KMEFIC Research l The petrochemical sector in Saudi Arabia ...€¦ · The petrochemical sector in...

Expected rate of return on equity in GCC

KMEFIC Research The petrochemical sector in Saudi Arabia: An understanding of the industry and review of its prospects, including investment opinions on 2 key sector players: SABIC and SAFCO.

July 2009

KMEFIC Research Department م.ك.م.شرآة الكويت والشرق األوسط لإلستثمارالمالي ش

Kuwait and Middle East Financial Investment Company K.S.C.C

INTRODUCTION........................................................................................................................................................ 3

HIGHLIGHTS ............................................................................................................................................................. 4

PETROCHEMICAL INDEX VS. TADAWUL ......................................................................................................... 5

PORTER’S 5 FORCES ON THE PETROCHEMICAL INDUSTRY .................................................................... 6

THREAT OF NEW ENTRANTS ................................................................................................................................... 7 SUPPLIERS POWER .................................................................................................................................................... 7 THREAT OF SUBSTITUTES ....................................................................................................................................... 7 BUYERS POWER ......................................................................................................................................................... 7 BUSINESS RIVALRY .................................................................................................................................................. 7

BASIC PRODUCTION FLOW .................................................................................................................................. 9

PETROCHEMICAL ...................................................................................................................................................... 9 FERTILIZER ................................................................................................................................................................. 9

MACROECONOMIC OVERVIEW ........................................................................................................................ 11

GROSS DOMESTIC PRODUCT & KEY GROWTH INDICATORS ........................................................................ 11 OIL VULNERABILITY .............................................................................................................................................. 13 THE GLOBAL FINANCIAL CRISIS .......................................................................................................................... 13

OIL & GAS OUTLOOK ........................................................................................................................................... 15

MARKET DYNAMICS ............................................................................................................................................... 15 OIL OUTLOOK ........................................................................................................................................................... 16 GAS OUTLOOK .......................................................................................................................................................... 17

FEEDSTOCK COST ADVANTAGE ...................................................................................................................... 18

CAPACITY AND INFRASTRUCTURES............................................................................................................... 19

SAUDI BASIC INDUSTRIES CORPORATION (SABIC) .................................................................................... 21

COMPANY & BUSINESS OVERVIEW .................................................................................................................... 22 FINANCIAL PERFORMANCE & VALUATION ...................................................................................................... 22 PROJECTS, STRATEGY ............................................................................................................................................ 23

SAUDI ARABIAN FERTILIZER COMPANY (SAFCO) ..................................................................................... 24

COMPANY & BUSINESS OVERVIEW .................................................................................................................... 25 FINANCIAL PERFORMANCE & VALUATION ...................................................................................................... 25 PROJECTS, STRATEGY ............................................................................................................................................ 26

APPENDIXES ............................................................................................................................................................ 27

SABIC BALANCE SHEETS ....................................................................................................................................... 27 SABIC INCOME STATEMENTS ............................................................................................................................... 27 SABIC CASH FLOW STATEMENTS ........................................................................................................................ 28 SAFCO BALANCE SHEETS ...................................................................................................................................... 28 SAFCO INCOME STATEMENTS .............................................................................................................................. 29 SAFCO CASH FLOW STATEMENTS ....................................................................................................................... 29

July 2009 KMEFIC Research Equity Analysis Report

The petrochemical sector in Saudi Arabia P a g e | 3

INTRODUCTION As the world tries to anticipate and looks out for potential signs of recovery, attention is unavoidably drawn to basic commodities such as oil and gas whose availability and prices partly shape the world growth. This has become even more relevant to petrochemical companies in the Middle East whose competitive advantage lies in the feedstock of their activities and whose profitability is therefore highly conditioned to oil and gas prices. Among GCC countries, one in particular, thanks to its abundant natural resources, has gained prominence on the global petrochemical scene. In less than a few decades, Saudi Arabia has become the largest producer of petrochemical products in the Middle East, accounting for about 6% of the global ethylene capacity in 2007 or 7 million tonnes, up 600% from 20041. Indeed, the gulf country which possesses around 20% of the world’s proven oil reserves (or 266.7 billion barrels2) and enjoys the fourth largest natural gas reserves in the world (258.4 trillion cubic feet2) in 2008 (year end) has long provided its successful home companies with an undisputable and sustainable strategic competitive advantage. Basic chemical products prices being highly correlated with oil and gas prices, the petrochemical industry in Saudi Arabia has displayed strong growth and high profitability since 2000. But this golden growth unexpectedly stopped in H2 2008 as oil prices fell dramatically from a record USD147 per barrel in July 2009 to about USD40 per barrel at 2008 year end, with most petrochemical prices going down subsequently amid worldwide equities meltdown. Though oil prices recovered higher levels in H1 2009, the global crisis has posed challenging questions regarding the expected growth and profitability of the petrochemical sector. This report provides an overall understanding of the petrochemical industry in Saudi Arabia, addresses some key factors to its prospects and presents valuation of two leading Saudi companies in their industry: Saudi Basic Industries Corporation, SABIC (petrochemicals) and Saudi Arabian Fertilizer Company, SAFCO (fertilizers). 1 Energy International Administration, 2008 2 Oil & Gas Journal, 2009



HIGHLIGHTS Saudi Arabia’s economy to be impacted by the crisis, but GDP’s growth expected to

remain positive in FY09 thanks to government stimulus package including a USD400 billion investments and development program announced by Saudi’s officials during the G20 meetings last April.

Absolute feedstock competitive advantage on the back of rising oil & gas prices trend (gas prices had already risen 20% in April MoM while oil prices gained almost 50% from late December FY08 to end of June FY09) to considerably help major petrochemical companies weather the financial crisis successfully.

Global ethylene capacity is expected to reach 173 millions of tonnes in 2015, up 47% from 2005 with Middle East growing almost 6 times as fast as the world average.

