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FALCOM Research AL RAJHI BANK

Saudi Arabia

1

Banking Sector

(SAR '000) 2007 2008 2009E 2010E 2011E

Operating Income 9,321,096 10,575,267 11,041,776 12,552,026 14,548,648

Net Income 6,449,657 6,524,604 6,974,583 8,192,538 9,796,832

EPS (SAR) 4.30 4.35 4.65 5.46 6.53

Spread (%) 7.7% 6.6% 6.1% 6.6% 6.9%

ROE (%) 29.5% 25.8% 24.1% 25.45 28.0%

ROA (%) 6.0% 5.4% 4.7% 5.1% 5.3%

PE (x) 27.3 12.8 11.1 9.5 7.9

PBV (x) 7.4 3.1 2.5 2.3 2.1

Dividend Yield (%) 1.5% 5.4% 5.8% 6.8% 7.7%

CAGR (2008-2012) Est.*

Net Investment Income 14.4%

Operating Income 13.0%

Net Income 16.5%

Deposits 10.7%

Investments 9.8%

Assets 9.8%

Shareholders’ Equity 11.7%

CAGR (2003-2008)

Net Investment Income 19.1%

Operating Income 20.6%

Net Income 26.2%

Deposits 18.0%

Investments 21.5%

Assets 20.6%

Shareholders’ Equity 24.9%

Valuation Indicators*

PEG 2009 1.61

PEG 2010 0.54

PE 2009 11.1

PE 2010 9.5

PBV 2009 2.5

PBV 2010 2.3

Shareholding Pattern Jan’09

Sulaiman Al Rajhi 24.6%

Saleh Al Rajhi 13.6%

GOSI 9.9%

Abdullah Al Rajhi 5.9%

Public 46.0%

Market Performance

Market Price (March 24, 2009) 51.75

52 week High 97.50

52 week Low 40.60

PE (LTM) 11.90

PBV 2.87

Dividend Yield 1.90%

YTD 2008 -7.6%

1 Year Return -40.5%

3 Years Return -41.5%

Beta 1.09

30 day Avg. Volume 1,861,817

Tadawul Code 1120 Bloomberg Code RJHI AB

TASI 4584.21 Banking Sector 12,861.75

PE 9.6 PE 11.3

PBV 1.6 PBV 1.9

Dividend Yield 4.5% Dividend Yield 2.6%

No. of Outstanding Shares (millions) 1,500

Market Capitalization (SAR millions) 77,625

% to Total Market Capitalization 11.2%

Enterprise Value (SAR millions) 71,617

% to Banking Sector 29.7%

Price Volume Chart

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FALCOM ResearchAL RAJHI BANK

Saudi Arabia Banking Sector

2

Contents

Executive Summary 03

Bank Profile 05

Business Segments 07

Operations 08

Saudi Banking Sector 11

Growth Strategy 13

Competitive Advantages 17

SWOT Analysis 19

Financial Analysis 20

CAMELS Analysis 25

Future Outlook 29

Valuation 32

Bank Financials 34

Glossary 38

Rating Rationale 39

Disclosures 40


Saudi Arabia

3

Banking Sector

Executive Summary Al Rajhi Bank is the world’s largest Islamic bank by asset size (SAR 165 billion) with a paid up capital of SAR 15 billion and a sizeable presence across the country. The Bank is a leading bank in Saudi Arabia and has:

Market share of 13.8%, 14.1% and 12.7% in banking deposit, credit and assets respectively and 25.2% market share in ATMs and 30.7% share in branches;

Net Investment Income of SAR 8.5 billion (USD 2.265 billion) and net interest margin of 6.6% for 2008;

Operating income of SAR 10.6 billion and a debt-equity ratio of 0.125 in 2008;

CAR of 21.4% and NPA at 1.2% of gross investments for 2008.

The Bank is positioning itself as a ‘universal bank of choice’ for customers. This is evident from new faces joining the Bank’s management in the last couple of years. The Bank has overhauled its operations in functional units by shifting focus from retail to corporate and also by supporting divisions to improve operational efficiency in order to accept the challenges of the coming era. The results of the Bank’s proactive transformation and repositioning have reflected in the Bank’s surging loan portfolio and deposit base. New strategies have been put in place to ride the next economic upturn. New market entries, increasing market share in loans, deposits and assets and launch of new innovative products and services would be the new milestones for the Bank. Though the competition has intensified within the banking sector, the Bank has been at the forefront of meeting customer needs. The Bank enjoys the highest spread in Saudi Arabia and is expected to continue with this position on the back of low cost deposit base. The Bank was expected to face intense competition from the new Islamic banks in attracting deposits. However, 2008 was a dismal year for recent entrants. Bank Al Bilad saw its deposit base shrink during the year while on the other hand, even after five months of operations, Alinma Bank with its huge capital base failed to attract any deposits. This highlights the strong brand image enjoyed by Al Rajhi Bank as an Islamic bank in the Saudi banking sector. Geographic expansion into new countries with an appetite for Islamic banking, particularly in the Middle East and South East Asia, would enable the Bank to leverage its low cost base and offer competitively priced products to its customers. Al Rajhi Bank has already set up operations in Malaysia and is looking for setting up first branch in Kuwait during 2009. Malaysia and other Far East countries have significant Muslim population, robust financial system subsequent to the currency crisis of 1998 and reasonable per capita income to support future growth of the Bank.



4

2006 marked the peak in net income for the Bank. Despite our conservative estimates, the Bank would surpass the high in bottom line by 2010. The Bank had been reducing its international investments from 2006 onwards and hence had zero exposure to the US related crisis. The Bank had huge provisions during 2008 at nearly 2.9 times the 2007 level and as a result the net income grew only 1.2% during the year. However, non-performing assets as a percentage of gross investments was just over 40% of 2007. Despite lower operating income growth, lower provisioning for 2009 should enable the net income of the Bank to expand by 6.9%. The Bank has one of the highest capital adequacy ratios in the industry. The Bank has however an important task of managing its asset-liability structure. Al Rajhi Bank has the second highest credit-deposit ratio in the industry and is more than the SAMA guidance figure of 85%. As Al Rajhi Bank continues to strengthen its foothold both domestically and overseas, FALCOM Research expects it to generate higher business growth. The low cost deposit base would keep the Bank’s profitability way ahead of its peers in the industry and hence enjoy higher valuations. The Bank offers tremendous opportunities for investors to gain from future global economic recovery while protecting then from downside in the current turmoil. The Bank is an attractive pick for investors looking for stocks that are cash-rich, has high profitability and dividend yields. FALCOM Research initiates its coverage report on Al Rajhi Bank with a STRONG BUY recommendation. The fair value of the stock based on Residual Income, Dividend Discount Model and Peer Group valuation is SAR 87.10. The table below highlights the strong investment indicators for the stock. Indicators 2008 2009E 2010E 2011E

PE (x) 12.8 11.1 9.5 7.9

PBV (x) 3.1 2.5 2.3 2.1

Dividend Yield (%) 5.4% 5.8% 6.8% 7.7%

Spread (%) 6.6% 6.1% 6.6% 6.9%

ROE (%) 25.8% 24.1% 25.4% 28.0%

ROA (%) 5.4% 4.7% 5.1% 5.3%

(Source: FALCOM Research) Historical PE & PBV multiples pertain to respective year-end prices. Valuation ratios adjusted for historical capital increase.


Saudi Arabia

5

Banking Sector

Bank Profile Al Rajhi Bank (‘Al Rajhi’ or ‘Bank’) is the largest Islamic bank in the world. Banking and trading activities of Al Rajhi began 50 years ago, in 1978 when individual establishments were merged into Al Rajhi Trading and Exchange Corporation and in 1987 it was converted into a joint stock company under the royal decree and renamed as Al Rajhi Banking and Investment Corporation. As the Bank continued to grow and move forward into new markets it took the decision to change the Bank’s identity and name to Al Rajhi Bank. Al Rajhi is a full-fledged Islamic bank providing wholesale, retail and commercial banking products and services. Headquartered in Riyadh, Al Rajhi is the 3rd largest bank in the Kingdom in terms of assets. The Bank has six regional offices and is supported by the largest local branch and ATM network of 432 branches and 2,266 ATMs respectively and has 17,631 POS terminals installed with merchants all over the Kingdom. In 2006, the Bank got a licence to operate in Malaysia, making it the first Saudi bank to operate outside the Kingdom. In late 2007, Al Rajhi applied for a license to operate in Kuwait and is expected to open its first branch in Q3 2009. The Bank is 44% owned by the Al Rajhi family. The Bank’s total outstanding shares is 1,500 million and is fairly liquid with an average 30-days volume of nearly 2 million shares.

