Aracemco Dec 2010 - Jazira Capital

8/7/2019 Aracemco Dec 2010 - Jazira Capital

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J AZIRA SECURITIES BROKERAGE Tuesday, December 21, 2010 ARACEMCO Equity Research

Another simple winning formulaHere is another mid cap company we like; Aracemco. Aracemco has the for-mula that we favor in our mid cap picks, which includes: a significant capacityexpansion just completed (most of the capex is behind us), manage to operateclose or at full capacity (will be able to push the expanded capacity swiftly tothe market), good position in its market, adequate profit margins with plans tocut cost further, and no debt burden draining its profitability. Furthermore,Aracemco has a relatively low price earning ratio and eventually will have ahigh dividend yield that supports our target price upside.

Aracemco captures around 4.5% and 10.0% of the Egyptian ceramic tilesand sanitary ware markets, respectively. Furthermore, it exports around22% of its sales, mostly to Gulf states, and around 10% of its exports goes toEastern European countries.

Aracemco is among the top 4 sanitary ware market players in Egypt . How-ever, it sells its sanitary ware units at around 40% discount from the mar-ket leader Lecico, which provides Aracemco with a better competitive edge inthe low and middle income broad market segments.

In 2009, nearly 71% of Aracemcos revenues were generated from ceramictiles sales and 30% were from sanitary ware sales. In 2010, the ceramic tilescontribution to revenues will increase to the upper 70s% due to completion of its expansion while by 2012, it will scale back to its historical levels, followingthe sanitary ware new line completion in March 2011.

Aracemco doubled its ceramic capacity in mid 2009 from 10.5 mn m 2 perannum to 21 mn m 2 per annum (or 60k m 2/day) with an investment cost worthEGP75 mn. The new plant provided major cost cutting advantages, as it re-quired less than half the older plants workforce, or 250 worker instead of 600worker. The new plant is also 30% more energy efficient.

Aracemco as a whole has 2.9k employee and the company utilize in-house cali-

bers to operate the new lines it establish.Furthermore, Aracemco will finalize in March 2011, the construction of anew sanitary ware line, worth EGP25 mn , which will produce 1.75 mn pieceper annum. Currently, the company has 4 operating sanitary lines, each with anannual capacity of 350k piece or 1.4 mn piece in total. However, the new lineuses the same energy requirements as one of the old lines.

Ultimately, Aracemco will use the new sanitary ware production line as its firstproduction option, as using it alone while producing the same capacity as nowwill reduce energy cost by 75%, or bringing the total sanitary ware operatingcost down by 11%. Furthermore, if the company would find a growing de-mand and use the older lines to up production to 2.45 mn piece.

Sanitary production can be further increased to 3.15 mn piece per annum, if thecompany spends between EGP3-4 mn on a sanitary ware accessories productionfacility bottle neck. However, the company will not spend this amount unless itsees demand hiking from its current levels of 1.4 mn piece to cross the 2.45mncapacity threshold.

A glazing production facility (the material used in creating the glazy resistantsurface on ceramic tiles) is expected to be completed in Q1 2011 , at a cost of EGP10 mn, Aracemco currently imports the glaze materials and its in-house production is expected to reduce ceramic production cost by around3-4%.

There are also plans to purchase and install a colors production facilityover the next 12 months to serve both the ceramic and sanitary ware lines

at an estimated cost between EGP10-15 mn.Both the coloring and glazing in-house production will reduce import exposureby EGP24 mn a year, or 14% of the production cost and both their respectivein-house production is expected to save between 5-6% of the total cost.

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FY ending Dec. 2009 a 2010 e 2011 f 2012 f

Revenues (EGP mn) 273 345 388 443

EBITDA Margin 34.5% 37.0% 38.1% 42.1%

EPS (EGP) 2.69 3.60 3.94 5.10

DPS (EGP) 2.00 2.00 3.00 4.27

PER 10.4x 7.8x 7.1x 5.5x

DY 7.1% 7.1% 10.7% 15.2%

EV/EBITDA 6.8x 4.8x 3.8x 2.7x

Net Cash (EGP mn) 12 35 67 82

Analyst: Mohamed Fahmy

Email : [email protected]

