• Cut FV to SAR48.0; still trading below peers We cut our FV for Saudi Ceramics to SAR48.0 to reflect changes in our forecasts post a weak set of results in 1H16. Our new FV implies 35% upside potential to current share price; hence, we reiterate our Buy rating as we believe challenges are priced in post the correction in the share price (-23% YTD). The valuation gap has, hence, widened between SCC (2016e PE of 11x, 2017e 9x) and peers (16x and 15x). We believe the stock will gain momentum when demand/oil prices recover, given SCC’s leadership position in the market and ongoing expansions.
• Expect double-digit revenue drop on sustained weak demand in 2016 We expect revenue to fall 15% Y-o-Y in 2016 on weak demand, affected by construction slowdown due to the cut in government spending and rising competition, leading to lower selling prices. We expect gradual recovery stating 2H17, supported by added sanitary ware and water heaters capacity, as well as increased contribution from the new red brick plant (2H16). Competition will continue to intensify, in our view, especially from GCC players (RAK Ceramics and Al Anwar) that compete on the same segment.
• Expect lowest earnings level in 2016 over the past few years We expect modest softening in gross margin by 40 bps Y-o-Y as the company was able to implement some cost-saving measures, mainly in the water heaters segment. We forecast EBITDA margin to contract c2 pp Y-o-Y to reach 26.2%, and EBIT 4 pp on increase in depreciation, leading to 39% drop in earnings (vs. recurring earnings growth of 5% in 2015). As demand recovers and margins normalise post 2016, in our view, we estimate three-year clean earnings CAGR of c10% post 2016. We expect SCC to distribute DPS of SAR1.0 for FY2016 (c30% payout, 2.7% yield) and maintain an average payout ratio of c40% in 2017-19.

Tarek El-Shawarby