P/E (x)content.argaam.com.s3-external-3.amazonaws.com/c92c0f63-585b-… · Al Hasan Shaker With a size of about SAR4.4bn, the Saudi air-conditioning market is one of the biggest in

Al-Hassan G.I. Shaker Co Industrial investment SHAKER AB: Saudi Arabia

20 May 2012

US$0.630bn 65.6% US$2.337mn

Market cap Free float Avg. daily volume

Disclosures Please refer to the important disclosures at the back of this report. Powered by Enhanced Datasystems’ EFA Platform 1

Target price 83.50 23.76% over current Consensus price 82.00 21.5% over current Current price 67.50 as at 19/5/2012

Underweight Neutral Overweight Overweight

Key themes

We believe the air-conditioning market will continue to tread the growth path. Shaker occupies a formidable position in the Saudi AC market - we estimate that it enjoys the highest market share in split AC space and a decent market share in window ACs. We believe Shaker’s strategy of manufacturing LG air-conditioners in the Kingdom will open a major channel for government projects and will drive the company’s growth.

Implications

We see Shaker as one of the major players in the Saudi AC market. The company is faring well and has outperformed many local competitors. We strongly believe growth in profitability coupled with decent dividends will support the share price. We are Overweight on Shaker.

Performance

Earnings

Period End (SAR) 12/11A 12/12E 12/13E 12/14E

Revenue (mn) 1,566 1,781 1,981 2,122

Revenue Growth 35.5% 13.7% 11.2% 7.1%

EBITDA (mn) 239 294 332 361

EBITDA Growth 21.5% 22.8% 13.0% 8.8%

EPS 5.15 5.96 6.73 7.36

EPS Growth 24.1% 15.8% 12.9% 9.3% Source: Company data, Al Rajhi Capital

Valuation

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Research Department Moath Al Shaikh, Investment Analyst

Tel 966 1 211 6429, [email protected]

Al Hasan Shaker growth story continues With a size of about SAR4.4bn, the Saudi air-conditioning market is one of the

biggest in the MENA region. We expect this market to continue to grow at a

healthy pace, largely backed by ever-increasing population, high GDP per

capita, the current boom in the construction market and above all these, the hot

climate of the Kingdom. Despite being one of the early movers, Shaker faces

intense competition in the Saudi air-conditioning market. Nevertheless, given

its competitive dynamics, we strongly believe the company is equipped quite

well to position itself firmly ahead of its peers. Backed by a ramp-up in

production capacity and improving demand, Shaker is poised to chart out the

growth path over the next few years. We initiate our coverage on Al Hasan

Shaker Company with an Overweight rating with a target price of SAR83.5,

which implies an upside potential of 23.7%.

Market is still booming: We believe the boom in the Saudi construction market

will play a crucial role in stimulating the air-conditioning demand. By our

estimates, the size of the Saudi air-conditioning market is currently above

SAR4.4bn and is expected to grow further capitalising on the growth in the

building and construction industry from both private and government projects.

In addition, while Split and Windows AC are still dominating the market,

Chillers and Packaged AC are currently outperforming in terms of growth.

Capacity ramp-up to boost sales: In mid 2011, Shaker doubled its LG plant

capacity reaching 1.4mn units per annum to meet growing demand from the

domestic and neighbouring MENA markets. This has boosted LG sales as it

derived 80% of LG’s revenues from units manufactured locally in 2011,

compared to 50% in 2010. In our forecasts, we assume no capacity additions as

the company will gradually increase its utilization rates from 55% in 2011 to 65%

this year.

Higher operating margins: Backed by its solid business model (partnership

with LG and favourable product mix), Shaker has outperformed its local peers in

terms of operating margins. The company achieved an operating margin of

15.6% in 2011 compared to 9.1% achieved by its only publicly listed rival, Al

Zamil. We believe the company is well positioned to continue to surpass local

competitors from both growth and margin perspectives.

Shaker is well positioned to emerge as an LG hub in the region: In 2011,

Shaker’s exports rose to a record high of SAR140mn (9% of sales) compared to

SAR38.1mn in 2010 (3.3% of sales). We believe Shaker is likely to expand its

exports to the GCC and MENA region as it offers a cheaper option compared to

imports from Korea. Further, Shaker’s well established R&D department (based

in Saudi Arabia) coupled with dynamic production lines allow the company to

cater to different markets with various consumer preferences.

Shaker still offers value: Using long-run discounted economic profit valuation,

we estimate the fair value per share for Shaker at SAR83.5. Our target price for

Shaker is driven by the long-run DEP method only. Our target price implies an

upside of 23.7% from the current levels. By our estimates, Shaker will distribute

a healthy DPS of SAR4.0 for 2012, implying an attractive dividend yield of 5.9%.

