity demand is expected to increase from 724Twh in 2003 to 1,799Twh in 2030, growing 3.4% annually over the same period. During this period, 301Gw of capacity is expected to be added at an investment of USD458bn. Although the above numbers appear conservative when we compare this number to BMI forecasts that call for 1,523Twh by 2013 (from 1,178Twh in 2008, 29.3% increase between 2008 and 2013), nonetheless it helps to understand the broad trend of strong electricity demand growth in the MENA region.
Page 24 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 59: Capacity additions (Gw) 2004-2030E Figure 60: Investment (USD bn) 2004-2030E
80 120
70 100 60 80 50
40 60
30 40 20 20 10
0 0 Saudi Iran UAE Iraq Kuwait Qatar Other Egypt Libya Algeria Other Saudi Iran UAE Iraq Kuwait Qatar Other Egypt Libya Algeria Other Arabia Middle North Arabia Middle North East Africa East Africa
Source: World Energy Outlook 2005 Source: World Energy Outlook 2005
GCC has one of the lowest per capita availability of natural renewable water GCC average per capita natural renewable water availability is approximately 1,200 cubic mtr. per year (Source: Zawya.com, Dec 2005), which is roughly 17% of global average of 7,000. This creates the necessity for investment in extracting water by alternative means, namely desalination and waste water treatment. The largest gap in demand and availability is in Saudi Arabia and UAE, with extraction and availability rates of 1,056/111 and 896/56, respectively.
Furthermore, according to the IEA, water demand (excluding agricultural demand) in Saudi Arabia, UAE, Kuwait, Qatar, Algeria, and Libya is expected to increase 2.4% annually from 7bn cubic mtr. in 2003 to 13.3bn cubic mtr. in 2030. The increase is due to high population growth, improvements in the standard of living, and industrial development in urban centres. The obvious beneficiary is the desalination sector, which is expected to increase from 3.7bn cubic mtr. in 2003 to 11.9 cubic mtr. in 2030 at an investment of USD38.6bn.
Figure 61: Water usage vs. availability of natural Figure 62: Water Demand in Saudi Arabia, Kuwait, UAE, renewable water (cubic mtr/capita) Qatar, Algeria and Libya (Mn cubic mtr.)
1200 14000
1000 12000
800 10000 600 8000 400
6000 200
0 4000 Saudi Arabia UAE Oman Qatar Bahrain Kuwait 2003 2010 2020 2030
Water abstraction Natural Renewable water
Source: Zawya.com Source: World Energy Outlook 2005
Deutsche Bank AG/London Page 25 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 63: Desalination capacity (m cubic mtr./year) Figure 64: Investment in water desalination (USD bn)
8000 25
6400 20
4800 15
3200 10
1600 5
0 0 Saudi Arabia UAE Kuwait Libya Qatar Algeria Saudi Arabia UAE Kuwait Libya Qatar Algeria
2003 2010 2020 2030 2004-2010 2004-2020 2004-2030
Source: World Energy Outlook 2005 Source: World Energy Outlook 2005
Residential construction: opportunities remain immense UAE: Dubai oversupplied but Abu Dhabi still suffers from a shortfall We believe that in the near term, the construction heydays of Dubai are over and residential construction opportunities are limited. We forecast that the emirate would face an oversupply of 32,000 (Deutsche Bank proprietary demand supply model) residential units by 2010E and will continue to remain oversupplied until 2012.
Figure 65: Cumulative shortfall (surplus) in Dubai Figure 66: Cumulative shortfall (surplus) in Abu Dhabi
40,000 35,000
30,000 30,000
20,000 25,000
10,000 20,000
- 15,000 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E (10,000) 10,000 (20,000) 5,000 (30,000) - (40,000) 2006E 2007 2008E 2009E 2010E 2011E 2012E
Housing demand Housing deliveried Cumulative shortfall (surplus) Housing demand Housing deliveries Cumulative shortfall (surplus)
Source: Deutsche Bank Source: Deutsche Bank
However, we believe that Abu Dhabi offers a different picture as it faces an acute shortage of both residential space and quality commercial space. Note that in Q2 09, in the middle of the economic slowdown, in which some newly constructed commercial spaces in Dubai saw vacancy rates of 60%, the residential and commercial vacancy rates in Abu Dhabi were a miniscule 3% and 2%, respectively (Source: Colliers). In addition, according to the Deutsche Bank proprietary demand supply model, undersupply in Abu Dhabi will peak at 30,000 units in 2009, and will continue to remain undersupplied until 2012. Furthermore, we presume that the government is likely to stick to its Plan Abu Dhabi 2030, which is a long-term development plan to build new commercial and residential cities, and islands to accommodate the growing young population. Finally, Aldar Properties was given the opportunity to build 5,000 villas in Al Falaah, which we argue is the starting point in the government-sponsored affordable housing solution for the population. We believe these structural drivers will create more long-term construction opportunities.
Page 26 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Opportunities abound in Saudi Arabia and Algeria Saudi Arabia, which has the largest population and is the biggest GCC economy, is also facing a chronic undersupply of residential units. According to the Deutsche Bank proprietary demand supply model, the country’s housing demand will increase from 5.1m units in 2009E to 6.3m units by 2015. Although the supply will increase to 5.8m units, nevertheless, the market will still be undersupplied by 500,000 units (between 2008 and 2015E). To put this into perspective, the largest Saudi contractor, Saudi Bin Laden Group, currently has the capacity to build c.5,000 units per year. This compares with an estimated demand for affordable units of c.200,000 units per year. In other words, 40 groups of the size of SBG in the segment would be required to meet the housing needs.
Figure 67: KSA housing demand/supply gap (m units) Figure 68: Algeria cumulative housing demand (m units)
6.5 0.6 2.5
0.5 6.0 2.0 0.4 5.5 1.5 0.3 5.0 0.2 1.0
4.5 0.1 0.5 4.0 0.0 2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E 0.0 2009 2010 2011 2012 2013 2014 2015 Cumulative annual demand (LHS) Cumulative annual supply (LHS) Cumulative shortfall (RHS)
Source: Deutsche Bank Source: University of Setif study
In the North Africa region, with an economy in transformation, we believe Algeria presents an interesting opportunity, with the demand for new housing set to increase to 2m units by 2015 (currently the market is undersupplied by 763,000 units), according to an university of Setif study conducted in August 2009.
Other MENA countries also taking initiatives to develop housing Opportunities for residential construction remain strong in most MENA countries. We highlight the following examples:
The government of Kuwait allocated its largest budget yet of USD3.5bn for housing projects.
In Egypt, demand for affordable housing remains sound, and according to BMI it is pegged at constructing 275,000-350,000 units annually.
According to Construction News Plus, 70,000-75,000 units of new housing are required every year in Libya in able to keep pace with the growing population. Significant investments in transport infrastructure In order to upgrade the transport infrastructure, MENA governments have drawn up significant investment plans in railways, ports, airports, and roads. According to Zawya.com, GCC has plans to invest almost USD40bn only to triple port capacity to 62m TEUs by 2028. Although the new economic realities could rationalize plans, nonetheless, this shows the governments’ intentions to grow and develop infrastructures. Figure 69 shows some of the major transport infrastructure projects in the MENA region.
Deutsche Bank AG/London Page 27 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 69: Major transport infrastructure projects in MENA USD bn Location Value Completion (USD bn) Railway / Metro
Dubai Metro (Red, Blue, Purple, Green) UAE 12.6 2010-2013 Abu Dhabi Metro UAE 7.0 2016 NTA - UAE Railway UAE 3.0 2015 Saudi Landbridge Saudi Arabia 6.6 2011 Makkah, Madinah Rail Link Saudi Arabia 6.0 2012 Mina, Arafa Railway Saudi Arabia 5.3 2013 Jeddah Monorail Saudi Arabia 3.7 2011 North-South Railway Saudi Arabia 4.6 2012-2012 Qatar UPDA - Doha Rail Network Qatar 1.0 2015 Bahrain Monorail - Phase 1 Bahrain 1.0 2016 Kuwait National Rail Network Kuwait 6.6 2014 GCC Rail Network GCC 14.0 2017 Libyan Railway Libya 11.6 2011-2013 Total 83.0 Airports Al Maktoum International Airport (JXB) UAE 8.3 2010 SCADIA - Abu Dhabi Airport Expansion UAE 8.1 2010 Ajman Airport UAE 3.4 2011 Ras Al Khaimah Airport Expansion UAE 1.5 2018 Dubai International Airport Expansion UAE 1.3 2011 King Abdulaziz International Airport Development Project Saudi Arabia 5.3 2012 New Doha International Airport Qatar 14.5 2012 Muscat International Airport Expansion Oman 4.8 2012-15 Kuwait International Airport Expansion Kuwait 22 2013 Sabha Airport Libya 0.4 2009 Total 69.6 Ports Khalifa Port / Mina Zayed and Industrial Zone Abu Dhabi 26.0 2010-2028 Jeddah Port Saudi Arabia 0.5 2010 Ras Al Zour Port Saudi Arabia 0.7 2010 Dammam Saudi Arabia 0.5 N/a King Abdullah Economic City Saudi Arabia 1.0 2012 King Abdulaziz Port Expansion Saudi Arabia 0.1 2017 New Doha Port Qatar 7.0 2025 Ras Laffan Dry Dock (Phase 1) Qatar 0.6 2010 Mesaieed Port Qatar 0.5 2010 Duqm Port Oman 1.8 2011-2012 Khalifa bin Salman Bahrain 0.1 2010 Bubyan Island Port (Phase1,2) Kuwait 1.4 2011-2013 Sokhna Egypt 1.3 2011 Port Said Egypt 5.5 2015 Total 47.0 Source: Zawya.com, Various websites
Page 28 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
MENA construction industry likely to pick up again
Introduction to the MENA construction industry
Figure 70: MENA comparative metrics Backlog 2009E GDP Population Size 2004-08 C/A balance Backlog/GDP GDP/Capita Backlog/Capita (USD bn) (USD bn) (m) (sq Km) (as of % GDP) (x) (USD) (USD)
UAE 908.0 224.2 5.6 82,880 14.2% 4.1 40,036 162,150 KSA 593.2 347.6 24.9 2,240,000 24.9% 1.7 13,960 23,822 Qatar 207.2 99.7 1.6 11,437 17.4% 2.1 62,313 129,526 Kuwait 159.0 101.9 3.4 17,820 38.6% 1.6 29,971 46,765 Oman 94.0 43.1 2.8 212,460 8.2% 2.2 15,565 33,955 Bahrain 64.3 18.1 1.1 707 11.2% 3.6 16,018 56,863 GCC 2,026 835 39 2,565,304 19.1% 2.4 21,183 51,416 Egypt 90.0 211.1 81.5 1,001,450 1.6% 0.4 2,590 1,104 Algeria 79.8 128.6 34.4 2,400,000 20.30% 0.6 3,738 2,320 Libya 58.6 63 6.3 1,759,540 39.70% 0.9 10,000 9,302 MENA 2,254 1,237 162 7,726,294 19.6% 1.8 7,656 13,949 Source: MEED, Zawya.com for Backlog, Deutsche Bank and IMF for GDP, EIU for population and C/A balance, Encyclopedia for area
According to MEED and our estimates, MENA countries had a backlog of USD2.3trillion of projects in October 2009. Despite the massive cancellations of real estate developments (namely in Dubai), the UAE still captures the lion’s share of the backlog (40%), followed by Saudi Arabia (26%), and Qatar (9%).
Figure 71: Breakdown of backlog of projects in MENA-08 Figure 72: Breakdown of GDP in MENA- 2008
Algeria Libya Libya Egypt 3% 5% 4% Algeria UAE 4% Bahrain 10% 19% 3% Oman 4% UAE 40% Kuwait 7% Egypt 17%
Qatar 9% Bahrain KSA 1% 29% Oman 3% KSA Kuwait Qatar 26% 8% 8%
Source: MEED, Deutsche Bank Source: IMF, Deutsche Bank
UAE still benefits from the highest amount of investment per capita, followed by Qatar, Bahrain, Kuwait, and Oman. Infrastructure spending per capita is much smaller for the other countries, primarily because of the size of the population. We also believe it is a sign of some underinvestment while needs remain high and driven by population growth. This is clearly represented in our view for Saudi Arabia, Egypt, Lybia, and Algeria.
Deutsche Bank AG/London Page 29 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 73: Backlog and GDP per inhabitant (USD) Figure 74: Backlog and GDP per capita
180 180
160 UAE 150 140 Qatar 120 120
100 90 80 60 60 Bahrain Kuwait Backlog/Capita (USD) 40 30 Oman 20 Algeria KSA Libya - - Egypt Qatar UAE Kuwait Bahrain Oman KSA Libya Algeria Egypt - 10203040506070
GDP/Capita (USD) Backlog/Capita (USD) GDP/Capita (USD)
Source: MEED, IMF, Deutsche Bank Source: MEED, IMF, Deutsche Bank
MENA project backlog stabilizing Backlog stabilizing – 77% of ongoing projects According to MEED, as of October 2009, the GCC had a project backlog of USD2.1tr that has stabilized at these levels (since June) after a sharp decline from USD2.7tr in March 2009. Furthermore, we see that 77% of all projects in the GCC region and 78% of all projects in the MENA region (GCC, Algeria, Egypt, and Libya) are live. Note that the backlog includes all live projects that encompass projects from planned/announced to the execution stage. As a result, the current data may have some anomalous data points, namely projects that have been announced or are only in the design stage and may be cancelled in subsequent periods. Nonetheless, these data points are helpful to understand the broad construction trends.
Figure 75: GCC Backlog (USD bn) Figure 76: GCC projects status-Oct 2009
3,000 Not Live 2,500 23%
2,000
1,500
1,000
500
0 Live 77% Jul -09 Jul Oct -09 Jun -09 Jun Mar -09 Mar Dec -04 Dec -05 Dec -06 Dec -07 Dec -08 -09 Aug -09 Sep
Source: MEED Source: Zawya.com, Deutsche Bank
UAE suffered the most but other MENA markets have proven good resilience 30% of UAE’s projects have been either cancelled or put on hold, and this accounted for 54% of the MENA non live projects. Kuwait comes in second (28% of MENA projects cancellation, 54% of the country’s projects) but that is primarily related to one single giga-real estate project (Silk City, worth USD130bn), which has been put on hold. Egypt saw 18% of its projects halted, but its share in the total MENA market remains relatively small.
Conversely, most other markets have shown good resilience with the level of ongoing projects in the 90% to 100% range. This is notably the case for Libya, Saudi Arabia, Qatar, Oman, Bahrain, and Algeria.
Page 30 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 77: MENA ongoing projects by country Figure 78: Breakdown of non-live projects by country- Oct 2009
100% AlgeriaEgypt 100% 96% 95% 94% Oman 93% 90% 2% 3% 1% 82% Bahrain 78% 77% 80% 1% 70%
60% Kuwait 46% 28% 40% UAE 54% 20%
0% Qatar 4% KSA UAE
GCC KSA Libya Qatar Egypt Oman MENA Kuwait Algeria
Bahrain 7%
Source: Zawya.com, Deutsche Bank Source: Zawya.com, Deutsche Bank
Real estate constitutes 73% of all project cancellations… Unsurprisingly, real estate accounted for the chunk (73%) of project cancellations or ones put on hold. Only 66% of the projects are still ongoing. Conversely, the infrastructure and power & water segments have only been slightly affected: A respective 94% and 92% of the projects are ongoing, and together they represent a mere 8% of project cancellations.
Figure 79: Breakdown of ongoing projects by sector Figure 80: Breakdown of non-live projects by sector-
Petrochem, Oil & Infrastructure 100% Power & Water 94% Gas, industry 5% 92% 3% 19% 90% 85%
80% 78% 77%
70% 66%
60%
50%
40% Infrastructure Power & Petrochem, Real Estate MENA GCC Water Oil & Gas, Real Estate industry 73%
Source: Deutsche Bank, Zawaya Source: Deutsche Bank, Zawaya
… but still constitutes the highest share of ongoing projects at 41% Across MENA, the real estate segment still captures the highest share at 41% despite the large amount of project cancellations. Among countries, the share of real estate projects is the highest in Egypt (73%), followed by UAE (61%), Bahrain (66%), and Oman (61%). These countries also saw the largest property project cancellations, namely the UAE (only 62% of projects ongoing), Egypt (80%), and Qatar (84%). Kuwait is again particularly affected by the Silk City project.
In most other MENA countries, the real estate segment has suffered from relatively limited cancellations, as more than 90% of the projects are ongoing. These countries are in the relatively early stages of the property boom, and the real estate segment’s share of the backlog is not predominant (Saudi Arabia 19%, Algeria 11%, and Libya 9%).
The Oil & Gas segment accounts for slightly less than one-third of the MENA backlog (but is predominant in Qatar and Algeria), followed by infrastructures (21%) and power & water projects (9%).
Deutsche Bank AG/London Page 31 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 81: Sectoral split of the backlog Figure 82: Status of real estate projects in MENA
100% 100% 100% 99% 98% 96% 15% 17% 100% 26% 25% 30% 30% 29% 84% 80% 37% 37% 80% 55% 80%
75% 66% 65% 60% 9% 62% 61% 19% 37% 41% 41% 60% 73% 55% 40% 11% 68% 22% 8% 48% 40% 9% 7% 31% 4% 20% 9% 11% 34% 29% 19% 3% 7% 21% 23% 13% 14% 20% 8% 10% 6% 0% 4%
0% KSA UAE GCC Libya Qatar Egypt Oman MENA Kuwait Algeria Bahrain KSA UAE GCC Libya Qatar Egypt Oman MENA Kuwait Infrastructure Power & Water Real Estate Petrochem, Oil & Gas, industry Algeria Bahrain
Source: Zawya.com, Deutsche Bank Source: Zawya.com, Deutsche Bank
Infrastructure and power & water projects remain particularly strong in most countries Ninety-four percent of all infrastructure projects are ongoing in the MENA region. Similarly, for power and water projects, 92% are live.
Figure 83: Status of infrastructure projects in MENA Figure 84: Status of power & water projects in MENA
100% 100% 100% 100% 100% 100% 99% 98% 100% 99% 97% 100% 94% 94% 100% 94% 90% 92% 89% 81% 77% 80% 80% 73%
60% 60%
40% 40%
21% 20% 20%
0% 0% KSA UAE GCC Libya KSA Qatar UAE Egypt GCC Oman Libya MENA Qatar Kuwait Egypt Oman MENA Bahrain Kuwait Algeria Bahrain
Source: Zawya.com, Deutsche Bank Source: Zawya.com, Deutsche Bank
New orders declined 42% year-on-year, mainly due to Dubai A 42% decline in new orders over 9m 09 After analyzing the backlog in terms of size and risk, we tried to study the trends in actual contracts awarded. Note that we only take non-oil-and-gas-related contracts in our calculations, as we believe these are the targeted projects accessible to our companies under coverage.
According to MEED and Deutsche Bank estimates, contracts awarded in the MENA region in 9m 09 amounted to USD45.5bn. That is a 42% decline to USD78bn in 9m 08, but remains ahead of USD36.3bn in 9m 07.
The decline was not uniform as in the cases of Saudi Arabia, Kuwait, Egypt and Bahrain contracts awarded in 2009 recorded substantial growth year-on-year.
Page 32 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 85: MENA contracts awarded (USD m) Figure 86: Contracts awarded by country
25 90,000
80,000 20
70,000 15 60,000
50,000 10
40,000 5 30,000
20,000 -
10,000 Libya Qatar Egypt Dubai Saudi Oman Arabia Kuwait Algeria Bahrain Dubai) - (Ex. UAE 9M07 9M08 9M09 9M07 9M08 9M09
Source: MEED, Deutsche Bank Source: MEED, Deutsche Bank
Saudi Arabia is leading the way, Dubai alone explains 60% of the drop in new awards Saudi Arabia accounted for 48% of new awards in 9m 09, vs. 17% in the same period last year. This is in line with a recent Deloitte Middle East estimate, stating that 50% of the Gulf’s construction activity is currently coming from KSA. The UAE (excluding Dubai) remains a significant contributor to new awards (15%), although orders are down 55%.
Figure 87: Share of new contracts awarded in 9M ‘08 Figure 88: Share of new contracts awarded in 9M ‘09
Libya Libya Egypt 7.8% Saudi Arabia Egypt 7.4% 0.5% Algeria 17.1% Algeria 3.3% Kuwait 6.4% 1.3% 0.4% Kuwait Oman 10.8% 4.6%
Bahrain Saudi Arabia 0.3% Oman 47.6% 4.8%
Dubai Bahrain 25.4% 1.2% Qatar Qatar 18.9% 6.7%
UAE (Exc. Dubai) UAE (Exc. Dubai) Dubai 18.8% 14.6% 2.4%
Source: MEED, Deutsche Bank Source: MEED, Deutsche Bank
Activity in Dubai fell by 95% and currently accounts for only 2% of MENA awards (vs. 26% last year). If Dubai had remained at the same level as last year, the MENA backlog would have decreased by 18%. In other words, the Dubai construction industry alone explains a 24% decline in the backlog (60% of it).
Cautious optimism returns to the project financing market Despite having attractive fundamentals, many projects in the MENA hit a roadblock in 2008, as liquidity dried up in the system, banks became risk averse and were not willing to lend for long tenures (a typical characteristic of project finance), and the cost of debt increased. This resulted in many gulf projects being shelved or cancelled in late 2008 and early 2009. The only notable deal was the financing for the USD3.8bn Ras Laffan C independent water and power project (IWPP) in Qatar. However, other similar projects could not manage long-term financing.
Deutsche Bank AG/London Page 33 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
The situation has currently improved with several transactions recorded in H2 09. They include Abu Dhabi’s Shuweihat 2 IWPP, Rabigh IWPP in Saudi Arabia, and Bahrain’s Addur IWPP. Because these projects were to close funding in 2008 but have only been able to secure it now shows that the financing is progressively getting more available.
Figure 89: Recent project financing deals Name Financing Cost of Financing Closed
Shuweihat 2 IWPP – Abu Dhabi USD2.1bn LIBOR+260-350bps,22 years Oct ‘09 Rabigh IWPP Saudi Arabia USD2.5bn LIBOR+300bps, 20 year Jul ‘09 Addur IWPP – Bahrain USD2.1bn LIBOR+350bps, 8 years June Source: MEED
The cost of financing was higher than that in the past. The Abu Dhabi project had a rate of LIBOR+260-350bps, whereas Rabigh IPP was financed at LIBOR+300 bps, both higher than the typical structures of LIBOR+50-100bps in the days before the crisis. This is partially balanced by the fact that LIBOR has declined in the meantime.
Furthermore, industry sources have indicated that USD9.6bn oil refinery in Jubail sponsored by Saudi Aramco and France’s Total is also aiming to secure prices similar to that of the Abu Dhabi project. This has lead us to believe that while transactions still remain relatively low compared to pre-crisis days, financing is slowly coming back on track and the cost of financing should decline going forward. The first leg of beneficiaries will be projects sponsored by governments and government-backed entities, and the next leg of beneficiaries could be privately financed initiatives.
New order growth of 20% projected in the next three years We have projected the 9m 09 new awards trends in FY09 and have built our own assumptions for the next three years. We have projected an overall rebound in new contracts as from 2010, as the collapse in Dubai real estate becomes progressively digested and Saudi Arabia ramps up quickly. The progressive return of available project financing and the expected rebound in GDP growth should drive some private initiative that will coincide with the massive government-led investment plans. In total, we foresee the MENA region as offering an USD280bn market opportunity for civil contractors over the next three years.
Figure 90: MENA new awards 2006-12E (USD bn) Figure 91: New awards CAGR 2009-12E
120,000 MENA 20%
100,000 Libya 28%
Saudi Arabia 24% 80,000 Egypt 23%
60,000 Qatar 17% Algeria 16% 40,000 UAE (Ex. Dubai) 15%
20,000 Bahrain 15% Oman 9% - Kuwait 2% 2006 2007 2008 2009E 2010E 2011E 2012E Dubai 0% Saudi Arabia Dubai UAE (Ex. Dubai) Qatar Bahrain Oman Kuwait Algeria Egypt Libya 0% 5% 10% 15% 20% 25% 30%
Source: MEED, Deutsche Bank Source: Deutsche Bank
We have identified the highest growth opportunities in Libya, Saudi Arabia, and Egypt. Conversely, we view Dubai and Kuwait as relatively unattractive markets for the coming years, only modestly rebounding from their 2009E lows.
Page 34 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
As a result, the landscape is evolving in favour of Saudi Arabia and North African countries, which would represent almost two-thirds of the market in 2012E. Conversely, Dubai is expected to remain insignificant in our forecasts.
Figure 92: Breakdown of new awards 2008 Figure 93: Breakdown of new awards 2012E
Libya Libya Egypt Algeria 7% Saudi Arabia Egypt 8% Kuwait Algeria 0% 1% 17% 3% 1% 6% Kuwait Oman 6% 4% Oman Bahrain 3% 0% Bahrain 1% Qatar 7% Qatar Saudi Arabia 17% Dubai 57% 29%
UAE (Ex. Dubai) 13% Dubai UAE (Ex. Dubai) 1% 19%
Source: MEED, Deutsche Bank Source: Deutsche Bank
Deutsche Bank AG/London Page 35 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Company Profiles
Page 36 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Middle East United Arab Emirates Real Estate, Construction and Building Materials Construction
17 November 2009 Arabtec Holding Buy Price at 16 Nov 2009 (AED) 3.24 Reuters: ARTC.DU Bloomberg: ARTC UN Price Target (AED) 4.50 52-week range (AED) 3.71 - 0.76
Risks abating, deep value play Price/price relative 10 8 6 4 We initiate coverage with a Buy rating, target price of AED4.5 2 We view Arabtec as the highest risk/return combination among its MENA peers. 0 The stock is the least expensive in our contractors’ universe globally, which in our 11/06 5/07 11/07 5/08 11/08 5/09 view does not reflect the declining risks and the mid-term growth potential. Arabtec Holding Besides, it offers a free option on a favourable outcome for the Oktha Center MSCI Arab (Rebased) contract and the Meydan claim, which could add up to AED1.2 per share. We initiate coverage with a Buy rating. Performance (%) 1m 3m 12m Absolute -11.7 12.1 94.0 Worst is behind; contract cancellations and receivables risks abate MSCI Arab -6.2 2.2 10.4 Arabtec suffered from the collapse of Dubai real estate, which translated into a 36% q-o-q fall in the backlog in Q1 09. Since then, new orders have allowed the Stock data order book to stabilize at c.AED19bn, i.e., 2.5x revenues. International expansion Market cap (AED)(m) 3,875.0 Shares outstanding (m) 1,196 is paying off: non-UAE contracts now account for 36% of the backlog, vs. 17% Free float (%) 89 nine months ago. We believe the risks of more contract cancellations have largely MSCI Arab 488.4 abated. Our analysis suggests that only 10% of the contracts are at risk, vs. 62% nine months ago. Dubai’s receivables remain a key concern, but overall liquidity Key indicators (FY1) has progressively improved, and we believe the worst is behind us. ROE (%) 30.6 Net debt/equity (%) 12.4 Free option that could add up to AED1.2 per share Book value/share (AED) 2.2 Investors are still cautious about the AED10bn Oktha Center project in St. Book value/share (AED) 2.2 Price/book (x) 1.5 Petersburg. We believe the first foundation testing contracts are a testimony of Net interest cover (x) 12.4 Gazprom’s commitment to move ahead, and final approval could be announced in EBIT margin (%) 11.3 early 2010E. This project would enhance earnings by 30% in the next few years as per our calculations. Besides, Arabtec has issued a claim following the sudden cancellation of the Meydan race course contract. While the outcome on both issues is uncertain, we view it as a free option that could add up to AED1.2 per share in value. Target price at AED4.5; option value related to Russian contract We value Arabtec using a DCF method (WACC 14%, LT growth 3%). This yields AED4 per share, i.e., an implicit 2010E P/E of 7.4x, vs. 9.5x for MENA contractors. We also added AED0.5 per share of option value (out of a potential AED1.2) related to the Oktha Center project and the Meydan claim. Thus, our target price is AED4.5 per share. MENA contractors are exposed to regional economic conditions, building and infrastructure spending, and availability of project financing. Project delays or cancellations and failure to recover receivables could materially affect our earnings/valuation. Main specific downside risks for Arabtec are 1) failure to secure new orders in MENA to offset the Dubai backlog decline, 2) more project cancellations, and 3) more delays in cash collection from customers putting the balance sheet at risk.
Deutsche Bank AG/London Page 37 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Model updated:16 November 2009 Fiscal year end 31-Dec 2006 2007 2008 2009E 2010E 2011E
Running the numbers Financial Summary Middle East DB EPS (AED) 0.18 0.45 0.80 0.57 0.54 0.54 Reported EPS (AED) 0.18 0.45 0.80 0.57 0.54 0.54 United Arab Emirates DPS (AED) 0.07 0.25 0.00 0.00 0.00 0.00 Construction BVPS (AED) 0.7 1.0 1.6 2.2 2.7 3.3 Weighted average shares (m) 1,058 1,118 897 1,196 1,196 1,196 Average market cap (AEDm) 2,216 3,325 5,469 3,899 3,899 3,899 Arabtec Holding Enterprise value (AEDm) 2,258 2,676 6,046 4,343 3,729 2,900 Valuation Metrics Reuters: ARTC.DU Bloomberg: ARTC UH P/E (DB) (x) 11.5 6.6 7.6 5.7 6.0 6.0 P/E (Reported) (x) 11.5 6.6 7.6 5.7 6.0 6.0 Buy P/BV (x) 3.52 4.46 1.43 1.51 1.20 1.00 Price (17 Nov 09) AED 3.26 FCF Yield (%) nm 36.9 nm 5.2 19.8 27.0 Target price AED 4.50 Dividend Yield (%) 3.1 8.4 0.0 0.0 0.0 0.0 52-week Range AED 0.76 - 3.71 EV/Sales (x) 0.8 0.6 0.6 0.6 0.5 0.4 EV/EBITDA (x) 7.5 4.0 4.5 3.7 3.3 2.5 Market Cap (m) AEDm 3,899 EV/EBIT (x) 10.9 4.9 5.6 5.1 4.5 3.4 USDm 1,061
Company Profile Income Statement (AEDm) Established in 1975, Arabtec Holding is one of the largest Sales revenue 2,810 4,273 9,722 7,609 7,925 8,148 civil construction companies in the GCC region and is the first Gross profit 449 860 1,752 1,557 1,570 1,614 contractor to be listed in DFM. The company primarily EBITDA 299 664 1,333 1,160 1,126 1,158 operates in the civil construction space and is engaged in the Depreciation 92 121 260 300300 309 construction of residential, commercial and mixed use Amortisation 0 0 0 00 0 buildings. It provides end-to-end contracting services across the construction value chain and is also involved in providing EBIT 207 544 1,073 860826 849 associated construction services namely mechanical, Net interest income(expense) 0 -4 -24 -69 -25 16 engineering and plumbing (MEP contracting), manufacturing Associates/affiliates 0 0 0 00 0 of ready mix concrete, structural steel fabrication, trading and Exceptionals/extraordinaries 0 0 0 00 0 leasing of construction machinery and equipment. Other pre-tax income/(expense) 13 39 47 30 32 33 Profit before tax 220 579 1,096 821 832 898 Price Performance Income tax expense 0 1 16 21 24 29 Minorities 2 42 122 115157 223 10 Other post-tax income/(expense) 0 0 0 0 0 0 8 Net profit 218 535 958 685 652 645 6 4 DB adjustments (including dilution) 0 0 0 0 0 0 2 DB Net profit 218 535 958 685 652 645 0 Nov 06 May 07 Nov 07 May 08 Nov 08 May 09 Cash Flow (AEDm) Cash flow from operations -5 1,511 70 409 1,088 1,378 Arabtec Holding MSCI Arab (Rebased) Net Capex -162 -285 -844 -207 -317 -326 Free cash flow -167 1,226 -773 202 771 1,052 Margin Trends Equity raised/(bought back) 0 0 0 0 0 0 Dividends paid 0 -78 -339 -29 -78 -112 16 Net inc/(dec) in borrowings 158 -51 1,025 -363 -574 -30 14 Other investing/financing cash flows 17 -294 -60 -42 0 0 12 Net cash flow 7 803 -147 -232 119 911 10 8 Change in working capital -331 731 -1,487 -569 -29 193 6 06 07 08 09E 10E 11E Balance Sheet (AEDm) Cash and other liquid assets 101 904 757 573 692 1,602 EBITDA Margin EBIT Margin Tangible fixed assets 416 750 1,381 1,322 1,339 1,356 Goodwill/intangible assets 179 514 495 460 460 460 Growth & Profitability Associates/investments 42 113 146 226226 226 Other assets 1,598 2,560 6,680 6,836 7,082 6,144 150 70 60 Total assets 2,335 4,840 9,460 9,417 9,798 9,789 100 50 Interest bearing debt 158 229 1,255 933 359 329 40 50 30 Other liabilities 1,367 3,222 6,086 5,590 5,808 5,063 0 20 Total liabilities 1,525 3,452 7,342 6,523 6,166 5,392 10 -50 0 Shareholders' equity 784 1,250 1,893 2,583 3,243 3,896 Minorities 26 138 225 311389 501 06 07 08 09E 10E 11E Total shareholders' equity 810 1,388 2,118 2,894 3,632 4,397 Net debt 57 -675 498 359 -333 -1,274 Sales growth (LHS) ROE (RHS)
Solvency Key Company Metrics Sales growth (%) 9.5 52.1 127.5 -21.7 4.2 2.8 40 200 DB EPS growth (%) 31.5 145.4 79.0 -28.5 -4.9 -1.0 20 150 EBITDA Margin (%) 10.6 15.5 13.7 15.2 14.2 14.2 0 100 EBIT Margin (%) 7.4 12.7 11.0 11.3 10.4 10.4 -20 -40 50 Payout ratio (%) 31.6 52.2 0.0 0.0 0.0 0.0 -60 0 ROE (%) 32.1 52.7 61.0 30.6 22.4 18.1 Capex/sales (%) 5.9 7.3 8.9 3.3 4.0 4.0 06 07 08 09E 10E 11E Capex/depreciation (x) 1.8 2.6 3.3 0.8 1.1 1.1 Net debt/equity (%) 7.0 -48.6 23.5 12.4 -9.2 -29.0 Net debt/equity (LHS) Net interest cover (RHS) Net interest cover (x) nm 149.2 44.1 12.4 32.4 nm
Nabil Ahmed Source: Company data, Deutsche Bank estimates +971 4 4283-862 [email protected]
Page 38 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Investment thesis
Outlook Arabtec Holding is one of the largest civil construction companies in the GCC region and has a proven track record in executing some of the world’s signature developments (Burj Dubai, Burj Al Arab hotel, Emirates Towers). As primarily a Dubai-based contractor, the company was affected by the real estate slowdown and the backlog (excluding the Oktha Center AED10bn contract in Russia) declined 36% QoQ in Q1 09. However, we believe the worst is behind us: after a steep decline in Q1 09, the order book has stabilized at around AED19bn (2.5x 2009E revenues).
