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September 27, 2016 Santhosh Balakrishnan Yasser Bin Ahmed Riyad Capital is licensed by the Saudi Arabia [email protected] [email protected] Capital Market Authority (No. 07070-37) +966-11-203-6809 +966-11-203-6805 Concerns Overweigh Our revised outlook on Saudi Kayan Company (Kayan) is modest after our model update, leading to an estimate and target price revision. In our view, Kayan’s operational concerns are yet to be resolved despite strong earnings trends since start of 2016. We continue to maintain Neutral for the following reasons i) strong earnings growth is unlikely to sustain in the coming quarters ii) volatile operating rates and unplanned shutdowns affecting efficiency and iii) subsidy impact from 2Q2017 could elevate feedstock costs and result in margin contraction. Despite topline growth concerns, we expect some improvement in earnings as margins expand in contrary to our earlier view. We change our valuation approach to EV/EBITDA method versus DCF earlier. The revised approach takes our 12-month target price to SAR 6.25 from earlier SAR 6.00. Despite such upward revision, stock offers negative real returns while valuation has moved beyond acceptable levels, suggesting Kayan is unappealing. Kayan is trading at expensive levels with EV/EBITDA of 12.5x for 2016E versus sector’s 10.1x. Strong 2Q16 earnings trends unlikely to sustain Kayan reported strong 2Q2016 earnings of SAR 91 million after five quarters of consecutive losses. Remarkably, kayan recorded its best ever margins and bumper earnings growth in this quarter surprising street expectations, the bright spot in its entire operational history. On the flipside, we believe this trend is unlikely to sustain as feedstock spreads have contracted and product prices have fallen slightly since 3Q. Operating rates continue to impact We believe concerns do arise and look forward for a consistent performance in operating metrics. Kayan operated at 77% utilization during 2015, due to a 53-day shutdown in 1Q2015, while it had a 40-day shutdown during 1Q2016 suggesting operating rates could be below 80% for 2016E. We believe such history of unplanned shutdown has led to an inconsistent outlook; we continue to view this as a major risk. Margins to contract due to subsidy cuts from 2Q2017 Kayan is likely to see the impact of feedstock costs starting 2Q2017 with ethane to be priced at $1.75/mmbtu and Butane priced at discount to international FOB prices. We believe such impact could lead to higher feedstock costs as Kayan operates a costlier feedstock structure due to presence of butane, which has low crack yields. Revise target price to SAR 6.25, maintain Neutral With expectations of losses over next 3-years, we ignore P/E and DCF approach and amicably rely on a target EV/EBITDA multiple of 12.0x to derive SAR 6.25 fair value. With barely any dividends over the next five years and marginal upside, a large fall from these levels would only make Kayan attractive. Until then, maintain Neutral. SAUDI KAYAN COMPANY (KAYAN) Update Report Rating Neutral 12-Month Target Price SAR 6.25 Expected Total Return Price as on Sep-26, 2016 SAR 6.07 9 Upside to Target Price 3.0% Expected Dividend Yield N.A Expected Total Return 3.0% Market Data 52 Week H/L SAR 10.2/4.5 Market Capitalization SAR 9,105 mln Enterprise Value SAR 31,209 mln Shares Outstanding 1,500 mln Free Float 35% 12-Month ADTV(mln) 14.6 Bloomberg Code KAYAN AB 1-Year Price Performance Source: Bloomberg Shareholding SABIC 35.0% Foreign Ownership (Inc. QFI) 0.5% Public Float 64.5% 30 40 50 60 70 80 90 100 110 120 130 S O N D J F M A M J J A KAYAN TASI TPCHEM -70% -60% -50% -40% -30% -20% -10% 0% 6M 1Y 2Y KAYAN TASI TPCHEM Key Financial Figures FY Dec31 (SAR mln) 2014A 2015A 2016E 2017E 2018E Revenue 11,636 7,976 7,581 8,320 9,299 EBITDA 2,950 1,884 2,569 2,421 2,271 Net Income (45) (1,243) (233) (177) (140) EPS (SAR) (0.03) (0.83) (0.16) (0.12) (0.09) DPS (SAR) NA NA NA NA NA P/E (x) NM NM NM NM NM P/B (x) 0.7x 0.8x 0.8x 0.8x 0.8x EV/Sales (x) 2.8x 4.0x 4.2x 3.8x 3.4x EV/EBITDA (x) 10.8x NM 12.5x 13.2x 14.1x
Transcript
Page 1: 2016 SAUDI KAYAN COMPANY (KAYAN SAR 6 · 2016 Santhosh Balakrishnan Riyad Capital is licensed by the Saudi ArabiaYasser Bin Ahmed santhosh.balakrishnan@riyadcapital.com Capital Market

September 27, 2016

2016

Santhosh Balakrishnan Yasser Bin Ahmed Riyad Capital is licensed by the Saudi Arabia

[email protected] [email protected] Capital Market Authority (No. 07070-37)

+966-11-203-6809 +966-11-203-6805

Concerns Overweigh Our revised outlook on Saudi Kayan Company (Kayan) is modest after our model update, leading to an estimate and target price revision. In our view, Kayan’s operational concerns are yet to be resolved despite strong earnings trends since start of 2016. We continue to maintain Neutral for the following reasons i) strong earnings growth is unlikely to sustain in the coming quarters ii) volatile operating rates and unplanned shutdowns affecting efficiency and iii) subsidy impact from 2Q2017 could elevate feedstock costs and result in margin contraction. Despite topline growth concerns, we expect some improvement in earnings as margins expand in contrary to our earlier view. We change our valuation approach to EV/EBITDA method versus DCF earlier. The revised approach takes our 12-month target price to SAR 6.25 from earlier SAR 6.00. Despite such upward revision, stock offers negative real returns while valuation has moved beyond acceptable levels, suggesting Kayan is unappealing. Kayan is trading at expensive levels with EV/EBITDA of 12.5x for 2016E versus sector’s 10.1x.

Strong 2Q16 earnings trends unlikely to sustain Kayan reported strong 2Q2016 earnings of SAR 91 million after five quarters of consecutive losses. Remarkably, kayan recorded its best ever margins and bumper earnings growth in this quarter surprising street expectations, the bright spot in its entire operational history. On the flipside, we believe this trend is unlikely to sustain as feedstock spreads have contracted and product prices have fallen slightly since 3Q.