Company Ownership (Mar'09)

Public, 46.0%

Saleh Al Rajhi, 13.6%

GOSI, 9.9%Abdullah Al Rajhi, 5.9%

Sulaiman Al Rajhi, 24.6%

(Source: Tadawul, FALCOM Research)

Return to Shareholders The Al Rajhi stock had outperformed the market index (TASI) and the sector index during Q4 of 2008. This is primarily on the backdrop of lower exposure to international markets and higher spread vis-à-vis its peers in the market. At the time of this report being published the stock was down 7.6% YTD and was trading at a trailing PE of 11.9x. On the other hand, TASI was down 4.6% with a trailing PE of 9.6x.

Islamic banking

Stock performance



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Price Performance

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TASI Al Rajhi Banking

(Source: Bloomberg, FALCOM Research; Rebased to 100) The shareholders have earned an investment return (including dividend) of minus 36% over a 2 year holding period vis-à-vis the index negative return of 47.5% for the same period. With a fair value estimate of SAR 87.1, the return is expected to be 68% from the current market price. The stock performance lately has been driven by global financial events and slowdown in credit off-take in Saudi Arabia. The current market price of Al Rajhi is a good entry point for investors looking for a bank with higher margins, growth story and clean balance sheet.

Yearly Performance

-7.6%

-52%-47%

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2006 2007 2008 YTD

(Source: Bloomberg, FALCOM Research)


Saudi Arabia

7

Banking Sector

Business Segments The operations of Al Rajhi can be broadly classified into following key business segments: Retail, Corporate, Treasury & Financial Institutions and Investment. The functioning and products & services offered under these segments is enumerated below;

Retail – The Bank offers a wide range of retail products and services through its network of 451 branches. These products and services include current accounts, demand deposits, personal finance, car finance, real estate finance and credit cards. Private banking services are offered to high net worth individuals from three main centres (Riyadh, Jeddah and Dammam).

Corporate – This segment offers products like corporte deposit accounts, working capital finance, overdrafts, provides trade finance services including line of credits, guarantees and cash management services. Al Rajhi’s corporate segment focuses on large and medium-sized companies, principally in the manufacturing, contracting, trading and real estate sectors and the Saudi government.

Treasury & Financial Institutions – This segment looks after the asset liability management of the Bank and mitigation of associated risks. Treasury also manages banking relationships with other banks and runs an active investment book to enhance the yield-based income, dealing in over 40 currencies. Al Rajhi is a leader in the bank-note business in both wholesale and retail in the GCC

Investment – In accordance with the requirements of the Capital Market Authority (CMA), the bank has established a separate subsidiary, Al Rajhi Financial Services Co. (ARFS), to handle its investment banking operations. This subsidiary offers mutual fund products to individuals and corporate under this segment. Portfolio management services, investment banking and local and international share trading services also fall under this umbrella.

Segmentation



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Operations Al Rajhi has six regional offices and 7 subsidiary companies which are closely held (99-100% shareholding). The latest subsidiary being Al Rajhi Financial Services Company established as a result of the brokerage business being hived off pursuant to the CMA rules. This subsidiary had SAR 4.63 billion assets under management for 2008 and accounted for 6.1% of AUM of Saudi Arabia’s investment funds. The Bank, with a 13.8% market share of the total Saudi banking deposits, is the 3rd largest bank in the Kingdom. Al Rajhi has a low-cost customer deposit base, with non-interest bearing deposits representing 85% of the total deposits in 2008, down from 91% in 2007. Al Rajhi is also the 2nd largest bank by loans with a market share of 14.1% with a growing retail and business portfolio. In terms of asset size, the Bank is the 3rd largest with 12.7% market share. Branch/ATM penetration… Al Rajhi has the largest branch network in Saudi Arabia with 432 branches currently operating and plans to add another 30 within the next 21 months. Al Rajhi is tapping into new markets and has started operations in Malaysia and currently has 19 branches. The bank views Malaysia as a potential gateway to other markets in Asia. In the GCC region, the Bank has recently been granted a license to open a branch in Kuwait. Al Rajhi expects to open its first branch in Kuwait by Q3 2009. The Bank had the highest market share of 31% in 2008 for branches in Saudi Arabia. The Bank has undertaken significant modernisation and expansion of its branch network (around 160 new branches in the 18 months from January 2007 to June 2008), while the distribution system continues to develop, with enhanced electronic payment services. The trend is to use branches primarily as sales outlets to get closer to customers, while automating transactions as far as possible. As part of the Bank’s ongoing investments in technologies and commitment to provide excellent banking services, Al Rajhi in Q1 2009 started installing advanced ATMs across Saudi Arabia that accept chip-cards based on international standards. In ATMs, the Bank, in line with its retail stronghold and geographic presence, had the largest market share of 25% in 2008. In mid-2008, Al Rajhi deployed Cisco’s customer care solutions that provide an open strategic platform in an effort to streamline its processes for communicating with banking customers through a variety of media including voice, Web, e-mail, and video. New product launches… Al Rajhi has always taken the lead in developing innovative financial solutions for its customers. In order to offer finest

Expanding network

Innovative products


Saudi Arabia

9

Banking Sector

business solutions to its corporate clientele the Bank in 2006 opened three specialized branches in Riyadh, Jeddah and Dammam. Realizing the importance of the small business segment, in 2005, the Bank embarked on a major initiative to establish a specialized department to meet the banking needs of small businesses operating in various sectors of the economy including trade, services and manufacturing. In early 2009, the Bank signed a partnership with Visa to provide selected employees of companies with Visa Corporate Cards by March 2009. The agreement allows companies to use Visa’s corporate card to streamline expenses of its employees. Under car financing solutions, the Bank has developed ‘The Car Express Program’ to give its customers a 'one stop shop' to search for their perfect car, without the hassle of moving from one dealership to another. The Bank has already started making its footprint in the real estate financing market. Al Rajhi provides real-estate financing solutions to first time owners, investors and developers for 10 to 25 years. Al Rajhi is also the market leader in the remittance market, with around two-third market share, focusing primarily on the Indian sub-continent and South East Asia. Sector focus… The economic landscape of Saudi Arabia has been undergoing a transformation ever since the oil boom started in 2003. In line with the changing economic landscape, Al Rajhi’s focus shifted to the commerce potential of the Kingdom. The commerce sector made up 25% of the Bank’s investments in 2008 up from 13.5% in 2006.

Economic Sectors 2008 2007 2006

Banks & FI 5.4% 7.5% 13.0%

Commerce 25.0% 17.1% 13.5%

Industry 3.8% 3.5% 2.4%

Government 17.4% 11.0% 10.1%

Services 2.4% 2.5% 0.9%

Agriculture & Fishing 1.2% 1.2% 1.8%

Building & Construction 5.7% 4.7% 2.8%

Personal 37.0% 50.8% 56.1%

Other 3.5% 2.5% 0.5%

Portfolio Provisions -1.4% -0.8% -1.1%

Net Investments 100% 100% 100% (Source: Company Financials, FALCOM Research)

Likewise, the loans advanced to building and construction sector more than doubled in the Bank’s portfolio during the same period. On the contrary, the lending activity was squeezed to the banking and personal sectors during 2006-08. This trend of realignment,

Changing loan portfolio



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with the changing landscape of the economy, is expected to continue as the Bank draws its attention to the growing corporate segment and real asset based financing. Geographical concentration… Lately, the Bank has been expanding its business across the border, more specifically in the GCC and Middle East markets. GCC and the ME accounted for 23% of the Bank’s business (investments) in 2008 from less than 5% in 2007. Saudi Arabia accounted for 73.6% of the investments and was down from nearly 92% in 2007. New market entries in the GCC and the ME will reduce the Bank’s portfolio concentration on Saudi Arabia. The other foreign market which has grown in size is South East Asia. This is primarily as a result of Malaysian operations. Going forward, the share of this market to the overall pie is expected to increase from the current 3.3% in 2008. Credit profile… The Bank’s investment portfolio enjoys a healthy mix of short term, medium term and long term credit. The short term credit of one year duration after having dipped to 35% in 2007, accounted for 50% of the Bank’s investments in 2008. Medium term credit with duration of 1-5 years, on the contrary, after having peaked in 2007 to near 50% came down to 40% in 2008. Long term credit growth was negative in 2008 and hence contributed only 10% of the overall portfolio.

