equity research initiation coveragemec.biz/term/uploads/gecs_18-03-2010.pdf · contractor in oman...

Equity Research Initiation Coverage

Falling out of grace

• Establishedin1972,GalfarEngineering&Contracting(Galfar)isthelargestgeneralcontractorinOmanandamongtheleadingandmostdiversifiedengineeringandcontractingcompaniesinthewiderMiddleEast.

• WiththeincreasinginfrastructurespendingbytheOmanigovernment,Galfar'ssupposedlystrongrelationshipwiththegovernmentwasexpectedtoconvertintoahealthybacklogcontributioninFY09.Contrarytomarketexpectations,Galfar'snewcontractawardsin2009fellbyastaggering71.1%YoYtoreachOMR158mn.Thecompany'scurrentbacklogisworthOMR465mn,equatingto1.2xFY10revenueswhichtogetherwithMohammadAlMojilGroupisthelowestinourcoverageuniverseofgeneralcontractors.

• AsofFY09-end,Galfar'snetdebtpositionwasOMR94mn,equivalenttoOMR0.31pershare.Totaldebt-to-equityreached120%in2009renderingGalfarthemostleveragedcontractorinourcoverageuniverse.Meanwhile,thevalueoftradereceivableswithmorethan270dayspastduereachedOMR28.4mn,up88%YoY-amajorsourceofconcerninourview.

• Despiterecordrevenuesin2009,Galfar'snetprofitstookanosedivefromthemostprofitableyeareverinFY08toanalltimelowofOMR3.8mnasmarginsplungedandQ409witnessedthecompany'sfirstquarterlyloss(OMR-5.9mninQ409).Whileweexpectthefadingcontributionfromthelossmakingprojects,whichsuppressedFY09profitability,toleadnetprofitsupbyaround3.6xtoreachOMR13.8mninFY10andafurther41.0%inFY11toOMR19.4mn,theywillremainshortof2008levels.

• WeinitiatecoverageonGalfarwithaSELLrecommendationbasedonourfairvaluetargetofOMR0.435pershare,implyinga14.8%downsidepotentialtothecurrentpriceofOMR0.511pershare.

March 18th, 2010

Galfar Engineering & Contracting (GECS.OM)

Current Price: OMR 0.511 Country: Oman

Fair Value Target: OMR 0.435 Sector: Building & Construction

Recommendation: SELL Exchange: Muscat Securities Market

Year Net profit (OMR'000)

BV (OMR'000)

EPS (OMR)

BVPS (OMR)

FCF yield RoAE (%) P/E (x) P/BV (x)

Dec-12E 17,789 119,959 0.06 0.40 20.1% 15.7% 8.6 1.3

Dec-11E 19,409 108,170 0.06 0.36 15.4% 19.5% 7.9 1.4

Dec-10E 13,761 91,761 0.05 0.31 7.2% 15.9% 11.1 1.7

Dec-09A 3,831 82,667 0.01 0.28 23.2% 4.6% 40.0 1.9

52-week range (OMR) 0.418-0.747

Number of shares ('000) 300,000

Free float 40%

Market cap (OMR '000) 153,300

Market cap (USD '000) 399,677

Dividend yield 2009 2.0%

Galfar stock performance vs. SC Oman Index performance

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Jan-

08

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8

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9

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Jan-

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Mar

-10

Galfar SC Oman Rebased

Sector Coverage TeamRoy Cherry+9714 3199 [email protected]

Taher Safieddine+9714 3199 [email protected]

March18th,2010 2

Galfar Engineering & Contracting

Contents

INVESTMENT HIGHLIGHTS .........................................................3

COMPANY OVERVIEW ................................................................4

GALFAR’S SUBSIDIARY: AL KHALIJ HEAVY EQUIPMENT & ENGINEERING...................................................... 4

CHAIRMAN AND MANAGEMENT ....................................................................................................................... 5

OWNERSHIP STRUCTURE .................................................................................................................................... 5

TRADING: ADTV OF USD 1.7MN ......................................................................................................................... 6

BONUS SHARES - APRIL 2009 AND 2010 .......................................................................................................... 7

STRATEGY ................................................................................8

OMANI ECONOMY ......................................................................9

INCREASING GOVERNMENT SPENDING: PRIORITY TO CIVIL INFRASTRUCTURE ......................................... 10

OMANI CONSTRUCTION MARKET ..............................................11

CIVIL IS THE LARGEST CONSTRUCTION SEGMENT.......................................................................................... 12

GALFAR'S TARGET MARKET .............................................................................................................................. 12

GALFAR’S BACKLOG .................................................................13

LOW BACKLOG/SALES, IMPLIES LOW EARNINGS VISIBILITY ........................................................................ 13

GALFAR’S TOP THREE CONTRACTS, ALL FROM THE GOVERNMENT .............................................................. 14

CLIENT CONCENTRATION RISK - HIGH WITH THE GOVERNMENT ................................................................. 15

BACKLOG GROWTH SLOWING DOWN FAST .................................................................................................... 15

GALFAR IS TENDERING FOR OMR 1.4BN OF 2010 CONTRACTS ..................................................................... 16

INCREASED PRESENCE OF FOREIGN FIRMS .................................................................................................... 16

NO LONGER THE PREFERENTIAL CONTRACTOR FOR THE GOVERNMENT ...................................................... 17

SWOT ANALYSIS ......................................................................18

FINANCIAL ANALYSIS AND FORECASTS ......................................19

REVENUES FALLING .......................................................................................................................................... 19

GROSS PROFIT RECOVERING FROM THE LOWS OF FY 09 .............................................................................. 20

EBITDA ............................................................................................................................................................... 22

NET PROFITS REACH BOTTOM IN 2009 ............................................................................................................ 22

HIGH NET DEBT, MOST LEVERAGED CONTRACTOR IN THE REGION .............................................................. 23

CASH CONVERSION CYCLE STABILISING ......................................................................................................... 24

RECEIVABLES PAST DUE UP 88% IN 2009 - A MAJOR CONCERN .................................................................. 24

CAPEX DECLINE ................................................................................................................................................. 25

DIVIDENDS PROPOSED ...................................................................................................................................... 25

VALUATION ............................................................................26

SCENARIO DRIVEN THREE-STAGE DCF ............................................................................................................. 26

RELATIVE VALUATION ........................................................................................................................................ 29

UPSIDE TO OUR VALUATION .............................................................................................................................. 30

RISKS TO OUR VALUATION ................................................................................................................................ 30

FINANCIALS ...........................................................................31

March18th,2010 3


Investment Highlights

• Establishedin1972,GalfarEngineering&Contracting(Galfar)isthelargestgeneralcontractorinOmanandamongtheleadingandmostdiversifiedengineeringandcontractingcompaniesinthewiderMiddleEast.

• BasedonourestimatedOmaniconstructionmarketofOMR24.4bn(USD63.6bn),Galfar'seffectivetargetmarketisworthanestimatedOMR10.5bn(USD27.3bn).Weexpectthisvaluetobeconvertedintosectorwidecashflowsoverthenext5yearswhichimpliesanaverageannualtargetmarketvalueofOMR2.1bn(USD5.5bn)peryearor5.6xGalfar'sFY10revenues.

• WiththeincreasinginfrastructurespendingbytheOmanigovernment,Galfar'ssupposedlystrongrelationshipwiththegovernmentwasexpectedtoconvertintoahealthybacklogcontributioninFY09.Contrarytomarketexpectations,Galfar'snewcontractawardsin2009fellbyastaggering71.1%YoYtoreachOMR158mn.Thecompany'scurrentbacklogisworthOMR465mn,equatingto1.2xFY10revenueswhichtogetherwithMohammadAlMojilGroupisthelowestinourcoverageuniverseofgeneralcontractors.

• Goingforward,weexpectthechallengingoil&gasconstructionmarketcoupledwiththeincreasinglycompetitivegeneralcontractingenvironmentandthemarket'sgrowingdependenceonthefewbuthighvaluegovernmentcontracts,toseparatethemarketwinnersfromtherest.TherecenttrendofhighprofilecontractlossesbyGalfartoglobalplayers(evenwhenitwasthelowestbidder)-fuelourdoubtssurroundingitsabilitytobeamongthebigwinners.

• AsofFY09-end,Galfar'snetdebtpositionwasOMR94mn,equivalenttoOMR0.31pershare.Totaldebt-to-equityreached120%in2009renderingGalfarthemostleveragedcontractorinourcoverageuniverse.Meanwhile,thevalueoftradereceivableswithmorethan270dayspastduereachedOMR28.4mn,up88%YoY-amajorsourceofconcerninourview.

• Despiterecordrevenuesin2009,Galfar'snetprofitstookanosedivefromthemostprofitableyeareverinFY08toanalltimelowofOMR3.8mnasmarginsplungedandQ409witnessedthecompany'sfirstquarterlyloss(OMR-5.9mninQ409).Whileweexpectthefadingcontributionfromthelossmakingprojects,whichsuppressedFY09profitability,toleadnetprofitsupbyaround3.6xtoreachOMR13.8mninFY10andafurther41.0%inFY11toOMR19.4mn,theywillremainshortof2008levels.

• WeinitiatecoverageonGalfarwithaSELLrecommendationbasedonourfairvaluetargetofOMR0.435pershare,implyinga14.8%downsidepotentialtothecurrentpriceofOMR0.511pershare.

March18th,2010 4


Company overviewEstablishedin1972,GalfarEngineering&Contracting(Galfar)isthelargestgeneralcontractorinOmanandamongtheleadingandmostdiversifiedengineeringandcontractingcompaniesinthewiderMiddleEast.Galfaroffersheavyandcivilcontractingandengineeringservices.Thecompany'srevenuesaregeneratedthroughfourkeysegments:

• Oil&Gas• Roads&Bridges• Structures&Buildings• Utilities

Thecompany’sOil&GasDivisionhasbeenthelargestsourceofrevenueoverthelastfiveyears,contributingaround35%tototalrevenue.Oil&gasworkinvolvesdesign,procurement,constructionofpipelines,maintenanceworks,expansionworkandstationshutdownjobs.

TheRoads&BridgesDivisionisinvolvedintheconstructionofroads,bridges,interchanges,underpassesandrechargedams.TheStructures&Buildingsunitcarriesoutlargeinfrastructureprojectssuchashospitals,marinefacilitiesandports.