Saudi Arabia ethylene capacity to reach 18.2 m tpa in 2013, more than double from that of 2008 levels, taking the KSA’s global ethylene capacity production market share to circa 12%, with Jubail and Yanbu the focus of petrochemicals developments over the medium-term.

Middle East to become the only net ethylene derivatives exporter in 2015, growing its trade flow by circa 226% from 2005, with the Asia Pacific region growing its net trade flow (imports) to about 21 millions of tones in 2015 up 130% from 2005 driven by China’s strong anticipated growth.

Petrochemical market in Saudi Arabia expected to recover in H2 FY09, but magnitude and timing to depend on global recovery.

Table 1 - Valuation highlights

LT FV CMP (30-June-09) Upside/(Downside) Comments

SABIC 70.58 62.75 12%

* Strong feedstock advantage

* Petrochemical demand expected to recover from H1 FY09 but the magnitude of recovery will depend on global recovery * Financials heavily impacted by bad performing US subsidiary (former GE plastics) in H1 FY09 (SAR1.2 billion impairment charge booked)

SAFCO 140.21 113.5 24% * Successful business model: high margin thanks to absolute cost advantage - very good cash conversion cycle - low CAPEX requirements – low leverage * Fertilizer demand strong in the long run - less sensitive to economic cycle (high correlation with agricultural needs)

Source: KMEFIC Research



PETROCHEMICAL INDEX vs. TADAWUL

The petrochemical sector is of key importance in the Saudi Stock Exchange. It is, indeed, composed of 13 companies, which altogether made around USD50 billion in revenue and USD7 billion in net earnings in FY08. As of 30 June 2009 the petrochemical sector accounted for more than 30% of the total market capitalization on the Saudi Stock Exchange, tied with the banking and financial services sector. The Tadawul was not spared by the global financial crisis. From end July 2008 to end November 2008 the Tadawul Index, TASI, dropped by circa 50% to low record 4,424 driven down by the petrochemical index on concerns about plummeting oil prices, which over the same period decreased by almost 70%. As a matter of fact, Q4 FY08 was one of the worst quarters to date with companies fourth quarter’s earnings literally plunging. Petrochemical heavyweight SABIC Q4 FY08 net earnings decreased by 96% QoQ to SAR0.3 billion, when fertilizer giant SAFCO Q4 FY08 net earnings dropped to SAR0.5 billion, down 71% QoQ and 28% YoY. However, from end November 2008 on until end March 2009, the TASI remained relatively stable overall, with the petrochemical index moving similarly to the TASI. End of March marked an apparent recovery for the TASI with the index going overall upward by 19% from 31 March 2009 to 30 June 2009, boosted by the petrochemical index, which over the same period recovered twice as fast (+ 41%) on the back of a USD400 billion stimulus plan (investment and development program for the government and the monetary sectors for the next five years) adopted and disclosed by the Kingdom during the G20 summits in early April. Likewise, sector volumes traded in April and May respectively increased by 18% and 44%.

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THREAT OF NEW ENTRANTS We considered the threat of new entrants to be low because barriers to entry include high capital cost, economies of scale, distribution channels, proprietary technology, environmental regulation and geopolitical factors. Furthermore, high levels of industry expertise are needed to be competitive at all levels in the petrochemical field. In addition, fixed cost levels are high for upstream, downstream, and chemical products. It is therefore very hard for new players to enter this market. SUPPLIERS POWER Suppliers bargaining power can be considered as high since the Organization of Petroleum Exporting Countries (OPEC) controls around 50% of the world’s supply of oil and owns about two thirds of the world oil reserves (EIA, 2007). This consequently gives this organization a strong influence over oil prices. OPEC’s influence on oil prices can thus be considered as a threat for companies which use oil & gas as feedstock as it can exert a considerable degree of uncertainty over the company’s chemical production costs. In fact, as it will be elaborated further in the section entitled “The feedstock cost advantage”, abundant natural resources in the Middle East countries in general (and Saudi Arabia in particular) has given the region a strategic position for key players in the petrochemical industry. THREAT OF SUBSTITUTES The threat of substitutes and new processes in the short term (next 20 years) can be regarded as low. The petrochemical industry produces materials such as plastics, synthetic rubbers, fibers and solvents which are indispensable to our everyday life products (in the form of packaging, clothes, computers, furniture, etc). Often these products generate energy savings during their use which by far outweigh the energy used to produce them. In fact, the petrochemical industry accounts for 30% of total global industrial final energy use and about 8% of world oil consumption (EIA, 2007). Besides, more than half of the energy used by the chemical industry is stored as feedstock in its product. Because of the high share of feedstock energy, the process energy efficiency using substitutes is quite limited, at least in the short term. Biomass feedstock could help to reduce CO2 emission and fossil fuel independence, but most experts argue this would be an option in the longer term, as its efficiency levels have yet to be proven competitive to oil and gas resources. BUYERS POWER Buyers can either be industrials or consumers. In both cases their power is quite limited due to the nature (necessity) of the petrochemical products. However, the continuous search for price reductions and higher margins has led more and more companies to settle their operations in Middle East countries to benefit from low cost feedstock. BUSINESS RIVALRY Due to tight regulations and high capital requirements, rivalry has been relatively low even while



the industry has been growing quite fast (in average 2 or 3% more than countries Gross Domestic Products). Indeed, the biggest share of the market is still split between a few major companies which have extended their operations from upstream to downstream and petrochemical activities. The petrochemical sector in Saudi Stock Exchange is composed of 13 listed companies, SABIC and SAFCO respectively amounting for 89% and 2.5% of market shares in 2008 (revenues for all public petrochemical companies).



BASIC PRODUCTION FLOW The below sections lay out the different materials and processes involved in the production of petrochemical products and fertilizers and bring out the importance and location of oil and gas feedstock’s within the production chain. PETROCHEMICAL Figure 3 (page 10) shows the global framework of the petrochemical industry from inputs (feedstock) to derivatives and end markets. FERTILIZER Figure 4 displays in more details the production process of ammonia, one of the most important basic chemical serving as a core component in the production of nitrogen fertilizer and urea. Urea is the most popular and commonly used nitrogen fertilizer worldwide.

