versus a 4-year average discount of 48% real estatemec.biz/term/uploads/4300-22-03-2011.pdfmar 22,...

Global Research

Initiation of Coverage

Equity – Saudi Arabia

Real Estate Sector

March 22, 2011

Saudi Arabia Real Estate Saudi real estate equities are trading at a 55% discount to TASI on PBx basis

versus a 4-year average discount of 48%

Strong fundamentals owing to attractive demographics coupled with large

undersupply of residential units, but financing is the key constraint

Strong Buy - DAAR - TP:SAR11.37, Hold - EEC - TP:SAR7.20, Strong Buy - Akaria

- TP:SAR30.40

Saudi real estate equities trading at a 55% PBx discount to TASI

As of March 2011, TASI is trading at 2.0x PBx versus 0.9x for real estate equities at a 55%

discount. Real estate average PBx needs to trade at a target of 1.1x to be inline with the

historical 48% discount to TASI between 1Q07 and 4Q10. The PBx discount of Saudi real

estate equities can be justified by investors preference of real asset ownership and the

sector’s low RoE and RoA. The market, however, is missing on the large premiums to land

value reported at cost in the books of listed equities compared to their realizable fair values

Attractive fundamentals, but sluggish project financing strains developments

The Saudi residential market suffers from a large supply shortage, especially in the low-mid

income segment. We estimate that a current shortage of 0.7mn units exist in the market and

an additional 1.2mn new units will be needed by 2014, offering attractive potential for Saudi

realtors. Off-plan sales are largely restricted leading to financing bottlenecks for developers

who are forced to fully finance projects prior to realizing cash inflows from unit sales.

Moreover, the dry credit market for real estate developers in 2009-10 has further

substantiated the funding quandary and led to execution delays.

The mortgage law is an initial step in the right direction, but not the sole solution

The proposed mortgage law is critical to unlock part of the pent up demand for real estate in

Saudi but it’s capacity to deliver an efficient solution to the sector vulnerabilities remains

feeble. Our view is devised given low base effect and limited reach owing to the disparity

between the strict financial requirements expected from lenders and the wide base of

inadequate borrowers. We prefer saying more credit extended to developers, which should

yield better results in the short to medium term.

Initiate coverage on Saudi real estate

Initiate on Dar Alarkan (DAAR) with a Strong Buy recommendation and a target price of

SAR11.37, Emaar Economic City (EEC) with a Hold recommendation and a target price of

SAR7.20 and Saudi Real Estate Company (Akaria) with a Strong Buy recommendation and

a target price of SAR30.40.

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Faisal Hasan, CFA Head of Research [email protected] Tel.: (965) 22951270 Mostafa El-Maghraby Senior Financial Analyst [email protected] Tel.: (965) 22951279 Global Investment House www.globalinv.net

Company Mkt. Cap.

PB (x)

11e

PE (x)

11e

CMP Target

Price Upside

Potential Recommendation

SAR mn SAR SAR

Dar Alarkan 9,342 0.6 6.4 8.70 11.37 31% Strong Buy

Emaar Economic City 5,568 0.8 NA 6.55 7.20 10% Hold

Saudi Real Estate Co. 728 0.9 28.9 22.75 30.40 34% Strong Buy

Source: Bloomberg, Global Research

Global Research - Saudi Arabia Real Estate Sector

March - 2011 2

Table of Contents

Valuation Methodology 3

Dar Alarkan Valuation 4

Emaar Economic City Valuation 5

Saudi Real Estate Company Valuation 6

MENA Peer Comparison 7

Real Estate Sector Fundamentals 10

Demographics 10

Funding 11

Mortgage Law 11

Residential Market 13

Commercial Market 13

Retail Market 14

Hospitality Market 14

Dar Alarkan 16

Emaar Economic City 27

Saudi Real Estate Company 38

Disclosures 49


Valuation Methodology We adopt a SOTP approach to arrive at a 12 month fair value target for Saudi real estate equities. We

construct our valuation methodology based on the following criteria:

We assign a RFR of 5.6% and MRP of 7.0%, which we believe is justified for Saudi equities

given the current political turmoil in the region, along with the respective Beta and financial

structure for each company to arrive at a justified WACC. When warranted, we incorporate

adjustments to the project WACC based on available data on project financing and our

perceived riskiness.

For investment properties, we utilize a two-stage DCF approach valuing each project according

to its respective credentials and discounting it at the project’s WACC before arriving at a

terminal reversion value based on available market capitalization rates on the fourth year of our

forecast horizon.

For development properties, we utilize a one-stage DCF approach extended over the life of the

project. We discount each project’s FCF by the relative WACC and build our assumptions for

selling prices and margins based on management guidance and prevailing market trends.

Where management guidance is not available on land sales, we use historical patterns and

current market trends as basis to our forecasts. Individual prices and margins of land plots

differ based on our assessments of factors including location, state of development and

available information on comparable sales.

We value land bank at historical cost based on its reported book value opting to stay on the

conservative side.

Market trends of listed real estate equities vary largely across MENA markets. Further, different

accounting practices impede the construction of peer valuations. Accordingly, we do not

incorporate relative valuations in our fair value targets. However, we conduct a relative

comparison exercise to investigate multiple trends for Saudi equities versus regional peers and

versus the overall Tadawul index.

Risks To Valuation

Execution risk is high for Saudi developers given funding constraints and can lead to diversions

from our assumed delivery dates.

Land sales are highly volatile and unpredictable and form a key risk factor in forecasting

revenues for Saudi real estate developers.

The application and the impact of the new package of laws concerning credit extension to real

estate developers and the mortgage law could impact future dynamics.

Political risk owing to the current upheavals across the MENA region impacts market activity

and drives risk premiums higher.

March - 2011 3


March - 2011 4

Dar Alarkan (DAAR) Valuation

Our valuation for DAAR has yielded a SOTP fair value of SAR10.03/share. Cash flows are discounted by a

WACC of 11.88%. The cost of equity has been calculated by utilizing the capital asset pricing model based

on a risk free rate of 5.6%, an equity risk premium of 7% and a beta of 1. For specific projects where our

judgment of the risk profile is higher, we adjust the inputs of our WACC lifting it up to a cap of 13.4%.

With the company currently trading at SAR8.70/share, our fair value target provides investors with 31%

upside potential. Accordingly, we issue a Strong Buy recommendation on DAAR stock.

DAAR Valuation Value (SAR bn) /share Methodology %

Development Sales 3,269 3.03 DCF 19%

Investment Portfolio 1,334 1.23 DCF / Cap. Rate 8%

Land Sales 13,004 12.04 DCF 73%

Total NPV 17,607 16.30

Add Cash FY10 1,189 1.10

Add: Other Investments at Cost 2010 1,162 1.08

Less Debt 2010 7,679 7.11

Equity Value 12,278 11.37

CMP (as on March 21, 2011) 8.70

Upside Potential 31%

Source: Global Research


March - 2011 5

Emaar Economic City (EEC) Valuation

Our valuation on EEC has yielded a SOTP fair value of SAR7.10/share. Cash flows are discounted by a

WACC of 12.6%. The cost of equity has been calculated utilizing the capital asset pricing model based on a

risk free rate of 5.6%, an equity risk premium of 7% and a beta of 1. For specific projects where our

judgment of the risk profile is higher, we adjust the inputs of our WACC lifting it up to a cap of 14.1%.

With the company currently trading at SAR6.55/share, our fair value target offers a 10% upside potential.

Accordingly, we issue a Hold recommendation on EEC stock.

EEC Valuation Value (SAR bn) /share % Methodology

Development Sales 602 0.71 11% DCF

Industrial Valley 213 0.25 4% DCF / Cap. Rate

Seaport 464 0.55 8% DCF

Land Sales 951 1.12 17% DCF

Land Bank 3,326 3.91 60% Cost

Total NPV 5,557 6.43

Add Cash 2010 339 0.40

Add: Other Investments at Cost 2010 225 0.27

Less Debt 2010 - -

NAV 6,121 7.20

CMP (as on March 21, 2011) 6.55




March - 2011 6

Saudi Real Estate Company (Akaria) Valuation

We utilize a SOTP approach to arrive at a fair value target for Akaria. For our DCF based valuations, we

arrive at a WACC of 13.9% derived from the capital asset pricing model factoring in a RFR of 5.6%, market

risk premium of 7.0% and Beta of 1.19. For specific projects where our judgment of the riskiness profile is

higher, we adjust the inputs of our WACC lifting it up to a cap of 15.4%.

