saudi electricity co · 2009. 10. 28. · saudi electricity co neutral a monopoly undermined by...
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U T I L I T I E S | 2 5 O c t o b e r 2 0 0 9 I N I T I AT I O N O F CO V E R A G E
Saudi Electricity Co Neutral A monopoly undermined by margin pressure Price (SR) 11.30
12-month target price (SR) 11.9
Potential upside (%) ↑ 5.1
Growing revenue, high credit rating and constant dividends are positives that are
undermined by margin pressure and negative free cash flows over 2009-12e due to high
capital expenditure. We initiate coverage on Saudi Electricity with a Neutral rating and a
12-month price target of SR11.9
Stock details
Financials
52-week range H/L (SR) 11.7/8.9 2007 2008 2009E 2010E 2011EMarket cap ($mn) 12,572 Revenues SR mn 20,839 22,289 23,726 25,289 26,934 Shares outstanding (mn) 4,167 EBITDA SR mn 7,486 7,508 8,421 9,120 10,186 Listed on exchanges Tadawul Net income SR mn 1,413 1,104 1,416 1,014 981
Price perform (%) 1M 3M 12M Total debt SR mn 9,825 10,204 31,408 51,499 67,814
Absolute 10.2 20.2 13.0 Div per share SR 0.70 0.70 0.70 0.70 0.70Rel. to market (0.2) 4.4 6.4 EBITDA margin % 35.9 33.7 35.5 36.1 37.8 Avg daily turnover (mn) SR US$ Net margin % 6.8 5.0 6.0 4.0 3.6 3M 32.2 8.6 ROE % 3.0 2.3 2.9 2.0 2.0 12M 23.7 6.3 Debt-to-capital % 17.0 17.4 38.9 50.8 57.4
Reuters code 5110.SE Source: Company, NCBC Research estimates
Bloomberg code SECO AB Website www.se.com.sa
Valuation multiples
08 09E 10EP/E (x) 42.6 33.2 46.4
P/B (x) 1.0 1.0 0.9
EV/EBITDA (%) 9.9 8.8 8.1
Div yield (%) 6.2 6.2 6.2
Source: NCBC Research estimates
Share price performance
-2468
1012141618
Jan-07 Nov-07 Aug-08 Jul-09-
2,000
4,000
6,000
8,000
10,000
12,000
14,000
SEC TASI
Source: Bloomberg
Ahmed Al Qahtani ah.alqahtani@ncbc.com Tel. +966 2 6907784
Please refer to the last page for important disclaimer
• Stability and high credit rating: SEC has enjoyed predictable and stable revenue growth
over the past decade and should continue to do so going forward. Moreover, majority
ownership by the Saudi Arabian government ensures full government support and
commitment to the company. As a result, SEC’s high credit ratings are equivalent to the
sovereign rating of the Saudi Government.
• Growing demand for power: A growing population, rising per capita consumption and
increasing industrial activity led to growth in demand for power at 7.7% per annum over
2003-08. We expect these factors to continue to drive demand going forward; we estimate
peak demand will grow at 6.4% per annum over 2008-16e.
• Stable dividend per share: The government has recently extended its dividend waiver for
a further 10 years until 2020. We expect dividends to remain at the SR0.7 level during this
time. At the current price, the stock offers a dividend yield of 6.2%. Given the sovereign
rating of the company, some investors view the stock as an alternative to Saudi sovereign
debt, but with a much higher yield.
• Extensive capital expenditure program: The aggressive capacity expansions will almost
double generation capacity over the next decade. Over 2009-13e, the company plans to
spend 118 times net income in 2008 which will pressure free cash flows. To finance that,
SEC will have to rely on external debt and we expect debt-to-capital to increase from
17.4% in 2008 to around 50% over the long-term.
• Steady EBITDA margin, but declining net income: We expect the EBITDA margin to stabilize around 35% over our forecast period, given SEC’s restructuring plans and tighter cost controls. Nevertheless, we expect net income to shrink over 2009-13e due to the expected rise in depreciation charges. However, beyond 2013e, as capital expenditure slows and income from equity investments improves, we expect income to start expanding
• Tariffs reform could trigger significant upside: Despite our Neutral rating, the valuation is highly sensitive to a change in tariffs; a raise in tariffs by only 5% could lead to an increase in the valuation by 60%. Our base case assumes no tariff reform.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 2
Contents
INVESTMENT SCENARIOS 3INVESTMENT VIEW 4
Downside risks 7
Upside risks 7
VALUATION 8
Cost of capital and terminal growth 8
Value of waived dividend 8
Discounted cash flow 9
Peer valuation 10
BUSINESS BACKGROUND 11
Corporate background 11
SEC’s operations 12
Business performance 14
INDUSTRY AND BUSINESS DYNAMICS 20
Demand-supply balance 20
Pricing 21
Privatization plans 22
FINANCIAL PERFORMANCE 23
Revenue 23
Profitability and margins 23
Capitalized interest 24
Dividends 25
Capital expenditure and financing 25
APPENDIX 26
SEC’s generation projects 26
FINANCIALS 27
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 3
Investment scenarios
Valuation can increase significantly with better tariffs
Historical and expected price performance (three scenarios)
3.42.1
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Historical price performance Price target
Scenario analysis
Investment view DCF scenarios
Price target: SR 11.90
We use DCF to arrive at our fair value of the company. We discount the FCFF over 2009-18e using our WACC, to arrive at EV, which we adjust by adding cash and equity investments and deducting debt. We then add our estimate of the value of the dividends waived by the government to arrive at our fair value estimate.
DCF bull case: SR 22.20
We assume the same electricity sales in Kwh as our base case, but we assume tariffs increase by 5% for all consumption categories. Moreover, we assume SEC will improve operational efficiencies more than what we factor in our base case.
DCF base case:SR 11.90
We expect revenue to grow steadily over our forecast period. We assume the electricity tariff structure to remain the same and the utilization rate to remain stable but low at 60%. We expect the company to improve cost management, which should positively impact margins. We use 7.0% as a discount rate.
• Continued monopoly: In 2008, SEC accounted for more than 87% of total power produced in Saudi Arabia; but 100% of power sold to end users. Despite plans to restructure the power sector and the company, SEC will continue to remain the monopoly provider of electricity to end users in the foreseeable future.