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Al-Hassan G.I. Shaker Co Industrial investment 20 May 2012

Disclosures Please refer to the important disclosures at the back of this report. 2

Corporate summary Share information Valuation

Al Hasan Shaker Company is one of the biggest manufacturers/distributers of air-conditioners in the Kingdom. The company has a JV with LG through which it manufactures air-conditioners under the famous brand name of LG. Further, Shaker exclusively distributes the respected Chinese Midea AC as well as McQuay Air Conditioning. Moreover, the company has bagged many exclusive distribution rights of many home appliance products such as refrigerators, washing machines and kitchen appliances.

Market cap (SAR/US$) 2.362bn / 0.630bn 52-week range 58.25 - 74.75 Daily avg. volume (US$) 2.337mn Shares outstanding 35.00mn Free float (est.) 65.6% Performance: 1M 3M 12M

Absolute -8.8% 4.7% 6.7% Relative to index -1.5% 3.3% 2.5% Major Shareholder:

Ibrahim Abu Nayan and Brothers Co. 12.2% Abdulgader Almuhaideb and Children Co. 12.2% Source: Bloomberg, Al Rajhi Capital

Period End 12/11A 12/12E 12/13E 12/14E

Revenue (SARmn) 1,566 1,781 1,981 2,122

EBITDA (SARmn) 239 294 332 361

Net Profit (SARmn) 180 209 236 258

EPS (SAR) 5.15 5.96 6.73 7.36

DPS (SAR) 3.50 4.00 4.50 5.15

EPS Growth 24.1% 15.8% 12.9% 9.3%

EV/EBITDA (x) 13.0 10.8 9.6 8.9

P/E (x) 13.1 11.3 10.0 9.2

P/B (x) 4.9 4.3 3.8 3.3

Dividend Yield 5.2% 5.9% 6.7% 7.6% Source: Company data, Al Rajhi Capital

Saudi AC market still… the best solution for heat

From a strategic “top down view”, the Saudi air-conditioning industry has so much to offer as it richly benefits from hot climate, a boom in the building and construction market, ever-increasing population and high GDP per capita. All these factors have contributed significantly in ensuring the continued growth of the Saudi air-conditioning industry. The local air-conditioning market is considered one of the biggest in the MENA region with an estimated market size of about SAR4.4bn. We expect this market to continue its growth path and clock a CAGR of 10.7% over the next five years. The major AC products are windows, splits, packaged and chillers, whereas the price, design, and capacity needed determine the choice of the consumer.

AL Hasan G. I. Shaker is one of the largest manufacturers/distributers of air-conditioners in the Kingdom. The company has struck a joint venture partnership with LG through which it manufactures air-conditioners under the brand name of LG. Further, Shaker also exclusively distributes both the respected Chinese Midea AC and McQuay Air Conditioning. The company has bagged various exclusive distribution rights of many home appliance products such as refrigerators, washing machines and other kitchen appliances.

Figure 1 Saudi AC market size (SAR mn)

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Source: Company prospectus, Al Rajhi Capital estimates

Saudi air-conditioning market has so much to offer

Shaker is one of the biggest AC manufacturers/distributers in the Kingdom



For the last few years, most air-conditioning products have delivered decent growth in the Saudi market. Some products have registered robust growth while demand for others is softening. According to our estimates, during the period 2004-2011, the compounded annual growth rate varied from 4% for window AC to 20% for packaged AC. We believe packaged air-conditioners will continue to clock the highest growth over the near to medium term, followed by chillers and split ACs respectively.

Split ACs are dominating the Saudi market with a market share of around 43%, while window ACs occupy the second spot with a market share of about 22%. Chillers, which have been growing at a rapid pace and is about to take over windows with a little less than 22% market share while the remaining 14% is held by packaged AC.

Figure 2 Saudi AC market break down (by value)

Source: Company prospectus, Al Rajhi Capital estimates

Over the past decade, split AC has recorded robust growth in the Kingdom. By our estimates, split AC posted a CAGR of 15% during the period 2004-2011. We estimate Shaker’s market share for split AC to be 38%. Other big players in this market are Daiken, O General, Fuji and recently Chinese brands such as MAITAB, MIDEA and GREE. Though the competition is intensifying in this segment, we think Shaker is well positioned to maintain its dominance mainly due to its early mover advantage, decent quality, and strong brand name.

In contrast, window AC market is growing at a slow pace. We believe window AC is loosing its market share on account of competitive prices for split AC coupled with modern designs and changing taste of the younger generation, in a market where customers prefer modern furniture, low noise and creative designs. Window AC witnessed a nominal growth of 4% CAGR during the period 2004-2011, with Al Zamil commanding the highest market share in the Saudi window AC market; estimated to be above 25%. Other brands capturing respectable market shares are O General, General Electric, and LG (Shaker). We estimate LG’s share to be around 18%.