Mobile: +2012 2157312

BUY Market Price (EGP/share) 28

Target (EGP/share) 41

Upside 47%

Reuters Codes CERA

Full Name: Arab Ceramics Company -Aracemco

Short Name Aracemco

Exchange Listing EGX

Index Inclusion n/a

Number of Shares (mn) 25.00

Market Cap (EGP mn) 700

EV 2010 (EGP mn) 686

52 Week Low-High (EGP) 17-31

Average Daily Volume (52 weeks) 40,937

Stock Performance Absolute / Relative to index (EGX70)

Three Month 25%/8%

Six Month 47%/13%

One Year 40%/25%

Shareholders Ownership stake

Fathallah Al Saudi Sons Co. 42%

Kuwaiti Real Estate Investment Group 24%

Musaad Al Saleh Group, Kuwait 7%

Nasser Social Bank 3%

Free Float & Others 24%

Aracemco Share Pr ice (EGP)

15

17

19

21

23

2527

29

31

33

D-09 J-10 F-10 M-10 A-10 M-10 J-10 J-10 A-10 S-10 O-10 N-10 D-10


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J AZIRA SECURITIES BROKERAGE December 21, 2010 ARACEMCO Equity Research

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Aracemco Main Highlights, continued

Aracemco management intends to propose to its board to adopt the dry milling technology for itsceramic production instead of its current wet method. The dry milling technology provides animproved final product quality, up to 80% lower energy cost, more economical in its raw materi-als use, no water consumption, eliminate pollution and increases kilns production.

The company received an offer from a specialized company in the field to install this line inaround one year with an estimated cost of EGP15 million and the offer promises that the newtechnology will reduce ceramic tiles production cost by EGP1/m 2 or around 11% of the totalcost.

Management hopes to get board approval soon, and have the dry milling line operating by Q12012.

The strengthening of the US Dollar against the Euro has been in favor of Aracemco since it im-ports around 15% of its sanitary ware production inputs (3% of the total cost) from countrieslike UK and Portugal using the Euro, while uses the US Dollar in pricing its exports.

The company is bank debt free and management have been able to finance 50% of its recentexpansions utilizing vendors finance with a tenor of around 1-2 years.

In a bid to control cost further, Aracemco has invested in a carton packaging green field, with aninvestment worth of EGP24 mn or 48% stake in Egyptian Company for Paper Industries - EGYPaper, enabling Aracemco to account for it using the equity method. EGY Paper started opera-tion earlier this year and have managed to contribute around EGP823k of investment income toAracemcos 9M 2010 income statement. However, Aracemco has still not benefited from thepossible synergies, through utilizing EGY Paper cartons in packaging its products.

Financial Assessment & Forecasts

During 9M 2010, we estimate that Aracemco managed to sell around 50k m 2 of ceramic tiles aday benefiting from the new founded capacity up from 37k m 2 average in 2009, since the newceramic line was established in mid year 2009. While in 2008, prior to the new line establish-

ment, it had sold less than 30k m2

a day.This surge in ceramic tile sale has re-sulted in a 20% surge in ceramic reve-nues and 16% in cumulative 2009revenues. Furthermore, 9M FY10salesrecorded a whopping 44% surge againsupported by the larger ceramic salesvolumes.

We project revenues to grow by a 30%yoy in FY10, compared to the 44%revenue growth reported in 9M FY10,as word has it, that the market activity

was slow in the forth quarter.Going forward, we expect revenues togrow 11% in 2011, driven by a 25% increase in sanitary ware revenues, following the comple-tion of the sanitary ware new line which will become fully operational by early 2011.

COGS/Revenue improved by over 600 basis points in 9M FY10 to reach 57% compared to 63%in 9M FY09. This improvement was driven with the new ceramic tile plant coming online inaddition to the stronger US Dollar against both the Egyptian pound and Euro.

The companys S,G&A remained relatively stable, as it recorded 2.8% of revenues in 9M FY10vs. 2.7% in the comparable period last year. However, as a figure it grew 51% to EGP7.6 mn.

Aracemco has no bank debt, while have a remaining vendors facilities balance of EGP29.5 mil-lion, as the company opted to finance its recent expansions with vendors financing leveraging

half of the expansions value and a two year tenor.