Galfar'sUtilityDepartmentisfocusedatvariousbuildingservicessuchassewage,watertreatmentplants,electronicsurveillanceandsecuritysystems,powerplantoperationandmaintenance,hospitalservices,reverseosmosisplants,heating,ventilatingandairconditioning(HVAC).

Thecompany'scurrentbacklogisworthOMR465mnspreadoutoverthefourdifferentbusinesslines.Throughitsvariousministriesandprojects,theGovernmentofOman,isGalfar'smajorclient.PetroleumDevelopmentOman(PDO),thenationaloilcompanyofOman,isanotherkeyclientforGalfar.

Currently,thecompanyisbuildingsomeofthelargestprojectsintheSultanateincluding:

• Shiprepairanddry-dockcomplexatDuqmPort• ServicefacilitieswithinQarmAlamsteamproject-theworld'sfirstfull-field

steam-injectiondevelopment.• A'Seebcoastalvacuumsewersnetworkandancillaryworks(wastewater)• MuscatExpresswayproject-a53kmexpresswaywithmorethan40bypassesand

bridges.

Galfar’s subsidiary: Al Khalij Heavy Equipment & Engineering

InJanuary2006,Galfaracquireda52.2%ownershipstakeinAlKhalijHeavyEquipmentandEngineeringLLCforatotalconsiderationofOMR0.6mnresultinginagoodwillofOMR0.28mn.Thecompanyoffersleasedtransportservices,rigsupportfunctionsandheavyliftactivities.Thesubsidiaryhasmanagedtogeneratemorethanhalfofitsrevenuesfromexternalcustomersoverthe2006-2008period.Hirerevenuesaccountedforamere0.4%ofGalfar'stotalFY09revenues.Moreimportantly,AlKhalijhasbeenmakinglossessinceacquisitionin2006.

Largest general contractor in Oman

Key clients include the government and PDO

Involved in some of the Sultanate's

largest projects

Subsidiary offers leasing services of heavy equipment

March18th,2010 5


Chairman and management

Mr. Salim Saeed Al Araimi, ChairmanMr.AlAraimiisthechairmanoftheboardofdirectorsatGalfar.HeisalsothechairmanofNationalDrilling&Services,AlKhalijHeavyEquipmentandOmanPackagingCompany.Mr.AlAraimialsoservedastheVicePresidentofOmanChambersofCommerce&IndustryandasaboardmemberofFranco-ArabChamberofCommerce.HeholdsanhonorarydegreeofDoctorofTechnologyfromtheGlasgowCaledonianUniversity,UK.His18%stakeinGalfarrendershimthesinglelargestshareholder.

Dr. Hans Erlings, CEO and PresidentDr.ErlingsjoinedGalfarinMarch2006followinga26-yearemploymentwithShell.DuringhistimewithShell,Dr.Erlingsheldvariousseniormanagementpositionsacrossdifferentcontinentsinthefieldsofengineeringandmanagement,thelastofwhichbeingtheGeneralManageroftheNigeriaoperations.HewasalsoengagedinbusinesswithPetroleumDevelopmentofOman(34%ownedbyShell)forsevenyears,wherehemostrecentlyheldthepositionsofEngineeringDirectorandManagerofContractsandProcurement.Dr.ErlingholdsadegreeinMaterialEngineeringandadoctorateinPhysicalChemistryfromtheUniversityofDelftintheNetherlands.

Mr. S Muthukrishnan, CFOMr.Muthukrishnanisresponsibleforthecompany'sfinancialoperationsfromfinancetotreasury.Hehasmorethan20yearsofexperienceintheconstructionindustryofwhich8yearsarewithGalfar.HeholdsamanagementprogramdegreefromtheIndianInstituteofManagement(IIM).

Ownership structure

TheestimatedfreefloatinGalfaris40%,withtheremainderbeingheldbythefoundinginvestors.ThelargeststakeisheldbySalimSaidAlAraimi,whoholdsan18%shareinthecompanybasedonthemostrecentlyavailabledata.

Galfar's ownership structure

Source: Galfar

Salim Said Al Araimi18.0%

P. Mohamed Ali10.0%

Public40.0%

Al Siraj Investment & Project 12.5%

Aimmar United Investment & Projects

12.0%PMA International Ltd.

5.0%

Qhassya Projects & Investment

2.5%

March18th,2010 6


Trading: ADTV of USD 1.7mn

Galfarhasthelowestaveragedailytradedvalue(ADTV)comparedtootherlistedGCCcontractors-ArabtecHolding(Arabtec),Drake&ScullInternational(DSI)andMohammadAlMojilGroup(MMG).

Source: Reuters, SHUAA Capital

Galfar'sADTVforthelasttwelvemonthsamountedtoUSD1.7mn.ThiscomparestoArabtec'sUSD24.1mn,DSI'sUSD10.2mnandMMG'sUSD10.8mn.Inshort,thevaluetradedinArabtec'ssharesis14xthatofGalfarandMMG'sADTVissixtimesthatofGalfar.


Galfar'sADTV/freefloatisaround1.1%comparedtoDSI's3.2%,Arabtec'sandMMG's4.0%.


ADTV - GCC Construction Companies

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20,000,000

40,000,000

60,000,000

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100,000,000

120,000,000

May-08

Jun-08

Jul-08

Aug-08

Sep-08

Oct-08

Nov-08

Dec-08

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Feb-09

Mar-09

Apr-09

May-09

Jun-09

Jul-09

Aug-09

Sep-09

Oct-09

Nov-09

Dec-09

Jan-10

Feb-10

USD

Arabtec DSI MMG Galfar

Traded value substantially lower than regional peers

ADTV mutiple of Arabtec, DSI and MMG vs. Galfar

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30

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70

80

90

100

May-08

Jun-08

Jul-08

Aug-08

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MMG, 28x

Arabtec, 88x

MMG, 16x

DSI, 10xArabtec, 7x

Jan-09

Feb-09

Mar-09

Apr-09

May-09

Jun-09

Jul-09

Aug-09

Sep-09

Oct-09

Nov-09

Dec-09

Jan-10

Feb-10

Mul

tipl

e of

Gal

far's

AD

TV

Arabtec DSI MMG

ADTV vs. free �oat of GCC constrcution companies

10,788 24,067 10,172 1,718

159,273

606,629

267,167

313,059

1.1%

4.0%4.0%

3.2%

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MMG Arabtec DSI Galfar

USD

'000

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4.5%

ADTV (USD '000) Free float (USD '000) ADTV/Free float

March18th,2010 7


Bonus shares - April 2009 and 2010

InApril2009,thecompany'sAGMwasheldandapprovedtheissuanceofa20%bonusshares.Asaresult,thesharecapitalincreasedfromOMR25mntoOMR30mnthroughthetransferofOMR5mn(equivalentto50mnshares)fromtheretainedearningsaccounttothesharecapital.

Currently,thecompany'ssharecapitalstandsatOMR30mndistributedover300mnsharesoutstandingwithaparvalueofOMR0.1pershare.

However,theBoardofDirectorsrecentlyproposedtheissuanceofanother10%bonusshares.ThispropositionissubjecttoshareholderapprovalattheAGMtobeheldonthe29thofMarch2010.Assumingshareholdersapprovethe10%bonussharesissuance,ourfairvaluetargetonGalfarshareswouldbereducedtoOMR0.396(thecurrentfairvaluetargetofOMR0.435/1.1[adjustmentfor10%bonusshares]).

Recommended issuance of 10% bonus shares

in March 2010

March18th,2010 8


StrategyGalfar'smainchallengehasbecometoconsolidateitspositionasamarketleaderinitshome-market,Oman,whereitisfacingincreasingcompetitionandaseeminglydeterioratingabilitytowincontracts.

Whileoil&gasrelatedcontractingrevenueshavebeenthelargestcontributortoGalfar'stop-line(estimatedaverageof35%inthepastfiveyears),thecompanyrealisesthatwithover6.5mbpdofexcessglobaloilcapacity,explorationandproductionspendingisboundtodeclinethusdiminishinganymedium-termgrowthpotentialinthissegment.Withthisinmind,Galfarisaggressivelypursuingexpansionintothecivilandinfrastructuresegments.

GalfaraimstocapitalizeontheOmanigovernment'sincreasingspendingoncivilprojectsandmorepreciselyinfrastructurework.ContractsarebeingtenderedandawardedfortheconstructionanddevelopmentofsixnewairportswithGalfarrecentlyclinchingthesecondphaseofRasAlHaddAirport.Galfarisalsobiddingforseveraltransportinfrastructureprojects,underitsRoads&BridgesDivision.Accordingtoouranalysis,thecivilsegmentisthelargestsegmentintheOmaniconstructionmarket,withatotalvalueofOMR9.0bn(37%share,USD23.5bn).

Inaddition,GalfarispursuingageographicdiversificationstrategywiththeaimtoreduceitsrelianceontheOmanimarketandtheearningsvolatilitythiscanleadto.Asafirstastepinthisdirection,thecompanyestablisheda100%ownedsubsidiaryinIndiaunderthenameofGalfarEngineering&Contracting(India)Pvt.GalfarIndia'sfocusisontheinfrastructuresegmentoftheIndianmarket,mainlyroadsandbridges.ThechoicefellonIndiaasthecountryisinvestingheavilyininfrastructureprojects.However,muchofthemajorinfrastructureprojectsintheroadsandbridgesdomaininIndia,arebeingawardedonaBOT(build,operate,transfer)basiswitha25yeartenure.Asaresult,GalfaroptedtojoinhandswithtwoothercompaniesandformtheMahakaleshwarTollwaysPvt.Ltd.(MTPL)consortium,whichisbiddingforBOTroadprojectsinIndia.Galfarholdsa26%stakeinMTPL.GalfarIndiaaimstobethecontractingarmofthisjoint-venture,effectivelytheBinBOT.Asafirststep,MTPLawardedtheconstructioncontractoftheIndore-UjjainroadtoGalfarIndialastyear.

Moreover,GalfaraimstoexplorethecompetitivenessofitsservicesinthewiderMENAregionandmorespecificallyinthelucrativeAbuDhabiandLibyanmarkets.TheobjectiveistomitigatetheimpactofdiminishingcontractawardsintheOmanioil&gasindustry.InanattempttoentertheAbuDhabioil&gasconstructionmarket,thecompanyisintheprocessofteamingupwithSaipem,oneofthelargestEPCcontractorsintheworld.GalfaraimstocapturetheconstructionpartoftheseEPCcontracts.TheconstructionportionofEPCcontractstypicallyconstitutes30-35%ofthetotalcontractvalue.GlobalplayerslikeSaipemtypicallysubcontracttheconstructionworktolocalandregionalcontractors.SofartherehasbeennoannouncementonanycontractawardstoGalfarinAbuDhabiorLibya;consequently,boththesepotentialmarketsforthecompany'sservicesarenotincludedinourvaluation.

