Share Data Bloomberg Symbol OCIC.EY Reuters Symbol OCIC.CA Market Cap (EGP) 50,695,155,000 Number of Shares 206,919,000 Free Float 38.00% Price-to-Earnings 13.7 Price-to-Book 3.2 Share Performance Source: Reuters -3.00% 1 Month Return 5.16% 3 Month Return -9.38% 6 Month Return -6.99% 12 Month Return 292 - 204 52 Week Range Initiating coverage with a HOLD Recommendation and a Fair Value of EGP 270 per share based on the channels of analysis below Fertilizer pricing and market dynamics favorable for growth Orascom’s fertilizer business continues to lead growth with revenues increasing by two-fold in 2010 and accounting for almost half of the company’s EBITDA. This will be further boosted during 2011 by rising prices and solid market dynamics. Overall, global demand of Nitrogen fertilizers is expected to expand by 15% through 2014 on increasing agricultural needs. Coupled with relatively high oil prices and significant exposure to stable markets in Europe, we anticipate prices to be on the rise during 2011-2013 with Orascom perfectly positioned to take advantage of this trend. Revenues surged during 2010 but a mild decline is expected for 2011 Net income reached EGP 3.65 billion in 2010, a 51% rise over 2009’s reported earnings on a better than expected performance from the fertilizer sector and an almost unchanged construction contribution. We estimate OCI’s revenues to slightly decline to EGP 27.1 billion in 2011 compared to 27.6 billion in 2010. Fertilizer revenues are expected to post a hefty 27% Y-O-Y increase vs. construction’s 13% revenue decline. As per management guidance, we can expect to see growth in capacity for some of its fertilizers effective 2012. Construction backlog estimated to decline in the short term The market outlook for Orascom’s construction business, which constituted 70% of revenue and 49% of EBITDA during 2010, remains weak for 2011. The company reported a backlog of USD 5.62 billion through 2010, 15% lower than the previous year. We expect to see further declines in 2011 as the potential for new business continues to weaken in Orascom’s major markets - Egypt and Algeria - comprising almost 40% of backlog. Growth may resume in 2012 provided the geopolitical situation in the region calms down and Egypt’s new political system takes shape. 245 Share Price (EGP): Equity Research – Initiation of Coverage 270 Fair Value (EGP): Construction/Fertilizers Sector: 10% Upside: Egypt Country: HOLD Recommendation: May 16, 2011 Date: Orascom Construction Industries Stock trades at discount with potential for appreciation___ We estimate OCI’s fair value at EGP 270 per share using a Sum-of-the- parts methodology with 38% attributed to the construction segment versus 62% to the growing fertilizer group. When comparing OCI to an average composite, we find that it is considerably undervalued with a P/E of 13.7 as opposed to 19.3 for its peers. The company’s earnings are projected to remain considerably high in 2011, hence providing a possibility for share price appreciation as geopolitical risks settle and a new Egyptian president is elected. ﻟﺘﺪاول ﻣﺼﺮ ﺑﻠﻮم اﻟﻤﺎﻟﻴﺔ اﻷوراقBLOMINVEST BLOM EGYPT SECURITIES BANK Performance and Forecasts Year 2008 2009 2010 2011e 2012f 2013f Revenues (EGP billions) 20.3 21.3 27.6 27.2 28.9 32.0 Net Income (EGP billions) 5.4 2.6 3.7 4.0 4.5 4.8 EPS (EGP) 25.8 11.7 17.7 19.5 22.0 23.4 BVPS (EGP) 72.9 71.1 76.1 75.6 79.0 88.0 ROA (%) 7.9 5.7 7.3 7.6 8.6 9.0 ROE (%) 12.1 15.1 21.7 23.4 25.8 25.4 Source: Company Historicals and Blominvest Estimates Contact Information: Equity Analyst: Karim Houri [email protected]Senior Equity Analyst: Issa Frangieh [email protected]Research Analyst: Nader Ali Khedr [email protected]Head of Research: Marwan Mikhael [email protected]Subject to Disclaimer on Last Page
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Share Data
Bloomberg Symbol OCIC.EY
Reuters Symbol OCIC.CA
Market Cap (EGP) 50,695,155,000
Number of Shares 206,919,000
Free Float 38.00%
Price-to-Earnings 13.7
Price-to-Book 3.2
Share Performance
Source: Reuters
-3.00% 1 Month Return
5.16% 3 Month Return
-9.38% 6 Month Return
-6.99% 12 Month Return
292 - 204 52 Week Range
Initiating coverage with a HOLD Recommendation and a Fair Value of EGP 270 per share based on the channels of analysis below
Fertilizer pricing and market dynamics favorable for growth Orascom’s fertilizer business continues to lead growth with revenues increasing by two-fold in 2010 and accounting for almost half of the company’s EBITDA. This will be further boosted during 2011 by rising prices and solid market dynamics. Overall, global demand of Nitrogen fertilizers is expected to expand by 15% through 2014 on increasing agricultural needs. Coupled with relatively high oil prices and significant exposure to stable markets in Europe, we anticipate prices to be on the rise during 2011-2013 with Orascom perfectly positioned to take advantage of this trend.
Revenues surged during 2010 but a mild decline is expected for 2011 Net income reached EGP 3.65 billion in 2010, a 51% rise over 2009’s reported earnings on a better than expected performance from the fertilizer sector and an almost unchanged construction contribution. We estimate OCI’s revenues to slightly decline to EGP 27.1 billion in 2011 compared to 27.6 billion in 2010. Fertilizer revenues are expected to post a hefty 27% Y-O-Y increase vs. construction’s 13% revenue decline. As per management guidance, we can expect to see growth in capacity for some of its fertilizers effective 2012.
Construction backlog estimated to decline in the short term The market outlook for Orascom’s construction business, which constituted 70% of revenue and 49% of EBITDA during 2010, remains weak for 2011. The company reported a backlog of USD 5.62 billion through 2010, 15% lower than the previous year. We expect to see further declines in 2011 as the potential for new business continues to weaken in Orascom’s major markets - Egypt and Algeria - comprising almost 40% of backlog. Growth may resume in 2012 provided the geopolitical situation in the region calms down and Egypt’s new political system takes shape.