Figure 4 - Ammonia & Urea Production Process

Primary Carbon Urea Separation &

Reformer Dioxide Synthesis Purification

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Reformer Converter Absorber Methanator Refrigerant Section Concentration

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Source: KMEFIC Research, SAFCO

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MACROECONOMIC OVERVIEW We will regard all GDP related issues with particular attention, as the demand for petrochemicals has been growing at around 3% above the world GDP. GROSS DOMESTIC PRODUCT & KEY GROWTH INDICATORS

Table 2: Key Macroeconomic Medium-Term Indicators Saudi Arabia 2004 A 2005 A 2006 A 2007 A 2008 A 2009 E 2010 E Average Import Crude Price & WTI* (USD/B) 38.6 52.7 62.5 69.7 96.1 59.1 70.9 Real GDP Growth Rate, % 5.3 5.6 3.0 3.5 4.6 1.8 1.7 Population (mn) 22.5 23.1 23.7 24.3 24.9 25.5 26.2 GDP/Capita (USD) 19,487 21,236 22,033 22,852 23,834 23,255 23,448 CPI Inflation (Y-o-Y % Change) 0.4 0.6 2.3 4.1 9.9 5.5 4.5 Net Foreign Assets (USD Bn) 99 158 240 313 450 355 370 Source: SAMA, IMF, BMI and KMEFIC Research *- West Texas Intermediate

Since 2003, Saudi Arabia has been able to achieve strong growth thanks to high oil revenues and a relatively fast expansion of the non oil sector. As a matter of fact, since 2003 growth has averaged 4.3% with a significant and increasing contribution from the non oil sector (Table 2, Figure 5). Furthermore, net foreign assets constantly increased over the past 8 years to reach an estimated USD450 billion in 2008 (Figure 6). Besides, the issue of population growth in the Middle East has come into prominence. Indeed, the Arab population has been growing at a relatively fast pace, at an average rate of 3% per year for the past decade. This strong population increase has raised some challenging economic issues for governments in the region. The main question being that in order to grow GDP per capita in an environment where population grows at 3% per year and inflation grows at 1.5% (at least) per year; governments have to find ways to grow their GDPs by at least 5% per year to generate real GDP growth of 0.5%. As displayed in Table 2, Saudi Arabia was able to grow its GDP per capita at CAGR 5.4% from 2004 to 2007. The country’s remarkable growth was accompanied by ambitious developments plans implemented by the government, which among many initiatives helped the country diversify its sources of revenues.



Saudi Arabia is currently undergoing its 8th five year development plan (spreading from 2005 to 2009). It marks a new phase in the development process of the kingdom of achieving long term sustainable development. Emphasis has been placed on key priorities among which are the diversification of the economic base and the improvement of the productivity and competitiveness of the national economy. Considerable attention has been given to promising areas such as strategic and manufacturing industries, the natural gas industry and information technology. Thus, oil wealth is being invested over the medium term to expand the non oil sector and boost oil production capacity to support global oil market stability (Figure 7).

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Source: KMEFIC Research, IMF

Figure 5: Saudi Arabia real oil & non-oil GDP growth

Infrastructure35%

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Figure 7: Investments breackdown from 2000-2007

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Source: KMEFIC Research, SAMA



OIL VULNERABILITY While oil importing countries might have welcome the fall in oil prices since mid-2008, this is certainly not the case for oil exporting countries, many of which are subsequently expecting dramatic declines in their fiscal balances along with much less growth in their net foreign assets and in their GDPs. Indeed, a heavy concentration of economic activity in the hydrocarbon sector naturally tends to raise a country vulnerability to sharp drop in oil prices. Standard & Poor’s recently released their oil price vulnerability index ranking3, placing Saudi Arabia second among the countries whose overall economy can be most impacted by oil prices fluctuations. Note that fiscal outturns are logically expected to weaken in 2009, in line with falling oil prices and revenues and the government deliberate countercyclical expansionary fiscal policy (elaborated further in the “global financial crisis” section of our report), with total expenditure expected to rise by 16% relative to 2008 budget. The government balance should, consequently, reach a deficit of circa 7% of GDP, reversing from a 20% surplus in average over the past four years. Nevertheless, Saudi Arabia holds enough cumulated fiscal surplus to digest this deficit in the medium term. THE GLOBAL FINANCIAL CRISIS

We do not expect Saudi Arabia to miraculously avoid the hit already taken by most countries amid the downturn. Falling oil pricing, declines in consumer spending, exports and imports should certainly undermine the Kingdom’s growth. However, as pointed out by Business Monitor International, there are still grounds for positive growth in 2009 thanks to government spendings and the momentum from ongoing infrastructure projects. Furthermore, the financial framework can reasonably be considered as stable, which will encourage investments. Indeed, the Saudi government, whose net asset position has been forecasted at 170% of GDP in FY093, holds 3 Gulf Cooperation Council Credit Survey, Standard & Poor’s, June 2009

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Source: KMEFIC Research, BMI

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Figure 9: World & Middle East real GDP growth forecasts



enough cash reserve to step in and rescue companies for political reasons. Furthermore, the government stimulus plans adopted to cope with the crisis will certainly bear fruits in the near term (Table 3). During the G20 summit meetings, held in London last April, Saudi Arabia adopted a USD400 billion investment and development program for the government and the monetary sectors for the next five years, comforting the country’s ambition to become one of the world’s ten most competitive economies by 2010 (the 10x10 plan). This was one of the largest economic initiatives prepared during the discussions of the economic recovery program for global economies. Finally, Saudi Arabia’s GDP growth is expected to reach above 3% by 2013 while the world should experience a continued growth from 2010 to 2013 (Figure 9), strongly driven by emerging economies (particularly the BRIC: Brazil, Russia, India and China).