Operating rates continue to impact We believe concerns do arise and look forward for a consistent performance in operating metrics. Kayan operated at 77% utilization during 2015, due to a 53-day shutdown in 1Q2015, while it had a 40-day shutdown during 1Q2016 suggesting operating rates could be below 80% for 2016E. We believe such history of unplanned shutdown has led to an inconsistent outlook; we continue to view this as a major risk.

Margins to contract due to subsidy cuts from 2Q2017 Kayan is likely to see the impact of feedstock costs starting 2Q2017 with ethane to be priced at $1.75/mmbtu and Butane priced at discount to international FOB prices. We believe such impact could lead to higher feedstock costs as Kayan operates a costlier feedstock structure due to presence of butane, which has low crack yields.

Revise target price to SAR 6.25, maintain Neutral With expectations of losses over next 3-years, we ignore P/E and DCF approach and amicably rely on a target EV/EBITDA multiple of 12.0x to derive SAR 6.25 fair value. With barely any dividends over the next five years and marginal upside, a large fall from these levels would only make Kayan attractive. Until then, maintain Neutral.

SAUDI KAYAN COMPANY (KAYAN) Update Report

Rating Neutral 12-Month Target Price SAR 6.25

Expected Total Return

Price as on Sep-26, 2016 SAR 6.07

9 Upside to Target Price 3.0%

Expected Dividend Yield N.A

Expected Total Return 3.0%

Market Data

52 Week H/L SAR 10.2/4.5

Market Capitalization SAR 9,105 mln

Enterprise Value SAR 31,209 mln

Shares Outstanding 1,500 mln

Free Float 35%

12-Month ADTV(mln) 14.6

Bloomberg Code KAYAN AB

1-Year Price Performance

Source: Bloomberg

Shareholding

SABIC 35.0%

Foreign Ownership (Inc. QFI)

0.5%

Public Float 64.5%

30

40

50

60

70

80

90

100

110

120

130

S O N D J F M A M J J AKAYAN TASI TPCHEM

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

6M 1Y 2Y

KAYAN TASI TPCHEM

Key Financial Figures

FY Dec31 (SAR mln) 2014A 2015A 2016E 2017E 2018E

Revenue 11,636 7,976 7,581 8,320 9,299

EBITDA 2,950 1,884 2,569 2,421 2,271

Net Income (45) (1,243) (233) (177) (140)

EPS (SAR) (0.03) (0.83) (0.16) (0.12) (0.09)

DPS (SAR) NA NA NA NA NA

P/E (x) NM NM NM NM NM

P/B (x) 0.7x 0.8x 0.8x 0.8x 0.8x

EV/Sales (x) 2.8x 4.0x 4.2x 3.8x 3.4x

EV/EBITDA (x) 10.8x NM 12.5x 13.2x 14.1x

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Page 2 of 15

SAUDI KAYAN COMPANY Update Report

Sector Update

Petrochemical sector, the best performer in TASI KSA petrochemicals sector has seen a positive stride after most companies reported strong earnings in 2Q2016, beating analyst expectations, while outperforming TASI and other sectors. The key reason for such positive increase is the improvement in product prices and resultant margin expansion. The sector recorded SAR 6.8 billion in earnings versus SAR 5.1 billion consensus, with an earnings beat of nearly +31%. Additionally margins have expanded significantly due to widened spreads in feedstock, positioned as the key advantage over global producers.

The increased margins, growth in product prices and increase in utilization rates has led to a superior earnings growth of +63% Q/Q though it declined by -20% Y/Y on subdued oil prices. Though 1Q2016 downturn was due to bottomed oil prices, product prices stood firm and managed to grow, however recovered lower than oil prices. Oil prices averaged US$42/bbl on a YTD basis, registering a sharp jump of +33% in 2Q2016 alone. The same is reflected in the KSA petrochemical index reporting a growth of +9% versus TASI’s +4%, reporting its best outperformance versus sectors.

Kayan’s operates with a diversified product mix With Kayan operating in the Olefins and Aromatics space with a variety of specialty chemicals. Its key product composition spanned across Mono Ethylene Glycol (MEG), Polyethylene (PE), Polypropylene (PP) and Polycarbonate (PC), this collectively accounts for 86% of its capacity, while rest are specialized chemicals.

Exhibit 1: Sector Indices Performance Exhibit 2: Sector Earnings Performance

Source: Bloomberg Source: Bloomberg

4% 4%

-4%

2%

31%

-30%

24%

58%

-17%

-1%

63%

0%

Reta

il

Foo

d/A

gri

Cem

ent

Banks

Petc

hem

Tel

eco

m*

2Q2016 Estimate Deviation Q/Q growth

-27

% -24

%

-18

% -16

% -13

%

-18

%

3%

-18

%

-17

%

-5%

-9%

-6% -4

%

2%

Reta

il

Foo

d/A

gri

Tel

eco

m

Banks

TA

SI

Cem

ent

Petc

hem

YTD 1H16

Exhibit 3: Kayan End Product Composition (capacity) Exhibit 4: Kayan Feedstock & Derivatives Composition

Source: Argaam, Company Reports Source: Argaam, Company Reports

MEG27%

LDPE13%

HDPE18%

PP16%

PC12%

Butanol5%

ETA5% Ethoxy

2%NDA2%

ETO15%

Ethylene40%

Propylene17%

Benzene3%

Acetone4%

BPA7%

Phenol6%

Cumene8%

Page 3: 2016 SAUDI KAYAN COMPANY (KAYAN SAR 6 · 2016 Santhosh Balakrishnan Riyad Capital is licensed by the Saudi ArabiaYasser Bin Ahmed santhosh.balakrishnan@riyadcapital.com Capital Market

Page 3 of 15

SAUDI KAYAN COMPANY Update Report

With product demand improving globally, few supply-demand imbalance do exist over short term but still robust over long term. We look at demand – supply scenario over the next 3-4 years.