In our view, Arabtec’s equity story relies on its ability to grow internationally to offset the likely continued decline in the Dubai construction market. The group has successfully set up joint ventures in Qatar (with NBK) and in Saudi Arabia (with Saudi Bin Laden Group), which have paid off very quickly: AED4.3bn in contracts have been awarded to Arabtec in these two countries and the share of non-UAE contracts currently accounts for 36% of the backlog vs. only 17% nine months ago. We believe the quality of the backlog has improved, and risks of further contract cancellations have materially abated; our analysis suggests only 10% of backlog is at risk, vs. 62% nine months ago. Overall, we expect revenues and earnings to progressively stabilize despite the drop in Dubai construction.
We believe that the working capital situation will also improve gradually. The second tranch of the USD20bn federal bonds could improve Dubai developers’ liquidity progressively next year, thus driving some improvement in cash collection for UAE contractors.
According to us, the stock offers a free option on a positive outcome for its Russian contract (Oktha Center, AED10bn) and its pending litigation regarding the Meydan race course (AED845m). This could add up to AED1.2 per share, in our view, significantly enhancing the stock’s upside potential. Multiples are very attractive vs. peers. We initiate coverage with a Buy rating.
Valuation We value Arabtec using a DCF method (WACC 14%, LT growth 3%). This yields AED4 per share, i.e. an implicit 2010E P/E of 7.4x, vs. 9.5x for MENA contractors. On top of that, we add AED0.5 per share of option value (out of a potential AED1.2) related to the Oktha Center project and the Meydan claim. Thus, our target price works out at AED4.5 per share.
Risk MENA contractors are exposed to regional economic conditions, building and infrastructure spending, and the availability of project financing. Project delays or cancellations and failure to recover receivables could materially affect our earnings and valuation. In our view, the main specific downside risks for Arabtec are: 1) failure to secure new orders in MENA to offset the Dubai backlog decline, 2) further project cancellations, and 3) more delays in cash collection from customers that could put risk on the balance sheet.
Deutsche Bank AG/London Page 39 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
SWOT analysis
Strengths
Strong brand name along with a strong execution track record of highly visible signature developments leading to a high probability of winning potential future contracts.
Long-standing relationships with notable developers enable the company to win repeat orders. Arabtec is a preferred partner for Dubai Properties, Emaar, and Nakheel.
Strong management team and proactive strategy to address current issues. Weaknesses
Backlog still heavily dependant on Dubai (51% of total) and real estate (94% of total).
Receivables (AED4.6bn in Q3 09) account for 52% of the balance sheet, as Dubai developers have frozen payments to contractors. Arabtec has been managing liquidity by contracting debt and delaying payments to its suppliers, and the situation appears to be stabilized. However, the balance sheet shows AED355m in net debt, which could put a strain on the company’s ability to secure new contracts or enter into new markets.
Although it has management control of its subsidiaries in Saudi Arabia and Qatar, Arabtec owns a respective 45% and 49% of the joint ventures. As these two countries carry the strongest development potential, an increasing portion of the group profits will be shared with partners. Opportunities
Diversification into the fundamentally stronger construction markets of Saudi Arabia (joint venture with Bin Laden group), Abu Dhabi and Qatar could provide backlog growth.
Positive outcome on the Russian contract worth AED10bn by Gazpromneft.
Positive outcome on the Meydan claim (AED850m estimated).
Improved liquidity in Dubai could allow better cash-collection terms. Threats
Order cancellations, lack of receipt of new orders, and delays in execution of the current contracts due to the real estate collapse, namely in Dubai.
Increased competition following the contraction of activity in Dubai.
Further delay in payments from clients and also working capital and capex requirements to enter into new markets could put a strain on the company’s development.
Ability to execute contracts in several countries with different regulation and bidding processes at the same time.
Page 40 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Valuation
Valuation We primarily use a DCF method to value MENA contractors. Our standard assumptions are the following:
We use our forecasts over the 2009-12E horizon, then use a normalized long-term FCF and a 3% growth to infinity;
A risk-free rate of 5% and an emerging markets equity market risk premium of 6.5%. In the case of Arabtec, we use a Beta of 1.4x, in line with the one-year historical average. Long-term gearing is assumed at 0% (once clients’ payment terms return to normal). Our WACC therefore works out at 14.0%.
As a result, our valuation for Arabtec business works out at AED4 per share.
Figure 94: Equity value AED m 2009E Enterprise Value 7,004
Net debt (359) Financial assets 229 Employee benefits (128) Minorities (1,948) Net equity value 4,795 Number of shares outstanding 1,196 Value per share 4.0 Source: Deutsche Bank
Using the same standard DCF assumptions and assuming margins and capex will be equivalent to the average of the group, we value the Oktha Center project at AED583m, i.e., AED0.5 per share. We put an 80% likelihood for this project to be finally approved, i.e., AED0.4 per share in our valuation.
Arabtec (through its 50/50 joint venture WCT Engineering) also submitted an initial claim of c.AED1.7bn (AED845m for the group’s share) following the cancellation of the Meydan racecourse contract. If fully recovered, this would add AED0.7 per share to our valuation. We have put a 15% likelihood, i.e. AED0.1 per share. This puts our target price at AED4.5 per share.
Figure 95: Target price justification Items Value Value (AED per % likelihood kept in Target price AED m) share) our valuation (AED per share) DCF underlying business 4,795 4.0 - 4.0 Oktha Center (80% likelihood) 583 0.5 80% 0.4 Meydan claim (15% likelihood) 845 0.7 15% 0.1 Total optional value 1,428 1.2 - 0.5 Total value 6,223 6.2 - 4.5 Source: Deutsche Bank
Deutsche Bank AG/London Page 41 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Company profile
Corporate profile Established in 1975, Arabtec Holding is one of the largest civil construction companies in the GCC region and is the first contractor to be listed in DFM. The company primarily operates in the civil construction space and is engaged in the construction of residential, commercial and mixed use buildings. It provides end-to-end contracting services across the construction value chain and is also involved in providing associated construction services, namely mechanical engineering and plumbing (MEP contracting), manufacturing of ready-mix concrete, structural steel fabrication, trading and leasing of construction machinery and equipment. The company went public in August 2004, raised AED222m by selling its 55% stake. The IPO was oversubscribed 74 times.
The company operates in five business segments, namely building construction, precast and concrete production, drainage and electro mechanical works, marine construction and others. However, the building construction segment is the bread and butter of the company and contributed to 88% of 9m 09 revenues and 74% of 9m 09 EBIT.
Figure 96: Revenue breakdown 9m 09 Figure 97: EBIT breakdown 9m 09
Marine, Precast Marine, Precast MEP and others and others 8% 4% 8%
MEP 18%
Building 74% Building 88%
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
The company has a proven track record of executing some of the world’s signature developments, namely Burj Dubai, Burj Al Arab, Burj Dubai Lake Hotel, Sky Gardens, Al Fattan Towers, 21st Century Towers and the Fairmont Hotel. This has enabled the company to create a strong brand name, which is a distinct competitive advantage when bidding for landmark projects across GCC and the wider MENA region/elsewhere. In addition, it has resulted in sticky relationships with the clients that have resulted in repeat orders. Note that Arabtec is the preferred partner for Emaar, Dubai Properties, and Nakheel.
As of Q3 09 and excluding the AED10bn Oktha Center project in Russia, Arabtec has a backlog of AED18.9bn (2.5x 2009E revenues) spread over Dubai, Abu Dhabi, Saudi Arabia, Qatar and others. Dubai formerly accounted for the bulk of the project pipeline, but its share is rapidly declining, as the construction market suffered a sudden halt and following efforts by Arabtec to diversify its future revenue base. In order to extend its geographical coverage, the company has entered into partnerships with notable contractors in strategic geographies, namely with Bin Laden group in Saudi Arabia, Nasser Bin Khaled Al-Thani & Sons (NBK) in Qatar and acquired 60% of Target Engineering (a contractor based in Abu Dhabi for USD432m) in 2007. Figure 98 provides the list of some important subsidiaries of Arabtec.
Page 42 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 98: Strategic subsidiaries of Arabtec Joint ventures Ownership Partners
Arabtec Pakistan (under formation), Pakistan 60% AMN Mauritius LLC (40%, part of Abraaj Capital) Target Engineering Construction, Abu Dhabi 60% Management of Target (40%) Arabtec Construction, Qatar 49% Nasser Bin Khaled Al-Thani & Sons (NBK, 49%) Arabtec Saudi Arabia 45% Saudi Bin Laden Group (35%), Prime Group (20%) AES-WCT Contracting, Dubai 51% WCT Contracting Malaysia(49%) Source: Company data, Deutsche Bank
In addition, Arabtec and its subsidiaries enter into joint ventures to bid for specific projects, and the joint ventures are dissolved once the projects are complete. Some of the notable project-specific joint ventures are in Figure 99.
Figure 99: Arabtec’s project specific J/Vs Project Specific J/Vs Ownership Project
Abu Dhabi Investment Authority HQ 40% Abu Dhabi Investment Authority Arabtec/Six Construct/Samsung 30% Burj Dubai Arabtec/ Max Bogl 50% Jebel Ali Airport Arabtec/ Aktor 50%/60% Cleveland Clinic(now cancelled) Arabtec/ Emirates Sunland 50% D1 Tower, Palazzo Versace Dubai Arabtec/WCT Engineering 50% Meydan Racecourse (now cancelled) Arabtec/AMN Holdings 60% Karachi Financial Towers Arabtec/Dubai Contracting Company 50% Ocean Heights Dubai Target Engineering/Marintek Middle East/Asia FZE 65% Manufacturing of heavy duty concrete pontoons Source: Company data, Deutsche Bank
Shareholding structure Founders and management (CEO Riad Kamal – 5.4%, Mr. Al Safi Hashem Alawi – 6.0%) hold 11% of the shares, whereas the free float is 89% (public 55%, institutional investors – 34%). Foreign investment permissible limit is 49%.
Figure 100: Shareholding structure Figure 101: Foreign ownership limit
Riad Kamal 5% Al Safi Hashem Alawi 6%
Foreign Ownership Limit 49%
Free Float 89%
Source: Bloomberg Source: Zawya.com
Deutsche Bank AG/London Page 43 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Key managers Figure 102: Key management personnel HH Sheikh Butti Bin Maktoum Bin Juma Al Maktoum Chairman
HH Sheikh Sultan Bin Saqer Al Qassimi Vice Chairman Mr. Riad Burhan Taher Kamal CEO Mr. Ziad Makhzoumi CFO Source: Company data
Page 44 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Strategy and outlook
Recent backlog evolution: the worst is behind A backlog historically heavily geared to Dubai and residential/mixed-use segments At the end of September 2009, Arabtec’s backlog stood at AED18.9bn (excluding the AED10bn Oktha Center project in Russia that we have excluded from all our calculations by caution and given its unusual size). Dubai accounted for 51%, followed by Saudi Arabia (18%), Qatar (16%) and Abu Dhabi (13%). Arabtec’s backlog remains heavily geared to the civil building segment (mixed-use, residential) contributing to a combined 94% of the total backlog.
Figure 103: Backlog by geography (Q3 09) Figure 104: Backlog by market segment (Q3 09)
Abu Dhabi Infra. & Utilities Saudi Arabia 13% 6% 18%
Residential 36%
Qatar 16%
Others Mixed Use 2% Dubai 58% 51%
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Top five projects and top five clients account for 46% and 54% of the backlog, respectively The top five projects account for roughly 46% of the backlog, with the biggest project being Al Wa’ab City in Qatar, followed by Lamar Towers in KSA, Mohammad Bin Rashid Development (MBR Devpt.) in Dubai, and Princess Noora Abdul Rahman (PNAR) University in Saudi Arabia. In addition, the top five clients account for 54% of the backlog, Cayan Investments being the biggest client followed by Nasser Bin Khaled & Sons (NBK), developer of Wa’ab City in Qatar and Zabeel Investments.
Figure 105: Backlog in top 10 projects (AEDbn, Q3 09) Figure 106: Backlog in top five projects (Q3 09)
4.5 Al Wa'ab City (Qatar) 3.6 15%
2.7
1.8 Lamar Towers (KSA) 0.9 11%
0.0 Others 54% MBR Devpt. Porto Onyx MBR (Dubai) Tower City Devpt. D1 Lamar Nation Towers Towers PNAR Office 8% Hotel & Al Furjan Al Wa'ab Palazzo University Versace + Versace Zabeel Inv Zabeel
Qatar Saudi Arabia Dubai Abu PNAR University Dhabi (KSA) Porto (Dubai) 8% Approved Contract Value Backlog (Q3 09) 4%
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Deutsche Bank AG/London Page 45 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 107: Backlog from top 10 clients (AED bn, Q3 09) Figure 108: Backlog from top five clients (Q3 09)
4.5 Cayan Inv. 3.6 15%
2.7
1.8 Others NBK 46% 15% 0.9
0.0 ICT
NBK Zabeel Inv. MBR Emaar Devpt 8% Housing Nakheel Onyx for Sunland Emirates Bin Ladin Cayan Inv. Cayan Zabeel Inv. Zabeel MBR Housing Bin Ladin 8% Approved Contract Value Backlog (Q3 09) 8%
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Backlog increases to AED18.9bn in Q3 after stabilization at around AED18bn in Q2 Arabtec’s backlog declined from AED29bn in Q4 08, but has increased 5% q-o-q to AED18.9bn after stabilizing at AED18bn levels in Q2.
Figure 109: Backlog evolution (ex. Oktha Center) Figure 110: Backlog per region (ex. Oktha Center)
30,000 10% 30,000 5% 25,000 26,000 0% -5% 20,000 22,000 -10% -15% 15,000 18,000 -20% 10,000 -25%
14,000 -30% 5,000 -35% 10,000 -40% - Q4 08 Q1 09 Q2 09 Q3 09 Q4 08 Q1 09 Q2 09 Q3 09
Backlog (AED m, LHS) Quaterly growth (%, RHS) Dubai Abu Dhabi Qatar Saudi Arabia Others
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
The decline has been driven by significant cancellations in Q4 08 and Q1 09, namely in Dubai (and, to a lesser extent, in Abu Dhabi). As from the beginning of 2009, Arabtec has also started to win new sizeable contracts from outside its Dubai home markets (namely Saudi Arabia, Qatar and Abu Dhabi).
Figure 111: Order cancellations in Q1 09 and Q2 09 Order Cancellations Place Q1 09 Q2 09
Cleveland Hospital Abu Dhabi AED3.5bn 531 Villas - Saadiyat Beach Resort Villas Abu Dhabi AED2.0bn The Atrium - Waterfront II Dubai AED2.4bn LamTara Project Dubai AED1.8bn Shahla Tower Dubai AED371m 68 Equestrian Villas at Emirates Hills Dubai AED353m 550 Villas Warsan Estate Development Dubai AED584m Karachi Financial Towers Pakistan AED323m Total AED10bn AED584m Source: Company data, Deutsche Bank
Page 46 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 112: Major order receipts in Q1 09, Q2 09 and Q3 09 Order Receipts Place Q1 09 Q2 09 Q3 09
Nation Towers Abu Dhabi AED799m Zabeel Inv Hotel Tower & United Tiara Office Towers Dubai AED819m 523 Villas - Al Furjan Dubai AED773m House Connections & Misc. Projects Dubai AED151m Onyx Towers Dubai AED687m Mohammad Bin Rashid Devpt.(Increase in scope of work) Dubai AED1,150m Dubai Sports City (Increase in scope of work) Dubai AED300m Sanctuary Falls Villas (Increase in scope of work) Dubai AED80m Princess Noora Abdul Rahman University Saudi AED1.5bn Lamar Towers - Saudi Arabia Saudi AED2.0 Total AED3.1bn AED3.0bn AED2.2bn Source: Company data, Deutsche Bank
Risks of contract cancellations have largely abated Almost all project cancellations were located in the UAE The recent decline in the order book has been above all driven by significant project cancellations and a lack of new orders. We estimate that in Q1 09, only about AED10.7bn of projects have been cancelled. It is worth noting that almost all projects (97%) were located in the UAE, almost equally split between Dubai and Abu Dhabi.
Figure 113: Major projects cancellations in Q1 2009 Figure 114: Major projects cancellations since Sept. 08
Others Others 3% 2%
Dubai Abu Dhabi 46% 42%
Abu Dhabi Dubai 51% 56%
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
44% of backlog is not started or in early stages of construction… Our analysis suggests that all order cancellations were related to projects where construction had not started yet. These projects still account for 30% of Arabtec’s backlog, whereas another 14% are in relatively early stages of construction (0-15% complete).
Deutsche Bank AG/London Page 47 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 115: % of completion of projects in the backlog- Figure 116: Early stage projects (less than 15% Q3 2009 complete)-Q3 2009
50%+ complete 12% Dubai 21% 0% complete 30%
Saudi Arabia 42%
Abu Dhabi 25%-50% 17% complete 38% 0%-15% complete 14% Others 2% 15%-25% Qatar complete 18% 6% Source: Deutsche Bank Source: Deutsche Bank
However, a significant portion of the backlog in early-stage construction is in the fundamentally stronger markets of Saudi Arabia, Qatar and Abu Dhabi, which leads us to believe that although there is always a risk in the current uncertain macroenvironment, the chances of cancellation in these regions are more limited.
Figure 117: Backlog breakdown by stage of completion % of completion Dubai Abu Dhabi Qatar Saudi Arabia 0-15% 18% 59% 48% 100% 15-50% 65% 24% 48% 0% 50%+ 17% 17% 4% 0% Total 100% 100% 100% 100% Source: Deutsche Bank
…but the cancellation risk in the backlog has declined to 10% from 62% in nine months Our definition of projects at risk is as follows:
Construction has not started or is in a relatively early stage (less than 15% complete).
Projects are located in areas where cancellations have largely materialized in previous quarters (mainly Dubai and Abu Dhabi but also Pakistan). Basically, we are assuming that projects in Saudi Arabia or Qatar—even at early construction stages—do not carry risks of cancellation.
We have excluded from our calculation of projects at risk recent awards (even in Dubai and or Abu Dhabi). As a result, the amount of contracts at risk in the backlog has declined to AED1.8bn from AED17.7bn nine months ago. They currently represent 10% of the current backlog vs. 62% by year-end 2008.
Page 48 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 118: Projects at risk in the backlog Figure 119: Q3 09 breakdown of projects at risk
20,000 70% Others 7% 60% 16,000 50%
12,000 40% Abu Dhabi 30% 8,000 34%
20% Dubai 4,000 59% 10%
0 0% Q4 08 Q1 09 Q2 09 Q3 09
Projects at risk (AEDm, LHS) as a % of backlog (RHS)
Source: Deutsche Bank Source: Deutsche Bank
As a result of the repositioning of the backlog into less-risky locations but also—and mainly— to massive projects cancellations in the UAE in Q4 08 and Q1 09, we currently believe Arabtec’s order book appears much safer.
Successful international diversification under way Development initiatives abroad paying off very quickly In line with the improvement in the quality of the backlog, we believe Arabtec is on track to successfully reposition its pipeline of projects into new locations. This has been achieved through the set-up of selected joint ventures, namely in Qatar and Saudi Arabia. The downside of this strategy is that Arabtec will share the profits from these new contracts with other contractors and partners. The upside is that it has paid off very quickly, by securing large contracts. Also worth mentioning is the acquisition of Target Engineering, which has significantly enhanced Arabtec’s presence in Abu Dhabi and on the infrastructure segment.
Figure 120: Major international initiatives Subsidiary Location Description Date of First award Value first Awarded so formation award far (AED m) (AED m)
Arabtec Qatar Qatar JV (Arabtec 49%, NBK 51%) Q4 06 Q4 06 1,000 3,573 Target Engineering Abu Dhabi Acquisition (Arabtec 60%, Founders 40%) Q4 07 Q1 08 65 2,104 Arabtec Saudi Arabia Saudi Arabia JV (Arabtec 45%, Saudi Bin Laden Group 35%, Prime Group 20%) Q1 09 Q1 09 1,500 3,500 Source: Company data, Deutsche Bank
New orders won so far in 2009 lends weight to our backlog stabilization scenario According to our analysis, AED6.7bn of new contracts (excluding former contract renegotiations) has been awarded so far this year to Arabtec. They came mainly from Saudi Arabia (AED3.5bn), but interestingly there were also some new contracts in Abu Dhabi (Nation Towers, AED800m in Q2) and in Dubai (Dubai Municipality, AED140m in Q1, Onyx Towers in Q3, increase in scope of work at Mohammad Bin Rashid Devpt., AED1.5bn, Dubai Sports City, AED300m in Q3).
Deutsche Bank AG/London Page 49 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 121: New orders received YTD by location Figure 122: New orders received YTD by quarter (AED m)
3,500
3,000
Dubai 2,500 36% 2,000
1,500 Saudi 52% 1,000
500
- Abu Dhabi Q1 09 Q2 09 Q3 09 12% Dubai Abu Dhabi Qatar Saudi Arabia Others
Source: Company data, Deutsche Bank Source: Company Data, Deutsche Bank
This lends weight to our FY09 estimate of AED8.9bn. Beyond we expect the continuation of the positive momentum on the international locations (namely Saudi Arabia) and new contracts to recover a growth mode. As from FY2010E, awards are expected to exceed revenues, meaning that if there are no further cancellations, backlog and future revenues will increase.
Figure 123: Expected new orders 2009-12E Figure 124: Expected new orders by location (AED m)
14,000 1.6 14,000
12,000 1.4 12,000 1.2 10,000 10,000 1.0 8,000 8,000 0.8 6,000 0.6 6,000 4,000 0.4 4,000 2,000 0.2 2,000 - - 2009E 2010E 2011E 2012E - 2009E 2010E 2011E 2012E
New orders (AED m, LHS) Revenues (AED m, LHS) New orders / Revenues Dubai Abu Dhabi Qatar Saudi Arabia Others
Source: Deutsche Bank Source: Deutsche Bank
Dubai’s contribution to the backlog and revenues expected fall to 17% by 2012E As a result of our order assumptions, the share of Dubai’s revenues and its contribution is expected to decline strongly. By 2012E, we expect the revenue contribution from Dubai to be close to 17% and the broader UAE to account for around one-third of sales.
Page 50 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 125: Contribution of Dubai revenues (AEDm) Figure 126: Contribution of UAE revenues (AEDm)
5,000 60% 7,000 80%
70% 50% 6,000 4,000 60% 5,000 40% 50% 3,000 4,000 30% 40% 3,000 2,000 30% 20% 2,000 20% 1,000 10% 1,000 10%
- 0% - 0% 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E
Dubai As of % of total revenues (RHS) UAE revenues (AED m, LHS) As of % of total revenues (RHS)
Source: Deutsche Bank Source: Deutsche Bank
Similarly, the regional breakdown in the backlog would basically highlight a very different Arabtec from what it is today, with a much greater contribution from Saudi Arabia.
Figure 127: Q3 09 backlog breakdown Figure 128: 2012E backlog breakdown
Others Others Dubai 2% 8% 11% Saudi Arabia 18%
Abu Dhabi 17%
Dubai 51% Qatar 16% Qatar 8% Saudi Arabia 56% Abu Dhabi 13%
Source: Company data, Deutsche Bank Source: Deutsche Bank
Russia could be an AED10bn-plus icing on the cake In 2008, Arabtec secured a contract from Gazpromneft to build the Okhta City Center (mixed- use) in St. Petersburg at a contract value of AED10bn. Since then, the status of the project has been questioned by investors, as there was some opposition among city inhabitants and Gazprom was widely seen as not having any more the money to spend. Arabtec’s management claims the project had to be redesigned and is currently under testing (Arabtec recently received an AED50m contract to start the foundation testing). The green light could come by year-end, which would mean work will start after the winter (Q2 10). This project has not been included in our estimates, although we factor in an option value in our target price. Some confirmation of the contract going through would be a positive development for the stock. Note that the Russian contract is a high-margin exotic contract (like Burj Dubai), and, if it materializes would alone contribute to a combined AED0.11 per share for EPS in 2010 (23% enhancement) and AED0.17 per share in 2011 (+37%) and 2012 (+32%). Beyond, we believe Arabtec is taking initiatives to secure other contracts in Russia (again not factored in our forecasts) and could be an area of positive surprises for the group.
Deutsche Bank AG/London Page 51 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Financials
Q3 09 results review We believe Q3 numbers were overall in line with company guidance.
Figure 129: Q3 results AED m Q3 09 Q3 08 % YoY chg. Q2 09 % QoQ chg. Revenues 1,658 2,278 -27% 2,050 -19% Gross profit 277 337 -18% 357 -23% as of % of sales 16.7% 14.8% 17.4% EBIT 202 299 -32% 221 -8% as of % of sales 12.2% 13.1% 10.8% Finance Cost (8) (2) (18) Other items 17 (3) (0) Tax (2) (1) (1) Minority interests (43) (38) (17) Attributable profit 167 255 -35% 184 -9% as of % of sales 10.0% 11.2% 9.0% Source: Company data, Deutsche Bank
Revenues in Q3 09 stood at AED1.7bn, down 27% y-o-y and 19% q-o-q. The sequential decline in revenues was expected, given the fewer working days due to restrictive hours during the summer season, the holy month of Ramadan and the Eid holidays. The gross margin increased to 16.7% from 14.8% in Q3 08 but remained below the 17.4% rate in Q2.
Lower SG&A and some cost cutting led to an improvement of EBIT margin to 12.2% (vs. 10.8% in Q2 09). Note that the Q2 09 base was depressed by AED164m in SG&A cost (change in accounting method for employee visa cost). The good surprise came from the net margin at 10%, which benefited from the decline in financial charges (compared to Q2 09), as a result of the decreased debt position.
Working capital management: towards a gradual improvement? Strong increase in receivables resulting in AED0.5bn of financial debt In general terms, we do not like contractors with a net debt position. We believe this cyclical service industry should have a relatively light capital-intensive business model and should get customers’ pre-payment and negative working capital. This was also the case for Arabtec until delays in UAE developers’ payments arose in the second half of 2008. Receivables rose from AED2.7bn in Q2 08 (110 days of annualized sales) to a peak of AED4.6bn in Q3 09 (229 days of annualized sales, higher than Q2 09 but at the same level as Q1 09). This has put the company into a net debt position of AED355m by September 2009, vs. net cash of AED269m a year ago. However, note that net debt declined from AED583m in Q2 09.
Page 52 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 130: Receivables, payables and WCR Figure 131: Net debt and WCR
300 15% 1,000 800 250 10% 600
200 5% 400
200 150 0% - 100 -5% Q1 07 Q2 07 Q3 07 Q4 07 Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 (200)
50 -10% (400) (600) - -15% (800) Q1 07 Q2 07 Q3 07 Q4 07 Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 (1,000) Trade receivables (days of sales, LHS) Trade payables (days of sales, LHS) Working capital (as a % of sales, RHS) Net debt / (net cash) WCR
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Arabtec has managed the situation by delaying its suppliers and subcontractors’ payments— thus, the increase in payables from AED3.7bn in Q2 08 (150 days of annualized sales) to a peak of AED5bn (246 days of annualized sales)—and by drawing short-term credit facilities (namely bank overdrafts). It has since then extended the maturity of its loan by contracting mid-term debt.
Figure 132: Structure of debt, 2008 Figure 133: Kind of debt vehicle, 2008
Term loan 5% Trust receipts LT Bank 10% borrowings 24% Acceptances 3%
ST Bank borrowings 76% Bank overdrafts 82%
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Modest provisioning on receivables from Dubai government-related entities At the end of 2008, allowances for doubtful debts were extremely modest: AED6m, i.e., 0.1% of receivables. We believe this is justified because the main debtors are the group’s largest customers historically, i.e., the Dubai government-owned master-developers (Nakheel, Emaar, Dubai Properties). At December 2008, the group’s largest customer represented AED561m, i.e., slightly less than 12% of receivables.
Deutsche Bank AG/London Page 53 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 134: Past due receivables Figure 135: Ageing of past due receivables
400 8% 400
350 7% 350
300 6% 300
250 5% 250
200 4% 200
150 3% 150
100 2% 100
50 1% 50
- 0% - 2006 2007 2008 2006 2007 2008
Ageing of past due but not impaired (AED m, LHS) as of % of receivables (RHS) Less than 3 months More than 3 months
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Gradual improvement expected after Dubai’s second tranch of USD20bn bonds Given their strong tie with the Dubai government, some implicit support is considered and we believe the risk of not getting paid by the master-developers should not be overstated. However, the key questions remain: When will contractors be paid and how much? We believe it is likely that some of the developers will try to settle their payables at a lower rate.
In terms of timing, we believe the second tranch of the USD20bn federal bonds will provide a much needed liquidity to Dubai. A significant portion of that amount is supposed to support the real estate sector, therefore, the developers. The first USD10bn bond last February triggered some payment to contractors. Since then, developers are paying but with delays. We expect the second USD10bn injection to act as a potential catalyst for better cash collection for contractors.
Our estimates assume only a slight deterioration between now and the end of the year. Nevertheless, we believe that the worst is behind as shown by the stable receivables situation (compared to Q1 level but slight increase compared to Q2) and that debt has continuously declined (albeit marginally in Q3 vs. Q2) from the end of 2008.
Figure 136: Quarterly receivables, payable and WCR Figure 137: Quarterly net debt and WCR
300 15% 1,500
250 10% 1,000 200 5%
500 150 0%
100 -5% - Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09E 50 -10% (500) - -15% Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09E (1,000) Trade receivables (days of sales, LHS) Trade payables (days of sales, LHS) Working capital (as a % of sales, RHS) Net debt / (net cash) WCR
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
We assume net debt will further decrease to around AED291m by year-end 2009. Beyond, we believe the situation will gradually improve, and Arabtec should generate around AED2bn of cash.
Page 54 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 138: Receivables, payable and WCR 2005-12E Figure 139: Net debt and WCR 2005-12E
300 20% 1,500
15% 250 1,000 10% 500 200 5% - 150 0% 2005 2006 2007 2008 2009E 2010E 2011E 2012E (500) -5% 100 -10% (1,000) 50 -15% (1,500)
- -20% (2,000) 2005 2006 2007 2008 2009E 2010E 2011E 2012E (2,500) Trade receivables (days of sales, LHS) Trade payables (days of sales, LHS) Working capital (as a % of sales, RHS) Net debt / (net cash) WCR
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Main assumptions Progressive ramp up in new orders We expect Q4 09 new awards to be broadly similar to Q3 09. We then expect relatively flattish backlog growth in 2010E before a ramp up with future avenues of growth are in place in Abu Dhabi, Saudi Arabia, Libya, Algeria and Egypt.
Figure 140: Backlog, new orders and revenues forecasts over 2009-12E AED m 2009E 2010E 2011E 2012E
Opening Backlog 28,526 19,048 19,582 21,986 New Awards 8,852 8,459 10,551 12,662 Closing Backlog 19,048 19,582 21,986 25,500 Revenues 7,609 7,925 8,148 9,148 Source: Deutsche Bank
Figure 141: New orders (AED m) Figure 142: Revenues (AED m)
14,000 10,000 9,000 12,000 8,000 10,000 7,000
8,000 6,000 5,000 6,000 4,000
4,000 3,000 2,000 2,000 1,000 - - 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E
Dubai Abu Dhabi Qatar Saudi Arabia Others Dubai Abu Dhabi Qatar Saudi Arabia Others
Source: Deutsche Bank Source: Deutsche Bank
Modest margin decline We expect a modest contraction in margins beyond 2009E and foresee the net profit margin at 7-8%, below the rate of company guidance (8-9%).