Consolidate position amid growing

competition

Diversify into the civil and infrastructure

segments

…By capitalizing on the government's

increased civil spending

And penetrating into key growth markets like India and MENA

March18th,2010 9


Omani economy

Source: Ministry of National Economy, IIF, SHUAA Capital

Oman's GDP growth

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10

20

30

40

50

60

70

2002 2003 2004 2005 2006 2007 2008 2009E 2010F

USD

bn

0%

2%

4%

6%

8%

10%

12%

14%

Nominal GDP (USD bn) Real GDP growth (%)

Oman's current account balance

(6)

(4)

(2)

-

2

4

6

8

2002 2003 2004 2005 2006 2007 2008 2009E 2010F

USD

bn

-15%

-10%

-5%

0%

5%

10%

15%

20%

Current Account Balance (USD bn) % GDP

Oman's total government debt

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2002 2003 2004 2005 2006 2007 2008 2009E 2010F

USD

bn

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

Total government debt (USD bn) % GDP

Oman's gross �xed capital formation

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4

6

8

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12

14

16

18

20

2002 2003 2004 2005 2006 2007 2008

USD

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60%

Gross fixed capital formation (USD bn) % GDP

March18th,2010 10


Increasing government spending: Priority to civil infrastructure

TheOmanigovernment'srevenuesdeclinedbyanestimated14%lastyearprimarilyduetofallingoilprices.Meanwhile,totalexpenditureincreasedby11%.

Omani government budget (OMR mn)

Details 2007 2008 2009 2010

Budgeted Actual Budgeted Actual Budgeted Estimated Budgeted

Revenues 4,490 5,921 5,400 7,639 5,614 6,567 6,380

Expenditure 4,890 5,880 5,800 7,560 6,424 6,719 7,180

Current expenditure 3,398 4,183 3,935 5,279 4,505 4,355 5,052

Investment expenditure 1,492 1,697 1,865 2,281 1,919 2,364 2,128

Budget surplus (deficit) (400) 40 (400) 78 (810) (152) (800)Source: Ministry of National Economy, Central Bank of Oman, SHUAA Capital

Nevertheless,thegovernmentincreaseditsinvestmentexpenditurebyaround4%toreachOMR2.4bnin2009.Whileinvestmentsincivilinfrastructureandoilproductionwitnessedagrowthof10%and4%respectivelyYoY,spendingongasproductiondeclinedbyanestimated14%.

Inanutshell,civilspendingisupandenergyinvestmentsaredown3%YoY-providingfurtherjustificationtoGalfar'sgrowingfocusoncivilcontracting.

Source: Ministry of National Economy, Central Bank of Oman, SHUAA Capital

2010 budget... largest in the Sultanate's history

Investment expenditure on the rise

… Powered by civil spending

Oman energy expenditure

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1,400

2005 2006 2007 2008 2009E 2010F

OM

R m

n

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30%

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50%

Budgeted Actual Growth in actual expenditure

Oman civil expenditure

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200

400

600

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1,000

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2005 2006 2007 2008 2009E 2010F

OM

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Budgeted Actual Growth in actual expenditure

March18th,2010 11


Omani construction marketInouranalysisoftheOmaniconstructionmarket,wereachedanestimatedmarketvalueofOMR24.4bn(USD63.6bn),implyinga36%reductiontothetotalvalueofannouncedprojectsduring2009.Wereachedthisfigurebyreviewingandadjustingallkeyprojectsandtheirannouncedvaluesfortheprevailingmarketrealityandaconservativelong-termoutlook.

Morespecifically,weanalysedcompanyannouncementsandproject-relatednewsonallprojectsaboveOMR200mn,takingintoaccountthefollowingmarketconditionsintoouranalysis:

• Decreaseinoilprices;themainsourceoffiscalrevenuesinOman• High-levelsofspareoilproductioncapacity• Relativelackoffunding,leadingmega-projectstobeputon-holdordownsized• Fallingprojectcostsasaresultofdecliningglobaldemand• Continueduncertaintyandlowvisibilityoffuturegrowth;highvolatilityofinvest-

ments'returns

Withtheprevailingmarketconditionsinmind,wereducedprojectvaluesweconsideredtobeoutdated,inflatedandinconsistentwithmarketreality.ThelargestprojectandtheonewhichhadthemostsubstantialreducingimpactontheestimatedmarketsizeinOmanwasBlueCity(AlMadinaA'Zarqa),whichhasbeenseverelyimpactedbythegulf-widerealestatemarketdeteriorationandthediminishedappetiteforoff-planpropertybuying.

Combined,thetop-fiveprojectsinOmanbeforeouranalysiswerevaluedatOMR14.6bn(USD38.2bn),implying38%ofannouncedprojectvaluesinthecountry.Postouranalysisandthevaluereductionsthisledto,theseprojectshaveanestimatedtotalworthofOMR6.0bn(USD15.6bn)andcontribute25%ofmarketvalue.

Top five Omani projects on hold

Project Announced project value (OMR mn)

SC project value (OMR mn)

Reduction in value

Blue City 7,427 1,485 -80%

Duqm Refinery & Petrochemical Complex 2,684 1,543 -43%

Coal Fired Power Plant in Raysut-PDO 1,877 1,502 -20%

Oman India Gas Pipeline 1,342 805 -40%

Sohar Olefins Complex - OPIC 1,304 652 -50%

Total 14,634 5,988 -59%Source: Proleads, SHUAA Capital

Oman'sBlueCityprojectisanOMR7.4bn(USD20bn)megadevelopmentinitiallyplannedtobea32-square-kilometercitybuiltover20yearsofferingresidential,commercialandretailspaceinadditiontovarioushotelsandamenities.Thecity,whichhadthelargestannouncedprojectvalueinOman,endedatthetopofourlistof'projectsonhold'.Moody'sandFitchdowngradedseveralbondissuesrelatedtotheprojectduetolowerthanexpectedsalesandslowerthananticipatedprogress.Thiscamewithunfavourablepropertymarketconditionsinlate2008andescalatingtroublesbetweentheproject'sownerswhichhadputtheprojecttoanalmostcompletestop.MarketreportsclaimtherehasbeennoprogressontheprojectsinceOctober2009,fuellingconcernssurroundingtheproject'sfate.

Omani construction market worth

OMR 24.4bn

Blue City project… the most substantial

reducing impact

Top five projects losing 59% after our analysis

March18th,2010 12


Civil is the largest construction segment

Basedonourfindings,thecivilsegmentisbyfarthelargestinOman,withanestimatedvalueofOMR9.0bnfollowedbypoweratOMR3.5bnandoilatOMR2.9bn.

Source: Proleads, SHUAA Capital

Galfar's target market

Incivilprojects,ageneralcontractorcanexecute65-90%ofaproject'stotalvalue;fromconstructiontomostoftheprocurementandevenagreatershareoftheengineeringandprojectmanagementworks.However,inthemoretechnicallyadvancedsegmentslikepetrochemicals,oil,gasandevenutilityprojects,contractorslikeGalfaronlytaketheconstructionportionoftheprojectwhichisgenerallyoutsourcedbyleadinginternationalEPC1contractorswithouttheprocurementandengineeringaspects.AsaruleofthumbtheconstructionproportionofEPCprojectstypicallyaccountsfor30-35%ofthetotalvalue.

Galfar's target market

Segment Value (OMR mn) Contractor's share Target market value (OMR mn)

Civil 9,020 65% 5,863

Oil & Gas 5,272 30% 1,582

Power 3,463 30% 1,039

Water 2,553 30% 766

Petrochemical 2,071 30% 621

Industrial 2,021 30% 606

Total 24,400 10,477 Source: SHUAA Capital

Asaresult,Galfar'seffectivetargetmarketisworthanestimatedOMR10.5bnbasedonthetotalvalueofannouncedprojectsinOman.Weexpectthisvaluetobeconvertedtosector-widecashflowsoverthenext5yearswhichimpliesanaverageannualtargetmarketvalueofOMR2.1bnperyear.

1 Engineering, procurement and construction

Civil segment is worth OMR 9bn

SHUAA Capital Oman projects value by segment

9,020

3,4632,884

2,553 2,3882,071 2,021

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

Civil Power Oil Water Gas Petrochemical Industrial

OM

R m

nCivil

37.0%

Power14.2%

Oil11.8%

Water10.5%

Gas9.8%

Petrochemical8.5%

Industrial8.3%

Target market worth OMR 10.5bn

March18th,2010 13


Galfar’s backlogGalfar'scurrentbacklogisworthOMR465mn,whichequatesto1.1xFY09revenuesand1.2xourrevenueprojectionsfor2010.Thecompany'spolicyistoannouncethetotalvalueofitsbacklogalongwiththefullyearfinancialsandtheassociatedDirectors'andManagementreports.

Whilethecompanydoesnotprovideadetailedbacklogbreakdown,basedonallpreviouscontractawardannouncementsandourestimatesonpercentageofcompletionpercontract;99.4%ofGalfar'sOMR465mnbacklogisinOmanwiththebalancerepresentingthecompany'sfirstcontractinIndia.Basedonourestimatesthebacklogisbroken-downasfollows:40.8%Civil,26.4%Utility,19.1%Roads&Bridges,13.1%Oil&Gasand0.6%India.

Source: Galfar, SHUAA Capital

Low backlog/sales, implies low earnings visibility

Galfar'sbacklog/salesratioof1.1xfor2009and1.2xfor2010are,togetherwithMohammadAlMojilGroup'sratios,thelowestinourcoverageuniverseofgeneralcontractors.Inotherwords,Galfarhasaverylowrelativerevenuegeneratingability,basedonexistingbacklog.Galfar'sratiois62%thatofDSIand91%thatofArabtec(excludingtheAED10bnRussiancontract).