Changing ceramic millingtechnology will bring ce-ramics production cost furtherdownward by 11%

Dry milling plant will costEGP15mn and is pendingboard approval

Has a 48% interest in a paperpackaging greenfield

During 2010, Aracemco man-aged to sell around 50k m 2 of

ceramic tiles per day after newline becoming operationalversus less than 30k m 2 beforethe upgrade

Q4 sales came slower after a

good 9M in 2010

The cost efficient new ceramictiles plant and better econo-mies of scale pulled marginsup

Interim Income Statement (EGP mn) 9M FY09 9M FY10 % Change Revenues from Operation 185.1 266.6 44% COGS (116.2) (153.1) 32% COGS/Revenues 63% 57% -9% S, G & Adm. Expenses (5.0) (7.6) 51% EBITDA 63.8 105.9 66% EBITDA margin 34% 40% 15% Depreciation (7.9) (11.8) 49% Reported EBITA 55.9 94.2 69% Net Interest Income 0.5 2.3 325% Investment Income 0.0 0.8 Other Non-Operating Income, Net 1.2 1.0 -22%

NPBT 57.7 98.3 70% Source: Aracemco financials


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Financial Assessment & Forecasts, continued

Cash balance increased significantly over the past couple of years up from EGP33 mn in FY08to EGP70 mn at the end of FY09 and again up to EGP91 mn by September 2010. This increasein cash has resulted in outstanding surge in net interest income, which increased to EGP2.4 mnin 9M FY10 vs EGP0.5 mn in 9M FY09.

Aracemco has a credit policy of less than one month, which is extended to 3 months in the caseof exports to Eastern European countries. With this healthy credit policy, growing sales andmost of the expansions being completed, by early 2012, we expect Aracemco cash balance willexpand further resulting in higher interest income and/or higher cash dividends.

In 2009, the companys effective tax rate stood at around 11%. However, some exemptions re-lated to new lines installed back in 2005 have expired at the end 2009 and the remaining exemp-tions will expire in 2010, making us expecting the effective tax rate will increase to 20% starting2011.

Net income grew 42% in FY09 to EGP76 mn vs. EGP54 mn in FY08, driven by higher ceramicsales and its related improved margins. Again in 9M FY10, net profit before taxes grew by 69%to EGP94.2 mn compared to EGP55.9 million in 9M FY09. However, we project that full year

FY10 net income will grow only by 34%, since we estimate the companys effective tax rate torise from 11% in FY09 to 14% in FY10, in addition to our estimation of a slower forth quartersales.

On average, Aracemco had a payout ratio of 63% over the past 4 years and distributed around74% of its net attributable income in FY09.

The company also distributed around 9.2% on employees and 2.0% on board in FY09.

We expect Aracemco may distribute EGP2/share in 2010, similar to its distributed figure in2009, given the company may require a capital expenditure of around EGP30-35 mn in each of 2010 and 2011, this is combined with management's preference to keep adequate cash balancesclose by. The new sanitary ware line and the glazing facility will be completed by March 2011.Furthermore, at the same time the company will be initiating the establishment of the new drymilling ceramic plant and the coloring facility, all of which will require capital expenditure out-flows.

Similar to when Aracemco first was thinking of the ceramic tile expansion it distributed a 1:2stock dividend in 2008, we think it may compensate the shareholders with a stock dividend witha ratio between, 1:3 and 1:2 in exchange for a lower payout ratio given the current expansions.

We have not plugged in the stock dividend in our model since it provides no significant input inour DCF value calculation and because it is just a guess.

In 2011, net income will grow by 9.2% compared to 2010 bottom line, although revenues andEBITDA will grow by 12.5% and 15.9%, respectively, due to the company being taxed in FY11with an effective tax rate of 20% versus our estimation of 14% effective tax rate in FY10.

We project that Aracemco would distribute in 2011 the same payout ratio as its 2009 dividendpayout ratio, which was 74%.

Our expectations of a better economic conditions by 2012, would enable Aracemco to be able tosell its ceramic tiles close to full capacity along with being able to operate on a better utilizationrate with respect to the sanitary ware line. These factors combined with our conservative 2%increase in the companys products prices, are expected to bring revenues higher by 14.3% toEGP443 million versus EGP388 million we expect in 2011.

