IPO Note Muscat City Desalination Company (SAOG) to 7% per year. The Companies in the water...

Al Maha Research

Al Maha Financial Services LLC www.almahafinancial.com

IPO Note – Muscat City Desalination Company (SAOG) (Under transformation)

6 December 2017

Al Maha Research

Al Maha Financial Services LLC www.almahafinancial.com Page 2 of 17

IPO Note – Muscat City Desalination Company (SAOG)

06 December 2017

Offer Summary

Fair Price RO 0.156

Upside Potential 35%

Recommendation Subscribe

Muscat City Desalination Company S.A.O.G. (under transformation)

Offer price RO 0.116 per share (comprising a nominal value of Bzs 100,

a premium of Bzs 14 and offer expenses of Bzs 2 per Share)

Face value RO 0.100

Offer size RO 6.3 million

Shares offered 54,442,640 Shares (35 per cent of the Paid-Up Share Capital)

Authorized share capital RO 25 million

Paid-up share capital RO 15.5 million

Minimum limit for the subscription Category I Investors : 1000 Shares and in multiples of 100 shares thereafter

by each applicant Category II Investors: 500,100 Shares and in multiples of 100 shares thereafter

Maximum limit for the subscription Category I Investors: 500,000 Shares

by each applicant Category II Investors: 5,444,200 Shares, representing apx.10 percent of the total offer

In case of over-subscription of the Offer, the allotment of the offer will be made as follows:

Category I : 65 percent of the Offer i.e.35,387,716 Shares, on a pro-rata basis.

Category II : 35 percent of the Offer i.e. 19,054,924 Shares, on a pro-rata basis.

Offer period 19 November 2017 to 18 December 2017

Approval of the CMA with regard to the proposed allotment December 31, 2017

Completion of the allotment and commencement of refund January 1, 2018

Listing of the Offer Shares with MSM January 2, 2018

Allotment Categories

Al Maha Research



06 December 2017

Investment Rationale

Growing Potable water demand in the Sultanate, favorable for MCDC

The Muscat City Desalination Company’s (MCDC) core business activity is to develop, own and operate the Al Ghubrah Independent Water

Plant. The desalination plant, located in the Interconnected Zone has a contracted capacity of 191,000 m3/d and it supplies approximately

60% of Muscat’s water capacity. Of the five water systems in the Sultanate, the Interconnected Zone is the largest, catering more than 80% of

the country’s potable water requirement. As per projections by the Oman Power and Water Procurement Company SAOC (OPWP), water

demand of the Interconnected Zone is expected to grow from 746,000 m3/d in 2016 to over 1 million m3/d in 2023, increasing at the rate of

5% to 7% per year. The Companies in the water desalination space including MCDC are expected to benefit from the favorable demand side.

Stable business model supported by a long-term contractual framework

The water desalination and power generation companies in Oman have a defensive and stable business model based on long-term agreements

with government entities such as Oman Power & Water Procurement Company (OPWP) which is the single buyer of power and water which

are distributed by the Public Authority for Electricity and Water (PAEW). The MCDC has contracted revenues with the OPWP for a period of

20 years until 2034 based on availability of the plant irrespective of water demand as per the Water Purchase Agreement (WPA). Thus its

revenues are secured comprising of a water capacity charge and water output operation and maintenance charge which are designed to cover

the investment by the Company such as debt service, return on capital, tax payments, fixed costs to operate and maintain the plant as well as

variable operation and maintenance costs to produce the water output delivered. Power supply required by the plant is ensured by long term

electricity transmission and electricity supply agreement with the Muscat Electricity Distribution Company (MEDC) and the Oman Electricity

Transmission Company (OETC) that is back-to-back with the OPWP off-take agreement. Operation and maintenance costs are contracted and

fixed over the life of the WPA as well as long term financing agreements with hedging strategy are in place to mitigate interest rate risk. Thus

the stable business model which is not susceptible to business cycles is expected to help the Company to generate steady revenue and

profitability until the expiration of the 20 year WPA with the government.

Al Maha Research



06 December 2017

Predictable cash flows and steady profitability

The defensive nature of the business model allows MCDC to maintain its steady profitability along with consistent and healthy operating cash

flows. Operating profit of the Company is expected to be stable and resilient to change in electricity charges and market dynamics. The

Company projects an average EBITDA margin of 45% for the five years from 2017 to 2022 and expects to maintain an average net profit

margin at 10% and Return on adjusted Equity1 of 10% on an average during the same period.