Deutsche Bank AG/London Page 55 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 143: Margin trends
20.0%
16.0%
12.0%
8.0%
4.0%
0.0% 2005 2006 2007 2008 2009E 2010E 2011E 2012E
Gross margin EBITDA margin EBIT margin Net margin
Source: Arabtec, Deutsche Bank
Detail of our estimates
Figure 144: Income statement 2008-12E AED m 2008 2009E 2010E 2011E 2012E Revenues 9,722 7,609 7,925 8,148 9,148 % growth 127.5% -21.7% 4.2% 2.8% 12.3% COGS (8,230) (6,352) (6,656) (6,842) (7,682) as of % sales -84.7% -83.5% -84.0% -84.0% -84.0% Gross profit 1,492 1,257 1,270 1,305 1,466 as of % sales 15.3% 16.5% 16.0% 16.0% 16.0% % growth 101.9% -15.7% 1.0% 2.8% 12.3% Other operating income/(expense) 167 107 111 114 128 SG&A (586) (504) (555) (570) (640) EBITDA 1,333 1,160 1,126 1,158 1,300 as of % sales 13.7% 15.2% 14.2% 14.2% 14.2% % growth 100.7% -13.0% -2.9% 2.8% 12.3% Depreciation & Amortization (260) (300) (300) (309) (347) EBIT 1,073 860 826 849 953 as of % sales 11.0% 11.3% 10.4% 10.4% 10.4% % growth 97.4% -19.9% -3.9% 2.8% 12.3% Finance Cost (24) (69) (25) 16 28 Other income/(expense) 57 38 40 41 46 Changes in Fair Value of non-current retentions (10) (8) (8) (8) (9) Profit before tax 1,096 821 832 898 1,018 Tax (16) (21) (24) (29) (40) Effective tax rate 1.5% 2.5% 2.9% 3.3% 3.9% Minority interests (122) (115) (157) (223) (285) % minorities 11.3% 14.4% 19.4% 25.7% 29.1% DB restated net income post minorities 958 685 652 645 694 as of % sales 11.0% 11.3% 10.4% 10.4% 10.4% % growth 89.3% -25.1% 1.4% 7.9% 13.4% Source: Deutsche Bank
Page 56 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 145: Cash flow statement 2008-12E AED m 2008 2009E 2010E 2011E 2012E Cash flow from operations 1,558 978 1,117 1,186 1,334 (Incr)/decr in working capital (1,487) (569) (29) 193 189 Purchase of property, plant and equipment (868) (248) (317) (326) (366) Disposal of property, plant & equipment 24 41 Total capex (844) (207) (317) (326) (366) as of % sales 8.7% 2.7% 4.0% 4.0% 4.0% Operating free cash-flow (773) 202 771 1,052 1,157 (Investments)/Proceeds from investments in securities (45) (36) Acquisition of investment in subsidiaries (net of cash) (16) - Investment in associate - (4) (Increase)/decrease in loans to a related party 2 (2) FCF after investing activities (833) 160 771 1,052 1,157 Dividends paid to non-controlling shareholders (40) (29) (78) (112) (142) (Repayments)/Proceeds from Bank Borrowings (net) 1,025 (363) (574) (30) (30) Minority Interests invested 0 Dividends Paid (299) - Net cash flow (147) (232) 119 911 985 Source: Deutsche Bank
Deutsche Bank AG/London Page 57 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 146: Balance sheet 2008-12E Balance sheet 2008 2009E 2010E 2011E 2012E ASSETS Current Assets Cash and Cash Equivalents 757 573 692 1,602 2,588 Other Financial Assets 93 130 130 130 122 Trade and other Receivables 4,983 5,074 5,286 4,505 4,016 Due from related parties 278 416 416 416 416 Inventories 1,017 836 871 714 598 Other Current Assets 158 168 168 168 133 Total current assets 7,286 7,198 7,562 7,535 7,872 Non current assets Other Financial Assets 53 96 96 96 96 Intangible Assets 242 207 207 207 207 Goodwill 252 252 252 252 252 Retentions Receivable - Non current portion 237 332 332 332 332 Other non-current assets 8 10 10 10 10 Property, plant and equipment 1,381 1,322 1,339 1,356 1,375 Total non-current assets 2,173 2,219 2,236 2,253 2,273 Total Assets 9,460 9,417 9,798 9,789 10,144 EQUITY & LIABILITIES Current Liabilities Bank Borrowings 1,102 692 118 88 58 Trade and other payables 5,732 5,021 5,230 4,477 4,016 Due to related parties 173 327 327 327 327 Income taxes payable 3 5 5 5 5 Dividend Payable Total current liabilities 7,010 6,045 5,680 4,897 4,406 Non Current Liabilities Bank Borrowings 154 241 241 241 241 Provision for employees end of service indemnity 114 128 128 128 128 Retentions Payable - non-current portion 64 109 117 126 135 Total non current liabilities 332 479 487 495 504 Total Liabilities 7,342 6,523 6,166 5,392 4,910 Shareholder's equity Issued Share Capital 1,196 1,196 1,196 1,196 1,196 Statutory Reserve 188 239 239 239 239 Fair value adjustement reserve (6) (3) (3) (3) (3) Retained Earnings 516 1,151 1,811 2,465 3,168 Equity attributable to equity holders of company 1,893 2,583 3,243 3,896 4,599 Non-controlling interests 225 311 389 501 643 Total Equity 2,118 2,894 3,632 4,397 5,243 Total Equity and Liabilities 9,460 9,417 9,798 9,789 10,153
Net debt 498 359 (333) (1,274) (2,289) Gearing 24% 12% -9% -29% -44% Net debt / EBITDA 0.4 0.3 (0.3) (1.1) (1.8) Source: Deutsche Bank
Page 58 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Middle East United Arab Emirates Real Estate, Construction and Building Materials Construction
17 November 2009 Drake & Scull Buy Price at 16 Nov 2009 (AED) 1.04 Reuters: DSI.DU Bloomberg: DSI UH Price Target (AED) 1.30 52-week range (AED) 1.22 - 0.64
War chest with ambitions Price/price relative 1.35 1.2 1.05 0.9 We initiate coverage with a Buy rating, target price of AED1.3 0.75 Drake & Scull is actively diversifying from its former Dubai-based MEP contracting 0.6 business to tap the potential of the MENA infrastructure markets. New contracts 3/09 9/09 could be announced soon, and the company has identified several potential Drake & Scull acquisitions, which could significantly speed up development. Cash accounts for MSCI Arab (Rebased) c.50% of market cap and allows for aggressive inorganic expansion. At 5.7x 2010E P/E (ex cash), valuation is attractive. We initiate with a Buy rating and Performance (%) 1m 3m 12m AED1.3 target price. Absolute -14.0 15.6 – MSCI Arab -6.2 2.2 10.4 The need to grow the infrastructure business into new MENA markets Despite being a former Dubai-based MEP contractor, Drake & Scull has suffered Stock data from limited order cancellations, resulting in a modest 6% decline in its backlog Market cap (AED)(m) 2,264.9 Shares outstanding (m) 2,178 since Q4 08. However, excluding the Bahrain project, non-UAE contracts Free float (%) 60 accounted for a mere 13% of the order book and the backlog/revenues ratio is MSCI Arab 488.4 1.4x, the lowest in our coverage universe. This highlights the necessity for Drake & Scull to gain new awards and namely grow its infrastructure business (currently Key indicators (FY1) 19% of the backlog) in MENA markets. We believe management is actively ROE (%) 21.9 addressing this issue, and new contracts in selected locations could be Net debt/equity (%) -37.0 Book value/share (AED) 1.2 announced soon. Book value/share (AED) 1.2 Price/book (x) 0.9 Cash accounts for c.50% of market cap’ and allows for expansion Net interest cover (x) – Drake & Scull has set an aggressive mid-term target to generate AED5bn EBIT margin (%) 13.8 revenue. We believe that this three-fold increase could be achieved through a mix of organic and external growth. Several targets have been identified in selected locations and AED500m could be spent between now and early 2010E. We believe this could potentially add AED1.3bn in the backlog, increasing the company’s scope of works by c.50%. Cash of AED1bn (c.50% of market cap’) raised at the IPO suggests that financing is not an issue and Drake & Scull could simultaneously pursue its share buy back program. Target price set at AED1.3; use of cash is the key issue Our target price is based on a DCF method (WACC 12.4%, LT growth 3%). This yields AED1.3 per share, i.e. an implicit 2010E P/E of 9.5x ex. cash, in line with MENA peers. MENA contractors are exposed to regional economic conditions, building and infrastructure spending and availability of project financing. Project delays or cancellation and failure to recover receivables could materially impact our earnings/valuation. Main specific downside risks for Drake & Scull are (1) failure to secure new orders in MENA to offset for the expected Dubai backlog decline, (2) further project cancellations and (3) M&A risks given the strong net cash position and the company’s aggressive expansion ambition.
Deutsche Bank AG/London Page 59 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Model updated:12 November 2009 Fiscal year end 31-Dec 2006 2007 2008 2009E 2010E 2011E
Running the numbers Financial Summary Middle East DB EPS (AED) 0.03 0.05 0.08 0.15 0.11 0.11 Reported EPS (AED) 0.03 0.05 0.10 0.14 0.10 0.11 United Arab Emirates DPS (AED) 0.00 0.00 0.00 0.00 0.00 0.00 Construction BVPS (AED) 0.0 0.1 0.1 1.2 1.3 1.4 Weighted average shares (m) 2,178 2,178 2,178 2,178 2,178 2,178 Average market cap (AEDm) na na na 2,287 2,287 2,287 Drake & Scull Enterprise value (AEDm) na na na 1,171 987 734 Valuation Metrics Reuters: DSI.DU Bloomberg: DSI UH P/E (DB) (x) na na na 7.1 9.7 9.2 P/E (Reported) (x) na na na 7.4 10.1 9.6 Buy P/BV (x) 0.00 0.00 0.00 0.91 0.83 0.77 Price (17 Nov 09) AED 1.05 FCF Yield (%) na na na nm 8.3 11.4 Target price AED 1.30 Dividend Yield (%) na na na 0.0 0.0 0.0 52-week Range AED 0.64 - 1.22 EV/Sales (x) nm nm nm 0.6 0.6 0.4 EV/EBITDA (x) nm nm nm 4.1 4.2 2.9 Market Cap (m) AEDm 2,287 EV/EBIT (x) nm nm nm 4.5 4.8 3.3 USDm 623
Company Profile Income Statement (AEDm) Established in 1966 and headquartered in Dubai, Drake and Sales revenue 496 820 1,720 1,882 1,783 1,928 Scull (DSI) is a vertically integrated specialized contracting Gross profit 87 170 349 414 353 379 company formerly active in the niche segment of providing EBITDA 67 121 181 288233 250 mechanical, electrical and plumbing services (MEP). Depreciation 6 15 25 2828 28 Additionally, it is also engaged in providing infrastructure, Amortisation 0 0 0 00 0 water & power (IWP) services and civil contracting services. EBIT 61 105 156 260205 222 Net interest income(expense) 1 -1 3 68 37 32 Associates/affiliates 0 0 0 00 0 Exceptionals/extraordinaries 0 0 0 00 0 Other pre-tax income/(expense) -3 1 53 -11 -10 -10 Profit before tax 58 106 212 317 233 244 Price Performance Income tax expense 0 0 0 0 0 0 Minorities 0 6 2 97 7 1.35 Other post-tax income/(expense) 0 0 0 0 0 0 1.2 Net profit 58 100 210 308 226 237 1.05 0.9 DB adjustments (including dilution) 5 5 -27 14 10 10 0.75 DB Net profit 63 105 182 321 236 247 0.6 Mar 09 Sep 09 Cash Flow (AEDm) Cash flow from operations 76 74 -16 -44 279 356 Drake & Scull MSCI Arab (Rebased) Net Capex -30 -54 -97 -14 -89 -96 Free cash flow 46 20 -113 -58 190 260 Margin Trends Equity raised/(bought back) -6 0 0 1,198 0 0 Dividends paid -25 -30 0 0 0 0 17 Net inc/(dec) in borrowings 9 -9 189 4 -76 0 15 Other investing/financing cash flows -2 9 -24 -87 0 0 14 Net cash flow 23 -11 52 1,058 113 260 12 11 Change in working capital 11 -50 -186 -385 18 84 9 06 07 08 09E 10E 11E Balance Sheet (AEDm) Cash and other liquid assets 63 128 162 1,233 1,347 1,607 EBITDA Margin EBIT Margin Tangible fixed assets 37 96 172 153 214 283 Goodwill/intangible assets 0 147 147 830 830 830 Growth & Profitability Associates/investments 16 21 25 203203 203 Other assets 227 567 944 1,385 1,317 1,352 120 100 Total assets 343 959 1,450 3,805 3,912 4,275 100 80 80 Interest bearing debt 16 66 262 293 217 217 60 60 40 40 Other liabilities 254 741 877 991 941 1,060 20 Total liabilities 269 806 1,139 1,284 1,158 1,277 0 20 -20 0 Shareholders' equity 74 144 297 2,516 2,742 2,979 Minorities 0 8 14 2734 41 06 07 08 09E 10E 11E Total shareholders' equity 74 152 311 2,543 2,776 3,020 Net debt -47 -62 100 -940 -1,130 -1,390 Sales growth (LHS) ROE (RHS)
Solvency Key Company Metrics Sales growth (%) nm 65.4 109.7 9.4 -5.2 8.1 40 140 20 120 DB EPS growth (%) na 67.7 73.0 76.2 -26.5 4.7 0 100 EBITDA Margin (%) 13.4 14.7 10.5 15.3 13.1 13.0 80 -20 60 EBIT Margin (%) 12.2 12.8 9.1 13.8 11.5 11.5 -40 40 Payout ratio (%) 0.0 0.0 0.0 0.0 0.0 0.0 -60 20 -80 0 ROE (%) 78.3 91.7 95.1 21.9 8.6 8.3 Capex/sales (%) 6.0 6.7 5.6 0.9 5.0 5.0 06 07 08 09E 10E 11E Capex/depreciation (x) 4.9 3.6 3.9 0.6 3.2 3.4 Net debt/equity (%) -63.8 -40.5 32.0 -37.0 -40.7 -46.0 Net debt/equity (LHS) Net interest cover (RHS) Net interest cover (x) nm 127.1 nm nm nm nm
Nabil Ahmed Source: Company data, Deutsche Bank estimates +971 4 4283-862 [email protected]
Page 60 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Investment thesis
Outlook Established in 1966 and headquartered in Dubai, Drake and Scull (DSI) is a vertically- integrated specialized contracting company engaged in providing mechanical, engineering and plumbing (MEP), infrastructure, water & power (IWP) and civil contracting services. Despite being known as a Dubai based MEP contractor, it suffered from limited order cancellation, resulting in a modest 6% decline in its backlog since its peak in end-2008. New orders have started to flow and as a result, the order book is back to a growth mode since Q1 09.
Additionally, the company is following an active and ambitious strategy to diversify from its former Dubai MEP contracting division to tap the potential in the MENA infrastructure markets. However, excluding the Bahrain project, non-UAE contracts account for a mere 13% of the order book and the backlog / revenues ratio is 1.4x, the lowest in our coverage universe. This highlights the need for Drake & Scull to gain new awards and namely grow its infrastructure business (currently 19% of the backlog) in MENA markets. We believe that the management is actively addressing this issue and new contracts in selected locations namely Saudi Arabia, Libya, Qatar or Oman could be unveiled soon.
With AED1bn of net cash raised during the recent IPO, we believe Drake & Scull enjoys a unique ‘cash rich’ player position among its peers. This offers some cushion against the receivables’ risk but, more importantly, offers a unique opportunity to the company to take advantage of the current market conditions. Management has set an aggressive target to generate AED5bn revenue in the next 3-5 years. We believe this three-fold increase could be achieved through a mix of organic and external growth. Several acquisition targets have been identified in selected locations and AED500m is likely to be spent by end-2010E. We believe this could potentially add AED1.3bn in the backlog, increasing the company’s scope of works by c.50%.
We believe that the way cash will be spent will be closely monitored by investors and also will be the key driver for Drake & Scull’s equity story in the coming months. This raises some M&A and execution risks; however, it offers a formidable room of maneuver to accelerate expansion in new geographies/segments. We initiate the stock as a Buy.
Valuation Our target price is based on a DCF method (WACC 12.4%, LT growth 3%). This yields AED1.3 per share, i.e. an implicit 2010E P/E of 9.5x ex. cash in line with MENA peers.
Risks MENA contractors are exposed to regional economic conditions, building and infrastructure spending and availability of project financing. Project delays or cancellation and failure to recover receivables could materially impact our earnings/valuation. Main specific downside risks for Drake & Scull are: (1) failure to secure new orders in MENA to offset for the expected Dubai backlog decline, (2) further project cancellations and (3) M&A risks given the strong net cash position and the company’s aggressive expansion ambition.
Deutsche Bank AG/London Page 61 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
SWOT analysis
Strengths
Well-recognized brand name and a long track record (the company was established in the UAE in 1966).
Strong net cash position of AED788m (AED0.36/share) as of Q3 09 (cash AED1.12bn, debt AED328m). The cash primarily accrued to it from its IPO in July 2008 at the near peak of the DFM. Despite the increase in WCR, Drake & Scull is the only contractor in our universe enjoying a net cash position.
Ability to generate new awards. In 2009, when construction slowed down globally, the company managed five sizable contracts worth AED1.4bn (55% of current backlog, excluding the Bahrain contract) in Dubai, Abu Dhabi and Thailand. Weaknesses
Current backlog is heavily geared to Dubai and civil construction (residential/mixed use) segment. Since aggressive diversification efforts would take some time to materialize, near-term earnings will be affected by construction slowdown in Dubai. Opportunities
Its strong cash position will enable DSI to tide over the working capital strain due to increasing receivables. It would also create a competitive advantage while bidding for new projects.
Further, it would provide enough reserve cash to look for attractive acquisition opportunities in strategic target geographies and market segments
Active diversification of operations from Dubai (55% of backlog as of Q309) to other growth markets of Saudi Arabia, Abu Dhabi, Bahrain, Qatar, etc,. Further diversification from MEP to IWP would also help to reposition the company in the growing MENA infrastructure market. Threats
Increased competition for new projects could pressurize margins across segments. Additionally, contract renegotiations could lead to lower margins on existing backlog.
Increase in receivables and lower down payments from customers could strain working capital in the near term. Additionally, there could be bad debts on the current receivables portfolio.
DSI has an aggressive expansion plan (organic/inorganic) across segments and geographies and as a result has execution risks.
Page 62 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Valuation
Valuation We primarily use a DCF method to value MENA contractors. Our standard assumptions are the following:
We use our forecasts over the 2009-12E horizon, then use a normalized LT FCF and a 3% growth to infinity;
Risk-free rate of 5% and EM equity market risks premium of 6.5%. In the case of Drake & Scull, we use a Beta of 1.1x, in line with the one-year historical average. Long-term gearing is assumed at 0%. Our WACC therefore works out at 12.4%.
As a result, our equity value works out at AED1.30 per share.
Figure 147: Equity value AED m 2009E Enterprise Value 1,739
Net cash 940 Other assets 225 Other liabilities (27) Minorities (81) Treasury shares 31 Net equity value 2,827 Number of shares outstanding 2,178 Value per share 1.30 Source: Deutsche Bank
Deutsche Bank AG/London Page 63 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Company profile
Corporate profile Established in 1966 and headquartered in Dubai, Drake and Scull (DSI) is a vertically- integrated specialized contracting company engaged in the niche segment of providing mechanical, electrical and plumbing services (MEP). Additionally, it is also engaged in providing infrastructure, water & power (IWP) services and civil contracting services.
Drake & Scull filed for an IPO in July ‘08 at an opportune time when DFM was near its peak and raised AED1.2bn (1.2bn shares at AED1.02/share) by selling 55% stake. The IPO was 101x oversubscribed and the stock was finally listed in DFM on 16 March 2009. Note that it is the second listed contractor in UAE after Arabtec.
DSI operates through three reportable segments namely MEP, IWP and civil contracting. Historically, MEP segment accounted for the largest portion of revenues and earnings. Note that during 17 November ’08 to 30 September ’09, it contributed to 65% of the revenue and 68% of the net profit (including pre incorporation profit of AED42m).
Figure 148: Revenue breakdown (17th Nov ’08 – Q3 09) Figure 149: Net Profit breakdown (17th Nov ’08 – Q3 09)
Civil Contracting Civil Contracting 14% 19%
IWP 18% IWP 16%
MEP 65% MEP 68%
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Further, in line with the industry trend, during the same period, IWP segment recorded the highest net margin of 19.0% followed by MEP (18.2%) and Civil Works (12.8%).
Page 64 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 150: Segmental net margins (17th Nov 2008 – Q3 09)
21.0% 19.0% 19.0% 18.2%
17.0%
15.0% 12.8% 13.0%
11.0%
9.0%
7.0%
5.0% MEP IWP Civil Works
Source: Company data, Deutsche Bank
MEP DSI has been engaged in MEP contracting since 1966. MEP projects are undertaken by its 100% subsidiary, Drake and Scull Abu Dhabi. This segment offers services to diversified commercial, industrial and residential clients. Services are either provided directly to the project developers (namely corporations, municipalities and other governmental entities, owners/developers) or indirectly as sub-contractor to the primary contractor. MEP services include installation of MEP systems that enable safe, effective, high-quality lighting, electricity, security, plumbing, heating, cooling and power generation in buildings across a wide range of industries. Note that DSI was awarded “MEP Contractor of the Year” for two consecutive years in 2007 and 2008. MEP contracting services fall principally into three categories: large installation projects, with contracts generally in the multi-million dirham range; smaller system installation projects involving fit-out, renovation and retrofit work; and facilities services.
IWP Established in 2006, IWP segment operates from Dubai and serves the UAE market. In the recent past, it has started offering services in other geographies namely Saudi Arabia, Bahrain, Oman and Sudan. IWP segment operates on an EPC and EPCM basis and margins are higher than civil contracting and MEP. This segment is engaged in the design and construction of district cooling, sewage & water treatment plants and power generation and distribution. In 2006, it was awarded the contract for building District Cooling System for the Jumeirah Beach Residence, Dubai, which then, was one of the largest in the world.
Civil Contracting DSI entered civil contracting only in 2007 through the acquisition of 80% of Gulf Technical Construction Company (GTCC, formerly Test Contracting). This segment is involved in the construction of civil, infrastructural and industrial works. The rationale for the acquisition was to secure a higher proportion of the customer’s wallet share by offering end-to-end services. Note that apart from real estate constructions, GTCC was also involved in the construction of district cooling plants in Dubai Festival City and Green Community. GTCC segment aims to secure niche segment of civil projects in the range of AED100m-AED500m.
Deutsche Bank AG/London Page 65 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 151: Segment-wise functionalities MEP IWP Civil Contracting
Power distribution systems Power Generation & Distribution Design & Build of civil, infrastructural & industrial works Heating, ventilation, air conditioning (HVAC) Sewage treatment Research and Development Lighting systems Water treatment & District Cooling Compliance expertise with the highest standards of LEED. Plumbing, process and high purity piping systems Telecommunications Piped heating and cooling water generation and distribution Oil & Gas Distribution & Storage Source: Company data, Deutsche Bank
Shareholding structure The CEO holds c.36% and Drake and Scull Group holds 5% of the shares, while 59% is the free float that includes both public and other institutional investors. Non GCC foreign ownership is limited to 49%, while GCC investors can own up to 100% of the outstanding shares.
Figure 152: Shareholding structure Figure 153: Foreign ownership limit
Drake and Scull Group Limited 5%
Khaldoun Rashid Tabari (CEO) Foreign ownership 36% limit 49% Free float 59%
Source: Zawya.com Source: DFM
Figure 154: Key management personnel Mr. Majed Saif Ahmad Al Ghurair Chairman
Mr. Khaldoun Rashid Tabari Vice Chairman & CEO Mr. Khaled Jarrar CFO Source: Drake & Scull
Page 66 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Strategy and outlook
Backlog stabilizing at AED2.5bn Historically heavily geared to Dubai and residential/mixed use segments At the end of September 2009, Drake & Scull’s backlog stood at AED3.1bn. We have excluded the Durrat Al Bahrain project (AED596m) from our analysis, taking a conservative approach and given that the contract is still in the LOI stage. Our restated backlog, therefore, works out at AED2.5bn. Dubai accounted for 55% (including Sharjah) followed by Abu Dhabi (32%) and Saudi Arabia (7%). Residential and mixed use segment combined accounted for 80% of the total backlog followed by infrastructure and utilities at 19%.
Figure 155: Backlog by geography (Q309) Figure 156: Backlog by market segment (Q309)
Sudan Thailand Others 1% 5% Saudi Arabia Infrastructure & 2% 7% Utilities 19%
Residential Dubai 51% Abu Dhabi 55% 32%
Mixed Use 28%
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Further, analyzing the mix in the individual geographies, residential and mixed use segment combined accounted for 80% of Dubai’s and 93% of Abu Dhabi’s backlog. However, in the new geographies such Saudi Arabia and Sudan, IWP accounts for 100% of the backlog .
Figure 157: Backlog numbers as of Q309 (AED m) Figure 158: Backlog by locations and market segments
1,600 100% 6% 3% 1,400 20% 80% 1,200
1,000 60% 39% 800 100% 100% 100% 90% 40% 600
400 20% 41% 200
0 0% Dubai Abu Dhabi Saudi Arabia Thailand Sudan Dubai Abu Dhabi Saudi Arabia Sudan Thailand
Residential Mixed Use Infra & Utilities Others
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Top five clients and top five projects account for 60% and 53% of the backlog, respectively As of Q3 09, backlog was diversified across 22 clients among whom the top 5 clients accounted for 60% of the backlog and the largest client for 17% of the backlog.
Deutsche Bank AG/London Page 67 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 159: Backlog by clients (AED m) Figure 160: Client concentration (as of % of backlog)
1,200 17% 18% 17% 16% 1,000 15% 800 12% 12% 10% 600 9% 400 6% 5% 6% 5% 5% 4% 200 3% 3% - 0% Cayan Taksin Meydan Hadeed Emicool Devpt Marina SABIC - SABIC Cayan Taksin Others Exclusive Resorts Meydan Luxury RE Luxury Hadeed Emicool Devpt Marina SABIC - SABIC Al Muneera Exclusive Seven Tides Resorts IFA Hotels & IFA Hotels Luxury RE
Approved Contract Value Backlog Al Muneera Seven Tides IFA Hotels & Hotels IFA Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Figure 161: Backlog by projects (AED m) Figure 162: Project concentration (as of % of backlog)
450 30% 400 26% 350 25% 300 20% 17% 250 15% 12% 10% 9% 200 10% 5% 5% 5% 5% 4% 150 5% 3% 100 0% 50 0 Others Al Muneera Tower Infinity (Dubai) Dhabi) School (Dubai) Dhabi) Palm (Dubai) Sheba (KSA) (Dubai) (Dubai) Amercian The River The (Thailand) Nad Al- Mangrove Fairmont place (Abu Kingdom of Al Muneera KPM Tower Sheba DC Hadeed DC Hadeed DC (KSA) DC Hadeed Hotel(Dubai) KPM Tower (Dubai) Plant (Dubai) The River (Thailand) Mangrove place (Abu Infinity Tower (Dubai) Infinity Tower Nad Al-Sheba DC Plant Amercian School(Dubai)
Approved Contract Value Backlog Kingdom of Sheba(Dubai) Fairmont Palm Hotel(Dubai) Palm Fairmont Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Recent backlog evolution: Stabilized at around AED2.5bn As of Q3 09, Drake & Scull reported a backlog of AED2.5bn, down a modest 6% from the December 2008 number (AED2.7bn). Compared to many of Dubai contractors, contract cancellation has been relatively modest in Q1 09 (we lack backlog data as of September 2008 for a detailed analysis of cancellations in Q4 08). Our analysis suggests that only one contract has been cancelled in the first quarter (for AED40m in Dubai).
Page 68 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 163: Recent backlog evolution Figure 164: Quarterly backlog by geography
2,800 20% 3,000
15% 2,700 2,500 10% 2,600 2,000 5% 2,500 0% 1,500 2,400 -5% 1,000 2,300 -10% 500 2,200 -15%
2,100 -20% - Q4 08 Q1 09 Q2 09 Q3 09 Q4 08 Q1 09 Q2 09 Q3 09
Backlog (AED m, LHS) % growth (RHS) Dubai Abu Dhabi Saudi Arabia Sudan Thailand
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Since then, the backlog stabilized at around AED2.4bn in H1 09 and even slightly increased to AED2.5bn in Q3 09, with new awards flowing into the order book.
Figure 165: Recent contract awards Date Project Name Location Value Client Work
Oct-09 Al Muneera Abu Dhabi AED420m Na MEP contract
Sep-09 The River Thailand AED130m Taksin Properties MEP contract for a luxury condominium
Jul-09 KPM Tower Dubai Marina AED250m Marina Exclusive Limited Civil Contracting - Design and build of the residential tower comprising 5 basement levels and G+38 floors May-09 Kingdom of Sheba Palm Jumeirah AED226m IFA Hotels & Resorts MEP - Supply, installation, testing and commissioning of (Dubai) complete MEP Works Feb-09 Mangrove Place Al Reem Island, AED400m Luxury Real Estate Civil Contracting of Mangrove Place (includes AED100m of (Abu Dhabi) Development MEP services) Source: Deutsche Bank
During the first nine months of 2008, Drake & Scull received new awards worth AED2.2bn. In line with industry trends, the company did not receive any substantial orders during September ’08 and April ’09. However, since May ’09, new orders shot up and the company received AED1.4bn of new awards in 2009 year to date.
Figure 166:Cumulative new awards Figure 167: Monthly new awards
2500 700
600 2000 500
1500 400
1000 300 200 500 100
0 0 Jul-09 Jul-08 Jul-09 Jul-08 Apr-09 Apr-09 Apr-08 Apr-08 Oct-09 Oct-08 Oct-09 Oct-08 Jun-09 Jun-08 Jan-09 Jun-09 Jun-08 Jan-09 Jan-08 Jan-08 Mar-09 Mar-09 Mar-08 Mar-08 Feb-09 Feb-09 Feb-08 Feb-08 Nov-08 Nov-08 Aug-09 Sep-09 Aug-08 Sep-08 Dec-08 Aug-09 Sep-09 Aug-08 Sep-08 Dec-08 May-09 May-08 May-09 May-08 2008 2009 Ytd 2008 2009 Ytd
Source: Company, Deutsche Bank Source: Company, Deutsche Bank
71% of the backlog has not yet started or in the early stages of construction… The analysis of Drake & Scull’s backlog shows a relatively diverse stage of completion depending on main locations.
Deutsche Bank AG/London Page 69 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 168: Stage of the backlog (Q3 09) % of completion Dubai Abu Dhabi KSA Sudan Thailand Total
0% complete 34% 52% 0% 0% 100% 40% 1%-15% 24% 38% 76% 0% 0% 31% 15%-50% 8% 0% 0% 100% 0% 6% 50%+ 34% 10% 24% 0% 0% 24% Total 100% 100% 100% 100% 100% 100% Source: Deutsche Bank
We have assessed the risk of project cancellation. Our analysis suggests that most orders cancellation were related to projects where construction has not been started yet. These projects account for 39% of Drake and Scull’s backlog, whereas the other 31% are in relatively early stages of construction (1%-15% complete).
Figure 169: % of completion of projects in the backlog- Figure 170: Early stage projects (less than 15% Q3 2009 complete)-Q3 2009
Thailand 7% 50%+ Saudi Arabia 24% 8%
0% complete 39% Dubai 45% 15%-50% 6%
Abu Dhabi 40%
1%-15% 31%
Source: Deutsche Bank Source: Deutsche Bank
…but we believe the risk of further project cancellation is relatively limited In our view, the projects at risk are as follows:
Construction has not started or is in a relatively early stage (less than 15% complete).
Projects are located in areas where cancellations have largely materialized in previous quarters (mainly Dubai and Abu Dhabi). Basically, we assume that projects in Saudi Arabia - even at early stages of construction - do not carry major risks of cancellation.
We have excluded recent awards from our calculation of projects at risk (even in Dubai and or Abu Dhabi). As a result, the amount of contracts at risk in the backlog has declined to AED332m from AED616m six months ago. They now represent 13% of the current backlog vs. 23% by end- 2008, all of which are located in Dubai.
Page 70 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 171: Projects at risk in the backlog Figure 172: Breakdown of projects at risk
700 28% 700
600 24% 600
500 20% 500
400 16% 400
300 12% 300
200 8% 200
100 4% 100
- 0% - Q4 08 Q1 09 Q2 09 Q3 09 Q4 08 Q1 09 Q2 09 Q3 09
Projects at risk (AED m, RHS) % of backlog (RHS) Dubai Abu Dhabi Saudi Arabia Others
Source: Deutsche Bank Source: Deutsche Bank
Although there is always a risk in the current uncertain macro environment, we believe that chances of cancellation of early stage projects should be kept in view in the case of Drake & Scull. Indeed, Drake & Scull’s MEP business is usually a later stage construction business as MEP construction usually comes at a later stage of the building process, i.e. the building has already been to a large extent completed and the client has, therefore, no option but to continue with the MEP work.