Maturity Mix

0%

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2008 2007 2006

- Short Term - Medium Term - Long Term (Source: Company Financials, FALCOM Research)

Business geography

Loan maturity


Saudi Arabia

11

Banking Sector

Saudi Banking Sector The banking sector in Saudi Arabia, in line with the GDP CAGR of 17.1% during 2003-08, has grown significantly in the recent years. This was driven primarily by the influx of petro-dollars into the local economy. The high oil prices of past five years saw the money supply increase significantly by 123% to SAR 929 billion in 2008 from SAR 417 billion in 2003. The trickle down effect of huge money supply was evident in both bulging bank deposits and increased appetite for loans and advances. The loans to GDP ratio increased during the oil boom period and reached a high of 42.5% by the end of 2008 from 31% in 2003.

Loan-GDP %

42.5% 41.9%

37.5%

31.0%

35.7%

38.6%

25%

29%

33%

37%

41%

45%

2008 2007 2006 2005 2004 2003

(Source: SAMA, FALCOM Research)

Loans & Advances The splurge in lending activity was evident as the demand for loans and advances grew at a CAGR 24.7% during the same period. The demand for credit from the corporate segment was channeled into new Greenfield projects, capacity expansion, et al and for consumer loans, credit card loans and stock investing purposes from the retail segment.

Bank Credit (SAR Millions)

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800,000

2008 2007 2006 2005 2004 2003

CAGR 24.7%


GDP CAGR @ 17.1%

Loans CAGR @ 24.7%



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Deposits The rise in money supply in the local economy over the years ultimately landed in bank deposits. As a result, bank deposits grew at a CAGR of 18.5% during 2003-08 from SAR 362 billion to SAR 846 billion. The increase in bank lending activities faster than the bank deposits saw the credit-deposit ratio peak at 92.5% in 2005 and then fall back to 88% in 2008.

Deposits (SAR Millions)

200,000

300,000

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500,000

600,000

700,000

800,000

900,000

2008 2007 2006 2005 2004 2003

CAGR 18.5%


Investments Over time, banking sector investments grew at a CAGR of 9% during 2003-08. At the same time, investments as a percentage of assets fell from 35.4% in 2003 to 22.8% in 2008. Foreign investments as a proportion of total investments grew from 18% in 2003 to 22% in 2008 after touching a peak of 33% in 2007. On the contrary, local investments dropped from 82% of total investments in 2003 to 78% in 2008 after dipping to 67% in 2007.

Investments

78%67% 72% 79% 80% 82%

22%33% 28% 21% 20% 18%

0%

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100%

2008 2007 2006 2005 2004 2003

Domestic Investments Foreign Investments (Source: SAMA, FALCOM Research)

Deposits CAGR @ 18.5%

Investments CAGR @ 9%


Saudi Arabia

13

Banking Sector

Growth Strategy Al Rajhi has a strategic objective outlined for the Bank i.e., to create value for all its stakeholders. In the coming 5 years, the Bank is positioning itself as a ‘universal bank of choice’ for customers. The idea is to cater to the commercial and investment banking needs of customers under one roof. Based on the management inputs, we believe that the Bank has three primary strategies to grow into a universal bank. This includes increasing market share, product penetration and geographic expansion across the Bank’s business segments. The Bank undertakes 5-6 initiatives for each business segment every year to strengthen its position in the market. (Source: Al Rajhi; FALCOM Research)

Market Share The Bank is only second to NCB in Saudi Arabia for loans and advances. In terms of deposits and balance sheet size, Al Rajhi is the 3rd largest bank in the Kingdom. Increasing market share in these areas will be complemented by the Bank’s growing corporate focus and retail presence. Al Rajhi has been increasing its market share keeping in mind the advent of new competition in the wake of newly formed Bank Al Bilad, Alinma Bank and conversion of NCB retail banking business into a shariah compliant one (only a matter of time before NCB changes over to full fledged Islamic banking). The management believes that the Saudi market has the capacity to absorb new banks and there will not be any major impact on the market share of the Bank keeping in mind the brand-loyalty it enjoys. In corporate banking, the Bank plans to develop a balanced portfolio by increasing customer base, building risk management techniques, enhancing sector specific expertise, among others. The Bank has identified strategies to grow its corportate forex business under Tahweel and increase murabaha fees from project finance activities, which has a huge potential. The Bank has also planned significant growth in installment sale for corporates in 2009. With the highest number of branches in Saudi Arabia, the Bank is enhancing its distribution capabilities to cater to its retail

Increase Market Share

Product Penetration

Growth Strategy

Geographic Expansion

Universal banking



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customers. In this regard, the Bank plans to increase its country side presence with retail kiosks staffed by 3-4 employees. The retail segment is also targeting companies with a small set up. In treasury, the Bank is active on both retail and money market operations. Al Rajhi has locked a significant portion of its treasury Mutaraja in high yield SAMA securities. This is expected to generate above market returns on its treasury operations. The Bank anticipates fair amount of scope in corporate investments. Within investment banking, apart from asset management, brokerage and advisory services, the Bank expects a full suite of investment banking products to come on stream soon. Al Rajhi plans to increase its funds management business. The Bank also plans to increase its local and international share trading brokerage business and focus on the private banking to cater to the high net-worth clients. The Bank expects the share of net income from this stream to increase to 5% from the current 2.5%. Product Penetration Al Rajhi supports its customer's beliefs and provides leading product and services, built on a foundation of experience, market knowledge and a consistent heritage of Islamic banking. The Bank has a host of products lined up for the retail, corporate and treasury segment. Apart from the products in the launch phase, Al Rajhi has a lot of products in the implementation phase. These product launches with enhanced features are expected to cater to the different customer needs in the coming 1-2 years. The Bank also continues to develop banking programs and projects with a focus on the latest electronic services and investment products in order to offer innovative banking and investment services, especially e-banking. The Bank’s recent initiatives like tie up with Visa for advanced corporate cash management services, launch of payroll service for companies and enterprises, et al will go a long way in enlargening the corporate product basket. Strong demand for Shariah compliant financial products across segments under one roof would encourage future product research and development. Geographic Expansion The Bank made its international foray by setting up the Malaysian operations in 2007. As indicated by the management, the Bank’s Malaysian corporate segment activity is expanding and there are no branch expansions expected in 2009. The Bank has strengthened its retail presence in Malaysia and boasts 19 branches and a balance sheet of nearly USD 4 billion for 2008. The Bank is authorized by Bank Negara Malaysia to open 50 branches. Accordingly, Al Rajhi plans to add this over the next few years and have an effective retail business. On the retail front, the Bank plans to create a balanced portfolio by expanding the home


Saudi Arabia

15

Banking Sector

financing business. It also wants to generate more fee income business, including wealth management business and cross-sell products to their customers. The Malaysian operations started off primarily with a focus on retail banking. This focus has lately shifted to doing niche corporate financing and servicing Malaysian companies doing business in the Middle East and vice versa. The Bank has also started doing business with local companies active in the domestic market. The set up is also expecting to get an Islamic investment banking license in the coming days. The increasing corporate and investment activity between Saudi Arabia and Malaysian will strategically place Al Rajhi, as the Bank has operations in both the countries. In early 2009, the Bank was awarded a license to operate in Kuwait. The Bank is expected to start its Kuwaiti operations in the 3rd quarter of 2009 with a single branch. Initially the focus would be corporate banking and would later move to retail banking. The Bank’s branch expansion in Kuwait would be subject to further negotiations with the Central Bank of Kuwait. The Bank has identified Jordan as the most likely market for entry. The studies regarding this are currently underway. The Bank has also received invitations from a number of countries for setting up Al Rajhi operations. However, these developments are in the preliminary stage. The Bank holds considerable potential to harness upon the increasing business activity in the Kingdom and more so the growth in Islamic nancial products, which are backed by booming oil revenues in Gulf economies. We believe Al Rajhi will use Malaysia as a base to expand its corporate and investment banking activities to South-East Asian countries like Indonesia and Singapore. Furthermore, investors from Hong Kong and China have also shown a growing interest in Islamic nancing. Other Initiatives In addition to the above, FALCOM Research believes a number of other aspects will help shape the growth of the Bank in the coming years. Al Rajhi’s focus on customer service and technology to maintain its strong position in retail banking and also expanding its corporate and investment banking activities through recruitment of experienced staff and developing new products. The Bank has been a party to the burgeoning Saudi infrastructure related projects and has been participating aggressively in the financing of big infrastructure projects. FALCOM Research believes, Al Rajhi through its Islamic project finance activites will benefit from the government’s 5-year USD 400 billion spending program.