Source: Company Projections

Owing to the changes in the income tax law in the beginning of the year, MCDC provides for deferred tax relating to origination and reversal

of temporary differences, leading to a one-off taxation charge of RO 0.9 million relating to the prior year in 2017 and additional charges of

RO 0.8 million on an average for 2017 and 2018 accounted for in the respective years and the Company’s management does not foresee any

further one-off charges or expenses related to the same during the forecast period.

1 Equity has been adjusted to exclude fair value changes of derivative instruments

7.8 8.07.7 7.7 7.8 7.8

3.5 3.3 3.2 3.1 2.9 2.8

1.82.2 2.0 2.1 2.3 2.5

0

1

2

3

4

5

6

7

8

9

2017E 2018E 2019E 2020E 2021E 2022E

RO

Mil

lio

ns

EBITDA, Finance costs and Profit Before Tax

EBITDA Finance cost Profit before tax

48% 47%44% 43% 43% 43%

7%10% 10% 11% 9%

0%

10%

20%

30%

40%

50%

60%

2017E 2018E 2019E 2020E 2021E 2022E

Profitability Margins

EBITDA Margin Net Margin

Al Maha Research



06 December 2017

Cash flows to show substantial growth, post the WPA Period

Project finance and shareholders’ loans of MCDC which amounts to RO 79 million as of July 2017, are co-terminus with the WPA agreement

and as the debt levels and finance costs reduce steadily over the term, profitability is expected to grow consistently. Useful plant life of the

Company is up to 40 years and cash flows are expected to increase substantially post the WPA period as the entire debt will be repaid by

2034.

Attractive Dividend yield, dividend payments to remain consistent

MCDC offers an attractive yield of 8% for the year 2018 at the offer price and going forward the Company projects attractive dividend payout

of above 75% translating to average dividend yield of 8.2% based on the projected dividends for the next five years.

2018 2019 2020 2021 2022

Earnings per share (RO) 0.008 0.011 0.011 0.013 0.011

Dividend per Share (RO) 0.0093 0.0094 0.0094 0.0096 0.0096

Dividend Pay Out 122% 86% 84% 75% 90%

Div Yield at Offer Price 8.0% 8.1% 8.1% 8.3% 8.3%

No mandatory cash sweep mechanism, limiting dividends:

Unlike many of the listed power and water companies in Oman, the financing arrangements of MCDC do not impose any mandatory cash

sweep mechanism in respect of the Company’s accounts. Hence Company’s ability to pay dividends is not expected to be constrained as if a

cash sweep was imposed. Also the company has no litigations or arbitrations pending at present, which could impact the future dividend

payments.

Though the payout is expected to be lower beyond 2022 as per the Company, the dividend yield of 6.6% at the offer price based on the

projected dividends during the same period still stays above that of the peer companies in the Power and Water space.

Al Maha Research



06 December 2017

Convincing track record of compelling listing gains and capital appreciation for Power and Water Companies

Power and Water companies in the local market are known for offering attractive listing gains in their Initial Public Offerings (IPO). Apart

from the listing gains, these companies have also demonstrate a proven track record of value creation, offering returns in the form of capital

appreciation to investors over a period of time.

Initial Public Offerings of power and Water companies in MSM: since 2011:

Company Listing

Year

Issue size

(RO Mn)

Over

subscription

(times)

Issue

price

(RO)

Listing

price

(RO)

Listing

Gains

Highest

price

since

listing

(RO)

Capital

appreciation

at highest

price

Current

price (RO)

Capital

appreciation

based on

current price

SMN Power 2011 24.59 1.7 0.352 0.362 3% 0.760 116% 0.692 97%

Sharqiyah Desalination 2013 2.28 13.1 1.063 3.127 194% 5.700 436% 3.960 273%

Sembcorp Salalah* 2013 53.12 8.3 0.159 0.200 26% 0.274 72% 0.225 42%

Al Suwadi Power 2014 32.5 10.5 0.130 0.157 21% 0.230 77% 0.141 8%

Al Batinah Power 2014 30.24 10.8 0.128 0.157 23% 0.230 80% 0.140 9%

Phoenix Power 2015 56.3 17.8 0.110 0.154 40% 0.162 47% 0.135 23%

Note: Prices of SMN Power and Semcorp Salalah are adjusted for share split

Face value of Sharqiyah Desalination is RO 1 per share.