The means to pursue aggressive expansion plans Organic growth through geographical diversification Drake & Scull is following a multitude of strategies to increase its order book across market segments and geographies. Management has set an ambitious target of AED5bn revenue in three to five years. While no specific timing has been set yet, we believe this reflects management’s ambitions to develop according to three main routes:
Diversify from MEP contracting into attractive infrastructure/civil engineering markets: this has been started by the creation of IWP in 2006 to address the infrastructure markets and the acquisition of GTCC in civil engineering last year.
Reduce reliance from Dubai and favor international expansion: the rebalancing of the backlog is also well under way with non-Dubai contract (namely Abu Dhabi, Saudi Arabia and Bahrain) already accounting for 45% of the backlog.
Vertical integration: Especially in its IWP segment, Drake & Scull relies on sub- contractors to execute works because of its lack of international presence. Design and engineering are monitored from Dubai, but we believe the company aims in some cases to internalize the whole value chain. In a bid to reduce its dependence on the Dubai market, we believe that the company will increasingly focus on new MENA locations. It already has contracts in Abu Dhabi, Saudi Arabia, Bahrain and Sudan. We believe the company is also seeking business opportunities in Kuwait, Qatar, Libya, Jordan, Egypt and Oman and new awards could confirm its successful international expansion.
AED1bn cash pile to be spent on acquisitions Drake & Scull can cash in on its IPO benefits of AED1.1bn to be partly used to finance acquisitions and speed up development. The management said it is has identified four potential targets and is currently in the process of due diligence. We believe some acquisitions could be announced before year-end and would significantly enhance the company’s presence in some markets or strengthen its fields of expertise.
Deutsche Bank AG/London Page 71 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
We believe that this makes Drake & Scull a relatively unique stock among our coverage universe. The company stands out as a cash-rich player in troubled times and has therefore an opportunity to emerge from the crisis in a much stronger form, at a relatively cheap cost. Alongside, we believe that all cash investments made by the company will be particularly scrutinized and will ultimately decide the stock’s fate.
We believe acquisitions could enhance the backlog by 50% Management has been guiding towards AED500m of acquisition value. Since a significant portion of cash is invested at 6%+ in time deposit (maturing in several stages in early 2010E), we believe the deals could be financed partly by debt – a much better optimization than breaking highly profitable time deposit at a prohibitive cost.
We have not factored in acquisitions in our financial forecasts. However, we have conducted a sensitivity test to the amount invested and valuation retained.
Our base case assumes AED500m deal value by year-end, financed 50% by debt facility and 50% in cash. We believe that companies could be acquired at an EV/backlog of 0.4x, in line with MENA contractors’ multiples (Drake & Scull is currently trading on 0.36x). That would be equivalent to 8.9x P/E or 4.0x EV/EBITDA, assuming the same margins as Drake & Scull. That would suggest AED1.3bn of incremental backlog, i.e. a 50% increase from current level.
Based on the same assumptions regarding backlog turnover, margins and capex than Drake & Scull, we believe that acquisitions will be earnings enhancing by 31% on average in the coming years. As a result, valuation multiples will appear more attractive for the stock.
Figure 173: Estimated impact of AED500m acquisition on P&L and earnings multiples Before After % revision AED m 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E Revenues 1,783 1,928 2,302 2,657 2,872 3,430 49% 49% 49% % growth -5.2% 8.1% 19.4% 41.2% 8.1% 19.4% EBITDA 233 250 299 348 373 445 49% 49% 49% as of % of sales 13.1% 13.0% 13.0% 13.1% 13.0% 13.0% % growth -18.9% 7.1% 19.4% 20.8% 7.1% 19.4% EBIT 205 222 265 306 331 395 49% 49% 49% as of % of sales 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% % growth -21.0% 8.1% 19.4% 17.8% 8.1% 19.4% Financial income 37 32 41 (0) (1) 13 -101% -102% -67% Net income 236 247 297 299 323 400 27% 31% 34% % growth -26.5% 4.7% 20.2% -6.9% 8.0% 23.8% Net cash 1,130 1,390 1,688 672 983 1,356 -41% -29% -20% P/E 9.4 9.0 7.5 7.4 6.9 5.6 P/E (ex cash) 5.7 4.1 2.2 5.3 4.0 2.4 EV / EBITDA 4.9 3.5 1.9 4.6 3.4 2.0 Source: Deutsche Bank
We have also conducted a sensitivity analysis to the main assumptions taken for the establishment of this acquisition model: namely the amount spent on acquisition and the EV/backlog ratio.
Page 72 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 174: Sensitivity analysis of earnings enhancement to acquisition parameters Acquisition value (AED m) 31% - 250 500 750 1,000 0.2 0% 39% 77% 116% 155% 0.3 0% 23% 46% 69% 92% 0.4 0% 15% 31% 46% 61% 0.5 0% 11% 21% 32% 42%
EV/Backlog (x) EV/Backlog 0.6 0% 7% 15% 22% 30%
Source: Deutsche Bank
Deutsche Bank AG/London Page 73 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Financials
Q3 09 results and recent announcements
Figure 175: Q3 results AED m Q3 09 Q2 09 % QoQ chg. Revenues 400 512 -22% Gross Profit 91 109 -17% as a % of sales 22.7% 21.2% EBIT 56 75 -26% as a % of sales 14.0% 14.7% Finance Income 18 18 Other Items (3) (2) Minority Interest (2) (4) Attributable Profit 69 87 -21% as a % of sales 17.3% 17.0% Source: Drake & Scull
Q3 09 revenues were AED400m (-22% vs. Q2 09, quarterly numbers for 2008 are not available). Revenue split was roughly 62% for MEP, 20% for IWP and 18% for civil works vs. 59% in MEP, 19% IWP and 23% civil in Q2 09.
Q3 09 gross margin expanded to 22.7% vs. 21.2% in Q209. We believe that since most of DSI’s contracts were fixed price contracts, falling commodity prices have led to the gross margin increase.
Net margin was 17.7% (vs. 17.6% in Q2 09) as a result of higher interest income on its cash balance from IPO proceeds. Note that interest income itself contributed to 25% of net profit in Q3 09.
On 9 May 2009, DSI announced plans to buy back 10% (217m shares) of outstanding shares (total 2.17bn shares outstanding). As of end September ‘09, the company has bought back 35m shares (1.6% of total outstanding shares). If the buyback happens at an average price of AED1.00 (CMP), this will translate to AED217m of cash outflow.
Cash balance provides cushion against increase in receivables Receivables stood at AED834m as of Q3 09 (190 days of annualized sales), lower than AED892m in Q2 09 (159 days of annualized sales) but were much higher than AED520m in end 2008. Working capital also increased to AED460m vs. AED352m in Q2 09 and AED291m in Q1 09. We believe that, similar to its peers, DSI is also affected by delayed payments from its clients. We assume working capital (as a % of sales) will peak in 2010 after which it will substantially improve. However, what differentiates DSI from its contracting peers is its strong cash balance (net cash of AED788mn as of Q3 09). We believe the cash balance is sufficient to offset any pressure from rising receivables. Note that the cash invested in deposits are yielding a high return of 6-9% per annum. Further, the company is also charging interest on receivables that are beyond the agreeable credit period.
Page 74 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 176: Receivables, payables and WCR Figure 177: Net debt and WCR
200 35% 1000 180 25% 160 500 140 15% 120 5% 0 100 2006 2007 2008 Q1 09 Q2 09 Q3 09 Q4 09E 2010 2011 2012 -5% 80 -500 60 -15% 40 -25% -1000 20 - -35% -1500 2006 2007 2008 Q1 09 Q2 09 Q3 09 Q4 09E 2010 2011 2012
Trade receivables (days of sales, LHS) Trade payables (days of sales, LHS) -2000
Working capital (as a % of sales, RHS) Working capital (LHS) Net Debt
Source: Deutsche Bank Source: Deutsche Bank
Main assumptions We forecast a progressive ramp up in new orders We forecast AED250m new orders in Q4 09. Beyond, we assume Drake & Scull should start getting awards from other locations such as Oman, Egypt and Saudi Arabia.
Figure 178: Backlog, new awards and revenues forecasts 2009-12E AED m 2009E 2010E 2011E 2012E
Opening Backlog 2,693 2,552 2,758 3,294 New Awards 1,926 1,990 2,464 2,956 Closing Backlog 2,552 2,758 3,294 3,948 Revenues 1,882 1,783 1,928 2,302 Source: Deutsche Bank
Figure 179: New Orders (AED m) Figure 180: Revenues (AED m)
4,000 2,500
3,500 2,000 3,000
2,500 1,500
2,000 1,000 1,500
1,000 500 500
- - 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E
Dubai Abu Dhabi Saudi Arabia Bahrain Others Dubai Abu Dhabi Saudi Arabia Bahrain Others
Source: Deutsche Bank Source: Deutsche Bank
Slight margin decline As for other MENA contractors, we expect a modest decline in margins beyond 2009E and foresee net profit margin at 12-14%.
Deutsche Bank AG/London Page 75 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 181: Margin assumptions
20.0%
16.0%
12.0%
8.0%
4.0%
0.0% 2006 2007 2008 2009E 2010E 2011E 2012E
Gross margin EBITDA margin EBIT margin Net margin
Source: Deutsche Bank
Detail of our estimates
Figure 182: Income statement 2008-12E AED m 2008 2009E 2010E 2011E 2012E Revenues 1,720 1,882 1,783 1,928 2,302 % growth 109.7% 9.4% -5.2% 8.1% 19.4% COGS (1,396) (1,497) (1,459) (1,577) (1,883) as of % sales -81.2% -79.5% -81.8% -81.8% -81.8% Gross profit 324 386 325 351 419 as of % sales 18.8% 20.5% 18.2% 18.2% 18.2% % growth 109.0% 18.9% -15.8% 8.1% 19.4% SG&A (168) (126) (119) (129) (154) EBITDA 181 288 233 250 299 as of % sales 10.5% 15.3% 13.1% 13.0% 13.0% % growth 49.7% 59.3% -18.9% 7.1% 19.4% Depreciation & Amortization (25) (28) (28) (28) (34) EBIT 156 260 205 222 265 as of % sales 9.1% 13.8% 11.5% 11.5% 11.5% % growth 48.0% 66.5% -21.0% 8.1% 19.4% Finance Income 3 68 37 32 40 Other income/(expense) 68 3 Management Fee (15) (14) (10) (10) (10) Profit before tax 212 317 233 244 296 Minority interest (2) (9) (7) (7) (8) % minorities 1.0% 2.8% 2.8% 2.8% 2.8% DB restated net income post minorities 182 321 236 247 297 as of % sales 10.6% 17.1% 13.2% 12.8% 12.9% % growth 73.0% 76.2% -26.5% 4.7% 20.2%
Page 76 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 183: Cash flow statement 2008 – 12E AEDm 2008 2009E 2010E 2011E 2012E Cash flow from operations 170 341 261 272 329 (Incr)/decr in working capital (186) (385) 18 84 84 Purchase of property, plant and equipment (97) (18) (89) (96) (115) Disposal of property, plant & equipment 0 4 Total capex (97) (14) (89) (96) (115) as of % sales 6.8% 0.7% 5.0% 5.0% 5.0% Operating free cash-flow (113) (58) 190 260 299 Trading Securities (1) 6 Net Cash Inflow on Business Combination - 85 Purchase of available for sale investments (2) (205) FCF after investing activities (116) (173) 190 260 299 Purchase of treasury shares (27) Loan to a shareholders recovered (45) 45 Movement in time deposits under lien 24 3 Share capital received in cash 1,198 Movements in due to banks 23 (32) (42) Term Loans 167 36 (34) Minority Interest 8 Net cash flow 52 1,058 113 260 299 Source: Deutsche Bank
Deutsche Bank AG/London Page 77 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 184: Balance sheet 2008-12E AEDm 2008 2009E 2010E 2011E 2012E
ASSETS Non current assets Property, plant and equipment 172 153 214 283 364 Goodwill & other Intangible Assets 147 830 830 830 830 Investments 13 196 196 196 196 Loans and advances 22 22 22 22 Long term prepayments 33 33 33 33 Total non-current assets 331 1,235 1,296 1,365 1,446 Current Assets Development properties 21 33 33 33 33 Inventories 2 8 8 8 8 Contract work-in-progress 226 284 269 298 364 Contract receivables and retentions 520 848 804 825 934 Due from related parties 15 15 15 15 15 Prepayments and other receivables 115 163 154 140 134 Trading securities 12 7 7 7 7 Loan to a shareholder 45 - - - - Bank balances and Cash 162 1,233 1,347 1,607 1,905 Time deposits under lien 46 43 43 43 43 Bank overdrafts 32 59 59 59 59 Total current assets 1,119 2,592 2,637 2,932 3,400 Total Assets 1,450 3,827 3,933 4,297 4,846 EQUITY & LIABILITIES Shareholder's equity Share capital 15 2,178 2,178 2,178 2,178 Treasury shares (27) (27) (27) (27) Statutory reserve 8 29 29 29 29 Retained earnings 274 336 562 799 1,087 Equity attributable to equity holders of company 297 2,516 2,742 2,979 3,267 Minority interest 14 27 34 41 49 Total Equity 311 2,543 2,776 3,020 3,316 Liabilities Non Current Liabilities Employee's end of service benefits 20 27 27 27 27 Term loans 178 162 - - - Total non current liabilities 198 189 27 27 27 Current Liabilities Accounts payable and accruals 532 553 524 661 903 Due to related parties 17 16 16 16 16 Advances received from customers 281 293 277 281 313 Excess billings 28 103 97 75 54 Term loans 52 179 179 179 Due to banks 84 80 37 37 37 Total current liabilities 941 1,095 1,130 1,250 1,503 Total Liabilities 1,139 1,284 1,158 1,277 1,530 Total equity and Liabilities 1,450 3,827 3,933 4,297 4,846 Net debt 100 (940) (1,130) (1,390) (1,688) Source: Deutsche Bank
Page 78 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Middle East Egypt Real Estate, Construction and Building Materials Construction
17 November 2009 Orascom Construction Hold Price at 16 Nov 2009 (EGP) 239.40 Reuters: OCIC.CA Bloomberg: OCIC EY Price Target (EGP) 230.00 52-week range (EGP) 275.73 - 97.37
It’s all about valuation Price/price relative 750 600 450 300 Initiate with a Hold, target price of EGP230 per share 150 This piece is an excerpt from a MENA construction note "Paving way for growth", 0 released on 17 October 2009. We view OCI as a high-quality company with a 11/06 5/07 11/07 5/08 11/08 5/09 solid track record of value creation. Its construction business offers in our view a Orascom Construction well-balanced exposure among the most attractive end-markets. Besides, the Hermes Egypt Stock M (Rebased) company is developing an attractive low-cost nitrogenous fertilizer business which will significantly ramp up over 2009-12E. The stock is trading close to fair Performance (%) 1m 3m 12m value according to us. We initiate with a Hold recommendation. Absolute -4.3 7.7 41.3 Hermes Egypt Stock Market Index 0.0 0.0 Ideally positioned to capture MENA infrastructure opportunities We believe OCI offers the best diversified backlog in our coverage universe. It has Stock data successfully repositioned its business towards infrastructure (63% of backlog in Market cap (EGP)(m) 51,416.1 Shares outstanding (m) 217 Q2 09 vs. 15% in 2006) and sovereign segments (59% in Q2 09 vs. 26% in 2006) Free float (%) 45 in the MENA countries (80%). Exposure to Dubai is limited to 4%. This has Hermes Egypt Stock Market Index 718.3 naturally resulted in a higher quality of backlog, as evidenced by a decline limited to 9% from peak to trough, and the company looks on track to exceed its new Key indicators (FY1) awards guidance. Additionally, the development of private-public partnerships ROE (%) 11.4 (PPP), namely in Egypt could provide another attractive opportunity for growth. Net debt/equity (%) 36.6 Book value/share (EGP) 83.3 Aggressive fertilizer capacity expansion plans with low-cost gas advantage Book value/share (EGP) 83.3 Price/book (x) 2.9 Following the disposal of its cement business to Lafarge in 2007, OCI has Net interest cover (x) 6.7 expanded in nitrogenous fertilizers. Capitalizing from cost-advantageous EBIT margin (%) 12.6 feedstock supply arrangements in Egypt and Algeria, OCI has aggressive capacity expansion plans to boost capacity (by 2.2x over 2009-11E). EBITDA margins should remain in the mid 50s in the meantime as OCI is developing a lower margin trading business to progressively secure market shares ahead of its capacity increase, but the business has a potential of generating significantly higher profitability and FCF. SOTP at EGP230 per share; oil prices the main upside/downside risk We value Orascom using DCF valuation for the construction (WACC 11.0%, LT growth 3%) and the fertilizer business (WACC 10.1%, LT growth 2%) separately. We then cross check our DCF valuation with peer group EV/EBITDA multiples. Our SOTP valuation works out to EGP230. Orascom Construction is exposed to oil prices, which indirectly drive building and infrastructure spending across MENA markets and fertilizer prices. Availability of project financing, contracts delays or cancellation and failure to recover receivables could also materially impact our earnings/valuation for the construction division. In fertilizers, urea and ammonia prices represent the main risk. Other risks include: (1) execution related to a significant ramp-up in capacity; and (2) inability to secure natural gas at advantageous prices once current arrangements expire.
Deutsche Bank AG/London Page 79 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Model updated:15 November 2009 Fiscal year end 31-Dec 2006 2007 2008 2009E 2010E 2011E
Running the numbers Financial Summary Middle East DB EPS (EGP) 14.44 6.26 20.97 9.28 13.20 20.74 Reported EPS (EGP) 14.44 6.26 20.97 9.28 13.20 20.74 Egypt DPS (EGP) 5.50 305.00 5.48 5.48 5.48 5.48 Construction BVPS (EGP) 42.9 360.6 80.8 83.3 91.2 106.7 Weighted average shares (m) 196 202 208 215 215 215 Average market cap (EGPm) 45,476 77,057 79,689 51,416 51,416 51,416 Orascom Construction Enterprise value (EGPm) 53,076 84,223 79,856 56,378 56,463 53,342 Valuation Metrics Reuters: OCIC.CA Bloomberg: OCIC EY P/E (DB) (x) 16.0 60.9 18.2 25.8 18.1 11.5 P/E (Reported) (x) 16.0 60.9 18.2 25.8 18.1 11.5 Hold P/BV (x) 6.37 1.59 1.74 2.87 2.62 2.24 Price (16 Nov 09) EGP 239.40 FCF Yield (%) nm nm 0.4 nm 2.7 9.1 Target price EGP 230.00 Dividend Yield (%) 2.4 80.0 1.4 2.3 2.3 2.3 52-week Range EGP 97.37 - 275.73 EV/Sales (x) 3.2 6.2 3.9 2.4 2.1 1.8 EV/EBITDA (x) 12.2 33.7 16.6 14.3 10.9 7.6 Market Cap (m) EGPm 51,416 EV/EBIT (x) 14.2 53.4 19.6 19.3 14.1 9.0 USDm 9,424
Company Profile Income Statement (EGPm) Established in 1950, Orascom Construction Industries (OCI) Sales revenue 16,475 13,482 20,253 23,213 26,848 29,562 is a leading international construction contractor and fertilizer Gross profit 5,591 3,233 6,031 5,409 6,863 8,897 producer based in Cairo, Egypt. In the construction segment, EBITDA 4,360 2,500 4,801 3,935 5,158 7,019 the company undertakes engineering, procurement and Depreciation 625 924 731 1,008 1,156 1,104 construction of large scale infrastructure, commercial and Amortisation 0 0 0 00 0 industrial projects for public and private customers mainly based in Middle East, North Africa and Central Asia. The EBIT 3,735 1,576 4,070 2,927 4,002 5,915 company is also involved in the production of fabricated steel, Net interest income(expense) -251 -237 503 -437 -408 -260 paints, construction chemicals and glass. Associates/affiliates 0 0 0 00 0 Exceptionals/extraordinaries 210 45 494 120 0 Other pre-tax income/(expense) 52 129 2 135 135 135 Profit before tax 3,746 1,513 5,069 2,638 3,729 5,790 Price Performance Income tax expense 136 82 576 489 588 914 Minorities 743 151 77 134274 372 750 Other post-tax income/(expense) 0 0 0 0 0 0 600 Net profit 2,867 1,280 4,416 2,015 2,866 4,504 450 300 DB adjustments (including dilution) 0 0 0 0 0 0 150 DB Net profit 2,867 1,280 4,416 2,015 2,866 4,504 0 Nov 06 May 07 Nov 07 May 08 Nov 08 May 09 Cash Flow (EGPm) Orascom Construction Cash flow from operations 3,831 927 3,255 2,155 4,325 5,899 Hermes Egypt Stock Market Index Net Capex -7,251 -6,484 -2,955 -3,988 -2,956 -1,242 (Rebased) Free cash flow -3,420 -5,557 300 -1,833 1,370 4,657 Margin Trends Equity raised/(bought back) 2,193 167 2,360 -70 0 0 Dividends paid -404 -1,111 -62,549 -997 -1,176 -1,176 28 Net inc/(dec) in borrowings 2,867 8,532 -2,532 384 -4,857 -3,047 24 Other investing/financing cash flows -667 -852 66,773 -31 0 0 20 Net cash flow 570 1,179 4,352 -2,546 -4,664 434 16 12 Change in working capital -723 -3,766 -2,195 -1,944 29 -82 8 06 07 08 09E 10E 11E Balance Sheet (EGPm) Cash and other liquid assets 2,738 3,917 8,269 5,533 869 1,303 EBITDA Margin EBIT Margin Tangible fixed assets 15,545 3,473 9,912 14,410 16,210 16,348 Goodwill/intangible assets 0 65 9,910 10,065 10,065 10,065 Growth & Profitability Associates/investments 1,400 1,648 3,216 2,627 2,623 2,636 Other assets 8,933 85,848 11,718 16,927 16,568 17,591 60 50 Total assets 28,616 94,952 43,026 49,563 46,335 47,943 40 40 Interest bearing debt 9,250 11,683 11,425 12,362 7,504 4,458 20 30 0 20 Other liabilities 8,207 9,374 14,019 18,543 18,208 19,162 -20 10 Total liabilities 17,456 21,056 25,444 30,905 25,712 23,620 -40 0 Shareholders' equity 8,672 72,847 17,355 17,898 19,588 22,916 Minorities 2,488 1,049 227 7601,035 1,407 06 07 08 09E 10E 11E Total shareholders' equity 11,160 73,896 17,581 18,658 20,623 24,323 Net debt 6,512 7,766 3,156 6,829 6,635 3,154 Sales growth (LHS) ROE (RHS)
Solvency Key Company Metrics Sales growth (%) 44.9 -18.2 50.2 14.6 15.7 10.1 70 25 DB EPS growth (%) 70.2 -56.6 234.7 -55.7 42.2 57.1 60 20 50 EBITDA Margin (%) 26.5 18.5 23.7 17.0 19.2 23.7 40 15 EBIT Margin (%) 22.7 11.7 20.1 12.6 14.9 20.0 30 10 20 Payout ratio (%) 37.7 nm 25.9 58.4 41.0 26.1 10 5 0 0 ROE (%) 44.3 3.1 9.8 11.4 15.3 21.2 Capex/sales (%) 45.3 49.9 15.8 18.2 11.6 4.4 06 07 08 09E 10E 11E Capex/depreciation (x) 12.0 7.3 4.4 4.2 2.7 1.2 Net debt/equity (%) 58.3 10.5 18.0 36.6 32.2 13.0 Net debt/equity (LHS) Net interest cover (RHS) Net interest cover (x) 14.9 6.7 nm 6.7 9.8 22.7
Nabil Ahmed Source: Company data, Deutsche Bank estimates +971 4 4283-862 [email protected]
Page 80 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Investment thesis
Outlook Established in 1950 and headquartered in Egypt, Orascom Construction (OCI) is engaged in two distinct businesses, namely construction and fertilizers. Often regarded as a conglomerate, we view OCI as a high-quality project manager with a private equity approach that has a solid track record of value creation.
In the construction segment, we believe Orascom offers the best diversified backlog in our coverage universe with a well-balanced exposure among the most attractive end-markets. It has successfully repositioned its business towards infrastructure (63% of backlog in Q2 09 vs. 15% in 2006) and sovereign segments (59% of backlog in Q2 09 vs. 26% in 2006) in the MENA countries (80% of backlog). Exposure to Dubai is limited to 4%. This has naturally resulted in a higher quality of backlog, as evidenced by a decline limited to 9% from peak to trough, and the company looks on track to exceed its USD3.0-3.5bn new awards guidance for FY09. Additionally, the development of private-public partnerships (PPP), namely in Egypt, could provide another attractive opportunity for growth.
Following the disposal of its cement business to Lafarge in 2007, OCI has expanded in nitrogenous fertilizers. Capitalizing on cost-advantageous feedstock supply arrangements (where the company procures natural gas at USD1.0-2.0/mmBtu in Egypt and USD0.5- 1.0/mmBtu in Algeria vs. current global price at USD3.5-4.5/mmBtu), OCI has aggressive capacity expansion plans to boost capacity (by 2.2x over 2009-11E) and will become one of the top 10 global producers of N-fertilizers. EBITDA margins should remain in the mid 50s in the meantime as OCI is developing a lower margin trading business to progressively capture market shares ahead of its capacity increase, but has a potential of above 70% EBITDA margin in our view once third-party volumes are replaced by internal volumes.
The stock has rallied strongly YTD (+75%) and is trading at a significant premium to peers, which we believe is justified by its solid position across businesses and by management’s superior track record. However, with little upside/downside to our SOTP, we initiate with a Hold recommendation.
Valuation We value Orascom using sum-of-the-parts (SOTP) DCF valuation for the construction (WACC 11.0%, LT growth 3%) and the fertilizer business (WACC 10.1%, LT growth 2%) separately. We then cross check our DCF valuation with peer group EV/EBITDA multiples. Our SOTP valuation works out to EGP230.
Risks Orascom Construction Industries is exposed to oil prices, which indirectly drive building and infrastructure spending across MENA markets and fertilizer prices. Availability of project financing, contracts delays or cancellation and failure to recover receivables could also materially impact our earnings/valuation for the construction division. In fertilizers, urea and ammonia prices represent the main risk. Other risks include: (1) execution related to a significant ramp up increase in capacity; and (2) inability to secure natural gas at advantageous prices once current arrangements expire.
Deutsche Bank AG/London Page 81 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
SWOT analysis
Strengths
Excellent track record of executing large scale, technically complex projects along with a truly diversified construction backlog across geographies and market segments (infrastructure, industrial, commercial) lowers the risk profile. Currently, the focus is on infrastructure projects in MENA backed by cash-rich governments.
Fertilizer business enjoys a distinct competitive advantage in the form low-cost natural gas supplies (USD0.5-1.0/mmbtu in Algeria, USD0.5-1.0/mmbtu in Nigeria and USD1.0- 2.0/mmbtu in Egypt vs Henry Hub current spot price of USD3.5-4.5/mmbtu). This translates to cash cost of USD85/ton compared to roughly USD135/ton for a US Gulf producer, USD220/ton for an Ukrainian producer and $230/ton for a Chinese producer
Strong management team that has an excellent execution track record of nurturing diverse businesses and maximizing value for its shareholders. Weaknesses
OCI is exposed to prices of nitrogenous fertilizer and infrastructure spending of MENA governments, both of which are direct/indirect derivatives of oil prices. Opportunities
Most MENA governments have extensive infrastructure spending plans and OCI can successfully capture a higher share of the pie in our view. Further, PPP projects (recently decentralized in Egypt) offer another attractive avenue of growth.
According to management, OCI will become one of the top ten global nitrogen producers by 2010. Further, the company is also looking to expand operations to other geographies which offer similar feedstock advantages.
The company has already taken measures to increase its fertilizer distribution platform through an agreement with FITCO in Brazil and with the acquisition of a 20% stake in US distributor Gavilion. It is also looking for further distribution partnerships in the US and Europe. Threats
Decline in pricing power in the current operating environment due to increased competition for new contracts. However, due its very nature, infrastructure/industrial projects have a lower number of bidders than civil construction.
Inability to secure natural gas in the future at advantageous costs (although long-term supply agreements are in place). Further, OCI operates in the frontier emerging markets namely Egypt, Algeria etc. as a result of which it is exposed to less certain business environments (E.g. Removal of tax holidays in Egypt, change in Algerian Investment Laws).
Page 82 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Valuation
SOTP calculation We value Orascom Construction Industries using a SOTP approach. Each business (construction and fertilizer) is valued through DCF model, cross-checked by looking at peers’ EV/EBITDA multiples.
We use a risk-free rate of 5% and EM equity risk premium of 6.5%. Tax rate is assumed stable at 15.8% (in line with company’s current rate). The historical beta for the stock averages 1.0 which we have kept in our WACC calculation. As a result:
For the construction division, we assume gearing at zero over the long term (in line with our MENA peers). Our WACC works out at 11.0%. We apply a 3% long term growth, in line with our long-term forecast for the MENA construction industry.
For the fertilizer division, we assume a LT gearing at 40%. Our WACC works out at 10.1%. We apply a 2% long term growth, in line with our LT forecasts for MENA fertilizer prices (see MENA Fertilizer, “Seeking fertile investments in the MENA region”, 6 October 2009). Our construction business’ EV works out at EGP25.5bn, i.e. 8.0x 2010E EBITDA, a significant premium to the MENA contractors’ peer group (4.5x), which we think is justified by the greater quality of the backlog, positioned on the most attractive end-markets and regions. This is close to the 7.4x EV/EBITDA 2010E displayed by our global contractors’ universe. Our fertilizer business’ EV works out at EGP29.1bn, i.e. 14.7x our 2010E EBITDA estimate. Again, this is a significant premium to our MENA fertilizer or global peer group (both on 7.9x). This is in our view warranted by the significant ramp up of capacities (multiplied by 2.2x) over 2009-12E. This potential is not captured in our 2010E estimates. Note that EV/EBITDA 2012E is 7.2x, close to the MENA peer group.
Figure 185: SOTP for Orascom Construction Industry EGP m Value % of assets EBITDA 2010E EV/EBITDA 2010E
Construction 25,506 47% 3,177 8.0 Fertilizers 29,095 53% 1,982 14.7 Total EV 54,601 100% 5,158 10.6 Net debt (6,829) Minorities (3,820) Other assets 3,171 Treasury shares 2,172 Potential equity (stock options) 570 Equity value 49,864 Fully diluted number of shares (m) 217 Value per share (EGP) 230 Source: Deutsche Bank
Our equity value works out at EGP230 per share or USD42.1.
Deutsche Bank AG/London Page 83 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Sensitivity calculation
Figure 186: EV breakdown of OCI (as per our SOTP) Figure 187: Equity value breakdown of OCI (DBe)
Treasury shares Treasury shares Other assets 4% Other assets 4% 5% 6%
Construction 43% Construction 48%
Fertilizers Fertilizers 42% 48%
Source: Deutsche Bank Source: Deutsche Bank
OCI exposure is almost equally balanced between construction and fertilizer from a valuation standpoint. Construction accounts for 43% of EV, but 48% of equity value (lower minorities and we assume no debt).
We have studied a wide range of scenario to test our equity value. We believe the two key parameters are:
Fertilizer prices: We assume USD274 per ton of urea in 2010E in our base case. We have tested lower/higher 2010E prices (price increases beyond are kept intact) and applying similar moves to ammonia prices.
Construction growth: Our current base case implies revenues CAGR 2009-12E of 12%. We have studied a wide range of other possible scenario.
Figure 188: Sensitivity of our SOTP to Urea prices (as from 2010E)and construction revenues CAGR 2009-12E 2010 Urea Px (USD/t) 178 205 233 260 274 288 315 342 370 -20% 115 136 158 179 186 200 221 242 264 -15% 120 142 163 184 191 205 226 247 269 -10% 126 147 168 190 197 211 232 253 274 -5% 132 153 175 196 203 217 238 259 281 0% 139 160 182 203 210 224 245 266 288 5% 147 168 189 211 218 232 253 274 295 12% 159 180 201 222 230 244 265 286 307 15% 165 186 207 228 236 250 271 292 313 2009-2012E 20% 175 196 217 239 246 260 281 302 323 25% 186 207 229 250 257 271 292 313 334 30% 198 219 241 262 269 283 304 325 346 Construction Revenue CAGR Revenue CAGR Construction 35% 211 232 253 275 282 296 317 338 359 40% 225 246 267 289 296 310 331 352 373
Source: Deutsche Bank
Page 84 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Company profile
Corporate profile Two main divisions: construction and fertilizers Established in 1950 and headquartered in Egypt, Orascom Construction Industries (OCI) is engaged in two distinct business operations namely construction and fertilizers. In the construction segment, the company undertakes engineering, procurement and construction of large-scale infrastructure, commercial and industrial projects for public and private customers based in Middle East, Africa and Central Asia. In the fertilizer segment, the company is currently engaged in manufacturing and distribution of nitrogenous fertilizers (urea, ammonia) from its plants based in Egypt and Algeria (which is scheduled to commence production from 2011E). Further, it has significant capacity expansion and product diversification plans for the next three years.
In H1 09, construction accounted for 89% of revenues and 64% of EBITDA while fertilizer accounted for 11% of revenues and 36% of EBITDA. In the same time period, EBITDA margin of the construction segment was 14% and the fertilizer was 59.9%.