Table 3: Fiscal and Monetary Policy Stimulus Measures Intervention Measures

Sep-08 Central Bank pledges liquidity to banking sector if needed Oct-08 Central Bank says that banks have option to borrow up to

75% of the value of their government paper holdings but none have taken up this offer

Oct-08 Repurchase rate cut by 100bps to 4.00%

Oct-08 Reserve requirement cut from 13% to 10%

Oct-08 Central Bank guarantees all deposits in banking sector

Oct-08 Central Bank injects USD 3 bn into banking system

Oct-08 USD 2.7 bn credit facility extended to low-income Saudis

Nov-08 Repurchase rate cut by 100bps to 3.00%

Nov-08 Reserve requirement cut from 10% to 7%

Dec-08 Record-breaking USD 126.7 bn budget announced Dec-08 Repurchase Rate but by 50bps to 2.5%, reverse

repurchase rate cut by 50bps to 1.5% Jan-09 Public Investment fund announces it will extend project

loan durations to 20 years, including a five-year grace period, from 15 years and will raise a cap on project lending to 40% of the value of the project from 30%

Jan-09 Reverse repurchase rate cut by 75bps to 0.75%

Apr-09 Reverse repurchase rate cut by 25bps to 0.5%

Apr-09 USD400 Bn investments and development program Source: BMI, KMEFIC Research



OIL & GAS OUTLOOK

MARKET DYNAMICS With around 266.7 billion barrels of proven oil reserves4 (around one-fifth of the proven, conventional world oil reserves) and 258.4 trillion cubic feet of natural gas4 (the fourth largest natural gas reserves in the world), Saudi Arabia enjoys an enviable, unparalleled advantaged energy and feedstock position; the revenue from oil & gas in turn supporting further investments and developments. Oil & Gas prices impact petrochemical development when they are high or low. Although there can be negative impact, the energy advantage prevails under both scenarios. Scenario I: High or relatively high oil prices imply that gulf countries in general maintain a share of the market at or near current levels. However, higher oil prices may also likely negatively impact the world economy, which translates into lower petrochemical demand growth and the requirement for fewer capital expenditures. As the incremental low cost producing region, petrochemical investments in the Middle East are likely to be maintained (thanks to higher cash margins) at the expense of other regions. Scenario II: Although it might have been hard to seriously consider for many until recently, low oil prices have the negative effect of reducing the inherent advantage of gulf petrochemical producers. Nevertheless, very low oil prices would have to be sustained for an extended period of time before investment economics were adversely affected. Prices would actually have to drop considerably lower before Middle East ethane based producers had difficulty competing on a delivered polyethylene cash cost basis (cf “feedstock cost advantage” section). Should oil prices be sustained for a long time, the demand in petrochemical products would grow as consumers would certainly fancy lower priced products. The resulting growth in the sector would push the need for more facilities (potentially outside of the Middle East). However, one should understand that very low oil prices for a very long period of time might be unlikely to occur as OPEC countries which control around 50% of the world’s supply of oil and own about two thirds of the world oil reserves would step in to influence market prices (up or down), trying to find consensus for their own benefits and the world economy.

4 Oil & Gas Journal, 2009



OIL OUTLOOK

In its latest issue of the Annual Energy Outlook (May 2009), the Energy International Administration laid out its updated assumptions on oil prices up to 2030 based on three price scenarios depending on economic growth. As expectations for future GDP growth rates may be subject to many uncertainties, the EIA included a high economic growth case (0.5 percentage point added to the growth rate assumed for each country in the reference case) and a low economic growth case (0.5 percentage point subtracted to the growth rate assumed for each country in the reference case) in addition to the reference case. The effects of different assumptions about future oil prices are illustrated in Figure 10. In the high price case, world oil prices (in real 2007 dollars) climb from USD68 per barrel in 2006 to USD200 per barrel in 2030; in the low price case, they drop to USD50 per barrel in 2015 and remain at about this level through 2030, while oil prices rise to USD130 per barrel in 2030 in the reference case.

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GAS OUTLOOK

Likewise, in its Annual Energy Outlook 2009 (March 2009) natural gas prices may vary with economic growth but also with technology progress assumptions. In fact, technology improvements reduce drilling and operating costs and expand the economic recoverable resource base. Quite logically, in the rapid technology case where exploration and development costs per well decline at a faster rate, natural gas prices reach lower levels. Conversely, in the slow technology case natural gas prices reach higher levels. In the high economic growth case, natural gas consumption grows more rapidly; thus natural gas prices rise more sharply than in the reference case reaching USD8.7 (per thousand cubic feet) in 2030. In the low economic growth scenario, natural gas consumption grows more slowly; thus natural gas prices are lower than in the reference case reaching USD7.8 (per thousand cubic feet) in 2030.

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CAPACITY AND INFRASTRUCTURES Feedstock availability coupled with high oil & gas prices for the past years (until end 2008) have enabled Saudi petrochemical prices to achieve very high cash margins. Petrochemical companies’ ability to be profitable has therefore been largely dependent on the country’s feedstock capacity. Growing feedstock capacities in the Middle East In 2008, the total petrochemical production of MENA countries reached about 85 million tonnes, that is about two third of the global production. Ethylene is a critical feedstock to the petrochemical industry both in terms of volume produced (circa 120 millions of tonnes globally in 2005) and number of end market products it may generate from automotives, packaging and synthetic rubbers to medical equipments (for a more exhaustive list please refer to Figure 3). Global ethylene capacity is expected to reach 173 millions of tonnes in 2015, up 47% from 2005 when the Middle East capacity should grow by 300% over the same decade, taking its global market share of ethylene to around 19% in 2015 (Figure 13). Furthermore, comforting its position as the most dynamic petrochemical region in the world, the Middle East is anticipated to become the only net exporter of ethylene in the world in 2015, significantly growing its trade flow by 226% from 2005 (Figure 14). Besides, we note that Asia Pacific should considerably increase its demand of ethylene driven by China’s strong growth to reach a net trade flow (import) of about 21 millions of tonnes in 2015, up 130% from 2005 (Figure 14).