Figure 3 Split AC market size & Shaker’s market share Figure 4 Windows AC market size & Shaker’s market share

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Packaged AC is posting the highest growth, followed by chillers

Split AC is dominating the market

Split ACs grew at a CAGR of 15% during the 2004-2011 period

Window ACs enjoy the biggest market share by units



Apparent growth opportunities

Booming construction market will push demand up for ACs In recent times, there has been a pressing need for installation of air-conditioners in practically every building in the Kingdom, be it a commercial, residential, or industrial one. Further, the Saudi government is carrying out wide-scale constructional activity to improve its infrastructure. In 2012, the government announced the highest allocation (SAR168.6bn, 24% of the total planned expenditure) for the education and training sector in an attempt to develop human resources across the country. The budget has allocated funds for setting up 742 new schools, 40 new colleges and an electronic university. In 2011, the total planned budget for education and training was SAR150bn (26% of planned budget), which included building 610 new schools and renovating 2,000 existing school buildings.

These projects will enhance the demand for all consumer durable products, including AC products, thus boosting their sales. During the course of last year, Shaker won many government contracts with both the Ministry of Higher Education (Najran University) and the Ministry of Education. This year, Shaker has been awarded by the Ministry of Education to supply LG air-conditioning units to a number of schools across the Kingdom. We strongly believe Shaker is well positioned to win more government contracts this year, especially in providing split and windows AC to schools.

Figure 5 Government appropriations for Education by agency (SAR bn)

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Source: Ministry of finance (budget division), Al Rajhi Capital

Government raises Real Estate Development Fund budget The Saudi government increased the budget for the Real Estate Development Fund by SAR40bn. Moreover, the fund raised its upper limit for loans from its earlier limit of SAR300,000 to SAR500,000. This should positively impact the housing market and consequently boost consumer durable products, in general, and air-conditioning products in particular.

SAR250bn allocated to sort out the housing supply problem The Saudi government announced that it would build 500,000 units to tackle the housing supply problem. In the 2012 announced budget, the Saudi government reinforced its decision and allocated SAR250bn from the surplus to build these residential units. This move will again stimulate the demand for all consumer durable products, including air-conditioners.

Prices and preference change The Saudi AC market witnessed a dramatic shift from Japanese air-conditioners to Thai and Korean ones over the last few decades. Nowadays, one can hardly see any Japanese AC products in the Kingdom. The last man standing was the famous Mitsubishi brand which has been facing cut-throat competition from Thai and Korean brands. We believe the consumer tastes and preferences have shifted from high quality to relatively lower ones. We are of the view that the major reason for that is the huge price difference which makes up for inferior quality. For example, prices of Japanese wall split AC ranges from SAR7,000, to SAR8,000 while prices of Thai brands ranges from SAR4,000 to SAR5,000. The market is likely to see

Huge government projects will boost demand for different AC products

Shaker is well positioned to win government contracts, especially with the Ministry of Education

Saudi government increased the upper limit for real estate loans to SAR500,000

The Saudi government announced that it will build 500,000 residential units



another shift toward Chinese products going forward. Currently, Chinese wall split AC prices range roughly from SAR2,500 to SAR3,000. We believe Chinese air-conditioners will capture more market share over the next years, especially split ACs. As a result, many companies have already started introducing new Chinese brands to the market such as Al Zagzoug (distributors of Fuji) which introduced the famous Chinese AC brand - GREE. Furthermore, Shaker (distributers of LG) now sells Midea which is another well-known Chinese brand. In our view, companies which are already selling Chinese air-conditioners are better positioned to capture more market share from this trend.

Figure 6 Comparing Split AC (wall type) prices between manufacturers

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Source: Al Rajhi Capital

Prices have gradually risen; Shaker’s LG caters to the middle class The average industry prices for window and split air-conditioners have grown at a CAGR of 1.4% and 3.3% respectively during 2006-2011.

Figure 7 Average prices for windows and split AC (SAR)

2006 2007 2008 2009 2010 2011 CAGR

Windows 966 964 1,002 1,013 1,024 1,036 1.4%

Split 2,690 2,778 2,892 2,979 3,068 3,160 3.3% Source: Company prospectus, Al Rajhi Capital estimates

LG air-conditioners are neither considered as high-end (such as Mitsubishi) nor inferior (like Chinese); it primarily caters to the middle class. LG enjoys a smaller premium over the average industry prices for both split and window air-conditioners. This is quite normal given the fact that LG capitalizes on its famous brand name in addition to its respectable quality.

Figure 8 LG air-conditioners average prices compared to the industry average

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Source: Market resources, Al Rajhi Capital estimates

LG air-conditioners enjoys a small premium over the average industry prices



Al Hasan Shaker Company background

Al Hasan Shaker Company commenced its business in the mid-nineties as an extension to Ibrahim Shaker’s business of importing and wholesaling air-conditioners and home appliances. Shaker is considered one of the pioneers in the Saudi AC market and has fared really well to keep itself ahead of its peers, bagging various exclusive and non-exclusive distribution rights of leading international brands such as LG, Maitag, Wandest, Ariston, Delonghi, Maccoi, American Standards, and Midiea.