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The Bank has been upgrading its infrastructure in order to increase internal efficiency and ensure better customer delivery. Al Rajhi has also deployed Oracle Collaboration Suite for its call center to enhance its business communication capabilities and reduce administrative costs. The Bank has also introduced new employee satisfaction programs to boost employee morale and reduce churn. The Bank is also trying to bolster its activities on the net through e-initiatives such as Al Mubasher Internet Banking and WAP Banking. All these measures would help the Bank to keep its expenses under check and enhance the Bank’s profitability in the long run. Growth Outlook… The Islamic financial assets globally are estimated at around USD 1 trillion and is growing at an estimated 20% to 40% per annum, depending on the asset class. Domestically, more Saudi corporates are now accessing Islamic finance as part of a diversification of sources of funding strategy. The inherent low cost of funding in the Shariah based deposits, coupled with the Bank’s intention to increase its presence in foreign countries and strong brand image will facilitate improvement in market share and protability. As Al Rajhi continues to strengthen its foothold both domestically and overseas, we expect this to generate higher business growth. FALCOM Research believes that the Bank’s active overseas expansion plans would enable Al Rajhi to reap long term benets. We believe that the bank is well-positioned to take advantage of the growth in the Saudi economy and will leverage its franchise to attract and retain the customers by offering innovative products and services. We think that sustaining loan growth in 2009 at the pace of 2008 will not be possible, given that the risk matrix has changed for both borrowers and lenders alike.


Saudi Arabia

17

Banking Sector

Competitive Advantages The banking industry holds tremendous potential in Saudi Arabia. The four largest banks — National Commercial Bank (NCB), Samba, Al Rajhi and Riyad Bank — dominate the market. However, the competitive landscape of the sector is changing slowly ever since the regulator, SAMA, started issuing licenses to both new local banks and foreign banks to establish their branches here. Likewise, banks in the Kingdom have started opening branches in other countries worldwide including the GCC. Al Rajhi, in the past 2-3 years, has been expanding into new Islamic markets to take advantage of low cost deposit base. The competitive environment of Al Rajhi in the context of the Saudi banking sector and the impact from the different market forces can be elaborated using Michael Porter’s 5 forces analysis framework. Force 1: Bargaining power of customers The bargaining power of customers in a services industry is driven primarily by the affluent class. However, like any industry, the other main determinants of buyer power are size and concentration of customers. The Saudi population of 25 million is largely concentrated in the urban areas. The bargaining power of banking customers is low as the pricing power is a function of interest rates prevailing in the economy. Al Rajhi is a strong brand in the Saudi banking sector with the 2nd largest market share in loans and advances and 3rd largest in deposits. Al Rajhi’s unique positioning as the world’s largest Islamic bank serves the interest of a huge section of the population looking for Shariah compliant financing solutions. Hence, the bargaining power of buyers is low for the Bank’s products and services. Force 2: Bargaining power of suppliers Banking industry is influenced by the forces of supplier power, if the sources of financing are inclined towards 3rd party elements including syndicated financing, preferential shares, subordinated debt, among others. The Saudi banking space is nearly immune from the pressures of 3rd party finances and is running high on deposits (deposits to assets percentage at 65% for 2008) to fuel its expansion plans. Al Rajhi is ahead of the industry average with nearly 71% of the deposits acting as a source of financing for the Bank. With no pressure from syndicated financing, the bargaining power of suppliers is very low for the Bank. Force 3: Threat of substitute products The banking industry generally has standardized products and services for the retail segment. However, corporate, both at the asset and liability side have the advantage of some customized solutions. Conventional and Islamic banking products and services have different pricing and benefits and hence could lure customers

Michael Porter analysis



18

to move from one school of banking to another. In general, however, the risk from substitute products is low for the industry. Al Rajhi has been aggressive on its branding drive to lure customers. Its unique retail offering for Saudi nationals and Islamic touch for corporate loans, have reduced the threat of substitute products from other Islamic banks in the domain. Hence, this risk is low for Al Rajhi. Force 4: Threat of new entrants The Saudi banking industry has been opened up for foreign banks to set up branches in the Kingdom. Regional and global players in the banking domain have set up their operations in Saudi Arabia. However, the shift of deposits and likewise loans and advances out of the local banking industry has been minimal. The psychological balance of ‘safety of money’ with local banks has overweighed over considerations. Unlike conventional banking, Al Rajhi has not faced any competition from foreign banks in the Islamic field. The Islamic banking competition from new local banks and NCB retail business has also not proved to be a threat. Therefore, it is obvious that the threat of new entrants is low for Al Rajhi compared to its size and market penetration. Force 5: Industry rivalry Industry rivalry is evident from the competition in the market for market share. For 2008, Al Rajhi had the 2nd highest market share of 14.1% for loans and advances. In deposits and assets, Al Rajhi was the 3rd largest player in the Saudi banking sector with a market share of 13.8% and 12.7% respectively. The competition has always remained fierce between the top 3 players, namely NCB, Samba and Al Rajhi. Given the current market dynamics, this risk is moderate for Al Rajhi.


Saudi Arabia

19

Banking Sector

SWOT Analysis Strengths

Strong founding shareholders 2nd largest bank in Saudi Arabia for loan and advances 3rd largest bank in asset size and deposits Deepest branch and ATM penetration Improving operational efficiency Huge capital base; CAR above 21% for 2008 Highest net interest margin of 6.6% vis-à-vis sector spread

of 3.3% High earnings growth rate (26.2% CAGR over 5 years) and

profitability margins Weaknesses

High concentration on retail segment; 50% assets in retail segment for 2008 (lately shifting)

Fall in spread; lower yield on corporate assets from 5.8% in 2007 to 3.5% in 2008

Liquidity stretched; CD ratio above the industry average High provisioning for 2008

Opportunities

New Islamic banking products and services for retail and corporate customers

Expansion of operations in new geographies Potential for real-estate loans from proposed Saudi

mortgage law Shift in customer banking habits from conventional to

Islamic banking Infrastructure related project finance business potential

and fee-based income from investment banking activities Government focus on infrastructure development and new

industrial/economic cities

Threats

Long term impact from sharing the Shariah platform with Bank Al Bilad and Alinma Bank

Slow down in corporate spending and lack of consumer demand for loans

Slower growth in oil prices and impact on associated government spending

Impact on business of different segments from entry of foreign banks



20

Financial Analysis High Margin Play Being an Islamic bank, the cost of funds for Al Rajhi are the lowest in the Saudi banking sector. As a result the spread earned is the highest in Saudi Arabia. The spread has contracted lately as a result of softening of benchmark repo rates by the central bank. Hence, the contraction is visible across the banking space and is not specific to the Bank. The year 2007 saw transformation of lending activities at Al Rajhi. Realizing the growing opportunities in corporate banking, Al Rajhi expanded rapidly in this domain. As a result, corporate lending increased by 69% and 78% in 2007 and 2008 respectively. Operating Income Analysis The Bank reported operating income growth of 13.5% from SAR 9,321 million in 2007 to SAR 10,575 million in 2008. Net income from investments contributed over 80% of the total operating income and was up 10% in 2008. The fees from banking services jumped 26.6% during 2008 and made up nearly 12% of the operating income. The total operating income of the Bank has grown at a CAGR of 20.6% during 2003-08.

Operating Income (2008)

Other Income,

3.4%

Exchange Income, 4.6%

Fees from Banking Services, 11.7%

Net Investment

Income, 80.3%

(Source: Company Financials, FALCOM Research)

Within investment income, installment sale contributed 61% in 2008, having grown 5% during 2008, and dropped from nearly 64% in 2007. Mutaraja growth softened to 9% in 2008 vis-à-vis 62% in 2007 and contributed 32.4% of the investment income. Income from murabaha jumped 347% during 2008 after having contracted 70% in 2007 and added 5% to the pie.

Operating Income CAGR @ 20.6%

Corporate focus & high margins


Saudi Arabia

21

Banking Sector

Investment Income (2008)

Installment Sale, 60.9%

Mutajara, 32.4%

Murabaha, 5.1%

Istisnaa, 1.6%


Segment and Geographic Overview Al Rajhi is the 2nd and 3rd largest bank in Saudi Arabia for loans and advances and assets respectively. Nearly 3 quarters of the Bank’s loans and advances have been deployed in the local economy. This is in contrast to 2007, wherein more than 90% of the loans and advances were disbursed locally. The loan portfolio for other GCC and Middle East countries multiplied more than 5 times with the overall share moving up from 4.4% in 2007 to 23% in 2008.