0

20

40

60

80

100

120

140

160

180

1995 2005 2015

Middle East

China

Rest of Asia

Japan

Europe

North America

Others

Source: KMEFIC Research, Parpinelli Tecnon

Figure 13 - Global Ethylene Capacity Trend

Cap

acity

(mill

ions

of t

onne

s)



Saudi Arabia, the heavyweight in the MENA petrochemical industry As for Saudi Arabia, whose total production capacity accounts for more than half of MENA’s, domestic ethylene capacity in 2013 is forecasted to be almost double that of 2008 levels, at 18.2m tpa, with Jubail and Yanbu the focus of petrochemicals developments over the medium-term (Table 4).

Table 4: Saudi Arabia ethylene capacity & global market share (actual/ forecast) 2008A 2013 E

Saudi Arabia ethylene capacity (m tpa) 7.4 18.2 Saudi Arabia global market share of ethylene capacity 6% 12% Source: KMEFIC Research, BMI, March 2009

-30

-20

-10

0

10

20

30

1995 2000 2005 2010 2015

Asia-Pacific

Western Europe

Middle East

North America

Source: KMEFIC Research, CMAI

Figure 14 - Changing Trade Flow Pattern of Ethylene DerivativesN

et T

rade

(Mn

of to

nnes

Eth

ylen

e Eq

uiva

lent

)

North America transactionsfrom net export to net importer

Middle East is theonly net exporter

Middle East is the primary exporter

Exporter

Importer



Saudi Basic Industries Corporation (SABIC) Listing : Tadawul Sector : Petrochemical Industries

CMP (30 Jun - 09) : SAR62.75

Upside/ (Downside) : 12% LTFV : SAR70.58 Opinion : Undervalued

Key Performance Indicators in'million'SAR unless otherwise indicated (Dec year end) FY08 A FY09 E FY10 E FY11 E Revenues 150,810 90,486 106,773 124,925 EBITDA 46,643 28,222 39,108 43,446 Net Profit 22,030 9,038 15,221 20,201

Gross Profit Margin 30.3% 29.5% 34.0% 36.0% Operating Margin 24.3% 19.3% 26.0% 28.0% Net Profit Margin 14.6% 10.0% 14.3% 16.2% ROE 15.7% 6.0% 9.7% 11.8%

EPS (SAR) 7.34 3.01 5.07 6.73 EPS growth ‐18.5% ‐59.0% 68.4% 32.7%P/E 8.5 20.8 12.4 9.3

BVPS (SAR) 48.9 52.0 56.7 62.4 P/BV 1.3 1.2 1.1 1.0 Dividend Yield 1.7% 2.9% 4.4% 5.3%

EV/EBITDA 4.0 6.7 4.8 4.3

Debt/Equity 63.2% 60.7% 58.1% 49.6% Net Debt 74,091 57,816 55,999 53,739

Source: KMEFIC Research, SABIC financial statements

Free Float 30.0%

Public Investment

Fund 70.0%

Source: KMEFIC Research, Zawya

Figure 16 - SABIC shareholding structure

0

5

10

15

20

25

30

35

40

0

20

40

60

80

100

120

140

160

J-08 J-08 A-08 S-08 O-08 N-08 D-08 J-09 F-09 M-09 A-09 M-09 J-09

Volume (Million Shares)SABIC (SAR)Petrochemical Index (Rebased)

Figure 15 - SABIC rebased to Petrochemical Index (& company shares tradingvolume)

Source: KMEFIC Research, TADAWUL

Million shares

SAR



COMPANY & BUSINESS OVERVIEW The Saudi Basic Industries Corporation (SABIC) was established by a royal decree in 1976 to produce chemicals, polymers and fertilizers, benefiting from oil and gas competitive feedstock thanks to the country’s abundant natural resources. Constantly growing organically and through acquisitions, SABIC has become a heavyweight in the petrochemical sector. In 2008, SABIC’s revenues topped about SAR151 billion, net profit SAR22 billion with a production of more than 56 million metric tonnes, up 60% YoY. Best known for being one of the world largest petrochemical companies, the Saudi Arabia based company has also grown and diversified its activities to become the largest steel producer in the Middle East. As a truly global company, SABIC currently employs more than 33,000 people in more than 100 countries over six continents. As on 30 June 2009, the company’s market capitalization was SAR188.2 billion, which is more than 60% of the petrochemical sector’s combined capitalizations in the Tadawul. FINANCIAL PERFORMANCE & VALUATION SABIC revenues continuously grew at CAGR 24.4% over the past three years, reaching about SAR151 billion in FY08 with a net profit of SAR22 billion, down 18.5% YoY though. SABIC’s growth was strongly supported by increasing demand for petrochemicals along with soaring oil and gas prices and successful acquisitions. Nevertheless, non exempt from the global turmoil, the company’s financial performance started weakening in the last fiscal year fourth quarter. Indeed, Q4 FY08 revenues plunged 39% YoY and net earnings came at SAR0.3 billion, down 96% QoQ due to lower petrochemical fundamentals (for both volumes and prices per unit). Besides, SABIC surprisingly disclosed a net loss of SAR0.9 billion in Q1 FY09 due to SAR1.2 billion impairment on its goodwill related to its US subsidiary Sabic Innovative Plastic (formerly GE Plastics). We note that Q1 FY09 normalized net earnings (from this exceptional write off) are still positive at SAR0.2 billion but lower than most analysts expectations. Despite the fact that we expect SABIC growth to be considerably haltered in FY09 (down 40% YoY) we still believe SABIC prospects are strong due to (i) an anticipated recovery of the petrochemical demands from H2 FY09, FY10 on and (ii) strong cash margin thanks to sustained low feedstock costs (gas prices already went up 16% in April) which should help the company weather the crisis. Our weighted Discounted Cash flows (Free Cash Flow to the Firm) and Relative Valuation models resulted in a Long Term Fair Value of SAR70.58, up 12% from the stock price as on 30 June 2009 (Table 5).