More importantly, by 2012, the dry milling ceramic plant will come into operation which willresult in a sharp drop in cost, bringing EBITDA margin to 42.1% in FY12 compared to 38.1%which we estimate to be achieved in 2011. This strong operational performance will result in asurge in 2012 earnings by 29% to EGP127 million up from EGP98 million in 2011.

We assumed starting 2013 that cost factors will increase at rates higher than the increases weproject in per unit sales, thereby EBITDA margins will start to shrink starting 2013.

A tight credit policy resultedin a high cash balance

Effective tax rate to move to20% in 2011 up from 11% in2009

We project FY10 bottom lineto grow by 34% yoy.

Major capital expenditure out-lays may result in conservativeAracemco management toreduce payout ratio in 2010

A stock dividend may come asa sweetener for shareholderslike in 2008

All tax exemptions will expireby 2010 end

We expect improved economicconditions to make Aracemcooperating close to its new ca-pacities ceiling by 2012

The dry milling technologywill cause a surge in operatingmargins in 2012


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Valuation

Aracemcos stock have showed strong correlation with the EGX70 index, as its beta came at0.86x against the index. Aracemco is not a constituent of the EGX70, as it was pulled out of it inthe latest rebalancing in August 2010, but we expect that with its growing trading volume andmarket capitalization improvement it will be included again in the coming revision. Using this

beta on our risk free rate of 8.75% and a market risk premium of 9.00%, it yielded a cost of eq-uity and consequently a WACC of 16.49%, since the company has no interest bearing debt.

We have valued Aracemco using discounted cash flow model, in which we discounted the oper-ating free cash flow stream using the discounted factor of 16.49% and a perpetual growth rate of 3.0%. Ultimately, we attained an enterprise value of EGP947 mn and then we added the book value of Egyptian Company for Paper Industries which amounts to EGP24 mn and an amount of EGP61 mn as excess cash. Thereby Aracemcos shareholders value came at EGP1,032 million,or EGP41.3/share.

Alternative Scenario - No Dry Milling Ceramic Tiles plant-

We have made an alternative scenario, in which we didnt assume that the company will estab-lish the dry milling ceramic plant. We opted to do this scenario just to assess the downside in-

case the plant establishment doesnt pass the board approval.The shareholders DCF value under this scenario would go down to EGP961 million orEGP38.4/share, which imply it would reduce our target price by 8%. However, even under thisscenario, Aracemco remains provide a hefty upside based on our target price compared to pre-vailing market price.

Aracemco Key Assumptions

Using a DCF model, we at-tained Aracemcos sharehold-ers value at EGP41.3/share

If Aracemco doesnt build thedry milling plant, our targetprice would drop by 8%

Annual ceramic tile capacityincrease to 14 mn m 2 in 2009since we assumed the newcapacity operated 1/2 of that

year

Although there are many fac-tors that would reduce costfurther, we assumed that thenormal growth in energyprices and raw materials willfactor part of the improvement

2008 a 2009 a 2010 e 2011 f 2012 f 2013 f 2014 f 2015 f

Ceramic tiles (mn m 2) 10.5 14.0 21.0 21.0 21.0 21.0 21.0 21.0Sanitary Ware (Pieces mn) 1.4 1.4 1.4 2.5 2.5 2.5 2.5 2.5

Productions (Annual) Ceramic tiles (mn m 2) 10.8 13.4 18.2 19.3 21.0 21.0 21.0 21.0Sanitary Ware (Pieces mn) 1.2 1.4 1.4 1.8 2.1 2.3 2.5 2.5

Utilization

Ceramic tiles 102% 96% 87% 92% 100% 100% 100% 100%Sanitary Ware 86% 98% 100% 71% 86% 93% 100% 100%

Unit Price (EGP) Ceramic tiles/m 2 15.12 13.61 14.29 14.57 14.86 15.16 15.46 15.77Sanitary Ware/Piece 52.52 56.72 57.86 59.01 60.19 61.40 62.62 63.88

Revenues (EGP mn) Ceramic tiles 159 190 260 280 312 318 325 331Sanitary Ware 74 79 81 103 126 140 153 156Total Revenues 232 270 341 384 439 458 478 488