Figure 189: H1 09 revenue and EBITDA breakdown Figure 190: H1 09 EBITDA margins
120% 65% 60%
100% 11% 52%
80% 36% 39% 60%
89% 26% 40% 19% 64% 14% 20% 13%
0% 0% Revenue EBITDA Construction Fertilizers Consolidated
Construction Fertilizers
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
The company floated an IPO on the Egyptian Stock Exchange in 1999 and raised USD108m by offloading 14%. In 2002, it listed its GDRs on the London Stock Exchange (GDR Ratio 1:1).
Management has a private equity approach with a solid track record of value creation Although it would seem that construction and fertilizer are not correlated, we believe OCI’s construction business acts as an anchor business which exposes it to different business opportunities (by virtue of constructing the facilities), gives it the know-how and apprises the company of the economics of different businesses. This enables OCI to evaluate and compare, pick the best and then reshuffle the portfolio to include the most value-accretive ones. This was the case with both the cement and fertilizer businesses where OCI was involved in the construction of plants and later included them in its portfolio.
Not only the company has a convincing track record of successfully building businesses from scratch, but also management has been active in the last couple of years in reshuffling its business portfolio and extracting value for its shareholders.
To put this track record into perspective, we have summarized some data related to recent deals.
Deutsche Bank AG/London Page 85 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 191: Recent major OCI deals Business Acquired Disposed Book value Exit price (EGP m) (EGP m)
Cement 1999 2007 2,305 71,108 Egyptian Container Handling Company 1999 2007 434 1,610 Fertilizer 2007-2008 Continuing to date 20,618* 29,095** Source: Deutsche Bank. * DB estimate of OCI cumulated investment in EFC, EBIC and Sorfert. ** DB valuation for the fertilizer group.
In end 2007, the company sold its cement operations at top-of-the-cycle valuations at FY1 EV/EBITDA of 11.6x, or an EV of roughly USD570/ton, one the highest ever transaction valuations in the cement industry. Orascom redistributed EGP63bn (USD11.2bn, i.e. 86% of the proceeds from the sale) to shareholders through special dividends of EGP305/share. The remaining portion was invested in acquiring the fertilizer business.
The operation of the cement group started in 1999 and the capacity was increased from 1.5mtpa in 1999 to 35mtpa in 2007 across Egypt, Algeria, northern Iraq, Pakistan, the UAE, Turkey and Spain. New investments in Nigeria, Saudi Arabia, Syria, and South Africa were planned to increase the annual gross cement production capacity to 45mtpa by 2010. According to management, the company divested its cement operations as it was operating in a consolidating industry and needed significant capital to maintain a competitive advantage. Additionally, management was of the view that construction, infrastructure and fertilizer businesses (backed by low-cost natural gas advantage) could offer superior growth opportunities.
Construction segment: vertically integrated and 3 main brands Three main brands with different geographical and segment focus Incorporated in 1950, the construction business is the oldest business of Orascom and it operates under three different brands, namely Orascom Construction, BESIX Group and Contrack International - having different geographical and segment focus.
Figure 192: Orascom’s construction brands Subsidiary % Holding Location Segment Focus Geography Note
Orascom Middle East and North 100% Egypt Large-scale infrastructure projects Construction Africa Commercial, industrial and Acquired in 2005 with the aim of increasing infrastructure projects. It focuses on market share in GCC commercial projects. Europe, northern and buildings, infrastructure and Additionally, BESIX and OCI had been working BESIX 50% Belgium central Africa & Middle environmental, industrial, civil closely for years on projects in Egypt and as a East engineering, maritime and port works result there were significant synergies in business and real estate development. combination. One of the largest contractors operating in The Middle East and Afghanistan. It operates a J/V namely Contrack Central Asia. namely, Contrack Stanley Group (J/V with US engineering firm 100% US Institutional projects Qatar, Bahrain, the International Stanley Consultants Inc) that provides design UAE, Jordan, Lebanon support for projects that require a design-build and Afghanistan approach, preferred by US government agencies. Source: Company data, Deutsche Bank
Additionally, OCI formed the JV Arabian Sea Foundation (50% stake) with Hydra Commercial Investments, Sorouh Real Estate and Capital Investment to undertake infrastructure work in Shams Abu Dhabi. Further, the company is also involved in many project-specific JVs (consortiums) with international partners with the typical modus operandi of dissolving the JVs once the contracts are completed. OCI has a long-established presence in the region and has strong local market knowledge and as a result is a preferred partner for many international clients operating in the region.
Page 86 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Construction materials complement the construction business OCI has investments in upstream subsidiaries that manufacture construction materials namely fabricated steel products, glass curtain walling, paints and concrete pipes. It has also invested in two property management companies, namely Suez Industrial Development Company (61%, industrial park developer and operator) and Contrack Fm (100%, property and facilities management company). OCI’s following subsidiaries are in the construction materials business.
Figure 193: OCI’s investments in construction materials companies Subsidiary % Holding Products Capacity Plant Locations Focus Area
National Steel 100% Fabricated steel products 67,000 tons of fabricated steel (to increase to 2 plants in Egypt Petroleum and construction Fabrication 120,000 tons in 2009 and 1 in Algeria customers in Egypt, Middle East and North Africa Alico Egypt 50% Glass facades and architectural curtain walling, N/A N/A Primarily for buildings projects aluminium and paint products National Pipe 40% Precast concrete pipes and 38 kilometers of concrete pipes 1 plant in Egypt Infrastructure projects namely Company pre-stressed concrete water transmission pipelines cylinder pipes and wastewater application United Paints and 50% Paints, gypsum, chemicals Dry Mix: - 218k tons of ready mixed mortars, Diverse construction materials Chemicals and mortar. Owns the brand Egyptian Gypsum Company: 835k tons of for the construction industry N/A Dry Mix gypsum and plaster based products, BASF: 51k tons of specialist chemicals SCIB Chemicals 15% Decorative paints and 70,000 kiloliters of paint 1 plant in Egypt N/A industrial coatings Source: Company data, Deutsche Bank
Investments in construction materials help it to secure additional margins and secure supply of critical raw materials. OCI is able to differentiate itself by showing vertical integration across the value chain, which could be preferred by clients and can also help to keep the costs under control in times of rapid price escalation. In line with its private equity approach, Orascom is also growing these companies to realize their full potential.
Fertilizer segment: focus on nitrogenous fertilizers Four main companies Built by successive acquisitions (EBIC in 2005, EFC in 2008), Orascom Construction Industries now operates four main companies in the fertilizer segment.
Figure 194: OCI’s fertilizer facilities Company Location OCI's stake Current Products in 2012 Target Market Note Products
Egyptian Fertilizer Sokhna Port, 100% 1.3mtpa of urea 1.6mtpa of urea Egypt, Europe, North America Acquired a 20% stake from Abraaj Company (EFC) Egypt and Africa Capital for USD150m and then the balance at USD1.9bn EBIC Egypt, near 60% 700ktpa of 700ktpa of Initially OCI had a 30% stake which was to EFC ammonia ammonia later increased to 60%. Sorfert Algerie Arzew 51% U/C 1.2mtpa of urea Europe, South America, East Greenfield project in JV with Sonatrach Industrial and 800ktpa of Africa and Sub-Saharan Africa Zone, Algeria ammonia by 2010/2011 Notore Port 20% 500ktpa of urea 500ktpa of urea Urea producer in Sub-Saharan Africa Harcourt, and 800ktpa of Nigeria NPK blending Source: Company data, Deutsche Bank
Egyptian Fertilizer Company (EFC) EFC is located at the Sokhna Port (Southern Entrance of Suez Canal), and is currently the largest fertilizer exporter on the Suez Canal. Its current capacity of 1.3mtpa of urea will be
Deutsche Bank AG/London Page 87 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
expanded to 1.4mtpa (by using excess CO2 and ammonia from the EBIC plant) through a de- bottlenecking project by 2010 and then to 1.6mtpa by 2012. Note that OCI was involved in the construction of the plant in 1997, and later in 2000 and 2006 for the construction of two urea production lines (with Uhde). Additionally, it is contemplating to incorporate 350ktpa of UAN capacity and has also undertaken a feasibility study to set up a 460ktpa DAP plant. According to management, it has already submitted for concessions and licenses for phosphate rock mining in Egypt and is also exploring opportunities in Algeria. Egypt Basic Industries Corporation Located adjacent to EFC plant, EBIC’s 700ktpa ammonia plant was a green-field development. Production began in H1 09 and was partly reflected in Q2 09 results. It has a production off-take partnership with global fertilizer trader Transammonia for the full capacity. Initially, OCI had a 30% stake (through acquisition of 50% from The Middle East Petrochemical Company that held 60% of EBIC) which was later increased to 60%.
Sorfert Algerie OCI holds 51% stake in Sorfert Algerie and the balance is held by Sonatrach. Currently, it is under construction. On completion in H2 10, it will have a capacity of 1.2mtpa of granulated urea and 800ktpa of ammonia. Note that OCI is the main contractor and Uhde is a supplier. Notore Chemical Industries (Notore) Notore is located in Port Harcout in Nigeria on the Atlantic Coast and is the only urea producer in Sub-Saharan Africa. Currently, it produces 500ktpa of granulated urea and is expected to add 800ktpa of NPK blending capacity by 2012. OCI has a minority stake of 20% in Notore (through acquisition of 100% of EFC).
Shareholding structure The founding members (Sawiris family) hold 55%. The free float is 45% (of which Abraaj Capital has 6% stake inherited from the EFC deal). GDRs listed on the London Stock Exchange account for 14% of the shares. There is no foreign ownership restriction.
Figure 195:Shareholding structure Figure 196: Foreign ownership
Public 39%
Sawiris Family 55% Open to foreign ownership 100%
Abraaj Capital 6%
Source: Company data, Bloomberg Source: Deutsche Bank
Key management
Figure 197: Key management Onsi Sawiris Chairman
Nassef Sawiris CEO Osama Bishai Managing Director Salman Butt CFO Source: Zawya
Page 88 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Construction strategy & outlook
Best diversified backlog in our coverage universe Backlog has proven resilient in the downturn As of Q2 09, Orascom Construction Industries reported a backlog of USD7.2bn. Unlike other MENA contractors, the company did not suffer from heavy contract cancellations (only USD200m in Q1 09 according to management, mostly in Dubai, i.e. an insignificant 2.8% of current backlog). OCI displayed the best resilience among MENA peers during the current global slowdown, with a peak to trough backlog decline limited to 9%. Since then, activity picked up again in H1 09 and new order receipts amounted to USD2.1bn.
Figure 198:Backlog growth (USD bn) Figure 199: Quarterly new awards (USD bn)
8.00 7.6 3.50 7.2 7.2 7.0 6.9 6.9 2.9 7.00 3.00
6.00 2.50 2.0 5.00 4.7 2.00
4.00 3.5 1.50 3.5 1.2 1.2 1.0 1.0 0.9 0.9 0.9 3.00 2.6 1.00 2.2 0.5 2.00 0.50
1.00 0.00 2006 Q107 Q207 Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209 Q107 Q207 Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Well-diversified backlog with strong focus on MENA countries Orascom’s backlog is well diversified across geographies. Egypt contributes 24%, followed by Algeria at 21%, Abu Dhabi at 16% and Qatar at 15%.
Figure 200: Backlog by geography (Q2 09) Figure 201: Backlog evolution by geography
Others 50% 45% 47% 10% Algeria 43% 21% Europe 40% 36% 9% 34%
Dubai 30% 24% 24% 23% 4% 21% 21% 19% 20% 16% 15% 13% 10% 10% Abu Dhabi 10% 16% Egypt 24% 0% Saudi Arabia North Africa Egypt Europe & Others Middle East/GCC 1% Qatar 15% 2004 2006 2008 Q2 09
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
From 2004 to Q2 09, Middle East/GCC’s share in the backlog increased from 34% to 36%; Africa’s (primarily Algeria) share in the backlog increased from 10% to 21%, Egypt’s share
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from 13% to 24% while Europe and others’ share in the backlog declined from 43% to 19% over the same period.
While one big award in any geography can create lumpiness and make the backlog look very different from one period to the next, the backlog trend suggests on-track execution of management strategy to increasingly focus on MENA economies. Orascom nevertheless displays two relatively unique characteristics relative to other MENA contractors:
The Dubai market only accounts for 4% of the backlog, which is obviously a key positive, indicating limited cancellation risks compared to peers;
Saudi Arabia is only 1% of the order book, which we find relatively low given the size of the market opportunity. Orascom opened an office in KSA in 2007. However, the management is seeking projects as the main contractor and not as a sub-contractor where it would have to forego higher margins. Strong position in infrastructure and sovereign segments We view the end-markets positioning of Orascom Construction’s backlog as ideal to capture current market opportunities in MENA countries. We note that infrastructure accounts for 63% of the backlog, followed by commercial at 25% and industrial at 12%. The share of infrastructure increased from 15% of the backlog in 2006 to 63% in Q2 09.
Figure 202: Backlog by sector (Q2 09) Figure 203: Backlog evolution by sector
70% 63% Commercial 60% 56% 25% 50% 46%
39% 38% 40% 32% 30% 31% 30% 25%
20% 12% 15% 14% Industrial Infrastructure 12% 63% 10%
0% 2006 2007 2008 Q2 09
Infrastructure Industrial Commercial
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Further, we note that share of projects awarded by governments/government-backed entities has steadily increased from 26% in 2006 to 59% in Q2 09 and the share of private projects trended down from 70% in 2006 in 38% in Q2 09. We believe this is primarily a reflection of the shift of the backlog towards infrastructure. Again, we believe the sovereign segment offers a good cushion against downturns, especially in a context where most MENA countries combine significant State budget surplus and a strong will to develop infrastructure.
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Figure 204: Backlog by client (Q2 09) Figure 205: Backlog evolution by client
Intergroup 80% 2% 70% 72% 70% 60% 59% 60%
50% Private 38% 38% 38% 40% 28% 30% 26%
Sovereign 20% 59% 10% 4% 2% 0% 2% 0% 2006 2007 2008 Q2 09
Sovereign Private Intergroup
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Ideally positioned to capitalize on MENA governments spending Ideally positioned to capitalize on MENA governments spending The MENA region lacks infrastructure (power, water, port, roads) and the governments are increasingly focusing on developing it to support a diversified economy and an ever-growing population. The company’s strategy is to secure an increasing share of public spending by MENA governments and reduce reliance on privately-financed construction.
We like the strategy of focusing on infrastructure/government-backed projects as they serve the following purposes:
Being state financed, infrastructure projects are less likely to be cancelled;
Since most of these projects are sovereign-backed, threat of non payments is nominal although payment cycles are longer (requires higher working capital);
The scale of projects is large and hence they are capital-intensive with long lead times (some projects namely water and power projects are also technically complex) and as a result they have fewer competitors which naturally leads to higher margins. This also complements the company’s strategy of not undercutting prices, but to bid for projects where it can differentiate itself from competitors.
Undertaking large-scale infrastructure projects requires an excellent execution track record with good relations with government. We believe OCI belongs to the category of the few contractors in MENA that combine a strong local footprint, technical expertise, and capacity to execute and size to handle large projects. New awards starting to pick up again In line with management’s strategy, roughly 60%-65% of new awards were contributed by infrastructure and industrial projects. Additionally, Egypt’s share of new awards amounted to 49%, confirming management’s focus in the home market. Note that Egyptian government announced USD5.4bn of stimulus plans to be mostly spent on infrastructure and utility projects. Additionally, according to MEED, Egypt intends to invest USD10.9bn in its transport infrastructure (road network, railways, public transport, ports and river transport) over the next three years.
Deutsche Bank AG/London Page 91 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 206: OCI’s H1 09 new awards Sector Location Value (USD m) Client Work Power Generation Egypt 258 West Delta Electricity Production Civil/fabrication works on the new 1,300 MW Abu Qir Thermal-Powered Company Power Plant
Infrastructure Afghanistan 125 US Govt. US government infrastructure work in Afghanistan
Oil & Gas/Petchem Algeria 280 Petrofac El Merk Central Processing Facility
General Public / Egypt 120 Al Futtaim Group New retail center at Cairo Festival City Commercial Services
General Public / Qatar 740 Qatari Diar Real Estate Investment Doha Convention Center & Tower Project Commercial Services Company
Wastewater Egypt 472* Egyptian Ministry of Housing Construction, operation and maintenance of New Cairo Wastewater Utilities & Urban Developments Treatment Plant over a 20 year concession period. Construction contract is worth $92 m Transportation Egypt 128 Egyptian Govt. Cairo-Alexandria highway
Transportation Egypt 140 Egyptian Govt. Civil, electromechanical and railway work on New Cairo Metro Line III
Source: Orascom Construction Industries, Deutsche Bank. * Project's net present value. OCI only booked the plant's construction value of US$ 92 million as backlog.
Management indicated that it aims to secure orders worth USD3.0-3.5 in 2009 and USD3.0- 4.0 in 2010. In H1 09, the company has received USD2.1bn worth of new orders. We believe the company’s guidance could prove conservative.
PPP programmes in Egypt could be icing on the cake Compared to other MENA countries, Egypt’s current account surplus was only 1.6% during 2004-2008. Further, in 2009/10, Deutsche Bank’s estimates call for a current account deficit of 3.2% of GDP and fiscal deficit of 6.7% of GDP. As a result, the government is more constrained in spending compared to other MENA peers. In order to avoid stress on fiscal budget, the government has undertaken a strategy to actively promote PPP projects particularly in infrastructure and utilities. According to the Ministry of Investment, official projections call for USD10bn of FDI in the next few years, which will be mostly concentrated in infrastructure.
In order to tap the opportunity, the company is aggressively focusing on PPP projects in Egypt. By nature, PPP projects are capital intensive, have long lead times, provide revenue visibility for longer time periods and naturally fetch higher margins (typical IRR of 25%). According to management, currently more than 50 projects worth EGP80bn (in ports, railways, roads, water and power plants and SEZs) are in the pipeline out of which 75% belong to the PPP category. Recently, OCI/Aqualia JV was awarded the first PPP project in Egypt (USD472m project for construction, operation and maintenance of New Cairo Wastewater Treatment Plant over a 20-year concession).
Page 92 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Fertilizer strategy & outlook
One of the top 10 N-fertilizer producers by 2010 Capacity to increase by 2.2x from 2.0mtpa to 4.3mtpa between 2009E-2011E Orascom Construction Industries is a new entrant in the fertilizer space and is in the process of ramping up its capacities significantly. Currently, the company has one operational urea plant (EFC) and one ammonia plant (EBIC) operating in Egypt and is in the process of constructing plants in Algeria.
It will become one of the top 10 nitrogen-based fertilizer producers worldwide in terms of production capacity by 2010 with projected ammonia capacity of 1.5mtpa and 2.6mtpa of urea. By 2012, urea capacity is set to increase to 2.8mtpa. Note that the company also has a toll manufacturing agreement with EFIC to produce up to 300ktpa of ammonium sulphate (economic benefits will be shared in the ratio of cost of raw materials at market-determined prices).
Figure 207: End of year capacities by product Figure 208: End of year capacities by company
5.0 5.0
4.0 4.0 1.5 1.5 1.5 2.0 2.0 3.0 3.0 2.0
2.0 2.0 0.7 0.7 0.7 0.7 0.7 2.6 2.8 2.8 1.0 1.0 1.6 1.6 1.3 1.3 1.3 1.3 1.4
0.0 0.0 2008 2009E 2010E 2011E 2012E 2008 2009E 2010E 2011E 2012E
Urea Ammonia EFC EBIC Sorfert Algerie
Source: Company data, Deutsche Bank Source: Company data, Deutsche Bank
Successful back to back distribution agreements with FITCO (Brazil) and Gavilon (USA) With significant investments underway to boost capacities, Orascom is seeking ways to maximize the potential. As a result, the company has been actively scouting for distribution partners in strategic markets namely Africa, Latin America, America and Europe. OCI has already entered in exclusive distribution agreements with FITCO which is a part of Grupo Fertipar, the 2nd largest fertilizer distributor in Brazil. Besides, it also has a production off-take agreement for EBIC’s volumes with Transammonia, a global fertilizer trader.
In July 2008, OCI acquired a 20% stake in Gavilon in USA for USD340m for distributing OCI’s products in North America. Through this stake acquisition, Orascom gained exclusive access to Gavilion’s distribution channel in North America. Gavilon is a distributor of fertilizers, grains, oilseeds, diary products, feed ingredients and energy, and it was ranked #1 2007 independent importer of fertilizers into the US with 7.1m tons. In order to expand its reach, currently, OCI is also holding negotiations with European and South Asian distributors.
Additionally, OCI has started trading third-party fertilizer volumes through Egyptian Fertilizer Trading Company (based in Dubai). The rationale is to secure a presence in key markets and replace third-party volumes with Sorfert Algerie volumes once that comes on stream in H2 10.
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We note that OCI’s target markets, namely US and Europe, offer attractive opportunities. As a result of the shift of industry to either low-cost production regions or key consumption centres, capacity in US and Europe has been reduced (in the last four yrs, European capacity has declined by 6% and North American capacity has declined by 7%) which has provided an opportunity to OCI to increase its market share in the US and Europe. The company maintains that its strategy of further penetrating strategic geographies remains in place and it is closely working with leading distributors to accomplish the objective.
Key competitive advantage is low-cost natural gas in Egypt and Algeria Across its plants, OCI fertilizer business revolves around the advantage of low-cost natural gas. The company has entered into long term fixed price natural gas supply arrangements in Egypt, Algeria and Nigeria with current procurement costs at USD1.0-2.0/mmbtu in Egypt, USD0.5-1.0/mmbtu in Algeria and USD1.0-2.0/mmbtu in Nigeria.
Figure 209: OCI’s fertilizer economics Name Holding Natural Gas Cost Cash Prod. Cost
Egyptian Fertilizer Company (EFC, Egypt) 100% USD1.0-2.0/mmbtu USD85/ton of urea Egypt Basic Industries Corporation (Egypt) 60% USD0.75-2.0/mmbtu USD85-90/ton of ammonia Sorfert Algerie (Algeria) 51% USD0.5-1.0/mmbtu Urea-USD70/ton, Ammonia- USD60/ton Notore Chemical Industries (Nigeria) 20% USD0.5-1.0/mmbtu N/A Source: Company data, Deutsche Bank
This compares with SAFCO’s procurement cost of USD0.75/mmbtu and Industries Qatar’s procurement cost of USD1.25/mmbtu, a Ukrainian producer’s (marginal producer) procurement cost of roughly USD7.00/mmbtu and a US Gulf coast producer’s natural gas cost of USD4.0/mmbtu.
Figure 210: Global natural gas costs, USD/mmbtu, 2008 Figure 211: Natural gas futures curve
15 9
8 12 7
9 6 5
6 4
3 3 2
0 1
US 0 China Egypt* Russia Ukraine Canada Algeria* Nigeria* Trinidad 10 11 12 13 14 15 18 19 21 N. Africa t- Venzuela Argentina Indonesia ct-16 W. Europe Oct-09 Oct- Oct- Oct- Oct- Oct- Oc O Oct-17 Oct- Oct- Oct-20 Oct- Middle East Middle
Source: PotashCorp, Deutsche Bank, * implies Orascom’s current and future geographies Source: Bloomberg
This leads to urea production cost of USD85/ton for OCI’s EFC, USD70/ton for Sorfert Algerie vs. USD230/ton for a Ukrainian producer and USD135/ton for a US Gulf-based producer. Note that China’s (largest producer and consumer) fertilizer production cost is USD230/ton using coal-to-methane conversion technology. Such a low cost production base ensures its profitability (although the cost advantage deteriorates) in the worst of times such as Q4 08 when fertilizer prices crashed by 40% q-o-q. Even then, the fertilizer division maintained an EBITDA margin of 44.3%. Having said that, OCI is also continuously looking for opportunities where the low fixed cost fertilizer business model can be exported to other countries.
Although oil and gas prices have fallen significantly from it high in 2008 (oil is down c.50%, with gas down c.75%, at current spot prices of c.USUSD3.5-4/mmBtu), MENA producers still
Page 94 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
have 4-5x cost advantage compared to other international industrial gas consumers. Furthermore, natural gas futures prices indicate significantly higher levels than the current spot market is trading at. This could signal better prospects for Orascom in the medium to long term.
Strategy beyond 2012E could evolve in several directions In the fertilizer industry, we do not expect OCI to take the lead as an acquirer as very limited acquisition opportunities exist that complement Orascom’s low-cost natural gas model. We believe further capacity expansion and/or product diversification could be announced beyond 2012E to ensure further avenues of growth.
On the other hand, we believe OCI’s fertilizer business could look attractive to any player seeking presence in low-cost gas regions. Note that Orascom is also probably one of the few players operating in the MENA region that is not government (directly/indirectly) controlled, which could make a easier target. Further, going by OCI’s private equity approach of value creation, management could revisit fertilizer strategy (sell out, merger, acquisition). However, we do not expect this to happen in the near term as two of its plants in Algeria and Nigeria are still under construction and as a result, the business is not realizing yet its full potential and we believe the current focus is execution. We also presume OCI would command a better valuation once these plants start contributing to cash flows in 2011/2012.
Long term positive fertilizer outlook supports Orascom’s case For more details on fertilizer outlook, please refer to DB research note on MENA Fertilizer, “Seeking Fertile Investments in the MENA region”, 6 October 2009 or in the appendix of the note.
The world population is growing; hence, food demand is increasing. Furthermore, increasing wealth, particularly from emerging markets, drives demand for higher-quality food, primarily animal protein. At the same time, our analysis indicates that arable land is shrinking, so causing more food to be produced out of less arable land – only achievable with higher use of fertilizers. Lastly, new sources of demand for crop steaming from biofuels are further increasing the demand for crops, and hence fertilizers.
Although commodity prices have always risen and fallen with changes in supply and demand, world agriculture now appears to be undergoing a structural shift towards a higher demand growth path, in our view. Despite the recent economic crisis, many countries, especially in Asia, have entered a period of faster economic growth vs. developed countries (shift towards more domestic driven demand vs. exports) that is generating strong demand for higher- quality diets including more meat, dairy products and vegetable oils. Lastly, global grain inventory stocks remain at multi-year lows, which should drive sustained high production of crops and higher prices vs. historical averages, in our view.
While the above trends create sustainable medium/long-term secular outlook for consumption of fertilizers, in the short term fertilizers are seeing the same adjustments in volumes and prices as most other commodities on the back of the recent excesses and global economic slowdown. Overall, we expect global fertilizer volumes to decline 6-7% in 2009E, followed by a similar rebound in 2010E.
Nitrogen (N) fertilizers (OCI’s key product area) – the largest of the three with a 58% share – should be least impacted with a modest decline of 1.5% as the supply/demand dynamic is relatively balanced, inventory levels are low and farmers cannot skip application without risking immediate yield impact. After 50-55% price correction in Nitrogen-based fertilizers YTD, we see prices stabilizing at current levels before slightly moving up next year.
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Financials
Q2 09 results Q2 09 numbers for the construction segment were better than market expectations while fertilizer segment performance was at par with market expectations.
Figure 212: Q2 09 results EGP m Q2 09 Q2 08 % YoY Ch. Q1 09 % QoQ Ch. Revenues
Construction 5,445 4,255 28% 4,085 33% Fertilizer 687 1,075 -36% 514 34% EBITDA Construction 707 615 15% 600 18% EBITDA Margin 13.0% 14.4% 14.7% Fertilizer 347 799 -57% 376 -8% EBITDA Margin 50.4% 74.4% 73.3% D&A (244) (183) 33% (217) 12% EBIT 810 1,231 -34% 759 7% Finance Income (83) 148 -156% (155) -46% Investment Income 10 38 -75% 107 -91% Tax (107) (90) 19% (126) -15% Other items 0 13 -100% 0 Minority Interest (53) (17) 206% 2 -3278% Attributable Profit 576 1,323 -56% 586 -2% Source: Company data
Construction: revenues were EGP5.4bn (+28% y/y, +33% q/q) and EBITDA was EGP707m (+15% y/y, +18% q/q). EBITDA margin was 13.0% vs. 14.7% in Q1 09 and 14.4% in Q2 08. Backlog remained stable q/q at USD7.2bn while new awards increased to USD1.17bn vs. USD930m in Q1 09.
Fertilizer: revenues were EGP687m (-36% y/y, +34% q/q) and EBITDA was EGP347m (- 57% y/y, -8% q/q). Urea prices were flat at USD265/t and ammonia prices were moderate at USD201/t. Q-o-q increase in revenues came from inclusion of fertilizer trading and ammonia sales in the product mix. In Q2 09, EBIC sold 70k tons of ammonia (quarterly production capacity 175k tons). Fertilizer margins were sharply lower at 50.1% compared to 73% in Q1 09 and 71% in Q2 08. This was due to inclusion of low-margin fertilizer trading (4-5% margin on estimated EGP130m in revenues) and lower margin ammonia sales. Excluding, fertilizer trading operations, fertilizer EBITDA margin would have been roughly 64% according to us. Overall, consolidated revenues were EGP6.1bn (+15% y/y, +33% q/q) and EBITDA was EGP1.0bn (-25% y/y, +8% q/q). Despite the q/q increase in EBITDA, q/q decrease in net income to EGP576m (-56.4% y/y, -1.6% q/q) was due to lower contribution of investment income as a result of one-off inventory write-down in Gavilion (lower fertilizer prices, underperformance of Gavilion’s grain business) and increase in minority interest payment. In 2009, OCI entered into a toll-processing agreement with Egyptian Financial and Industrial Corporation (EFIC) for producing ammonium sulphate to be produced from ammonia supplied by OCI. According to the agreement, OCI will supply 78k tons of ammonia and the sulphuric acid will be supplied by EFIC at market prices. Note that 78k tons of ammonia can produce up to 300k tons of ammonium sulphate, which will be exclusively distributed and sold by OCI. This gives OCI the flexibility to sell ammonia/ammonium sulphate whichever leads to higher margins at a given time.
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Q3 09 Preview
Figure 213: Q3 09 Results preview EGP m Q3 09 Q3 08 % YoY Ch Q2 09 % QoQ Ch Revenues Construction 4,830 4,137 17% 5,445 -11% Fertilizers 811 1,245 -35% 687 18% Group 5.641 5,383 5% 6,132 -8% EBITDA Construction 662 469 41% 707 -6% Fertilizers 412 1,198 -66% 347 19% Group 1,075 1,667 -36% 1,054 2% EBITDA Margin Construction 13.7% 11.3% 13.0% Fertilizers 50.9% 96.2% 50.4% Fertilizers (exc. EFT) 66.0% N/A 65.0% Group 19.1% 31.0% 17.2% Attributable Profit 559 1,113 -50% 576 -3% Source: Deutsche Bank Main assumptions Progressive ramp up in new orders in constrcution We believe OCI is likely to exceed its USD3.0-3.5bn new awards guidance for FY09 and USD3.0-4.0 for FY10. Looking beyond, we forecast 20% growth p.a. in new orders.
Figure 214: Backlog, new orders and revenues forecasts over 2009-12E USD m, unless stated 2009E 2010E 2011E 2012E
Opening Backlog 6,930 6,984 7,493 8,637 New Awards 3,747 4,700 5,640 6,768 Closing Backlog 6,984 7,493 8,637 10,223 Revenues 3,612 4,190 4,496 5,182 Revenues (EGP m) 20,286 23,162 24,590 28,338 Source: Deutsche Bank
Figure 215: Backlog and new orders (USD bn) Figure 216: EBITDA margins
12,000 14.0%
10,000 13.5%
8,000 13.0%
6,000 12.5%
4,000 12.0% 2,000 11.5% 0 2006 2007 2008 2009E 2010E 2011E 2012E 11.0% 2008 2009E 2010E 2011E 2012E Backlog New Awards
Source: Deutsche Bank Source: Deutsche Bank
As a result of increased competition for new projects, we expect industry-wide margins to decline slightly. However, OCI’s positioning on less competitive and higher margins location (North Africa) as well as its focus on more complex infrastructure projects that yield higher
Deutsche Bank AG/London Page 97 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
margins should allow the company to maintain EBITDA margin of 13-14%% during 2009- 2012E in our view.
Significant increase in fertilizer production and gradual increase in prices Ukraine is a marginal producer and its current cost of production is roughly USD240/ton. Ukraine receives natural gas from Russia calculated by a formula which is linked to crude oil price with a lag of six months. Hence, as a result of increase in crude oil price in the past six months, Ukraine should have a higher cost of production towards the end of year which could lead to increase in spot urea prices. In the longer term, we forecast prices to increase gradually to levels of USUSD275-300/t by 2013, on the back of tight supply/demand dynamics, limited inventory stocks, and the inability of farmers to reduce nitrogen application over prolonged periods, given the immediate impact it has on yields.