Another important trend for Al Rajhi during 2008 was the shift of banking assets from retail segment to corporate segment. Retail segment accounted for nearly 39% of the Bank assets in 2008 vis-à-vis 50% in 2007. Likewise, the share of corporate segment in the Bank’s assets increased from nearly 25% in 2007 to over 33% in 2008. The total assets of the Bank have grown at a CAGR of 20.6% during 2003-08.

Assets (2008)

Retail, 38.8%

Corporate,33.3%

Treasury, 28.0%

Assets CAGR @ 20.6%



22

On the back of robust banking growth in Saudi Arabia, the net income of Al Rajhi has grown at a CAGR 26.2% during 2003-08. The Bank’s bottom line increased marginally in 2008 by 1.2% from SAR 6.45 billion to SAR 6.52 billion after having contracted 11.2% in 2007. Within the segments, the retail segment has been the most profitable segment for the Bank. The retail segment contributed 50% of the Bank’s net income in 2008 with a ROA of 5.2% as compared to 5.5% in 2007. However, the corporate segment with over 33% of the Bank’s assets contributed nearly 23% to the bottom line. Corporate segment’s ROA fell from 5.8% in 2007 to 3.5% in 2008. This was mainly due to the rapid expansion of the portfolio during the year. The treasury segment in line with its exposure to the Bank’s assets contributed a quarter of the Bank’s net income with a ROA of 4.2% for 2008.


Ratio Analysis The Bank’s profitability margins as measured by NIM, ROE and ROA have dropped for the last two years after having peaked in 2006. The spread (NIM) particularly dropped in 2008 after the benchmark rates used for pricing of loans softened during the second half of the year. ROE and ROA fall was more dramatic and can be attributed to the fall in net income from its 2006 levels while at the same time increase in the shareholders equity and balance sheet for the corresponding period. Al Rajhi deposits and investments grew at a faster rate than the sector for 2007 and 2008. Deposits jumped 22.2% and 30% in 2007 and 2008 respectively vis-à-vis the sector deposit growth of 21.2% and -4.6% for the same period. Likewise, the Bank’s investments grew at over 37% in 2008 as compared to sector growth of 1.7% for 2008. For 2007, the loans portfolio of Al Rajhi grew at over 17% while the sector witnessed a 21.3% surge in loans and advances. The investments as a percentage of deposits jumped from 116% in 2007 to 123% in 2008. However, the Bank’s actual credit-deposit

Net Income (2008)

Retail, 49.9%

Corporate,22.8%

Treasury,24.8%

Investment,2.6%

Number play


Saudi Arabia

23

Banking Sector

ratio, ignoring investments as clubbed in the overall investments, was similar to the ratio in previous years and was marginally higher than the C-D ratio recorded for the sector. The Bank’s provisioning as a percentage of gross investments has increased to 0.9% from 0.4% in 2007. The provisioning for personal loans in 2008 were 55% of that in 2007 while the general provisioning more than doubled during the year. Overall, the 2008 provisions in absolute terms was nearly three times the 2007 level. On efficiency grounds, the Bank’s business per employee after dipping in 2007 reverted back to 2006 levels of SAR 1.27 million. Branch expansion in new markets resulted in business per branch at SAR 23.45 million to grow slowly in 2008. On the other hand, the income per employee and cost to income ratio deteriorated on account of higher provisioning during the year. The dividend and earnings yield became quite attractive by the end of 2008. And the price-to-book value multiple fell to its lowest level in 5 years. However, the price-to-earnings multiple remained over the sector average of 11.1 in 2008 as a reward for sound banking practices.



24

Ratios 2006 2007 2008

Profitability Ratios (%)

Cost of Funds 1.1% 1.0% 0.8%

Yield on Investments 8.8% 8.7% 7.5%

Spread 7.7% 7.7% 6.6%

Return On avg. Equity 43.4% 29.5% 25.8%

Return On avg. Assets 7.5% 6.0% 5.4%

Growth (%)

Net Investment Income 20.2% 13.1% 10.0%

Net Income 29.6% -11.7% 1.2%

Deposits 4.7% 22.2% 30.0%

Investments (Incl. Loans & Advances) 11.5% 17.1% 37.3%

Assets 10.7% 18.7% 32.1%

Shareholders’ Equity 49.8% 17.0% 14.5%

Other Measures (%)

Investment/Deposit 122% 117% 123%

Equity/Assets 19.2% 18.9% 16.4%

Provisions/Gross Invest. 0.3% 0.4% 0.9%

NPA/Gross Investments 2.2% 2.9% 1.2%

Efficiency Ratios

Business/Employee (SAR Mn) 1.26 1.11 1.27

Business/Branch (SAR Mn) 24.45 22.14 23.45

Income/Employee (SAR Mn) 0.97 0.77 0.79

Cost/Op. Income (%) 23.2% 30.8% 38.3%

Valuation Ratios

PE (x) 17.8 27.3 12.8

PBV (x) 6.5 7.4 3.1

PEG (x) 0.6 - 2.3 11.0

Dividend Yield (%) 0.3% 1.5% 5.4%

Earnings Yield (%) 5.6% 3.7% 7.8%

(Source: Company Financials, FALCOM Research) Historical PE & PBV multiples pertain to respective year-end prices. Valuation ratios adjusted for historical capital increase.


Saudi Arabia

25

Banking Sector

CAMELS Analysis The CAMELS approach was developed by bank regulators in the United States to measure the financial condition of a financial institution. The acronym CAMELS stands for: Capital Adequacy, Asset Quality, Management, Earnings (Profitability), Liquidity and Sensitivity. FALCOM Research has adopted CAMELS to analyze the financial standing of Al Rajhi. Capital Adequacy is a measurement of a bank to determine if solvency can be maintained due to risks that have been incurred in the course of business. Capital allows a financial institution to establish, maintain and grow both public and regulatory confidence, and provide a cushion (reserves) to absorb potential loan losses. A bank must be able to generate capital internally, through earnings retention, as a test of capital strength. As per Basel II framework, the regulatory authority, SAMA, has set the minimum requirement of Capital Adequacy Ratio (‘CAR’) at 8%. CAR is calculated by dividing the bank's core capital by the bank's total risk-weighted assets. Al Rajhi stands strong with a CAR of 21.4% for 2008. Al Rajhi has remained consistently strong over the years on all the parameters of capital adequacy.

Capital Adequacy 2008 2007 2006

CAR 21.4% 24.4% 26.5%

Debt/Equity 6.9% 7.9% 9.3%

Provisions/Equity Capital 1.6% 1.1% 2.7%

Equity Capital/Total Assets 16.4% 18.9% 19.2%


Asset Quality broadly evaluates risk, controllability and adequacy of loan provisions. The quality of a bank's assets hinges on their collectivety during and at maturity. Provisions and Non-Performing Assets (‘NPA’) are the twin indicators of asset quality for banks. Higher provisioning indicates the severity of the losses expected from bad loans and vice-versa. On the other hand, higher NPAs are the actual loans that have fallen overdue and not realized. Al Rajhi has scored very high on asset quality during the current market conditions. Provisions as a percentage of gross loans reached 0.9% in 2008 from 0.4% in 2007. At the same time, NPA as a percentage of gross loans contracted to 1.2% in 2008 from 2.9% in 2007. The risk of NPA to the equity capital has reduced, having fallen from 13.3% in 2007 to 6.7% in 2008.

Asset Quality 2008 2007 2006

Provisions/Gross Loans 0.9% 0.4% 0.3%

NPA/Gross Loans 1.2% 2.9% 2.2%

Provisions/NPA 71% 14% 12%

Capital Adequacy

Asset Quality



26

NPA/Equity Capital 6.7% 13.3% 10.1%

NPA Growth Rate -42.5% 53.0% 23.5%


Management takes into account the qualitative and quantitative aspects of a bank. Qualitatively, the ownership structure, branch network penetration, credit administration and strategic planning come into play. On the other hand, market capitalization and operational efficiency define the quantitative performance of a bank. The Bank is 44% owned by the Al Rajhi family and signifies the family’s continued interest in the banking business. Al Rajhi has the largest branch and ATM network in the Kingdom. Strategically, Al Rajhi has also been exploring new geographic areas of growth in Islamic banking. The Bank’s cost to income ratio has come under pressure as a result of higher general and administrative expenses and because of higher provisioning in 2008. Likewise, due to increased expenses and provisioning, the income per employee has fallen from SAR 0.97 million in 2006 to SAR 0.79 million in 2008. Nevertheless, the Bank was able to retain its business per employee at SAR 1.27 million in 2008, similar to 2006.