Shaker’s business model revolved around signing exclusive dealership contracts with international brands. However, in March 2006, the company decided to transform its business model and reduce its reliance on imports; it struck a JV partnership with the famous Korean manufacturer LG and built a factory in Saudi Arabia for air-conditioners. By doing so, Shaker Company not only improved its margins and trimmed shipping costs, but also became a Saudi manufacturer of ACs, which allowed the company to bid for government projects. This threw open a large business opportunity for the company considering the government’s recent spending on infrastructure projects. In 2011, LG air-conditioners (locally produced and imported) contributed 83% to Shaker’s total revenues.

Furthermore, the company continually seeks potential international brands to diversify its product portfolio and serve more customers. MIDEA - one of the largest AC manufacturers in China - has been one of the most successful deals struck by the company.

Figure 9 Al Hasan G. I. Shaker revenue breakdown

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LG Other products LG (locally manufactures) LG (imported)


Shaker is a hub for exporting LG units to GCC and MENA region In 2011, Shaker’s exports rose to a record high of SAR140mn (9% of sales) compared to SAR38.1mn in 2010 (3.3% of sales). We believe Shaker is likely to expand its exports to the GCC and MENA region as it offers a cheaper option compared to imports from Korea. Further, Shaker’s well established R&D department (based in Saudi Arabia) coupled with dynamic production lines allow the company to cater to different markets with various consumer preferences.

JV Partnership with LG ends in 2016; unlikely to be discontinued As per the 2006 JV agreement, the partnership between Shaker and LG would last for 10 years, i.e. the JV ends in 2016. After that, the agreement will be automatically renewed for one more year unless one party decides to terminate the agreement. We believe this partnership will continue for another 10 years and is unlikely to be discontinued considering the success the JV and the importance it carries for both parties..

Shaker is considered one of the pioneers in the air-conditioning industry

The JV with LG enabled Shaker to bid for government projects

The partnership with LG ends in 2016; however, we believe both companies will renew it



No capacity additions in the near future Shaker’s AC factory is located in the industrial Tatweer city of Riyadh. In 2008, the company started producing split ACs with an initial capacity of 500,000 units per annum. Consequently, Shaker and LG increased the production capacity to 700,000 units per annum in 2010. Last year, the company commenced a new production line to produce split and window AC units equipped with a capacity of 700,000 units per annum, taking Shaker’s total capacity to 1.4mn units per annum. The utilization rate for the plants in 2011 was approximately 55%.

In our forecasts, we assume no additional capacity scale-up as the company will gradually increase its utilization rates. However, we believe Shaker & LG will eventually raise their capacities in accordance with demand growth. We further note that Shaker recently announced on Tadawul its Board of Director’s Resolution to purchase a land adjacent to LG Shaker factory in Riyadh to furnish future expansions for the plant. That said, we do not include any capacity additions in our forecasts as many factors can change till then.

Chinese air-conditioners: a key driver In 2009, Al Hasan Shaker started distributing MIDEA AC. In general, Chinese brands are known for their low prices and decent quality, making them an affordable choice for price-sensitive customers. MIDEA has earned a respectable reputation in just two years of arrival in the market, indicating that Shaker has been doing well in marketing and distributing this brand. As per our discussions with different distributers, MIDEA has emerged as one of the best-sellers in their stores. Looking ahead, we expect Shaker to leverage on its strong track record to roll out new brands.

Jordanian Modern Vision set to grow The only consolidated company that Shaker owns outside the kingdom is the Modern Vision Electronics and Electrical Appliances Company - established under the Jordanian Kingdom laws –in which Shaker owns a 50% stake. Unlike the local rights, Modern Vision exclusively distributes all LG products including AC, home appliances and electronics in Jordan.

In 2011, Modern Vision recorded revenues of SAR109mn as the company gradually built its operations. Looking ahead, we expect revenues from Modern Vision Company to make another strong round and grow by 95% this year, contributing 12% of overall revenues.

Partnership with LG helps sustain raw material prices LG International Group is responsible for providing logistics and raw materials to its plants worldwide, including LG Shaker plant. This substantially benefits Shaker as LG enjoys bargaining power with the raw material suppliers. LG deals with those suppliers for the full LG group and thereafter allocates the materials needed to all its plants globally. This gives Shaker a competitive advantage over other local producers.