Our fair value target of Akaria is SAR30.40/share implying a 34% upside potential from the current share

price of SAR22.75. We, accordingly, issue a Strong Buy recommendation on the stock.

Akaria Valuation Value (SAR bn) /share % Methodology


Investment Properties 1,243 10.36 53% DCF/Cap.rate



Add: Cash 2010 159 1.32


Less Debt 2010 - -

EV 3,648 30.40

CMP (as on March 21, 2011) 22.75




MENA peer comparison

Given the significance of accounting discrepancies across different MENA countries, we believe that a peer

based valuation can not be utilized as a valuation metric for real estate listed equities. Earnings based

valuations are distorted by the revenue recognition method utilized. Further, the revenue mix of different

companies proposes additional constraints. Different models driven by land sales, investment portfolios,

development sales and construction activity impair the ability to structure a fair value judgment based on

earnings metrics.

Balance sheet based valuations also offer constraints to constructing a multiples based valuation because of

the recognition methodology adopted in reporting land and investment properties. Saudi companies report

land at the historical cost of acquisition, which, in most cases, is significantly lower than its fair market value.

Taking the above factors into consideration, Saudi real estate listed companies trade at a historical 2010

0.9x PBx reflecting a 31% discount to MENA average. Within our coverage universe, DAAR is trading at a

46% discount, EEC at 38% discount and Akaria at a 36% discount to MENA average. Akaria is the only

company trading in line with the Saudi real estate average PBx of 0.9x.

DAAR reported a historical RoE of 10.4%, which is significantly higher than the Saudi average of 3.8%. We

attribute this to DAAR’s capital structure incorporating debt versus Akaria’s debt free balance sheet and

EEC’s negative RoE. In a regional context, Saudi developers RoE is significantly lower than their regional

peers, excluding the one time impact of Aldar’s exceptional figure of negative 121% in 2010 driven by the

company’s impairments in 4Q10 on the UAE average.

March - 2011 7

MENA Real Estate Peer Valuation

Security Market Cap

(USD mn) ROE ROA PBx PSx

Talaat Moustafa Group 2,214 3.9% 1.9% 0.5 2.5

Palm Hills Developments SAE 860 12.0% 3.9% 1.2 2.9

Six of October Development & Investment 493 7.1% 2.5% 1.3 11.1

Egypt (Average) 7.6% 2.8% 1.0 5.5

Mabanee Real Estate Co 1,294 15.7% 7.8% 2.8 12.8

Kuwait (Average) 15.7% 7.8% 2.8 12.8

Barwa Real Estate Co 3,622 17.1% 2.6% 1.2 7.0

United Development Co 915 19.7% 6.0% 1.0 2.7

Qatar (Average) 18.4% 4.3% 1.1 4.9

Dar Al Arkan Real Estate Development 2,491 10.4% 6.2% 0.7 2.5

Emaar Economic City 1,598 -7.7% -6.4% 0.8 64.4

Saudi Real Estate Co 728 5.8% 5.4% 0.9 6.8

Arriyadh Development Co 428 6.6% 6.0% 1.1 9.9

Saudi Arabia (Average) 3.8% 2.8% 0.9 20.9

Emaar Properties PJSC 4,892 8.2% 3.9% 0.6 1.5

Aldar Properties PJSC 1,067 -120.3% -22.3% 0.8 1.8

Sorouh Real Estate Co 786 0.1% 0.1% 0.5 2.3

United Arab Emirates (Average) -37.3% -6.1% 0.6 1.8

MENA Average 1.6% 2.3% 1.3 9.2

Source; Bloomberg, Global Research


Investors ignore asset value appreciation

Real assets have historically offered a favorable resort for Saudi investors on the back of strong

fundamentals, familiarity with market dynamics and the absence of downward demand pressures. The

TASI crashes of 2006 and 2008 coupled with the historical negative interest rates on bank deposits have

given more credentials to real asset ownership, as investors shy away from equities, contributing to the

strong cumulative appreciation in prices over the past 5 years.

Based on several actual land transactions, return on land ownership in 2010 has crossed the 200% mark

for land plots acquired during 2006-07. For residential properties, excluding the marginal slowdowns of

2009 in both rental and selling prices, the longer term trend in price movement remains to the upside.

Saudi real estate equities traded at a historical PBx average discount of 48% to TASI between 1Q07 and

4Q10. Currently, TASI PBx stands at 2.0x whereas real estate equities trade at 0.9x at a 55% discount. To

trade inline with the historical 48% discount, the current real estate average PBx needs to trade at a target

of 1.1x. In our view, the historical discount could be justified by investors preference of real asset

ownership. However, this ignores the large discounts to the value of land reported at cost in the books of

listed real estate companies to the fair valuations based on realizable market prices.

March - 2011 8


Real estate listed companies recorded an aggregate net income CAGR of negative 19% between 2007-10

underperforming TASI’s 0.2% CAGR during the same period. This, coupled with the sector’s under-leverage

has resulted in the consistently inferior RoE as compared to the overall market. For companies under our

coverage, DAAR stands out on that front with relatively higher return ratios due to its highly leveraged

financial structure.

In terms of price performance, Saudi listed real estate equities have significantly underperformed TASI over

the past six quarters since the beginning of 3Q09 through to the end of 2010. TASI recorded an 11%

appreciation while the real estate Index dropped 23% over the same period. TASI appreciation came in sync

with similar movements in oil prices and the S&P500 signaling negative divergence in real estate equities.

In our view, the key real characteristics and drivers of the market will not change in the short term given the

current strong market fundamentals and the persistence of the undersupply of residential units. Accordingly,

we believe that a re-adjustment to real estate equities discounted multiples is warranted in the medium term.

For DAAR and Akaria, we see land sales as the key short term catalyst ahead of project deliveries in 2013

and 2014. For EEC, the availability of sufficient long term funding and land sales are the favorable news flow

in the short term.

March - 2011 9


Real Estate Sector Fundamentals

Attractive Demographics

The Saudi real estate market suffers from a well documented supply shortage, especially in the low-mid

income housing segment. We estimate that a current shortage of 0.7mn units exists in the market while an

additional 1.2mn new units will be needed by 2014. Housing demand has been escalating owing to a

growing number of expatriate workers (27% of 2009 population), urbanization (82% of total population), a

relatively high rate of birth amongst Saudi nationals (5 year av. 27/1,000 population) and a declining family

size.

Saudi demographics are highly skewed towards young population. The below 25 years age group represent

50% of the aggregate implying strong future demand for housing. Further, due to its vast geographic size,

the country has a high ratio of land area per capita of 83,500 sqm and a low population density of 12 people/

sqm, which validates the programs undertaken by the government to expand outside of the historically

populous cities into greenfield developments.

Riyadh and Makkah districts, collectively, host 50% of the Saudi population due to the former’s lively

business and political activity and the latter’s proximity to the tourism destinations of Makkah and Madinah in

addition to high business activity in Jeddah. The large expatriate population of 6.8mn (2009 census), that

has historically had low participation in property ownership on the back of strict freehold regulations,

acquires a significant share of the rental market. This is mostly represented in gated compounds, shared

villas or flat apartments in short to mid-rise buildings.

March - 2011 10


Funding Constraints

The contextual framework of the Saudi real estate sector suffers from intrinsic impediments that have created

an accumulated state of disorganization. Off-plan sales are banned leading to financing bottlenecks for

developers who are forced to fully finance projects prior to realizing cash inflows from unit sales. Moreover,

the dry credit market for real estate developers in 2009-10 has further substantiated the situation. Banking

credit extended to contractors and developers declined 18% in 2009 before picking up again in 9M10 but

remains at a lower percentage of total credit compared to the 2006-08 period. Further, official figures put the

contribution from the government’s zero interest Real Estate Development Fund (REDF) at a marginal 8% of

annual developments in the country.

Mortgage Law

The lack of a clear defined mortgage law has

restrained affordability in the market. The current

percentage of mortgage lending to total credit stands at

a mere 2.8% compared to 16% in the UAE. With an

average annual salary averaging at SAR36,000 for a

Saudi national joining the workforce and a sluggish

contribution from government grants, the disparity

between the offering of luxury units and realizable pent

up demand is amplified. We see this pattern continuing

in the foreseeable future as the largest share of units

due for delivery remain highly priced for the low-mid

income bracket.