245 Share Price (EGP): Equity Research – Initiation of Coverage 270 Fair Value (EGP):Construction/Fertilizers Sector: 10% Upside:Egypt Country: HOLD Recommendation: May 16, 2011Date:
Orascom Construction Industries
Stock trades at discount with potential for appreciation___ We estimate OCI’s fair value at EGP 270 per share using a Sum-of-the-parts methodology with 38% attributed to the construction segment versus 62% to the growing fertilizer group. When comparing OCI to an average composite, we find that it is considerably undervalued with a P/E of 13.7 as opposed to 19.3 for its peers. The company’s earnings are projected to remain considerably high in 2011, hence providing a possibility for share price appreciation as geopolitical risks settle and a new Egyptian president is elected.
األوراق المالية بلوم مصر لتداول BLOMINVEST BLOM EGYPT SECURITIES BANK
Cash / Current Liabilities 0.56 0.38 0.29 0.27 0.28 0.30 Current Assets / Current Liabilities 1.35 1.25 1.14 1.05 1.09 1.16 Net Working Capital / Current Assets 0.26 0.20 0.12 0.05 0.08 0.14
STRATEGY ...................................................................................................................................................... 11 Fertilizer Segment to Lead Growth ...................................................................................................... 11 Revenue Expansion in Growing Markets ............................................................................................ 11 Cost Control ............................................................................................................................................. 11 Brand Associated with Top Quality and Competitive Pricing .......................................................... 12 Government Partnerships ...................................................................................................................... 12
OUTLOOK ...................................................................................................................................................... 13 Construction Backlog Continues to Decline ....................................................................................... 13 New Awards Expected to Continue Slump during 2011 .................................................................. 13 Reliance on Regional Infrastructure Investments .............................................................................. 14 Fertilizer Market Tied to World Demand for Food and Energy ........................................................ 14 Expectations for Fertilizer Prices & Capacity ....................................................................................... 15
I – List of Comparable Peers ................................................................................................................. 28
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ORASCOM CONSTRUCTION INDUSTRIES
INVESTMENT SUMMARY
We are initiating a HOLD recommendation on Orascom Construction Industries (OCI) shares after
carefully analyzing the following:
Business Model
OCI is a leading construction contractor and fertilizer producer on a regional and international
scale. The company actively pursues contracts in various sectors but the preponderance of its
contracts consist of infrastructural works; ranging from building transportation projects to raising
power plants as well as a multitude of industrial and commercial ventures. More than 60% of its backlog consists of infrastructure while the rest is split between industrial and commercial
contracts. The grand majority of its backlog springs from the MENA region with Egypt, Algeria
and GCC countries leading way. In the span of a few years, the group has become a major player
in Nitrogen based fertilizers with a total production capacity of over 4.84 mtpa as of late 2010 with a target of 7.75 mtpa in 2012. Fertilizer revenues have followed an increasing trend and have
grown in importance in relation to the weight of the total revenue mix.
Profitability Net income reached EGP 3.65 billion in 2010, a 51% surge over 2009’s sharp fall to 2.53 billion
that was weighed down by the slowdown. This recovery in large part is due to the better than
expected performance from the fertilizer sector and an almost unchanged construction
contribution. Despite a lower share in revenue, fertilizers possess the advantage of having higher gross margins than construction which permits for a higher gross profit contribution. We estimate
gross margin for fertilizer in 2011 to be around 40%, significantly higher than construction’s near
20% margin. Construction COGS hover in the 80% range and are somewhat stable. We estimate
ROA to slightly increase to 7.6% in 2011 with ROE nearing 24%. Both ratios are expected to
fluctuate around these levels in the coming years as the fertilizer operations start to turn in more profits and as the construction sector recovers.
Growth
We expect OCI’s revenues to slightly decline in 2011 to reach EGP 27.1 billion compared to 27.6 billion in 2010. Growth is estimated to record a CAGR of 5.7% for the 2011-2014 timeframe. In our
model, fertilizer revenues are expected to post a hefty 27% Y-O-Y increase in 2011 vs.
construction’s 13% revenue decline. As per management guidance, we can expect to see growth
in capacity for some of its fertilizers effective 2012. OCI reported a backlog of USD 5.62 billion through 2010, 15% lower than what was reported in
2009. The stagnating and even diminishing backlog has been attributed to a slowdown in
construction activity and real estate in both the regional and international fronts. This decline
began in the year superseding the credit crunch that interrupted OCI’s exceptional performance in 2008 where backlog grew by 46% to around USD 7 billion. We expect this decrease to persist
through 2011 but we anticipate a rebound in construction activity and a return to backlog growth
during 2012.
Financial Position OCI’s liquidity ratios have conjointly followed a feebly-sloped downward trend from 2008 to 2010
as more borrowings and liabilities reached maturity. We see them continuing to decline in 2011
but stabilizing in 2012. Orascom’s current ratio is estimated at around 1.05 in 2011 with the quick
ratio also reaching a low of 0.27. OCI has held the reputation of being a cash-rich company as witnessed by its high cash balances of nearly EGP 5.5 billion in 2010. With ongoing expansion
plans and acquisitions in an otherwise slowing market, OCI maintained its capital expenditures in
order to remain competitive causing reliance on debt to surge from 2008 onwards. We expect a
debt to equity ratio of around 90% in 2011, with a possible gradual decline to start in 2012 as no
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ORASCOM CONSTRUCTION INDUSTRIES
new plans for acquisitions or expansions are in sight for the short term. OCI’s interest coverage
ratio has fluctuated between 5 and 6 during 2008 - 2010, which is associated with a relatively safe investment. As earnings improve along with little debt issues, we see the ratio climbing to 8.
