• 1Q16 earnings softening milder than expected Combined clean earnings were down 10% Y-o-Y for covered companies, excluding Yamama (+4%) and Southern (+7%). This retreat was driven by revenue and margins. However, earnings were mostly ahead of estimates on better-than-expected margins; companies benefited from one or more of the following: i) lower usage of costly imported clinker; ii) more efficient usage of energy; and iii) clinker inventory produced pre-fuel price rise (up to seven months). We believe the impact of hike in energy cost should be more felt in coming quarters. Our expectation for 2016 clean earnings calls for a fall of 23% on average (view full report). We assume gradual recovery starting in 2017 (+6% Y-o-Y on avg.) on improving volume and prices, from a low base.
• Modest volume growth in 1Q2016; further pressure on prices Saudi cement sector's local sales volume were flat Y-o-Y in Mar-16 at c5.8 million tonnes, as expected. 3% Y-o-Y growth in 1Q16 was driven mainly by growth in Jan. and Feb., likely helped by projects under construction the government is committed to finalise, in our view. We expect sector volume to inch down 2% Y-o-Y in 2016 (post 7% growth in 2015) on demand slowdown, affected by a cut in government spending, given weak oil prices. We assume gradual recovery starting 2017 (+2%). Average selling prices in 1Q16 fell 6% Y-o-Y (ranging -2% to -12%) as companies offered further discounts to defend their market shares or absorb transport cost on selling far from the regional market.
• Export ban to be lifted with certain conditions; challenges are there Cement producers need to fulfil the following criteria to be able to export: i) having sufficient cement supply to cover local demand; ii) having a minimum inventory of clinker at 10% of annual production (almost all cement companies has higher levels); and iii) the previously-imported clinker amount that enjoyed government subsidy cannot be used for exports, unless it had been imported for over a year. Also, the government will collect the difference between local and global energy prices (no clear guidance yet on the mechanism). Allowing exports should benefit companies with idle capacity and located far from higher demand areas (western, central). Challenges include: i) competition from regional markets with excess capacity; ii) political tensions in main target markets (Yemen, Libya, Syria etc…); and ii) sustainability of competitive edge as the government will likely adjust the fuel subsidy for exporters downwards.
• Picks: Yanbu, Saudi & Eastern; Reduce Tabuk to Sell; upside to DPS forecast Our top picks are Yanbu, Saudi and Eastern as they trade at a discount to local peers despite providing some of the highest EBITDA margins (except Eastern), FCF dividend yields and room for volume growth. We downgrade Tabuk to Sell as it trades a high multiple post share price rally and posted weakest 1Q16 results. There is room for upside to our conservative DPS forecasts (particularly for companies with no expansion plans) as companies increase payout (similar to Qassim in 1Q16).

Tarek El-Shawarby