• Stability and high credit rating: Supply of electricity is an essential service and therefore its demand is insulated from business cycles. This has helped SEC register steady revenue growth. Moreover, full government support enhances the company’s credit ratings, bringing them on par with the Saudi Arabian government’s sovereign rating.
• Sustainable growth in demand: Peak power demand in KSA has grown at 7.7% per annum over 2003-08 and we forecast 6.4% annual growth over 2008-16e. Demographic factors such as a growing population, creation of households, rising per capita income, and rapidly growing industrial activity are the main drivers
• Significant capital expenditure requirement: SEC’s current capacity barely supports current demand. The company will have to enhance generation capacity to meet growing future demand. SEC has announced capital expenditure plans of SR130bn over 2009-13e to meet the additional demand.
• Steady EBITDA margins, but squeezed net margin: We project EBITDA to grow in line with revenue over our forecast period. However, we expect net income and net margin to decline over 2009-13e due to rising depreciation charges.
DCF bear case: SR 5.10
We assume revenue growth to be similar to our base case. However, we factor in lower levels of efficiency that will reflect in higher fuel, operating, and maintenance costs. Additionally, we increase our discount rate by 1% relative to the base case.
Potential catalysts Investment risks
• Tariff restructuring: Current tariffs are significantly low, which impact SEC’s profitability. An increase in electricity prices will have a significant positive impact on the company’s valuation.
• Rising consumption per capita: In our model, we have assumed per capita usage to grow marginally during the forecast period. Higher than expected growth in per capita consumption will have a positive impact on revenue and valuation.
• Change in customer mix: In our forecast, we assume residential consumption will grow more than other categories. Residential rates are the lowest amongst all categories. If growth in other categories is higher than our forecast, SEC’s revenue, earnings and valuation will be positively impacted.
• Rising cost of purchased power: The price of electricity that SEC purchases from IPP’s and IWPP’s is not linked to the price at which SEC sells to end-users. If prices of purchased energy increases more than what we expect, profits would be impacted negatively.
• Rising fuel costs: SEC purchases fuel from Saudi Aramco at a subsidized price. Although a change in electricity tariffs would accompany any change in subsidy, there is no guarantee that the increase in tariffs would be proportional to the increase in fuel cost.
• Difficulty mobilizing necessary financing: Given the company’s capital expenditure plans, SEC will have to rely heavily on debt in order to finance these expansions. If obstacles arise in securing the necessary funding, revenue growth would likely be impacted.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 4
Investment view
INITIATING COVERAGE ON SEC WITH A NEUTRAL RATING AND A PRICE TARGET OF SR11.9
SEC is the only electricity seller to end users in the country, which has allowed it to capitalize on
the ever-growing demand for power. This factor also puts pressure on the company to increase
generation capacity, which will require significant investments over next few years. Such
expansion will be financed mostly through debt that will be raised from the market and/or the
government. The unlimited and unconditional government support has resulted in credit ratings
that are equivalent to the rating assigned to the Saudi government. Part of this support takes
shape in a dividend waiver, which, we believe contributes around 40% to SEC’s intrinsic value.
This support, however, comes at a cost. The Saudi government has set electricity tariffs at low
levels that results in low RoE for SEC relative to peers, globally and regionally. Going forward,
we expect profits to be squeezed despite rising revenue, led by higher depreciation charges due
to large capital expenditures.
CONTINUED MONOPOLY DESPITE PROPOSED RESTRUCTURING PLANS
The Saudi Electricity Company (SEC) is more than 80% owned by the government (directly and
indirectly). The company produced more than 87% of total power in Saudi Arabia in 2008.
Despite the rising proportion of power supplied by other producers, SEC is and will remain the
only supplier of power to end-users in the foreseeable future.
We believe that despite plans to restructure the industry and the company, SEC will maintain its
monopoly over the electricity generation, transmission and distribution businesses. The
company purchases power from the Independent Power Producers (IPPs) and the Independent
Water and Power Producers (IWPPs) through long-term contracts at an agreed rate and sells
electricity to end users at tariffs set by the government.
Recently announced plans to split SEC into several but similar companies would have a positive
impact on the company’s efficiency. However, this will not have any impact on the sector as a
whole since the competition between these companies will be confined to SEC.
STABILITY AND HIGH CREDIT RATING
SEC operates in the stable utilities sector, which has protected the company from earnings
swings that other companies have experienced. Thus, despite the global economic crises, SEC
has maintained steady revenue growth.
The government owns a more than 80% stake in the company. Along with this, the critical
importance of the electricity sector to the development of the wider economy engenders
unconditional government support to SEC. The credit rating agencies in 2008 increased their
ratings to factor in this support, bringing SEC’s ratings on par with the sovereign rating of Saudi
Arabia. These high credit ratings strengthen SEC’s credit and financial risk profile and allow it to
mobilize funding even during adverse economic conditions.
GROWING DEMAND FOR ELECTRICITY TO PUSH TOP LINE
Peak demand for power has been growing at 7.7% per annum over 2003-08 and we forecast
6.4% growth over 2008-16e. Demographic factors such as a growing population, creation of
households, rising per capita income, and growing industrial activity are driving this growth.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 5
I NV ES T M E N T V I EW
This growth is expected to benefit the company’s top line. We forecast revenue to grow from
SR22.3bn in 2008 to SR35.1bn in 2016e (CAGR 5.8%). Most of the growth in electricity sales
will come from residential customers which have the lowest revenue per Mwh, which explains
the slower increase in revenue relative to consumption.
Exhibit 1: We expect electricity sales to grow at 5.9% per annum over 2008-16e
-
5,000
10,000
15,000
20,000
25,000
30,000
35,000
2008 Residential Commercial Government Industrial Others 2016E
SR m
n
Source: Company, NCBC Research estimates
STEADY EBITDA MARGIN, BUT DECLINING NET PROFIT MARGIN
SEC’s EBITDA margin has declined over 2003-08. However, we expect it to stabilize around
35%, driven by SEC’s restructuring program and cost control measures. These measures aim to
boost productivity and increase efficiency.