According to the latest announcements, the Shura

council is currently studying the draft mortgage law that

is expected to be finalized within the coming few

months. The law is expected to identify clear measures

on foreclosures, property evacuation and title deeds

along with organizing the associated role of judicial and

enforcement bodies.

The law is critical to unlock part of the pent up demand

but we remain skeptical on it’s capacity to deliver an

efficient solution to the sector’s vulnerabilities. Our view

is devised given low base effect and limited reach

owing to the disparity between the strict financial

requirements expected from lenders and the wide base

of inadequate borrowers.

March - 2011 11


For a Saudi national to acquire a 20 year mortgage loan with 90% financing at an 8% interest rate for a

moderate house worth SAR550,500, the minimum required monthly salary should be SAR9,209 to meet

the 45% loan to income criteria needed for approval. This figure is 47% above the upper limit of the third

quintile of the income band that earns a monthly salary of SAR6,250. This shrinks the addressable market

significantly to less than 8% representing part of the upper two income quintiles. Accordingly, we anticipate

a weak market response to the new laws as approved mortgage volumes remain low. To counter this in the

short term, we prefer seeing more funding extended to developers in order to accelerate construction

progress.

Government New Housing Initiatives

The Saudi king announced a plan to pump SAR250bn for the construction of 500,000 housing units across

the kingdom. The delivery of these units could be extended for a minimum of five years given the prolonged

time for the tendering, design and approval phases and also taking into account the Saudi current

construction capacity of around 120,000 units per year.

These units target the lower band of the population, which falls outside the addressable market for the

companies under our coverage universe. Opportunities from these initiatives, however, would accrue over

the long term from the added value to land plots owned by DAAR and Akaria as the surrounding

infrastructure developments take place. Further, both companies can enter JV’s with the government and

book project management fees.

March - 2011 12

Model of Saudi Development Costs, Mortgage & Availability

Input SAR

Cost of un-serviced land per sqm 300

Cost of services and infrastructure works per sqm 150

Master developer design, marketing and infrastructure works mark up of 30% per sqm 135

Net cost of land per sqm 585

Land cost assuming plot size of 300 sqm 175,500

Construction cost at SAR1250/sqm 375,000

Total development cost 550,500

Monthly installment assuming 20 years, 90% financing and 8% interest rate 4,144

Required monthly salary assuming financing cap of 45% per month 9,209

Financing gap assuming average monthly salary of SAR4,000 5,209

Financing gap as percent of monthly salary 130%

Source; Various Industry Sources, Global Research


Residential market

Riyadh suffers from a large supply deficit in residential units with additions to apartment stock not keeping

pace with the growing demand, which we estimate at 45,000 unit/an. Although the rental market softened

8-10% in 2009 owing to the mismatch in available offerings, strong signs of recovery are showing with

apartment and villa prices increasing 10% and 5%, respectively in 2010. In our view, high land prices and the

lack of affordable units would continue to impel new rounds of price escalation over the coming two years.

In Jeddah, the key residential themes are delayed

supply and the introduction of freehold units, which

are showing price resilience signaling the presence of

strong foreign demand for the city’s properties. A high

degree of land speculation coupled with the existing

shortage in low-mid income supply are the main

drivers of price escalation. Jeddah Municipality puts

the cost of 100sqm of serviced land at 19.4x the

average family income while the number of Saudi

families living on rented dwellings are more than 50%

of the city’s population. Only 68% of the city’s land

bank is allotted for residential developments and the

rest remains vacant leaving the city suffering from an

immediate supply shortage of 283,000 units.

Commercial Market

We prefer Jeddah’s commercial market to that of

Riyadh on higher absorption of upcoming grade A

supply as the city is mostly dominated by lower grade

office space. A number of developments under

construction in Jeddah will be offered on freehold

schemes, a positive step in attracting investments in

the sector and in benchmarking with regional

standards. Riyadh commercial market is more

saturated and runs a high vacancy rate of 26%

compared to 5.5% in Jeddah. With 200,000sqm of

new office space made available in 2010 and an

additional 1.1mn sqm by 2013, we forecast a

downward pressure in Riyadh’s office selling prices

and rents as tenants upgrade at competitive prices.

March - 2011 13

Global Office Market Highest Vacancy Rates 2Q10

Market Percent

Riga 30.0%

Dubai 30.0%

Fairfield 26.8%

Budapest 26.1%

Riyadh 26.0%

Los Angeles - Inland Empire 24.7%

Las Vegas 24.7%

Columbia 24.1%

Orange County 23.6%

Cincinnati 22.6%

Source; Colliers International


Retail market

Saudi shopping malls are of less quality and lack in-mall attractions compared to regional peers. They

remain, however, a major source of leisure due to the absence of entertainment varieties in the country on

the back of cultural constraints making the segment a resilient play against economic slowdowns. Current

supply stands at 3.4mn sqm and an additional 1.7mn sqm is expected to be added by 2013 in the three

major districts. We like the segment’s short term strong fundamentals owing to attractive occupancy rates of

80-85% and resilience to downward price pressures. However, we expect rentals and yields, especially of

older stock to drop significantly once new supply enters the market.

Hospitality Market

Saudi tourism is largely driven by religious visitors

as Makkah and Madinah receive 8.5-9mn visitors

annually representing 70% of aggregate arrivals.

Makkah has 50,000 hotel rooms that are expected

to double over the coming ten years as the city

witnesses several major redevelopment plans while

Madinah runs a smaller stock of 20,000 rooms. A

seasonality pattern with strong fluctuations exists in

the market with occupancy rates peaking during the

Hajj season and the month of Ramadan but drop

significantly throughout the rest of the year.

March - 2011 14


Jeddah and Riyadh both suffer from undersupply of quality hotels at international standards but several

developments that will be managed by recognized brands have either initiated operations or are currently in

the pipelines. The hotel market runs high occupancy rates in 5-star hotels by business visitors at c.80%

versus lower demand in inferior classes. Negative seasonality also exists in this segment as demand slows

during summer time on the back of slowing business activity and increasing outbound travelling.

Economic Cities

Saudi is adopting a mega-city development model to direct future population and developments away from

congested metropolitans. The developments are made on private investments under the sponsorship of the

government as opposed to the state-owned and operated model of Jubail and Yanbu Industrial Cities. To

date, four cities with an estimated development cost of USD69bn are under construction. The below table

shows headline visionary figures provided by Saudi Arabia General Investment Authority (SAGIA).

March - 2011 15

Source; SAMA,Global Research

Economic City Location Area Investment Jobs Population

(mn sqm) (USD bn) (000) (mn)

King Abdullah Economic City Jeddah 168 27 1,000 1.5

Jazan Economic City Jizan 100 27 100 0.3

Prince Abdulaziz Bin Musaid Economic City Hael 156 8 55 0.3

Knowledge Economic City Madinah 4.8 7 20 0.2

March - 2011 16

Dar Alarkan (DAAR) Strong Buy

Target Price

SAR11.37

Market Data

Bloomberg: ALARKAN AB

Reuters: 4300.SE

CMP (Mar 21, 2011): SAR8.70

O/S (mn) 1,080

Market Cap (SAR mn): 9,342

Market Cap (USDmn): 2,491

Price/EPS 2011e(x): 6.4

Price/Bv 2011e (x): 0.6

Price Performance 1-Yr

High (SAR): 14.4

Low (SAR): 7.40

Average Volume: 3,286,175

1m 3m 12m

Absolute (%) -5.4 -1.1 -37.2

Relative (%) -4.5 -5.0 -42.6

Price Performance

Cash flows highly reliant on land sales till 2012

Ability to repay the 2012 international sukuk and execution progress

are the key concerns

Initiate coverage with Strong Buy recommendation and TP of

SAR11.37

Business model highly reliant on land sales

DAAR’s business model is highly reliant on land sales, forming 91% of total

revenues in 2009 and 2010, with property sales making the balance. The first

contribution from rental income is expected in 2011 from Alqasr residential

units and Alqasr mall. Cash flow is highly reliant on land sales through to

2012 with deliveries from Shams Ariyadh and Shams Alarous to drive

revenues in 2013.