Valuation
We estimate OCI’s fair value at EGP 270 per share using a Sum-of-the-parts (SOTP) methodology with 38% attributed to the construction segment versus 62% to the growing fertilizer group. Both
lines of business were valued using a discounted cash flow (DCF) model with a WACC of 11% for
fertilizer and 13% for construction; 2% was added to construction due to its high concentration in
the Middle East. As per management guidance, weighted average selling prices and capacity were provided for each product from each plant constituting the basis of our analysis.
When comparing OCI to an average composite, we find that it is considerably undervalued with a
P/E of 13.7 as opposed to 19.3 for its peers. This temporary discount that OCI trades at accounts
for the unrest that occurred recently in Egypt and the region, where the company’s construction
business mostly operates. However, OCI’s revenues and earnings surged during 2010 and are expected to remain considerably high in 2011, hence providing a possibility for share price
appreciation as the situation settles.
Dividends Historically, OCI has been consistently distributing dividends bi-annually since 2008. Besides its
large 300 EGP/share offered in march of 2008 which disbursed most of its earnings from the sale
of the cement group, the usual semi-annual dividend offered amounts to around 5 EGP or the
equivalent of 1 USD. The company’s dividend payout ratio is around 45% of net earnings.
Risks
While unrest has settled in Egypt, a key market for Orascom, uncertainty continues in several
markets that present a growth opportunity for the company. This may cause a delay in gaining new awards and have an adverse effect on its backlog since sovereign projects constitute a major
share of Orascom’s construction business.
Another key concern is the competitive environment in the construction business. With the sector
going through successive booms in the region, the market is now flooded with strong competitors on both the local and international levels with whom OCI has to contend in bidding
for new contracts.
The company’s reliance on commodity prices is another notable risk since these fluctuate
aggressively as witnessed globally by the large spikes and sharp falls across the board. A drop in
commodities would signify a decrease in fertilizer prices and hence a drop in profitability. Specifically, oil has a direct impact on its fertilizer business; as oil prices increase, fertilizer prices
follow suite resulting in higher profitability. On the other hand, oil prices have an indirect effect on
its construction business; a considerable portion of Orascom’s backlog comes from oil-exporting
countries whose budgets rely on oil prices. The mounting tensions between the Egyptian and Algerian governments that occurred during the
summer of 2010 present another growth-impeding risk. Sorfert Algerie, an OCI fertilizer
subsidiary, is set to begin operations in 2011 and could face hindrances from the local
government that may hurt its profitability.
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ORASCOM CONSTRUCTION INDUSTRIES
COMPANY PROFILE
Orascom Construction Industries (OCI) is a leading construction contractor and fertilizer producer on a regional and international scale. It was originally founded in 1976 by Onsi Sawiris as a
general contracting and trading company based in Cairo and has grown into one of Egypt’s
largest corporations employing over 84,000 employees and workers. Throughout the years, the
construction group has positioned itself as one of the most prominent contractors in the MENA region, scoring multi-million dollar contracts from various locations. The newly acquired and
growing fertilizer segment represents a means of diversification as well as an alternative
independent revenue stream. Since its inception in the mid 2000’s, the nitrogen based fertilizer
group has grown to rank amongst the top 5 nitrogen fertilizer producers worldwide in terms of capacity. This sector shows substantial room for growth through continuous investments as
witnessed by the acquisition of new plants and the erection of others in different countries.
Share Ownership OCI made its initial public offering (IPO) on March of 1999, offering 14% of its outstanding shares
(8.63 million shares) with a par value of USD 12.50/share. Ordinary shares are listed on the Cairo
and Alexandria Stock Exchange (CASE) whereas its GDR shares are listed on the London Stock
Exchange (LSE) at a 1:1 ratio since 2009. Further issues followed suit bringing the total of shares
issued to 206,918,461. The Sawiris family collectively controls 55% of the outstanding shares of the company.
Source: OCI
Board & Management
Mr. Nassef Sawiris Chairman & CEO
Mr. Onsi Sawiris Chairman & Non-Executive Director
Mr. Salman Butt CFO
Mr. Osama Bishai Managing Director for Construction Group
Mr. Karim Camel-Toueg Director & Contrack President Mr. Nicolas Estay Executive Vice-President (Europe)
Mr. Kevin Struve Strategic Planning Director
Ms. Dalia Khorshid Corporate Treasurer
Mr. Fady Kiama Corporate Controller
Mr. Hassan Badrawi Director Business Development Mr. Hussein Marei General Counsel
Ms. Heba Iskander Corporate Development Director
Mr. Sherif Tantawy CFO Construction Group
Mr. Johan Beerlandt CEO BESIX Group Mr. John Baracat Managing Director NSF
Mr. Hossam Khattab Managing Director EFC
Mr. Amr Hassaballah Managing Director EBIC
Mr. Hesham Abdelsamie Director of Subsidiaries
Source: OCI
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ORASCOM CONSTRUCTION INDUSTRIES
Subsidiaries and Associates
OCI operates through wholly as well as partially owned subsidiaries in both construction and fertilizer segments.
Subsidiary Ownership
Construction
Orascom Construction 100%
BESIX Group 50%
Contrack 100%
Construction Materials
National Steel Fabrication 100%
United Paint and Chemicals 56.5%
United Holding Company 56.5%
Alico Egypt 50%
National Pipe Company 40%
SCIB Chemical 15%
Fertilizer
Egyptian Fertilizers Company 100%
Egypt Basic Industries Corporation 100%
OCI Nitrogen 100%
Sorfert Algerie 51%
Associate
Notore Chemical Industries 13.5%
Gavilon 16.8%
Source: OCI
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ORASCOM CONSTRUCTION INDUSTRIES
BUSINESS MODEL Revenue Mix OCI derives its revenue stream from two distinct business segments: a construction group which
has constituted the core of the company’s operations since its establishment and a newly
founded nitrogen fertilizer production group.
