Arabtec Holding PJSC January 4, 2009 Fair Value Estimate: AED 4.6 INITIATING COVERAGE Recommendation:: Buy Share Data Market Cap AED 2,703.0 mn Executive Summary Price AED 2.3 DFM 1,636.3 Reuters ARTC.DU Bloomberg ARTC UH Arabtec has a strong order backlog of AED 44.3bn, equivalent Avg. Volume (52 Week) 6.4 mn to 10.4x 2007 revenues, providing excellent top-line visibility 52-Week High/Low AED 9.95 / 1.42 Shares Outstanding 1,196.0 mn for the next 3–4 years and enabling the Company to maintain Fair Value Estimate AED 4.6 positive earnings growth in a weak macroeconomic environment. Key Figures (AED mn) Year to 31 Dec 2007 2008 We believe the current share price more than discounts any Revenue 4,272.9 8,339.9 risks associated with the Company’s contracting exposure in EBITDA 664.4 1,292.7 Adjusted Net Profit 528.7 988.2 Dubai. Currently, Dubai accounts for 52.4% of Arabtec’s order EPS (AED) 0.48 0.83 backlog, a share set to decline in coming years as the Company +/- (%) 163.9% 71.1% focuses on other markets. RoA (%) 14.7% 15.9% RoE (%) 48.1% 54.0% We expect net profit margins to deteriorate to around 11.2% in P / E (x) 4.7x 2.7x 2009 and 10.4% in 2010 from 11.9% for the first nine months EV / EBITDA (x) 3.3x 2.6x P / BV (x) 1.9x 1.2x of 2008 due to the Company’s contract mix comprising one- third cost plus, one-third cost esclation and one-third fixed price. Shareholding Pattern (%) Riad Burhan Taher Kamal 10 In addition, we also expect clients to renegotiate prices of Clients of Shuaa Capital 5 contracts already agreed. Public 85 Outlook: We expect a significant reduction in new order growth Relative Performance in 2009 compared with 2008, due to a slower home market. However, we expect longer term value accretion due to the 12.0 9.0 Company’s geographical and portfolio diversification strategy, 6.0 execution skills and long-term client relationships. 3.0 Valuation: The recent correction in the Company’s stock price 0.0 creates an attractive buying opportunity. Our valuation model Jul-08 Apr-08 Oct-08 Jan-08 Jun-08 Dec-07 Feb-08 Aug-08 Sep-08 Nov-08 Dec-08 Mar-08 May-08 yields a fair value of AED 4.6 per share (ex-bonus), implying an Arabtec Rebased Index upside potential of 102.2% from the current market price of AED 2.3. If we ignore the peer-based valuation, a DCF valuation alone yields a fair value AED 3.4, implying upside potential of 47.8%. We initiate coverage with a Buy rating. ARABTEC HOLDING PJSC ADCB Wealth Management Group I Research I +97126973525 | [email protected] 1 Creating Value Arabtec Holding Company (Arabtec) is a leading construction company in the UAE and one of the largest listed companies in the GCC region. Currently, its operations are largely concentrated in the domestic market, although it is progressively establishing itself in overseas markets including Qatar, Syria, Pakistan, and Russia. Arabtec has reported an exceptionally strong order intake since its inception, particularly during the first nine months of 2008. While we expect the Company’s order intake growth to weaken due to the current economic slowdown, we regard its present valuation as attractive. We initiate coverage with a Buy rating. Strong order backlog provides excellent revenue visibility The Company reports a strong order backlog of AED 44.3bn, equivalent to 10.4x 2007 revenues, providing excellent top-line visibility. At the end of 2008, we expect an outstanding order backlog of around AED 43bn. While we believe Arabtec’s new order growth will slow over the next few years due to the prevailing global economic slowdown generally and expected weakness in Dubai (its home market) in particular, we still forecast positive revenue and earnings growth based on the company’s exceptionally strong order intake in 2008. We expect positive new order inflow from its key focus markets in Abu Dhabi, Saudi Arabia, and Qatar. We conservatively forecast order inflows for 2009, 2010, and 2011 of AED 4.5bn, AED 5bn, and AED 6.9bn, respectively. Valuations more than discount any probable slowdown in Dubai; Abu Dhabi and Saudi Arabia likely to be key focus markets Dubai’s real estate and construction industry, adversely affected by reduced credit availability, is facing challenging market conditions with demand for various properties declining sharply. As a result, existing projects are facing delays while certain others have been suspended. However, we believe Arabtec’s current valuation more than discounts the fact that Dubai is the Company’s