MEG a good volume driver Globally, Mono Ethylene Glycol (MEG) is a 26 million MT market as of 2015 with 51% of its supply controlled by China. MEG by usage carries lot of significance in the PET bottle industry. In our view, Kayan is a small player globally, but large on a regional level. With its 609 KT of capacity (27% of its product capacity), we believe MEG is key to Kayan’s volume growth. With the help of SABIC and its affiliate Yansab (MEG capacity of 809 KT), we believe synergies do rise gradually. According to TM research, the MEG market is expected to grow at +6.1% CAGR during 2015-23. We believe Chinese consumers are increasingly relying on imports from MENA producers, though new capacities are expected to be in place by end of 2018. In our view, this risk is due, to create an imbalance in supply-demand for medium term.

PP demand is more Asia focused

Kayan operates a 350 KT polypropylene plant, which accounts for 16% of its end-product capacity. We believe with such high proportion, Kayan is likely to explore more in the Asian markets as demand from Asia is expected to remain high for 2016-18E, according to Nexant research. Additionally, Nexant predicts global PP demand is expected to grow at +5% CAGR and reach 74 million MT by 2020, equating supply.

Exhibit 5: Global MEG Demand & Supply (mln Tons) Exhibit 6: Global MEG Demand Proportion 2016

Source: Nexant, Bloomberg Source: Nexant, Bloomberg

20

25

30

35

2014 2015 2016 2017 2018 2019 2020

Supply Demand

China51%

Asia Ex-China

26%

Americas13%

Europe7% MEA

3%

Exhibit 7: Global PP Demand & Supply (mln Tons) Exhibit 8: Global PP Demand Proportion 2016

Source: Nexant, Bloomberg Source: Nexant, Bloomberg

50

55

60

65

70

75

2014 2015 2016 2017 2018 2019 2020

Supply Demand

North America

12%

South America

6%

Europe11%

MEA8%

Asia Pacif ic

32%

China20%

United States

11%

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SAUDI KAYAN COMPANY Update Report

The long-term demand stems from end user industries in auto and electronics sectors. China alone has a 20% share of the PP market due to its significance in China’s plastics industry. We believe capacities are expected to increase in this market at a steady pace in US, China and Korea from 2017.

PE to see some supply-demand imbalance from 2018 Kayan’s PE (LDPE, HDPE and LLDPE) products account for 34% of its production capacity with a combined capacity of 700 KTA. Globally, PE products (LDPE, HDPE and LLDPE) are expected to grow at a CAGR of +6% through 2020 to 109 million MT. We do not expect an immediate ramp-up in capacity though expected to show some level of increased supply from 2018 as China and US are in the process of expanding its capacity across products. With consumption, remaining robust, supply growth is gathering pace to equal demand. Additionally global operating rates have not significantly expanded, barely affecting price-demand equation. We believe the PE industry has shown a narrowing supply-demand gap, however concerns on over capacity do exists.

Polycarbonate a promising business, SABIC driving initiatives Global Polycarbonate (PC) market is a highly concentrated market with five large producers forming 75% of total capacity. Kayan has a 260 KTA of capacity in this segment (12% of its product capacity) mainly driven by SABIC’s initiatives in JV with GE plastics, regarded as innovative plastic segment. This being a high value segment is mainly used in optical media and production of bottles. Asia is the largest consumer of this market with a share of 64%. PC demand is driven by electronic and automotive industries, with Nexant forecasting +6% CAGR through 2020 and reach U$19.6 billion.

Exhibit 9: Global PE Demand & Supply (mln Tons) Exhibit 10: Global PE Demand Proportion 2016

Source: Nexant, Bloomberg Source: Nexant, Bloomberg

80

85

90

95

100

105

110

2014 2015 2016 2017 2018 2019 2020

Demand Supply

North America

14%

South America

5%

Europe13%

MEA8%

Asia Pacif ic

31%

China18%

United States

11%

Exhibit 11: Global PC Demand & Supply (mln Tons) Exhibit 12: Global PC Demand Proportion 2016

Source: Nexant, Bloomberg Source: Nexant, Bloomberg

10

11

12

13

14

15

16

17

18

19

20

2014 2015 2016 2017 2018 2019 2020

Supply Demand

North America

15%

South America

1%

Europe17%

MEA3%

Asia Pacif ic

64%

Page 5: 2016 SAUDI KAYAN COMPANY (KAYAN SAR 6 · 2016 Santhosh Balakrishnan Riyad Capital is licensed by the Saudi ArabiaYasser Bin Ahmed santhosh.balakrishnan@riyadcapital.com Capital Market

Page 5 of 15

SAUDI KAYAN COMPANY Update Report

Asia and Middle East are Kayan’s key market Kayan exports 47% of its volumes to Asian markets predominantly to China followed by MENA, while exposure to Europe and North America is lower. With Kayan’s largest market being Asia and Middle East, synergies do arise from affiliates (Yansab) but primarily driven by parent company SABIC and its JV partners. With Asia being predominant in its geographical mix, Kayan is less prone to volatile cycles in developed markets, which is a positive at times of low growth in Europe and North America.

Page 6: 2016 SAUDI KAYAN COMPANY (KAYAN SAR 6 · 2016 Santhosh Balakrishnan Riyad Capital is licensed by the Saudi ArabiaYasser Bin Ahmed santhosh.balakrishnan@riyadcapital.com Capital Market

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SAUDI KAYAN COMPANY Update Report

Financial Analysis

Revisions driven by margins and changes in product outlook for 2016-19 We revisit our models and revise our outlook for 2016-19E considering the upbeat 2Q2016 results which was largely driven by a surge in petrochemical prices. Our revision braces towards a slightly mixed outlook for 2016-19, hence adjust topline downwards and earnings upwards. We cut revenue growth and believe utilization to be lower in the coming quarters due to unplanned shutdowns. However, product prices are expected to grow at decent rates, mimicking oil prices. An upgrade in earnings is driven by Kayan’s consecutive positive surprises, over the last two quarters (refer Ext-21) sighting growth in margins. Additionally, trim our loss expectations for 2016-19E versus earlier estimates. We believe Kayan continues to benefit from a superior product composition and believe the downside risk is the volatile utilization rates, which we believe to improve in the coming years.

Revenue growth trimmed to +11% CAGR Revenue is expected to grow at +11% CAGR and slightly lower to our expectations earlier. We base our macro oil forecasts on EIA’s expectations of a +6% CAGR with oil prices reaching US$ 73/ bbl by 2019.