Management 2008 2007 2006

Market Capitalization / Equity Capital

310% 670% 291%

Cost/Income 38.3% 30.8% 23.2%

Business/Employee (SAR Mn)

1.27 1.11 1.26

Income/Employee (SAR Mn) 0.79 0.77 0.97


Earnings determine the ability of a bank to retain capital, absorb loan losses, support the future growth of assets and provide a return to investors. The largest source of income for a bank is net special commission (commission earned from lending activity less commission paid on deposits and debt). A substantial source of income also comes from foreign exchange, commission fees, fees from banking services and stock trading. The most important ratio to gauge the profitability of banks is spread. Higher the spread, higher the pricing ability of the underlying bank. For Al Rajhi, this spread has been the highest in the Saudi banking sector. The spread contracted from 7.7% in 2007 to 6.6% in 2008 as a result of softening repo (benchmark) rates.

Management

Earnings


Saudi Arabia

27

Banking Sector

The Bank has the highest ROA and ROE among the big-cap banks in Saudi Arabia. Net investment income, the same as net special commission, contributes over 80% of the operating income pie.

Earnings 2008 2007 2006

Spread (NIM) 6.6% 7.7% 7.7%

ROE 25.8% 29.5% 43.4%

ROA 5.4% 6.0% 7.0%

Net Investment Income / Total Operating Income

80.3% 82.8% 71.8%


Liquidity refers to reserves of cash, government securities, precious metals and unused bank lines of credit. Liquidity is required for banks to meet its obligations towards customers (deposit account holders). The credit-deposit ratio, composition of liabilities, availability of liquid assets, among others determines the liquidity position of a bank. Al Rajhi investment-deposit percentage, which comprises of loans and investments, was very high at 123% for 2008 as compared to its historical standards. However, the Bank’s C-D ratio is closely tracking the sector average of less than 90% for the same period. The higher loan portfolio growth has been funded with a lower deposit base and syndicated bank financing. The Bank stands strong to meet its obligations towards deposit holders with more than 12% of deposits being parked in liquid assets. Deposits make up nearly 71% of the Bank’s overall balance sheet and hence needs to grow faster than its loan portfolio to reduce the credit-deposit gap.

Liquidity 2008 2007 2006

Credit/Deposit 123% 117% 122%

Liquid Assets/Deposits 12.2% 15.5% 14.6%

Credit/Assets 87.3% 84.0% 85.1%

Deposit/Assets 70.7% 71.8% 69.8%


Sensitivity to market risks look at risks, such as interest rate risk, facing the bank and the bank's ability to meet and handle such risks. Interest rates in any economy are linked to the benchmark rates fixed by the respective monetary authority. The repo rates have come down from 5.5% in mid-2008 to 2% by the beginning of 2009. Al Rajhi being an Islamic bank has seen minimal impact from this decision on its deposit accounts. However, the yield on investments has fallen from 8.7% in 2007 to 7.5% in 2008. Nonetheless, Al Rajhi, with the highest spread in the Saudi banking

Liquidity

Sensitivity



28

sector, stands strong to competitively price its loan portfolio and still remain above the industry average to maintain profitability. Hence, the sensitivity of the Bank to changes in interest rate is lower than its peers in the market.

Sensitivity 2008 2007 2006

Cost of Funds 0.8% 1.0% 1.1%

Yield on Investments 7.5% 8.7% 8.8%

Spread 6.6% 7.7% 7.7%


FALCOM Research believes that the Bank has demonstrated superior performance on Capital Adequacy, Asset Quality, Earnings and Sensitivity.


Saudi Arabia

29

Banking Sector

Future Outlook FALCOM Research believes the Bank will continue its expansion both locally and internationally, more towards Middle East and South East Asia, to increase its market share. This move would take Al Rajhi ahead of its peers in the local markets and hence strengthen its financial performance over the coming years. Hereunder, FALCOM Research presents its views on the different aspects of the Bank’s financial projections. Net Interest Margin The low cost deposit base would enable the Bank to enjoy the highest spread in the Saudi banking sector. The current downturn would reduce the yields on the loan portfolio in 2009. However, the reversal of trend is expected in 2010 and the spread is expected to strengthen from a low of 6.1% in 2009 to 7.3% in 2012. This would however be lower than the peak of 7.7% enjoyed in both 2006 and 2007. The net investment income of Al Rajhi is expected to grow at a CAGR of 14.4% during 2008-2012.

Net Interest Margin

0%

2%

4%

6%

8%

10%

2008 2009E 2010E 2011E 2012E

Cost of Funds Yield on Investments Spread

(Source: FALCOM Research) Operating & Net Income The operating income of the Bank is expected to grow at a CAGR of 13% during the forecast period. This is evident as the Bank has indicated its willingness to increase its fee based income. The growing forex business is also expected to bolster the operating income growth of the Bank. The operating expenses of the Bank are expected to grow in line with previous year growth. Hence, the net income of the Bank for 2009 is expected to be lower than that recorded during the previous year and grow at a CAGR of 16.5% during 2008-12.

NII CAGR of 14.4%

Net income CAGR of 16.5%



30

Operating & Net Income

3,000

6,000

9,000

12,000

15,000

18,000

2008 2009E 2010E 2011E 2012E

SA

R M

illio

ns

Operating Income Net Income

(Source: FALCOM Research) Profitability The Bank’s profitability ratios are expected to improve over the forecast period. The ROE after slipping in 2009 is expected to add 650 bps to reach 30.6% by 2012. The ROE would be supplemented by a CAGR of 11.7% in the shareholders equity during 2008-12. The ROA, on the other hand, is expected to add nearly one percent and settle at 5.6% for 2012 after a low of 4.7% in 2009. The Bank’s balance sheet is expected to grow at a CAGR of 9.8% during the same period.

Profitability

30.6%

28.0%

25.4%24.1%

25.8%

5.6%

5.3%

5.1%

4.7%

5.4%

22%

25%

28%

31%

34%

2008 2009E 2010E 2011E 2012E4.0%

4.5%

5.0%

5.5%

6.0%

ROE ROA

(Source: FALCOM Research) Investments and Deposits The investments of the Banks are expected to grow at CAGR of 9.8% from SAR 144 billion in 2008 to SAR 209.6 billion in 2012. Likewise, the deposits of the bank are expected to grow at CAGR of 10.7% from SAR 116.6 billion in 2008 to SAR 175 billion in 2012. This would bring down the investments-deposit ratio to less than

120% by 2012. The Bank’s geographic expansion would add steam to the growth momentum of investments and deposits. Hence, FALCOM Research is of the view that Al Rajhi would be able to strengthen its balance sheet faster than its peers in the local banking sector.

ROE @ 30.6%

I-D ratio @ 120%


Saudi Arabia

31

Banking Sector

Investments & Deposits

100

130

160

190

220

2008 2009E 2010E 2011E 2012ES

AR

Billio

ns

117%

119%

121%

123%

125%

Investments Deposits I-D Ratio

(Source: FALCOM Research) Operational Efficiency With new internal efficiency drive in place, the operating expenses including provisions (cost) as a percentage of operating income is expected to come down from the current high of 38.3% to 30.3% by 2012. The cost to operating income percentage would still be higher than the low of 23.2% in 2006.

Operational Efficiency

0.79 0.82

1.07

1.25

0.94

0.4

0.6

0.8

1.0

1.2

1.4

2008 2009E 2010E 2011E 2012E25%

28%

31%

34%

37%

40%

Income/Employee (SAR Mn) Cost/Op. Income (%)

(Source: FALCOM Research) Apart from growing operating income, contained operating expenses and lower provisioning would enable the net income (income) per employee to grow from a low base of SAR 0.79 million in 2008 to SAR 1.25 million in 2012. The income per employee in 2011 is expected to surpass the peak of SAR 0.97 million in 2006.



