Cement Sector Note - September 2016

PRIME INVESTMENT RESEARCH AUTOMOTIVE |EGYPT

GB AUTO – INITIATION OF COVERAGE JANUARY, 14TH

2016

PRIME INVESTMENT RESEARCH

BUILDING MATERIALS |EGYPT CEMENT SECTOR NOTE

19TH SEPTEMBER, 2016

EGYPT’S TROUBLED ECONOMY WEIGHS ON

LOCAL CEMENT INDUSTRY.

SKEPTICAL CEMENT DEMAND GROWTH

EXPECTATIONS, WITH A BLEAK OUTLOOK.

NEW CAPACITIES ENTRIES ARE EXPECTED TO

PUT PRICES IN A FREEFALL SITUATION.

ARC REAPS THE BENEFITS OF EARLY

MIGRATION TO COAL, WHILE MARGINS ARE

PRESSURED BY FX LOSSES.

MCQ’S ACQUISITION SPARKS GROWTH.

SUCE’S LOW LIQUIDITY BLUNTING STOCK’S

HIGH POTENTIAL.

SCEM’S BREAKTHROUGH IS NOT SEEN IN THE

HORIZON.

SVCE’S PLANS TO DOUBLE CAPACITY IS THE

MAIN CATALYST.

2

PRIME INVESTMENT RESEARCH CEMENT SECTOR NOTE


CEMENT SECTOR… A SUSPICIOUS OUTLOOK, TRIGGERED BY NEW CAPACITIES AND SLOWER DEMAND GROWTH…

Perilously slower demand growth rate... Local cement demand growth rate came perilously lower

in 1H2016 at 6%, y-o-y, compared to a growth rate of 9% in 1H2015, y-o-y. We believe this lower

growth rate came as a result of: 1- The rockiness of Egypt’s economy and the fluctuations in

exchange rate. 2- Lower growth rate of construction and building sector. 3- The seasonality effect

of Ramadan also dealt a setback in this lower growth rate. It is worthy to note that, the market’s

utilization rate reached 83% in 1Q2016, 72% in 2Q2016 and 80% in 1H2016.

… gives us a suspicious outlook over demand growth. We are less optimistic now over the growth

of local cement demand in the upcoming years. Although the fragility of the local economy and

the declining value of the EGP pushed investors to use real estate as a hedging tool in the past few

years, we expect the unprecedented spikes in real estate’s prices as a result of the continuous

hikes in building material’s prices, will make the majority of investors unable to afford investing in

real estate, therefore, we expect to see a lower growth rate in construction activity in the

upcoming years. As a result, we do not see cement demand booming in the coming period,

however, it will grow at lower rates. Subsequently, we expect the market to reach equilibrium

between supply and demand by 2020, compared to our previous expectations of reaching

equilibrium by 2018. Egypt’s cement market remained underutilized of 17mn tpa in 2015, as

demand recorded c53mn tons compared to a local capacity of 70mn ton in the same year.

FX crisis drags margins down. Although Local cement manufacturers depend on locally sourced

raw materials, many players have migrated to coal to use it as a source of energy, due to the

shortage of NG supply and the very expensive HFO, which is imported. The devaluation of the EGP

against the USD by 14% in March 2016, in addition to the unavailability of foreign currency

through official sources forcing coal importers to source FX from the parallel market, with a spread

of more than 40%, pushed us to consider parallel market rates in our valuation model.

Nevertheless, as the devaluation in March 2016 was followed by higher selling prices, we also

expect any further devaluation or floatation to be followed by hikes in cement selling prices,

especially after all manufacturers migrate to coal. And thus, our new exchange rates forecasts

were coupled with higher expected selling prices.