We believe Kayan is positioned well and efficiently leverages SABIC’s distribution network. We remain positive on Kayan’s product portfolio comprising of volume and value, with MEG driving volumes and PC driving value growth. On a combined basis these core products (MEG, PP, PE and PC) accounts for 76% of production volumes and 80% of sales as of 2015. Our revised outlook suggests revenues are expected to reach SAR 10.3 billion by 2019. On the product prices front, MEG on a standalone basis is expected to grow at +5% CAGR through 2019 according to Nexant, while a +4% CAGR is expected from PE and PP.

Table 1: Changes in Estimates (SAR mln)-RC versus Consensus

RC Estimates (Old) RC Estimates (new) Consensus (New)

2016E 2017E 2018E 2016E 2017E 2018E 2016E 2017E 2018E

Revenue 8,117 9,107 10,293 7,581 8,320 9,299 8,545 9,968 10,258

Gross Profit 81 364 206 569 582 651 1,037 1,186 1,169

EBITDA 1,801 1,858 1490 2,569 2,421 2,271 2,966 3,392 3,602

Net Income (724) (494) (692) (233) (177) (140) (216) (178) 605

Source: Riyad Capital, Bloomberg

* Comparison show n till 2018E as consensus for 2019 not available

Exhibit 13: Revenue (SAR mln) and Growth Forecasts Exhibit 14: Geographical Sales Mix

Source: Riyad Capital, Company Reports Source: Riyad Capital, Company Reports

11

,63

6

7,9

76

7,5

81

8,3

20

9,2

99

10

,23

7

-35%

-25%

-15%

-5%

5%

15%

201

4

201

5

201

6E

201

7E

201

8E

201

9E

Revenue YoY

Asia47%

Middle East & Africa

39%

Europe9% Other

Countries

5%

Page 7: 2016 SAUDI KAYAN COMPANY (KAYAN SAR 6 · 2016 Santhosh Balakrishnan Riyad Capital is licensed by the Saudi ArabiaYasser Bin Ahmed santhosh.balakrishnan@riyadcapital.com Capital Market

Page 7 of 15

SAUDI KAYAN COMPANY Update Report

A historical correlation of quarterly sales versus product prices suggests correlations have declined since start of 1Q2016. A recap of the performance in product prices suggests a lag in oil’s correlation versus product prices. Oil prices are exempted from volatile demand cycles while product prices are prone to such cycles. Hence, do form part of a less volatile cycle over the short term causing pricing imbalance.

Feedstock spreads have aided growth in margins A close look at recent trends in petrochemical prices, suggest slight improvement in topline mainly driven by PC and PE. Though products are not affected largely, the feedstock prices has seen exceptional volatility (ethane, propane and butane) once oil prices plummeted to decade lows. The steep fall in feedstock prices has led to an advantage for producers due to higher feedstock spreads. With added feedstock spreads and impending discount from Aramco, this has led to superior growth in margins for Kayan.

Margins are prone to contract from 1H2017

Kayan is protected from energy price hike till 1H2017 due to the grace period allowed to many KSA producers by Aramco at the time of inception. We believe Kayan’s costs are higher due to its feedstock mix comprising of ethane and butane, with butane forming 30%. With ethylene yields being lower from butane compared to ethane, Kayan has a higher cost structure versus other 100% ethane based crackers. With ethane priced at $0.75/mmbtu till 2Q2017 for Kayan and will be hiked to $1.75/mmbtu.

Exhibit 15: Quarterly Revenues (SAR bln) versus Growth in Global Product Prices (Avg) Trends

Source: Riyad Capital, Company Reports, Bloomberg

2.4

2.0

2.3

2.2

2.9

2.1

2.3

3.1

2.9

2.9 3.0

3.2

2.5

1.8

2.1 2.2

1.9

1.7

2.2

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

1.0

1.5

2.0

2.5

3.0

3.5

4Q

11

1Q

12

2Q

12

3Q

12

4Q

12

1Q

13

2Q

13

3Q

13

4Q

13

1Q

14

2Q

14

3Q

14

4Q

14

1Q

15

2Q

15

3Q

15

4Q

15

1Q

16

2Q

16

Revenue MEG PP PE

Exhibit 16: Quarterly COGS (% of Sales) versus Global Feedstock Price (Avg) Movements

Source: Riyad Capital, Company Reports, Bloomberg

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

120%

130%

4Q

11

1Q

12

2Q

12

3Q

12

4Q

12

1Q

13

2Q

13

3Q

13

4Q

13

1Q

14

2Q

14

3Q

14

4Q

14

1Q

15

2Q

15

3Q

15

4Q

15

1Q

16

2Q

16

COGS Ethane Q/Q Butane Q/Q

Page 8: 2016 SAUDI KAYAN COMPANY (KAYAN SAR 6 · 2016 Santhosh Balakrishnan Riyad Capital is licensed by the Saudi ArabiaYasser Bin Ahmed santhosh.balakrishnan@riyadcapital.com Capital Market

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SAUDI KAYAN COMPANY Update Report

Butane supply on the other hand will be priced at 20% discount to international prices until 1H2017 versus 27% earlier, we believe costs are likely to elevate. As a result, we forecast Opex to be at 93% on an average for 2016-19 and higher starting 2017.

Cost efficiency is beyond operational limits Kayan continues to operate at lower utilization rates and believe its unable to cover fixed costs fully at current operating rates. This cost inefficiency is attributed to the falling topline and believe a threshold range of 90% utilization is deemed necessary. Unless product prices move significantly or utilization breaches 90%, kayan would fail to deliver the required efficiency in costs. Keeping such assumptions, gross profit CAGR of +13% through 2019 is expected reaching SAR 819 million. On the other hand average EBITDA margins of 24% for 2016-19 is expected. We expect EBITDA CAGR of +8% through 2019 and reach SAR 2.2 billion. Depreciation rate of 21% to sales during 2015 is relatively high versus other producers. Keeping such rates, thin operating margins of 5% is expected and result in operating profit of SAR 614 million by 2019.

Trimming loss expectations, starting 2019 should be green Loss of SAR (6) million by 2019 is expected, showing signs of improvement. With such a loss scenario, accumulated losses could reach SAR (556) million over the next three years. We forecast LPS of SAR (0.16) for 2016 and do not expect any dividends over the next 5 years.

