Saudi cement sector faces another difficult quarter

The second quarter of 2010 will be another difficult quarter for the cement sector in Saudi Arabia, according to the latest NCB Capital report.

"The cement sector reported poor results in 1Q10 with net income down by 0.8 per cent for the eight listed companies, despite these eight companies selling 15 per cent more in terms of volumes year-on-year," said the report. "We expect the six covered stocks to increase sales volumes by some eight per cent y-o-y in 2Q10."

"Yamama was the standout company with net income up 31 per cent y-o-y in 1Q10. The weak numbers for the sector but strong performance by Yamama is in line with our cautious view on the sector, but overweight rating on Yamama."

 

Flat first quarter

Revenues for the Saudi Arabia-listed cement sector increased by eight per cent in 1Q10 y-o-y to SR2,114 million (Dh2,070m) with Yamama showing the best growth at 35 per cent and Yanbu reporting the weakest with revenues declining by 14 per cent. Gross income for the sector was flat at SR1,111m in 1Q10 with Yamama showing the best growth at 27 per cent and Arabian reporting the weakest figure with gross profit down by 22 per cent.

"We believe profitability suffered at Arabian Cement due to a mechanical problem at one of the lines leading to its shutdown for around a month," said the NCB Capital report.

Gross margins for the sector fell by four per cent to 53 per cent. Net income for the sector fell by one per cent to SR1,008m in 1Q10 with Yamama showing the best growth at 31 per cent and Arabian reporting the weakest, down by 21 per cent. Net income margins for the sector fell by four per cent y-o-y to 48 per cent in 1Q10. Total sales volumes for the Saudi cement sector increased by 26 per cent to 11,670 million tonnes in 1Q10.

For the eight listed stocks, total volumes increased by 14.6 per cent to 9,184 million tonnes; sales volumes increased by 93.8 per cent to 2,486 million tonnes for the four private cement companies in Saudi Arabia. From the listed companies, Yamama recorded the best growth at 37 per cent and Yanbu reporting the weakest, down by seven per cent.

The average price of cement per tonne for the eight listed stocks fell by six per cent y-o-y to SR228, and down one per cent quarter-on-quarter. The average cost of cement per tonne increased by two per cent y-o-y to SR107, although it was down nine per cent q-o-q. This was primarily due to Arabian Cement, where q-o-q costs fell by 24 per cent as in 4Q09 it had stopped production at one of its lines leading to a sharp increase in the cost per tonne recorded here.

 

Cautious views

"The results are in line with our sector update dated March 30, 2010. We highlighted our cautious view on the sector as a whole due to concerns on oversupply in the market, the ongoing conditional export ban, as well as intensifying competition from existing private players and new companies coming online. We stated that although volume growth should be impressive, the reported financials will not match this due to the mentioned sector-side concern," added the NCB Capital report.

The firm believes 2Q10 will be another difficult quarter for the cement sector. "For the six covered stocks, we expect revenues to increase by 3.3 per cent with gross profit remaining flat and net income declining by 2.3 per cent. Prices are set to remain weak, falling by three per cent y-o-y and flat q-o-q to SR231, we believe," said the report.

"Although we expect total volume growth in the sector to be around 18 per cent in 2Q10, this is eight per cent lower than the 26 per cent y-o-y growth seen in 1Q10. Additionally, an increasing amount of this extra volume will continue to go to private players."

Yamama Cement was the only company that managed to increase prices q-o-q, by two per cent.

"We believe this is due largely to the location of Yamama Cement near Riyadh where most of the cement demand in KSA is currently concentrated, thus allowing it to charge a location premium. Total sales volumes for the covered stocks increased by 15 per cent y-o-y in 1Q10, 11 per cent slower than for the sector as a whole when private companies are included," said the report. "We believe the increasing market share going to the private players is a key threat to the listed companies; based on the latest data (end of May 2010), private players had a 22 per cent share of the domestic market against 14 per cent a year ago.

"Saudi Cement is down 11 per cent since our initiation leading to our upgrade on the stock to neutral. It has been able to leverage on its high stock levels by meeting demand easily. However, this has not been met by similar profitability growth due to lower margins from its high transport costs/low cement prices. We remain cautious on the stock, but believe concerns are now reflected in the share price."

With a mixed outlook, the firm remains neutral on Qassim Cement.

"2Q10 is set to be another weak quarter for Qassim as it is expected to report weak sales volume data leading to poor financials, in contrast to 1Q10. Sales volumes increased by an impressive 19 per cent at Qassim in 1Q10. However, due largely to a fall in cement prices, the financial performance was not as impressive with gross income up only three per cent and net income down by four per cent. With easy access to key raw material inputs coupled with a highly efficient workforce and technologically advanced plant, Qassim produced cement at SR96 per tonne in 1Q10 versus the industry average of SR109 per tonne," it said.