New capacities deepen the wounds of an already oversupplied industry. In our cement note

issued in February 2016, we expected the new 14 licenses offered by IDA to represent a major risk

for our valuation. This is still one of the main risks to our valuation, as the total market’s capacity

will reach 98mtpa, leading to a higher gap between supply and demand, especially after many

current and new players submitted offers for these licenses including South Valley Cement, Misr

Beni Suef Cement, El Sewedy Cement and others. Furthermore, Sinoma International Engineering

announced in mid-June 2016 that it has signed a contract with the Ministry of Defense to build six

cement production lines with the largest capacity locally estimated at 12-14mtpa in Beni Suef and

will probably be online by 2019. This represents a huge setback for local cement industry, as this

capacity will result in a total capacity of c82mn tpa, excluding new licenses. We opted to include

neither the new licenses capacities’ nor the Ministry’s of Defense project capacities’ in our

assumptions, as there is no official announcement yet. However, recent news from Industrial

Development Authority states that the bidding for the new cement licenses will start at EGP 120-

150mn and the bidding will be held in October. And hence, our forecast may be revised down

further.

Arabian Cement (ARCC)

FV EGP 9.3

Mkt Price EGP 6.2

Potential 50.0%

Recommendation Strong Buy

Daily Average Turnover EGP 4.0mn

Free Float 22.5%

Misr Cement Qena (MCQE)

FV EGP 84.2

Mkt Price EGP 80.6

Potential 4.5%

Recommendation Hold

Daily Average Turnover

EGP 1.1mn

Free Float 24.0%

Suez Cement (SUCE)

FV EGP 20.0

Mkt Price EGP 10.4

Potential 92.3%

Recommendation Strong Buy


Free Float 29.4%

Sinai Cement (SCEM)

FV EGP 16.2

Mkt Price EGP 23.4

Potential -31%

Recommendation Sell


Free Float 35.3%

South Valley Cement (SVCE)

FV Under Review

Mkt Price EGP 4.09

Potential -

Recommendation -


Free Float 44.8%

3



CEMENT PRODUCTION AVG SELLING PRICE

SOURCE: IDA & PRIME RESEARCH

PRODUCTION & UTILIZATION RATE

Overall, we downgraded fair values for all covered cement companies due to;

1- Higher risk free rate, which crossed 16%.

2- New exchange rate assumptions.

3- Higher electricity prices.

4- Softer demand expectations.

5- We preferred to apply a 2% liquidity risk premium in valuation models for stocks with low turnover

namely; MCQ, SUCE and SCEM.

It is worthy to note that, if our expectations of 1% interest rate hike in the next MPC meeting materialized, we will

downgrade our fair value even further.

Company Name FV Last Price

Potential Recommendation

P/Ex EPS Dividend Yield P/BV

2015a 2016f 2015a 2016f 2015a 2016f 2015a 2016f

Arabian Cement

9.3 6.2 50% Strong Buy 8.49 8.26 0.73 0.75 5.56% 8.50% 1.71 1.66

Misr Cement Qena

84.2 80.6 4.5% Hold 9.05 9.07 8.91 8.88 3.72% 2.46% 2.87 2.73

Suez Cement 20.0 10.4 92.3% Strong Buy NA 17.05 -0.33 0.61 9.61% 1.47% 0.26 0.29

Sinai Cement 16.2 23.4 -31% Sell NA 55.71 -0.57 0.42 0.00% 4.27% 1.22 1.22

South Valley Cement

Under Review

4.1 - - 27.33 - 0.15 - 0.00% - 0.60 0.57

0

5000

10000

15000

20000

25000

30000

1Q 2Q 1H

Th

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san

d T

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2014 2015 2016

0

100

200

300

400

500

600

700

800

1Q 2Q 1H

EG

P

2014 2015 2016

69%

70%

76%

73%

74%

76%

64%

66%

68%

70%

72%

74%

76%

78%

45000

46000

47000

48000

49000

50000

51000

52000

53000

54000

2010 2011 2012 2013 2014 2015

Th

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Cement Production Utilization Rate

4



Arabian Cement, our top pick is crushed under risk free rate,

We downgraded ARC’s fair value to be EGP 9.3/share from the previous EGP 9.9/share, with an upside potential of

50% and a Strong Buy recommendation. This downgrade was mainly resulted from the very high risk free rate that

weighs on all equities through increasing cost of equity. However, we now expect a healthier energy mix for ARC than

before, as it was able to provide its facilities with the required coal despite of the consistent FX crisis in the local

market. On the other hand, we reduced our utilization rates expectations than before, as a result of the expected

slower demand growth in the upcoming years. Meanwhile, new EGP floatation expectations were partially

compensated by the expected price spikes. ARC announced that it will construct a new pet coal mill with an

investment cost of EGP 80mn. This, according to the company, should reduce the amount of coal imported by ARC

and hence reducing the amounts of foreign currency required to import coal. We believe this bodes well for ARC as it

will hedge, partially, the FX risk for the company through depending on local pet coal.