Highly leveraged balance sheet Kayan has nearly SAR 27.1 billion of debt as of 2Q2016 with major part of repayment scheduled between 2018-2022, however over the next 2 years, its relatively lower. D/E ratios of 2.2x is relatively high. This leaves earnings stressed at times of a muted topline growth (2014-15 is a good example), leading to low interest coverage ratios at times. Kayan continues a decent capex run rate of 7% except in 2015 and 1Q2016 due to shutdown.

Exhibit 17: Gross Profit (SAR mln) and Margin Forecasts Exhibit 18: EBITDA (SAR mln) and Margin Forecasts

Source: Riyad Capital, Company Reports Source: Riyad Capital, Company Reports

97

6

-20

9

56

9

58

2

65

1 81

9

-4%

-2%

0%

2%

4%

6%

8%

10%

201

4

201

5

201

6E

201

7E

201

8E

201

9E

Gross Profit Gross Margins

2,9

50

1,8

84 2,5

69

2,4

21

2,2

71

2,2

40

15%

20%

25%

30%

35%

201

4

201

5

201

6E

201

7E

201

8E

201

9E

EBITDA EBITDA Margins

Exhibit 19: Net Profit (Loss) Forecasts (SAR mln) Exhibit 20: Total Debt (SAR mln) and Net Debt to EBITDA

Source: Riyad Capital, Company Reports Source: Riyad Capital, Company Reports

(45

)

(1,2

43

)

(23

3)

(17

7)

(14

0)

(6)

201

4

201

5

201

6E

201

7E

201

8E

201

9E

29

,10

5

26

,98

4

24

,83

0

22

,58

0

20

,08

0

17

,58

0

6

7

8

9

10

11

12

13

14

201

4

201

5

201

6E

201

7E

201

8E

201

9E

Total Debt Net Debt to EBITDA

Page 9: 2016 SAUDI KAYAN COMPANY (KAYAN SAR 6 · 2016 Santhosh Balakrishnan Riyad Capital is licensed by the Saudi ArabiaYasser Bin Ahmed santhosh.balakrishnan@riyadcapital.com Capital Market

Page 9 of 15

SAUDI KAYAN COMPANY Update Report

2Q2016 Review

Record-breaking performance Revenue of SAR 2.2 billion in 2Q2016 has beaten our expectations of SAR 1.65 billion, increased by +27% Q/Q and flat Y/Y mainly on higher product prices. Operational costs declined as growth in feedstock costs were lower causing costs to shrink and margins to expand. The major feedstock prices increased barely in the global markets. Gross profit of SAR 398 million during 2Q2016 increased by +413% Q/Q and +54% Y/Y. Gross margins recorded the highest ever in its operational history with 19% in 2Q2016 from 5% in 1Q2016 and improved from 12% in 2Q2015. Operating margins recorded the highest with 14%, the last best was 8% in 3Q2015. Operating income of SAR 291 million almost doubled from SAR 150 million, a year ago before reverting to green, but reported a loss in 1Q2016 to SAR (24) million. Net income of SAR 91 million came after continuous quarterly losses over the last six quarters and beat our estimates of SAR (281) million loss for 2Q2016. Net margins stood at 4%, the highest.

Kayan started seeing positive surprises after an era of misses Kayan’s earnings have mostly been a mixed bag since 2015 with consensus rarely meeting actuals, posting negative surprises. However, it consistently delivered positive surprises from the start of 2016 and the trend is clearly visible in exhibit 22. We believe most analysts have been pessimistic due to one-sided negative directions in earnings.

Table 2: Quarterly Income Statement Summary (SAR mln)

3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16

Revenue 3,052 2,933 2,909 2,965 3,235 2,526 1,753 2,149 2,195 1,879 1,693 2,155

Gross Profit 305 259 257 124 318 268 -368 258 269 -368 78 398

EBITDA 788 749 771 618 812 731 208 770 776 130 480 574

EBIT 198 155 158 5 207 145 -443 150 175 -476 (24) 291

Net Income 43 3 10 (133) 67 12 (592) (13) (14) (624) (216) 91

EPS (SAR) 0.10 0.01 0.02 (0.30) 0.15 0.03 (1.31) (0.03) (0.03) (1.39) (0.48) 0.20

Gross Margins 10.0% 8.8% 8.8% 4.2% 9.8% 10.6% -21.0% 12.0% 12.3% -19.6% 4.6% 18.5%

EBITDA Margins 25.8% 25.5% 26.5% 20.8% 25.1% 28.9% 11.9% 35.8% 35.4% 6.9% 28.4% 26.6%

EBIT Margins 6.5% 5.3% 5.4% 0.2% 6.4% 5.7% -25.3% 7.0% 8.0% -25.3% -1.4% 13.5%

Net Margins 1.4% 0.1% 0.3% -4.5% 2.1% 0.5% -33.8% -0.6% -0.6% -33.2% -12.8% 4.2%

Source: Company Reports

Exhibit 21: Revenue Surprises (SAR mln -Est vs Act) Exhibit 22: Earnings Surprises (SAR mln -Est vs Act)

Source: Company Reports, Bloomberg Source: Company Reports, Bloomberg

-247

-660

0

-221

620

-403

-353

667

-646

66

63 1

70

-127

-6

-449

205

-174 -4

7

505

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-730

-236

-429

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-155

-5

-133

18

-162

-111

-174

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-40

-311

-36

-59

-643

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2Q

16

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SAUDI KAYAN COMPANY Update Report

Valuation

Revised Target price to SAR 6.25 using EV/EBITDA We update our models and value Kayan using relative valuation methods. We believe its apt, as Kayan continues to deliver negative operating cashflows due to shutdowns amid inconsistent utilization rates. With expectations of losses over next 3-years, we ignore DCF approach and rely on a target EV/EBITDA multiple. In this scenario, we believe 12.0x EV/EBITDA multiple metric is the most appropriate in valuing Kayan, which is an average for last 2 years. The target EV/EBITDA multiple method derived a fair value of SAR 6.25 which is higher from SAR 6.00 earlier. A marginal increase in target prices is justified due to upgraded estimates and as we move from DCF approach to EV/EBITDA method.

Risks to valuation Any fall in product prices could lead to a tricky situation in maintaining margins though cost advantage over feedstock is till 1H2017. The potential slowdown in demand from Asian markets could prove to a dampener for growth as Kayan exports nearly half of its product to Asia. We also caution against any impact of technical outage, which can result in plant shutdown affecting operating rates and affect topline. Additionally any increase in fuel prices could have a downside on estimates.