Source: BlomInvest
Construction Group: Throughout the years, OCI’s brand has become synonymous with a degree
of quality and competency in the MENA region allowing the company to contend in diverse markets and competitive bids for new contracts. The company actively pursues contracts in
various sectors but the preponderance of its business consist of infrastructural works; ranging
from building transportation projects to raising power plants as well as a multitude of industrial
and commercial ventures. In 2009, 60% of its backlog consisted of infrastructure while the rest was split between industrial and commercial contracts. In the last few years, the bulk of new
contracts awarded has stemmed from sovereign clients outgrowing those from its private
clientele. OCI operates through three entities, mainly: Orascom Construction, Contrack, and
BESIX. The company has also formed a 50/50 joint venture with Morgan Stanley to develop infrastructure in the MENA region.
Source: OCI
Fertilizer Group: OCI ventured into the fertilizer business in 2005 by acquiring Middle East Petrochemical Company (MEPCO) which held a 30% stake in EBIC. OCI later increased that stake
to 60% to control the majority of the company. With the divestment of its cement operations in
2007 by the sale of Orascom Building Materials Holding Co, a global cement producer, to Lafarge
SA, the firm was able to direct its attention to the fertilizer segment and expand its operations with the acquisition of EFC, DSM Agro & Melamine (now OCI Nitrogen), the erection of a new
plant in Algeria (Sorfert) as well as minority stakes in Notore and Gavilon. In the span of a few
years, the group has become a major player in Nitrogen based fertilizers with a total production
capacity of over 4.84 mtpa as of late 2010 with a target of 7.75 mtpa in 2012.
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ORASCOM CONSTRUCTION INDUSTRIES
Geographical Diversification
Through its acquisitions and investments in subsidiaries and associates, OCI benefits from a global presence in international markets asides its predominance in local markets for both
construction and fertilizer activities. Orascom construction has strong presence in emerging
markets across the Middle East and North Africa. Contrack and Besix, which are based in the
United States and Belgium respectively, provide OCI with exposure to the American and European market which were otherwise inaccessible. However, the grand majority of the backlog
springs from the MENA region with Egypt, Algeria and GCC countries leading way. During 2010,
both Europe and Asia constituted 15% of total backlog. The group maintains a well-diversified
backlog making it less prone to regional risks.
As for fertilizers, the recent takeover of Dutch-based OCI Nitrogen (formerly DSM Agro &
Melamine) as well as the minority stake attained in Gavilon, the largest distributor of fertilizers in
the US, allowed OCI to obtain this geographical diversification and offered the opportunity to
operate via different distribution channels and the ability to cater to different markets.
Source: OCI
Vertical Integration & Synergy The construction group owns and operates construction materials companies which consist of a
series of enterprises that specialize in the different phases of the construction process. From its
whose core businesses entail of paint, glass, steel, chemicals and aluminum, OCI benefits largely from this vertical integration. Their involvement in the process means that OCI secures its building
materials and necessities from inside sources which provide a more maneuverable approach,
prompter service while granting lower margins and minimizing costs.
OCI also benefits from synergies through ventures and acquisitions that extend to the fertilizer segment. A prime example would be Sorfert Algeria which is set to begin production in 2011. OCI
owns 51% of Sorfert while the remainder is owned by Sonatrach, the largest oil and gas company
in Algeria. Sonatrach signed an agreement to provide gas stock supply at a competitive cost for
the plant over a period of 20 years. This proves to minimize substantial cost for a major input in the production process. The close proximity of EBIC and EFC permits the plants to benefit from
synergies by facilitating the exchange of inputs and materials.
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ORASCOM CONSTRUCTION INDUSTRIES
Products & Services
With 60% of its backlog consisting of infrastructural works, OCI has been associated with this particular kind of activity capturing both soft and hard infrastructure contracts. Construction
expertise varies from building bridges, highways and railroads to water and energy plants to
telecommunications. With the advance of new technologies, OCI is gradually widening its
operating scope and reducing barriers for capturing new awards.
Fertilizers offered by OCI are mainly nitrogen based that vary by their nitrogen concentration and
their chemical composition. Since each type of fertilizer possesses different physical and
chemical characteristics, their usage varies as each would present advantages and disadvantages to the soil type and crop being grown.
At the base, anhydrous ammonia is amongst the cheapest and most commonly used
fertilizers. Most other commercial fertilizers are derived from it.
Urea contains 45-46% nitrogen content. On application, the nitrogen present in it gets converted into ammonia. It readily dissolves in water and is capable of showing quick
results.
UAN consists of a solution of Urea and Ammonium Nitrate. It has become popular
because it is more versatile as a liquid and is widely available. CAN is Ammonium Nitrate in crystallized from which is quick-acting but highly
hygroscopic.
Ammonium Sulfate (AS) contains only 21% nitrogen and is applied in dry form with no
nitrogen loss. It is a good source of sulfur that is an essential nutrient to plants. However it is acidifying and requires large quantities of lime to counteract the acidic effects.
Melamine, a derivative of urea, contains 66% nitrogen and is more expensive to produce
than other nitrogen fertilizers. Its nitrogen mineralization process is extremely slow,
making this product both economically and scientifically impractical for use as a fertilizer.
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ORASCOM CONSTRUCTION INDUSTRIES
STRATEGY Fertilizer Segment to Lead Growth The construction group has slowed in terms of growth relatively to that of the fertilizer segment
that has grown exponentially since inception and shows potential for more. Part of OCI’s strategy
is to catapult this segment which already ranks among the top 10 producers worldwide for
nitrogen fertilizers into the top 3. With the erection of Sorfert Algerie and the broadening of distribution channels, this target is highly likely. As for construction, despite the sluggish
performance that has ensued the global financial crisis, OCI remains strongly competitive in its
core markets but is recently weighed down by the regional upheaval.
Source: BlomInvest
Revenue Expansion in Growing Markets The Construction group recently conducted endeavors to solidify its presence in already
established markets such as the MENA region while penetrating new ones, mainly emerging
markets with strong construction opportunities such as India. OCI has been granted various
awards across the MENA such as a USD 675 million contract as part of the billion dollar Qatar development plan as well as a prior USD 750 million contract to expand the international airport.