ARC’s KPIs Hist. Forecast

In EGP Mn 2015 2016F 2017F 2018F

Revenues 2,273 2,278 2,590 2,752

Change 0.2% 0.2% 13.7% 6.3%

Gross Profit 731 864 1,007 1,082

GPM 32.1% 37.9% 38.9% 39.3%

EBITDA 633 768 901 963

EBITDA Margin 27.8% 33.7% 34.8% 35.0%

Depreciation & Amortization 175 184 191 196

Net Income After Minority & Taxes 277 285 452 546

NPM 12.2% 12.5% 17.5% 19.8%

EPS 0.7 0.8 1.2 1.4

P/Ex 8.9 7.8 5.2 4.4

DPS 0.4 0.5 0.8 1.0

EV/Ton 912.7 895.7 838.8 691.8

Misr Cement Qena, Asec’s acquisition is the main catalyst,

Although standalone 1H2016 financial results came in line, we downgraded the fair value of MCQ to be EGP

84.2/share from EGP 102.5/share, with an upside potential of 4.5% and Hold recommendation. This downgrade

comes as a result of the aforementioned reasons, in addition to the less efficient energy mix used in Asec Cement.

Asec Cement showed a very high utilization rate in 1H2016, recording 120%. Hence, we opted to increase the

company’s utilization rates in the upcoming years above our previous expectations. We still see Asec’s acquisition by

MCQ represents a potential for the company, as we believed this acquisition will double both the market share and

the bottom line for MCQ on consolidated level, and 1H2016 consolidated results came to support our view. However,

liquidity is a major concern, as average daily traded volume one year back was 14 thousand shares only. This

pushed us to apply a 2% liquidity risk premium in our valuation model.

5



MCQ’s KPIs Hist. Forecast

In EGP Mn 2015 2016F 2017F 2018F

Revenues 1,096 2,592 2,698 2,848

Change -4.8% 136.5% 4.1% 5.6%

Gross Profit 392 884 1,093 1,219

GPM 35.8% 34.1% 40.5% 42.8%

EBITDA 355 732 941 1,056

EBITDA Margin 32.4% 28.3% 34.9% 37.1%


Net Income After MI 266 265 388 489

NPM 24.3% 10.2% 14.4% 17.2%

EPS 8.9 8.9 13.0 16.4

P/Ex 9.1 9.1 6.2 4.9

DPS 3.0 4.3 9.0 13.2

EV/Ton 756.5 955.0 830.2 687.5

Suez Cement, high potential hindered by low liquidity,

Although we downgraded Suez cement’s fair value from EGP 24/share to be EGP 20/share, there is still a

considerable upside potential of 92.3% with a Strong Buy recommendation. However, the low liquidity of

the stock is a setback for reaping the benefits of this high potential, as its average daily traded volume

one year back was at 35 thousand shares. Tourah’s quarries issue with the government was solved by

2Q2016, paving the way for the company to increase its production in the same quarter, and hence

reducing fixed costs. In addition, the migration to coal in Suez’s two lines, Suez and Katameya,

strengthened the company’s margins on standalone basis. We also expect Tourah’s and Helwan’s coal

mills to come on stream by 2018, leading to healthier margins for Suez Group.