"In an industry facing pricing pressure, Qassim's low-cost status is a key advantage for the stock. Due to the poor outlook, we remain neutral on Qassim. At 11.4x 2010e price-earnings ratio, 7.5 per cent above the sector average, Qassim looks expensive from a valuation perspective. However, its expected dividend yield of 7.4 per cent is amongst the highest in the sector. With fundaments weak though, dividends alone are not enough for us to become buyers of the stock."

The firm has upgraded Eastern Cement to neutral, largely based on its low valuation against peers.

"Eastern announced on May 31 that it had started operations on its SR117m power generation plant. We view this as a positive given the risk that subsidies from the government on power could be reduced leading to cost pressures for those companies fully reliant on the government for power," it said.

"Although we are cautious on the fundamental outlook for Eastern, it has underperformed the Tasi by seven per cent and the sector by six per cent since our downgrade to underweight. It is currently trading at 9.2x 2010 P/E, a 13 per cent discount to peers leading us to believe most of the poor outlook is now priced in to the stock."

 

Ideal location

NCB Capital maintained an overweight on Yamama Cement with upside of 21 per cent. "Yamama is well located to take advantage of the increased momentum of the construction sector in 2010, particularly in the Central region. A low-cost base and self-integrated plant remain key positives for the stock," it said. "2Q10 is set to be relatively weak for Yamama due to the floods and sandstorms seen in Riyadh in April/ May that led to intermittent shutdowns in construction projects.

But the Central region remains the centre of cement demand in Saudi Arabia and Yamama is ideally positioned to benefit.

"Around 35 per cent of the total Saudi cement demand is based in the Central region. Due to its location just outside Riyadh, Yamama is ideally located to meet this demand and will incur minimal logistical costs in the process. We believe over 90 per cent of Yamama sales are focused in the Central region."

Yamama currently trades at 10.2x for 2010e P/E, below the industry average of 10.6x. "However, we believe its advantageous location and ability to meet new demand will enable it to trade at least at par with the industry average, going forward," added the report.

The report remains neutral on Yanbu Cement as it continues to be cautious on the fundamental outlook.

"It continues to suffer from its old lines and the slow pace of demand momentum in the Western region. Yanbu's average cement price in 1Q10 was SR235 per tonne, 0.9 per cent ahead of the sector, helping limit its top-line declines. We believe it will be able to maintain a small price premium over its peers due its location advantage close to the demand points in the western region," it said. "Yamama had a torrid 1Q10, but this has been reflected in its stock performance where year to date, it has underperformed the sector by 12 per cent and the Tasi by 15 per cent. It trades at 10.1x 2010 P/E, with a six per cent discount to peers. We maintain our neutral rating."

In most cases, the firm has lowered its 2Q10 and 2010 sales volume forecasts for the stocks under coverage. The notable exceptions are Eastern Cement, where due to the company starting to sell clinker in Saudi Arabia to replace low cement sales, overall 2010 sales volumes are set to be 12 per cent higher than previously expected.

Saudi Cement is also expected to sell 19 per cent more cement than it previously envisaged.

"The caveat with the above point is that in both Eastern and Saudi cement's instances, we believe lower prices are being used to aide volume growth, hence these increases in sales volume growth are not fully translated into the financials. Conversely, we believe the likes of Southern and Yanbu will try to keep a premium to the sector average prices, thus leading to their financials not being as bad as the volumes data may suggest," said the report. "We believe some of the extreme weather seen in Riyadh (flooding and sandstorms) will lead to a softer than expected performance from the companies with exposure to the Central region; principally Yamama, but also Qassim."

The firm continues to remain cautious on the sector with oversupply, the export ban and increased competition expected to lead to continued pressure on cement prices and market shares of the companies.

"In our view, the main positive of the sector remains the high dividends, with yields in many cases above seven per cent. We expect the six covered stocks to increase sales volumes by some eight per cent y-o-y in 2Q10," it said.

Strong volumes, mixed financials expected in Q2

The report expects revenues to increase by 20 per cent to SR427 million (Dh418m) in 2Q10 with net income increasing by nine per cent to SR182m.

"2Q10 is expected to be a repeat of 1Q10. Despite sales volumes increasing by 30 per cent in 1Q10, revenues increased by only 17 per cent, with net income increasing by only 16 per cent to SR177m. We believe Saudi Cement was charging prices around three per cent lower than the sector average. This, coupled with the implicit high transport costs present for the firm, we believe, led to net margins of 43 per cent against 47 per cent for peers," it said.

The firm downgraded Southern Cement to underweight due to increased competition, particularly from its local private peer Najran Cement. "This is exacerbating the existing sector-wide issues leading to a poor outlook, with limited catalysts in the medium-term to change this; we are cautious on Southern."

Southern reported the second worst sales volumes figures in the sector, down by two per cent against the 26 per cent increase the sector as a whole saw.

"We believe Najran is aggressively marketing its cement, leading to increased pressure on Southern. In 1Q10, Najran increased its sales volume by 139 per cent and took its market share to 6.2 per cent from 3.3 per cent," it said. "With Southern faring worse than expected against the competition, we downgrade the stock to underweight. Southern is trading at a P/E of 13.6x 2010e earnings, above the industry average of 10.6x."