The firm has also created a joint venture with Indian company HCC Infrastructure Limited (HIL) to
tender to projects issued by the National Highways Authority of India and have already begun to
grab part of the 11,854 km of roads and highway works that will be built.
Cost Control
Through vertical integration, OCI benefits from having the necessary capabilities of keeping its
margins in check despite volatile price environments. Since 2007, operating margin has averaged at 17% as a result of stable COGS (around 78% of total revenue) and constant SG&A.
Source: BlomInvest
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ORASCOM CONSTRUCTION INDUSTRIES
Brand Associated with Top Quality and Competitive Pricing
The OCI name and brand has been linked with top grade quality and efficiency in services and products offered at competitive prices. Through extensive years of experience in the field, the
contractor has gained a level of knowhow by overseeing various types of projects. Benefitting
from low cost margins has given OCI the ability to provide their service at favorable prices thus
giving an edge in the bidding process. A low cost player providing higher quality services are attributes that are favored thus giving OCI an advantage in gaining new awards. Customer
satisfaction is essential since the majority of their clientele consist of governments undergoing
infrastructural works; this gives rise to recurring businesses and the awarding of vast projects
which is more favorable and larger in size than those undertaken by private ones.
Government Partnerships
With almost 65% of its backlog stemming from sovereign clients, OCI has formed ties and
partnerships with many governments across the MENA region. In the GCC countries where it
conducts most of its business, OCI’s service is looked favorably upon in Qatar and UAE where no favoritism is exhibited towards local competitors. However, that is not the case in Saudi Arabia
where OCI’s exposure is weak due to the high barriers of entry and the availability of strong local
competitors which capture most of the new infrastructure projects.
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ORASCOM CONSTRUCTION INDUSTRIES
OUTLOOK Construction Backlog Continues to Decline OCI reported a backlog of USD 5.62 billion through 2010, 15% lower than 2009. The diminishing
backlog is attributed to a slowdown in construction activity on both the regional and international
fronts. This started in 2008 as countries in the GCC and the entire MENA region felt the effect of
the worldwide economic slowdown. We expect to see further declines in 2011 as the potential for new business continues to weaken
in Orascom’s major markets, such as Egypt and Algeria which constitute almost 40% of backlog.
Growth may resume in 2012 as the geopolitical situation in the region calms down and Egypt’s
new political system takes shape. Both infrastructure and real estate investment are key demands of revolutions in the region with their respective governments indicating strong support by
declaring massive spending plans. On a positive note, projects in Qatar, which constitute 20% of
Orascom’s backlog, are anticipated to continue growing as massive infrastructure projects take
place in preparation for the World Cup.
Source: OCI, BlomInvest
New Awards Expected to Continue Slump during 2011 New awards have experienced a phase of decline since 2008 where they reached a record USD
5.48 billion, almost 80% of total backlog for the year. In 2009, new awards slumped to USD 3.17
billion as a result of the slowdown in construction activity where the fourth Quarter of 2009
proved to be the worst in 4 years with a meager USD 360 million. New awards in 2010 showed no improvements as OCI reported weaker numbers than last year with USD 2.62 billion vs. 3.17
billion in 2009. We expect New Awards to continue declining throughout 2011 due to geopolitical
pressure that may slow demand for new construction. However, governments all over the MENA
have declared spending plans to update their infrastructure and increase housing supply which
would improve the company’s construction line-of-business. We expect this to begin appearing in Orascom’s operational and financial results in 2012.
Source: BlomInvest
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ORASCOM CONSTRUCTION INDUSTRIES
Reliance on Regional Infrastructure Investments
While the outlook for 2011 remains grim, we see new awards increasing in 2012 through augmented exposure to new markets and increased investment in key markets. Looking forward,
this sector shows promise, and with the advent of new development plans in various countries
throughout the GCC and MENA region, OCI’s strong competitive edge and competencies in its
field are guaranteed to make it capture an extensive portion of bids. Chief among these structuring plans are listed here below:
o On the domestic level, Egypt is planning development and infrastructural projects for USD
24 billion. The Algerian government has allotted USD 150 billion to spend on infrastructure
by 2013. o In the Gulf, Qatar has consorted significant restructuring and development plans that will
shape and direct the country’s future. The government is implementing new plans to erect
stadiums and to rearrange and renew infrastructure in preparation for the World Cup.
o In the UAE, Abu Dhabi announced that a major USD 300 billion package is underway for
construction and infrastructure. o As for Dubai, workload has slowed noticeably this past year upon suffering from the
effects of the debt crisis contrarily to Abu Dhabi. However, upon the restructuring of its
debt and improvements in its economy, activity is likely to resume.
o Saudi Arabia, a market in which OCI does not possess strong presence due to strong local competition, might see increased exposure as new plans are being implemented to
secure the long-term development of the country.
Fertilizer Market Tied to World Demand for Food and Energy Fertilizer markets overall whether potash, nitrogen or phosphate based took a downturn in 2009
but has firmly rebounded in 2010 and is expected to maintain sustained growth trends for the
coming four years. At the start of 2010, supply stagnated due to slower than anticipated growth in
capacity. However, we expect a surplus to run for nitrogenous fertilizers in the long run due to capacity growth overtaking that of demand. Fertilizer production and consumption remain tied to
the health of the global economy. As the economic recovery progresses, the agricultural market
fundamentals are stabilizing and thus increasing agricultural needs to meet world demand for
food and energy. Overall, global trade of Nitrogen fertilizers is expected to expand by 15% through 2014. In the short-run however, OCI has benefitted from favorable market dynamics in
2011: Competitors from Ukraine and China are experiencing rising cash costs in production while
exports from Russia, China and Ukraine are constrained due to the surge in domestic
consumption.