Suez’s KPIs Hist. Forecast

In EGP Mn 2015 2016F 2017F 2018F

Revenues 5,642 5,780 6,673 7,841

Change -8.3% 2.4% 15.5% 17.5%

Gross Profit 887 1,092 1,476 1,891

GPM 15.7% 18.9% 22.1% 24.1%

EBITDA 322 672 988 1,314

EBITDA Margin 5.7% 11.6% 14.8% 16.8%


Net Income After MI -60 112 303 504

NPM -1.1% 1.9% 4.5% 6.4%

EPS -0.3 0.6 1.7 2.8

P/Ex NA 17.3 6.2 3.7

DPS 1.0 0.2 0.6 8.0

EV/Ton 210.9 251.6 204.6 121.9

6



Sinai Cement, troubled governance of Sinai weighs on margins,

We downgrade SCEM’s fair value to EGP 16.2/share with a downside potential of 31%, implying a Sell

recommendation. The company is suffering from high SG&A expenses due to its location in the troubled

governance of Sinai. Furthermore, the company’s energy mix was less efficient than our expectations;

subsequently, we opted to reduce energy mix efficiency in the upcoming years. Moreover, Sinai cement is

selling at a discount of c14% to the local average prices, which also weighs on the company’s gross profit

margin.

SCEM’s KPIs Hist. Forecast

In EGP Mn 2015 2016F 2017F 2018F

Revenues 975 1,237 1,322 1,531

Change -18.3% 26.8% 6.9% 15.8%

Gross Profit 203 399 489 598

GPM 20.8% 32.3% 37.0% 39.1%

EBITDA 49 167 246 321

EBITDA Margin 5.1% 13.5% 18.6% 20.9%


Net Income After MI -39 29 65 139

NPM -4.0% 2.3% 4.9% 9.0%

EPS -0.6 0.4 1.0 2.0

P/Ex NA 58.5 23.4 11.7

DPS 0.0 1.0 1.0 1.0

EV/Ton 1,010 821 810 747

South valley Cement, doubling capacity bodes well for the company,

SVC is currently Under Review, as we are awaiting it to publish its 1H2016 results in order to analyze the effects of

the events in 1H2016 over its financial results. SVC applied for one of the new licenses issued by the government, in

order to construct new clinker silos to provide the new cement line with its required clinker. This bodes well for SVC,

as the company’s early plan was to rely on imported clinker, which its cost is significantly higher than the locally

produced clinker, to supply the new line. Therefore, we consider SVC’s application for the new licenses the main

catalyst for the stock.

In the next section we exhibit a comparative analysis, showing the performance of the companies under coverage

during 1H2016,

7



CEMENT PRODUCTION

SOURCE: IDA, COMPANIES & PRIME RESEARCH

SALES VOLUME

0

500

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3500

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4500

ARCC MCQE SUCE SCEM

Th

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1Q2016

2Q2016

1H2016

0

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4500

ARCC MCQE SUCE SCEM

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1Q2016

2Q2016

1H2016

Supply softened in 2Q16,

Q-o-Q, as a result of the

holy month of Ramadan…

…this was reflected in

2Q16’s sales volume.

8



CLINKER PRODUCTION

UTILIZATION RATE

SOURCE: IDA, COMPANIES & PRME RESEARCH


-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

ARCC MCQE SUCE SCEM

Th

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san

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1Q2016

2Q2016

1H2016

0%

20%

40%

60%

80%

100%

120%

140%

ARCC MCQE SUCE SCEM

1Q2016

2Q2016

1H2016

Only SCEM witnessed a

jump in clinker

production in 2Q16, Q-o-

Q.

MCQ witnessed the

highest utilization rate, as

a result of the jump in

Asec’s utilization rate,

that it recently acquired.

9



SALES VALUE

GROSS PROFIT


-

500

1,000

1,500

2,000

2,500

3,000

3,500

ARCC MCQE SUCE SCEM

EG

P M

n 1Q2016

2Q2016

1H2016

0

100

200

300

400

500

600

700

ARCC MCQE SUCE SCEM

EG

P M

n

1Q2016

2Q2016

1H2016

Selling price hikes in

2Q16, partially mitigated

for the drop in sales

volume.

Healthier gross profit in

Q216 comes as a result of

the spike in selling prices.

10



GROSS PROFIT MARGIN


EBITDA

-

50

100

150

200

250

300

350

400

450

ARCC MCQE SUCE SCEM

EG

P M

n 1Q2016

2Q2016

1H2016

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

ARCC MCQE SUCE SCEM

1Q2016

2Q2016

1H2016

ARC recorded the highest

GPM in 1H16, as it has

the most efficient energy

mix amongst the 4

companies.

