Government projects expected to boost Saudi Cement Sector in 2012

NCB Capital, Saudi Arabia’s leading wealth advisor and Kingdom’s largest asset manager, expects the Saudi cement sector to continue witnessing strong demand in 2012, led primarily by government projects. However ongoing fuel issues with Aramco could delay the 4.5mn tons of new capacity expected in 2012. This potential supply constraint should provide strong pricing support.

The new NCB Capital report analyzing the Saudi cement sector noted that there are concerns on supply due to an apparent inability by Yanbu and Southern Cement to receive increased quantities of subsidized fuel from Aramco for their new lines, leading to potential delays in the start of their operations. “If this is the case, this would lead to a strong pricing support in 2012,” said Farouk Miah, Acting Head of Equity Research at NCB Capital. “The potential demand-supply imbalance could become particularly acute in the western region where demand is expected to be high, coupled with possible supply constraints at Yanbu Cement where its new 3mn tons/yr line is expected to start commercial production in 1Q12.”

NCB Capital downgraded Yamamah Cement to Neutral with a PT of SR75.6 due to its strong recent performance (up 33% since NCB Capital’s overweight call vs. 8% fall in the TASI). At the same time, it has upgraded Yanbu to Neutral with a PT of SR61.4 due to a better pricing outlook. “Our fair value price targets for most companies have increased by an average of 8-9% due to a better demand and pricing outlook,” explained Mr. Miah.

Although NCB Capital remains neutral on all names in the sector, on a relative basis, the report favors Yamamah, Saudi and Southern. “The key reason for this is their spare capacity/ high stock levels which are key positives for a sector which may face supply constraints in the coming 12-24 months. Due to this, we believe these names should trade at a 10% premium to peers which are already near 100% utilization rates and have low stock,” added Mr. Miah.

NCB Capital expects 4Q11 to show good profit growth from the cement stocks under coverage due to a combination of strong growth in sales volume and steady prices. For the six covered stocks, revenues are expected to total SR1,972mn, up 19% YoY, with gross profit at SR1,098mn, an increase of 25% YoY; net income is estimated to expand 30% YoY to SR1,003mn during 4Q11. NCB Capital expects an average price of SR240 per ton in 4Q11 – up 4% YoY but down 3% QoQ. The average cost per ton is likely to decline 1% YoY.

For 2012, NCB Capital expects YoY growth to slow. “We expect YoY growth of domestic sales at covered stocks of 5% against the 9% expected for 2011. For revenue and profitability, we expect the stocks under coverage to record growth of 4.6% and 5.3% respectively against the 13.8% and 18.7% expected in 2011,” highlighted Mr. Miah.

This slowdown is due in part to the very strong numbers and thus a high base in 2011, as well as the larger companies using up their inventories of clinker which should stop any significant inflation in prices in 2012. One consequence of higher usage of clinker inventories will be higher cost per ton given the presence of fixed costs which will not be utilised in the production of clinker, but only for the conversion of clinker to cement.

NCBC believes that government demand should drive volumes in 2012. Construction contracts worth SR95bn were awarded in Saudi Arabia during 3Q11, more than the combined value during 1H11 and a 104% increase over 3Q10. Also, the total value of contracts awarded during 9M11 was 125% higher than 9M10. Although delays in major projects are the norm, NCB Capital believes 2012 should see good progress in major projects which will support demand.

“Feedback from cement players indicates that demand in 2011 was largely private sector led, indicating that government demand is yet to come and should support the sector in the coming few years. On average, our sales volumes estimates for 2012 have increased for most companies under coverage by 1-2%, although for Saudi cement it has fallen by 2.8% as we believe it will focus on margins as opposed to volume driven growth,” Concluded Mr. Miah.