Source: Blominvest
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ORASCOM CONSTRUCTION INDUSTRIES
Expectations for Fertilizer Prices & Capacity
As prices bottomed in 2009, they did not gain as much momentum as was expected in 2010. However, we are witnessing a gradual recovery and we expect prices to be on the rise during
2011-2013. As stated above, capacities aren’t experiencing much growth. Worldwide
expectations remain positive over a four year time scale. For OCI, as per management guidance,
we can expect to see growth in capacity for some of its fertilizers effective 2012. Year by year, the fertilizer segment grows in importance. The acquisition of DSM Agro & Melamine now known as
OCI Nitrogen which outperformed in the first half of the year plays a pivotal role in the expansion
plans of the group as it has gained the capability to access new markets such as Europe and
China. The erection of Sorfert in Algeria will also increase their foothold in the continent as well secure their domination in the nitrogenous fertilizer world.
Source: Blominvest
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ORASCOM CONSTRUCTION INDUSTRIES
RISKS Outlined here are some of the main hurdles that could threaten to slow OCI’s growth and affect revenue hence shrinking profitability:
Delay in Demand for Construction
While unrest has settled in Egypt, a key market for Orascom, uncertainty continues in several markets that present a growth opportunity for the company. This may cause a delay in gaining
new awards and have an adverse effect on its backlog since sovereign projects constitute a major
share of Orascom’s construction business. Plans to update infrastructure and increase housing
supply are already being proposed by several Middle Eastern governments in response to protester demands. However, actual construction and contract signing may lag until political risks
in the region decline.
Increased Competition in an Already Saturated Market OCI’s construction division benefited from large margins early on due to the unavailability of
equally experienced construction companies. However, with the advances made to the sector
ensuing successive construction booms in the region, the market is now flooded with strong
competitors on both the local and international level with whom OCI has to contend in the bidding for new contracts.
Algerian Government Squabbles
With mounting tensions between the Egyptian and Algerian governments that occurred during the summer of 2010, the outlook in Algeria remains uncertain for Egyptian companies. Orascom
Telecom already faced some backlash with Djezzy, its Algerian operations as the government
imposed high taxes and pushed for a hostile takeover. Sorfert which is set to begin operations in
the first half of 2011 could face hindrances from the local government, thus affecting its
profitability.
Fluctuating Commodity Price Cycles
Most commodity prices move concomitantly as witnessed globally by the large spikes and sharp
falls across the board. OCI’s reliance on commodity prices is apparent in both business segments. Specifically, oil has a direct impact on its fertilizer business; as oil prices increase,
fertilizer prices follow suite resulting in higher profitability. On the other hand, oil prices have an
indirect effect on its construction business; a considerable portion of Orascom’s backlog comes
from oil-exporting countries whose budgets rely on oil prices. As oil prices increase, thicker budget surpluses encourage them to invest in new construction projects.
Another key commodity that affects Orascom’s fertilizer business is natural gas, as it constitutes
a large part of the costs. Despite having contractual agreements to have gas supplied at fixed prices, some contracts are about to expire such as OCI Nitrogen in 2012 (paying $5/MMBTU)
which may push the company to pay spot prices that are expected to average $7/MMBTU in 2012
based on futures.
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ORASCOM CONSTRUCTION INDUSTRIES
FINANCIAL ANALYSIS Revenues We expect OCI’s overall revenues to stagnate in 2011 due to the regional turmoil that may cause
a temporary slowdown in new orders for construction. However, the company’s strategy to
propel the fertilizer group coupled with a recovery in fertilizer prices will help spark an increase in
revenues. We expect fertilizer revenues to post a hefty 27% Y-O-Y increase vs. construction’s languorous 4% in 2011. Fertilizers are gradually capturing a larger part of total revenues,
estimating growth to record a CAGR of 16.1% for the 2010-2014 timeframe.
Source: BlomInvest
Gross Margins Despite lower revenue contributions, fertilizers possess the advantage of having higher gross
margins than construction which permits for a higher gross profit contribution. We estimate gross
margin for fertilizer in 2011 to reach 44%, significantly higher than construction’s near 20%
margin. Construction COGS hover in the 80% range and are somewhat stable while fertilizer costs are more variable and are forecasted to near 60% in the future. In 2011, we estimate around EGP
4.2 billion of gross profit from fertilizer compared to EGP 3.2 billion from construction.
Source: BlomInvest
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ORASCOM CONSTRUCTION INDUSTRIES
Earnings
Net income is estimated to reach EGP 4 billion in 2011, an 11% rise over 2010’s reported earnings of EGP 3.65 billion. This increase in large part would be due to the favorable environment for
fertilizer sellers as demand continues to expand and high oil prices allow gross margin
enhancements. OCI nitrogen has been consistently beating estimates with better than expected
results, and Sorfert Algeria which is on track to begin operations in 2011 will give an important boost to fertilizer revenues. Despite an expected sloppy performance in the construction sector
for 2011, we anticipate an expansion for 2012 with higher awards granted and a return to backlog
growth by year end.
Source: BlomInvest
Liquidity
OCI’s liquidity ratios have conjointly followed a feebly-sloped downward trend since 2008 as more
borrowings and liabilities reach maturity. However, we see them stabilizing near our 2012 estimates. The company’s current assets have always been greater than its current liabilities while
the cash ratio, a measure of cash availability, will remain around 0.30. OCI has held the reputation
of being a cash-rich company as witnessed by its high cash balances of nearly EGP 5.4 billion in
2010.
Current Ratio = Current Assets / Current Liabilities
Cash Ratio = Cash / Current Liabilities
Net Working Capital (NWC) Ratio = (Current Assets – Current Liabilities) / Current Assets
Source: BlomInvest
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ORASCOM CONSTRUCTION INDUSTRIES
Leverage
With ongoing expansion plans and acquisitions in an otherwise slowing market, OCI continued the same level of capital expenditures in order to remain competitive. Reliance on debt
experienced a surge from 2009 and its capital structure mix was varied with more leverage
factored in. For example 70% of the Sorfert plant’s investment cost was debt-financed as the
company tapped a EUR 1.064 billion loan facility. Consequently, this had for effect of pushing up the debt equity ratio by 25% in 2009. We expect the ratio to start a gradual decrease during 2011
as no new plans for acquisitions or expansions are in sight for the short term. OCI’s interest
coverage ratio was around 7 in 2010, which is considered a relatively safe investment. As
earnings improve along with little debt issues, we see the ratio climbing to the 8-10 range.