32

Valuation FALCOM Research has valued Al Rajhi using Residual Income, Dividend Discount Model and Peer Group methodology. Residual Income (‘RI’) The Residual Income method under equity capital approach views the intrinsic value of a firm’s equity as the initial book (invested equity capital) plus the present value of future residual income (value created). The fair value of Al Rajhi stock under the RI method is SAR 81.10 using the following assumptions:

1) Risk free rate of 5.13%, which is the current yield on 4-year Saudi Government bond;

2) Equity risk premium of 5%;

3) Beta of 1.10, the current beta over 3 year trading history;

4) Using the above inputs, the cost of equity is 10.63%; and

5) Residual income terminal growth rate of 5% after 2012;

Dividend Discount Model (‘DDM’) Al Rajhi intends to maintain a healthy dividend payout ratio in the coming years. The management views CAR of 15% as the threshold limit for any subsequent capital increase. FALCOM Research anticipates the CAR to remain over this during the forecast period. The following assumptions were used to determine the fair value of Al Rajhi under DDM:

1) Cost of equity @ 10.63%; as calculated under RI method;

2) Dividend payout ratio of 56-64% of earnings during 2009-2012; and

3) Dividend growth rate of 7.5% after 2012

Based on FALCOM Research estimated earnings of the Company through 2012, the fair value is SAR 114.90. Peer Group An inference is drawn on the profitability ratios for 2008 from the banking sector in Saudi Arabia and Islamic banks in UAE and Malaysia.

2008 at a Glance

Company NIM ROA ROE

Al Rajhi Bank 6.6% 5.4% 25.8%

Saudi Banking Sector 3.3% 2.1% 16.5%

Dubai Islamic Bank 2.6% 2.0% 16.9%

Abu Dhabi Islamic Bank 14.2% 1.8% 15.4%

Bank Islam (Malaysia) 9.7% 0.7% 9.6%

(Source: Zawya, Bloomberg, FALCOM Research)

RI valuation @ SAR 81.10

Peer valuation @ SAR 43.30

DDM valuation @ SAR 114.90


Saudi Arabia

33

Banking Sector

FALCOM Research has considered a number of valuation multiples for the banks in order to assign a fair value for Al Rajhi. No attempt was made to separate the different business lines in which the Bank is not present.

Company PE PBV

Saudi Banking Sector 11.30 1.90

Dubai Islamic Bank 5.56 0.98

Abu Dhabi Islamic Bank 7.06 1.07

Bank Islam (Malaysia) 3.70 0.33

Average 10.13 1.68

(Source: Zawya, Bloomberg, FALCOM Research) Based on weighted average peer PE of 10.13x, the Bank’s stock is valued at SAR 47.10 based on 2009 forecasted earnings. Likewise, based on weighted average peer PBV of 1.68x and 2009 year end net worth, Al Rajhi is valued at SAR 34.60. Assigning 70% and 30% to PE and PBV respectively, the peer group valuation for the Bank is SAR 43.30. Recommendation For fair value calculation 40%, 40% and 20% weight to RI, DDM and Peer Group respectively has been assumed. Based on the weighted average valuation the fair value for Al Rajhi is SAR 87.10. The current price leaves a potential for 68% appreciation. Therefore, FALCOM Research initiates its coverage report on Al Rajhi with a “STRONG BUY” recommendation.

Analyst Call: STRONG BUY



34

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70

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5,6

90

1

85

,70

7,6

75

2

08

,98

2,8

91

2

40

,06

1,9

52

D

ue t

o Ban

ks3,

434,

549

3,

473,

246

2,

593,

090

7,

901,

630

5,

926,

223

5,

333,

600

6,

400,

320

7,

360,

368

Syn

dica

ted

Mur

abah

a Fi

nanc

ing

- 1,

875,

000

1,

875,

000

1,

875,

000

-

- -

- Cus

tom

er D

epos

its

70,1

12,1

92

73,3

97,9

80

89,7

25,1

67

116,

611,

043

12

2,44

1,59

5

134,

685,

755

15

2,19

4,90

3

175,

024,

138

O

ther

Cus

tom

er A

ccou

nts

2,28

8,41

9

2,48

4,44

2

3,03

0,96

9

3,68

6,57

6

4,05

5,23

4

4,46

0,75

7

4,90

6,83

3

5,39

7,51

6

Oth

er L

iabi

litie

s5,

733,

527

3,

798,

600

4,

056,

144

7,

823,

753

7,

041,

378

7,

745,

515

8,

907,

343

10

,243

,444

To

tal

Liab

ilit

ies

81

,56

8,6

87

8

5,0

29

,26

8

10

1,2

80

,37

0

13

7,8

98

,00

2

13

9,4

64

,42

9

15

2,2

25

,62

7

17

2,4

09

,39

9

19

8,0

25

,46

7

Sha

re C

apital

4,50

0,00

0

6,75

0,00

0

13,5

00,0

00

15,0

00,0

00

15,0

00,0

00

15,0

00,0

00

15,0

00,0

00

15,0

00,0

00

Sta

tuto

ry R

eser

ve3,

658,

332

5,

483,

805

7,

096,

219

8,

727,

370

10

,471

,016

12

,519

,150

15

,000

,000

15

,000

,000

Gen

eral

Res

erve

1,40

0,00

0

1,40

0,00

0

197,

650

-

- -

- -

Reta

ined

Ear

ning

s3,

319,

253

5,

547,

650

1,

588,

326

12

1,28

6

950,

245

71

2,89

8

573,

493

5,

286,

486

Pr

opos

ed D

ivid

ends

591,

709

99

8,02

1

1,22

3,91

7

3,18

3,14

3

4,50

0,00

0

5,25

0,00

0

6,00

0,00

0

6,75

0,00

0

To

tal

Sh

are

ho

lders

' Eq

uit

y1

3,4

69

,29

4

20

,17

9,4

76

2

3,6

06

,11

2

27

,03

1,7

99

3

0,9

21

,26

1

33

,48

2,0

48

3

6,5

73

,49

3

42

,03

6,4

86

To

tal

Liab

ilit

ies

& E

qu

ity

95

,03

7,9

81

1

05

,20

8,7

44

1

24

,88

6,4

82

1

64

,92

9,8

01

1

70

,38

5,6

90

1

85

,70

7,6

75

2

08

,98

2,8

91

2

40

,06

1,9

52

Bank Financials

Balance Sheet


Saudi Arabia

35

Banking Sector

(In

SA

R '0

00

)2

00

52

00

62

00

72

00

82

00

9E

20

10

E2

01

1E

20

12

E

Net

Inc

ome

from

Inv

estm

ents

5,67

7,26

2

6,82

6,08

6

7,72

1,81

2

8,49

4,44

1

9,26

8,98

6

10,5

99,7

12

12,2

99,8

0114

,564

,400

Fees

fro

m B

anki

ng S

ervi

ces

1,31

2,25

5

1,56

3,31

9

980,

625

1,

241,

267

99

3,01

4

1,09

2,31

5

1,25

6,16

21,

507,

395

Exch

ange

Inc

ome

360,

915

39

0,29

9

470,

872

48

3,45

9

459,

286

49

1,43

6

550,

408

63

2,97

0

Oth

er I

ncom

e40

1,01

0

730,

194

14

7,78

7

356,

100

32

0,49

0

368,

564

44

2,27

6

530,

731

To

tal

Op

era

tin

g I

nco

me

7,7

51

,44

2

9,5

09

,89

8

9,3

21

,09

6

10

,57

5,2

67

1

1,0

41

,77

61

2,5

52

,02

61

4,5

48

,64

81

7,2

35

,49

6

Gen

eral

& A

dmin

. Ex

pens

es1,

426,

194

1,

771,

585

2,

140,

040

2,

392,

843

2,

632,

127

2,

947,

983

3,

301,

740

3,69

7,94

9

Dep

reci

atio

n &

Am

ortiza

tion

155,

948

18

3,77

8

288,

159

38

3,40

1

479,

251

59

9,06

4

718,

877

86

2,65

2

Inco

me b

efo

re P

rovi

sio

n6

,16

9,3

00

7

,55

4,5

35

6

,89

2,8

97

7

,79

9,0

23

7

,93

0,3

98

9,0

04

,98

01

0,5

28

,03

01

2,6

74

,89

5

Prov

isio

ns &

Im

pairm

ents

535,

973

25

2,64

4

443,

240

1,

274,

419

95

5,81

4

812,

442

73

1,19

8

658,

078

N

et

Inco

me

5,6

33

,32

7

7,3

01

,89

1

6,4

49

,65

7

6,5

24

,60

4

6,9

74

,58

38

,19

2,5

38

9

,79

6,8

32

12

,01

6,8

16

EP

S3

.76

4

.87

4

.30

4

.35

4

.65

5.4

6

6.5

3

8.0

1

Income Statement



36

Rati

os

20

05

20

06

20

07

20

08

20

09

E2

01

0E

20

11

E2

01

2E

Pro

fita

bilit

y R

ati

os

(%)

Cos

t of

Fun

ds0.