Figure 217: Price assumptions (USD per ton) Figure 218: Sales volume assumptions (in mtpa)
350 2.5 2.2 2.1 306 310 300 295 295 2.0 274 265 270 1.5 1.3 1.3 248 237 1.1 1.0 230 1.0 0.7
190 0.5 0.3
150 0.0 2009E 2010E 2011E 2012E 2009E 2010E 2011E 2012E
Urea FOB Px ($/ton) Ammonia FOB Px ($/ton) Urea Ammonia
Source: Deutsche Bank Source: Deutsche Bank
Group revenues and EBITDA forecasts Figure 219: Revenues and EBITDA forecasts 2008-12E 2009E 2010E 2011E 2012E Revenues Construction 20,286 23,162 24,590 28,338 Fertilizers 2,926 3,687 4,973 5,471 Consolidated Revenues 23,213 26,848 29,562 33,809 EBITDA Construction 2,782 3,177 3,372 3,887 Fertilizers 1,614 1,982 3,647 4,037 Fertilizers (exc. EFT) 1,588 1,946 3,647 4,037 Consolidated EBITDA 4,396 5,158 7,019 7,924 EBITDA Margin Construction 13.7% 13.7% 13.7% 13.7% Fertilizers 55.1% 53.7% 73.3% 73.8% Fertilizers (exc. EFT) 66.6% 67.3% 73.3% 73.8% Consolidated EBITDA 18.9% 19.2% 23.7% 23.4% Source: Deutsche Bank
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Detail of our estimates
Figure 220: Income statement 2008-12E EGP m 2008 2009E 2010E 2011E 2012E Revenues 20,253 23,213 26,848 29,562 33,809 % growth 50.2% 14.6% 15.7% 10.1% 14.4% COGS (14,952) (17,803) (19,985) (20,666) (23,738) Gross profit 5,300 5,409 6,863 8,897 10,071 as of % sales 26.2% 23.3% 25.6% 30.1% 29.8% % growth 129.5% 2.1% 26.9% 29.6% 13.2% Other operating income/(expense) 64 153 177 195 223 SG&A (1,093) (1,276) (1,475) (1,625) (1,858) Provision for claims and doubtful debts (201) (352) (407) (448) (513) EBITDA 4,801 4,396 5,158 7,019 7,924 as of % sales 23.7% 18.9% 19.2% 23.7% 23.4% % growth 92.0% -8.4% 17.3% 36.1% 12.9% Depreciation & Amortization (731) (1,008) (1,156) (1,104) (1,238) EBIT 4,070 3,388 4,002 5,915 6,686 as of % sales 20.1% 14.6% 14.9% 20.0% 19.8% % growth 158.2% -16.8% 18.1% 47.8% 13.0% Net interest income/(expense) 503 (437) (408) (260) (117) Investments Income 2 135 135 135 135 Profit before tax from continuing operations 4,575 3,099 3,729 5,790 6,704 % growth 211.5% -32.3% 20.3% 55.3% 15.8% Tax (576) (489) (588) (914) (1,058) Effective tax rate 12.6% 15.8% 15.8% 15.8% 15.8% Results from discontinued operations (net of tax) 11 Gain on Sale of Investments 1,434 Minority interest's share in net (loss) profit for the period 77 134 274 372 403 % minorities 1.9% 5.1% 8.7% 7.6% 7.1% Net attributable profit 5,367 2,476 2,866 4,504 5,243 DB restated net income post minorities 3,428 2,476 2,866 4,504 5,243 as of % sales 16.9% 10.7% 10.7% 15.2% 15.5% % growth 188.0% -27.8% 15.8% 57.1% 16.4% Source: Deutsche Bank
Deutsche Bank AG/London Page 99 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 221: Cash-flow statement 2008-12E EGP m 2008 2009E 2010E 2011E 2012E Cash flow from operations 5,450 4,100 4,297 5,981 6,884 (Incr)/decr in working capital (2,195) (1,944) 29 (82) (202) Purchase of property, plant and equipment (3,198) (4,219) (3,127) (1,315) (1,315) Disposal of property, plant & equipment 243 231 171 72 72 Total capex (2,955) (3,988) (2,956) (1,242) (1,242) as of % sales 14.6% 17.2% 11.0% 4.2% 3.7% Operating free cash-flow 300 (1,833) 1,370 4,657 5,439 Payments for purchase of intangible assets (77) - - - - Proceeds from sale of Cement segment 77,267 - - - - Proceeds from sale of long term investments 1,742 - Payments for purchase of long-term investments, net (12,137) (18) - - - FCF after investing activities 67,094 (1,851) 1,370 4,657 5,439 (Payment) of treasury stock, net (1,574) (70) - - - (Payments of) Proceeds from Bank Overdraft and Loans (2,693) 1,268 1,000 - Increase(decrease) in Long term Loans (1,362) (5,857) (3,047) (2,144) Increase (Decrease) in Long term liabilities, net 161 478 - - - Changes in Minority Interest (22) (13) - - - Cash dividends to shareholders (62,549) (997) (1,176) (1,176) (1,176) Injection of capital (at fair value) 3,934 - Net cash flow 4,352 (2,546) (4,664) 434 2,119 Source: Deutsche Bank
Page 100 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 222: Balance sheet 2008-12E EGP m 2008 2009E 2010E 2011E 2012E
ASSETS Non current assets Property Plant and Equipments 9,912 14,410 16,210 16,348 16,352 Payments for purchase of investments 2,785 - - - - Intangible assets 9,910 10,065 10,065 10,065 10,065 Investment in associated companies 136 2,152 2,152 2,152 2,152 Investments available for sale 133 268 268 268 268 Deferred tax assets 36 37 37 37 37 Long term receivables 255 313 313 313 313 Total non-current assets 23,167 27,246 29,046 29,184 29,188 Current Assets Inventories 1,462 1,681 1,643 1,751 2,016 Marktable securities 163 207 202 215 248 Trade and other receivables 8,236 12,617 12,334 13,139 15,131 Due from clients 1,194 1,736 1,697 1,808 2,082 Assets held for sale 535 544 544 544 544 Cash in hand & at banks 8,269 5,533 869 1,303 3,422 Total current assets 19,859 22,317 17,289 18,760 23,443 Total Assets 43,026 49,563 46,335 47,943 52,631 Shareholder's equity Share Capital 1,074 1,074 1,074 1,074 1,074 Legal Reserve 505 537 537 537 537 Other Reserve 5,678 5,818 5,818 5,818 5,818 Retained Earnings 11,851 12,255 13,946 17,274 21,340 Cumulative adjustment on translation of foreign companies (86) (49) (49) (49) (49) Treasury stock (1,668) (1,738) (1,738) (1,738) (1,738) Total Shareholder's Equity 17,355 17,898 19,588 22,916 26,983 Minority interest in subsidiary companies 227 760 1,035 1,407 1,810 Total Equity 17,581 18,658 20,623 24,323 28,793 Non Current Liabilities Long term Loans 7,754 9,740 3,883 836 (1,308) Provisions 1,891 1,918 1,918 1,918 1,918 Other long term liabilities 613 1,170 1,170 1,170 1,170 Deferred tax liabilities 507 494 494 494 494 Total non current liabilities 10,766 13,323 7,465 4,419 2,274 Current Liabilities Bank overdraft and current portion of long term loans 3,671 2,622 3,622 3,622 3,622 Trade and other payables 8,318 10,665 10,426 11,107 12,791 Due to clients 1,600 3,180 3,109 3,312 3,814 Provisions 634 889 869 926 1,066 Income taxes payable 457 226 221 235 271 Total current liabilities 14,679 17,582 18,247 19,202 21,564 Total Liabilities 25,444 30,905 25,712 23,620 23,838 Total equity and Liabilities 43,026 49,563 46,335 47,943 52,631 Net debt 3,156 6,829 6,635 3,154 (1,109) Gearing 18% 37% 32% 13% -4% Source: Deutsche Bank
Deutsche Bank AG/London Page 101 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Appendixes
Page 102 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Appendix A: country-specific opportunities
UAE Backlog stabilized at USD910-920bn levels since Jun ’09 According to MEED, live projects as of Oct‘09 stood at USD908bn, sharply down from USD1.3trillion in Mar 09. However, we note that the backlog has stabilized at USD910-920bn levels since June ’09. Further, live projects represented 70% of total projects.
Figure 223: UAE backlog (USD bn) Figure 224: Status of projects in UAE-Oct 2009
1,400
1,200 Non Live Projects 1,000 30%
800
600
400
200 Live Projects - 70% Jul -09 Jul Oct -09 Jun -09 Jun Mar -09 Mar Dec -04 Dec -05 Dec -06 Dec -07 Dec -08 -09 Aug -09 Sep
Source: MEED, Deutsche Bank Source: Zawya.com, Deutsche Bank
Courtesy Dubai, real estate accounted for 87% of projects cancellation A closer look at the backlog tells us that while real estate represents 62% of all live projects, it also represents 87% of all non-live projects. This is not a surprise to us as Dubai, the key real estate market (until recently) was characterized by heavy project cancellations, consolidations and delays. Additionally, our DB proprietary demand supply model tells us that Dubai would have an oversupply by 32,000 units by 2010E, which further supports the rationale for project cancellations.
Fundamentally stronger Abu Dhabi still provides opportunities On the other hand, we forecast an undersupply of 26,000 units in Abu Dhabi by 2012. Hence, Abu Dhabi has seen less project cancellation than Dubai. Overall, we believe heydays in Dubai real estate are unlikely to return in the near term while Abu Dhabi, with its strong fundamentals (undersupply, strategic vision of the government) will continue to provide opportunities.
Deutsche Bank AG/London Page 103 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 225: Live projects-Oct 2009 Figure 226: Non live projects- Oct 2009
Petrochem, Oil & Petrochem, Oil & Infrastructure Gas, industry Gas, industry 5% Infrastructure 15% 4% Power & Water 19% 4%
Power & Water 4%
Real Estate Real Estate 62% 87% Source: Zawya.com, Deutsche Bank Source: Zawya.com, Deutsche Bank
9 out of top 10 non live projects were in Dubai and none in Abu Dhabi USD308bn of real estate projects which are non live, the top 10 account for roughly USD271bn (roughly 90%) and all except one belong to Dubai. However Abu Dhabi does not feature in the top 10 list and its big ticket projects namely Al Raha Beach, Al Reem Island, Yas Island, Saadiyat Island are live thanks to direct/indirect government support.
Figure 227: Main non live real estate projects Project Developer Location Value (USD bn)
Jumeirah Gardens City Meraas Development Dubai 95 Mohammad Bin Rashed Gardens Dubai Properties Dubai 56 Nakheel Harbour and Tower Nakheel Dubai 38 Mudon Development Dubai Properties Dubai 21 Culture Village Dubai Properties Dubai 14 Downtown Jebel Ali Limitless Dubai 13 Palm Deira Nakheel Dubai 13 Al Salam City Tameer Holding Umm Al Quwain 8 Al Burj Tower Nakheel Dubai 8 Palm Deira - Phase 1 Nakheel Dubai 6 Source: Zawya.com, Deutsche Bank
Figure 228: Main live real estate projects in Abu Dhabi Project Developer Value Completion (USD bn)
Saadiyat Island Development - Masterplan TDIC 27 2,018 Al Raha Beach (all phases) ALDAR Properties 15 2,018 Reem Island (all phases) Sorouh, Reem, Tamouh 10 2,023 Najmat Abu Dhabi Reem Developers 8 2,012 Mohammed Bin Zayed City Abu Dhabi Municipality 7 2,012 Source: Zawya.com, Deutsche Bank
90% of infrastructure projects live 90% (vs. only 62% of real estate) of infrastructure projects are ongoing. We believe infrastructure projects are mostly government funded compared to real estate projects which are ultimately funded by private initiative (investors). Further, our analysis of infrastructure projects tells us that ongoing top 15 (86% of all infrastructure projects) infrastructure projects are equally split between Dubai and Abu Dhabi (at 47%/46%) while Abu Dhabi accounts for only roughly 10% of non alive projects and the rest almost exclusively belong to Dubai.
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Figure 229: Live project status in UAE
97% 94% 100% 90%
80% 73% 62% 62% 60%
40%
20%
0% Industry Oil & Gas Real Estate Real Infrastructure Power & Water Power Petrochemicals Source: Zawya.com, Deutsche Bank
Figure 230: Big ticket live infrastructure projects in UAE Project Location Type of Project Expected Value Completion (USD bn)
Dubai World Central (DWC) Dubai Economic Zones 2020 33.0 Al Maktoum International Airport (JXB) Dubai Airports na 8.0 Dubai Metro Dubai Metro 2014 4.2 Dubai Metro - Purple Line Dubai Metro 2013 2.7 Dubai Logistics City Dubai Economic Zones 2018 2.2 Dubai Metro - Blue Line Dubai Metro 2014 3.0 Khalifa Port and Industrial Zone (KPIZ) Abu Dhabi Ports, Industrial Zones 2028 24.0 Masdar Carbon Free City Abu Dhabi Economic Zones 2016 22.0 Abu Dhabi Metro Abu Dhabi Metro 2016 7.0 Abu Dhabi Airport Expansion Abu Dhabi Airports 2016 6.8 Mafraq - Ghweifat Road Upgarde Abu Dhabi Roads 2014 2.5 Ajman Airport Others Airports 2011 3.4 NTA - UAE Railway Others Railways 2015 3.0 Source: Zawya.com, Deutsche Bank
The Abu Dhabi’s 2030 plan present a sustained long term opportunity for contractors The government plan will be executed in 3 phases.
Figure 231: Abu Dhabi 2030 plan Growth Metrics 2007 2013 2020 2,030
Population 930,000 1.3 million 2 million 3 million CAGR 5.7% 6.3% 4.5% Residential Units 180,000 251,000 411,000 686,000 CAGR 5.7% 7.3% 5.3% Office Space (Sq M) 1.4 million 2.5 million 3.5 million 7.5 million CAGR 10.1% 4.9% 7.9% Industrial Space (Sq M) 4 million 6.5 million 10 million 15 million CAGR 8.4% 6.3% 4.1% Tourist (Visits) 1.8 million 3.3 million 4.9 million 7.9 million CAGR 10.6% 5.8% 4.9% Hotels (Rooms) 10,000 27,000 49,500 74,500 CAGR 18.0% 9.0% 4.3% Source: Abu Dhabi Govt.
Deutsche Bank AG/London Page 105 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Although we believe, the current plan is ambitious and current economic realities could shift the plan backward, we nonetheless believe that Vision 2030 along with the government’s commitment to diversify the economy supported by years of budget surpluses will create a long term construction demand in Abu Dhabi. Additionally, according to Oxford Business Group’s “Abu Dhabi 2009” report, the government is pushing ahead with all of its ambitious infrastructure and development plans. This leads us to believe that while Dubai is likely to remain muted in the near term, construction activity in Abu Dhabi will remain strong and would increasingly be a target market for contractors, GCC and non-GCC alike.
Saudi Arabia USD400bn of projected spending in the next five years In the beginning of 2009, the government announced expenditure of USD400bn on infrastructure projects over the next five years. Such a heavy spending plan clearly indicates government’s commitment to stick to its ambitious infrastructure development program. However, one may argue that since oil forms a significant portion of GDP and government revenues, low oil prices could lead to project cancellations. The government dispelled the skeptics by announcing no downsizing of construction spending even if oil prices were to fall below the budgeted levels of USD37/bbl. With current oil prices at USD70-80/bbl, the chances of scaling down infrastructure spending are limited.
In 2009 budget, the government adopted a expansionary fiscal policy (at USD37/bbl of oil vs. DBe 2009E USD64/bbl) and pegged total expenditure at SAR475bn (16% higher than the 08 budgeted expenditure) leading to a projected fiscal deficit of SAR65bn. SAR225bn (55% of total) was earmarked for capital expenditure (vs. SAR99bn budgeted in 2008 and USD165bn actually spent) aimed primarily at infrastructure spending (water, health, education, transport).
Figure 232: 2009 budgetary allocations Sector Allocation Objective Education & Manpower SAR 122bn Build 1500 new schools, renovate 2000 schools, build a university for women and a medical city within King Saud University
Healthcare and Social Services SAR52bn Build 86 new hospitals and primary care centers, along with new social and sports centers, labor offices as well as support poverty reduction programs. Municipalities SAR20bn Upgradation of streets, traffic, and environmental services Transportation and SAR19.2bn Construction of 5,400 km of new roads, in addition to the 30,000 km of roads already under construction Telecommunication and the 56,000 km of existing road network Water, Agriculture, Infrastructure SAR35.4 finance new projects in Jubail and Yanbu and upgrading of the sewage and other water-related projects Real Estate Development Fund SAR25.0bn Saudi Credit and Saving Bank SAR10bn Specialized credit institutions SAR40bn Source: Ministry of Finance
Severe undersupply in the housing market; demand to reach 1.2 million units by 2015 According to DB estimates, Saudi Arabia is characterized by severe undersupply (2008E demand 5.2m units vs. current stock of 4.6m units). Demographic trends such as increasing population as well as reduction in family size will create further demand and according to DB proprietary demand supply model, demand will increase by 1.2million units by 2015. Though we do not have exact data, we believe, the story in the commercial market will not be too different either. Further Saudi Arabia has a high local population but low home ownership levels of less than 50% (of households) primarily due to lack of affordability as well as lack of efficient mortgage market
We believe Saudi Arabia given its size along with attractive fundamental factors currently presents a good opportunity for developers/contractors but could potentially be a much bigger opportunity than currently envisioned once structural issues (such as mortgage availability, foreign home ownership) are sorted out.
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6 Economic cities will be future growth engines…but more of a long term opportunity In Q1 08, the government, through Saudi Arabian General Investment Authority (SAGIA), announced the planned construction of six economic cities. Currently, four have been launched and two other have been announced. According to SAGIA, the new cities will contribute roughly USD150bn to the Kingdom’s economy by 2020, create 1.3m jobs opportunities and become home to 4-5m residents. (Roughly 14% of the 2020E population of 32m, Source: World Bank). We have mentioned a snapshot of the economic cities below.
Figure 233: Snapshot of economic cities Name Location Cost Features (USD bn) Completion
King Abdullah Economic City Jeddah 110 168m sqm. , 2m population 2,025 Jazan Economic City Jazan 27 100m sqm., 1.2m population 2,037 Prince AbdulAziz bin Mousaed Economic City Hail 8 156m sqm. 300k population 2,025 Knowledge Economic City Medina 7 4.8m sqm., 150k population 2,020 Eastern Province Economic City N/A Planning Tabuk Economic City N/A Planning Source: Zawya.com, SAGIA
Electricity consumption to rise from 35,000Mw in 2007 to 140,000Mw in 2032 According to Ministry of water & electricity, Saudi Arabian electricity consumption could rise 5.7% annually to 140,000 MW in 2032 vs. 35,000 MW in 2007 and at the lowest could increase to 108,000Mw (+4.6% annually). Accordingly, total power demand should increase to 572,000Gwh in 2032 from 163,000Gwh in 2006. Further, it estimates that the country will require up to 20 gigawatts (GW) of additional power generating capacity by 2019 - nearly the same amount as today's 26.6 GW - at a cost of USD4.5-6.0bn per year. Currently, the power demand is growing 7% annually and according to BMI, during 2008-2013, power generation capacity will increase 5.3% annually and increase 4.0% annually during 2013-2018.
93% of the projects live…infrastructure, power & water and real estate strong at 99%, 100% and 95%, respectively According to MEED, total value of projects outstanding was USD593bn, an 8% decrease from USD645bn in end March ’09. Note that this decline compares favourably with an average GCC decrease of 20% during the same time. Further, we note that 94% of the projects in Saudi Arabia are live with live infrastructure, power & water and real estate accounting for 99%, 100% and 95%, respectively.
Figure 234: Saudi Arabia project backlog Figure 235: Backlog status- Oct 2009
700 Non Live 7% 600
500
400
300
200
100
-
Jul -09 Jul Live Oct -09 Jun -09 Jun Mar -09 Mar Aug -09 Aug -09 Sep Dec -04 Dec -05 Dec -06 Dec -07 Dec -08 93%
Source: MEED Source: Zawya.com, Deutsche Bank
Deutsche Bank AG/London Page 107 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 236: Segment wise project status in Saudi Arabia
100% 99% 100% 95% 94%
77% 80% 73%
60%
40%
20%
0% Industry Oil & Gas Real Estate Real Infrastructure Power & Water Power Petrochemicals Source: Zawya.com, Deutsche Bank
Figure 237: Live projects- Oct 2009 Figure 238: Non live projects- Oct 2009
Infrastructure Power & Water 4% 1%
Real Estate Industry, oil & gas Infrastructure 12% & petrochemicals 34% 36%
Power & Water Industry, oil & gas 11% & petrochemicals Real Estate 83% 19% Source: Zawya.com, Deutsche Bank Source: Zawya.com, Deutsche Bank
Figure 239: Main live projects in each sector Sector Value (USD bn) Infrastructure Saudi Landbridge 6.6 Makkah, Madinah Rail Link 6.0 Arafa Railway 5.3 King Abdulaziz International Airport - Phase 1 4.5 Jeddah Monorail 3.7 Power & Water Egypt - Saudi Arabia Power Interconnector 8.5 Ras Al Zour Power and Desalination Plant 5.4 Yanbu Power Generation and Desalination Plant 4.0 PP10 Power Plant 3.0 Shuaibah Power Plant Expansion - Phase III 2.9 Real Estate Kingdom Tower 13.6 Kingdom City 13.3 Al Wasl Community 12.0 Jeddah Hills 11.2 Jeddah Central District 8.0 Source: Zawya.com, Deutsche Bank
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Qatar Government has the commitment and the financial muscle for development In the wake of global economic contraction in 2009E, Qatar is one of the very few countries in the world to post a strong 2009E real GDP growth of 18% (DBe). Further, according to BMI, construction sector is also expected to grow 5.0% y/y. For 2009E, the government adopted an expansionary budget (at USD40/bbl of oil) and allocated QR 37.9bn (40% of total budget) for capital expenditure.
Though the budget did not provide for any breakdown of sectoral spending, we note that infrastructure accounted for roughly 75% of capital spending in 2008. We believe, emphasis on infrastructure spending positively reflects on government’s commitment to meet the increasing infrastructure needs of the country. The governor of the central bank also reiterated that the government will continue spending on development to support the needs of country’s growing population.
We further believe that the four pillars of Qatar National Vision 2030 (human development, social development, economic development, environmental development) that aim to create a dynamic and diversified economy will necessitate further investment in infrastructure for years to come. We also note that in May 2009, S&P said that Saudi Arabia, Abu Dhabi and Qatar are most resilient in the GCC and they are also most likely to overcome the global slowdown through spending their reserves in developing their non oil dependant sectors to help support their economies.
90% of projects live with infrastructure and power and water projects remain strong According to MEED, as of Oct’09, Qatar had USD207bn of live projects representing 90% of total projects. Infrastructure and power and water projects were extremely strong with 99.7% and 100%, respectively of ongoing projects vs. 87% for real estate. We believe, the strong market environment in Qatar should present a potentially good opportunity for contractors and we should see more contractors moving to Qatar sooner than later.
Figure 240: Qatar backlog (USD bn) Figure 241: Status of Qatari projects- Oct 2009
250 Non Live 10%
200
150
100
50
-
Live 90% Jul -09 Jul Oct -09 Jun -09 Mar -09 Dec -04 Dec -05 Dec -06 Dec -07 Dec -08 Dec Aug -09 Sep -09
Source: MEED Source: Zawya.com, Deutsche Bank
Deutsche Bank AG/London Page 109 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 242: Segment wise project status in Qatar
100% 100% 98% 100% 94% 84% 80%
56% 60%
40%
20%
0% Industry Oil & Gas Real Estate Real Infrastructure Power & Water & Power Petrochemicals Source: Zawya.com, Deutsche Bank
Figure 243: Live projects- Oct 2009 Figure 244: Non live projects- Oct 2009
Infrastructure Infrastructure 3% 13%
Power & Water 9% Real Estate 38%
Industry, oil & gas & petrochemicals Industry, oil & gas 56% & petrochemicals Real Estate 59% 22%
Source: Zawya.com, Deutsche Bank Source: Zawya.com, Deutsche Bank
Figure 245: Main live projects in major segments Sector Value (USD bn) Infrastructure New Doha International Airport 11.0 New Doha Port 7.0 Barwa Al Khor - Phase 1 1.4 Power & Water Ras Girtas Power Company - Ras Girtas IWPP 3.9 Kahramaa - West Coast IWPP 3.0 Mesaieed IPP 2.3 Real Estate The Pearl Qatar 14.0 Heart of Doha 5.5 Lusail Development 5.5 Source: Zawya.com, Deutsche Bank
Oman “The Future Vision 2020” is a guiding force for future development The Vision 2020 plan aims to set a working plan and mechanism to boost the capabilities of Oman’s economy, encourage private sector to invest and diversify the sources of income to reduce dependency on oil. In line with this strategy, the country has been investing in infrastructure and according to the chairman of Oman Chamber of Commerce and Industry,
Page 110 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
the government is focusing on investing in modern road network, set up means of communication and providing services such as electricity and water so that the private sector can play its role as a key partner in development.
In line with the overall strategy, in Aug 2009, Public Authority for Electricity and Water announced that the country will invest USD7.8bn to enhance the power and water supply. Further, in June ministry of transport signed 17 new agreements worth USD220m in a bid to develop the country’s transport infrastructure and 22 agreements worth USD228m for developing its ports and civil aviation sectors.
USD94bn of live projects (95% of all projects) As of Oct’09, live projects were USD94bn accounting for 95% of all projects. Except petrochemicals, all sectors look strong, with live projects accounting for 97% of real estate and power and water and 100% for infrastructure, oil & gas and industry.
Figure 246: Oman backlog (USD bn) Figure 247:Status of Omani projects- Oct 2009
120 Non Live 5%
100
80
60
40
20
-
Live Jul -09 Oct -09 Jun -09 Mar -09 Dec -04 Dec -05 Dec -06 Dec -07 Dec -08 Aug -09 Sep -09 95%
Source: MEED, Deutsche Bank Source: Zawya.com, Deutsche Bank
Figure 248: Segment wise project status in Oman
100% 100% 100% 97% 96% 100%
80%
60% 45% 40%
20%
0% Industry Oil & Gas Oil Real EstateReal Infrastructure Power & Water & Power Petrochemicals Source: Zawya.com, Deutsche Bank
Deutsche Bank AG/London Page 111 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 249: Live projects- Oct 2009 Figure 250: Non live projects- Oct 2009
Infrastructure Power & Water 8% 4% Industry, oil & gas Power & Water & petrochemicals 7% 30%
Industry, oil & gas Real Estate & petrochemicals 44% 52%
Real Estate 55%
Source: Zawya.com, Deutsche Bank Source: Zawya.com, Deutsche Bank
Three mega projects each USD20bn each namely Blue City, Frontier Town and Duqm Downtown account for the lions’ share of all real estate developments.
Figure 251: Main real estate projects in Oman Project Cost Completion Features (USD bn) Duqm New Downtown 20 2020 Community development project (225m sqm., 65,000 residents)
Blue City 20 2020 Community development project (34 sqkm 250k residents) Omran - Frontier Town 20 2020 Community development project Source: Zawya.com, Deutsche Bank
Figure 252: Main projects in infrastructure and power and water Infrastructure Value (USD bn) Muscat International Airport Expansion 2.5 Sohar Special Economic Zone 2.0 Duqm Port 1.4 Power and Water Al Duqm IWPP 2.0 Barka 3/Sohar 2 IPPs 1.0 Barka 2 IWPP 1.0 Source: Zawya.com, Deutsche Bank
Bahrain According to MEED, as of Oct’09, Bahrain’s project backlog stood at USD64bn. Further, we note that 96% of all projects were live (source: Zawya.com). Note that Bahrain’s backlog is much smaller compared to its MENA peers and again, real estate dominates the backlog accounting for 68% of all live projects.
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Figure 253: Status of Bahrain’s projects- Oct 2009 Figure 254: Segment wise project status in Bahrain
Non Live 100% 100% 100% 99% 98% 4% 100%
80%
60%
37% 40%
20%
0% Industry Oil & Gas Oil
Live Estate Real Infrastructure Power & Water
96% Petrochemicals
Source: Zawya.com, Deutsche Bank Source: Zawya.com, Deutsche Bank
Kuwait Only country in GCC to reduce infrastructure spending in the 2009E budget Contrary to its gulf peers, who are increasing infrastructure/capital spending to tackle the current crisis, Kuwait, in its 2009 budget (at oil price USD35/bbl) aimed to reduce spending by lowering welfare contributions and infrastructure investments. Contribution to social welfare funds will decrease by USD18.4bn whereas infrastructure investments are expected to drop from USD5.7bn to USD4.2bn. Additionally, in April 2009, Kuwait came out with a stimulus package of USD5.2bn but that was mostly aimed at assisting troubled investment firms and to encourage banks to offer new credit and not aimed at infrastructure.
However USD3.5bn allocation for housing and USD63bn of planned expenditure for the next 4 years In Oct ’09, Kuwait government allocated its largest budget yet of USD3.5bn for housing projects. This was done to provide houses to Kuwaitis who have been waiting to receive government housing and the housing ministry intends to reduce the waiting time. Additionally, it was reported in the press that Kuwait has plans to spend USD63bn in the next 4 years on 250 large scale projects. Note that the press source did not mention the sectoral allocation of the planned expenditure but said that the plan would focus on boosting the private sector's role in the domestic economy.
Transportation stake sale to private investors in the offing A potential opportunity could be the transport sector where developing mass transportation has been a part of government’s plan to ease traffic congestion and encourage a greater private sector role. As a means to achieve its objective, the government plans to auction 26% stake (to local and international investors) in 3 transportation system projects worth up to USD5.3bn. The government will own a 24%, and the remaining 50% will be offered to Kuwaiti investors. The projects were approved by the government to develop the country's first railway and monorail systems.
Only 46% of ongoing projects According to Zawya.com, live projects in Kuwait were USD159bn. Further, we note that only 46% of all projects were live. This primarily stems from the Silk City real estate project worth USD130bn which has put on hold. If we exclude Silk City, live projects account for 74% of the projects.
Deutsche Bank AG/London Page 113 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 255: Status of Kuwaiti projects- Oct 2009 Figure 256: Segment wise project status in Kuwait
100% 94% 85% 85% 80% 70%
60% 55%
Live 40% 46% Non Live 20% 54% 20%
0% Industry Oil & Gas Real Estate Real Infrastructure Power & Water Petrochemicals
Source: Zawya.com, Deutsche Bank Source: Zawya.com, Deutsche Bank
Figure 257: Live Projects- Oct 2009 Figure 258: Non live projects- Oct 2009
Infrastructure 4% Power & Water Industry, oil & gas Industry, oil & gas 3% & petrochemicals & petrochemicals 26% Infrastructure 25% 29%
Power & Water 8%
Real Estate Real Estate 68% 37%
Source: Zawya.com, Deutsche Bank Source: Zawya.com, Deutsche Bank
Figure 259: Main live projects in major segments Sector Value (USD bn) Infrastructure Kuwait International Airport Expansion 21.0 GCC Rail Network 14.0 Kuwait National Rail Network 6.6 Power & Water Al Zour North Power Plant - Phases 1 and 2 3.6 Subiya Power Plant 2.7 Shuaiba North Power & Desalination Plant 1.3 Real Estate Sabah Al Ahmad Future City 27.0 Khairan Residential City 20.0 Bubiyan Island 6.0 Source: Zawya.com, Deutsche Bank
Algeria At the early stages of transformation Algeria was negatively affected by years of civil war (1991-2002) and as result construction activity was not at the centrestage. This left a visible shortage in terms of housing and physical infrastructure. However, after the civil war, there was a need for upgrading the infrastructure. Coupled with demand, Algeria also immensely benefited from high energy
Page 114 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
prices during 2003-2008 which left it with huge surpluses (20.3% current account balance during 2004-2008, Source: EIU) and it directed a significant portion of this income to build infrastructure for not only its energy sector but also for the development of other sectors namely transport and real estate. Hence, this comes as no surprise when Oxford Business Group, describes Algeria’s construction market potential as monumental. According to BMI, construction sector in Algeria grew 12.5% in 2008 but will decrease 5.1% in 2009 as a result of global financial crisis. Nonetheless, it is one of the few countries to maintain positive growth this year.
Government programs aimed at residential construction and infrastructure 70% of the USD145bn 2005-09 Programme for the Support of Economic Growth was allocated for housing and infrastructure. This included construction of 1.25m affordable homes which according to Oxford business group is not sufficient. According to a recent study published in Aug ’09 by university of Setif, current market is undersupplied by 763,000 units and demand for new housing will increase to 2million units by 2015.
USD150bn development plan for 2009-2013 The government of Algeria announced that they are entering an ambitious five-year development program valued at USD150bn (1.1x2009E GDP) for 2009-2013 which will largely be spent on infrastructure. Additionally, the ministry of energy and mines has planned to invest USD69bn during 2009-2014 which will be progressively increased to USD120bn by 2020. Note that the state budget was calculated at USD37/bbl, so current average oil prices of USD70-80/bbl provides comfort that the spending plan is not likely to be slowed down. Some of the infrastructure development projects include the following:
USD12bn of East-West Motorway (1200km from Tlemcen to Annaba)
USD11bn of Hauts Plateaux Beltway project;
USD3.8bn planned spending on Rail Network and Algiers Metro which is currently under construction and first phase will open in October 2009. Live projects at 86%, real estate and power & water at 100% and 99%, respectively According to Zawya.com, live projects in Algeria was USD80bn in August, accounting for 86% of all projects. We note that 100% of real estate and 99% of power and water projects were live.
Figure 260: Status of Algerian projects- Oct 2009 Figure 261: Segment wise project status in Algeria
Non Live 100% 100% 99% 14% 100% 86%
80%
60% 49%
40%
20%
0% Live Industry Real Estate Power & Water Oil & Gas Petrochemicals 86%
Source: Zawya.com, Deutsche Bank Source: Zawya.com, Deutsche Bank
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The table below provides a glimpse of major projects ongoing in the respective sectors.