Figure 10 Copper and Aluminium prices (USD/MT)

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Source: Bloomberg, Al Rajhi Capital

The total capacity of LG Shaker Company is 1.4mn units per year

In our forecasts, we assume no additional capacity expansion

MIDEA gained a respectable market share within 2 years

We expect Modern Vision revenues to grow by 95% this year



Financial analysis and forecasts

Robust top and bottom-line growth Shaker logged robust top and bottom line growth during the period 2006-2011. Revenues grew at a CAGR of 19%. More importantly, gross profit, EBITDA and net profit grew at a CAGR of 24%, 27% and 24% respectively. For the full year 2011, Shaker delivered tremendous revenue growth, surging 35% y-o-y while net profit jumped by 24%. Additionally, Shaker’s exports zoomed from SAR38 mn to SAR140.6mn. These figures further reinforce our view that Shaker is on course to emerge as an LG hub for the MENA region. For the first quarter of 2012, Shaker continued its robust performance, reporting 16% and 19% top and bottom-line growth. Looking ahead, we expect Shaker to clock a respectable revenue growth of 13.7% this year with export revenues climbing 67% to reach SAR234.7mn.

Figure 11 Shaker revenue and profit growth

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Growth & margins: Shaker is outperforming Al Zamil Over the last five years, Shaker has achieved strong revenue growth, sharply higher than its only listed peer, Al Zamil. During the period 2008-2011, AL Zamil AC reported a CAGR of 6% while Shaker posted a CAGR of 20%. This difference can be attributed to Shaker’s recent expansion programs and strong exports. Furthermore, we believe that Shaker’s clear focus on the AC business provides it a competitive advantage to outstrip Al Zamil as the latter remains distracted in the highly competitive steel market.

Figure 12 Al Zamil Ac division vs. Shaker revenues (SAR mn)

2008 2009 2010 2011 CAGR

Al Zamil AC division 1,552 1,577 1,636 1,836 6%

Shaker 918 998 1,156 1,566 20% Source: Companies data, Al Rajhi Capital

* Note: Shaker did not report breakdown between LG and other revenues until 2010, thus we took all Shaker revenues

Furthermore, Shaker benefits from strong operating margins compared to Al Zamil. In 2010, and 2011, Shaker achieved EBIT margins of 15.6% and 13.7% respectively compared to 9.1% and 8.7% for the Al Zamil AC division. We cannot attribute one factor to this huge difference, as we believe Shaker operates with a different model. In addition, Shaker has a favourable product mix compared to Al Zamil (Al Zamil commands the highest market share in window ACs which carry lower margins). We believe Shaker is well positioned to continue outperforming local peers over the next few years.

Between 2006-2011 period, revenues grew at a CAGR of 19%

Shaker has higher operating margins compared to Al Zamil AC division



Figure 13 Al Zamil operating profits vs. Shaker’s

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Source: Companies data, Al Rajhi Capital

Shaker: growth yet to come

Set to grow on the back of higher utilization rates We expect Shaker’s revenues to grow by 13.7% this year on the back of higher utilization rates at the LG Shaker plant. We also expect a strong growth of 95% from its operations in Jordan (New Vision). As for LG’s local market share, we believe that the company will be able to retain its 38% market share in the split market and its 17-18% share in the window AC market.

Figure 14 Shaker revenues forecasts (SAR mn)

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As stated earlier, prices of air-conditioners products have been increasing. We expect this trend to continue on the back of strong demand and rising logistics costs. This should benefit all AC companies including Shaker in-terms of sales value. On that basis, we expect 1.8% of the 12.5% revenue CAGR for 2012-2016 period for the locally manufactured LG only to come from price appreciation and the remaining 10.7% to be from volumes.

Margins to improve In 2011, Shaker margins took a hit as LG margins slipped by almost 470bps from 2010 levels. We believe the prime reason for that was the huge appreciation in copper and aluminium prices last year. However, the first quarter of 2012 showed marked improvement in margins; gross margins for LG products rose from 28.6% last year to 31.8%. For the full year, we

We expect Shaker’s revenues to grow by 13.7% this year



expect LG margins to improve by 172bps on the back of expected weak raw material prices over this year compared to last year; however, other segments’ margins are likely to decline as we expect revenues from Jordan (which carry lower margins) to increase. This would result in aggregate gross margin of 30.7%, slightly above 2011 level of 29.8%. That said, we expect margin to gradually improve over the next three years.

Figure 15 Copper and Aluminium consensus estimates Figure 16 Shaker: gross profit forecasts (SAR mn)

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Efficiency to be back on track after dropping last year Since the establishment of the LG plant in 2008, Shaker’s efficiency improved rapidly during the period 2008-2010; working capital days have dropped from 137 days in 2008 to 99 in 2010. However, last year, working capital days rose to 135 mainly due to higher-than-usual inventory days accompanied by lower creditor days. This move resulted in negative cash flow from its operating activities in 2011.

Last year, Shaker inked many government contracts with both the Ministry of Higher Education (Najran University) and the Ministry of Education. We believe the company piled up large inventory levels to cater to these requests. This ratio is likely to improve as we expect inventory days to drop and help reduce working capital days to 124. As a result, Shaker should turn its negative operating cash flow to positive during this year.