home market. At the same time, we argue that the risks associated with the company’s project execution in Dubai have been overstated. At the end of Q3 2008 Dubai accounted for 52.4% of the Company’s order backlog while Russia and Abu Dhabi represented most of the balance. Furthermore, we expect the Company to prioritise its business in Abu Dhabi, which has emerged as the new driver for the domestic construction industry. The Company is also entering the Saudi Arabian market, the second largest in the GCC region in terms of planned projects spending. We believe the Company’s construction expertise and experience will support its continued expansion in these markets. Net profit margin likely to deteriorate We expect the Company’s net profit margin to fall to around 11.2% in 2009 and 10.4% in 2010 from 11.9% over the first nine months of 2008 due to the Company’s current contract mix of one-third cost plus, one-third cost escalation and one-third fixed price. We expect cost plus and cost escalation contracts to undermine margins in a likely scenario of a decline in construction costs. In addition, we believe clients will seek to renegotiate prices of already agreed contracts as they face pressure to maintain their margins in deteriorating macroeconomic conditions. We also forecast an increase in the effective tax rate, due to an increasing revenue contribution from international markets. ARABTEC HOLDING PJSC ADCB Wealth Management Group I Research I +97126973525 | [email protected] 2 Valuation We value Arabtec Holding using Discounted Cash Flow (DCF) and Peer-Based Multiples methodologies. Our ex-bonus fair value estimate (base case) for Arabtec Holding is AED 4.6 per share. We attach a 70% weight to our DCF valuation because it discounts firm-specific cash flows and a 30% weight to our peer-group multiple valuation. Weighted Average Value per Share Valuation Method Value (AED) Weight (%) Discounted Cash Flow (DCF) 3.4 70% Peer-based multiple valuation 7.3 30% Weighted Average Fair Value 4.6 100% Source: ADCB research Sensitivity of Arabtec’s fair value in three different scenarios Fair Value per Scenario Major Assumptions share (AED) Base Case1. Assigned a project execution risk to each project 4.6 depending on their status at the end of Q3 2008 2. Considered a delay in project completion of between 6- 24 months depending on the original project schedule and the current completion status 3. Dubai projects which have not yet commenced - applied a 100% execution risk 4. Okhta Center project, Russia - applied a 100% execution risk 5. Contracts which are not yet awarded are assigned 100% execution risk Best Case All the projects are assumed to be completed without any 5.4 execution risks Worst Case1. Dubai projects which have not yet commenced or have 3.7 less than 10% completion at the end of Q3 2008 - applied a 100% execution risk 2. Okhta Center project, Russia - applied a 100% execution risk Source: ADCB research ARABTEC HOLDING PJSC ADCB Wealth Management Group I Research I +97126973525 | [email protected] 3 Discounted Cash Flow (DCF) model We use a two-stage DCF model with explicit forecasts to 2015. Free cash flows (FCFs) (Operating Profit + Depreciation - Capex - Changes in working capital) are calculated and discounted in order to estimate the fair value of the firm. Cost of equity has been derived by using the Capital Asset Pricing Model (CAPM). We have made the following key assumptions in our model: Risk free rate: 4.79% (3 yr. average of 10 yr. US Treasury Bond Rate) Country Risk Premium: 0.9% Equity Premium: 6.0% Company Beta: 1.31 Cost of equity: 13.55% WACC: 12.40% Terminal growth rate: 1% Based on these assumptions, our estimate of the fair value of equity is AED 4,054.1mn. Current outstanding shares after bonus issue total 1,196 mn. On this basis, our DCF model yields a fair value of AED 3.4 per share. Sensitivity of fair value estimate, by using different rates for terminal cost of capital and terminal growth rates, are shown below: Terminal Cost of Capital 3.4 11.40% 11.90% 12.40% 12.90% 13.40% 0.00% 3.4 3.3 3.2 3.2 3.1 0.50% 3.5 3.4 3.3 3.2 3.2 1.00% 3.6 3.5 3.4 3.3 3.2 1.50% 3.7 3.6 3.5 3.4 3.3 Terminal growth 2.00% 3.8 3.7 3.6 3.5 3.4 Source: ADCB research Peer-Based Valuation method For our peer-based multiples valuation, we apply a peer-group average EV/EBITDA multiple for 2008 of 7.3x in order to calculate Arabtec Holding’s enterprise value. This method yields a ex-bonus fair value of AED 7.3 per share.