Source: BlomInvest
Profitability
We estimate a slight increase in ROA to reach 7.7% in 2011 along with ROE rising to 23%. Both
ratios are expected to improve further in 2012 as the fertilizer operations start to turn in more profits and construction recovers from a slowdown in orders. In 2010, OCI’s ROA experienced a
boost to reach 7.3% from 5.7% in 2009. This in large part is due to a recovery in earnings from
the prior year where both business segments were under pressure.
.
Source: BlomInvest
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ORASCOM CONSTRUCTION INDUSTRIES
Dividends
Historically, OCI has been consistently distributing dividends bi-annually since 2008. Besides its large 300 EGP/share offered in march of 2008 which disbursed most of its earnings from the sale
of the cement group, the usual dividend offered amounts to around 5 EGP or the equivalent of 1
USD. The company’s dividend payout ratio is around 45% of net earnings.
Date Price/Share (EGP) Div./Share (EGP) Div.Yield
30-Jun-08 367.00 5.00 1.36%
21-Sep-08 326.11 5.48 1.68%
25-Mar-09 144.86 5.63 3.89%
27-Sep-09 245.30 4.40 1.79%
29-Mar-10 267.22 5.50 2.06%
13-Sep-10 257.74 5.71 2.21%
07-Apr-11 248.50 5.70 2.29%
Source: OCI, BlomInvest
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ORASCOM CONSTRUCTION INDUSTRIES
COMPARABLE ANALYSIS When studying a company, we find it necessary to see how it compares to its peers from three
standpoints:
1. Profitability Comparison: Indicative of how efficiently the company is managing its
expenses through different margin analysis (Gross Margin, Operating Margin, Net Income)
2. Relative Valuation: Shows how the market perceives the company as opposed to its
peers (overvalued, undervalued, or fairly valued)
3. Management Efficiency: Shows how well management is utilizing its assets and equity to generate earnings.
Comparable Firms
We stratify our selection to companies that operate in the region and/or the fertilizer and construction industries which will provide insights into the strengths and weaknesses of our
target company. Since OCI operates in two industries that possess dissimilar margins and
different dynamics, comparison of the consolidated business to other firms can be distorted.
Hence we proceeded by compiling a list that consists of 8 fertilizer producers and 8 contracting
companies. To account for the differences, we computed a weighted average for these companies with the weights based on the gross profit contribution by both business segments in
OCI. Thus a weight of 50% was accorded to both the construction and fertilizer businesses based
on their gross profit contribution in 2010.
The average market cap was of USD 6.6 billion with values ranging between 650 million and 16.9 billion. The average was significantly lower than OCI’s 8.8 billion market cap due to the inclusion
of smaller cap competitors from the MENA region.
The complete list of companies is available in the appendix.
Relative Valuation
We compared Price against earnings, revenues, book value and cash flow in order to alleviate
differences in accounting standards that can arise from operating in different countries. Through
price to earnings and revenues, we can see that OCI is significantly undervalued compared to the peer composite due to an excellent performance in 2010 where both earnings and revenues
registered around 30% growth. Instead of a rise in its share price, the stock fell considerably
caused by the recent upheaval in the region. Performance during 2011 is expected to be close to
its 2010 performance indicating an undervalued share price. On the other hand, its price to book value and cash flow are on par with the peer composite.
Source: BlomInvest, Reuters
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ORASCOM CONSTRUCTION INDUSTRIES
Profitability Comparison
OCI’s gross margin is of 24% when compared to the significantly higher average of 29%. The individual companies that compose the list exhibit various discrepancies. Mainly, construction
firms from Europe have unusually high gross profit margins which tend to skew our data.
However, OCI’s gross margin seems to be the most competitive relative to its Middle Eastern
peers. On another note, OCI’s operating margin is slightly higher than that of the average composite. This indicates that OCI is more cost effective in running its day-to-day activities. OCI
has leveraged its know-how through extensive years of experience in the field to achieve better
quality at lower costs. This is further validated through its SG&A margin which is almost half that
of its peer. Net income margin is slightly lower than the peer average. Its higher debt results in higher interest expense which reduces its net income margin compared to its peers.
Source: BlomInvest, Reuters
Management Efficiency OCI’s Return-on-Equity (ROE) at 21% is on par with its peer average whereas its Return-on-Assets
(ROA) is lower. This lagging performance can be attributed to OCI’s overleveraging with a Debt-to-
Equity (D/E) ratio of 91%, resulting in considerably higher interest expenses. In addition, its
Revenue/Assets ratio is half that of its peers which further contributes to a lower ROA.
Source: Blominvest, Reuters
23
ORASCOM CONSTRUCTION INDUSTRIES
VALUATION We estimate OCI’s fair value at EGP 270 per share using a Sum-of-the-parts (SOTP) methodology. Both lines of business were valued using a discounted cash flow (DCF) model; however the
construction segment was valued as a whole while the fertilizer subsidiaries were segregated and
valued individually.