Figure 17 Shaker working capital days

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We expect Shaker to have positive cash flow from operating activities this year



Valuation Shaker offers good long-term value

High economic profit; growth in dividend By our estimates, AL Hasan Shaker Company achieved a return on invested capital (ROIC) of 20.4% in 2011. This is more than our estimates of the company’s weighted average cost of capital (WACC) of 9.5%, implying that the company achieved an economic profit spread (ROIC – WACC) of 11%. We expect Shaker’s economic profit spread to increase from this year onward and remain above 12% over the next few years.

Figure 18 Shaker: Economic profit spread (ROIC–WACC)

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14.0%

16.0%

18.0%

2007 2008 2009 2010 2011 2012E 2013E 2014E

Economic prof it


In 2010, the company started distributing annual dividends. Shaker paid SAR3 per share for the whole year with a dividend payout ratio of 72%. In 2011, Shaker announced a payment of SAR3.5 per share with a payout ratio of 68%. For the full year 2012, we expect the company to distribute a dividend of SAR4.0 backed by strong earnings and healthy financials; this implies a 2012 dividend yield of 5.9 % at current prices.

Summary of our approach and conclusions Our key valuation method for Shaker is the long-run discounted economic profit (DEP), sometimes also called discounted long-run EVA (“economic value added”). This is a simple variation on discounted cash flow, and is mathematically equivalent. In our models, we make explicit forecasts for income statement, balance sheet and cash flow through to 2023. We then assume a steady fading of return on invested capital, i.e. excess return, down to the cost of capital over a period of up to 40 years from end of our period of explicit forecasting. This approach avoids a common problem in long-run modelling: the analyst stops forecasting at some arbitrary point when the company in question is still generating high returns. In terms of financial theory this is implausible, and excess returns will eventually disappear through competition, regulation or some other means.

Our DEP valuation is sensitive to many factors, including assumed revenue growth, EBITDA margin and capex/sales ratio in 2023, i.e. the last year of explicit forecasting. Another important variable is the assumed duration of the competitive advantage period, i.e. the period during which the company generates returns above the weighted average cost of capital (WACC). Deciding on the length of the competitive advantage period is naturally a subjective exercise. We have assumed 30 years for Al Hassan Shaker on the grounds that it is one of the leaders in the market and that it would take several years for its rivals to effectively challenge them.

However, as with any DCF-based approach, the factor to which the DEP valuation is most sensitive is WACC; we have assumed a WACC of 9.5% for Al Hassan Shaker. Shaker has an adjusted beta of around 0.87 according to Bloomberg.

High economic profit of 11%

We expect Shaker to pas dividend of SAR4 this year; implying a 5.9% dividend yield

Our key long-run method of forecasting is discounted economic profit (DEP)



WACC is in turn highly sensitive to the assumed terminal capital structure. Estimating a terminal capital structure is again a rather subjective exercise. We have assumed a terminal debt (debt plus equity) ratio of 20% for Al Hassan Shaker, compared to about 42% at present. We expect the company to retire some of the debt as more cash is generated; given this, we expect gearing to decrease over the long run.

Figure 19 Shaker; weighted average cost of capital (WACC)

Risk-free Rate 2.0%

Expected Mkt Return - Risk-free Rate 10.5%

Adjusted Beta 0.87

Cost of Equity 11.1%

Pre-tax Cost of Debt 3.0%

Effective Tax rate 6.4%

After-tax Cost of Debt 2.8%

Target D/(D+E) 20.0%

WACC 9.5% Source: Bloomberg, Al Rajhi Capital

One of the advantages of discounted economic profit forecasting is that it splits the analyst’s appraised fair enterprise value for a company between discounted economic profit, i.e. the present value of the company’s future returns in excess of the cost of capital, and invested capital, i.e. (in simple terms) the debt and equity funding already invested in the business. With regard to Al Hassan Shaker, as the table below shows, we calculate the discounted economic profit at SAR2,437mn, i.e. roughly 2.7x the opening invested capital of SAR917mn. In other words, about 73% of our estimated fair enterprise value for Al Hassan Shaker comes from discounted economic profit. This means that a large part of the company’s value lies in its high economic returns that we expect it to continue to generate in the future.

As noted, the appraised fair enterprise value is the sum of discounted economic profit and invested capital. From the appraised fair enterprise value we subtract the net debt to estimate the fair value of equity. We divided the fair value of equity by the number of shares to arrive at the intrinsic fair value per share. Based on the long-run DEP analysis, and using our core assumption of a competitive advantage period of 30 years, we thus estimate the fair value per share for Al Hasan Shaker at SAR83.5.