Table 3: Price Sensit ivity and Target EV /EBITDA V aluation using Bear-Base-Bull Case EBITDA Estimates

E

V/E

BIT

DA

Ran

ge (

x)

EV/EBITDA 2015A

Actuals Base Base Base BaseEBITDA

(SAR mln) 1,884 2,106 2,569 2,877 2,155 2,421 2,736 2,044 2,271 2,589 1,993 2,240 2,576

11.0x -0.75 0.88 4.27 6.53 1.24 3.19 5.50 0.42 2.09 4.42 0.42 2.09 4.42

12.2x 0.70 2.51 6.25 8.75 2.90 5.06 7.61 2.00 3.84 6.42 2.00 3.84 6.42

13.0x 1.76 3.69 7.69 10.37 4.11 6.42 9.14 3.15 5.12 7.87 3.15 5.12 7.87

14.0x 3.02 5.09 9.41 12.28 5.54 8.03 10.97 4.51 6.63 9.60 4.51 6.63 9.60

15.0x 4.27 6.50 11.12 14.20 6.98 9.64 12.79 5.87 8.14 11.32 5.87 8.14 11.32

16.0x 5.53 7.90 12.83 16.12 8.42 11.26 14.62 7.24 9.66 13.05 7.24 9.66 13.05

17.0x 6.79 9.30 14.54 18.04 9.85 12.87 16.44 8.60 11.17 14.78 8.60 11.17 14.78

18.0x 8.04 10.71 16.26 19.96 11.29 14.49 18.26 9.96 12.69 16.50 9.96 12.69 16.50

19.0x 9.30 12.11 17.97 21.87 12.73 16.10 20.09 11.32 14.20 18.23 11.32 14.20 18.23

20.0x 10.55 13.52 19.68 23.79 14.16 17.71 21.91 12.69 15.71 19.95 12.69 15.71 19.95

21.0x 11.81 14.92 21.39 25.71 15.60 19.33 23.73 14.05 17.23 21.68 14.05 17.23 21.68

2016E 2017E 2018E 2019E

EBITDA Estimates (SAR mln) 2,569 2,421 2,271 2,240

EV/EBITDA based valuation (SAR)

Valuation at last 3 year average of 12.8x 7.35 6.09 4.81 4.55

Based on KSA sector 2016E median EV/EBITDA of 10.3x 2.56 1.57 0.57 0.36

Estimated valuation at EV/EBITDA of 12.0x 6.25 5.06 3.84 3.59

Source: Company Reports, Riyad Capital

E

V/E

BIT

DA

(x)

Ran

ge

Valuation based on EV/EBITDA

Bull

2016E 2017E 2018E 2019E

Bear Bull Bear Bull Bear Bull Bear

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SAUDI KAYAN COMPANY Update Report

Valuations expensive, stock rally overdone On a TTM basis, Kayan trades at a premium to sector, hence unconvincing on the valuations front. Valuation appears to be full and does not command large consideration with its EV/EBITDA of 13.6x higher to sectors 10.5x. Stock prices have rallied by +35% (TASI: +1% and Sector: +15%) over last 6 months following strong 2Q2016 earnings. Additionally, the recent rally of +28% since 1Q2016 versus TASI’s +4% and sectors +9% leaves little scope for conviction. We believe rally is overdone.

Band chart suggests Kayan is trading at a bear cycle A 12-month forward rolling band chart suggest Kayan EV/EBITDA average is nearly 14.0x, while historically (2012-14) it always traded above 18.0x which we believe is when markets at a bull cycle and when oil prices averaged $100/bbl.

Table 4: KSA Petrochemicals Sector Valuation (TTM basis)

Company Name

Price

(SAR)

Mcap

SAR mln

EV

SAR mln P/E P/B P/S

EV/

Sales

EV/

EBITDA

Div.Yld

(%) YTD

52 Wk-

Hi (SAR)

52 Wk-

Lo (SAR)

Saudi Basic Industries Corp 82.00 246,000 299,966 14.6x 1.5x 1.8x 2.2x 6.9x 4.9 7% 92.75 59.50

Saudi Arabian Fertilizer Co 68.75 28,646 27,370 18.7x 4.5x 9.2x 7.6x 12.7x 4.4 (16%) 98.25 58.00

National Industrialization Co 13.00 8,696 36,074 NA 1.1x 0.6x 2.5x 15.9x NA 23% 14.65 7.50

National Petrochemical Co 14.60 7,008 18,890 8.5x 1.1x 1.0x 2.9x 8.1x NA (13%) 23.90 10.60

Saudi Industrial Investment Group 12.50 5,625 20,388 10.0x 0.8x 0.8x 3.0x 8.4x NA (9%) 20.00 9.80

Sahara Petrochemical Co 10.30 4,520 5,496 19.3x 0.8x 2.5x 3.1x 10.1x 4.9 1% 13.30 7.40

Yanbu National Petrochemical Co 43.70 24,581 25,342 13.7x 1.6x 3.5x 3.5x 7.6x 6.9 35% 52.00 23.80

Saudi International Petrochemical Co13.60 4,987 13,119 28.3x 0.9x 1.4x 3.7x 10.9x NA (3%) 23.50 9.75

Advanced Petrochemical Co 38.60 7,596 7,594 10.7x 2.9x 3.4x 3.5x 8.3x 6.5 23% 44.17 26.58

Saudi Kayan Petrochemical Co 6.07 9,105 31,209 NA 0.7x 1.2x 4.0x 13.6x NA (8%) 10.30 4.40

Rabigh Refining & Petrochemical Co 10.15 8,891 46,668 NA 1.1x 0.4x 2.3x 54.5x NA (17%) 18.15 7.00

Alujain Corp 13.30 920 2,404 8.1x 0.9x NA NA NA NA (8%) 19.50 9.50

Nama Chemicals Co 5.40 694 1,462 NA 0.7x 1.6x 3.6x NA NA (24%) 9.90 4.95

Methanol Chemicals Co 6.15 742 1,594 NA 0.5x 1.1x 2.6x 24.9x NA (14%) 10.25 4.95-