Table 5 - SABIC Valuation

in SAR LTFV Weight Weighted Value

DCF - FCFF 75.32 80% 60.26

Relative valuation 51.64 20% 10.33

Hybrid valuation 70.58



Table 6 - Sensitivity analysis of fair value (SAR) to WACC and Growth

WACC

70.58 9.21% 10.21% 11.21% 12.21% 13.21%

GR

OW

TH

1.0% 84.33 73.32 64.48 57.26 51.23

1.5% 89.21 77.03 67.38 59.57 53.10

2.0% 94.76 81.19 70.58 62.10 55.14

2.5% 101.14 85.90 74.16 64.89 57.36

3.0% 108.55 91.25 78.17 67.99 59.81 PROJECTS, STRATEGY As a move to cope with the current financial crisis SABIC decided to keep costs minimal. Along with other cost cutting measures, SABIC innovative Plastics announced last February it would be cutting around 100 jobs. This company, which was purchased from GE about 2 years ago forced SABIC to book a SAR1.2 billion in their Q1 FY09 financials. SABIC could, however, still be involved in some inorganic growth transactions, as Prince Saud Bin Abdullah Bin Thenayan Al Saud, the company’s chairman told Alarabiya TV in May 2009: “The economic crisis had some negative as well as some positive effects…, and it could be a chance for some new acquisitions”. Furthermore, SABIC and Spichem announced in May 2009 their cooperation on projects in order to create synergies after the downturn somehow hit their profitability. Under a memorandum of understanding, SABIC agreed it will crack ethane feedstock to provide Sipchem; in return, Sipchem will provide SABIC with carbon monoxide. Furthermore, within the framework of its strategy to become “the preferred world leader in chemicals”, SABIC has engaged in multiple expansion and development projects, among which are key projects in the Asia Pacific region whose demand for petrochemicals is bound to increase (Figure 14 in section Capacity, Infrastructures).Thus, in January 2008 SABIC signed a contract with China Petroleum & Chemical Corporation to set up a plant in Tianjin, China. Likewise, in April 2008 SABIC announced its plans for a petrochemical project in India. Besides SABIC also signed a joint venture agreement with Ma’aden (Saudi Arabian Mining company) in 2007 for a phosphate project.



Saudi Arabian Fertilizer Company (SAFCO) Listing : Tadawul Sector : Petrochemical Industries

CMP (30 Jun - 09) : SAR113.50 Upside/ (Downside) : 24%

LTFV : SAR140.21 Opinion : Undervalued

Key Performance Indicators in'million'SAR unless otherwise indicated (Dec year end) FY08 A FY09 E FY10 E FY11 E Revenues 5,243 3,408 4,430 5,095 EBITDA 4,594 2,481 3,600 4,044 Net Profit 4,280 2,353 3,389 3,839

Gross Profit Margin 83.7% 69.0% 79.0% 78.0% Operating Margin 80.8% 64.0% 74.5% 73.5% Net Profit Margin 81.6% 69.0% 76.5% 75.3% ROE 60.9% 30.5% 38.6% 37.5%

EPS (SAR) 17.12 9.41 13.56 15.35 EPS growth 55.0% ‐45.0% 44.1% 13.3% P/E 6.6 12.1 8.4 7.4 BVPS (SAR) 32.1 29.6 40.7 41.1 P/BV 3.5 3.8 2.8 2.8 Dividend Yield 10.6% 4.6% 6.6% 7.4%

EV/EBITDA 6.2 11.4 7.9 7.0

Debt/Equity 7.3% 8.1% 7.3% 8.3% Net Debt ‐2,102 ‐1,735 ‐4,229 ‐3,758

Source: KMEFIC Research, Financial Statements

SABIC43%

General Organization

for Social Insurance

14%

Free Float 43%

Figure 18 - Share ownership of SAFCO

Source: KMEFIC Research, Zawya

0123456789

0

50

100

150

200

250

300

J-08 J-08 A-08 S-08 O-08 N-08 D-08 J-09 F-09 M-09 A-09 M-09 J-09

Volume (Million Shares)

SAFCO (SAR)

Petrochemical Index (Rebased)

Source: KMEFIC Research, TADAWUL

Figure 17 - SAFCO rebased to Petrochemical Index (& company shares trading volume)

Million shares

SAR



COMPANY & BUSINESS OVERVIEW The Saudi Arabian Fertilizer Company (SAFCO), the first petrochemical company in Saudi Arabia, was established in 1965 by a royal decree. SAFCO’s products include urea (since 1970), ammonia (since 1970), sulfuric acid (since 1972) and melamine (since 1984). They are mostly used in the agricultural industry but may as well supply other industries (Figure 4 in section “Basic production flow”). The company’s products are sold domestically but also widely exported to Asia, North America, South America, Australia and Europe. SAFCO, which has grown organically to become the leading manufacturer and exporter of fertilizers in the Gulf region, generated revenues of SAR5.2 billion in FY08, up 49% YoY, with 4.8 million metric tonnes produced. SAFCO is currently 43% owned by SABIC, which may give it the opportunity to benefit from potential synergies in certain business areas (such as sales, marketing, R&D). As on 30 June 2009, the company’s market capitalization was SAR28.4 billion. FINANCIAL PERFORMANCE & VALUATION Despite the financial crisis SAFCO’s revenues in FY08 reached a five year high SAR5.2 billion with net earnings at SAR4.3 billion, up 94% YoY. This is explained by strong fertilizers demand for the first three quarters of FY08 along with outstanding gross profit margins (84% in FY08) due to an exceptional feedstock cost advantage. As a matter of fact, SAFCO is supplied in natural gas through Saudi Aramco at a fixed price of USD0.75 MBTU (as a comparison, in April 2009 natural gas prices stood at about USD3.5 MBTU). However, SAFCO revenues for Q1 FY09 dropped to SAR739.4 million on lower fertilizer prices worldwide, down 10% QoQ while net earnings fell to SAR524.5 million, down 27.5% YoY. In spite of the current economic situation, we believe the fertilizer industry, which shows less sensitivity to cyclical effects, along with the company’s efficient business model (low leverage, high free cash flow generation due to absolute feedstock advantage, low conversation cycle and low CAPEX requirements) provide the company with bullish prospects. Our weighted Discounted Cash flows (Free Cash Flow to the Firm) and Relative Valuation models resulted in a Long Term Fair Value of SAR140.21, a potential upside of 24% from the stock price as on 30 June 2009 (Table 7).