Figure 20 Shaker valuation - discounted economic profit (000 SAR)

Total value created/ (detroyed) 2,437,363

Opening invested Capital 917,413

Total Enterprise Value 3,354,776

Add:

Value of associates and non-core assets 4,781

Less:

Value of debt (2012E) (353,006)

Minority interest (84,921)

Equity value 2,921,630

Number of shares 35,000

Fair value per share 83.5 Source: Company data, Al Rajhi Capital

Risks associated with our assumptions It is important to mention that our valuation relies heavily on forecasts, which are subject to errors. We have come up with several assumptions including growth, cost of capital, and market trend to predict the future performance. We have tried to arrive at the most accurate assumptions; however, reality may deviate from our forecasts depending on new microeconomic or macroeconomic factors. Competition is another factor that can influence our assumptions. New entrants or transformation of current rivals’ business models might cause a change in the whole market, and hence in our overall assumptions and forecasts.

We estimate Shaker’s WACC at 9.5%

Nearly 73% of our estimated fair enterprise value for Shaker comes from future economic returns

We estimate the fair value per share at SAR83.5



Income Statement (SARmn) 12/10A 12/11A 12/12E 12/13E 12/14E

Revenue 1,156 1,566 1,781 1,981 2,122

Cost of Goods Sold (769) (1,100) (1,235) (1,369) (1,458)

Gross Profit 387 467 546 612 664

Government Charges - - - - -

S.G. & A. Costs (206) (252) (280) (314) (340)

Operating EBIT 180 215 266 298 324

Cash Operating Costs (959) (1,327) (1,487) (1,649) (1,761)

EBITDA 197 239 294 332 361

Depreciation and Amortisation (17) (25) (28) (34) (37)

Operating Profit 180 215 266 298 324

Net financing income/(costs) (3) (11) (15) (12) (11)

Forex and Related Gains

Provisions - - - - -

Other Income 4 3 4 2 2

Other Expenses

Net Profit Before Taxes 182 206 257 290 317

Taxes (15) (13) (18) (20) (22)

Minority Interests (22) (12) (30) (34) (37)

Net profit available to shareholders 145 180 209 236 258

Dividends (105) (123) (140) (158) (180)

Transfer to Capital Reserve

12/10A 12/11A 12/12E 12/13E 12/14E

Adjusted Shares Out (mn) 35.00 35.00 35.00 35.00 35.00

CFPS (SAR) 5.24 6.21 7.62 8.69 9.48

EPS (SAR) 4.15 5.15 5.96 6.73 7.36

DPS (SAR) 3.00 3.50 4.00 4.50 5.15

Growth 12/10A 12/11A 12/12E 12/13E 12/14E

Revenue Growth 15.8% 35.5% 13.7% 11.2% 7.1%

Gross Profit Growth 23.9% 20.6% 17.0% 12.1% 8.5%

EBITDA Growth 20.7% 21.5% 22.8% 13.0% 8.8%

Operating Profit Growth 18.3% 19.0% 24.1% 11.8% 9.0%

Net Profit Growth 9.6% 24.1% 15.8% 12.9% 9.3%

EPS Growth 9.6% 24.1% 15.8% 12.9% 9.3%

Margins 12/10A 12/11A 12/12E 12/13E 12/14E

Gross profit margin 33.5% 29.8% 30.7% 30.9% 31.3%

EBITDA margin 17.0% 15.3% 16.5% 16.8% 17.0%

Operating Margin 15.6% 13.7% 14.9% 15.0% 15.3%

Pretax profit margin 15.7% 13.1% 14.4% 14.6% 14.9%

Net profit margin 12.6% 11.5% 11.7% 11.9% 12.1%

Other Ratios 12/10A 12/11A 12/12E 12/13E 12/14E

ROCE 35.3% 34.8% 36.8% 35.6% 33.9%

ROIC 32.7% 33.1% 27.0% 27.4% 28.5%

ROE 36.0% 39.9% 40.5% 40.0% 38.5%

Effective Tax Rate 8.4% 6.4% 6.9% 6.8% 7.0%

Capex/Sales 8.3% 4.6% 4.6% 3.0% 4.0%

Dividend Payout Ratio 72.3% 68.0% 67.1% 66.8% 70.0% Valuation Measures 12/10A 12/11A 12/12E 12/13E 12/14E