SEC receives fuel at a subsidized price from the government and we expect this to continue as
long as current tariffs are maintained. In 1999, the council of ministers issued resolution No. 169
that links any change in the existing fuel subsidy to a review of the structure of electricity tariffs.
Thus, in the unlikely scenario of the government changing the fuel subsidy, we believe this will
be coupled with a new tariffs structure that would at least partially offset the negative impact on
operating margins.
We forecast net profit margin, on the other hand, to decline significantly over 2009-13e, driven
by rising depreciation charges owing to increased capital expenditure. We estimate depreciation
expense will rise from SR6.7bn in 2008 (30% of revenue) to SR10.8bn in 2013e (36% of
revenue). Over 2014-15e, however, we expect net margin to recover, as depreciation expenses
would grow less than proportionately to revenue and EBITDA. Given the size of the depreciation
expense, this should have a sharp impact on the company’s net income.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 6
I NV ES T M E N T V I EW
Exhibit 2: Net income and net margins
-
500
1,000
1,500
2,000
2,500
3,000
2007 2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E0
2
4
6
8
10
12
Net income Net margin % (RHS)
(SR
mn)
Source: Company, NCBC Research estimates
FIXED DIVIDENDS PROVIDE STABLE AND HIGH YIELD
When SEC was established, the Saudi Arabian government waived its rights to the company’s
dividends over 2001-09 (provided the dividends do not exceed 10% of par value). In 2009, the
government extended the waiver for another 10 years. This waiver by the largest shareholder in
the company has resulted in dividend per share (DPS) that exceeds earnings per share (EPS).
At the current price, SEC offers a 6.2% 2009e dividend yield.
SIGNIFICANT CAPITAL EXPENDITURE REQUIREMENT
SEC’s current capacity will not be sufficient to meet the expected growth in peak demand over
the coming years. In fact, the current capacity barely covers current peak summer demand,
leading to occasional power outages in various parts of the Kingdom. To meet this growing
demand SEC has outlined an expansion program involving significant expenditure of more than
SR130bn over 2009-13e. Our analysis indicates that the capacity expansion expected over the
next ten years is equivalent to the capacity added over the past 45 years. To put this into
perspective, the company’s planned capex over 2009-13e will amount to 118 times the
company’s earnings in 2008.
To finance this expansion, SEC will capitalize on its low leverage and full support and commitment
of the Saudi Government. We expect debt levels to increase from SR10bn in 2008 to SR52.5bn in
2016e. The Debt-to-capital ratio will increase from 17% at end 2008 to over 50%, through our
forecast period. We expect the company to maintain this leverage over the long term.
Exhibit 3: SEC will increase debt level in order to finance capital expenditure 2008 2009E 2010E 2011E 2012E 2013E 2014ECapex SR mn (22,154) (33,092) (32,222) (28,140) (24,625) (20,805) (16,855)
Gross cash SR mn 1,232 1,898 2,023 2,155 2,283 2,419 2,557
Gross debt SR mn 10,204 31,408 51,499 67,814 73,156 70,969 75,175
Equity SR mn 48,553 49,421 49,889 50,322 50,519 50,879 51,889
Debt-to capital % 17.4 38.9 50.8 57.4 59.15 58.24 59.16
Source: Company, NCBC Research estimates
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 7
I NV ES T M E N T V I EW
Downside risks • Rising cost of purchased power: As indicated earlier, SEC will purchase electricity from
the IPP’s and IWPPs. The price at which SEC purchases electricity depends on the price
proposed in the bidding process by the private investors. On the other hand, SEC sells
electricity at rates determined by the government and there is no direct relationship
between the cost of purchased electricity per unit and revenue per unit.
If cost per unit of purchased energy increases more than that factored in our model,
margins can contract more than we anticipate. However, from our discussion with
management, we believe that the company expects the government to step in and bear
some of the cost burden if the price of purchased energy increases to unacceptable levels.
• Difficulty mobilizing necessary finance for expansion: The necessary fund to finance
capacity additions are immense and cannot be funded through internal accruals, as
discussed earlier. Thus, we believe that the company will have to increase debt-to-capital
to over 50% from 17% (as of Dec 08).
If SEC faces difficulty in mobilizing financing, new capacity additions will not be possible.
However, we believe that the government’s commitment to the sector means that if SEC is
unable to raise the finance from the public markets, the government would step in and
provide finance.
• Increase in fuel costs: Currently, SEC receives fuel at subsidized prices, like all other
companies in the Kingdom. However, if the government were to remove or reduce the
subsidy, it would have a significant impact on the cost of producing energy. Although a
review of tariffs will accompany the increase in cost of energy, the increase in tariffs may
not be proportionate to the impact of the increase in fuel costs.
Upside risks • Restructuring electricity tariffs: There have been some discussions on increasing
electricity tariffs, which could present a significant upside to our price target. In our scenario
valuation, we factored a 5% increase in average revenue per Kwh, which resulted in a
more than 60% increase in our DCF valuation. However, the decision to set tariffs at the
current level is more political than economic. Thus, we do not believe that a change in
tariffs will happen during our forecast period.
• Rising per capita consumption: In our model, we assumed per capita consumption to
grow marginally over our forecast period. However, if it were to grow more than our
forecast, revenue could grow at a higher rate than what we have factored, leading to a
higher valuation
• Change in consumption by customer category: We assumed in our model that
residential consumption would grow at a higher rate relative to other customer categories.
Since residential tariffs are the lowest, this has a negative impact on average revenue per
Kwh. If other categories grow at a higher rate than expected, this can push up revenue per
Kwh, resulting in higher earnings for the company.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 8
Valuation
Valuation methodology Among the different valuation methods, we believe DCF and Dividend Discount Model (DDM)
are the most appropriate methodologies to value SEC. However, we have mainly used DCF
because it allows us to explore the impact of a number of scenarios, which DDM does not do.
Although DCF gives us the Enterprise Value (EV), it does not value the government’s forgone
dividends. As explained earlier, the government has waived its rights to dividends. In our view,
the waiver, translated into tangible terms, offers an important value to shareholders, which we
add to our valuation.