Sector Median* 358,011 537,576 13.7x 1.0x 1.4x 3.1x 10.5x 4.9

Source: Bloomberg

*Market Cap and EV are total

Exhibit 23: 12-Month Rollng EV/EBITDA band Chart

Source: Bloomberg, Riyad Capital

20

30

40

50

60

70

80

Sep-1

1

Dec-1

1

Ma

r-1

2

Jun-1

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Sep-1

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EV (SAR Bln) EV @ 14.0x EBITDA EV @ 18.0x EBITDA EV @ 20.0x EBITDA EV @ 22.0x EBITDA EV @ 24.0x EBITDA EV @ 28.0x EBITDA

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SAUDI KAYAN COMPANY Update Report

Appendix

Exhibit 24: 3 Year Price Multiples Trading History

Source: Bloomberg

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

Jan-1

3

May-

13

Sep-1

3

Jan-1

4

May-

14

Sep-1

4

Jan-1

5

May-

15

Sep-1

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Jan-1

6

May-

16

P/B Ratio

P/B 3 Yr Avg 12M Avg

0.5

1.0

1.5

2.0

2.5

Jan-1

3

May-

13

Sep-1

3

Jan-1

4

May-

14

Sep-1

4

Jan-1

5

May-

15

Sep-1

5

Jan-1

6

May-

16

P/S Ratio

P/S 3 Yr Avg 12M Avg

10.0

12.0

14.0

16.0

18.0

20.0

22.0

24.0

26.0

28.0

30.0

Jan-1

3

May-

13

Sep-1

3

Jan-1

4

May-

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Sep-1

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Jan-1

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May-

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Sep-1

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6

May-

16

EV/EBITDA Ratio

EV/EBITDA 3 Yr Avg 12-M Avg

3.5

3.7

3.9

4.1

4.3

4.5

4.7

4.9

5.1

5.3

5.5

Jan-1

3

May-

13

Sep-1

3

Jan-1

4

May-

14

Sep-1

4

Jan-1

5

May-

15

Sep-1

5

Jan-1

6

May-

16

EV/Sales Ratio

EV/Sales 3 Yr Avg 12M Avg

0

200

400

600

800

1,000

1,200

1,400

1,600

Jan-1

3

May-

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Sep-1

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4

Jan-1

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16

Value Traded (SAR Mln)

Turnover (SAR Mln)

0

20

40

60

80

100

120

Jan-1

3

May-

13

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Jan-1

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15

Sep-1

5

Jan-1

6

May-

16

Volume Traded ( Mln Shares)

Volume (Mln Shares)

Exhibit 25: KSA Petrochemicals Sector Valuation-Consensus EPS Growth Vs P/E

Source: Bloomberg

SABIC

SAFCO

Petrochem

SIIG

YANSAB

Sipchem

Adv anced

Saudi Kay an

Sahara

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

5.0 7.0 9.0 11.0 13.0 15.0 17.0 19.0 21.0 23.0 25.0

2016-1

8 E

EPS

gro

wth

2017E P/E

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SAUDI KAYAN COMPANY Update Report

Summary Financials and Ratio’s

Table 5: Saudi Kayan Financial Forecasts

2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E

Income Statement (SAR mln)

Total Sales 2,403 9,482 10,353 11,636 7,976 7,581 8,320 9,299 10,237

Cost of Sales (2,371) (9,331) (9,750) (10,660) (8,185) (7,013) (7,738) (8,649) (9,418)

Gross Profit 32 152 602 976 (209) 569 582 651 819

S,G&A Expenses (89) (330) (367) (453) (384) (230) (168) (186) (205)

EBIT (56) (179) 235 523 (594) 339 414 465 614

Financial Charges (113) (524) (483) (523) (574) (585) (603) (615) (627)

Others (6) 2 (9) 32 7 7 7 7 6

Income before Zakat (176) (701) (256) 32 (1,160) (239) (182) (143) (6)

Zakat Adjustments (74) (72) (90) (77) (83) 6 5 4 0

Net Income (250) (772) (346) (45) (1,243) (233) (177) (140) (6)

EPS (0.17) (0.51) (0.23) (0.03) (0.83) (0.16) (0.12) (0.09) (0.00)

DPS - - - - - - - - -

EBITDA 400 1,818 2,527 2,950 1,884 2,569 2,421 2,271 2,240

Balance Sheet (SAR mln)

Assets

Cash & Equivalents 469 569 269 1,654 1,720 1,643 1,573 1,002 854

Inventories 1,545 1,960 2,176 2,332 1,680 1,683 1,857 1,730 1,884

Receivables 2,625 3,134 3,199 2,730 2,061 2,502 2,829 2,790 2,457

Others 362 501 735 641 564 379 416 465 512

Total Current Assets 5,001 6,165 6,380 7,358 6,025 6,207 6,674 5,987 5,706

Property Plant & Equipment 41,522 40,271 38,910 37,251 35,553 33,059 30,309 28,529 26,648

Others 165 463 928 611 676 557 581 607 634

Total non-Current Assets 41,688 40,733 39,838 37,862 36,230 33,616 30,891 29,136 27,282

Total Assets 46,689 46,898 46,218 45,220 42,254 39,822 37,565 35,123 32,988

Liabilities & Equity

Short Term Debt 530 1,166 1,737 2,123 2,153 2,250 2,500 2,500 2,200

Other Current Liabilities 1,847 2,641 2,537 1,736 2,093 2,029 2,179 2,356 2,706

Total Current Liabilities 2,377 3,806 4,274 3,859 4,246 4,279 4,679 4,856 4,906

Long Term Debt 28,981 28,515 27,615 26,982 24,830 22,580 20,080 17,580 15,380

Others 119 137 235 330 372 391 410 431 452

Total non-Current Liab 29,100 28,652 27,850 27,312 25,202 22,971 20,490 18,011 15,832

Total Liabilities 31,477 32,458 32,124 31,171 29,448 27,250 25,169 22,867 20,738

Retained Earnings 163 (609) (956) (1,000) (2,243) (2,477) (2,654) (2,793) (2,800)

Total Equity 15,212 14,440 14,094 14,049 12,806 12,573 12,396 12,256 12,250

Total Liab & Equity 46,689 46,898 46,218 45,220 42,254 39,822 37,565 35,123 32,988