P/E (x) 16.3 13.1 11.3 10.0 9.2

P/CF (x) 12.9 10.9 8.9 7.8 7.1

P/B (x) 5.6 4.9 4.3 3.8 3.3

EV/Sales (x) 2.4 2.0 1.8 1.6 1.5

EV/EBITDA (x) 14.2 13.0 10.8 9.6 8.9

EV/EBIT (x) 15.5 14.5 12.0 10.7 9.9

EV/IC (x) 4.6 3.4 3.1 3.0 2.8

Dividend Yield 4.4% 5.2% 5.9% 6.7% 7.6% Source: Company data, Al Rajhi Capital

We expect Shaker to report revenues of SAR1,781mn this year

We expect Shaker to distribute dividends of SAR4 this year

Shaker trades on a foreword PE of 11.3 and yields 5.9%



Balance Sheet (SARmn) 12/10A 12/11A 12/12E 12/13E 12/14E

Cash and Cash Equivalents 52 61 92 158 190

Current Receivables 197 269 302 329 318

Inventories 376 586 629 686 700

Other current assets - - - - -

Total Current Assets 626 916 1,023 1,173 1,209

Fixed Assets 242 290 345 370 418

Investments 5 5 5 5 5

Goodwill 1 1 1 1 1

Other Intangible Assets - - - - -

Total Other Assets - - - - -

Total Non-current Assets 248 296 350 375 423

Total Assets 874 1,212 1,373 1,548 1,632

Short Term Debt 154 368 384 384 384

Accounts Payable 174 192 226 302 265

Accrued Expenses - - - - -

Dividends Payable - - - - -

Other Current Liabilities - - - - -

Total Current Liabilities 342 570 623 685 649

Long-Term Debt 26 50 59 59 59

Other LT Payables - - - - -

Provisions 21 26 26 26 26

Total Non-current Liabilities 47 76 86 86 86

Minority interests 62 85 115 149 187

Paid-up share capital 350 350 350 350 350

Total Reserves 73 131 199 278 361

Total Shareholders' Equity 423 481 549 628 711

Total Equity 485 566 665 777 897

Total Liabilities & Shareholders' Equity 874 1,212 1,373 1,548 1,632

Ratios 12/10A 12/11A 12/12E 12/13E 12/14E

Net Debt (SARmn) 128 356 351 285 253

Net Debt/EBITDA (x) 0.65 1.49 1.20 0.86 0.70

Net Debt to Equity 26.3% 63.0% 52.9% 36.7% 28.2%

EBITDA Interest Cover (x) 61.2 20.9 19.5 27.5 32.6

BVPS (SAR) 12.09 13.74 15.70 17.93 20.31

Cashflow Statement (SARmn) 12/10A 12/11A 12/12E 12/13E 12/14E

Net Income before Tax & Minority Interest 182 206 257 290 317

Depreciation & Amortisation 17 25 28 34 37

Decrease in Working Capital (26) (263) (42) (21) (40)

Other Operating Cashflow (11) (13) (15) (20) (22)

Cashflow from Operations 161 (45) 227 283 292

Capital Expenditure (96) (72) (82) (59) (85)

New Investments - - - - -

Others 1 - - - -

Cashflow from investing activities (96) (72) (82) (59) (85)

Net Operating Cashflow 65 (117) 145 224 207

Dividends paid to ordinary shareholders (105) (123) (140) (158) (175)

Proceeds from issue of shares - - - - -

Effects of Exchange Rates on Cash - - - - -

Other Financing Cashflow 12 11 - - -

Cashflow from financing activities (38) 126 (115) (158) (175)

Total cash generated 27 9 30 67 32

Cash at beginning of period 25 52 61 92 158

Implied cash at end of year 52 61 92 158 190

Ratios 12/10A 12/11A 12/12E 12/13E 12/14E

Capex/Sales 8.3% 4.6% 4.6% 3.0% 4.0% Source: Company data, Al Rajhi Capital

Due to ongoing expansions, Shaker’s balance sheet is growing

Shaker has healthy gearing ratios

We expect Shaker to report positive cash flow from operating activities this year



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1. Explanation of Al Rajhi Capital’s rating system

Al Rajhi Capital uses a three-tier rating system based on absolute upside or downside potential for all stocks under its coverage except financial stocks and those few other companies not compliant with Islamic Shariah law:

"Overweight": Our target price is more than 15% above the current share price, and we expect the share price to reach the target on a 6-9 month time horizon.

"Neutral": We expect the share price to settle at a level between 5% below the current share price and 15% above the current share price on a 6-9 month time horizon.

"Underweight": Our target price is more than 5% below the current share price, and we expect the share price to reach the target on a 6-9 month time horizon.

2. Definitions

"Time horizon": Our analysts make recommendations on a 6-9 month time horizon. In other words, they expect a given stock to reach their

target price within that time.

"Fair value": We estimate fair value per share for every stock we cover. This is normally based on widely accepted methods appropriate to

the stock or sector under consideration, e.g. DCF (discounted cash flow) or SoTP (sum of the parts) analysis.

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why a share price is unlikely to reach fair value within our time horizon. In such a case we set a target price which differs from estimated fair value per share, and explain our reasons for doing so.

Please note that the achievement of any price target may be impeded by general market and economic trends and other external factors, or if a company’s profits or operating performance exceed or fall short of our expectations.

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P/E (x)content.argaam.com.s3-external-3.amazonaws.com/c92c0f63-585b-… · Al Hasan Shaker With a size of about SAR4.4bn, the Saudi air-conditioning market is one of the biggest in

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