Cost of capital and terminal growth We valued SEC’s enterprise value (EV) by discounting Free Cash Flows to the Firm (FCFF)
using a Weighted Average Cost of Capital (WACC). Special attention is needed in estimating
SEC’s Beta because of the expected change in the company’s capital structure. We calculated
historical (observed) beta using two years weekly data and then adjusted it for leverage, to
reflect our expectation of debt-to-capital ratio increasing to 50%. The table below summarizes
our estimate of cost of capital.
Exhibit 4: Weighted Average Cost of Capital Risk free rate (%) 3.7
Historical beta 0.70
Long term beta 1.10
Market risk premium (%) 8.8
Cost of equity (%) 9.8
Cost of debt, net of Zakat (%) 4.6
Target debt-to-capital (%) 50.0
WACC (%) 7.0
Source: NCBC Research estimates
Beyond our forecast horizon, we assume 2.0% terminal growth rate, which is in line with the
long-term inflation rate and the theoretical growth (ROE* retention ratio) of SEC.
Value of waived dividends SEC’s dividend historically has been SR0.7/share and we expect this to continue. However, we
do not believe the dividend would be at the same level if the government were to discontinue its
waiver. If the SR0.7/share were to continue even without the dividend waiver, total dividend
payouts would increase from SR547mn per year to nearly SR3bn per year, which we believe
would be unsustainable from a balance sheet perspective. Given this, we would assume that
the total payout level would remain at similar levels, meaning a much lower DPS if the
government were to give up the waiver. This calculation results in a DPS of SR0.13/share
assuming no government waiver. Thus, current shareholders are benefiting from an increased
dividend of about SR0.57/share due to the government waiver. Discounting the difference
between the scenarios using the cost of equity over 2009-20e results in a PV of SR4.30/share.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 9
V A LU A TI O N
Exhibit 5: Value of waived dividends to the public Unit Annually over 2009-20Total dividends paid (SR mn) SR mn 547
Implied DPS (assuming no gov. waiver) SR/share 0.13
Actual DPS to the public SR/share 0.70
Excess DPS due to government waiver SR/share 0.57
PV of excess dividends over 2009-20 SR/share 4.30
Source: NCBC Research estimates
Discounted Cash Flows The company’s earnings are expected to increase over 2009-18e, which should have a positive
impact on FCFF. However, the massive capital expenditure requirements (around SR130bn
over 2009-13e only) will result in negative FCFF over 2009-12e before a turnaround in 2013e
owing to lower capex and growing earnings.
The table below shows our DCF valuation summary in which we include detailed forecasts for
2009-18e and assume a 2.0% growth thereafter. We adjust enterprise value for cash, equity
investments (book value), and debt, to arrive at the fair value of equity. We then add the value
of the dividend waived by the government, to reach the fair value of equity to the public.
Exhibit 6: Discounted cash flows valuation 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018ENOPLAT 1,416 1,014 981 744 907 1,557 1,644 2,346 2,991 3,795
Depreciation 7,329 8,589 9,711 10,539 10,791 11,150 11,283 11,356 11,273 11,209
Capex (Less: capitalized interest) (31,901) (30,836) (26,313) (22,509) (18,390) (14,100) (13,000) (10,000) (10,000) (10,000)
Change in working capital 3,157 2,647 1,210 8,005 11,418 1,862 7,200 754 2,664 1,722
Operating non-current assets 1,559 1,061 1,133 1,471 1,585 (187) (64) (494) (914) (666)
FCFF (18,440) (17,524) (13,278) (1,750) 6,311 283 7,063 3,962 6,015 6,061
PV of FCFF (18,196) (16,719) (11,842) (1,459) 4,918 206 4,810 2,522 3,580 3,372
Terminal value 124,272
Discounted terminal value 69,189
Enterprise value 58,570
Cash 1,898
Equity investments 2,520
Debt (31,408)
Total equity value 31,580
Number of shares 4,167
Equity value per share 7.58
Value of dividends waiver 4.30
Public equity value 11.9
Source: NCBC Research estimates
We run a sensitivity analysis of the DCF valuation to our WACC and terminal growth rate
assumptions, as summarized in the table below. We note that there is a wide variance on the
valuation to both changes in WACC and terminal growth. This is due to our calculations that
more than 100% of the EV of the firm is due to the terminal value. Given the extremely large
capex program which the company will be undertaking over the next 5 years, from a cash flow
perspective, there will be negative value generation until 2013e with value generation only
picking up in the outer years.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 10
V A LU A TI O N
Exhibit 7: Sensitivity table WACC (%) 5.2 6.2 7.2 8.2 9.2
1% 18.0 12.1 8.1 5.2 3.1
2% 25.4 16.2 10.7 7.0 4.4
3% 39.4 23.1 14.6 9.5 6.0 Terminal Growth
4% 76.8 36.1 20.9 13.1 8.3
Source: NCBC Research estimates
Dividend Discount Model Valuing SEC using DDM will result in a lower valuation for the company. We assumed dividend
per share at SR0.7 over 2009-20e and 2% growth thereafter. Discounting these at the cost of
equity results in SR8.9 per share.
However, we believe that DCF is more appropriate in valuing SEC as it allows us to factor in the
potential improvement in the company’s performance and enables us to explore different
scenarios that would impact the company’s valuation (e.g. tariffs reform). We do not use DDM in
our valuation of SEC.
Peer valuation As a cross check on our fundamental valuation, we have performed a comparative valuation
looking at relevant peers in the region. As is the often the case in this type of analysis, finding
direct peers is often difficult given the different business units and business maturities of the
various companies.
For SEC specifically, we note that its PE ratio is very high currently (29.7x 2009E earnings) due
to the high investment phase that it is going through which has increased the depreciation
expense relative to its revenues and profits. This compares to the average for the comparative
peers at 11.9 PE-TTM. We also note that this does not take into account the additional value
accrued to shareholders from the very favorable government dividend waiver which accounts for
about 40% of the valuation, according to our calculations.
We believe EV/EBITDA is a somewhat more relevant ratio to compare these companies as it
will compare the operating figures before depreciation. On this basis, SEC trades at
EV/EBITDA-TTM of 8.2 which compares favorably to 12.4 for the peer group average. At our
price target of SR11.9/share, the 09E EV/EBITDA ratio would still be reasonable 9.1 which
makes us comfortable with our valuation and recommendation.