Sluggish performance in 2009-10

2010 revenues dropped 24% y-o-y to SAR4.1bn on slower sales in both land

plots and residential properties registering the lowest margins since 2007. Net

income dropped 31% to SAR1.5bn in 2010 after dropping 10% in 2009.

The 2012 SAR3.75bn sukuk is the upcoming liquidity challenge

Management intends to repay the 2012 sukuk utilizing internal funds

generated via land sales. The ability to refinance the 2012 SAR3.75bn

International sukuk appears feasible, if needed The cost of refinancing

remains the key challenge, in our view.

Avoiding margin erosion in land sales is the key catalyst till 2012

The ability to generate short term cash flow from land sales is comforting;

avoiding stressed margins is the major positive catalyst. To the downside,

timely execution and the 2012 sukuk repayment are the key concerns.

Initiate with a TP of SAR11.37 and a Strong Buy recommendation

We value DAAR at SAR11.37/share implying a 31% upside potential over the

current market price of SAR8.70. We, accordingly, issue a Strong Buy

recommendation on the stock.


Investment Indicators

Year 2009 2010 2011e 2012e 2013e 2014e

Revenues (SAR mn) 5,464 4,142 4,126 4,513 10,683 7,722

Net Profit (SAR mn) 2,123 1,456 1,464 1,523 3,781 2,713

EPS (SAR mn) 2.0 1.3 1.4 1.4 3.5 2.5

BVPS (SAR mn) 13.1 13.4 14.8 16.2 18.7 19.2

P/E (x) 4.4 6.5 6.4 6.2 2.5 3.4

P/BV (x) 0.7 0.6 0.6 0.5 0.5 0.5

Source: Company Reports & Global Research

Global Research - Saudi Arabia Dar Alarkan

Company Profile

DAAR is the largest Saudi real estate listed developer. DAAR was established in 1994 specializing in land trading, property development, management and investment. In 2007, DAAR went public through floating 30% of its shares in an IPO that was 423% oversubscribed and was listed the same year on Tadawul stock exchange.

Business Model

DAAR is a master developer of mega projects focused on the sales of land and developed properties. The company purchases large land parcels of 1-5mn sqm and also purchases available additional land around the area designated for the project. After the design phase and the initial announcement of the master plan, DAAR realizes value added gains on sale of land parcels around the project as prices escalate yielding high margins that averaged at 49% between 2007-10. DAAR’s property developments are tailored to the middle income bracket. Announced future developments are concentrated in Riyadh and Jeddah although the company’s extensive land bank of approximately 32mn sqm is extended across several major cities in Saudi. Property sales margins have dropped sharply from 47% in 2007 to a low of 12% in 2010 due to fluctuating realizable margins between different developments. Properties in projects like Altilal and Alqasr, where a small part of the total land is developed to generate footfall and create value for the surrounding land, are sold for lower margins averaging 15-20% but DAAR realizes higher margins on land sales around these developments. Other projects designated purely for sales are sold for higher margins averaging at 35% with any higher margins realized on property sales rep-resenting exceptional deals on full buildings. Further, DAAR has a policy by which it targets a minimum of 40% margin on land sales and manages sales volume in order to avoid margin erosion. To increase its exposure to the attractive rental market, DAAR has classified units in its new developments; namely Alqasr, for that purpose. Out of the total 3,051 units in Alqasr, 1,318 are directed to generate recurring rental income. In the same direction, Alqasr Mall is 85% complete and is planned to start commercial operations in 2H11. Once completed, the mall will be the largest in Riyadh with 78,584sqm of GLA. Alqasr Mall, along with other attached retail shops in Alqasr development, will comprise the retail contribution to the rental portfolio. We like the move towards a more stable recurring income especially the exposure to the residential rental market although the contribution from DAAR’s rental portfolio to the topline will remain muted compared to other sources of income. Our long term concerns over the retail segment are contained on the back of the prestigious profile of Alqasr Mall. Management indicated a target yield of more than 10% for the mall citing controlled construction costs and premium positioning.

March - 2011 17


Project Profile

Altilal

Altilal is DAAR’s completed project in Madinah comprising 499 villas spread over 170,000sqm. The project cost was SAR375mn and was delivered in 2010 with only 48 villas remaining in DAAR’s inventory. The project’s land comes in as a part of a large 2.2mn sqm land owned by DAAR and is currently sold as developed land.

Alqasr

Alqasr is a SAR1.8bn mixed use development encompassing a land area of 813,643sqm and a BUA of 1.2mn sqm. The project comprises 1,733 residential units designated for sale, 1,318 residential units designated for rentals, 63,135 sqm of retail GLA and 20,000sqm of leasable office space. As of early 2011, the project is almost fully completed with 1,508 units already sold at an average margin of 18-25%. Investment properties have started slowly in 4Q10 and are expected to pick up pace in 1Q11.

Alqasr Mall

Once completed, Al-Qasr mall will be the largest in Riyadh. The mall comprises a GLA of 78,584 sqm inclusive of a 8,7800 sqm of GLA already leased to Carrefour on a 14 year lease. As of 4Q10, the mall was 85% complete and is expected to commence operations in 2H11 with management guidance on expected yields of more than 10%.

Shams Ariyadh

A mega project spread over 5mn sqm of land in the outskirts of Ryiadh targeting the upper middle income

class. The project comprises 2,694 villas of unit size ranging between 400-600 sqm, complementary retail

shops and a 481,000sqm land parcel designated for sale to be developed into a 3mn sqm of commercial

space. To date, 28% of the project is completed and is expected to be delivered in 2013. Management

expects a 35% margin on the project entailing in a selling value of SAR8bn on an expenditure of SAR5.9bn.

Shams Alarous

Shams Alarous is located 12km away from Jeddah downtown on a land area of 3mn sqm with an initial

BUA of 25mn sqm that has been significantly increased after the company received permission to raise the

number of built up floors from four to seven. The SAR7.5bn development will be carried on several phases

with the first one spanning two years and covering 20% of aggregate land. Management expects a margin

of 15-20% from the project.

Qasr Khozam

A real estate redevelopment in Jeddah’s inner city to renovate the historical site of Khozam. Khoazm

company; a 51:49 JV between DAAR and Jeddah municipality with a paid up capital of SAR540 mn was

formed to undertake the development of the site with expected investment requirements of SAR10bn.

DAAR’s revenues will come from selling the developed land plots after undertaking the infrastructure to

renovate the land along with receiving management fees. Financing for the project will come under Khozam

Company, which should facilitate fundraising given government involvement. To date, the master plan has

been finalized and the infrastructure plan is in the process of receiving governmental approvals.

March - 2011 18

DAAR Ongoing and Future Projects

Project Operations Capex

(SAR mn) Completed Total Units Sold to Date Delivery

Alqasr Mixed 1,800 99% 3,051 1,508 2010

Altilal Sales 375 100% 499 451 2010

Alqasr Mall Rental 950 84% NA NA 2011

Shams Ariyadh Sales 5,800 28% 2,694 0 2013

Qasr Khozam Mixed 10,000 0% 0 2015

Shams Alarous Mixed 7,500 17% 10,000 0 2016

Source; DAAR, Global Research


Financing

DAAR’s outstanding debt stood at SAR7.7bn

comprising SAR3.75bn of international sukuk

maturing in 2012, international Islamic sukuk of

SAR1.7bn maturing in 2015, local sukuk of

SAR750mn maturing in 2014 and SAR1.7bn of

bank loans in the form of Islamic murabaha.

DAAR’s coming credit crunch comes in 2012 as it

needs to pay off its SAR3.75bn International

sukuk. Management indicated that DAAR is will not

rollover the debt and that the company intends to

fully pay bondholders at maturity. The needed cash

will be raised through land sales.

The 2015 sukuk are priced at 10.75% versus the company’s previous cost of 7.5% for the 2012 sukuk

issued in July 2007. The recent downgrade by Moody’s to a Ba3 from Ba2 rating could cast some doubt

and perhaps increase future funding cots. Pricing in line of the previous 10.75% should significantly

increase the company’s average cost of debt given that the 2012 sukuk are priced at LIBOR plus 2.25%.