Backlog/revenues comparison

Company Backlog/Revenues 09E Backlog/Revenues 10E

Saipem 1.8 1.8

Technip 1.2 1.3

Petrofac 2.2 1.8

Arabtec Holding* 1.7 1.4

MMG 1.0 1.3

DSI 2.2 2.0

Samsung Engineering 3.5 2.6

GS Engineering 4.3 3.7

Daewoo Engineering 4.8 4.5

Larsen & Tubro 2.1 1.7

Carillion 4.2 4.3

Strabag 1.1 1.1

Average - regional peers 1.7 1.5

Average - all peers 2.5 2.3

Galfar 1.1 1.2Source: SHUAA Capital, Company reports, Bloomberg

* Used Arabtec backlog excludes AED 10bn equivalent Russian contract

Backlog stands at OMR 465mn

…41% in civil, 26% in utility & services and

19% in roads & bridges

Galfar's estimated backlog by segment190

123

89

61

3-

20

40

60

80

100

120

140

160

180

200

Civil Utility Roads & Bridges Oil & Gas India

OM

R m

n

Civil40.8%

Utility26.4%

Roads & Bridges19.1%

Oil & Gas13.1%

India0.6%

Backlog is 1.2x projected FY 10 revenues

March18th,2010 14


Galfar’s top three contracts, all from the government

Vacuum sewers network and ancillary works, A'Seeb coastal stripInFebruary2008,GalfarwasawardedanOMR86.9mncontractfromOmanWastewaterServicesCompany(OWSC)fortheconstructionofsewersnetworksandvariousancillaryworksforwastewatertreatmentsalongA'Seebcoastalstrip.OWSCisafullyownedgovernmententityoperatingundertheMinistryofFinance.ThisawardisoneofseveralwithinthisprojectaimedatupgradingthewaterutilitiesstructuresalongtheSeebarea.TheexpectedcompletiondateofthisprojectisQ311.Basedonourestimatesalmost26%ofthecontractworkwascompletedasofFY09-end.

A'Seeb coastal strip

Contract details Contract name Vacuum sewers network and ancillary works

Contract value OMR 86.9mn

Current backlog estimate OMR 64.7mn

Expected completion date Q3 11

Client name Oman Wastewater Services Co./Ministry of FinanceSource: Galfar, SHUAA Capital

Ras Al Hadd Airport contractGalfarsecuredinFebruary2010anOMR40.5mncontractfortheconstructionofthesecondphaseofthenewRasAlHaddAirportinAlSharqiahregion.TheMinistryofTransportationandCommunicationalreadyawardedthefirstphaseoftheprojecttothelocalDesertLinesProjectsbackinH22008.Galfar'sscopeofworkentailsarealevellinginadditiontotheconstructionofafourkilometer-longrunway,fuelhydrantandotherfacilities.Theprojectisexpectedtobecompletedtowardsthesecondhalfof2011.TheclientwilltenderthethirdandlargestphaseofthisairportprojectinH210whichwillcovertheconstructionofanewpassengerterminalbuildingandanairtrafficcontroltower.

Ras Al Hadd Airport

Contract details Contract name Package 2 - Airside infrastructure




Client name Ministry of Transportation & Communication Source: Galfar, SHUAA Capital

Ship repair yard and Dry-dock complex, Duqm Port InJanuary2008,TheMinistryofNationalEconomyawardedtheJ.VofDaewooEngineeringandGalfarEngineeringanOMR170.2mncontractfortheconstructionofashiprepairyardandadry-dockcomplexattheDuqmPort.Galfar'sshareoftheprojectwas41%withacontractvalueofOMR69.6mn.WhencompletedinH210,thedockwillrivalthebiggestintheregionasitwillbeequippedtohandlesomeofthelargestvesselsinservicetoday,includingtheUltra-LargeCrudeCarriers(ULCCs).ThedrydockwilltakeadvantageoftheDuqmport'sproximitytothebusyregionalsealanescrossingOman'swaters.Weestimatethatalmost49%ofthecontractworkwascompletedasofFY09-end.

Duqm Port

Contract details

Contract name Ship repair yard and Dry-dock complex




Client name Ministry of National Economy Source: Galfar, SHUAA Capital

Estimated backlog value of OMR 65mn

Second phase of a new airport

A J.V for Oman's largest dry dock

March18th,2010 15


Client concentration risk - high with the government

WhilenamesofGalfar'sclientsvary,mostofitscontractscomefromfully-ownedorquasi-governmententities.68.7%ofGalfar'sbacklogisdirectlyfromthegovernmentor100%ownedgovernmententities.Afurther15.6%ofthebacklogcomesfromquasi-governmententities,whichincludesPetroleumDevelopmentOmanandOmanGasCompany.Thebalanceof15.7%ismainlyfromsubcontractsfromprivatecompaniesactingasleadcontractorsongovernmentprojects.MajorprivateclientsincludePetrofacandVale.PetrofacisaglobalEPCcontractorwithafocusonoil&gasprojectsandtheEPCcontractorontheHarweelEORproject.Valeisthesecondlargestminingcompanyintheworld;andhassubcontractedtheconstructionportionoftheirEPCcontractforapelletizingprojectatSohar.


Backlog growth slowing down fast

WeestimateGalfarwonOMR158mnworthofcontractsduring2009,whichimpliesa71%declineYoYinbacklogadditions.However,weexpect2010towitnessastrong52%improvementrelativetothepreviousyeardespiteremainingwaybelowtherecordyearof2008.Weexpectthecompany'smedium-termbackloggrowthtocomemainlyfromcivilprojectsrelatedtothegovernmentsuchasairports,roadsandbridgesworkonthebackofincreasinginfrastructurespending.


Around 69% of the backlog directly with the governemnt

Breakdown of Galfar's contracts and backlog by client

-

50

100

150

200

250

300

350

400

Petr

oleu

mD

evel

opm

ent

Om

an

Min

istr

y of

Tran

spor

tatio

n &

Com

mun

icat

ion

Mus

cat

Mun

icip

ality

Om

anW

aste

wat

erSe

rvic

es C

o.

Petr

ofac

Oth

ers

Min

istr

y of

Nat

iona

lEc

onom

y

Min

istr

y of

Hea

lth

Bank

Mus

cat

Publ

ic A

utho

rity

for E

lect

ricity

&W

ater

Roya

l Cou

rtA

ffairs

Min

istr

y of

Def

ense

Om

anEl

ectr

icity

and

Tran

smis

sion

Om

an G

as

Mus

cat

Elec

tric

ity &

Dis

trib

utio

n Co

.

Min

istr

y of

Regi

onal

Mun

icip

aliti

es &

Wat

er

OM

R m

n

Contract value Backlog estimate

Government68.7%

Quasi-Government

15.6%

Private15.7%

Awarded OMR 158mn in 2009, 71% lower YoY

Backlog additions 2008-2012

533

717

465

330251

547

158240 285 255

(363) (410) (375) (364) (336)

717

465

330251

169

(600)

(400)

(200)

-

200

400

600

800

1,000

2008 2009 2010F 2011F 2012F

OM

R m

n

Opening backlog Backlog additions Revenue Closing backlog

March18th,2010 16


Inourbacklogprojections,weestimatethatGalfarwillsecurearoundOMR240mninnewawardsduringFY10,themajorityofwhichweexpecttobegeneratedfromcivilworks.Movingforward,weexpectover80%ofnewcontractawardswillcomefromcivilworks,withthebalancefromoil&gas.

Galfar is tendering for OMR 1.4bn of 2010 contracts

GalfariscurrentlytenderingforatleastOMR1.38bn(USD3.61bn)inOman,withalmosttheentirebasketoftendersbeingonOmanigovernmentcivilprojects.Themajorityoftheseprojectsareairportdevelopmentpackages.Galfar'sgrowingfocusonthesepre-dominantlycivilandinfrastructureprojectsisadirectresultoftheincreasingOmanigovernmentprioritisationofthissegmentovercontinuedoil&gasinvestments.ThisstrategicshiftbytheOmanigovernmentintendstomaketheOmanieconomymorediversifiedandthuslessreliantonitshydrocarbonresourcesandthevolatilityoftheirmarketprices.

TheMinistryofTransportandCommunicationisexpectedtocontinueitsspendingspreeinlinewithplanstodevelopandupgradeatotalofsixairportsintheSultanate.Galfarisbiddingforalmostalltheseongoingtendersamidstincreasingcompetitionfromlocalandforeigncompanies.Severalroadspackagesarealsoexpectedtobeawardedduring2010includingphase4oftherehabilitationworksforNizwa-ThumraitRoad.WenotethatGalfarisalreadyworkingonthecurrentlyongoingthirdphaseofthisproject.

Galfar key tenders

Project Estimated tender value (OMR mn)

Muscat International Airport- Air Traffic Control Tower 23

Muscat International Airport- New Terminal Building 345

Salalah Airport- New Terminal Building 326

New Sohar Airport - Package 2 - Airfield Infrastructure 38

New Sohar Airport - Package 3 - Passengers Terminal 115

Duqm Airport - Phase 2 - Airfield Infrastructure work 38

Duqm Airport - Phase 2 - Passenger Terminal Building 75

Ras Al Hadd Airport - Package 3- Passengers Terminal 48

Crown Plaza Duqm Resort - Construction Package 115

Multipurpose harbour and road network at Halaniyat Islands - Construction Package 38

New hospital at Masirah - Main Construction Package and Ancillary Works 12

Nizwa - Thumrait Road - Phase 4 - Rehabilitation Works 38

Wadi Daiqah Dam - Quriyat Network 115

Muscat Wastewater project - New Darsait STP 58

Total 1,384 Source: Proleads, SHUAA Capital

Increased presence of foreign firms

ThestreamofoncomingtendersinOmanhasresultedinnoticeablyhigherparticipationfromforeigncompanieshighlightingGalfar’sexposuretoincreasedcompetition.Galfar’smightystandingamongstlocalcontractors,intermsofcapacityandcapabilities,isnotaspronouncedwhenotherrespectableforeignplayersareincluded.

MajorplayersthatarepermanentlypositioningthemselvesinOmanincludeLarsen&ToubroOman(India),CCC(Greece),TAV(Turkey),Carillion(UK)andStrabagOman(Austria).Thisincreasinglycompetitivelandscapehasledmajorforeignfirmstoventurewithlocalfirmsaimingtoleverageontheirexistingknow-howoftheOmaniconstructionmarketthusincreasingtheircompetitiveedge.Inoilandgas,keyEPCplayerslikePetrofachavealreadybeenactiveforsometimeintheSultanate.