It is pertinent to note that Power and Water Companies, unlike most of the companies of other sectors which came out with IPO during the

same period, offered substantial upside at the current prices levels from their issue prices apart from the listing gains, irrespective of volatility

in the broader market moves. Track record of successful listing of the Power and Water Companies is likely to draw and encourage investor

participation in the upcoming IPO for listing gains as well as for long term returns.

Al Maha Research



06 December 2017

Key Concerns

Uncertainty relating to material adverse changes

Under the WPA, in the case of a buyer risk event due to change in the law, the material adverse changes owing to an increase in the Company’s costs

and expenses in excess of RO 250,000 are to be compensated to the company by OPWP through a mutually agreeable mechanism, resulting in a pass

through effect for MCDC. Due to changes in the tax law in 2017, which include introduction of withholding tax for foreign nationals, the Company

finds a cumulative material adverse change in excess of RO 250,000 and it has notified the same to OPWP for a mutually agreeable position. In case,

the Company and OPWP are unable to agree upon the occurrence of the material adverse change, within the timeline provided in of the WPA, then

either party shall be entitled to refer the matters in dispute to an expert for determination as provided under the terms of the WPA.

Also there remains uncertainty on whether payment obligations under hedging agreements, entered into by companies in Oman, will fall under the

category of payments of interest or as payment for services within the meaning of Article 52 of the Tax Law. If payment obligations under hedging

agreements entered into by the Company are considered to be subject to withholding tax under Article 52 of the Tax Law by the local tax authorities,

then this may result in an increase in the tax related costs for the Company.

Any negative outcome of buyer risk event due to change in Tax Law for the Company could have a material adverse effect on its financial condition

including the capacity of the Company to pay dividends.

High leverage and debt covenants for dividend payments

The business being highly capital intensive in nature, MCDC has a high leverage and the Company’s total borrowings constitute 83% of its total

capital as of July 2017. Although the leverage is expected to gradually decline going forward and the debt is expected to be repaid entirely by the end

of WPA period, the Company is bound to maintain a Debt Service Coverage Ratio (DSCR) covenant of 1.10 and above for paying dividends,

provided that the projected DSCR is forecasted to be above 1.20 for each of the next four quarters. Due to the debt prepayment of OMR 6.5 million

made in July 2017 the Coverage Ratio has moved beyond the threshold level for distribution of dividends. However, the Company has received

waivers from its lenders with regards to DSCR covenant technical breaches in the past and does not anticipate any further breaches going forward

due to the prepayment made in July 2017, based on which the forecasted DSCR is 1.2 and above.

Al Maha Research



06 December 2017

Valuation

Our hybrid valuation matrix includes the Dividend Discount Model, Comparable Dividend yield Model and Relative Valuation using Price to Book

Value and Price to Earnings multiples to arrive at the fair value for the stock offering of Muscat City Desalination Company.

Dividend Discount Model (DDM)

We find dividend policy of MCDC attractive owing to its regular dividend payments supported by stable cash flows; the payout of the Company

during the forecasted period too remains higher as compared to the peers in the local market. In addition to the financial projections by the Company,

we have used the following base data and assumptions for our DDM valuation.

Dividend Discount Model (DDM)

31-Dec-18 31-Dec-19 31-Dec-20 31-Dec-21 31-Dec-22

Dividend 0.0093 0.0094 0.0094 0.0096 0.0096

Discount Factor 0.921 0.852 0.789 0.730 0.676

Discounted Cash Flows 0.009 0.008 0.007 0.007 0.006

Primary Value 0.037

Terminal Value 0.162

Discounted Terminal Value 0.110

Equity Value per Share 0.147

(Figures in RO)

Base Data and Assumptions

Beta 0.51

Risk Free Rate 5.50%

Risk Premium 5.00%

Cost of Equity 8.03%

Terminal Growth 2.0%

Al Maha Research



06 December 2017

Comparable Dividend yield Model

To arrive at the fair value of MCDC using the Comparable Dividend yield Model, we have considered a benchmark dividend yield of 6%, which is in

line with the cash dividend yields offered by the latest listed companies in the Power and Water space which are liquid in the market, and the average

annual dividend projected by the Company for the next three years. Expected Dividends