Management affirmed to us the intention to pay off the 2012 sukuk and that there are no plans to raise any

further debt except when new projects avail. We, however, prefer to assume the rollover of the amount due

and factor in replacement of DAAR’s 2012 debt at a similar 10.75% until further confirmation.

Financial Performance

Revenues registered SAR4.1bn in 2010 reflecting a 24% drop from 2009 on slower sales in both land plots

and residential properties. Both segments reported their lowest margins since 2007 with land sales

registering 45.6% slightly above the 40% floor acceptable margin indicated by management. Property sales

from both Altilal and Alqasr yielded lower margins as well recording 12.4% down from 23.3% in 2009 and

42.3% in 2008. Due to changes in the mix of units sold, DAAR’s residential margins have historically

fluctuated aggressively between a high of 56.5% in 2Q08 and a low of 5.7% in 3Q10.

Interest expense stood at SAR214mn up from SAR146mn the previous year on growing debt and higher financing costs, a pattern we see sustainable in the near future while net income dropped 31% to SAR1.5bn after dropping 10% the previous year.

March - 2011 19


Forecast Assumptions

Development sales

DAAR model does not integrate off plan sales and accordingly we roll out unit sales based on scheduled

completions. For 2011, we only incorporate sales from the remaining units of Alqasr and Altilal. In 2012 we

factor in early sales from Shams Alarous phase 1 and Shams Ariyadh. These two projects to be the key

revenue driver in 2013. We exclude Shams Alarous phase 2 and Qasr Khozam from our valuation until fur-

ther clarity.

Investment properties

We expect 2011 to be the first year of significant revenue generation from DAAR’s investment properties.

We incorporate revenues from Alqasr 1,318 residential units, office space and retail as of 2Q11 and then

factor in contribution from Alqasr Mall effective 3Q11. We apply a 9% yield on residential units, 6% on

office space, 7-8% on street retail attached to Alqasr development and 10% on Al-Qasr mall (below

management guidance of +10% yield). For occupancy rates we assume 50% for residential units in 2011

and then grow it to 99% in 2012 (in line with market trends and similar occupancy rates for Akaria). We

assume 70% occupancy rate for office space and 85% for retail. Based on existent projects and our

forecasted revenues, we expect contribution from this segment to hover around 4-6% of total revenues in

our forecast horizon.

Land Sales

In our view, land sales will remain the key cash generating machine for DAAR through to 2012 on sluggish

property sales in 2011 and most of 2012. We maintain a margin of 45%; slightly below historical margins

factoring in pressured sales to meet capital expenditure requirements and financial commitments. We

factor in the sale of 6.5mn sqm in 2011 and 5.5mn sqm in 2012 at 2010 average price of 568/sqm.

Dividends

We rule out any dividend payments through 2011 and 2012 as cash will be directed to servicing existing

debt and capital expenditures. We expect a dividend of SAR1/share and SAR2/share in 2013 and 2014

once more cash generation takes place as Shams Alarous and Shams Ariyadh are delivered.

Risks to Assumptions

Based on our assumptions, DAAR remains heavily reliant on land sales for the next two years to generate

the cash flow needed for project financing and the repayment of the 2012 sukuk. In case of any emerging

financing needs, DAAR can resort to discounting its target gross margin on accelerate land sales and

generate the needed cash flow. Further, timely execution remains a risk in spite of the company’s track

record. Any unaccounted for deviations from our set delivery dates would impact our valuations. Also,

although we believe DAAR will successfully refinance the 2012 maturing debt, we remain cautious as to the

actual refinancing terms.

March - 2011 20


March - 2011 21


Valuation

Our valuation on DAAR has yielded a SOTP fair value of SAR10.03/share. Cash flows are discounted by a

WACC of 11.88%. The cost of equity has been calculated by utilizing the capital asset pricing model based

on a risk free rate of 5.6%, an equity risk premium of 7% and a beta of 1. For specific projects where our

judgment of the risk profile is higher, we adjust the inputs of our WACC lifting it to a cap of 13.4%.


upside potential. Accordingly, we issue a Strong Buy recommendation on DAAR stock.

March - 2011 22

DAAR Valuation Value (SAR bn) /share Methodolgy %

Development Sales 3,269 3.03 DCF 19%

Investment Portfolio 1,334 1.23 DCF / Cap. Rate 8%

Land Sales 13,004 12.04 DCF 73%

Total NPV 17,607 16.30

Add Cash FY10 1,189 1.10


Less Debt 2010 7,679 7.11

Equity Value 12,278 11.37

CMP (as on March 21, 2011) 8.70




March - 2011 23

Income Statement Dar Alarkan

SAR mn 2008 2009 2010 2011e 2012e 2013e 2014e

Revenue 5,611 5,464 4,142 4,126 4,513 10,683 7,722

Cost of revenues 2,766 2,957 2,378 2,318 2,661 6,428 4,610

Gross Profit /(Loss) 2,845 2,507 1,764 1,808 1,853 4,255 3,112

SG&A 152 146 106 107 113 214 193

EBITDA 2,694 2,361 1,658 1,701 1,740 4,042 2,919

Depreciation & Amortization 22 41 40 49 51 58 61

EBIT 2,671 2,321 1,618 1,652 1,688 3,983 2,858

Interest Income 4 - - - - - -

Interest Expenses 272 146 214 249 243 250 208

Other income 13 (2) 79 95 114 137 162

Income Before Zakat 2,417 2,173 1,483 1,498 1,559 3,870 2,812

Zakat 60 50 27 34 36 89 65

Net Profit /(Loss) 2,356 2,123 1,456 1,464 1,523 3,781 2,747

P&L Appropriation Dar Alarkan

Opening Retained Earnings 11,000 11,736 13,859 14,235 15,698 17,222 19,923

Dividends (1,620) - (1,080) - - (1,080) (2,160)

Net profit /(loss) 2,356 2,123 1,456 1,464 1,523 3,781 2,747

Closing Retained Earnings 11,736 13,859 14,235 15,698 17,222 19,923 20,510

Source: Company Reports, Global Research


March - 2011 24

Balance Sheet Dar Alarkan

SAR mn 2008 2009 2010 2011e 2012e 2013e 2014e

Cash & bank balances 716 2,223 1,189 1,504 964 1,144 1,276

Account receivables 2,742 1,081 2,225 1,622 1,599 3,158 2,317

Development properties & land 1,269 964 456 919 983 1,002 1,027

Total Current Assets 4,728 4,269 3,869 4,044 3,546 5,304 4,620

Net fixed assets 711 1,621 2,005 2,088 2,358 2,479 2,493

Development properties 13,478 16,446 16,310 16,846 17,672 18,547 18,568

Investment in Associates 1,120 1,162 1,162 1,279 1,406 1,547 1,702

Other Long Term Assets 127 3 2 2 2 3 3

Total Non Current Assets 15,436 19,232 19,480 20,215 21,438 22,576 22,765

Total Assets 20,164 23,501 23,349 24,259 24,984 27,880 27,386

Short term debt 1,635 2,688 1,000 4,183 863 1,035 1,449

Account payables and accruals 785 1,106 1,158 1,171 1,193 1,216 1,216

Total Current Liabilities 2,420 3,794 2,158 5,354 2,055 2,251 2,665

Long term debt 6,000 5,572 6,679 2,929 5,429 5,429 3,933

Other Long Term Liabilities 8 12 13 13 13 13 13

Total Non Current Liabilities 6,008 5,584 6,692 2,942 5,442 5,442 3,946

Total Liabilities 8,427 9,378 8,849 8,296 7,497 7,692 6,611

Share capital 7,200 10,800 10,800 10,800 10,800 10,800 10,800

Reserves 3,600 462 608 608 608 608 608

Retained earnings 936 2,597 2,827 4,291 5,814 8,515 9,102

Total Shareholders Equity 11,736 13,859 14,235 15,698 17,222 19,923 20,510

Minority Interest 0 265 265 265 265 265 265

Total Liabilities & Equity 20,164 23,501 23,349 24,259 24,984 27,880 27,386



March - 2011 25

Cash Flow Statement Dar Alarkan

SAR mn 2008 2009 2010 2011e 2012e 2013e 2014e

Profit /(loss) before zakat 2,417 2,173 1,483 1,498 1,559 3,870 2,812

Depreciation & Amortization 22 40 40 49 51 58 61

Finance Income, net 267 146 214 249 243 250 208

Zakat Paid (24) - - 34 36 89 65

Net CFO before change WC 2,682 2,359 1,737 1,796 1,854 4,179 3,081

Account receivables & prepayments (866) 1,661 (1,143) 603 23 (1,559) 841

Development properties (2,187) (2,663) 644 (999) (889) (895) (45)

