In its latest updated equity research report on the Saudi cement sector, NCB Capital, the GCC’s major wealth manager and the Kingdom’s largest asset manager, believes that the demand outlook for the sector remains strong, but expects that importing clinker will only be a short term solution and will compress margins due to insufficient subsidies.
“In the long term, the ability of the local firms to meet demand remains unclear due to the uncertainty over fuel supply to planned expansions,” stated Abdulelah Babgi, equity research analyst at NCB Capital. “We remain neutral on the sector due to capacity constraints and concerns over margins compressing. Our top picks are Yanbu and Southern Cement.”
Babgi added: “We maintain our neutral rating on the Saudi cement stocks under our coverage, despite improvements in the outlook of some of the companies. We expect cement sales to grow by 8.2 percent YoY in 2013 to reach 56 million tons and continue to grow at a CAGR of 6.3 percent until 2015. Since our last update, we have increased our 2013 estimates for most of the companies (excluding Eastern and Saudi Cement) by an average of 2.8 percent due to the better than expected H1 2013 results. This has led to an average increase of 3 percent in our price targets with the increase for Yanbu Cement the highest at 6 percent.”
NCB Capital’s main short-term concerns for the sector are the expected compression of margins due to imports, as well as the uncertainty of fuel supply to planned expansions. “Imports could lead to margin pressure due to insufficient government subsidies,” added Babgi. “On average, we have reduced our 2014 net margins by 63 bps due to the expected margin pressure as a result of cement imports.”
“Although we are neutral on all cement stocks under coverage, on a relative basis, Yanbu and Southern Cement are our top picks,” stated Babgi. “For Yanbu Cement, we believe the high inventory level (135 percent above the sector’s average) positions it well to meet the demand needs in the Western Region. As for Southern Cement, we believe the increasing construction activity in the south, the ability to sell in the west and the potential for increased capacity are its key positives.”
NCB Capital believes overall earnings growth potential for most companies remains limited due to high utilization rates and restrictions on prices. Companies with high inventory levels are better positioned to benefit from the increase in demand. However, for the whole sector, NCB Capital believes only multiple expansion could provide additional upside. The sector currently trades at 14.3x 2013 P/E compared to 12.6x at the beginning of the year. Dividends remain the sector’s key strength with an average yield of 5.5 percent.
“We continue to expect a strong demand outlook for cement in Saudi Arabia in the coming few years. This is mainly due to the ongoing and new mega projects announced by the government, coupled with an increase in private sector activity,” said Babgi.
“Recently the Ministry of Interior awarded three contracts worth a total of SR10.4 billion for the construction of security compounds and other facilities around the Kingdom. These three contracts are expected to be completed by 2016.
Moreover, the Ministry of Finance awarded a contract worth SR13 billion to Saudi Binladen Group for the construction of Abraj Kudai, a mixed-use real estate development in Makkah.
Other mega projects that are expected to consume cement for the coming years include the metro projects in the Central and Western regions, the expansion of Riyadh and Jeddah airports and the expansion of the two holy mosques. Additionally, the need for more than 2 million housing units is expected to support demand over the longer term,” noted Babgi.