Tendering for at least OMR 1.4bn of

2010 contracts

Bidding for all airport development packages

Losing its standing for growing foreign

competition

March18th,2010 17


Major tenders lost by Galfar to foreign firms

Project Sector Contractor Estimated tender value (OMR mn)

Muscat International Airport - Infrastructure and Civil Works Civil CCC & TAV 500

Batinah coastal road - Phases 1 and 2 CivilMakyol and Nagarjuna Construction

274

Oman Parliament - Construction Works Civil Carillion Alawi 100

New Sohar airport - Infrastructure Works Civil Strabag Oman 40

Power substations and grid networks - EPC Works Power Larsen & Tubro 35

Amarat Heights Dam in Wadi Adai - Construction Works Civil Strabag Oman 28

New royal flight hangar at Seeb International Airport - Construction Works Civil Larsen & Tubro 16

Asian Beach Games - Infrastructure Works Civil Larsen & Tubro 9

Total 1,001

Source: Proleads, SHUAA Capital

No longer the preferential contractor for the government

GalfarwastheOmanigovernment'spreferredcontractor,mainlyduetotheexceptionallyhighrateofOmani'swithinitworkforceinamarketdominatedbyforeignworkers,whichledittogainareputationasthegovernment’shandyman.Galfarhasenjoyedthecontinuedparticipationingovernmentcontractsandthoseawardedbylocaloilandgascompanies,mostnotablywithPetroleumDevelopmentOmanforoverthreedecades.

WhilethegrowingspendingbyGalfar'slargestclient,theGovernmentofOman,oninfrastructureprojectsduring2009andtheyearsaheadwouldnormallybeexpectedtohaveapositiveeffectonthelargestlocalcontractorandthelargestsingleemployerofOmani'sintheSultanate,therealityonthegroundsuggestsotherwise.Infact,thetotalvalueofGalfar's2009contractadditionsfellby71%YoYtoreachOMR158mninFY09.

ItseemsachangeisinthemakingwiththegovernmentofOmanclearlysignallingtheendofaneraandthebeginningofanewone.Perhapsthemostsymbolicofthisshift,wasthefactthattheGalfarJVwithIndianLarsen&ToubrolosttheMuscatAirportdespitebeingthelowestbidder,toanentirelyforeignconsortiumofGreek-basedConsolidatedContractorsCompany(CCC)andTurkey’sTAV.WhileGalfaraskedforUSD1.28bn,CCCwondespitebiddingUSD1.32bn.AnotherexampleistheSoharAirport;thisOMR40mncontractwasawardedtoanotherforeigncompany,StrabagOman.

The government's handyman?

March18th,2010 18


SWOT analysis

Strengths

• LargestlocalcontractorinOman• SolidrelationshipsandtrackrecordwiththeOmanigovernmentand

PetroleumDevelopmentOman• Offersconstructionservicesspanningthevariousmarketsegmentsfromoil&

gastoroads&bridgesandcivilprojects

Weaknesses

• AlmostallofGalfar'sbacklogisrestrictedtothelocalmarket• Over-relianceongovernmentworkswithlimitedcontributionfromtheprivate

sectortothebacklog• Lowbacklog/salesratiocomparedtoregionalandglobalpeers,implying

reducedfutureearningsvisibility

Opportunities

• ExpanditsbusinessbeyondOmanintoothergrowthmarketswithinthewiderMENAandontheIndiansub-continent

• Furtherdiversificationofrevenuestreamsbypursuingmoreworkwithintheinfrastructureandcivilsegments

Threats

• Increasinglycompetitiveenvironment,deterioratingpricingpowerandabilitytowincontracts

• Erodingcompetitiveadvantageandlossofgovernmentsupport• Highnetdebtposition• Highreceivablespastdue

March18th,2010 19


Financial analysis and forecastsRevenues falling

GalfargeneratedOMR410.3mninFY09revenues(+13%YoYvs.OMR363.0mninFY08),anall-timehigh.However,mostofthisgrowthcameonthebackofgovernmentcontractsawardedtoGalfarbetween2005-2008whichinthemidstofthecrisiswerere-invigoratedbythecombinationofaKeynesianpushandthecompany'sconclusionthatthesegrowingdelayswereplacingitoutoffavourwithgovernment.

WhileOmaniprivatesectorinvestmentssufferedduring2009,especiallyinrealestate,thegovernmentincreaseditsspendingandwentaheadwithseverallargescaleinfrastructureprojects.Galfar'ssupposedlystrongrelationshipwiththegovernmentwasexpectedtoconvertintoahealthycontributiontoitsbacklog.Contrarytomarketexpectations,Galfar'snewcontractsawardsin2009fellbyastaggering71.1%YoYtoOMR158mn.

Goingforward,weexpectthechallengingoil&gasconstructionmarketcoupledwiththeincreasinglycompetitivegeneralcontractingenvironmentandthemarket'sgrowingdependenceonthefewbuthighvaluegovernmentcontracts,toseparatethemarketwinnersfromtherest.TherecenttrendofhighprofilecontractlossesbyGalfartoglobalplayers(evenwhenitwasthelowestbidder)-fuelourdoubtssurroundingitsabilitytobeamongthebigwinners.Medium-termgrowthseemsunlikelyandsustainabilitywillbeachallengingobjectivetoachieveinourview.


WhileweexpectGalfarin2010tocontinuereapingthebenefitsofthecontractsamassedduringthegoldenerabetween2005and2008,theexistingbacklogwilllikelybeinsufficienttosustaintop-linegrowthdespiteourprojectedincreaseinnewcontractawardsrelativeto2009.

WiththecurrentbacklogsignificantlydepletedbyFY10,thecompanyislikelytoseeitslowbacklog/salesratiotakingitstollontheFY11topline.WeexpectGalfartorecordFY11revenuesofOMR364.1mn,beforedecliningdowntoOMR336.3mninFY12,implyingaYoYdeclineof2.9%and7.6%respectively.

Basedonourforecasts,theexistingbacklogcontributionwillbe88%(OMR329.2)ofFY10revenueswithnewcontractawardsproducingtheremainder(OMR45.8mn)ofourFY10top-lineforecast.Only3%ofFY12revenueswillcomefromthecurrentbacklog.

2009 contract awards down 71% YoY

Galfar's revenue 2006-2012

164,492

267,464

362,976

410,275

374,915 364,101336,297

62.6%

35.7%

13.0%

-8.6%

-2.9%-7.6%

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

2006 2007 2008 2009 2010E 2011E 2012E

Reve

nue,

OM

R '0

00

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

Reve

nue

grow

th

Revenue growthRevenue

Revenues declining

March18th,2010 20



Weexpectrevenuesfromoil&gastolosetheirtop-linedominancetoagrowingshareofcivil,roads&bridgesandutilityprojects;segmentsthatbenefitfromtheOmanigovernment'sincreasedspendinganddiversificationplanstowardalessoildependanteconomy.Weexpecttheoil&gassegmenttocontribute15%ofthetop-lineinFY12,downfromanestimatedshareof36%inFY09.


Gross profit recovering from the lows of FY 09

Between2005and2009,generalcontractorswerebeingchasedbydeveloperstoperformworkontimewhenpricewasnotaconcern;thebargainingpowerwasinthehandsofthecontractors.Surprisingly,duringthatperiodGalfarwasaclearunderperformercomparedtoUAEbasedcontractors;togetherwithMMGitmadeanetmargindeclineversusanetincreaseforArabtecandDSI.

Comparative GPM table 2006-2009

Company 2006 2007 2008 2009

Arabtec Holding 12.7% 17.3% 15.3% 17.3%

Drake & Scull International 16.3% 18.9% 18.7% 20.8%

Mohammad Al Mojil Group 32.7% 36.4% 28.4% 15.5%

Average of peers 20.6% 24.2% 20.8% 17.9%

Galfar 15.2% 13.0% 10.0% 3.9%Source: SHUAA Capital, Company reports

Thisrealityismainlyattributedtothelowmargin,fixedpricenatureofGalfar'smostnotablecontractsduringaperiodofrisingbuildingmaterialcostsanderodingoperationalefficiency.Moreover,currentmarketconditionshaveledtoamorecompetitivecontractinglandscapewithashiftinbargainingpowerfromcontractorstoclients.

Galfar revenues and current backlog depletion

-

50

100

150

200

250

300

350

400

2010F 2011F 2012F

OM

R m

n

Revenues from existing contracts Revenues from new contracts

Oil & Gas contribution declining

Galfar FY 09 & 12 revenue breakdown

Oil & Gas 36.0%


Civil23.6%

Utility & Services17.6%

India0.0%

Oil & Gas 15.3%


Civil35.7%

Utility & Services23.3%

India2.4%

March18th,2010 21


Aseeminglygrowingnumberofregionalandinternationalcompaniesarechasingfewercontractsalongsidethelocalcontractors-leadingtoerosioninpricingpower.PerhapsthemostsignificantandtellingsetbackinGalfar'sdeterioratingperformanceanddescendingstandingwithitslargestlocalclient,thegovernmentofOman,wasthecompany'sfailuretowintheOMR500mnMuscatAirportnewterminalcontractdespitebeingthelowestbidderandthecontractorwiththelongesttrack-recordwiththeclient.

WithGalfar'shistoricalmarginsbelowregionalindustryaverages,theeffectofreducedpricingpowerwasmorepronouncedonthisnamethanonotherleadingregionalcontractors.FY09grossmarginsdeclinedto3.9%,608bpsbelowFY08numbers.Moreover,thecompany'squarterlymarginstooareinadownwardspiralfrom8.2%inQ109allthewayto4.0%inQ309beforeheadingsubzeroinQ409.

Accordingtomanagement,2009margins,especiallythoseofQ409sufferedfromthedelays,upgrades,revisionsofscopeandlossesonthelong-runningMuscatexpressway,withoutfurtherdetailsbeingprovided.Whilethisistruefor2009andespeciallyQ409,thetrendhasbeenheadingsouthforfouryearsnow.Consequently,weareexpectingtheGPMdistortionfromthenegativeimpactoftheMuscatExpresswayprojecttofadeasitreachescompletioninFY10-leadingtoamarginincrease.However,wedonotexpectmarginstoreachbacktotheFY08levelsof10%anytimesoon.

WeforecasttheGPMtoincreasefrom3.9%inFY09upto6.9%inFY10beforestabilisingaroundthe8.6%byFY11.