Cash Flows (SAR mln)

CFO (862) 1,149 1,404 2,160 2,294 2,223 2,007 2,536 2,689

CFI (3,057) (1,219) (1,376) (770) (614) (550) (578) (606) (637)

CFF 3,421 170 (328) (5) (2,121) (1,750) (1,500) (2,500) (2,200)

Source: Company Reports, Riyad Capital

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SAUDI KAYAN COMPANY Update Report

Table 6: Saudi Kayan Valuation and Ratios

2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E

Valuations

P/E NM NM NM NM NM NM NM NM NM

P/B 0.7x 0.7x 0.7x 0.7x 0.8x 0.8x 0.8x 0.8x 0.8x

P/S 4.1x 1.0x 1.0x 0.9x 1.2x 1.3x 1.2x 1.1x 1.0x

P/CF -11.5x 8.6x 7.1x 4.6x 4.3x 4.5x 4.9x 3.9x 3.7x

EV/Sales 13.3x 3.4x 3.1x 2.8x 4.0x 4.2x 3.8x 3.4x 3.1x

EV/EBITDA NM NM 12.7x 10.8x NM 12.5x 13.2x 14.1x 14.3x

EV/EBIT NM NM 135.9x 61.2x NM 94.4x 77.2x 68.8x 52.1x

Dividend Yield NM NM NM NM NM NM NM NM NM

Growth (YoY)

Total Sales - 295% 9% 12% -31% -5% 10% 12% 10%

Gross Profit - 367% NM 62% NM NM 2% 12% 26%

EBITDA - 193% NM 99% NM NM 16% 12% 30%

Net Income 209% NM NM NM NM -24% -21% -96%

Margins

Total Gross NM 2% 6% 8% NM 8% 7% 7% 8%

Total EBITDA NM NM 3% 5% NM 5% 5% 5% 6%

Total Net Margins NM NM NM NM NM NM NM NM NM

Key Ratio's

Cash Ratio 0.20 0.15 0.06 0.43 0.40 0.38 0.34 0.21 0.17

Current Ratio 2.10 1.62 1.49 1.91 1.42 1.45 1.43 1.23 1.16

Inventory Turnover 1.53 4.76 4.48 4.57 4.87 4.17 4.17 5.00 5.00

Interest Cover -50% -34% 49% 100% -103% 58% 69% 76% 98%

Debt to EBITDA (753.9) (252.9) 89.4 45.3 (50.1) 61.0 47.1 37.2 25.6

Debt to Assets 62% 61% 60% 61% 61% 59% 56% 53% 51%

Debt to Equity 191% 197% 196% 198% 202% 187% 170% 153% 137%

ROA 0% 1% 1% -2% 1% 1% 2% 2% 0%

ROE -2% -5% -2% 0% -10% -2% -1% -1% 0%

ROIC 0% 0% 1% 1% -2% 1% 1% 2% 2%

Cashflow /EBITDA -216% 63% 56% 73% 122% 87% 83% 112% 120%

Capex/Sales 127% 13% 7% 5% 6% 7% 7% 7% 6%

Capex/Depreciation 669% 61% 32% 22% 21% 25% 29% 34% 39%

Per Share Ratio's

EPS (0.17) (0.51) (0.23) (0.03) (0.83) (0.16) (0.12) (0.09) (0.00)

BVPS 10.14 9.63 9.40 9.37 8.54 8.38 8.26 8.17 8.17

DPS - - - - - - - - -

Sales/Share 1.60 6.32 6.90 7.76 5.32 5.05 5.55 6.20 6.82

FCF I/Share (0.57) 0.77 0.94 1.44 1.53 1.48 1.34 1.69 1.79

FCF II/Share (2.04) (0.81) (0.92) (0.51) (0.41) (0.37) (0.39) (0.40) (0.42)

FCF III/Share 2.28 0.11 (0.22) (0.00) (1.41) (1.17) (1.00) (1.67) (1.47)

Source: Company Reports, Riyad Capital

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SAUDI KAYAN COMPANY Update Report

Stock Rating

Buy Neutral Sell Not Rated

Expected Total Return

Greater than 15%

Expected Total Return

between -15% and +15%

Expected Total Return less

than -15% Under Review/ Restricted

* The expected percentage returns are indicative, stock recommendations also incorporate relevant qualitative factors

For any feedback on our reports, please contact [email protected]

Disclaimer

The information in this report was compiled in good faith from various public sources believed to be reliable. Whilst all

reasonable care has been taken to ensure that the facts stated in this report are accurate and that the forecasts, opinions and

expectations contained herein are fair and reasonable. Riyad Capital makes no representations or warranties whatsoever as to

the accuracy of the data and information provided and, in particular, Riyad Capital does not represent that the information in this

report is complete or free from any error. This report is not, and is not to be construed as, an offer to sell or solicitation of an

offer to buy any financial securities. Accordingly, no reliance should be placed on the accuracy, fairness or completeness of the

information contained in this report. Riyad Capital accepts no liability whatsoever for any loss arising from any use of this report

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responsible for the contents hereof. Riyad Capital or its employees or any of its affiliates or clients may have a financial interest

in securities or other assets referred to in this report.

Opinions, forecasts or projections contained in this report represent Riyad Capital's current opinions or judgment as at the date

of this report only and are therefore subject to change without notice. There can be no assurance that future results or events

will be consistent with any such opinions, forecasts or projections which represent only one possible outcome. Further, such

opinions, forecasts or projections are subject to certain risks, uncertainties and assumptions that have not been verified and

future actual results or events could differ materially.

The value of, or income from, any investments referred to in this report may fluctuate and/or be affected by changes. Past

performance is not necessarily an indicative of future performance. Accordingly, investors may receive back less than originally

invested amount.

This report provides information of a general nature and does not address the circumstances, objectives, and risk tolerance of

any particular investor. Therefore, it is not intended to provide personal investment advice and does not take into account the

reader’s financial situation or any specific investment objectives or particular needs which the reader may have. Before making

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Riyad Capital is a Saudi limited liability company, with commercial registration number (1010239234), licensed and organized by the Capital Market

Authority under License No. (07070-37), and having its registered office at Al Takhassusi Street, Prestige Building, Riyadh, Kingdom of Saudi Arabia

(“KSA”). Website: www.riyadcapital.com


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