Figure 262: Main live projects in major segments Industry Value (USD bn)
Beni Saf Aluminum Smelter Complex 5.0 Algeria Steel Factory 1.0 Power & Water Koudiet Edraouch Power Plant 2.2 Terga Power Plant 2.0 Real Estate Dounya Parc Algiers 6.0 Algeria Economic Zone 3.0 Source: Zawya.com, Deutsche Bank
Egypt Stimulus package of USD5.4bn to provide short term support in the near term Construction sector in Egypt greatly benefited from the reforms programme undertaken in 2004 which led to Egypt’s investment boom in tourism, real estate, infrastructure and petrochemicals. However, like other countries in the world, Egypt was not immune to the global meltdown. As a result, similar to other countries, in order to sustain growth, Egypt also adopted an expansionary fiscal policy in 2009 with a budget deficit of 8.4%.
Additionally, in mid December, Egypt announced USD2.7bn stimulus package that included public investments in infrastructure projects. Later in February 2009, the government decided to double its earlier stimulus package to USD5.4bn. Again, the extra expenditure will mostly go towards funding the infrastructure and utility projects. However, according to BMI, despite the government support, Egypt’s construction will still be affected and post a growth of only 0.15% in 2009.
PPP projects in infrastructure and utilities Compared to other MENA countries, Egypt’s current account surplus was only 1.6% during 2004-2008. Further in 2009/10, Dbe call for C/A deficit of 3.2% of GDP and fiscal deficit of 6.7% of GDP. As a result, the government is more constrained in spending compared to other MENA peers. In order to avoid stress on fiscal budget, the government has undertaken a strategy to promote PPP projects particularly in infrastructure and utilities. Recently, a J/V between Orascom Construction and Aqualia was awarded the first PPP project worth USD472m for a wastewater plant in Cairo. Additionally, according to the country’s trade minister, infrastructure is a key focus area and that strong foreign investor interest exists in roads, ports, logistic centers, water-treatment facilities and the electricity sector. Although the liquidity crunch could pose a hurdle in attracting investments in the short term, on a long term basis, we view this development positively as opening the market to private players is typically associated with above normal investment growth. This could also present a significant opportunity for contractors as they could potentially manage the projects and earn recurring revenues (e.g. toll fees for a toll operator)
USD20bn allocated to power plants and USD10.9bn in transport infrastructure In Jun 2009, Egyptian government approved an USD20bn plan to build 9 power stations and expand the electricity generation capacity. Construction for these plants is expected to start in 2012 and complete in 2017.
Additionally, according to MEED, Egypt intends to invest USD10.9bn in its transport infrastructure over the next three years. According to the Transport Ministry, it is targeting investments in the country’s road network, railways, public transport, ports and river transport.
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82% of all projects live According to Zawya.com, live projects in Egypt were roughly USD90bn accounting for 82% of all projects. We note that 94% of the power and water projects and 80% of real estate projects were ongoing. Further, we believe that in real estate and infrastructure sectors, our dataset do not accurately capture the true picture as only 1 infrastructure project namely Sokhna Port Expansion worth USD1.3bn was delayed while in real estate only 1 project namely Gamsha Bay (USD16.3bn) by Dubai based Damac properties is a part of non live projects. Excluding the Sokhna and the Gamsha Bay project, 100% of all infrastructure and real estate projects were live
Figure 263: Status of Egyptian projects- Oct 2009 Figure 264: Segment wise project status in Egypt
100% 100% 100% 94% Non Live 18% 80% 80% 74%
60%
40% 21% 20%
0%
Live Industry Oil & Gas Oil
82% Estate Real Infrastructure Power & Water Power Petrochemicals Source: Zawya.com, Deutsche Bank Source: Zawya.com, Deutsche Bank
Figure 265: Live projects- Oct 2009 Figure 266: Non live projects- Oct 2009
Infrastructure Industry, oil & gas Infrastructure Industry, oil & gas Power & Water 0.4% & petrochemicals 6.7% Power & Water & petrochemicals 10.2% 16.7% 6.2% 2.8%
Real Estate Real Estate 72.7% 84.3%
Source: Zawya.com, Deutsche Bank Source: Zawya.com, Deutsche Bank
Libya A country in transformation Due to sanctions imposed on it by US (since 1980s) and UN (since 1992), Libya has been characterized by massive underinvestment in the past which has led to significant deterioration of physical infrastructure (roads, ports, airports, power generation, and water treatment systems). However, following lifting of sanctions in 2003, the country has taken important steps forward to diversify the economy and integrate the country in the international community. This has resulted in development plans for infrastructure and energy. Currently, Libya faces housing shortage, roads are not well maintained and it also does not have any railway system. We believe Libya presents an attractive opportunity for contractors as it satisfies two basic conditions; first, inherent demand (infrastructure, housing) coupled with low amount of investments in the past and second, huge accumulated surplus to satisfy the demand.
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USD260bn developmental program in the next 5 years In Jan 2009, the Libyan Planning Ministry estimated the gross amount of investments for the developmental program in the coming five years at USD260bn. 77% of the amount is expected to be funded from the state budget and the remaining is planned to be secured from non-state budget sources.
The Planning Ministry’s reports also indicated that 58% will be allocated to the infrastructure sector and utilities-related programmes will be prioritized for funding. Note that In Aug ’09, Libyan Investment and Development Company awarded a contract worth USD996m contract to construct 5,000 houses in Tobruk.
Figure 267: Infrastructure development plans Power Power demand is growing rapidly, approximately 8-9 percent annually. Power sector is set to double in terms of output from 4,700MW to 9,700MW within the next five years at a projected cost of USD7.5bn Water USD6bn has been allocated to waste water systems and management. Over 60% of medium and large capacity desalination plants are more than 17 years old. Further, according to MEED, Libya plans to triple water desalination capacity to 1.8m cubic meters a day by 2015 Housing 70,000 units/year are needed to keep pace with the growing population
Roads and bridges 2,000 kms of road improvements. In August 2008 Libya signed a deal with Italy for the construction of a USD4.7bn 2,000-km coastal motorway stretching from Egypt in the east to the Tunisian border in the west Seaports Ambitious development plans to bring the ports and logistics network up to international standards in terms of design, equipment and efficiency. Capacity expansion of Tripoli port Airports USD1bn scheme to modernize all the country's 13 civilian airports .A new terminal at Tripoli International Airport is under construction, and a new airport in Benghazi is a priority Railways Russia and Libya signed a contract, worth USD3.2bn, to build a 554-km railway between the cities of Sirte and Benghazi. This is supposedly part of a larger deal between the two countries, worth up to USD20bn, to oversee the construction and management of the Libyan railway programme Tourism Growth in hotel construction is forecast to increase the number of beds to 10,000 by 2010 as part of a USD7bn tourist development plan Hydrocarbon Raising oil production from its current level to 2 million b/d by 2010, with longer term ambitions to raise it to 3 million b/d by 2015. government is seeking USD40bn of foreign direct investment to develop the industry Source: Construction News Plus
Live projects account for 100% of all projects According to Zawya.com, USD60bn of projects are ongoing in Libya and all are live. According to BMI, although the growth in construction (infrastructure) will slow down, the real annual growth will still be 5%, which we believe, in the current market conditions is not unattractive.
Iraq Significant reconstruction opportunity…but for the brave hearted contractors The war shattered oil rich country is undergoing reconstruction and anecdotal evidence suggests that the whole country itself is a construction site. Though we do not have exact numbers as to how much the construction market is worth, in the wake of improving political situation, we believe huge spending potential exists and hence an attractive opportunity for strong-hearted contractors. The whole country needs to be rebuilt and as a result billions of dollars needs to be spent to put in place the required basic infrastructure namely roads, ports, water, power, housing etc.
USD45.8bn of contracts to be procured (from government agencies) in the near term According to the spokesman for Baghdad’s security plan, USD30bn is required only for the rehabilitation of Baghdad and the corresponding figure for the country runs into hundreds of billions of dollars (Project Rebuild Iraq 2008 puts the reconstruction market at USD100bn and says its is set to expand further). Further, according to UK Trade and Investment, some USD45.8bn of contracts are still to be procured (from government agencies) in the near term which could present a significant opportunity for contractors.
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USD157bn of projects ongoing…97% of total According to MEED, as of August 2009, USD157bn of projects was ongoing in Iraq which represented 97% of total projects implying only 3% were put on hold. This represents a 14x increase from USD10bn on Dec 2004.
Figure 268: Iraq backlog (USD bn) Figure 269: Status of Iraqi projects- Oct 2009
180 Non live 160 12%
140
120
100
80
60
40
20
-
Live Jul -09 Jul Oct -09 Jun -09 Mar -09 Dec -04 Dec -05 Dec -06 Dec -07 Dec -08 Aug -09 Sep -09 88%
Source: MEED Source: MEED
1.27mn new housing required between 2006-2016 In a 2006 housing market study by UN, it was estimated that 1.27m new housing units will be required between 2006 and 2016. Assuming a development cost of USD31,000/unit (Source: UN Habitat), the housing market potential itself is worth USD39bn. Note that in Jan 2009, USD320mn of housing projects to build 5,000 housing units were awarded in Karbala and Sulaimaniyah. Further, in Jan 2009, the local council in Diwaniya set aside a huge plot of land for the construction of a USD1.5bn "new city" in Al-Qadisiyah province.
USD20bn investment in power and USD14bn investment in water required According to World Bank, Iraq needs to invest USD20bn over the next 10 years simply to upgrade the country’s power sector and Ministry of electricity estimates it needs USD27bn (US estimates more than USD54bn) to meet the entire country’s demand by 2015. Additionally, World Bank also estimates that Iraq needs USD14.4bn to improve the water system.
Investments required primarily in the priority sectors…cancellation risk very low Although, the sovereign budget is highly dependant on oil revenues (contributed 91% of 2008 budget) and lower oil prices could strain government finances (2009 budget was cut to USD58bn from USD80bn earlier due to lower oil prices and 22% of the revised budget is allocated to capital projects), most of the expenditure needs is in the priority sectors such as transportation, water, power, housing which were erstwhile destroyed by war. The very nature of the projects tells us that the project cancellation risks are very low. Nonetheless, security risk does exist and note that contractor Bechtel had to exit Iraq in 2006.
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Appendix B: The case for fertilizers
The following is an excerpt from a MENA Fertilizers note, “Seeking Fertile Investments in the MENA region”, released on 6 October 2009.
Population growth is slowing while wealth is increasing
Population growth rate to The entire section is an excerpt from DB Research note “MENA Fertilizers: Seeking Fertile th slow down from 1.7% pa in Investments in the MENA Region” published on 6 October 2009. the period `69-99 to less than 1% pa until 2030 US census data reveals that world population has increased by some 30% over the past 20 years and 122% since the 1960s, growing at a 1.9% rate pa. Although population growth rate is expected to slow down from 1.7% pa in the period 1969-99 to less than 1% pa until 2030, in absolute terms this still translates to an average of 85-90m new demanders of food.
Figure 270: Population growth, percentage change pa Figure 271: Per capital GDP, percentage change pa
2.5% 5.0% 4.4% 4.5% 4.3% 4.0% 2.0% 1.7% 4.0% 3.7% 1.6% 3.5% 1.5% 1.2% 2.9% 2.8% 3.0% 2.6% 0.9% 2.3% 1.0% 2.5% 2.0% 0.5% 1.5% 1.0% 0.0% 0.5% -0.5% 0.0% World Developing Transition countries Industrial countries World Developing Transition countries Industrial countries countries countries
1969-99 1979-99 1998-2015e 2015-30e 1998-2015e 2015-2030e
Source: IMF, FAO, Deutsche Bank Source: IMF, FAO, Deutsche Bank
At the same time, as emerging markets become more developed, global wealth, in the form of per capita GDP, is expected to accelerate further from 2.3% pa in the period 98-2015e to Global wealth, in the form of c.3% pa during 2015-30e, according to FAO projections. per capita GDP, is expected to accelerate further from Food consumption – eating slightly more food but of much 2.3% pa to c.3% pa higher quality
Cereal consumption to As the global wealth factor improves, demand for higher quality of life, starting with better increase only 4% until 2030, quality food, will be in higher demand. Therefore, while cereal consumption is expected to while total food increase only 4% until 2030, total food consumption is to expand at 2x the rate of cereal consumption is to expand at growth, mainly due to projected 24% increase in meat consumption over the period. 8%, as meat consumption Cereal consumption leveling off grows 24% Cereal consumption has leveled off in recent decades and is projected to grow at rate similar to population growth. However, total food consumption is still estimated to grow at a rate of 8% pa, with the developing world showing the highest growth rate of 14%, followed by transition countries at 7%, and 3% for developed countries.
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Figure 272: Cereal consumption, kg per capita/yr Figure 273: Total food consumption, kg per capita/yr
400 700 3% 1% 350 7% 4% 6% 600 -1% 300 500 8% 14% 250 400 200 300 150 200 100
50 100
0 0 World Developing Transition countries Industrial countries World Developing Transition countries Industrial countries Countries Countries
1979-81 1997-99 2015e 2030e 1979-81 1997-99 2015e 2030e
Source: IMF, FAO, Deutsche Bank; Note: #’s in circle indicate growth rate between 1997-99 & 2030e Source: IMF, FAO, Deutsche Bank; Note: #’s in circle indicate growth rate between 1997-99 & 2030e
The meat factory – increased meat consumption drives stronger demand for grains in form of feedstock In China, meat production As consumers become more affluent, they demand better quality food. This means a diet has grown by 7% pa in the with more consumption of meat, eggs, dairy and aquatic products. The primary drive for the past 30 years increased food consumption vs. cereal consumption is the expected strong growth in global meat consumption, particularly in emerging markets. This, in our view, is directly linked with the increasing wealth of consumers in those countries. Proteins are more expensive than grains and therefore their consumption is highly correlated with income per capita levels. This is most visible in China, where meat production has grown by 7% pa in the past 30 years (see Figure 275).
Figure 274: Meat consumption, kg per capita/yr Figure 275: China meat consumption
120 90 13% 100 80 70 80 31% 60 60 24% 44% 50 40 40 m tonnes 20 30
0 20 World Developing Transition countries Industrial countries 10 Countries 0 1979-81 1997-99 2015e 2030e 1978 1988 1998 2008 2018e
Source: IMF, FAO, Deutsche Bank; Note: #’s in circle indicate growth rate between 1997-99 & 2030e Source: USDA, National Bureau of Statistics of China
Soft grain to protein Meat production requires grain feed. The FAO estimates that meat consumption is expected transformation ratio is 7-1, to increase by 24% by 2030e. Livestock needs to consume several kilos of soft grain 4-1 for pork and 2-1 for feedstock in order to gain one kilo of weight. The soft grain to protein transformation ratio is seven-to-one for beef, four-to-one for pork and two-to-one for poultry (see Figure 277). poultry
Chinese per capita We expect meat consumption to remain strong in China, where per capita meat consumption consumption of meat is 60% is behind that of the world average – Chinese per capita consumption of meat is 60% of the of the world average and world average and 20% of that of North America. As living standards in emerging markets 20% of North America continue to rise, there remains considerable room for increased meat consumption, since average consumption is below half that of developed countries. This makes grains for protein production the key long-term secular driver for increased grain demand.
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Figure 276: Crop production vs. meat consumption Figure 277: Soft grain-to-protein conversion ratio
North America Poultry
LatAm
Pork World
Asia Beef
Africa
012345678 0 20406080100120140 Kg of feed grain to produce 1Kg of Meat
Source: IMF, FAO Source: Doane, PotashCorp
In summary, we draw the following observation from the population, wealth and dietary data presented above:
The majority of soft grains produced globally are used as feed for protein production (beef, poultry, pork), rather than directly as food.
Figure 278: Use of crops
Food 36%
Feedstock 64%
Source: USDA
We are in the midst of a long-term trend of higher living standards in developing countries driving higher meat consumption, underpinning higher demand for grains.
The ‘grains for meat’ trend is highly positive for the fertilizer and agchems industries since these crops require higher application rates than subsistence crops. In addition, soft grains tend to be produced by large commercial farms that are the most intensive consumers of fertilizer and agchems as they understand the benefits of yield optimization.
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Biofuels – just more fuel to the fire
The biofuel crops are high The increase in corn consumption for ethanol in the US has created a new demand shock consumers of fertilizers and over the last two years, driving prices up and global grain inventories down. have been a key driver for increased potash and While we expect growth in corn consumption for ethanol to slow in coming years and phosphate demand in the expect a growing backlash, US biofuel targets are mandated to 2012. most recent years The biofuel crops are high consumers of fertilizers and have been a key driver for increased potash and phosphate demand in the most recent years.
While biofuels have created upside for fertilizer demand, they also represent a key risk. Currently ethanol production in the US is subsidized, and is not economically sustainable on a stand-alone basis. A lowering or removal of subsidies could have a rapid and negative impact on both crop prices and fertilizer demand. Rapid biofuel growth driving crop and fertilizer demand Biofuel production is very concentrated – about 75% of global production is located in the US and Brazil. Production has tripled from 5bn gallons in 2000 to 16bn gallons in 2007, with ethanol accounting for close to 90% and biodiesel accounting for the remainder.
Figure 279: Global biofuel production, 07 Figure 280: Global biofuel production, 2000-07
Brazil 32%
EU China 15% 3% Other India 5% 1%
US 44%
Source: FO Licht, includes only ethanol for fuel Source: IEA, FO Licht
Food for oil In 2007 an estimated 60% of In the US the primary source of ethanol production is corn, whereas Brazil’s ethanol is based corn consumption growth mainly on sugarcane. The dramatic increase in ethanol production in the US has been an globally was attributable to important source of the increase in global corn consumption since 2006/7. In 2007, according the US ethanol industry to the USDA, in 2007 an estimated 60% of corn consumption growth globally was attributable to the US ethanol industry. Since corn requires a high ratio of potassium application, this has had a significant impact on US potash demand. Indeed, corn alone accounts for more than 40% of US fertilizer consumption.
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Figure 281: Contribution to the increase in global corn Figure 282: US corn production going to ethanol consumption
Source: USDA, IMF Source: National Corn Growers Association, USDA Baseline projections
About a quarter of all corn production in the US is now used for producing ethanol due to the significant government support (through subsidies and a Brazilian imports tax, nearly 20% of Biofuels currently account the cost of producing bioethanol is subsidized by the government). We expect these for 5% of global grain subsidies to be in place for at least the next four years, unless growing global pressure forces consumption, up from c2% the new US administration into cutting back the subsidy program. To give some perspective, biofuels currently account for 5% of global grain consumption, up from c2% in 2006. in 2006
The USDA forecasts that 30% of total US corn production will go into bioethanol production in 2012, but the rate of growth is now leveling off compared to what was experienced in 2002-07. The US government is committed to its biofuel targets and recently reiterated its long-term target and subsidies to ethanol producers until 2012.
Figure 283: Corn for ethanol use as a percentage of US corn production
40% 34.2% 34.9% 35% 33.3% 32.8% 30.7% 29.6% 30% 26.8%
25% 23.2% 20.0% 20%
15%
10%
5%
0% 06/07e 07/08e 08/09e 09/10e 10/11e 11/12e 12/13e 13/14e 14/15e
Source: USDA
Regulatory drivers Biofuels in general and Biofuels in general and ethanol in particular have become a global political issue. The sector is ethanol in particular have being blamed for the rising price of grains which has led to sharply higher food prices become a global political globally. Nevertheless, there has been regulatory legislation in the US to increase the issue relevance of ethanol in its energy matrix over the next decades.
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Figure 284: The Renewable Fuel Standard
Source: RFA, Deutsche Bank
The US Renewable Fuel Standard targets biofuel production to reach 15bn gallons from 2013 compared to 7bn last year. The RFS includes a cap on corn-based ethanol, as shown in Figure Biofuel production to reach 284, which should mean a slowing in the growth of corn consumption for ethanol from 2010, 15bn gallons in 2013 as reflected in the USDA’s forecasts. Starting in 2010, cellulosic ethanol, in particular, and compared to 7bn last year other non-corn ethanol are mandated. It is important to note that we know of no company that has produced cellulosic ethanol on a commercial scale.
The US is not alone in setting biofuel targets, though it has the largest and most visible program. Figure 285 sets out the key targets in the main biofuel countries globally over the next few years.
Figure 285: Biofuel blending targets Country Crops used for ethanol production 2007 production Blending target (bn glls)
US primarily corn 6.5 use of 15bn gallons of biofuel from 2013e; rising to 36bn by 2022e Brazil sugarcane, soybeans, palm oil 5 25% blending ratio of ethanol with gasoline (E25) in 07; 2% blend of biodiesel w/ diesel (B2) in early 08; 5% by 2013e EU wheat, other grains, sugar beets, wine, 0.6 5.75% biofuel share of transportation fuel by 2010; 10% by 2020 alcohol Canada corn, wheat, straw 0.3 5% ethanol content in gasoline by 2010; 2% biodiesel in diesel by 2012 China corn, wheat, cassava, sweet sorghum 0.4 Five provinces use 10% ethanol blend w/ gasoline; 5 more targeted for expanded use India molasses, sugarcane 0.1 10% blending of ethanol in gasoline by late 08; 5% biodiesel blend by 2012 Thailand molasses, cassava, sugarcane 0.1 Plans call for E10 consumption to double by 2011 through use of price incentives; palm oil production will be increased to replace 10% of total diesel demand by 2012 Indonesia sugarcane, cassava 10% biofuel by 2010 Malaysia none 5% biodiesel blend used in public vehicles; govt. plans to mandate B5 in diesel- consuming vehicles and in industry in near future Source: USDA, “The Future of Biofuels: A Global Perspective”
Sugarcane, a more efficient source Sugarcane is the ideal Sugarcane is the ideal feedstock for making ethanol, given its high energy yield of 1:8 (the feedstock for making energy employed to grow, harvest, transport and convert the feedstock into ethanol vs. the ethanol, given its high amount of energy the ethanol itself then provides as a fuel). Brazil, with the world's largest energy yield ethanol production, makes most of its ethanol from sugarcane. If there is a greater shift from corn to sugarcane, we note that sugarcane is a heavy user of both fertilizers and crop protection chemicals.
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Biofuel backlash? The rising cost of food, particularly during 2007/08, triggered a backlash against biofuels, particularly corn ethanol produced in the US. A World Bank report in April 2008 tied higher food prices to ethanol, stating that nearly all of the increase in global corn production from 2004 to 2007 went for biofuel production in the US, while existing stocks were depleted by the increase in global consumption for food, feedstock and other uses. Studies have been published showing that production of ethanol contributes to global climate change and emission of greenhouse gases as a result of destruction of the rain forest (slash-and-burn) in order to increase acreage and emission of nitrous oxide via application of fertilizers (nitrogen- based, not potash however).
There is growing pressure to There is growing pressure to reduce subsidies for corn ethanol production. The US state of reduce subsidies for corn Missouri is already considering rolling back a mandate supporting ethanol production after ethanol production, implementing it at the beginning of 2008. Despite growing concerns about the impact of the however US ethanol biofuel program, the use of a high proportion of the US corn crop for ethanol production is mandated over the next four years (2012). production is mandated until 2012 The need for yield – declining arable land per person requires more use of fertilizers Limited land supplies require high fertilization rates Arable land has declined yet Arable land has declined yet overall demand for grain has increased, hence farmers have overall demand for grain has been increasingly forced to seek higher production levels, resulting in increasing demand for increased, resulting in fertilizers. We highlight several factors driving this increasing demand for fertilizers: increasing need for fertilizers to boost yields There are two main ways to rebuild global grain stocks (aside from lowering consumption): either by increasing yields of existing arable land or by expanding arable land areas. Both routes lead to the same place: more fertilizer and crop protection demand.
In Europe and the US, land brought back from set-aside programs is of lower quality and so requires more fertilizer per acre.
Brazil aside, the quality of unused arable land is low, meaning that higher fertilizer application will be required to supply the necessary nutrients.
As the amount of arable land per capita declines longer term, that land will be increasingly deployed using industrial farming techniques to increase yields, implying higher fertilizer and crop protection demand.
Fertilizer usage in India, China and Brazil would need to increase dramatically to reach internationally recommended crop nutrient levels. These markets already see the highest demand growth for fertilizers, a trend we anticipate will continue. Limited land availability drives fertilizer and agchem usage With the exception of Brazil, new arable land available to farmers is limited. Therefore, with a growing population and a higher demand for food, the main solution is to increase agricultural productivity and yields. Increased use of fertilizers, improved technologies, GM seeds and use of agro-chemicals are the key ways of achieving this.
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Figure 286: Hectares of arable land per person Figure 287: Developing world can improve crop yields substantially
0.6 10 10000
0.5 8 8000
0.4 6 6000 0.3
4 kg / Ha 4000 0.2
2 2000 0.1
0 0 0 1950 1960 1970 1980 1990 2000 2010E 2020E Rice Corn Soybeans
Per Capita Arable Land for Agriculture Population (bn) RHS US China India Brazil
Source: USDA, IMF, Deutsche Bank Source: FAO, Deutsche Bank; based on 3-year avg. 2005-07
Growing fertilizer application in India, China, and Brazil India could triple its Potash The spread of agronomic techniques in India, China and Brazil is still in relatively early stages consumption and more than and crop yields lag those of developed markets as indicated in Figure 287. As a result there double its Phosphate and has been a historic imbalance in crop nutrient application. For example, the International Plant Nitrogen use to bring arable Nutrition Institute (IPNI) notes that nitrogen is used in India to mine other nutrients from the soil, leading to nutrient depletion over time. It estimates that despite the application of 20m land yields to developed tonnes of fertilizer annually, there is an annual deficit of nutrients removed by crops market levels harvested in India of 9-10m tonnes. The IPNI estimates that India could almost triple its potash consumption and more than double its phosphate and nitrogen use, and sees fertilizer demand reaching 40-45m tonnes by 2025.
In Brazil the rise of large commercial farms (as smaller farms are acquired) is leading to increased fertilizer and crop protection application and an improvement of yields. The growth in arable land in Brazil will focus mainly on large commercial crops such as soy, which are heavy consumers of potash-based fertilizers. The soil in parts of Brazil is naturally low in potassium, compounding the need for potash. The IPNI estimates that China needs to more than double its annual potash application to sustain yields on existing agricultural land.
China’s corn yields are Yields for major crops remain low in the developing markets of India, China and Brazil. roughly half of those in the China’s corn yields are roughly half of those in the US, while its soybean yields are at 60%. US, while its soybean yields These are crops essential for feeding livestock for the pork, beef and poultry industries. Rice are at 60% yields in India – where it is a staple crop – are half of US levels, while its corn and soybean yields are even lower. Brazil’s soybean yields are closer to those in the US, thanks largely to a focus on this key crop and an excellent climate.
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Figure 288: Potential BIC demand of potash
30
25
20
15
m tones KCI m tones 10
5
0 Brazil India China
1987 1997 2007 Potential
Source: PotashCorp, Fertecon, IPNI, Deutsche Bank
Poor quality of unused land Brazil accounted for roughly At first sight, land supply may not appear to be a concern in the short term. The world has approximately 4.0bn ha of potential arable land, of which 1.6bn ha were being used in 2005. 20% of the total global Therefore, there were 2.4bn ha of arable land still available at that year. There is, it would arable unused land, while seem, plenty of unused land available for agriculture in the world. However, Brazil aside the the US and Russia quality of unused arable land is not as high as that already in use, meaning that higher represented 7% each fertilizer application will be required to supply the necessary nutrients. In addition, the amount of arable land per capita is on a downward trend globally, leading to a need to increase yields through higher fertilizer and agrochemical usage.
Acreage in Brazil should increase more than in other regions, as it is the only country in the world that combines a large stock of potential arable land, weather patterns extremely favorable for agriculture and geopolitical stability. For instance, in 2005, Brazil accounted for roughly 20% of the total global arable unused land, while the US and Russia represented 7% each. However, infrastructure in inland districts such as Matto Grosso is sorely lacking, and is likely to delay land expansion.
Figure 289: Global land statistics – availability of land for agricultural development
1200
1000
800
600 487
400 232
200 387 265 0 LatAm & Sub- East Asia South Asia Near East Industrial Transition Caribbean Saharan & North countries countries Africa Africa
Arable land in use, 1997-99 Additonal suitable for rainfed crop production
Source: FAO, Terrastat, Deutsche Bank
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Crop demand in recent years drives inventories to record lows – support for crop prices Inventories are at historically low levels Several factors have combined to deplete global grain inventories over the last few years, to levels not seen since the early 1970s for most grains. These include:
Growing demand for food, particularly by developing markets such as China
Changing eating habits with more affluent consumers in emerging markets demanding more and higher quality foods
Growing demand from the biofuel industry
Poor climatic conditions in some regions that have reduced harvests in the last few years Outlook: stocks-to-use ratio improving, but still at low levels The stock-to-use ratios for Stocks-to-use ratios should improve for most grains and seeds, with the notable exception of most grains still remain corn, where demand is being boosted by ethanol use in the US. Nonetheless, the stock-to- below comfortable and use ratios for most grains still remain below comfortable and historic levels, and as a result historic levels we expect prices, albeit lower than the levels seen in 2007/08, to remain higher than the longer-term historic levels for the foreseeable future.
Higher level of planting and The latest USDA forecasts foresee production gains only for wheat, +12%, a modest productivity needs to be increase for rice, +3%, flat production of corn and a decline of 4% for soybeans, after the sustained for another couple record 2007/08 harvest season. We believe that a higher level of planting and productivity of years for most inventories needs to be sustained for another couple of years across the globe so that most inventories can reach the safe buffer level (20-25% from 12-13% in 2007/8) – note this assumes no can reach the safe buffer disaster such as severe drought or storms close to the harvest. We therefore expect stock- level (20-25% from 12-13% in to-use ratios for corn, soy and rice to remain at low levels until 2010-12 at least (see Figure 2007/8) 290 to Figure 293) which should continue to support prices and therefore farm incomes for the foreseeable future.
Figure 290: Corn price vs. stock-to-use ratio Figure 291: Wheat price vs. stock-to-use ratio
50% 350 45% 300 45% 40% 300 250 40% 35% 35% 250 30% 200 30% 200 25% 25% 150 20% 20% 150 15% 100 15% 100 10% 10% 50 50 5% 5% ending stock / total consumption total / stock ending 0% 0 consumption total / stock ending 0% 0
5 4 5 60 66 69 72 7 81 8 87 90 93 96 02 05 08 60 66 72 7 81 84 87 93 96 99 02 05 08 0 19 1963 19 19 19 19 1978 19 19 19 19 19 19 1999 20 20 20 19 1963 19 1969 19 19 1978 19 19 19 1990 19 19 19 20 2 20
Stock-to-use ratio Price (r.h.s) Stock-to-use ratio Price (r.h.s)
Source: USDA, Bloomberg, Deutsche Bank Source: USDA, Bloomberg, Deutsche Bank
Deutsche Bank AG/London Page 129 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 292: Soybean price vs. stock-to-use ratio Figure 293: Rice price vs. stock-to-use ratio
8% 600 40% 800
7% 35% 700 500 6% 30% 600 400 5% 25% 500
4% 300 20% 400
3% 15% 300 200 2% 10% 200 100 1% 5% 100 ending stock / totalconsumption / ending stock ending stock / total consumption total / endingstock 0% 0 0% 0
0 4 3 76 85 00 63 964 987 996 005 1 1967 197 1973 19 1979 1982 19 1988 1991 1994 1997 20 2003 2006 2009 1960 19 1966 1969 1972 1975 1978 1981 198 1 1990 199 1 1999 2002 2 2008
Stock-to-use ratio Price (r.h.s) Stock-to-use ratio Price (r.h.s)
Source: USDA, Bloomberg, Deutsche Bank Source: USDA, Bloomberg, Deutsche Bank
High and rising crop prices drive fertilizer use
Crop prices are in our view Crop prices are in our view the single most important factor in the demand and evolution the single most important of fertilizer prices and historically show strong correlation with NPK fertilizers (see Figure factor in the demand and 294)
evolution of fertilizer prices When crop prices are high, farmers have more incentive to ensure that yields are high (through optimal fertilizer application), and that crops are protected from pests, fungus and weeds (through applying agrochemicals)
When increasing arable land, it is generally through use of incremental land of lower quality, on which farmers need to apply more fertilizer than usual
With stocks-to-use ratios close to all-time lows, we expect crop prices to remain high on a 2-3 year view (relative to average prices over recent years), though we caution that crop prices have been cyclical historically and that declining prices would be very negative for both the fertilizer and crop protection sectors. As shown in Figure 295, FAO projects that all agricultural commodity prices will remain above the average prices seen during the period 1997-06, albeit significantly lower than the highs of 2007/08.