High SG&A is one of the

main problems that Sinai

Cement faces, and it

weighs on the company’s

EBITDA…

11



EBITDA MARGIN


EBIT

50-

-

50

100

150

200

250

300

350

ARCC MCQE SUCE SCEM

EG

P M

n

1Q2016

2Q2016

1H2016

5%

10%

15%

20%

25%

30%

35%

40%

45%

ARCC MCQE SUCE SCEM

1Q2016

2Q2016

1H2016

… Leading to an almost

zero EBITDA margin in

1Q16 in SCEM.

Operating profit

improved in 2Q16, Q-o-Q,

for all companies.

12



EBIT MARGIN

NET INCOME


60-

40-

20-

-

20

40

60

80

100

120

140

160

ARCC MCQE SUCE SCEM

EG

P M

n

1Q2016

2Q2016

1H2016

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

ARCC MCQE SUCE SCEM

1Q2016

2Q2016

1H2016

An impressive jump in

SCEM’s EBIT margin in

2Q16, Q-o-Q.

The jump in interest

expenses and the high FX

losses, weighed on

companies bottom line.

13



NET PROFIT MARGIN

COGS/SALES


-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

ARCC MCQE SUCE SCEM

1Q2016

2Q2016

1H2016

40%

45%

50%

55%

60%

65%

70%

75%

80%

85%

90%

ARCC MCQE SUCE SCEM

1Q2016

2Q2016

1H2016

MCQ’s NPM was heavily

crushed under the

interest expenses of the

new loan.

The higher selling price in

2Q16 resulted in a huge

drop in COGS/Sales in

1Q16, Q-o-Q.

14



EPS

PRICE/TON


(1.00)

-

1.00

2.00

3.00

4.00

5.00

ARCC MCQE SUCE SCEM

1Q2016

2Q2016

1H2016

MCQ recorded the

highest EPS in 1H16, as its

bottom line doubled on

consolidated level, due to

Asec acquisition.

MCQ is selling at a

premium to all companies

under coverage.

400

450

500

550

600

650

700

ARCC MCQE SUCE SCEM

EG

P 1Q2016

2Q2016

1H2016

15




COST/TON

ARC has reaped the

benefits of being a

pioneer in coal migration.

300

350

400

450

ARCC MCQE SUCE SCEM

EG

P 1Q2016

2Q2016

1H2016

16



Stock Recommendation Guidelines

Recommendation Target-to-Market Price (x)

Buy x > 15%

Accumulate 5%< x <15%

Hold -5% < x < 5%

Reduce -15% < x < -5%

Sell x < -15%

Strong Buy x > 40%

Investment Grade Explanation

Growth 3 Yr. Earnings CAGR > 20%

Value Equity Positioned Within Maturity Stage of Cycle

Speculative Quality Earnings Reflect Above Normal Risk Factor

17



PRIME SECURITIES

Hassan Samir Managing Director +202 3300 5611 [email protected]

RESEARCH TEAM

Aboubakr Emam, CFA Head of Research +202 3300 5724 [email protected]

Eman Negm, MSc Economist +202 3300 5716 [email protected]

Mohamed Marei Equity Analyst +202 3300 5725 [email protected]

Ali Afifi Equity Analyst +202 3300 5723 [email protected]

Omneya El Hammamy Equity Analyst +202 3300 5718 [email protected]

Ingy Fahmy Equity Analyst +202 3300 5722 [email protected]

Taher Seif Equity Analyst +202 3300 5719 [email protected]

Mohamed Magdi Junior Equity Analyst +202 3300 5720 [email protected]

SALES TEAM

Mohamed Ezzat Head of Sales & Branches +202 3300 5784 [email protected]

Shawkat Raslan Heliopolis Branch Manager +202 3300 5110 [email protected]

Amr Saber Team Head – Institutions Desk +202 3300 5659 [email protected]

Amr Alaa, CFTe Manager +202 3300 5609 [email protected]

Mohamed Elmetwaly Manager +202 3300 5610 [email protected]

Emad Elsafoury Manager +202 3300 5624 [email protected]

HEAD OFFICE

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Cement Sector Note - September 2016

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