Exhibit 8: Peers comparison Reuters Ticker PE-09 PE-TTM EV/EBITDA-TTMAES Barka AESB 5.6 5.3 5.6
Al Kamil Power KPCS NA 8.9 7.2
Dhofar Power DHPS NA 15.4 18.9
Jordan Electric Power JOEP NA 20.4 18.7
Qatar Electricity QEWS 11.8 12.2 15.8
Taqa(Abu Dhabi National Energy) TAQA 12.7 9.2 8.3
Average 10.0 11.9 12.4
Saudi Electricity 5110.SE 33.2 36.7 8.2
Source: NCBC Research estimates
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 11
Business background
Corporate background Saudi Electricity Company (SEC) was formed in 1999 as an integrated electricity company
engaged in power generation, transmission and distribution. Prior to SEC’s formation, the
industry was run by four state-owned companies — the ‘SCECOs’ that operated in the Eastern,
Western, Central and Southern regions and General Electricity Corporation which oversaw the
Northern region.
The government has 81.2% ownership of SEC — it directly owns a 74.3% stake and indirectly
owns 6.9% stake through Saudi Aramco (the state oil company).
Exhibit 9: Ownership structure %
Government, 74.3%
Public, 18.8%
Aramco, 6.9%
Source: Tadawul, NCBC Research
As a primary supplier of electricity (87.7% of all electricity generated in Saudi Arabia) the
government imposed a strict regulatory structure on SEC to prevent it from taking advantage of
its monopoly. This is especially because residential customers dominate the company’s
customer profile (they comprised 53.4% of SEC’s electricity sales in 2008).
SEC announced plans to restructure in 2008 by unbundling the generation business into four
units with separate entities for generation, transmission and distribution. We believe this is to
induce competition and improve efficiency and service. Nevertheless, we believe this proposed
structure will not have a material impact on the structure of the industry.
SEC’s current structure has three business units (generation, transmission and distribution) in
addition to investments. Total investments reached SR2.2bn in 2008; 79% of which is the
company’s investment in GCC Interconnection Authority.
Exhibit 10: Investments breakdown (both equity method and cost method) as of Dec 2008 Investment Value (SR000) Ownership % Accounting methodGCC Interconnection Authority 1,703,285 40 Equity method
Water Electricity Company 15,551 50 Equity method
Rass Al Zoor Water & Electricity Co 1,000 20 Equity method
Rabeq Electricity Company 2,000 100 Equity method
Al-Shuaiba Water and Electricity Co 400 8 Cost method
Al-Shuqaiq Water and Electricity Co 400 8 Cost method
Al-Jubail Water and Electricity Co 250 5 Cost method
Al-Shuaba Holding Co 160 8 Cost method
Source: Company, NCBC Research
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 12
B U S I NE S S B A C K G RO U N D
SEC’s operations SEC’s operations comprise generation, transmission and distribution of electricity. By end-2008,
SEC had 70 operational power plants and transmitted electricity through a 39,792km high
voltage transmission grid and distributed electricity from the grid to end users through
345,420km of power lines.
Generation capacity Total available generation capacity in the Kingdom has been growing annually 5.5% over 2003-
08 due to capacity additions by SEC and others (mainly the Saline Water Conversion
Corporation ‘SWCC’). By end 2008, SEC accounted for more than 87% of the available
capacity.
SEC is committed to increase capacity to meet the growth in peak summer demand. IPPs and
IWPPs are expected to be a major source of growth in generation capacity. Although IPPs and
IWPPs face challenges, we expect the government to step in and make sure these projects
materialize even if means changing the privatization plans. (Please refer to industry section for
more discussion of IPPs and IWPPs)
The Water and Electricity Company (WEC) will buy water and electricity from IWPPs and will
sell electricity to SEC. Marafiq and IPPs will sell their electricity directly to SEC. As a result, SEC
will remain the principal seller of electricity to end users.
More contribution from the IPPs or IWPPs will not have an impact on SEC’s revenue stream, as
the company will remain the seller of electricity to end users. However, the impact on costs and
margins cannot be ignored, as we discuss later in the report.
Exhibit 11: SEC’s contribution to total installed capacity is expected to decline marginally
0
10
20
30
40
50
60
70
80
FY04 FY05 FY06 FY07 FY08 FY09E FY10E FY11E FY12E FY13E FY14E FY15E FY16E
Cap
acity
(GW
)
0
10
20
30
40
50
60
70
80
90
100
SEC capacity Purchased capacity SEC contribution % (RHS)
Source: Company, NCBC Research estimates
Utilization (Average Load Factor) SEC operates at low utilization rates due to seasonal variations in electricity demand in the
Kingdom. Due to varying weather conditions in Saudi Arabia, demand peaks in summer (second
and third quarter) driven by higher use of air conditioners, and it drops in winter.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 13
B U S I NE S S B A C K G RO U N D
In summer, demand sometimes exceeds installed capacity resulting in power outages. To avoid
power outages, SEC’s capacity needs to match the peak load and the company needs to
maintain a minimum safety margin (excess capacity margin over peak load) of 10% to meet
unexpected demand. This results in significant excess capacity in winter, leading to low
utilization rates. This has a negative impact on profit margins. Thus, SEC faces the conflicting
objectives of achieving higher utilization and maintaining sufficient excess capacity.
The chart below illustrates this conflict. We expect utilization rates to remain below 60% in the
future, which would depress the company’s operating efficiency. At the same time, our model
suggests that assuming all planned projects come on stream as scheduled, the safety margin
will remain at dangerously low levels until 2016e.
Exhibit 12: Despite growing energy sales, utilization will decline due to extreme seasonality
-
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
FY04
FY05
FY06
FY07
FY08
FY09
E
FY10
E
FY11
E
FY12
E
FY13
E
FY14
E
FY15
E
FY16
E
0
10
20
30
40
50
60
70
80
Available capacity (MW) Peak load (MW)
Utilization % (RHS) Safety margin % (RHS)
Source: Company, NCBC Research estimates
Peak demand in different regions in KSA (and other neighboring countries) does not coincide
due to time differences. As a result, the sum of peak demand in each region is actually higher
than the countrywide peak. This means that the effective safety margin is actually lower than
what is presented in the chart above, explaining why some regions in Saudi Arabia face power
outages.