Dividend month

Dividend

per share

(Bz)

Feb-18 3.2

Nov-18 6.1

May-19 4.7

Nov-19 4.7

May-20 4.7

Nov-20 4.7

May-21 4.8

Nov-21 4.8

May-22 4.8

Nov-22 4.8 Source: Company IPO Prospectus

Comparable Dividend yield Model

Average Annual Dividend of next 3 years 0.0094

Benchmark Dividend Yield

6%

Fair value 0.156

(Figures in RO)

Al Maha Research



06 December 2017

Relative Valuation

The power and water companies listed on Muscat Securities Market are considered as comparable companies for relative valuation as they operate in

a similar business environment with long term exclusive contractual framework and have steady financial performance.

Comparable Financials

Peer Companies P(W)PA

Expiry

Share

Price

Market

Cap.

Div.

Yield* PE* PBV

ACWA Power 2021 0.772 123,520 6.2% 12.93 2.05

Kamil Power 2021 0.312 30,030 3.2% 15.71 1.02

Sohar Power 2022 0.157 34,699 0.0% 19.26 1.16

Sembcorp Salalah 2027 0.225 214,778 4.8% 19.68 1.98

Sharqiyah Desalination 2036 3.960 38,729 0.0% NM 2.17

SMN Power 2022 / 2024 0.692 138,151 4.8% 14.94 3.61

Suwadi Power 2028 0.141 100,731 6.6% 16.32 1.07

Batinah Power 2028 0.140 94,484 6.0% 19.46 1.09

Phoenix Power 2029 0.135 197,451 5.9% 10.28 1.17

Muscat City Desalination* 2034 0.116 18,044 8.0% 15.10 1.18

Peer Average 15.25 1.53

*PE and Dividend Yield based on Trailing Twelve Months,

Equity has been adjusted to exclude fair value changes of derivative instruments for uniformity

NM- Not meaningful

(Figures in RO '000s except per share data)

Al Maha Research



06 December 2017

Comparable Valuation

Price to Book Value

Comparable Price to Book Value 1.53

Book Value per Share (2019E )

0.101

Equity Value Per share 0.154

Price to Earnings Ratio

Comparable Price to Earnings Ratio 15.25

Earnings per Share (2019E )

0.011

Equity Value Per share 0.167

Weighted Average Valuation Matrix

Valuation Metric Weights Fair Value (RO)

Dividend Discount Model 25% 0.147

Average Dividend Yield 25% 0.156

Price to Book Value 25% 0.154

Price to Earnings Ratio 25% 0.167

Weighted Average Fair Value 50% 0.156

Offer Price 0.116

Up side 35%

Based on our weighted average valuation matrix, we have arrived at a fair value of RO 0.156 for the stock, which is being offered at

an attractive discount at the issue price of RO 0.116 per share.

(Figures in RO)

Al Maha Research



06 December 2017

Outlook and Recommendation

We hold a positive view on the equity offer of Muscat City Desalination Company and find an upside potential of 35% for the stock

from the offer price of RO 0.116. Hence, we recommend investors to ‘Subscribe’ to the issue, in view of the stable and defensive

business model of the Company, consistent profitability, attractive dividend yield as well as the capital appreciation potential of the

stock on listing and going forward.

Al Maha Research



06 December 2017

Key Financials

Income Statement

Source: Company IPO Prospectus

2017E 2018E 2019E 2020E 2021E 2022E

Revenue 16,256 17,143 17,428 17,771 18,024 18,335

Operating cost -7,598 -8,277 -8,876 -9,233 -9,331 -9,610

Gross profit 8,658 8,866 8,552 8,538 8,693 8,725

Administrative expenses -831 -838 -863 -889 -916 -927

Depreciation -2,549 -2,549 -2,549 -2,556 -2,549 -2,549

Finance cost -3,486 -3,262 -3,151 -3,059 -2,910 -2,754

EBITDA 7,832 8,037 7,705 7,667 7,799 7,819

Other income 5 9 16 18 22 21

Profit before tax 1,797 2,226 2,005 2,052 2,340 2,516

Taxation -2,150 -1,031 -301 -308 -351 -853

Net profit / (loss) for the year -353 1,195 1,704 1,744 1,989 1,663

(Figures in RO '000s)