Table 7 - SAFCO Valuation

in SAR LTF value Weight Weighted Value

DCF - FCFF 134.94 80% 107.95

Relative valuation 161.30 20% 32.26

Hybrid valuation 140.21



Table 8 - Sensitivity analysis of fair value (SAR) to WACC and Growth

WACC

140.21 10.93% 11.93% 12.93% 13.93% 14.93%

GR

OW

TH

1.0% 154.45 143.47 134.31 126.64 120.05

1.5% 158.87 146.97 137.13 128.95 121.97

2.0% 163.77 150.82 140.21 131.45 124.04

2.5% 169.26 155.07 143.58 134.18 126.27

3.0% 175.45 159.81 147.30 137.15 128.69 PROJECTS, STRATEGY In July 2008 SAFCO announced the signature of an agreement with Hadeed to construct a 50/50 owned facility in Jubail Industrial City for the production of flat steel products with an annual capacity of 1.7 million metric tonnes. In addition to this project, the facility should rely on the quantity of gas allocated to SAFCO plant in Dammam, which was closed by the end of Q3 FY08. During the construction phase of the flat products facility, SAFCO reached agreement with SABIC affiliate, the Saudi Methanol Company (AR-RAZI) to make use of the above referenced gas quantity to produce methanol for SAFCO for an interim period until the completion of the flat steel products project, scheduled for a period estimate.



APPENDIXES

SABIC BALANCE SHEETS

SABIC INCOME STATEMENTS

in "000" SAR FY05 A FY06 A FY07 A FY08A FY09 E FY10 E FY11 E

Sales

78,253,536

86,327,862

126,204,404

150,809,596

90,485,758

124,924,637

143,663,332

Gross profit

33,084,330

35,228,022

47,950,176

45,763,281

26,693,298

36,302,886

44,972,869

Operating Profit

29,169,978

30,886,120

41,046,523

36,591,289

17,473,188

27,761,030

34,978,898

EBITDA

35,700,701

37,005,356

48,652,533

46,643,288

28,221,927

39,107,700

43,446,250

Net Profit

19,159,685

20,293,942

27,022,272

22,029,843

9,038,302

15,220,975

20,200,535

in "000" SAR FY05 A FY06 A FY07 A FY08 A FY09 E FY10 E FY11 E

Cash & Cash Equivalents

28,172,569

39,556,764

45,876,795

51,027,586

63,960,610

72,961,812

72,151,044

Net Receivables

17,465,830

20,759,432

30,122,511

20,067,638

16,036,087

18,625,991

21,445,396

Other Current Assets

10,642,446

13,658,245

22,305,959

24,359,750

12,768,466

15,066,790

17,628,144

Total Current Assets

56,280,845

73,974,441

98,305,265

95,454,974

92,765,163

106,654,592

111,224,584

PP&E

66,096,734

79,970,622

123,113,574

141,440,177

150,598,304

156,335,346

162,858,951

Intangibles and Others

14,572,901

12,643,757

32,312,242

34,864,838

34,552,186

36,088,592

39,026,662

Total non Current Assets

80,669,635

92,614,379

155,425,816

176,305,015

185,150,490

192,423,938

201,885,613

Total Assets

136,950,480

166,588,820

253,731,081

271,759,989

277,915,653

299,078,530

313,110,197

ST Debt

6,703,959

6,128,796

4,671,224

4,288,816

4,384,740

4,445,100

4,176,090

Payables

7,781,718

11,065,422

16,732,412

10,426,809

9,412,327

10,588,295

12,193,804

Other Current Liabilities

7,461,439

7,747,658

12,279,002

11,864,382

7,336,133

8,456,437

9,594,212

Total Current Liabilities

21,947,116

24,941,876

33,682,638

26,580,007

21,133,200

23,489,832

25,964,106

LT Debt

23,017,180

33,611,628

75,437,595

88,367,462

90,491,980

94,334,900

88,625,910

Other LT Liabilities

6,764,647

7,545,079

10,114,576

10,170,907

10,272,616

11,136,278

11,299,878

Total non Current Liabilities

29,781,827

41,156,707

85,552,171

98,538,369

100,764,596

105,471,178

99,925,788

Total Liabilities

51,728,943

66,098,583

119,234,809

125,118,376

121,897,796

128,961,010

125,889,893

Minority Interest

22,880,920

27,607,078

43,342,241

43,709,139

47,331,206

51,568,726

56,753,193

Total Equity 85,221,537

100,490,237

134,496,272

146,641,613

156,138,577

170,117,520

187,220,303



SABIC CASH FLOW STATEMENTS


Cash Flow from operations

33,135,996

34,734,906

46,655,309

46,229,845

41,782,740

34,567,933

37,769,890

Cash Flow from investing activities

(10,626,649)

(17,867,006)

(73,703,935)

(29,806,609)

(24,163,965)

(19,873,661)

(19,135,971)

Cash Flow from financing activities

(17,581,909)

(5,483,705)

33,520,656

(11,272,445)