Besides capacity expansion, investments in transmission projects can potentially help address
this issue by enabling the transmission of excess power in a region to others with shortages.
However, this can be done only if the regions are interconnected, which is not currently the
case. To date, the Eastern Province and Central Region are the only fully interconnected
regions. However, management has indicated that the Western region will eventually be fully
connected to the Central and Eastern regions.
Linking other regions and indeed, linking the electrical power networks of other countries in the
region, can improve the safety margin and can lead to higher utilization rates, potentially
reducing the overall need for generation capacity expansion. According to SEC’s management,
the GCC interconnection is already happening and the project is in its last phase.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 14
B U S I NE S S B A C K G RO U N D
Business performance SEC’s top line has grown 4.9% annually over 2003-08 due to increased electricity consumption
in Saudi Arabia. Over the same period, EBITDA increased 2% per annum as costs rose faster
than revenue while net income declined from SR1.4bn in 2003 to SR1.1bn in 2008 due to
depreciation charges. This had a negative impact on net profit margin, which declined from 8%
in 2003 to 5% in 2008.
Revenue SEC’s revenue currently comprises electricity sales, meter reading and maintenance and
service connection tariffs. Electricity sales accounted for 93% of total revenue over the past five
years and are expected to account for the same proportion over our forecast horizon. Thus,
energy sales will remain the main driver of revenue, going forward.
Exhibit 13: We expect electricity sales to grow at 5.9% per annum over 2008-16e
-
5,000
10,000
15,000
20,000
25,000
30,000
35,000
2008 Residential Commercial Government Industrial Others 2016E
SR m
n
Source: Company, NCBC Research estimates
Although SEC discloses electricity sales in Gwh per customer category, the company does not
provide a revenue breakdown per customer category. To arrive at a revenue breakdown per
customer category, we estimated the weighted average tariff per customer category by
analyzing the electricity consumption pattern for each category and the applicable tariff for each
consumption level. Our analysis indicates that residential customers have the lowest average
revenue per Mwh.
Exhibit 14: Residential customers has the lowest average revenue per Mwh
Energy sold
(Gwh)Contribution
(%)Revenue 2008e
(SR mn)Contribution
(%)Avg revenue
(SR/Mwh)Residential 96,687 52.9 8,105 39.2 84
Commercial 20,826 11.4 3,019 14.6 145
Government 21,213 11.6 4,402 21.3 208
Industrial 33,567 18.4 3,899 18.8 116
Others 10,622 5.8 1,275 6.2 120
Total 182,916 100.0 20,701 100.0 113
Source: Company, NCBC Research estimates
Since the average price per Mwh for residential customers is significantly lower than that of
other categories, the revenue contribution from the residential customers is disproportionate to
their total energy consumption.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 15
B U S I NE S S B A C K G RO U N D
SEC has no pricing power as electricity consumption tariffs are set by the Council of Ministers
based on recommendations by the Electricity and Co-generation Regulatory Authority (ECRA).
Going forward, we do not expect any change in the tariff structure, especially for residential
customers. Thus, we believe that a change in the weighted average revenue per Mwh will come
from a change in customer mix.
In the absence of tariff reforms, we believe the blended average revenue per Mwh (from energy
sales) will exhibit a marginal decline over our forecast horizon from SR113 per Mwh in 2008 to
SR109 per Mwh in 2016e (from SR122 to SR117 including other revenue sources) due to the
rising contribution of residential customers. This decline will be offset by rising energy
consumption, leading to a higher top line, as illustrated in the chart below. Energy sales
increased 4.8% per annum over 2003-08 and we forecast 5.9% growth over 2008-16e.
Exhibit 15: Growth in electricity sales is the main driver of revenue growth
-
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
2005 2006 2007 2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E
SR
mn
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
Electricity Sales Others Electricity sales in Gwh (RHS)
Source: Company, NCBC Research estimates
Cost structure and drivers Fuel, operating and maintenance (O&M), purchased energy and depreciation are the firm’s
largest cost drivers, representing around 96% of total costs. The table below summarizes our
estimates of SEC’s major cost drivers.
Exhibit 16: Summary of major cost items (SR per Mwh sold) 2008 2009 2010E 2014E 2016E
Fuel cost 30 31 31 29 29
Purchased energy 8 8 7 11 14
Operating and maintenance 42 39 38 34 32
Depreciation 34 29 31 28 22
G&A 1 1 1 1 1
Total 114 107 109 103 98
Source: Company, NCBC Research estimates
O&M has been (and is expected to remain) the largest cost component. However, we factor a
marginal improvement in operating efficiency that will reflect on O&M costs, resulting in a
decline in O&M cost per Mwh from SR42 in 2008 to SR32 in 2016e.
Depreciation has been another major component of cost. We expect this to continue in our
forecast period, given SEC’s significant capital expenditure plans. Depreciation costs accounted
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 16
B U S I NE S S B A C K G RO U N D
for 29.3% of costs in 2008 or SR33.5 per Mwh; however, this is expected to decline to SR22 per
Mwh in 2016e as capital expenditure slows and revenue keeps growing.
SEC currently receives energy at a subsidized price from Saudi Aramco and we assume in our
model that this will continue. Thus, we do not expect a significant jump in fuel costs per unit of
consumption. However, we expect fuel cost per Mwh of energy sold to decline marginally as
more energy will be purchased instead of being generated internally.
Exhibit 17: SEC receives energy at a substantial discount Type of fuel Price (US$/MBTU)Natural gas 0.75
Diesel 0.63
Light crude oil 0.74
Heavy fuel oil 0.32
Source: Company, NCBC Research
Purchased energy has not been a significant component of SEC’s cost base; but we believe this
will be a major cost going forward. SEC will buy electricity from IPPs and Marafiq directly
whereas WEC will purchase water and power from the IWPPs and will sell power to SEC.
We estimate that the cost of purchased energy in 2008 was SR8.1 per Mwh (7% of total costs).