Margins suffer from loss making projects

Galfar's gross pro�t and GPM 2006-2012

25,068

34,81536,369

16,175

25,968

31,44228,764

15.2%

8.6%8.6%

6.9%

3.9%

10.0%

13.0%

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

2006 2007 2008 2009 2010E 2011F 2012F

Gro

ss p

ro�t

, OM

R '0

00

Gross profit marginGross profit

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Reve

nue

grow

th

March18th,2010 22


EBITDA

Justlikewiththe2006-2009GPMcomparison,GalfarandMMGstandoutastheonlytwogeneralcontractorsinourcoverageuniversewithanegativenetEBITDAmargintrendduringtheperiod.

Comparative EBITDA margin table 2006-2009

Company 2006 2007 2008 2009Arabtec Holding 10.64% 15.55% 14.51% 16.09%Drake & Scull International 13.4% 14.7% 12.1% 15.3%Mohammad Al Mojil Group 27.6% 32.7% 25.4% 17.4%Average of peers 17.2% 21.0% 17.3% 16.3%Galfar 17.1% 15.1% 12.7% 7.3%

Source: SHUAA Capital, Company reports

Selling,generalandadministrative(SG&A)expensesareexpectedtoremainatcurrentlevels,c.2.1-2.3%ofrevenues.ThepartialGPMrecoveryfromFY09onwardscoupledwiththeexpectedstabilityinSG&AexpensesisforecastedtoleadEBITDAuptoOMR40.0mnin2010,astrong34.6%YoYgrowth.Movingforward,thecontinuedrecoveryingrossmarginwillleadEBITDAtoOMR47.0mninFY11andOMR44.7mnbyFY12-end.

WhiletheGPMisnotexpectedtoreachbacktotheFY08levelstheEBITDAmarginwill,mainlyonthereversalofthedisproportionatelyhighdepreciationexpensesasrevenuesdecline.


Net profits reach bottom in 2009

Galfar'sbottomlineexpanded38.2%between2006and2008fromOMR16.6mntoOMR22.9mn.Thisstronggrowthcametoanabruptendin2009whichsawGalfarnosedivefromitsmostprofitableyeareverinFY08toitsalltimelowofOMR3.8mninFY09asmarginsplungedandQ409witnessedthecompany'sfirstquarterlyloss(OMR-5.9mninQ409).


Galfar's EBITDA and EBITDA margin 2006-2012

28,096

40,488

46,96044,65145,992

29,756

40,046

17.1% 15.1%

12.7%

7.3%

10.7%12.9%

13.3%

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

2006 2007 2008 2009 2010E 2011E 2012E

EBIT

DA

, OM

R '0

00

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

EBIT

DA

mar

gin

EBITDA EBITDA margin

Net profits growth in 2010

Galfar's Net pro�t and net pro�t margin 2006-2012

16,576

22,156 22,913

3,831

13,761

19,40917,789

10.1%8.3%

6.3%

0.9%3.7% 5.3% 5.3%

-

5,000

10,000

15,000

20,000

25,000

2006 2007 2008 2009 2010E 2011E 2012E

Net

pro

t O

MR

'000

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Net

pro

t m

argi

n

Net profit Net profit margin

March18th,2010 23


WeexpectGalfar'sbottomlinetowitnessagradualimprovementoverthecomingyearsasmarginsrecoverfromtheir2009lowsdespitedecliningrevenues.Whileweareprojectingrevenuestodeclineby8.6%and2.9%inFY10andFY11respectivelyonthebackofbacklogdepletion,netprofitsareexpectedtogrowbyaround3.6xinFY10andafurther41.0%YoYgrowthinFY11toreachOMR13.8mnandOMR19.4mnrespectively.Thisdiscrepancybetweentop-linedeclineandbottom-linegrowthismainlyaresultofaGPMrecoverycoupledwithourexpectationofstableSG&Aexpensesoffsettingthedeclineinrevenues.

Thenetprofitmargin(NPM)expansionisexpectedtobeslowerthanthatoftheGPMandEBITDAduetotherelativelyhighnetinterestexpense-leadingittolandon3.7%and5.3%inFY10andFY11respectivelybyadding274bpsand166bpsYoY.

High net debt, most leveraged contractor in the region

AsofFY09-end,GalfarheldOMR4.56mnincashandcashequivalentsagainstwhichthecompanyhadOMR98.5mnindebt.Asaresult,thenetdebtpositionwasOMR94mn,equivalenttoOMR0.31pershare.


Totaldebt-to-equityreached120%asofFY09-end,almostinlinewithFY08leverageratioof129%.Consequently,Galfaristhemostleveragedcontractorinourcoverageuniverse.

Key contractors' net cash (debt) and leverage

Company Net cash (debt) per share (USD)

Debt-to-Equity

Arabtec Holding (0.07) 35%

Drake & Scull International 0.10 32%

Mohammad Al Mojil (0.88) 25%

Galfar Engineering (0.81) 120%Source: SHUAA Capital, Company reportsCash, debt and equity figures corresponds to the last reported figures

Net debt of OMR 0.31/share

Galfar's cash and debt 2006-2012

(55)

(108)(99)

(86)(79)

13 18 145 5

21

37

(84)

(65)

(42)(36)

(89)

(23)(37)

(93) (94)(120)

(100)

(80)

(60)

(40)

(20)

-

20

40

60

2006 2007 2008 2009 2010E 2011E 2012E

OM

R m

n

Debt Cash Net cash (debt)

March18th,2010 24


Cash conversion cycle stabilising

ThepastyearssawGalfarenjoyingasignificantworkingcapitaladvantage;receivableswerecollectedaheadofpaymentstosuppliersandsubcontractors.ThestrongtieswiththegovernmentwhichGalfarhad,presumablyallowedthecompanytocollectlargeupfrontpayments.However,thisadvantagebegantodiminishinFY08.


Receivables past due up 88% in 2009 - A major concern

Asof2009year-end,GalfarhadOMR159.3mnoftradereceivables,outofwhich63.5%arepastdue.Thevalueoftradereceivableswithmorethan270dayspastdue,amountstoOMR28.4mnand17.8%ofthetotal-amajorconcerninourview.

Thefactthatthe270daybracketincreasedby88%YoYwhenrevenuesincreasedbyarelativelylow13%isamajorsourceofconcernontherecoverabilityofthismoney.Giventhisdeterioratingreceivablesposition,webelievethatitishighlylikelythatGalfarwillbookimpairmentsonreceivablesinthefuture.Asaresult,wehaveoptedtoaddressthisconcerninourfourvaluationscenarios,bydiscountingpotentialimpairmentsdirectlyfromthefairvalue.OurimpairmentassumptionsrangefromOMR10-28.4mn,dependingonscenario.Moreonthisisavailableinourvaluationsection.

Galfar's cash conversion cycle 2006-2012

(61)

(16)

26

4642 40 42

(80)

(60)

(40)

(20)

-

20

40

60

2006 2007 2008 2009 2010E 2011E 2012E

Day

s

Receivables past due deteriorating

March18th,2010 25


Capex decline

Withtherapidbacklogexpansionandtheanticipationofastrongfuturegrowth,Galfarkeptitscapitalexpenditurehighbetween2006and2008inattemptstostrengthenitsabilitiesincapturingandexecutingmorework.Whilethiswasnecessarytoenablethecompanytocapturegrowthopportunities,theexpecteddeclineinrevenuesisforecasttobringmajorcapexadditionstoanabruptend-leadingcapex/salesdown.

AlthoughrevenuespeakedinFY09,capexdeclinedtoOMR28.8mnfromOMR48.9mntheyearbefore.Consequently,thecapex/salesratiocamedownto7.0%inFY09,losingsixpercentagepointsfromFY08.


Withthecompany'smedium-termgrowthlookingverydifferenttodaythanitdidinFY08,capexisexpectedtostayaroundtheFY09levelsgoingforwardreflectingthenewmarketdynamicsforthecontractingplayers.Weforecastacapex/salesratioof6.9%inFY10comingdownto6.0%inFY11andstabilizingat5.5%inFY12.

Dividends proposed

ForFY08,GalfardistributeddividendsofOMR0.02persharewhichcamebelowtheguidancesetintheIPOprospectusofOMR0.035pershare.Despite2008beingarecordyearintermsofnetprofits,Galfar'smanagementoptedtopreservecashespeciallyasthecompany'sworkingcapitaladvantagewasdiminishing,receivables'impairmentriskgrowinganddebtlevelsescalating.

Despitethecompany'sdeterioratingprofitabilityandlimitedcashbalancein2009,Galfar'smanagementandBODproposeddividendsofOMR0.01pershare-implyingadividendyieldof2.0%ontheshare'slastclose.Movingforward,weexpectdividendstostayatthesamelevelforFY10,beforeacceleratingtoOMR0.02/shareinFY11.

Capex/sales goes down to 5.5%

Galfar's estimated capex requirements 2006-2012

44,503 48,86321,791 18,446

42,522 28,775 25,850

27.1%

15.9%13.5%

7.0% 6.9% 6.0% 5.5%

-

100,000

200,000

300,000

400,000

500,000

600,000

700,000

2006 2007 2008 2009 2010E 2011E 2012E

Cape

x, O

MR

'000

0%

5%

10%

15%

20%

25%

30%

% o

f rev

enue

s

Capex % of revenues

Dividend yield of 2%

March18th,2010 26


ValuationWeinitiatecoverageonGalfarEngineering&Contracting(Galfar)withaSELLrecommendationbasedonafairvaluetargetofOMR0.435pershare,implyinga14.8%downsidepotentialtothecurrentpriceofOMR0.511pershare.

Valuation Fair value Weighting Weighted fair value/share

DCF 0.352 70% 0.25

Relative 0.630 30% 0.19

SC fair value 100% 0.435

Current price 0.511

Upside/(downside) -14.8%Source: SHUAA Capital

Ourfairvaluetargetisaweightedaverageoftwovaluationexercises.Thefirstisascenariodriventhree-stageDCFvaluationbasedonourfinancialprojections.ThesecondmethodisarelativevaluationapproachbasedontheaverageP/E10,EV/EBITDA10andP/backlogmultipleforagroupofcomparablecompanies.OurfairvaluetargetwasbasedonSHUAACapital'sstandardweightedaverage:a70%weightingallocatedtoourDCFvalueandtheremaining30%fortherelativevaluation.

Scenario driven three-stage DCF

Ourthree-stageDCFvaluationofGalfar,whichwassubjectedtofourdifferentscenarios,producedascenario-weightedfairvaluetargetofOMR0.352pershare-implyinga31.1%downsidepotentialtothelatestclosingprice.TheDCFwasbasedonatenyearforecastperiodandaterminalvalue.Theweightedaveragecostofcapital12(WACC)usedwas11.0%.