Revenue Breakdown Ceramic tiles 68% 71% 76% 73% 71% 70% 68% 68%Sanitary Ware 32% 29% 24% 27% 29% 30% 32% 32%

COGS/Revenues 67.0% 63.6% 60.2% 59.1% 55.1% 56.3% 57.6% 58.8% Capex (EGP mn) 40 55 35 30 10 5 5 5

Annual Capacity (based on 350 days/annum operation)

Source: Aracemco historical, Jazira Capital calculations, estimates and projections


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Historical & forecasted financials Figures are in EGP mn Income Statement 2008 a 2009 a 2010 e 2011 f 2012 f 2013 f 2014 f 2015 f

Revenues 235 273 345 388 443 463 483 493Growth 27.4% 15.9% 26.3% 12.5% 14.3% 4.5% 4.4% 2.0%EBITDA 73 94 128 148 187 189 191 189Growth 52.3% 28.4% 35.4% 15.9% 26.2% 1.4% 1.2% -1.0%EBITDA Margin 31.2% 34.5% 37.0% 38.1% 42.1% 40.9% 39.6% 38.4%

Depreciation & Amortization (20) (12) (16) (18) (19) (18) (16) (15)Reported EBIT 54 82 111 130 167 171 175 175Non-Operating Items 2 2 4 4 5 5 6 6Net Interest 1 1 3 4 7 9 11 12Net Profit Before Tax 57 85 118 139 180 186 192 193Income Tax (5) (9) (17) (28) (36) (37) (38) (39)

Net Profit After Tax 51 76 102 111 144 149 153 154

Extraordinary Items 2 0 - - - - - -

Minority Interest - - - - - - - -

Net Income 54 76 102 111 144 149 153 154

Non-Appropriation Items (6) (9) (11) (12) (16) (17) (17) (17)Net Attributable Income 48 67 90 98 128 132 136 137

EPS 1.9 2.7 3.6 3.9 5.1 5.3 5.4 5.5

Growth 22.8% 41.5% 33.8% 9.2% 29.6% 3.5% 3.0% 0.6%

Balance Sheet 2008 a 2009 a 2010 e 2011 f 2012 f 2013 f 2014 f 2015 f

Cash & Marketable Securities 33 70 96 154 205 237 266 291

Trade Receivables-Net 5 8 10 12 13 14 14 15

Inventory 56 48 62 71 83 87 92 95

Other Current Assets 6 8 10 11 12 13 14 14

Total Current Assets 100 133 178 248 313 352 387 414

Net Fixed Assets 74 117 136 148 139 126 114 105

Other LT Assets 31 26 24 24 24 24 24 24

Non-Current Assets 105 143 160 172 163 150 138 129

Total Assets 205 276 337 420 476 501 525 543

Short Term Bank Debt & CPLTD - - - - - - - -

Account Payable 6 11 13 15 17 18 19 19

Dividends Payable 25 59 61 87 123 127 131 132

Other Current Liabilities 18 31 38 40 37 24 8 (10)

Total Current Liabilities 49 100 113 143 177 169 158 141

Long-Term Debt & Bonds - - - - - - - -

Other LT Liabilities 19 23 32 46 64 83 103 123

Non-Current Liabilities 19 23 32 46 64 83 103 123

Paid in Capital 75 100 100 100 100 100 100 100

Total Shareholders' Equity 137 153 193 216 237 259 281 303

Net Cash (adjusted with Div. Payable & debt) 8 12 35 67 82 110 135 159

Working Capital 52 33 65 105 137 183 229 273

Free Cash Flow 2008 a 2009 a 2010 e 2011 f 2012 f 2013 f 2014 f 2015 f NOPLAT 47 78 104 117 151 155 158 158Depreciation 20 12 16 18 19 18 16 15Gross Cash Flow 66 90 120 135 171 173 174 172Gross Investments (58) (39) (49) (40) (29) (24) (27) (26)Operating Free Cash Flow 8 51 71 95 142 148 148 146

Source: Aracemco financials & Jazira Capital estimates and forecasts


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Aracemco Dec 2010 - Jazira Capital