Due to the increase of purchased energy in our forecast horizon, we expect this to increase to
SR14.4 per Mwh in 2016e. This is expected to double the relative contribution of purchased
energy to total cost over our forecast horizon.
The chart below presents the current relative contribution of the different cost components in
2008 and our forecast of the cost structure in 2016e. As discussed earlier, the cost of
purchased energy is expected to rise from 7% of total costs in 2008 to 15% in 2016e, driven by
a higher contribution of purchased capacity to total available capacity.
Exhibit 18: Cost of purchased energy will grow much faster than other cost components
Cost breakup – 2008 Cost breakup – 2016e
G&A1%
Fuel cost26%
7%
29%
O&M37%
Depreciation
Purchased Energy
Fuel cost30%
G&A1%
15%
22%
O&M32%
Depreciation
Purchased Energy
Source: Company, NCBC Research estimates
Profitability analysis The chart below is a graphical representation of the income statement in 2008. We start from
revenue, which stood at SR22bn, and then deduct all cost components to arrive at net income.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 17
B U S I NE S S B A C K G RO U N D
Exhibit 19: Net income margins was 5% in 2008
-
5,000
10,000
15,000
20,000
25,000
Rev
enue
Fuel
cos
t
Purc
hase
den
ergy O&
M
Dep
reci
atio
n
G&
A
Fina
ncin
gco
sts
Oth
erin
com
e
Net
inco
me
SR m
n
Source: Company, NCBC Research estimates
Despite our estimate of a good EBITDA margin (above 30%), operating margins and net
margins are significantly low. This is mainly due to high depreciation charges because of the
large fixed assets base and significant capex plans.
In our forecast period, we believe the company’s operating and net margin will come under
additional pressure. This is because the company has planned large capital expenditure
programs amounting to SR130bn over 2009-13e, resulting in higher depreciation expenses.
It is important to note that SEC receives energy at a substantial discount. As discussed earlier,
we have assumed in our model that there will not be a change in energy costs per unit of
consumption. In our modeling for other companies in the country, we assume the government
will increase natural gas prices from USD0.75 per MBTU to USD1.5 per MBTU in 2012, but we
do not do this in SEC’s case for a very important reason: The government will not increase the
cost of fuel without an appropriate revision to electricity tariffs. Since we do not incorporate a
tariff revision in our forecast horizon, we have also not factored an increase in the cost of fuel
per unit of consumption.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 18
B U S I NE S S B A C K G RO U N D
Capital expenditure Due to rising peak demand, SEC has no option but to expand generation capacity and invest in
transmission and distribution projects. According to the company’s management, over the next
five years, SEC plans to invest SR88bn on generation capacity expansion: SR12.9bn per
annum on transmission projects over the next ten years and SR71.2bn on distribution projects.
Exhibit 20: Distribution of SEC’s planned capital expenditure %
Distribution, 21.5%
Transmission, 39.0%
Generation, 39.5%
Source: Company, NCBC Research
These investments are needed to meet the increasing peak summer demand. The table below
summarizes the company’s planned capital expenditure over the next five years. Beyond
2013e, we assume a decline in required capex towards a sustainable SR10bn per annum over
2016-18e. (Please refer to appendix on page 24 for generation capacity expansion details)
Exhibit 21: Capex expansion plans 2009E 2010E 2011E 2012E 2013E
Planned capex 31,901 30,836 26,313 22,509 18,390
Source: Company, NCBC Research estimates
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 19
B U S I NE S S B A C K G RO U N D
Debt financing Historically, SEC has maintained a stable debt-to-capital ratio around 15-17%. To meet funding
requirements of future expansion projects, in June 2009, SEC raised SR7bn through an
oversubscribed Sukuk offering at 160 basis points above the Saudi Interbank Offered Rate
(SIBOR) and SR4.1bn through direct loans. Going forward, given the stability of the business
and capital expenditure requirement, we expect the company to raise further debt and maintain
a long-term debt-to-capital ratio of 50%.
Exhibit 22: Debt level is expected to rise in order to finance expansion projects
-
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
2006 2007 2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E0
10
20
30
40
50
60
70
Total debt outstanding Debt-to-capital % (RHS)
(SR
mn)
Source: Company, NCBC Research estimates
In addition, the Saudi Government, which owns 81% of the company directly and indirectly, will
ensure that SEC raises the required financing for future expansion. This Government
commitment has resulted in a high credit rating (AA- from Fitch and S&P and A1 from Moody’s)
and enabled SEC to raise debt at a relatively inexpensive cost.
Dividends As already mentioned, the Saudi government directly owns 74.3% of SEC and 6.9% indirectly
through Aramco. The Government has waived its rights to dividends since SEC’s inception in
2001 until 2009 as long as the dividend does not exceed 10% of par value. Recently, the waiver
period was extended again for another 10 years (until 2020).
The dividend waiver has resulted in less shares entitled to receive dividends (only around 18%
of outstanding shares) resulting in higher dividend per share to the public. The company has
been paying SR0.7 per share (7% of stock par value) as a dividend to the public and is
expected to continue to do this in future. Waiving the government dividend rights has a value for
the public, which we factored in our valuation of the company (Please see valuation section).
That makes SEC an important dividend play, given the current market price, resulting in around
6.2% dividend yield. Given the company’s ratings (equivalent to the Saudi Government rating),
some investors view SEC as an alternative to Saudi sovereign debt, but with a much higher
yield.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 20
Industry and business dynamicsThe electricity industry currently faces major challenges and significant restructuring is planned
for the industry as a whole. Capacity has to grow to meet rising peak demand, which has led to
power shortages and blackouts. The Saudi Government has been trying to liberalize the sector
by pushing for more Independent Power Producers (IPPs) and Independent Water and Power
Producers (IWPPs). These plans, however, were hit over the past year by the global economic
slowdown and tight capital markets.
Demand-Supply balance Peak load has been growing at 7.7% per annum over the past five years, led by a growing
population, amplified by rising per capita consumption. Industrial activity has also increased
rapidly, driven by economic growth and artificially low tariffs that we believe have encouraged
sub-optimal usage by end users. Going forward, we expect the peak load to grow by 6.4%
annually over 2008-16e, mainly driven by growth in residential and industrial consumption.