Figure 294: Crop prices vs. fertilizer prices Figure 295: Select food commodities: percentage change relative to 1997-06 avg. price
300 120
250 100
200 80
150 60
100 40
50 20
0 0 Rice Jul-05 Jul-06 Jul-07 Jul-08 Oct-05 Oct-06 Oct-07 Oct-08 grain Jan-05 Apr-05 Jan-06 Apr-06 Jan-07 Apr-07 Jan-08 Apr-08 Jan-09 Wheat Coarse % change relative to avg. crop price 97-06 price to avg. crop relative change % Veg. oil Oilmeal Oilseeds Raw sugar Raw urea price / grain index DAP price / grain index KCl price / grain index Avg. 2007-08 Avg. 2009-18
Source: Bloomberg, Factset, Deutsche Bank Source: OECD, FAO, Deutsche Bank
Page 130 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Playing underperformance in agricultural commodities via fertilizers Looking at long term commodity price evolution, we find that gold and crude oil are most richly priced commodities currently while prices in many parts of the agricultural complex are trading at or below their long run historical averages in real terms.
Figure 296: Valuing commodities in real terms
100 90 81 80 Cheap Expensive 64 65 How far prices in real terms 60 are currently trading 50 39 43 40 compared to their average price since 1972 20 9 12 12 12 0 1 1 0 -3 -20 How far prices in real terms are currently -24 -40 -27 -26 trading compared to their average price since -38 1972 -60 -45 Tin Zinc Gold Corn Lead Silver Sugar Nickel Cocoa Wheat Cotton Coffee Copper Uranium Platinum Crude oil Crude Palladium Soybeans Aluminium US natural gas natural US
* Long run is from 1972 with the exception of platinum, palladium and US natural gas where data runs from 1977, 1988 and 1990, respectively Source: Bloomberg, Deutsche Bank
In fact we find that out of the widely tracked soft/hard commodities, six out of ten commodities that have underperformed their long run historical averages are from the agricultural complex, with only soybeans, at 12% running above its historical trend.
We believe the agricultural sector is trading at fundamentally cheap levels of valuation. In our view, the low levels of global inventories will sustain price spike risks in the agricultural market in the even of sudden increase in demand, for example China, an adverse weather event such as drought in the US or even a further rise in the crude oil price.
Deutsche Bank AG/London Page 131 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Appendix C: Fertilizer primer
The following is an excerpt from a MENA Fertilizers note, “Seeking Fertile Investments in the MENA region”, released on 6 October 2009.
Fertilizers are primarily used to replenish soil nutrients and enhance production yields. While a number of nutrients are directly available in soil, as crops grow they absorb these nutrients, resulting in their depletion. Although over time nutrients are reabsorbed in the form of organic matter and plant residue, the replenishment rate is not rapid enough to cope with the demands of farming today. The incentive to use fertilizers to boost yields is further enhanced by the fact that fertilizer costs typically account for a small proportion of total grain production costs.
Figure 297: Grain production cost breakdown
General Overhead 6% Rent Seed 24% 10%
Chemical 7%
Ferilizers 15%
Power and Labour Machinery 8% 30%
Source: USDA, Deutsche Bank
The use of fertilizers could yield significant incremental profits for farmers The adequate application of As mentioned before, mineral fertilizers are used to replenish lost nutrients while providing an nitrogen could increase optimal nutrient balance, enabling the farmer to obtain higher yields. Appropriate fertilizer use production output from 2.07 has a significant impact on average crop profitability, with the increased revenue from higher yields more than offsetting the costs of the fertilizer. tonnes grain/ha up to 9.3 tonnes grain/ha According to a study conducted on European farms, the adequate application of nitrogen could increase production output from 2.07 tonnes grain/ha up to 9.3 tonnes grain/ha. Taking the same output parameters and applying current prices for grain and urea, we conclude that assuming adequate nitrogen application, farmers could still yield up to 11x return on their investment and accept up to 70% reduction in wheat prices before the return on their fertilizer investment becomes less compelling.
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Figure 298: Yield response, in monetary value, to N Figure 299: Grain production cost breakdown fertilizer rate 1600
1400
1200 - Fertilizer Investment: 192 kg/ha @ US$500/t (US$1.09/kg N) urea = US$209 1000 - Wheat price US$185 ------800 Production output: - w / fertilizer 9.3t grain/ha
Income US$/ha 600 - w /out fertilizer 2.07t grain/ha ------Finacial output: 400 - w / fertilizers US$1721/ha - w /out fertilizers US$383/ha 200 Net return > 7x investment
0 0 50 100 150 200 250 300 350 Fertilizer application, kg N/ha
Source: Yara, Winter wheat yield data: Long term trial, Boadbalk, Rothamsted Source: Deutsche Bank
The primary fertilizer categories are based on the most commonly required and applied nutrients – nitrogen (N), phosphorus (P), and potassium (K). Nitrogen is the main constituent of proteins and is considered essential for growth and development in plants. Supply of nitrogen determines a plant’s growth and yield, and it is the most easily depleted nutrient. Phosphorus plays a vital part in root development and aids in drought resistance, while potassium is responsible for the translocation of the resulting products from photosynthesis, and aids in increasing yields and improving crop resistance to diseases.
Among the three major nutrients (N-P-K), nitrogen is far and away the most important factor as far as higher crop yields are concerned, and accounts for 58% share of total global fertilizer consumption and is generally applied annually to maintain yields.
Figure 300: Fertilizer consumption by type – 07/08 Figure 301: Fertilizer use by crop at global level 06/07
180.0 Wheat 160.0 Other Crop 15% 24% 140.0 Soybeans 120.0 3% 100.0 80.0 Rice 60.0 Cotton 15%
m nutrients tones 4% 40.0 20.0 Oil Palm 0.0 Fruits & Veg. 2% 17%
1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Maize Sugar Crop 16% Nitrogen (N) Phosphate (P2O5) Potash (K2O) 4%
Source: CRU, Deutsche Bank Source: IFA
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World fertilizer consumption to drop by 6-7% in 2009 and rebound in 2010 by 7%
Aggregate world fertilizer Like most other commodities, fertilizers have been affected by the economic downturn. demand in 2009 is expected Aggregate world fertilizer demand in 2009 is expected to decline c.7%, from 170.7 to 159m to decline c.7%, from 170.7 T. Nitrogen has been much less affected, as farmers cannot afford drastic cuts in N fertilizer to 159m T application rates without immediate yield penalties, contrary to the situation with P and K fertilizers.
For 2009, N, P and K For 2009, N, P and K fertilizer demand is estimated to decline 1.6%, 7.3% and 23%, fertilizer demand is respectively. Drops in consumption are to be registered in all the regions except South Asia estimated to decline 1.6%, and Eastern Europe and Central Asia – two regions where farmers enjoy strong governmental 7.3% and 23%, respectively support for greater fertilizer use – and Africa. The largest contractions in volume are to be observed in Western and Central Europe, North America and Latin America.
Figure 302: Global Fertilizer demand 2006-10e Figure 303: Fertilizer demand variation by region 2008- 10e
180 169 171 171 Oceania 159 160 Africa 140 West Asia
120 E. Europe & C. Asia 97 101 99 102 100 W. & C. Europe 80 LatAm & Carib 60 m tones nutients m tones 38 39 36 38 North America 40 33 31 30 24 South Asia 20 East Asia 0 Nitrogen (N) Phosphate (P) Potash (K) Total -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0%
2007 2008 2009e 2010e Variation 2008/09 Variation 2009/10 Source: CRU, IFA, Deutsche Bank Source: CRU, IFA, Deutsche Bank
Demand to rebound in 2010 but volume levels of 2007 will not be reached until 2011 Demand to rebound in 2010 Demand is expected to rebound in 2010 with combined fertilizer demand expecting growth with growth of 7% with of 7% – supported by prevailing agricultural market fundamentals, as well as anticipated strong recovery in North progressive recovery of the world economy. However, this rebound is strongly conditioned America and continuing on brisk recovery in the potash market, which according to British Sulphur is expected to rebound 25% in 2010, supported by the return to the market of large buyers in Asia, Europe demand from Asia and US. Without this strong potash recovery, the fertilizer demand recovery will be more tepid.
Across regions, strong recovery is expected in North America, with more modest rebound in East Asia and W. and C. Europe. Demand is to remain strong in South Asia, but at a lower rate than in 2008/09, and will further drop in Latin America.
Fertilizer consumption to expand at 2.5% medium term, driven by Asia and Latam
NPK to grow at 1.9%, 2.8% In the medium term, world fertilizer demand is projected to recover progressively from the and 3.7% respectively, in the contraction seen during 2008/09. Compared to 2007/08 levels (pre-crisis base), global medium term demand in 2013/14 is seen as increasing 2.5% pa and is expected to reach 187m T. NP K are expected to grow at 1.9%, 2.8% and 3.7% respectively, in the medium term .
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Figure 304: Medium term fertilizer demand by type Figure 305: Medium term fertilizer demand by region
80 2.0% 250 70 2.5% 60 200 50 40 3.9% 1.9% 30 1.3% 150 2.7% 0.8% 20 5.6% 1.5% 3.5% 10 0.0% 100 0 2.8% a a a m nutrients tones ia ib 3.7% s ric r Asia A a 50 C . Asi Africa me & st Asi ast uth A e Oceania E o W S th e & C r p o No LatAm r 0 W. & C. Europeu . E E Nitrogen (N) Phosphate (P) Potash (K) Total
Avg. 06/07 to 08/09 Variation 2013/14 2008 2013
Source: CRU, IFA, Deutsche Bank Source: CRU, IFA, Deutsche Bank
Bulk of the increase in At the regional level, the bulk of the increase in demand during the next five years would still demand during the next five come from Asia and, to a lesser extent, Latin America. East Asia and South Asia together years would still come from would account for some 62% of total growth. If Latin America is added, the three regions Asia and, to a lesser extent, together would account for 75% of the increase in demand. Latin America Figure 306: More than half of the global fertilizer demand comes from Asia
CE & EECA LatAm 6% 6%
Others China 8% 33%
West Europe 9%
North America 13% South Asia NE & SE Asia 19% 6%
Source: CRU, Deutsche Bank
In East Asia, the growth of regional demand is seen as slowing down as China approaches a ‘mature’ market status for N and P fertilizers. At the same time, China is seen as recovering only slowly from its cut in K fertilizer applications in 2008 and 2009. Average regional demand is seen as increasing 2% p.a.
Demand is projected to remain strong in South Asia, with an average growth rate of 4% p.a., as larger amounts of fertilizer are required to ensure food security. However, the expected forthcoming revision of the fertilizer subsidy scheme in India could impact the outlook.
North America is seen as recovering relatively quickly from the sharp market contraction recorded in 2008/09 as farmers respond to market signals. Average growth for the next five years is forecast at 1.5% p.a. Fertilizer demand in Latin America is seen as remaining
Deutsche Bank AG/London Page 135 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
depressed in 2009. Recovery would start in 2010, as South American countries strengthen their position on the international agricultural market. Regional consumption would increase at 3% p.a.
After two decades of decline or stagnation, and a further drop of 18% in 2008/09, fertilizer consumption in Western and Central Europe is seen as slowly recovering during the outlook period. Average annual growth is forecast at 1%.
Fertilizer consumption in Eastern Europe and Central Asia is seen as increasing regularly in response to a favourable policy context and to the potential for increasing production during a relatively short period of time. Regional fertilizer demand would grow at some 5.5% p.a.
Fertilizer demand in West Asia is seen as increasing only modestly since the potential for increasing crop production in the region is limited. Consumption is seen as rising 1.5% p.a.
Fertilizer consumption in Africa is likely to pick up in some countries, in response to governmental initiatives to establish fertilizer subsidy schemes, as well as in response to an increase in the area used for commercial farming and export. An increase of 3.5% p.a. is anticipated.
Finally, agriculture in Oceania is seen as hardly recovering from two consecutive drought- affected years. Consumption is anticipated to recover slowly, reaching a level at the end of the outlook period comparable to the calculated base year.
Note that the above projections are based on ours and IFA estimates “Medium-Term Outlook for Global Fertilizer Demand, Supply and Trade: 2009-2013”, which we use as base for our analysis and forecasts for the industry and in turn the fertilizer companies under coverage in this report. As IFA points out in the report, these base-line forecasts are subject to major uncertainties, in particular up to 2010. Some of the main uncertainties that could influence the forecasts are the evolution of the financial and economic downturn, the yield impact on lower P and K application rates in 2008/09, the actual levels of fertilizer inventories in the distribution pipeline, and the evolution of fertilizer prices relative to crop prices.
Nitrogen & Phosphate fertilizer prices stabilizing with signs of gradual improvement; Potash still slated for further price correction At the peak of the cycle in 2008, NPK fertilizer prices had multiplied 5x, 5.5x and 6.5x from the previous 10-year average. From the fallout of the global economic crisis and the subsequent fall in commodities, fertilizer prices corrected rapidly as well. From the July/August peak, by December urea prices declined some 70% to US$245/t, albeit still 45% higher that the 10-year average price. DAP declined some 65% to US$350-375, still 50% higher than the previous 10-year average DAP price. Potash, on the other hand, sustained the US$875/t price it reached in mid 2008, and the correction in prices did not start until Q2 09 with current spot prices moving to US$480/t level.
Page 136 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 307: NPK prices 1996-13e
1,200 1,100 1,000 900 800 700 600 500 US$ per T per US$ 400 300 200 100 - 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2009e 2010e 2011e 2012e Jul-08 Oct-08 Jan-08 Feb-08 Apr-08 Jun-08 Dec-08 Sep-08 Mar-08 Aug-08 Nov-08 May-08
Ammonia Urea, Black Sea DAP, Tampa KCl, Vancouver
Source: Fertecon, Bloomberg, CRU, Deutsche Bank
Nitrogen fertilizers – given the already strong correction in Q4 08 of N-based fertilizer Urea prices should stabilize prices and urea in particular, urea prices should stabilize at levels of US$250/t in 2009 at levels of US$250/t in 2009 and increase gradually to levels of US$275-300/t by 2013, on the back of tight and increase gradually to supply/demand dynamics, limited inventory stocks, and the inability of farmers to reduce levels of US$275-300/t by nitrogen application over prolonged periods, given the immediate impact it has on yields. 2013 Phosphate fertilizers – DAP prices should stabilize in the in the US$300-320/t range (US$100-110/t for phosphate rock). Stable supply/demand dynamics should persist at DAP prices should stabilize least until 2012/13, keeping prices at above levels. The biggest uncertainty, and potential in the in the US$300-320/t downside risk on prices, is the potential impact that Ma’aden will have on the market, range (US$100-110/t for once it begins operations in 2011/12 (see section on Ma’aden for more details). phosphate rock) Phosphate fertilizers – Potash prices resisted the broader commodity price correction Potash prices to correct to in H2 08, and following a H1 09 period when volumes virtually collapsed, recent data levels of US$375-400, from indicate that prices would have to go down to US$375-400/t levels before any real demand picks up. Large inventory buildup in main importing markets such as China and US$480 currently the US, will also be drag on demand, putting further pressure on prices. In our view, only at prices of US$375-400/t, we would see potash demand going back to the levels of 50- 55m T vs. the less than 40mT expected for 2009e.
Deutsche Bank AG/London Page 137 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 308: Fertilizer summary Potash (K) Phosphate (P) Nitrogen (N)
Market size 08 26.5m T (K201) 37.5m T (P205) 101.1m T Primary benefits Improves crop resistance to disease and Used for root development, increases Primary constituent of proteins, essential drought crop size for growth Application requirements Annual application not always done Annual application not always done Annual application is critical Geographical availability of Very limited Limited Readily available (natural gas) Raw Material Producing Countries 12 (based on KCI) ~60 (based on NH3) ~44 (based on P2O5) #1 – Canada #1 – China #1 – US #2 – Russia #2 – India #2 – China #3 – Belarus #3 – Russia #3 – Morocco #4 - Germany #4 - US #4 - Russia Major Importers KCI DAP Ammonia #1 – China #1 – India #1 – US #2 – US #2 – China #2 – India #3 – Brazil #3 – Pakistan #3 – South Korea #India #4 - Turkey #4 – France % Traded Across Boarders 81% (KCI) 42% (DAP) 12% (Ammonia) Long Term Pricing Stability High Medium Low Profitability High Low / Medium Low / Medium Barriers to Entry High Medium Low Cost of Greenfield capacity US$ 2.8b for 2m T (KCI) US$1.5b for 1m T (P205) US$ 1b for 1m T (NH3) Greenfield Development Min. 7 years 3-4 years 3 years Source: IFA, PotashCorp, Yara, Deutsche Bank estimates
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Appendix D: Nitrogen market
The following is an excerpt from a MENA Fertilizers note, “Seeking Fertile Investments in the MENA region”, released on 6 October 2009.
Nitrogen products are manufactured from anhydrous ammonia, which is most commonly synthesized from natural gas, steam and air.
Urea is the primary nitrogen Urea is the primary nitrogen fertilizer product. Liquid urea and ammonium nitrate can be fertilizer product combined to make nitrogen solutions (UAN), which are also used in agriculture. Ammonium nitrate, which has both industrial and agricultural applications, is made by combining ammonia with nitric acid.
Figure 309: Nitrogen production process Natural Gas Carbon Dioxide CO2 Air from the 32.5 MMBtu/ton Atmosphere Anhydrous Ammonia NH3
0.29 t/t 0.22 t/t 0.58 t/t
Nitric acid Liquid Ammonium Liquid Urea UR NA Nitrate AN 0.80 t/t 0.78 t/t
0.45 t/t 1.01 t/t UAN Solutions 0.35 t/t 28-32% N UAN 1.01 t/t
Prill tower or Prill tower or granulator granulator
Ammonia Nitric Acid Ammonium nitrate UAN Solution Solid Urea
fertilizers, feeds Fertilizers & industrial sales Explosives Fertilizers & industrial industrial sales sales
Source: Deutsche Bank
Given the nature of the product, most ammonia is consumed where it is produced Because it is costly to transport and requires specialized vessels to ship, most ammonia is consumed domestically.
Deutsche Bank AG/London Page 139 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 310: Global Ammonia production vs. trade
100 000 90 000 80 000 70 000 60 000 50 000 40 000 30 000 20 000 10 000
Asia Europe North LatAm Africa Other America
Source: IFA, CRU, Deutsche Bank
China, the largest nitrogen China, the largest nitrogen market, consumes almost one-third of the world’s ammonia. market, consumes almost Because it produces nearly all it consumes, China does not typically impact global ammonia one-third of the world’s trade. North America – the world’s largest ammonia importer, accounting for about 40% of ammonia global trade – obtains nearly 40% of its ammonia from lower-cost regions, including more than half that total from Trinidad.
Evolution of gas prices - main component of Ammonia production costs Natural gas can account up Natural gas can account for approximately 90% of the US cash cost of producing ammonia, to 90% of the US cash cost depending on the cost of gas. A $1/MMBtu increase in the gas price typically adds about $35 of producing ammonia to the cost of manufacturing one metric ton (MT) of ammonia.
However, despite the fact that natural gas is the main cost component of ammonia/urea, the prices of the latter show stronger correlation with evolution of oil prices than with natural gas.
Figure 311: Natural gas is key production cost component
400
300
200
100 US$ Ton Short Ammonia
0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0
Gas Cost Conversion
Source: Deutsche Bank
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MENA producers, in The case for MENA nitrogen-based fertilizer producers particular KSA and Qatar, With volatile global energy prices, the importance of a secure, low-cost gas source is key to have access to a stable, sustaining profitability in this business. MENA producers have access to a stable, secure and secure and relatively cheap relatively cheap supply of natural gas making their fertilizer producers one of the cheapest supply of natural gas ammonia/urea players globally.
Figure 312: Global natural gas costs, US$/mmbtu, 2008 Figure 313: Natural gas futures curve
9 Canada Russia $9.95 8 $2.30 W. Europe $13.00 Ukraine 7 US $8.25 $11.00 China 6 $3.75 Middle East N. Africa $.80 5 Trinidad $.60 $5.30 4
Indonesia 3 $2.00
Venezuela 2 $1.00 1
Argentina 0 $3.50 10 12 14 16 18 21 Oct-09 Oct- Oct-11 Oct- Oct-13 Oct- Oct-15 Oct- Oct-17 Oct- Oct-19 Oct-20 Oct-
Source: PotashCorp, Deutsche Bank Source: Bloomberg
Although oil and gas prices have fallen significantly since the highs reached during 2008 (oil is down c.50% with gas down c.75%, at current spot prices of c.US$3.5-4/mmBtu), MENA producers still have 4-5x cost advantage than other international industrial gas consumers. Furthermore, looking at natural gas futures prices, they still point out to materially higher levels than the current spot market is trading at, indicted in Figure 313.
Black Sea and Gulf Black Sea and Gulf producers are main export hubs for ammonia and urea producers accounted for In terms of global ammonia and urea trade, Black Sea and Gulf producers accounted for c.40% and 50%, respectively, c.40% and 50%, respectively, of the overall trade, as of 2007. Given existing expansion of the overall trade in plans, CIS and Middle East producers could reach c.50% and 65% of the global ammonia ammonia and urea and urea trade by 2015e (see Figure 321 and Figure 323).
Figure 314: Main global ammonia flows, m tonnes Figure 315: Main global urea flows, m tonnes
1.3(1.3) 1.6(1.8) 1.0(2.1) 1.0(1.1) 0.2(0.3) 1.7(1.8) 1.3(1.0) 0.6(0.8) 1.4(1.6) 4.2(1.0) 0.5(0.7) 2.9(1.7) 2.0(1.8) 0.5(0.5) 0.9(0.4) 1.9(1.7) 6.6(5.5) 4.4(4.3) 1.0(0.9) 2.4(2.1) 1.2(0.6) 0.9(0.8) 0.6(0.6) 4.0(2.9)
Source: Deutsche Bank, Yara Source: Deutsche Bank, Yara
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Nitrogen demand to increase by c.2% medium/long-term Global nitrogen demand is Between 2008 and 2013, nitrogen capacity developments (a key ingredient for urea/ammonia forecast to grow at an production) will be shaped by bullish prospects for fertilizer demand growth, differential input annual rate of 2.2% pa, to costs, downstream developments and export opportunities. The nitrogen industry is reach c.142 Mt in 2013 expected to improve energy efficiency while reducing its carbon footprint and replacing aging facilities.
The global supply of nitrogen (a key ingredient in the production of urea and ammonia) is estimated at 155 Mt in 2009 and is projected to reach 179 Mt in 2013. Global demand is forecast to grow at an annual rate of 2.2% pa, to reach c.142 Mt in 2013.
Figure 316: Global ammonia consumption per region Figure 317: Global nitrogen supply/demand balance 08- 13e CAGR 180 000 mil metric T N 2007/8 2009e 2010e 2011e 2012e 2013e 08-13e 160 000 CAGR 99-07: 2.4% Supply 140 000 Capacity 140 154.9 158.3 164.7 172.7 179 4.0% 120 000 Total Supply 130 133.5 137.4 143.1 149.5 154.7 3.3% 100 000 Utilization, % 93% 86% 87% 87% 87% 86% 80 000 Demand 60 000 '000 tones NH3'000 tones Fertilizer Demand 101.0 101 103.9 106.1 108.2 110.3 1.8% 40 000 Non-fertilizer Demand 22.8 22.8 24.2 25.7 26.8 27.9 20 000 Distribution Losses 3.1 3.1 3.2 3.3 3.4 3.5 Total Demand 126.9 126.9 131.3 135.1 138.4 141.7 2.2% 1999 2000 2001 2002 2003 2004 2005 2006 2007
Potential Balance 3.1 6.6 6.1 8 11.1 13 Asia Europe North America LatAm Africa Other Supply / Demand gap (%) 2% 5% 5% 6% 8% 9%
Source: CRU, IFA, Deutsche Bank Source: IFA, CRU, Deutsche Bank
For the period 2009 to 2013, the global nitrogen supply/demand balance is to remain at surplus levels, albeit at c.5-6% in the period until 2010/11 and gradually expanding to c.9-10 by 2013, as new capacity comes on stream.
Urea, +3.4% pa and specialty fertilizers should grow faster
Urea is expected to grow at As highlighted in Figure 318, urea is the largest finished nitrogen fertilizer product (52% of 3.5% p.a. on average total) and is expected to grow at 3.5% p.a. on average through 2013e, at least. Over the past through 2013e 10 years, urea growth has significantly exceeded the growth over other types of nitrogen- based fertilizers due to its higher nitrogen content per unit (which makes it lighter and cheaper to transport), the fact that it is more widely available and traded and the fact that it is much safer to store and handle than its closest alternative product, ammonium nitrate. Due to the growing restrictions on the storage and handling of ammonium nitrate (China banned ammonium nitrate a few years ago), we believe urea should continue to take market shares from some other nitrogen products.
Page 142 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 318: Nitrogen fertilizer consumption by type of Figure 319: Global urea supply/demand balance 08-13e product CAGR Ammonia mil metric T urea 2007/8 2009e 2010e 2011e 2012e 2013e 08-13e 4% Other Supply 13% Capacity 148 173.7 179.3 188.7 201.4 210.2 7.3% Total Supply 144 154.9 160.7 167.9 177.2 185.6 5.2% DAP/MAP Utilization, % 97% 89% 90% 89% 88% 88% 6%
Urea Demand 52% Fertilizer Demand 129.9 135.3 140.2 144.5 149.1 153.3 3.4% NPK 11% Non-fertilizer Demand 16.1 16.8 18 19.2 20.2 21.2 Total Demand 146.0 152.1 158.2 163.7 169.3 174.5 3.6%
ANCAN Potential Balance -2.0 2.8 2.5 4.2 7.9 11.1 9% UAN Supply / Demand gap (%) -1% 2% 2% 3% 5% 6% 5%
Source: CRU, Yara Source: IFA, CRU, Deutsche Bank
Risk of export taxes in China should keep exporters at bay
Some 43% of the world’s Some 43% of the world’s existing urea capacity is located in China and some 50% of existing urea capacity is planned investments in urea projects should also come from China. Large expansions in located in China and some China appear consistent with the government’s policy to guarantee self-sufficiency at all 50% of planned investments times without relying on imports. Increasing fertilizer supply is a way for the government to make it affordable for the farmers so that they can use more fertilizers and thus improve crop in urea projects should also yields and overall production. come from China
Figure 320: Urea capacity per region (09e) Figure 321: Urea capacity changes by region, 06-13e
LatAm Europe North America 12000 4% 6% CIS 5% 7% 10000 Africa 3% 8000
Middle East 6000 9% 4000 '000 tones 2000 China 43% 0 2006 2007 2008 2009e 2010e 2011e 2012e 2013e Asia (ex China) -2000 23%
Europe CIS Africa Middle East Asia (ex China) China North America LatAm
Source: Fertecon, CRU, Deutsche Bank Source: Fertecon, CRU, Deutsche Bank
Due to the size of the urea market, China has been perceived as a significant risk to the global urea balance as small deviation in Chinese domestic urea balance can create large waves in the global market, as when the domestic surplus is exported or the deficit is made up by imports.
Deutsche Bank AG/London Page 143 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Figure 322: China urea production/consumption balance Figure 323: Global urea exporters
70000 25.0% 100%
60000 20.0% 80% 50000 15.0% 40000 60%
30000 10.0%
'000 tones 40% 20000 5.0% 10000 20% 0 0.0% 2005 2006 2007 2008 2009e 2010e 2011e 2012e 2013e 0% 2005 2006 2007 2008 2009e 2010e 2011e 2012e 2013e China urea production China urea consumption Middle East CIS Africa Europe Asia (ex China) North America LatAm China China excess production as % of global urea trade
Source: Fertecon, CRU, Deutsche Bank Source: Fertecon, CRU, Deutsche Bank
In 2004, China became the 2nd largest urea exporter globally when it exported c.4m tonnes as a result of increased production and higher international urea prices. Since 2005, the Chinese government has introduced an export tax (0-35% range) in order to curtail excessive exports and assure sufficient domestic availability of urea. Despite the export tax, in 2007, due to the record high prices, China exports reached 4% of global urea consumption or 20% of global urea trade. As a result, the Chinese government imposed a further, but temporary, 100% export tax with the objective to keep fertilizer prices as low as possible during the spring season, in order to boost grain production and thus limit food imports and price inflation.
Potential for export tariffs likely deterrent on future China urea exports The financial crisis that brought most commodity prices down, including urea, limited the incentive for China urea producers to export, in our view. Nonetheless, through the episode of 2007/8, China has demonstrated that through the introduction of export taxes, the government fully intends to limit urea exports (for domestic price controls and production necessities), thus we expect China to play a very marginal role in the global trade of urea.
MENA urea producers are MENA producers to play increasing role in the urea market expected to go from 32% of Middle East and African urea producers are expected to go from 32% of the global urea export market in 2005, to 44% share in 2009 and reach c.58% by 2020e. the global urea export market in 2005, to 44% share Figure 324: Largest urea exporters 2005 – 2020e in 2009 and reach c.58% by
2020e 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Middle CIS Africa Europe China LatAm North Asia (ex East America China)
2005 2008 2009e 2013e 2020e
Source: Fertecon, CRU, Deutsche Bank
Page 144 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
The author of this report wishes to acknowledge the contribution made by Dipanjan Ray, an employee of Evalueserve DIFC, a third-party to Deutsche Bank of offshore research support services.
Deutsche Bank AG/London Page 145 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Appendix 1
Important Disclosures Additional information available upon request
Disclosure checklist Company Ticker Recent price* Disclosure Arabtec Holding ARTC.DU 3.20 (AED) 17 Nov 09 6,8 Drake & Scull DSI.DU 1.03 (AED) 17 Nov 09 NA Orascom Construction OCIC.CA 239.40 (EGP) 16 Nov 09 6,8
*Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies.
Important Disclosures Required by U.S. Regulators Disclosures marked with an asterisk may also be required by at least one jurisdiction in addition to the United States. See “Important Disclosures Required by Non-US Regulators” and Explanatory Notes. 6. Deutsche Bank and/or its affiliate(s) owns one percent or more of any class of common equity securities of this company calculated under computational methods required by US law. 8. Deutsche Bank and/or its affiliate(s) expects to receive, or intends to seek, compensation for investment banking services from this company in the next three months.
Important Disclosures Required by Non-U.S. Regulators Please also refer to disclosures in the “Important Disclosures Required by US Regulators” and the Explanatory Notes. 6. Deutsche Bank and/or its affiliate(s) owns one percent or more of any class of common equity securities of this company calculated under computational methods required by US law.
For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr.
Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst about the subject issuers and the securities of those issuers. In addition, the undersigned lead analyst has not and will not receive any compensation for providing a specific recommendation or view in this report. Nabil Ahmed
Page 146 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Historical recommendations and target price: Arabtec Holding (ARTC.DU) (as of 11/17/2009)
25.00 Previous Recommendations
Strong Buy Buy 20.00 Market Perform Underperform 1 Not Rated Suspended Rating 15.00 Current Recommendations
Buy Hold 10.00 Sell
Security Price Security Not Rated Suspended Rating
*New Recommendation Structure 5.00 2 3 as of September 9, 2002
0.00 Nov 06 Feb 07 May 07 Aug 07 Nov 07 Feb 08 May 08 Aug 08 Nov 08 Feb 09 May 09 Aug 09 Date 1. 25/4/2008: Transferred to EMC coverage. 3. 17/11/2009: Buy, Target Price Change AED4.50 2. 13/8/2009: Transferred to sector coverage.
Historical recommendations and target price: Drake & Scull (DSI.DU) (as of 11/17/2009)
1.40 Previous Recommendations
Strong Buy 1.20 Buy 1 Market Perform Underperform 1.00 Not Rated Suspended Rating Current Recommendations 0.80 Buy Hold 0.60 Sell
Security Price Security Not Rated Suspended Rating 0.40 *New Recommendation Structure as of September 9, 2002 0.20
0.00 Mar 09 Jun 09 Sep 09 Date 1. 17/11/2009: Buy, Target Price Change AED1.30
Deutsche Bank AG/London Page 147 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
Historical recommendations and target price: Orascom Construction (OCIC.CA) (as of 11/17/2009)
800.00 Previous Recommendations
Strong Buy 700.00 Buy Market Perform 600.00 Underperform Not Rated Suspended Rating 500.00 Current Recommendations
400.00 Buy Hold Sell
Security Price Security 300.00 1 Not Rated Suspended Rating
200.00 *New Recommendation Structure as of September 9, 2002 100.00
0.00 Nov 06 Feb 07 May 07 Aug 07 Nov 07 Feb 08 May 08 Aug 08 Nov 08 Feb 09 May 09 Aug 09 Date 1. 17/11/2009: Hold, Target Price Change EGP230.00
Equity rating key Equity rating dispersion and banking relationships
Buy: Based on a current 12- month view of total share- 400 holder return (TSR = percentage change in share price from 46 % current price to projected target price plus pro-jected 350 40 % dividend yield ) , we recommend that investors buy the 300 stock. 250 200 Sell: Based on a current 12-month view of total share-holder 150 14 % return, we recommend that investors sell the stock 100 14 % 12 % Hold: We take a neutral view on the stock 12-months out 50 08 % and, based on this time horizon, do not recommend either a 0 Buy or Sell. Buy Hold Sell Notes: 1. Newly issued research recommendations and target Companies Covered Cos. w/ Banking Relationship prices always supersede previously published research. Global Universe 2. Ratings definitions prior to 27 January, 2007 were: Buy: Expected total return (including dividends) of 10% or more over a 12-month period Hold: Expected total return (including dividends) between -10% and 10% over a 12-month period Sell: Expected total return (including dividends) of -10% or worse over a 12-month period
Page 148 Deutsche Bank AG/London 17 November 2009 Real Estate, Construction and Building Materials MENA Construction & Infra
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