(4,685,751)

(5,693,070)

(19,444,687)

(Decrease) increase in cash & cash equivalents

4,927,438

11,384,195

6,472,030

5,150,791

12,933,024

9,001,202

(810,768)

Cash Flow at year - end

28,172,569

39,556,764

45,876,794

51,027,586

63,960,610

72,961,812

72,151,044

SAFCO BALANCE SHEETS

in "000" SAR FY05 A FY06 A FY07 A FY08 A FY09 E FY10 E FY11 E

Cash & Cash Equivalents

304,139

594,238

1,572,063

3,917,745

3,310,877

5,987,075

5,771,091

Net Receivables

441,731

529,396

838,053

850,724

567,952

726,032

820,785

Other Current Assets

367,717

431,650

422,434

370,226

305,691

371,145

426,127

Total Current Assets

1,113,587

1,555,284

2,832,550

5,138,695

4,184,520

7,084,252

7,018,002

PP&E

3,922,873

4,025,640

3,811,597

3,457,565

3,407,565

3,359,826

3,357,565

Intangibles and Others

1,170,865

1,093,095

1,509,279

1,253,777

1,374,360

1,499,233

1,911,313

Total non Current Assets

5,093,738

5,118,735

5,320,876

4,711,342

4,781,925

4,859,059

5,268,878

Total Assets

6,207,325

6,674,019

8,153,426

9,850,037

8,966,445

11,943,310

12,286,881

ST Debt

-

176,786

148,393

236,786

200,000

247,500

284,625

Payables

250,902

190,270

394,225

556,060

294,442

233,576

281,199

Other Current Liabilities

101,717

96,922

262,090

- -

- -

Total Current Liabilities

352,619

463,978

804,708

792,846

494,442

481,076

565,824

LT Debt

695,000

1,063,214

826,428

589,643

600,000

742,500

853,875

Other LT Liabilities

371,638

407,450

507,953

433,588

481,283

534,224

592,988

Total non Current Liabilities

1,066,638

1,470,664

1,334,381

1,023,231

1,081,283

1,276,724

1,446,863

Total Liabilities

1,419,257

1,934,642

2,139,089

1,816,077

1,575,724

1,757,800

2,012,687

Equity

4,788,068

4,739,377

6,014,337

8,033,960

7,390,721

10,185,510

10,274,193



SAFCO INCOME STATEMENTS


Sales

1,823,985

1,831,252

3,516,028

5,242,632

3,407,711

4,430,024

5,094,528

Gross profit

1,074,666

1,090,249

2,294,474

4,388,701

2,351,320

3,973,732

4,202,985

Operating Profit

981,553

988,450

2,127,414

4,234,781

2,180,935

3,300,368

3,744,478

EBITDA

1,177,835

1,182,652

2,470,576

4,593,652

2,480,935

3,600,368

4,044,478

Net Profit

1,108,308

1,151,324

2,209,226

4,279,788

2,352,612

3,388,965

3,838,513

SAFCO CASH FLOW STATEMENTS

FY05 A FY06 A FY07 A FY08A FY09 E FY10 E FY11 E

Cash Flow from operations

922,659

1,004,992

2,397,134

4,269,285

2,420,413

3,634,576

1,123,023

Cash Flow from investing activities

(782,791)

138,232

45,870

124,789

(5,000)

40,000

115,000

Cash Flow from financing activities

(211,259)

(853,125)

(1,465,179)

(2,048,392)

(3,022,281)

(998,378)

(1,454,007)

(Decrease) increase in cash & cash equivalents

(71,391)

290,099

977,825

2,345,682

(606,868)

2,676,198

(215,984)

Cash Flow at year - end

304,139

594,238

1,572,063

3,917,745

3,310,877

5,987,075

5,771,091



This report is being provided for informational purposes only and on the condition that it will not form a primary basis for any investment decision. This report is not an offer to buy or sell any of the securities that may be referred to herein. In no event will KMEFIC be liable for any loss occurring from investment decisions made based on the recommendation here-enclosed. Past performance is not necessarily a guide to future performance. Investors should make their own decision on whether or not to buy or sell the securities covered herein based upon their specific investment goals and in consultation with their financial advisor. KMEFIC has no obligation to update, modify or amend this report or to otherwise make any notification or announcement thereof in the event that any matter stated herein, or any opinion, projection, forecast or estimate set forth herein, changes or subsequently becomes inaccurate. The inclusion of any opinions/estimates does not necessarily imply a recommendation or endorse the views expressed within them. Many areas of the report contain opinions and/or analysis that represent the involved analysts' views; neither the analysts nor KMEFIC shall be in any way liable for their opinions expressed in the report. KMEFIC may or may not have ownership or interest in companies mentioned in this report. This report has been prepared and issued by the Research Department @ Kuwait & Middle East Financial Investment Co. S.A.K. (KMEFIC), a licensed Kuwaiti investment company regulated by the Central Bank of Kuwait. KMEFIC prepared this report using publicly available information, internal data, and other sources considered reliable; however, KMEFIC makes no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability with respect to the report or the information, analysis, opinions, or related graphics contained on the report for any purpose. While great care has been taken to ensure that the facts stated are accurate, neither KMEFIC nor any of its employees shall be in any way responsible for the contents. Neither this document nor any of its contents may be distributed in any jurisdiction where its distribution is restricted by law. Neither this document nor its content may be copied, transmitted or distributed without the prior written consent of KMEFIC. Additional information on the contents of this report is available on request.



م.ك.م.المالي ش شرآة الكويت والشرق األوسط لإلستثمار

+)965( 63222525: فاآس –+) 965( 22255000: هاتف –13009صفاة الكويت 819.ب.صKuwait and Middle East Financial Investment Company K.S.C.C P.O.Box 819 Safat 13009 Kuwait – Telephone: (+965) 22255000 – Fax: (+965) 22252563 [email protected] – www.kmefic.com.kw

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