Account payables and accruals (221) 271 51 14 21 23 1

Other adjustments (281) (131) (78) (333) (331) (398) (334)

CF from Operations (874) 1,497 1,211 1,081 678 1,350 3,543

Additions to fixed assets (331) (929) (384) (82) (270) (122) (14)

Other Investing Activities (1,041) (45) (177) (116) (128) (141) (155)

CF from Investing (1,372) (975) (561) (199) (398) (262) (169)

Change in debt 1,235 720 (605) (567) (820) 173 (1,082)

Non-controlling Interest - 265 - - - - -

Dividends Paid (1,620) - (1,080) - - (1,080) (2,160)

CF from Financing (385) 985 (1,685) (567) (820) (908) (3,242)

Change in cash (2,630) 1,507 (1,035) 315 (540) 180 132

Beginning cash 3,347 716 2,224 1,189 1,504 964 1,144

Ending Cash 716 2,224 1,189 1,504 964 1,144 1,276



March - 2011 26

Ratio Analysis Dar Alarkan

2008 2009 2010 2011e 2012e 2013e 2014e

Liquidity Ratios

Current Ratio (x) 2.0 1.1 1.8 0.8 1.7 2.3 1.7

Quick Ratio (x) 1.4 0.9 1.6 0.6 1.2 1.9 1.3

Inventory Stock (Days) 0.3 0.6 0.6 0.3 0.4 0.5 0.4

Receivables Outstanding (Days) 178.4 72.2 196.1 143.4 129.3 107.9 109.5

Length of Operating Cycle (Days) 178.4 72.2 196.1 143.4 129.3 107.9 109.5

Payables Outstanding (Days) 36.2 58.1 65.1 68.9 63.0 27.4 38.2

Length of Cash Cycle (Days) 142.2 14.1 131.0 74.5 66.3 80.5 71.3

Working Capital (mn) 2,308 475 1,711 -1,337 1,427 2,954 1,855

Profitability Ratios

Total Assets Turnover (x) 0.3 0.2 0.2 0.2 0.2 0.4 0.3

Total Net Fixed Assets Turnover (x) 7.9 3.4 2.1 2.0 1.9 4.3 3.1

Gross Profit Margin 50.7% 45.9% 42.6% 43.8% 41.1% 39.8% 40.3%

Operating Margin 47.6% 42.5% 39.1% 40.0% 37.4% 37.3% 37.0%

Net Profit Margin 42.0% 38.8% 35.1% 35.5% 33.8% 35.4% 35.6%

Return on Assets 11.7% 9.0% 6.2% 6.0% 6.1% 13.6% 10.1%

Return on Equity 20.1% 15.0% 10.0% 9.2% 8.7% 18.7% 13.2%

Leverage Ratios

Times Interest Earned (x) 9.8 15.9 7.5 6.6 6.9 15.9 13.7

Debt / Equity (x) 0.7 0.6 0.5 0.4 0.4 0.3 0.3

Degree of Total Leverage (x) 1.2 3.8 1.3 -1.4 0.4 1.1 1.0

Ratios Used for Valuation

EPS (SAR) 2.2 2.0 1.3 1.4 1.4 3.5 2.5

Book Value Per Share (SAR) 10.9 13.1 13.4 14.8 16.2 18.7 19.2

EV/Revenue (SAR) 1.7 2.3 3.9 3.7 3.5 1.4 1.9

EV/EBITDA (x) 3.6 5.3 9.8 9.1 9.1 3.7 5.1

Dividend Yield 19.2% 38.3% 11.5% 0.0% 0.0% 11.5% 23.0%

Market Price (SAR) 14.9 14.1 9.0 8.7 8.7 8.7 8.7

Market Capitalization (SAR mn) 10,728 15,174 9,720 10,422 10,422 10,422 10,422

P/E Ratio (x) 4.0 4.4 6.5 6.4 6.2 2.5 3.4

P/BV (x) 0.8 0.7 0.6 0.6 0.5 0.5 0.5


* Market price for 2011 and subsequent years as per closing prices on March 21, 2011

March - 2011 27

Emaar Economic City (EEC) Hold

Target Price

SAR7.20

Market Data

Bloomberg: EMAAR AB

Reuters: 4220.SE

CMP (Mar 22, 2011): SAR6.55

O/S (mn) 850

Market Cap (SARmn): 5,568

Market Cap (USDmn): 1,485

Price/EPS 2011e(x): 5.94

Price/Bv 2011e (x): 1.14

Price Performance 1-Yr

High (SAR): 10.00

Low (SAR): 5.65

Average Volume: 4,289,833

1m 3m 12m

Absolute (%) -5.8 -7.7 -34.5

Relative (%) -6.3 -19.8 -64.5

Price Performance

Deteriorating cash balance, long term funding key for project revival

Unique business model with one project spanning through to 2025

Negative earnings expected through to 2014

Initiate coverage with a HOLD recommendation and TP of SAR7.20

Business model highly reliant on land sales

As of 4Q10, EEC cash balance stood at an alarming SAR339mn with a

working capital of SAR130mn putting most operations on hold till new funds

are raised. Long term funding is the key concern for operational revival in the

absence of any significant cash flows from operations in the foreseeable

future. Negotiations for a long term SAR2.5bn loan from the government are

currently taking place. If granted, this should revive the project in the short term

and act as a catalyst for the share price.

Negative earnings since inception and expected through to 2014

Revenues peaked in 2009 at SAR261mn before dropping 65% in 2010 due to

slowdown in development progress reflecting funding constraints. With the

exception of 2007, EEC reported negative earnings since inception.

Residential sales are the only source of revenue with minor contributions from

the industrial valley. We expect negative earnings to drill through to 2014 until

significant contributions from the seaport start to kick in the top line.

A shift in strategy to land sales to generate short term cash flow

Management indicated a shift in strategy moving away from residential

developments to serviced land sales. This step should generate part of the

needed cash flow in the short term. Recurring income from the industrial valley

remains minimal while the move towards long term recurring income still

requires a period of 2-3 more years.

Initiate with a TP of SAR7.20 and a Hold recommendation

With the company currently trading at SAR6.55/share, our fair value target

provides investors with 10% upside potential. Accordingly, we issue a Hold

recommendation on EEC stock.

Investment Indicators

Year 2009 2010 2011e 2012e 2013e 2014e

Revenues (SAR mn) 261 91 517 595 689 801

Net Profit (SAR mn) (309) (584) (100) (114) (168) (17)

EPS (SAR mn) (0.4) (0.7) (0.0) (0.1) (0.2) (0.0)

BVPS (SAR mn) 9.3 8.6 8.5 8.4 8.2 8.2

P/E (x) NA NA NA NA NA NA

P/BV (x) 1.0 0.8 0.8 0.8 0.8 0.8



Global Research - Saudi Arabia Emaar Economic City

Company Profile

EEC is a Saudi joint stock company established in 2006 with a share

capital of SR8.5bn and was made public the same year through

floating 30% of its shares. The purpose for incorporating EEC is the

development of King Abdullah Economic City (KAEC) project under

the expertise of Emaar Properties PJSC and SAGIA’s patronage.

Land Acquisition

At inception, an in kind contribution of 37mn sqm was made by

Dayem Modern Company in exchange of SAR1.7bn at a value of

SAR46/sqm. EEC further acquired another 6mn sqm from the same

company for a consideration of SAR300mn at SAR48/sqm. The other

125mn sqm was purchased from quasi government agencies at a

value of SAR14/sqm bringing the overall weighted average price of

the 168mn sqm project land to SAR22/sqm.

Business Model

EEC’s business model is focused on the full development of King Abdulla Economic City; a mixed use

development spread over 168mn sqm of land located in Rabigh, close to Jeddah. The project comprises

several developments that collectively create a new urban community to attract new business ventures and

drive population density away from the older overpopulated city of Jeddah.

