• Cut FVs; Buyers of Yanbu, Saudi, Arabian, Yamama & Eastern We cut our FVs by 16% on average due to our 200bps cost of equity increase to reflect the higher risk free rate and the risk of a further reduction in fuel subsidies; the main downside risk to earnings forecasts. We maintain our negative outlook on the sector given the expected demand slowdown and margin erosion in the short term. However, we reiterate our Buy calls on names that look attractive post the share price correction: Yanbu (FV SAR55, upside 25%), Saudi (SAR75.7, 33%), Arabian (SAR60, 32%), Yamama (SAR40.6, 47%), and Eastern (SAR40.7, 31%). Our top picks are Yanbu (2017e P/E 9.5x) and Yamama (9.2x) that trade below peers (11.1x) despite boasting some of the highest EBITDA margins, FCF, and dividend yields. Share prices for covered names hit new lows (-24%, in line with TASI) after the subsidy reform in late December 2015, but rebounded 14% over the last two weeks post DPS announcements.
• Expect 2016 margin contraction on energy cost hike… We expect the 2016 sector EBITDA margin to contract 7pp on a hike in fuel prices (natural gas up 67% to USD1.25/mmBTU, heavy fuel oil up 81% to USD3.8/bbl), and electricity tariffs (we previously expected a fall in energy prices in 2017). At the same time, no decision was made to raise the cement ex-factory price cap (SAR240/tonne); a future cap rise is less likely to happen given the industry’s superior margins relative to global and regional peers.
• …and demand slowdown on cut in government spending… We remain cautious on cement demand post the budget announcement of public spending cuts. We expect demand to inch down 2% in 2016, post 7% growth in 2015 (on pent-up demand as deportation of illegal labour had an adverse effect in 2013-14), and to recover gradually starting from 2017 (+2%). We expect ex-factory prices to remain under pressure (below cap for several players), as companies continue to offer discounts to defend market share or absorb transportation costs (those located far from high-demand areas).
• …to weigh down on earnings & dividends, but yields remain attractive We expect avg. clean earnings to fall 23% Y-o-Y in 2016, leading to lower DPS (-26%). However, we expect sector yields will remain attractive at 6.3% in 2016 versus 8.6% in 2015. We expect earnings to start recovering in 2017 (+6% Y-o-Y on average) on improving volume and prices, from a low base.
• Catalysts include the potential lifting of export ban and white land tax Removal of the export ban is an upside risk, and more likely to happen post the ease in energy subsidies and the tight 2016 budget, but strong competition from regional players with excess capacity is a key challenge. We believe beneficiaries are producers in the North (Tabuk, Jouf, Northern), South (Southern, Najran), followed by those in the East (Eastern, Saudi). The implementation of white land tax could lead to acceleration in land development, but regulations are unclear, and it may take time for the effect to filter down. (refer to our 2 December 2015 sector update for details).

Tarek El-Shawarby