Galfar's scenario weighted DCF fair value

Scenario Net cash/share

PV of FCF/share

TV/share FV/share before

impaired receivables

Impaired receivables (|OMR mn)

Impairment/share

FV Weighting Weighted fv/share

Doomsday (0.31) 0.30 0.10 0.091 28 (0.09) (0.004) 10% (0.00)% fair value contribution -344.4% 334.4% 110.0% 100.0%

Bear (0.31) 0.37 0.19 0.249 20 (0.07) 0.183 30% 0.05 % fair value contribution -125.6% 150.2% 75.4% 100.0%

Base (0.31) 0.46 0.32 0.471 15 (0.05) 0.421 50% 0.21 % fair value contribution -66.6% 98.1% 68.5% 100.0%

Bull (0.31) 0.63 0.59 0.909 10 (0.03) 0.875 10% 0.09 % fair value contribution -34.5% 69.7% 64.8% 100.0%

Fair value/share 0.352 Upside/(downside) -31.1%

Source: SHUAA Capital

Toaddressthegrowingconcernssurroundingtheissueofreceivablescollectionsstemmingfromclients'paymentsdelays,wesubjectedourDCFvaluationtoassumptionsonimpairmentsofreceivables,akeyriskfacingGalfarandthecontractingindustryingeneral.Asof2009year-end,GalfarhadOMR101.2mnofreceivablespastdueoutofwhichOMR28.4mnismorethan270dayspastdue.The270daysagebracketisup88%YoYandrepresents17.8%of2009tradereceivables.WeassumedimpairmentsonreceivablespastduerangingbetweenOMR10-28.4mn(negativeOMR0.03-0.09pershare).Theassumedimpairmentpersharewassubsequentlysubtractedfromthescenario-specificfairvalue.

2 The WACC was based on a cost of equity of 12% and a cost of debt of 8%. The cost of equity was derived through a risk free rate of 6%, an equity risk premium of 5% and an industry beta of 1.2. 2

Initiating with a SELL recommendation

Fair value based on two methods

DCF fair value is OMR 0.352/share

Valuation scenarios subjected to impairments

March18th,2010 27


Doomsday scenarioWithrevenuespeakinginFY09,thedoomsdayscenarioassumesaprolongeddeclineinrevenuesfromFY10andgoingforwardfuelledbyanextendedcontractioninoil&gasinvestments,saturationofmegainfrastructureinvestmentsbythegovernmentandasharperriseincompetitionleadingtolowercontractawards;byFY19,revenuesareprojectedtobedownc.65%comparedto2009.Underthisscenario,netprofitswillmakeareboundfromthelowsofFY09,onthebackofthefadingcontributionofthelossmakingMuscatExpressway.ByFY19,Galfar'sbottomlineisprojectedtobec.55%higherthanthedistortedFY09figures.

ThisscenarioassumesthatOMR120mnwouldbeawardedtoGalfarinFY10followedbyOMR142.5mninFY11andOMR127.5mninFY12.Together,thesenewawardsamounttohalfofthebacklogadditionsinourbasescenario.

Theprojectedcompoundedannualgrowthrate(CAGR)forrevenuesbetween2009and2019isnegative9.9%.Withmarginsrecoveringovertheforecastperiodrelativeto2009,thegrossprofitandEBITDACAGRdeclineismuchlesspronouncedatanegative3.9%and5.0%respectively.Underthisscenario,netprofitsareforecasttostayabovethe2009-lowsanddeliveraCAGRof4.4%overtheperiodbackedbyahigherGPM,lossesfromAlKhalijsubsidingandalowerSG&A/grossprofitsratio.

ThisscenarioassumesOMR28.4mn(OMR0.09pershare)ofpotentialimpairmentsonreceivablesandnoterminalgrowthrate.Webelievethatthecompany'scurrentnetdebtpositioncoupledwithafullimpairmentofexistingpastdueswillwipeouttheequityvalue.

Doomsday scenario CAGR's Stage 1 Stage 2 Stage 3

CAGR 2009-2012 2012-2014 2014-2019 2009-2019 2010-2019Revenue -25.0% -5.5% -1.3% -9.9% -9.4%

Gross profit -6.8% -5.5% -1.4% -3.9% -6.9%

EBITDA -10.7% -5.3% -1.4% -5.0% -6.9%

Net profit 19.8% -1.8% -1.6% 4.4% -5.0%


Bear scenarioWhilethebearscenarioassumesdeteriorationinGalfar'srevenuegeneratingability,itismoremoderatethanthedoomsdayscenario.Inthebearscenario,weexpectGalfartosecureOMR180mnworthofnewcontractsinFY10followedbyOMR213.75mnandOMR191.25mninFY11andFY12respectively.ThecumulativevalueofawardsfortheperiodisOMR585.0mn,1.5xourdoomsdayscenarioadditions.

RevenueCAGRfortheperiodbetweenthepeakin2009andFY19isnegative5.6%.Withmarginsrecoveringoverourforecastperiod,grossandnetprofitsCAGR'swillturngreenat1.4%and12.8%respectivelyover2009-2019.BearcaseFY19EBITDAwouldbeinlinewithFY09levelsyetstill35.6%lowerthanFY08highs.Thecompany'snetprofitsinFY19willstillbe44.2%lowerthanFY08levelsdespitegrowingmorethanthreetimesfromthelowsofFY09.

ThisscenarioassumesOMR20mn(OMR0.07pershare)inimpairmentsonreceivablesanda1.0%terminalgrowthratereturningascenario-specificfairvalueofOMR0.183pershare,implyingadownsidepotentialof64.2%tothelastclose.Bear scenario CAGR's Stage 1 Stage 2 Stage 3

CAGR 2009-2012 2012-2014 2014-2019 2009-2019 2010-2019

Revenue -14.7% -3.8% -0.3% -5.6% -4.9%

Gross profit 8.2% -3.8% -0.4% 1.4% -2.5%

EBITDA 3.0% -3.7% -0.3% -0.1% -2.4%

Net profit 45.5% 0.2% 1.5% 12.8% 1.2%


Doomsday wipes out equity value

Bear case fair value at OMR 0.183

March18th,2010 28


Base scenarioThebasescenario,whichisthebasisofallsectionsinourreportandhasthehighestweightinginourvaluation,assumestherevenuedeclinewitnessedinthepreviousscenariosendsinFY14andthatarecoverystartsthefollowingyear.However,FY19revenuesareexpectedtoremain17.9%shortoftheFY09levels.

Here,weexpectGalfartocaptureOMR240mnworthofnewawardsinFY10followedbyOMR285mnandOMR255mninFY11andFY12respectively.DespitecomingshortoftheOMR547mnrecordadditionsofFY08,thesearefarmorethantheOMR158mnwoninFY09.

BasecaseCAGRforrevenuesbetweenthepeakof2009and2019isnegative1.9%.Moresignificantly,EBITDAandnetprofitsCAGRare4.2%and19.1%respectively,poweredbyimprovedmarginsrelativetothe2009margins.FY09marginssufferedespeciallyinthesecondhalfoftheyearonthebackofthelowmarginontheMuscatExpresswayproject.Underthisscenario,FY19EBITDAisprojectedtobe50.5%higherthanFY09,butstay2.6%belowtheFY08peak.By2019,netprofitisexpectedtobemorethanfivetimesFY09numbers,yetstilldown4.4%fromFY08highs.

Withaterminalgrowthof2.0%andOMR15mn(OMR0.05pershare)inimpairmentsonreceivables,thisscenarioreturnsafairvaluepershareofOMR0.421-implyinga17.7%downsidetothecurrentsharepriceofGalfar.

Base scenario CAGR's Stage 1 Stage 2 Stage 3

CAGR 2009-2012 2012-2014 2014-2019 2009-2019 2010-2019Revenue -6.4% -1.5% 0.7% -1.9% -1.2%

Gross profit 21.2% -1.5% 0.6% 5.9% 1.2%

EBITDA 14.5% -1.4% 0.6% 4.2% 1.3%

Net profit 66.8% 2.6% 3.2% 19.1% 5.3%Source: Galfar, SHUAA Capital

Bull scenarioBeingthemostoptimisticofourscenarios,bullrevenuesareprojectedtoexceedtheFY09peakanddeliveraCAGRfortheperiodbetween2009and2019of3.1%.Thisforecastedbullrevenuegrowth,coupledwiththeexpectedincreaseinmarginsfromthesuppressed2009levelsleadtoanEBITDAandnetprofitCAGRof9.9%and26.7%respectivelyoverthesameperiod.

OurassumptionsonbacklogadditionsimplyOMR360.0mninnewcontractwinsinFY10followedbyOMR427.5mninFY11andOMR382.5mninFY12.WhilethisannuallevelofbacklogadditionsisstillshortoftheOMR547mnclinchedinFY08,itisfarmorethantheOMR158mnwoninFY09.Incumulativeterms,forthisthreeyearperiod,weproject50%moreadditionsthanourbasecase.

Whenapplyingthisscenario,Galfar'sFY19EBITDAexpandsby156.9%comparedtoFY09andexceedstheFY08peakbyastrong66.2%.Meanwhile,thebottomlinemanagestosurpassFY08recordlevelsby78.6%andexpand11xcomparedtoFY09numbers.Toaccountforthepotentialimpairmentofreceivables,wediscountOMR10mn(OMR0.03pershare)fromGalfar'sequityvalue.Weapplyahigherterminalgrowthrateof2.5%toreachafairvaluepershareofOMR0.875pershare-implyinganupsidepotentialof71.3%fromthecurrentprice.

Bull scenario CAGR's Stage 1 Stage 2 Stage 3

CAGR 2009-2012 2012-2014 2014-2019 2009-2019 2010-2019Revenue 6.8% 1.1% 1.7% 3.1% 3.8%

Gross profit 40.9% 1.1% 1.6% 12.0% 6.0%

EBITDA 32.3% 1.1% 1.7% 9.9% 6.1%

Net profit 97.8% 5.0% 4.6% 26.7% 10.4%Source: Galfar, SHUAA Capital



March18th,2010 29


Relative valuation

OurweightedrelativevaluationmethodreturnsanequityvalueofOMR0.630persharederivedfromthemedianFY10P/E,EV/EBITDAandP/backlogofselectedpeersandsubjectedtoascenario-basedimpairmentofreceivablespastdue.