Due to the nature of the project, large sunk costs were required to develop basic amenities of the

unserviced land. The initial plan was to complete the project in four phases with the first phase planned for

completion in 2011. This plan has highly missed its target due to delivery delays and lack of investor

interest on the back of the financial crises and execution delays. Phase one encompasses the development

of 10% of the total land area including the infrastructural works along with residential and industrial

developments.

To facilitate the flow of investments to the project, SAGIA has established direct presence in the city aiming

at minimizing red tape. Further, to encourage foreign investments, KAEC was the first development in

Saudi to be granted the right of non-national freehold ownership.

March - 2011 28


Residential Developments

The initial plan was to develop the residential, resorts and CBD areas to generate cash flow at the project’s

early life via property sales. The company incurred SAR712mn of development capital expenditures in seven

projects, mostly catered to the upper-middle to high end segments while construction in the first middle in-

come project will start in 2011. These projects offer a collective 1,048 units of which only 611 were sold at the

end of 2010. Several other projects were scheduled to commence construction but were put on hold due to

funding problems and weak demand. We anticipate additional capital requirement of SAR333mn through to

2013 to complete the existing projects. Further, EEC is offering 103 serviced land plots of 2,500 sqm each for

sale in the high end Esmeralda development.

Industrial Valley

The industrial valley comprises 30% of KAEC land bank and was initially designated to be developed and

leased on long term contracts to generate recurring income. Due to the hefty capital requirements and the

slow movement of tenants, cash generation form this segment has been significantly subdued with a reve-

nue contribution of SAR2mn in 2010. Current leased industrial land stands at 319,000 sqm expected to reach

1mn sqm by 2012 representing 75% of phase one originally planed land.

Management has indicated that EEC is currently considering the sale of 2mn sqm of land in the valley to gen-

erate cash flow. Further, management has also pointed that EEC awaits the approval of a long term loan in

the realm of SAR300mn from the Saudi Industrial Development Fund (SIDF).

Although the longer term capital requirements appear to us much higher than this figure, we believe that this

loan, if granted, will help accelerate progress in the pending infrastructural works needed to facilitate tenant

movement.

Seaport

KAEC seaport is the first to be fully financed by the private sector in Saudi and is ultimately planned to cover

13mn sqm of land and handle 20mn TEU’s. Port Development Company (PDC); a 49:51 JV was formed

between EEC and Saudi Bin Laden Group for the development, finance and operation of the seaport. Based

on management guidance, phase one should start operations in 2012 with a handling capacity of 600,000

TEU and increase to 1.9mn TEU by 2014.

PDC revenue generation will come in the form of a 33% operating fees along with royalty fees from other ter-

minal operators in addition to the regular utility fees. Given the current funding crunch that EEC is going

through, we are under the impression that negotiations could take place and eventually change the structure

of the JV or the scheduled operations start date.

March - 2011 29

Source; EEC, Global Research

EEC Property Developments

Project Name Total

Units Delivery

Sales Capex (SAR mn)

to 2009 2010 2011e 2009 2010 Remaining

Ongoing Projects

Marina 1 192 2011 185 3 0 158 9 1

Marina 2 192 2011 78 8 0 74 14 68

Marina 4 116 2011 69 0 0 91 16 43

Beach 1 116 2011 107 0 9 153 2 1

Beach 2 116 2011 54 5 1 133 10 11

Town Homes 181 2014 101 0 0 60 17 70

SOD Villas 5 2010 0 1 4 43 0 0

Mid Income 130 2012 0 0 130 0 0 220

Total Ongoing 1,048 594 17 144 712 69 414

Land Plots Designated For Sale

Esmeralda Plots 103 2010 0 13 57 200 44 0

Total Land Plots 103 0 13 57 200 44 0


Financing

Since raising the initial SAR2.6bn of IPO proceeds and the founders seed contribution of SAR4.3bn in

2006, no new financing of any kind was tapped. As of the end of 2010, this aggregate amount was fully

channeled into infrastructure works and property developments that have not generated any significant

cash flow to support operations. At the end of 2010, EEC balance sheet reported an alarming cash balance

of SAR339mn and a working capital of SAR130mn on current assets of SAR1.6bn inclusive of SAR1.1bn of

development properties.

On top of bank’s reluctance to lend to the sector, we believe that the nature of the project has exacerbated

the situation due to its large requirements of sunk capital expenditures at the early stage of its prolonged

life and the lack of visibility on demand prospects. In our view, the long term anticipated government loan of

SAR2.5bn is EEC’s best bet as we do not see any change in bank’s appetite to lend to the company in the

short term given current prospects.

We factor in SAR3.5bn of loans to be channeled to EEC between 2011 and 2013. Based on our estimated

required expenditures, we believe this amount of funding is merely sufficient to bridge the needed funding

gap for the company and pull it out of the current status quo in order to start realizing returns on its

investments incurred over the past five years.

Financial Performance

In line with Saudi real estate companies, EEC recognizes revenue from development sales based on the

percentage of completion method. With the exception of minor contributions from leases in the industrial

valley, all revenues generated between 2007-10 were from unit sales. Revenues peaked in 2009 at

SAR261mn before dropping a significant 65% to SAR91mn in 2010 reflecting funding bottlenecks and the

associated slowdown in development progress.

EEC contained its SG&A expenses by 35% in 2010 to SAR185mn compared to SAR283mn in 2009,

excluding depreciation expense. The company created provisions of SAR54mn in 2009 against residential

property maintenance and SAR283mn as a fair value impairment against assets held for disposal.

Collectively, this has led to an operating loss of SAR305mn and SAR590mn in 2009 and 2010,

respectively.

With the exception of the 2007 net gain of SAR26mn realized on the back of SAR207mn interest income,

EEC has reported consecutive losses amounting to a collective SAR1.2bn since inception through to 2010.

March - 2011 30


Forecast Assumptions

Development sales

We rule out any additional projects in the development properties segment until we receive confirmed

assurance from management as we do not see any further demand formulating in the near future. For

2011, we set sale prices between SAR5,000/sqm up to SAR12,000/sqm based on management guidance

on actual realized sales and our perception of every project’s prospects. We further factor in a movement

of current unsold inventory of property developments over the period spanning 2011 through to 2015.

Industrial Valley

For industrial leases, we assume SAR14/sqm/a. and add 25% service charge to arrive at an aggregate

rental of SAR17.5/sqm/a. We further factor in a 2% annual growth in rents. Based on management

guidance, we build our assumptions on 750,000 sqm of available lease land in KAEC industrial valley in

2011 and grow the number to 1mn sqm in the following year before leaping further to 2mn sqm by 2015.

Seaport

We factor in revenues from the seaport in 2013. We believe that this should be the first significant year of

recurring income generation for EEC provided the project is delivered as scheduled. We estimate a reve-

nue of SAR400/TEU in line with 2010 realizable prices and maintain the same growth rate of 2% as in

industrial valley valuation.

Land Sales

Based on the company’s change in strategic direction from developing property twords the shorter cash

generation cycle of land sales, management has indicated that 103 plots of land are designated for sale in

Esmiralda development. We account for a plot size of 2,500sqm and factor in a selling price of SAR1,750/

sqm based on the premium location of these land plots and the developed golf course and available

facilities around them. To date, contracts for the sale of 13 plots have been signed in 2010 and we assume

all remaining plots will be sold by 2013.

For the 2mn sqm of unserviced land designated for sale in the industrial valley (Plan to be approved), we

assume a selling price of SAR250/sqm based on the lower ban of guidance received from management.

We believe this price is justified given the value added from nearby dwellings and facilities.

Land Bank

We lack specific guidance on the actual development magnitude, specifically in terms of the seaport and its

delivery phases. Accordingly, we exclude only the 10% of land, equivalent to 16.8mn sqm, to be used in

phase 1 as indicated by EEC’s initial plan and value the remaining land bank at cost.

Risks to Assumptions

In our view, once funding is made available to EEC, especially in the magnitude of SAR5bn as indicated by

management, the stock price could rally swiftly and we could revisit our assumptions based on the new

capital structure. Further, given the nature of land sales, we believe that any acceleration in sales would be

perceived as a positive catalyst. To the downside, a prolonged delay before funding availability and further

execution risks in the form of construction delays are our major concerns.