4%1.

1%1.

0%0.

8%0.

7%0.

7%0.

7%0.

7%Yi

eld

on I

nves

tmen

ts8.

0%8.

8%8.

7%7.

5%6.

8%7.

4%7.

7%8.

0%Spr

ead

7.6%

7.7%

7.7%

6.6%

6.1%

6.6%

6.9%

7.2%

Retu

rn O

n av

g. E

quity

47.6

%43

.4%

29.5

%25

.8%

24.1

%25

.4%

28.0

%30

.6%

Retu

rn O

n av

g. A

sset

s7.

1%7.

5%6.

0%5.

4%4.

7%5.

1%5.

3%5.

6%

Gro

wth

(%

)N

et I

nves

tmen

t In

com

e37

.3%

20.2

%13

.1%

10.0

%9.

1%14

.4%

16.0

%18

.4%

Ban

king

Ser

vice

s Fe

es95

.9%

19.1

%-3

7.3%

26.6

%-2

0.0%

10.0

%15

.0%

20.0

%N

et I

ncom

e91

.9%

29.6

%-1

1.7%

1.2%

6.9%

17.5

%19

.6%

22.7

%D

epos

its

15.1

%4.

7%22

.2%

30.0

%5.

0%10

.0%

13.0

%15

.0%

Inve

stm

ents

(In

cl.

Loan

s &

Adv

ance

s)23

.7%

11.5

%17

.1%

37.3

%3.

3%8.

3%12

.9%

15.2

%Ass

ets

22.1

%10

.7%

18.7

%32

.1%

3.3%

9.0%

12.5

%14

.9%

Sha

reho

lder

s' E

quity

32.2

%49

.8%

17.0

%14

.5%

14.4

%8.

3%9.

2%14

.9%

Oth

er

Measu

res

(%)

Inve

stm

ent/

Dep

osit

115%

122%

117%

123%

122%

120%

120%

120%

Equi

ty/A

sset

s14

.2%

19.2

%18

.9%

16.4

%18

.1%

18.0

%17

.5%

17.5

%Pr

ovis

ions

/Gro

ss I

nves

t.0.

6%0.

3%0.

4%0.

9%0.

6%0.

5%0.

4%0.

3%N

PA/G

ross

Inv

estm

ents

2.0%

2.2%

2.9%

1.2%

1.4%

1.1%

1.1%

0.9%

Effi

cien

cy R

ati

os

Bus

ines

s/Em

ploy

ee (

SAR M

n)1.

16

1.26

1.11

1.27

1.30

1.44

1.60

1.79

Bus

ines

s/Bra

nch

(SAR M

n)20

.13

24.4

5

22.1

4

23.4

5

23.5

4

25.7

7

28.1

4

30.9

4

Inco

me/

Empl

oyee

(SAR M

n)0.

84

0.97

0.77

0.79

0.82

0.94

1.07

1.25

Cos

t/O

p. I

ncom

e (%

)27

.3%

23.2

%30

.8%

38.3

%36

.8%

34.7

%32

.7%

30.3

%

Valu

ati

on

Rati

os

PE (

x)43

.3

17.8

27.3

12.8

11.1

9.5

7.9

6.5

PBV (

x)18

.1

6.5

7.4

3.1

2.5

2.3

2.1

1.8

PEG

(x)

0.5

0.6

2.3

11

.0

1.6

0.5

0.4

0.3

Div

iden

d Yi

eld

(%)

1.2%

0.3%

1.5%

5.4%

5.8%

6.8%

7.7%

8.7%

Earn

ings

Yie

ld (

%)

2.3%

5.6%

3.7%

7.8%

9.0%

10.6

%12

.6%

15.5

%

Ratios & Analytics


Saudi Arabia

37

Banking Sector

Inco

me S

tate

men

t(I

n S

AR

mil

lio

ns)

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Net

Inc

ome

from

Inv

estm

ents

1,55

4

1,68

5

1,77

4

1,81

2

1,82

3

1,90

5

1,99

1

2,00

3

2,03

0

2,14

0

2,13

7

2,18

8

Fees

fro

m B

anki

ng S

ervi

ces

516

46

2

29

3

29

2

24

0

23

7

24

7

25

6

27

7

43

2

39

9

13

3

Ex

chan

ge I

ncom

e10

8

83

70

130

11

8

11

2

12

0

12

1

13

8

10

2

13

4

10

9

O

ther

Inc

ome

96

95

81

459

27

52

77

8 39

43

34

240

To

tal

Op

era

tin

g I

nco

me

2,2

73

2,3

25

2,2

18

2,6

93

2,2

08

2,3

06

2,4

34

2,3

73

2,4

85

2,7

16

2,7

05

2,6

69

Gen

eral

& A

dmin

. Ex

pens

es41

5

42

7

43

0

50

0

51

0

53

0

53

8

56

2

60

7

60

5

66

3

51

9

D

epre

ciat

ion

& A

mor

tiza

tion

38

42

46

57

57

70

77

84

88

93

95

108

In

com

e b

efo

re P

rovi

sio

n1

,82

1

1

,85

6

1

,74

2

2

,13

6

1,6

41

1,7

06

1,8

19

1,7

27

1,7

90

2,0

19

1,9

48

2,0

43

Prov

isio

ns &

Im

pairm

ents

66

80

50

57

71

96

124

15

2

18

8

27

7

19

1

61

9

N

et

Inco

me

1,7

54

1,7

76

1,6

92

2,0

79

1,5

69

1,6

10

1,6

94

1,5

76

1,6

02

1,7

42

1,7

57

1,4

24

20

08

20

06

20

07

Quarterly Overview



38

Glossary

ATM Automated Teller Machine

CAGR Compounded Annual Growth Rate

CAR Capital Adequacy Ratio

CD Credit-Deposit

EPS Earnings Per Share

LTM Last Twelve Months

NIM Net Interest Margin

NPA Non Performing Assets

PBV Price to Book Value ratio

PEG Price Earnings to Growth

PE Price to Earnings ratio

POS Points of Sale

ROE Return On average Equity

ROA Return On average Assets

SAMA Saudi Arabia Monetary Authority


Saudi Arabia

39

Banking Sector

Rating Rationale FALCOM Research assigns ratings based on the calculated fair value of a stock. Recommendation assumes, unless specifically mentioned, the holding period of 2 years for a stock to get closer to its fair price. We assign

Strong Buy if Fair Value > 20% of the Current Market Price Buy if Fair Value > 10% of the Current Market Price Hold if Fair Value is between +10% and -10% of the

Current Market Price Sell if Fair Value < 10% of the Current Market Price Strong Sell if Fair Value < 20% of the Current Market Price



40

Disclosures

Analyst certification

The views expressed herein accurately reflect the personal views of the analyst provided in good faith and with reasonable due care and diligence.

No part of the analyst’s compensation was, is or will be directly or indirectly be related to the specific recommendation(s) or views contained in this research report.

The analysis contained herein is based on number of assumptions and investor should be aware that different assumptions could result in materially different results.

Analyst/s covering the report may take investment decisions inconsistent with the recommendations in this report.

Corporate

FALCOM Financial Services did not receive any compensation for the preparation of this report.

FALCOM Financial Services was not involved in the management of public issue of the company in the last 12 months.

FALCOM Financial Services does not hold equity shares of the researched company.

FALCOM Financial Services may provide oral or written market commentary or trading strategies to FALCOM clients and proprietary trading desks that reflect opinions that may be contrary to the opinions expressed in this research report.

FALCOM asset management, FALCOM proprietary funds management desk, FALCOM brokerage division and FALCOM investment banking may take decisions that are inconsistent with the recommendations or views expressed in this research report.

No employee of FALCOM Financial Services serves on the Board of Directors of the company.

Others

This report is prepared after meeting the management of the Company. The report represents the final views of the analyst which may or may not match with the views of the management.

All stock price data included in this report are dated as at close of March 24, 2009 and market data for the nearest available period, unless otherwise indicated in the report.

FALCOM Financial Services has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research reports.

Chinese wall procedures are in place between the different business units to ensure that any confidential and/or price sensitive information is handled in an appropriate manner.

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