Al Maha Research



06 December 2017

Balance Sheet

2016 2017E 2018E 2019E 2020E 2021E 2022E

Assets

Non-current assets

Plant and equipment 97,106 94,564 92,015 89,466 86,910 84,361 81,812

Deferred tax 1,420 579 560 519 499 480 460

Total non-current assets 98,526 95,143 92,575 89,985 87,409 84,841 82,272

Current assets

Trade and other receivables 1,442 1,284 1,297 1,310 1,323 1,336 1,350

Cash and cash equivalents 10,467 1,777 1,946 1,951 1,918 1,953 1,305

Total current assets 11,908 3,061 3,243 3,261 3,241 3,289 2,655

Total assets 110,434 98,204 95,818 93,246 90,650 88,130 84,927

Equity and Liabilities

Share capital 15,555 15,555 15,555 15,555 15,555 15,555 15,555

Total equity 15,257 15,315 15,166 15,656 16,056 16,654 16,932

Non-current liabilities

Non-current portion of term loans 71,969 62,536 59,430 56,243 52,928 49,465 45,835

Non-current portion of fair value of derivative instruments 3,028 2,669 2,548 2,281 2,161 2,036 1,906

Total non-current liabilities 83,079 78,046 75,850 72,697 69,569 66,332 62,696

Current liabilities

Current portion of term loans 3,423 3,024 3,106 3,188 3,314 3,462 3,630

Current portion of fair value of derivative instruments 134 120 114 102 97 91 86

Accruals and other payables 2,739 1,699 1,582 1,603 1,614 1,591 1,583

Total current liabilities 12,099 4,843 4,802 4,893 5,025 5,144 5,299

Total liabilities 95,177 82,889 80,652 77,590 74,594 71,476 67,995

Total equity and liabilities 110,434 98,204 95,818 93,246 90,650 88,130 84,927

(Figures in RO '000s)

Per Share data in RO

Al Maha Research



06 December 2017

Key Ratios

2017E 2018E 2019E 2020E 2021E 2022E

Operating Margin 32.5% 32.0% 29.6% 28.8% 29.1% 28.7%

EBITDA Margin 48.2% 46.9% 44.2% 43.1% 43.3% 42.6%

Net Margin -2.2% 7.0% 9.8% 9.8% 11.0% 9.1%

Earnings per share -0.002 0.008 0.011 0.011 0.013 0.011

Book Value Per Share 0.098 0.097 0.101 0.103 0.107 0.109

Dividend per Share 0 0.0093 0.0094 0.0094 0.0096 0.0096

Dividend Pay Out 0 121% 86% 84% 75% 90%

Dividend Yield 0.0% 8.0% 8.1% 8.1% 8.3% 8.3%

Return on Equity -2.3% 7.9% 10.9% 10.9% 11.9% 9.8%

Return on Assets -0.4% 1.2% 1.8% 1.9% 2.3% 2.0%

Debt to Equity 4.9 4.7 4.4 4.1 3.7 3.4

Current Ratio 0.63 0.68 0.67 0.64 0.64 0.50

Interest Coverage 1.52 1.68 1.64 1.67 1.80 1.91 Source: Company IPO Prospectus, Al Maha Research

Al Maha Research



06 December 2017

Contacts Telephone E-mail

Customer service & Operations:

Zakia Al Ghammari 24827134 [email protected]

Muna Al Hashmi 24827139 [email protected]

Research:

Suresh Kumar 24827137 [email protected]

Khushboo Badlani 24827140 [email protected]

Asset Management:

Syed Zahiruddin 24827135 [email protected]

Shailendra Kumar Singh 24827169 [email protected]

Brokerage:

Mahmoud Al Hamsaidi 24827144 [email protected]

Halima Al Mahrooqi 24827181 [email protected]

Nasser Al Banna 24827177 [email protected]

Al Maha Financial Services LLC PO Box 1065 PC 117, Al Wade Al Kabir, Sultanate of Oman

Tel: 00 968 2482 7171, Fax: 00968 24827121

Al Maha Research



06 December 2017

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and its affiliates including analyst who has issued this report, may, on the date of this report, and from time to time, have long or short positions in, and buy or sell the securities

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