March - 2011 31


March - 2011 32


Valuation

Our valuation on EEC has yielded a SOTP fair value of SAR7.10/share. Cash flows are discounted by a

WACC of 12.6%. The cost of equity has been calculated utilizing the capital asset pricing model based on a

risk free rate of 5.6%, an equity risk premium of 7% and a beta of 1. For specific projects where our

judgment of the risk profile is higher, we adjust the inputs of our WACC lifting it to a cap of 14.1%.


upside potential. Accordingly, we issue a Hold recommendation on EEC stock.

March - 2011 33

EEC Valuation Value (SAR bn) /share % Methodology


Industrial Valley 213 0.25 4% DCF / Cap. Rate

Seaport 464 0.55 8% DCF

Land Sales 951 1.12 17% DCF



Add Cash 2010 339 0.40

Add: Other Investments at Cost 2010 225 0.27

Less Debt 2010 - -

NAV 6,121 7.20

CMP (as on March 21, 2011) 6.55




March - 2011 34

Income Statment Emaar Economic City

SAR mn 2008 2009 2010 2011e 2012e 2013e 2014e

Revenue 102 261 91 517 595 695 810

Cost of revenues (222) (191) (155) (368) (463) (436) (444)

Gross Profit /(loss) (120) 69 (64) 149 132 259 366

SG&A (254) (283) (185) (155) (149) (278) (223)

EBITDA (375) (214) (249) (6) (17) (19) 143

Depreciation & Amortization (24) (37) (58) (59) (57) (65) (72)

Provisions & Impairments - (54) (283) - - - -

EBIT (399) (305) (590) (64) (74) (84) 71

Interest Income 141 12 2 3 16 7 2

Interest Expenses - - - (25) (50) (88) (88)

Other income - 1 10 6 8 7 9

Income Before Zakat (259) (292) (578) (81) (100) (158) (5)

Zakat (34) (17) (6) (19) (14) (10) (10)

Net Profit /(Loss) (292) (309) (584) (100) (114) (168) (16)

P&L Appropriation Emaar Economic City

Opening Retained Earnings (17) (309) (618) (1,202) (1,302) (1,416) (1,583)

Dividends - - - - - - -

Net profit /(loss) (292) (309) (584) (100) (114) (168) (16)

Closing Retained Earnings (309) (618) (1,202) (1,302) (1,416) (1,583) (1,599)



March - 2011 35

Balance Sheet Emaar Economic City

SAR mn 2008 2009 2010 2011e 2012e 2013e 2014e

Cash & bank balances 2,219 864 339 234 543 1,579 454

Account receivables 228 400 115 227 268 327 359

Development properties 57 509 1,103 1,042 1,058 1,330 1,327

Other Current Assets - - 14 14 14 14 14

Total Current Assets 2,503 1,773 1,572 1,517 1,883 3,249 2,155

Net Fixed Assets 7,024 7,315 6,884 7,727 9,010 9,987 10,331

Other Long Term Assets 5 79 225 259 298 343 394

Total Non Current Assets 7,029 7,394 7,109 7,986 9,308 10,330 10,725

Assets classified as held for disposal - 139 204 204 204 204 204

Total Assets 9,532 9,305 8,885 9,708 11,395 13,783 13,084

Short term debt - - -

-

-

- -

Account payables and accruals 1,294 1,298 1,442 1,292 2,083 3,127 2,431

Total Current Liabilities 1,294 1,298 1,442 1,292 2,083 3,127 2,431

Long term debt - - - 1,000 2,000 3,500 3,500

Other long term liabilities 48 126 145 159 169 181 193

Total Non Current Liabilities 48 126 145 1,159 2,169 3,681 3,693

Total Liabilities 1,342 1,423 1,587 2,451 4,253 6,808 6,124

Share capital 8,500 8,500 8,500 8,500 8,500 8,500 8,500

Retained earnings (loss) (309) (618) (1,202) (1,244) (1,358) (1,525) (1,541)

Total Shareholders Equity 8,191 7,882 7,298 7,256 7,142 6,975 6,959

Total Liabilities & Equity 9,532 9,305 8,885 9,708 11,395 13,783 13,084



March - 2011 36

Cash Flow Statement Emaar Economic City

SAR mn 2008 2009 2010 2011e 2012e 2013e 2014e

Profit /(loss) before zakat (259) (292) (578) (81) (100) (158) (5)

Depreciation 24 37 58 (59) (57) (65) (72)

Provisions & Impairments - 54 283 - - - -

Other Adjustments (138) (9) (14) 198 80 102 36

Net CFO before change in assets & Liabilities

(372) (209) (251) 59 (78) (120) (41)

Account receivables & prepayments (210) (173) (329) (112) (40) (59) (33)

Development properties 407 (234) 91 62 (17) (271) 2

Account payables and accruals 1,008 22 152 (150) 791 1,044 (696)

Zakat (11) (33) (13) (19) (14) (10) (10)

CF from Operations 822 (626) (350) (161) 565 464 (819)

Additions to fixed assets (2,823) (684) (170) (843) (1,282) (978) (344)

Other Investing Activities 3,536 (59) (28) (20) 26 49 39

CF from Investing 713 (743) (198) (863) (1,256) (928) (305)

Debt Raised 1,330 - - 1,000 1,000 1,500 -

Debt Repayment (1,330) - - - - - -

Issue of share capital - - - - - - -

CF from Financing - - - 1,000 1,000 1,500 -

Change in cash 1,536 (1,369) (548) (24) 309 1,036 (1,125)

Beginning cash 640 2,176 806 258 234 543 1,579

Ending Cash 2,176 806 258 234 543 1,579 454



March - 2011 37

Ratio Analysis Emaar Economic City

2008 2009 2010 2011e 2012e 2013e 2014e

Liquidity Ratios

Current Ratio (x) 1.9 1.4 1.1 1.2 1.0 0.7 0.9

Quick Ratio (x) 1.9 1.0 0.3 0.4 0.5 0.3 0.4

Inventory Stock (Days) 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Receivables Outstanding (Days) 818.5 560.9 461.9 160.6 164.3 171.6 161.8

Length of Operating Cycle (Days) 818.5 560.9 461.9 160.6 164.3 171.6 161.8

Payables Outstanding (Days) 2,128.7 2,479.0 3,403.9 1,283.0 1,641.1 2,618.2 1,997.1

Length of Cash Cycle (Days) (1,310.2) (1,918.1) (2,942.0) (1,122.4) (1,476.9) (2,446.7) (1,835.3)

Working Capital (mn) 1,209 476 130 234 99 (994) (186)

Profitability Ratios

Total Assets Turnover (x) 0.0 0.0 0.0 0.1 0.1 0.1 0.1

Total Net Fixed Assets Turnover (x) 0.0 0.0 0.0 0.1 0.1 0.1 0.1

Gross Profit Margin -118% 27% -70% 29% 22% 37% 45%

Operating Margin -393% -117% -649% -1% -12% -12% 9%

Net Profit Margin -288% -119% -642% -8% -19% -24% -2%

Return on Assets -3% -3% -7% 0% -1% -1% 0%

Return on Equity -4% -4% -8% -1% -2% -2% 0%

Leverage Ratios

Times Interest Earned (x) 0.0 0.0 0.0 (0.2) (1.5) (1.0) 0.8

Debt / Equity (x) 0.0 0.0 0.0 0.1 0.3 0.5 0.5

Degree of Total Leverage (x) 0.0 0.0 (1.4) (0.2) 11.6 2.8 (5.5)

Ratios Used for Valuation

EPS (SAR) (0.3) (0.4) (0.7) (0.0) (0.1) (0.2) (0.0)

Book Value Per Share (SAR) 9.6 9.3 8.6 8.5 8.4 8.2 8.2

EV/Revenue (SAR) 33.0 18.1 57.5 12.2 11.3 12.4 10.5

EV/EBITDA (x) NA NA NA 120.0 NA NA 59.5

Dividend Yield 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Market Price (SAR) 8.95 9.60 7.10 6.55 6.55 6.55 6.55

Market Capitalization (SAR mn) 7,608 8,160 6,035 5,568 5,568 5,568 5,568

P/E Ratio (x) NA NA NA NA NA NA NA

P/BV (x) 0.9 1.0 0.8 0.8 0.8 0.8 0.8


* Market price for 2011 and subsequent years as per closing prices on March 21, 2011

March - 2011

versus a 4-year average discount of 48% real estatemec.biz/term/uploads/4300-22-03-2011.pdfmar 22,...

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