• Cut FV to SAR60/share; trading at deep discount to peers We cut our FV for Saudi Ceramics by 30% on raising cost of equity by 175 bps to reflect higher risk free rate and the uncertainty regarding further ease in fuel subsidy in the future; a main downside risk to earnings. Our new FV implies 67% upside potential to current share price; hence, we reiterate our Buy rating as we believe these challenges are priced in post the sharp correction in the share price (-29% YTD, -42% in 2015). Thus, the valuation gap has widened between SCC (2016e PE of 7.1x, 2017e 6.6x) and peers (17.1x and 15.1x), and also compared to its average historical forward multiple of 14.5x. SCC remains one of our preferred stocks in Saudi industrials, given its leadership position in the market and ongoing expansions that will allow it to outperform when demand/oil prices recover.
• Expect flattish revenue on sustained weak demand in 2016 We expect flattish revenue in 2016, as we believe demand growth will remain weak, affected by construction slowdown due to the cut in government spending and will witness gradual recovery in 2017 (+8%). We expect revenue to be supported by relatively higher pricing (partially passing on fuel price rise, in our view), added sanitary ware and water heaters capacity, as well as the new red brick plant (1H2016). Competition would continue to intensify, in our view, especially from the GCC players (RAK Ceramics and Al Anwar) that compete on the same segment.
• Hike in energy cost to drag down margin and earnings in 2016 Following government announcement to ease fuel subsidy and increase electricity tariffs, natural gas cost has increased 67%; hence, we expect the company’s EBITDA margin to contract c4 pp Y-o-Y to reach 24.5%, leading to 18% drop in earnings (versus recurring earnings growth of 5% in 2015). We expect three-year clean earnings CAGR of c10% post 2016, on expected recovery in demand and normalised margins. We expect SCC to maintain an average payout ratio of 34% in 2016-17, yielding c5% on average.

Tarek El-Shawarby