Line of Business OCI Ownership Value (in EGPm) Per Share (in EGP)
Construction Group 100% 27,729 134.01
Fertilizer Group 40,462 195.54
Subsidiaries
EFC 100% 11,392 55.06
EBIC 60% 5,500 26.58
OCI Nitro 100% 20,072 97.00
Sorfert 51% 1,624 7.85
Notore 13.5% 96 0.46
Gavilon 16.8% 1,777 8.59
Total 68,191 329.55
Less: Net Debt 11,339 54.80
Less: Minorities 1,018 4.92
Net Equity Value 55,834 269.83 Source: BlomInvest
Assumptions in Valuation
Discount Rate We used a WACC of 11% in valuing the fertilizer business group and a WACC of 13% for
construction derived as follows:
Fertilizer WACC = (Weight of Debt * Cost of Debt)*(1-Tc) + (Weight of Equity * Cost of Equity) = (50% * 5.98%)*(1-15%) + (50%*17.16%) = 11.09%
OCI Cost of Debt = Interest Expense for 2010 / Debt for 2010
We used a Risk-Free Rate of 10.4% represented by the yield on the one year Treasury bill
issued by the Egyptian Government. This captures the additional risk of investing in a
relatively undeveloped country such as Egypt when comparing it to the U.S. Treasury.
OCI’s weekly Beta over the past 3 years is estimated at 1.06. This is a measure of OCI’s
share volatility against the EGX-30 Index that represents the 30 largest shares on the Egyptian Stock Exchange.
A Market Risk Premium of 6.4% is the result of the difference between the average 5
year return of the EGX-30 estimated at 16.8% and the Risk-Free Rate of 10.4%. This
represents the premium investors expect to gain for realizing the additional risk of investing in securities.
To calculate construction’s WACC, we added a 2% premium to the WACC of the fertilizer
business segment in account for geopolitical risks in the MENA region where most of Orascom’s construction projects are.
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ORASCOM CONSTRUCTION INDUSTRIES
Terminal Growth Rate
With the construction and fertilizer business segments being in different stages, we took different terminal growth rates beyond our forecasts to account for this. A 3% growth rate was used for
construction compared to 4% for fertilizers.
Corporate Tax Rate A 15% effective tax rate was applied on our forecasts based on previous taxes paid and due.
Assumptions in Forecasting Construction Revenues
1. Existing Projects in Backlog Revenues were recognized over a four year time frame using an accelerated method with
revenues heavily recognized in the first two years and then moderately over the remaining
two. This assumption was based on historical observations of project completion time as
well as the payment compatibility from clients. The top ten biggest contributors to backlog
with values exceeding USD 140 million each had their revenues recognized independently. The remainder of backlog was then recognized as a whole with an average template of 30%
in year 1, 40% in year 2, 20% and 10% in year 3 and 4 respectively.
2. New Awards Based on our estimates of the construction outlook in the region, as well as OCI’s positioning
in the markets, we see new awards gaining momentum as early as 2011. New awards are
expected to bounce back to the USD 4 billion range in 2011 from its scanty USD 3.12 billion
end-of-year estimate in 2010. Thereafter, we anticipate bids won to maintain an upward trend for the coming three years. Note that once awards are won, they are captured in the backlog
and therefore follow the same principles for revenue recognition as existing projects.
Our assumptions hence yielded the following forecasts:
Costs of Goods Sold were assumed stable and hovering around 80% of total revenues.
Assumptions in Forecasting Fertilizer Revenue
Fertilizer Price Forecasts Since OCI owns and operates different fertilizer plants, revenues and profits were recognized by
subsidiary. As per management guidance, weighted average selling prices and capacity were
provided for each product from each plant constituting the basis of our analysis.
Our forecast for average selling prices over the next three years is as follows: Prices are in USD per ton
Fertilizer 2010 2011e 2012f 2013f 2014f
Urea 238 249 261 275 289
Ammonia 321 336 352 372 390
UAN 204 213 224 236 247
CAN 227 238 249 263 276
AS 200 210 219 231 243
Melamine 1,512 1,584 1,659 1,750 1,837
Source: BlomInvest
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ORASCOM CONSTRUCTION INDUSTRIES
Among the factors we considered to model our fertilizer pricing forecasts are:
Production Inputs & Natural Gas Costs
The production of nitrogenous fertilizers requires natural gas as a primary input. Although most
plants have contracts for natural gas to be provided at fixed costs, OCI Nitrogen’s contract will
expire forcing the company to pay spot prices in 2012 and resulting in a hike in costs. Other production input prices were assumed to increase marginally every year.
Global Supply & Demand
Overall, we estimated that global supply of nitrogenous fertilizer will increase on average causing surplus to rise accordingly. These dynamics are correlated to many factors that interplay resulting
in an upward or downward pressure on prices. Chief amongst these factors considered were
world agricultural needs, granular prices, restraints and oversupply from other producers,
This research is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. Blom Bank SAL or BlomInvest SAL can have investment banking and other
business relationships with the companies covered by our research. We may seek investment banking or other business from
the covered companies referred to in this research. Our salespeople, traders, and other professionals may provide oral or written market commentary or trading strategies to our clients and our proprietary trading desks that reflect opinions that are
contrary to the opinions expressed in this research. Our asset management area, our trading desks and investing businesses
may make investment decisions that are inconsistent with the recommendations or views expressed in this research. We and
our affiliates, officers, directors, and employees, excluding equity analysts, will from time to time have long or short positions
in, act as principal in, and buy or sell, the securities or derivatives (including options and warrants) thereof of covered companies referred to in this research. This research is not an offer to sell or the solicitation of an offer to buy any security in
any jurisdiction where such an offer or solicitation would be illegal. It does not constitute a personal recommendation or take
into account the particular investment objectives, financial situations, or needs of individual clients. Clients should consider
whether any advice or recommendation in this research is suitable for their particular circumstances and, if appropriate, seek professional advice. The price and value of the investments referred to in this research and the income from them may
fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original
capital may occur. Certain transactions, including those involving futures, options, and other derivatives, give rise to
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price of, or income derived from, certain investments.
Copyright 2010 BlomInvest SAL.
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written consent of BlomInvest SAL.
Equity Rating Key
Buy: A recommendation with a potential return
greater than 10% based on our current 12-month
view of total shareholder return*.
Hold: A recommendation with a potential return
between -10% and 10% based on our current 12-
month view of total shareholder return.
Sell: A recommendation with a potential return of
less than -10% based on our current 12-month view
of total shareholder return.
* Total Shareholder Return is calculated by the
potential price growth over a 12-month period along