Galfar's peers

Detail Country Market Cap (USD mn) P/E 2010E EV/EBITDA 2010E P/backlog

Saipem Italy 15,605 15.3 6.3 0.6

Technip France 8,069 14.7 5.1 0.7

Petrofac UK 6,301 13.6 4.5 0.5

Arabtec Holding PJSC* UAE 736 4.4 3.0 0.2

Mohammad Al Mojil KSA 763 23.4 10.2 1.2

Drake & Scull International LLC UAE 526 8.1 4.8 0.5

Samsung Engineering South Korea 4,192 11.6 8.1 0.3

GS Engineering South Korea 4,108 8.9 6.7 0.2

Daewoo Engineering South Korea 3,230 11.5 11.2 0.1

Larsen & Tubro India 20,467 23.0 17.3 1.0

Carillion UK 1,895 8.0 5.4 0.1

Strabag Austria 2,916 14.0 4.6 0.2

Average 13.0 7.3 0.5 Source: Reuters, SHUAA Capital, Company reportsNote: Prices as of 15.03.2010, *= backlog used for Arabtec excludes the Russian contract

ThepeergroupweusedincludesmainlygeneralconstructioncompaniesandsomeEPCcontractorswhichareeitherGCC-basedorhavesignificantexposuretotheregioningeneralandOmaninparticular.Galfar'soperationswithintheconstructionindustryrangefromcivilandroadscontractingtooil,gasandutilitiesengineeringservices.Inourview,thisjustifiesMMG,ArabtecandDSIasregionalpeers.OtherinternationalpeerssuchasLarsen&Tubro,CarillionandStrabaghaveeitherestablishedsubsidiariesorjointventuresoperatingintheOmanicontractingmarket.

Galfar's weighted relative valuation, post impairment

Valuation post impairment Fair value/share Weighting Weighted fair value/share

P/E 2010E 0.54 33% 0.18

EV/EBITDA 2010E 0.62 33% 0.21

P/backlog 0.73 33% 0.24

SC FV per share 0.630

Last close 0.511

Upside/(downside) 23.2%Source: SHUAA Capital

Peer based valuation is OMR 0.630/share

March18th,2010 30


Upside to our valuation

Theupsidetoourvaluationcouldcomefromafirmerandfasterrecoveryinmarginsthanwehavealreadyanticipated.Galfarwashamperedbyadrasticdeclinethatsawitsgrossmarginsdivefrom15%inFY06to3.9%inFY09.

Inlightoftheslowdownintheoil&gasmarketandthesubsequentdropinrelatedspendingonnewcapacity,Galfarismakinganaggressivepushintothecivilsegmentwherethegovernment'sexpansionaryfiscalpolicyisinaction.However,recenttenderingset-backsongovernmentcontractsincludingthelossoftheMuscatInternationalAirportExpansionPackage,despitebeingthelowestbidder-impliesGalfarcouldbelosingthebenefitofpreferentialgovernmenttreatmentatatimewheninternationalcompetitionisgrowinginOman.ShouldGalfarprovetheseconcernsmisplacedanddemonstrateitsabilitytowinmajorgovernmentcontracts,allowingittooffsetthedecliningpotentialintheoil&gasfieldandexceedourexpectationsonbacklogadditions,thenthiswouldprovideadditionalupside.

WhileGalfarisseekinggeographicdiversificationbeyondOman,therehasbeenlittleprogressbeyondthesmallIndiancontracts(only0.6%ofitsbacklog).IncontrastcompanieslikeArabtecandDSIhavemadesuccessfulandsizeablemarketpenetrationsintherestoftheGulfandbeyond.ShouldGalfarbeabletoexpandinIndiaandeventuallyalsointoitstwootherstatedtargetmarketsofAbuDhabiandLibyainameaningfulform,thenthiscouldhaveaverypositiveeffectonourvaluation.

Risks to our valuation

WhilewehaveaccountedforthegrowinginternationalcompetitionwithintheOmaniconstructionmarket,mainlybyassumingthatEBITDAandnetmarginswillneverrecoverbacktothe2007levelsletalonethoseof2006-inourview,itisnotunlikelythatthegrowingcompetitionandseeminglydeterioratingcompetitiveadvantageofGalfarcouldleadittoengageinadetrimentalpricewartomaintainmarketshare.

Afurtherdeteriorationincashcollection,mainlyfromprivateclients,couldpotentiallyleadtohigherimpairmentsofreceivablesthanwehavealreadyassumed.Ourconcernssurroundingthismatterarerising,especiallygiventhatGalfar'sreceivablespastdueover270daysincreasedbysome88%YoYtoreachOMR28.4mn.Whileourvariousvaluationscenariosaccountforimpairments,afurtherdeteriorationofthepastduereceivablespositionishighlyplausibleinouropinion.

March18th,2010 31


Financials

Consolidated balance sheet (OMR '000)

Year to December 2007 2008 2009 2010E 2011E 2012E

Inventories 21,762 46,295 23,245 28,681 27,342 25,277

Trade and other receivables 96,386 102,747 122,122 102,716 99,754 92,136

Work in progress - 47,740 45,450 41,087 39,902 36,854

Prepayments, advances and other receivables 9,030 13,588 11,968 11,299 10,973 10,135

Cash and cash equivalents 17,644 14,302 4,556 4,780 20,852 37,335

Total current assets 144,821 224,672 207,340 188,563 198,822 201,738

Net Property, plant equipment 100,607 130,061 134,402 137,757 135,882 130,787

Goodwill 275 275 - - - -

Investment in associate - - 1,067 1,067 1,067 1,067

Available for sale investments 145 145 145 145 145 145

Retentions Receivable 11,668 15,993 25,300 20,543 19,951 17,506

Total non-current assets 112,695 146,474 160,913 159,512 157,044 149,505

Total assets 257,516 371,146 368,254 348,075 355,866 351,242

Bank borrowings 14,288 38,874 22,962 21,077 20,469 18,796

Short-term loans 4,200 17,672 22,500 19,321 18,764 17,229

Term loans - current portion 16,683 14,640 20,796 19,321 18,764 17,229

Current portion of finance lease liability - 3,957 2,648 2,635 2,559 2,349

Trade and other payables 105,873 136,930 159,909 133,843 127,595 117,958

Provision for taxation 1,521 878 - - - -

Total current liabilities 142,565 212,951 228,817 196,197 188,151 173,562

Term loans 19,956 27,078 26,729 23,712 23,028 21,145

Provision for employees' end of service indemnity 3,905 5,182 6,147 6,792 7,254 7,485

Deferred tax liability 4,314 6,527 7,220 7,857 8,476 9,048

Creditors for purchase of PP&E 10,419 5,834 3,992 4,780 4,557 5,055

Non-current portion of finance lease liability - 5,333 2,897 2,635 2,559 2,349

Advances on contracts 5,409 24,184 9,785 14,340 13,671 12,638

Total non-current liabilities 44,003 74,138 56,770 60,117 59,545 57,721

Total liabilities 186,569 287,089 285,587 256,313 247,696 231,283

Total shareholders equity 70,416 83,329 82,016 91,110 107,519 119,308

Total equity 70,947 84,056 82,667 91,761 108,170 119,959

Total liabilities and equity 257,516 371,146 368,254 348,075 355,866 351,242


Consolidated income statement (OMR '000)


Revenue 267,464 362,976 410,275 374,915 364,101 336,297

Cost of sales (232,649) (326,607) (394,100) (348,947) (332,659) (307,533)

Gross profit 34,815 36,369 16,175 25,968 31,442 28,764

Hire gross profit (767) (666) (505) (300) (146) -

Selling, general & administrative expenses (7,120) (7,882) (8,751) (8,117) (8,002) (7,653)

EBITDA 40,488 45,992 29,756 40,046 46,960 44,651

EBIT 26,928 27,821 6,919 17,551 23,294 21,111

Other income, net 1,697 2,356 1,993 1,875 1,821 1,681

Net interest (2,956) (3,978) (4,304) (4,177) (3,599) (3,013)

Impairment of goodwill of subsidiary - - (165) - - -

Net income before tax 25,670 26,199 4,444 15,249 21,515 19,779

Tax (3,339) (3,090) (690) (1,628) (2,181) (2,003)

Minority interest (175) (196) 76 140 75 13

Net profit attributable to shareholders 22,156 22,913 3,831 13,761 19,409 17,789

EPS (OMR) 0.07 0.08 0.01 0.05 0.06 0.06


March18th,2010 32


Key ratios


Growth

Revenues 62.6% 35.7% 13.0% -8.6% -2.9% -7.6%

Gross profit 38.9% 4.5% -55.5% 60.5% 21.1% -8.5%

EBITDA 44.1% 13.6% -35.3% 34.6% 17.3% -4.9%

Net profit 33.7% 3.4% -83.3% 259.2% 41.0% -8.3%

Equity 132.7% 18.5% -1.7% 11.0% 17.9% 10.9%

Assets 48.5% 44.1% -0.8% -5.5% 2.2% -1.3%

Margins & Profitability

Gross profit margin 13.0% 10.0% 3.9% 6.9% 8.6% 8.6%

EBITDA margin 15.1% 12.7% 7.3% 10.7% 12.9% 13.3%

Net profit margin 8.3% 6.3% 0.9% 3.7% 5.3% 5.3%

RoAE 44.1% 29.8% 4.6% 15.9% 19.5% 15.7%

RoAA 10.3% 7.3% 1.0% 3.8% 5.5% 5.0%

Leverage

Net cash (debt) (OMR '000) (37,483) (93,253) (93,977) (83,921) (65,291) (41,763)

Total debt to equity 78.3% 129.1% 120.1% 97.4% 80.1% 66.3%

Valuation

EPS 0.07 0.08 0.01 0.05 0.06 0.06

BVPS 0.24 0.28 0.28 0.31 0.36 0.40

P/BV 2.2 1.8 1.9 1.7 1.4 1.3

P/E 6.9 6.7 40.0 11.1 7.9 8.6

Fair value based P/E 5.9 5.7 34.1 9.5 6.7 7.3

Dividend yield 6.52% 3.26% 1.96% 1.96% 3.91% 3.91%

FCF yield -22.0% -37.0% 23.2% 7.2% 15.4% 20.1%

Liquidity

Cash conversion cycle (15.5) 26.1 45.7 41.5 40.4 41.8

Cash ratio 0.12 0.07 0.02 0.02 0.11 0.22


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March18th,2010 35


Research

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