We believe the high growth rate in residential demand is driven by two factors: first, the
population has been growing at 2.5% annually and is expected to continue to grow at the same
rate over our forecast period. Second, the declining household size, coupled with a growing
population, indicates that the number of households will grow at a higher rate relative to the
population in what is described as “household creation process”. We expect the number of
households to grow at 4.6% annually over the forecast period, which will ultimately increase per
capita electricity consumption.
To meet demand, SEC has planned significant capacity additions over the next few years. The
chart below is based on SEC’s announced capacity additions over 2009-14e and our estimates
for 2015e and 2016e.
The Saudi Government (and SEC) targets 10-15% excess capacity margin above peak
demand, to ensure that capacity can meet an unexpected rise in demand to help prevent power
outages that have become common in the summer. However, based on our estimates of
demand growth and given the planned capacity expansions, we do not see this happening until
2015e.
Exhibit 23: Expected capacity additions by SEC
20,000
25,000
30,000
35,000
40,000
45,000
50,000
55,000
60,000
2008 2009 2010E 2011E 2012E 2013E 2014E 2015E 2016E Capacity2016E
Cap
acity
(MW
)
Source: Company, NCBC Research estimates
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 21
I N D US T R Y A ND B U S I NE S S DYN A M I CS
Although average capacity utilization has been around 60%, the capacity has not been able to
match growth in peak demand. Electricity consumption in Saudi Arabia is seasonal as most of
the demand arises in the second and third quarter of every year due to increased consumption
in the summer (because of higher use of air conditioners). Historically, this seasonality has
resulted in power outages in summer and low utilization in the first and fourth quarters, resulting
in losses during these two quarters. This is mostly because residential customers represent the
largest consumers of electricity as illustrated in the chart below.
Exhibit 24: Demand breakdown by customer category
0%
20%
40%
60%
80%
100%
2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 2015E 2016E
Residential Commercial Government Industrial Others
Source: Company, NCBC Research estimates
Pricing The government sets electricity tariffs and SEC does not have pricing power. Tariffs in Saudi
Arabia are low, relative to international and regional prices. We believe this low price has
encouraged non-optimal usage of electricity and has resulted in a lower RoE for SEC.
Exhibit 25: Tariffs (US cents per Kwh)
0
5
10
15
20
25
30
35
40
45
50
Denmark Italy Ireland Germany UK Spain USA France Australia Dubai Saudi
Source: NCBC Research
Although there are discussions on restructuring tariffs to prevent wasteful usage, we do not see
this happening any time soon. We believe tariffs in Saudi Arabia are driven more by political and
social, rather than economic considerations. Thus, we do not factor a tariff change in our model.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 22
I N D US T R Y A ND B U S I NE S S DYN A M I CS
However, we expect average revenue per Kwh to decline marginally over our forecast period
due to the rising contribution of residential consumption, a segment characterized by low
revenue per Kwh, as discussed earlier.
Privatization plans Apart from the electricity produced by SEC, the IPPs and IWPPs are projected to contribute
significantly in the future. The Saudi Arabian government has displayed its market driven
intentions by opening the electricity sector to private participation, to promote efficiency and
healthy competition. This is also a significant opportunity to meet the growing demand.
The IPP’s and IWPPs face financing challenges. For instance, in case of the Ras Al-Zour
project, the government decided to go ahead with the project as a regular EPC instead of IWPP
when one of the investors could not implement the project. In our opinion, this clearly signals
the government’s commitment to expand generation capacity even if it comes at the expense of
privatization.
We feel that not all IPP’s and IWPPs will proceed on schedule and not all of them will proceed
as IPP’s or IWPP’s. The table bellow illustrates the IPPs and IWPPs that we actually factor in
our model. SEC will be the sole purchaser of energy from those IPP’s and IWPPs, which will
have an impact on the cost of purchased energy, as discussed earlier.
Exhibit 26: IPPs and IWPPs 2012E 2013E 2014E 2015E 2016EIndependent Power Producers (IPP’s)
Power Plant #11 2,000
Qurayyah II P/P 2,000
Rabigh II P/P 1,200
Independent Water and Power Producers (IWPPs)
Yanbu II P/P 1,200
Shuqaiq II P/P 900
Shuaibah 900
Source: SEC, Meed, NCBC Research estimates
SEC plans to separate its generation business into several companies with similar
characteristics. According to the management, this will boost internal competition and push for
more efficiency. Moreover, SEC will establish two other companies that will handle transmission
and distribution.
This could be a transition period that would pave the way for actual privatization. In our opinion,
this restructuring will have a positive impact on the company’s profitability, with no meaningful
impact on the industry structure.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 23
Financial performance
Revenue SEC’s revenue is composed of three main drivers: electricity sales, meter reading and
maintenance tariff. However, electricity sales are the main revenue driver, accounting for more
than 90% of total revenue. We expect total revenue to keep growing at a steady 5.8% rate over
2008-16e, compared with 4.9% over 2003-08.
We expect revenue growth to be driven by electricity sales (CAGR 5.9% 2008-16e). While we do
not factor any change in the tariff structure, we do expect a decline in average revenue per Mwh
due to the rising proportion of residential electricity sales over our forecast period.
Exhibit 27: We forecast revenue to grow at 5.8% over 2008-16e
0
5
10
15
20
25
30
35
40
2004 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E 2015E 2016E0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
Total revenue Electricty sales in Gwh (RHS)
(SR
bn)
Source: Company, NCBC Research estimates
Profitability and margins Despite the expected decline in revenue per Mwh, we forecast a stable EBITDA margin. This
will be driven by improved efficiency that will result in a less than proportionate increase in O&M
expenses and declining G&A costs because of the company’s recent restructuring plans. We
expect the rising cost of purchased energy from IPP’s and IWPPs will partially offset these
benefits.
Exhibit 28: We expect EBITDA to grow in line with revenues
0
2
4
6
8
10
12
14
2007E 2008E 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E20
22
24
26
28
30
32
34
36
38
40
EBITDA EBITDA margin % (RHS)
(SR
bn)
Source: Company, NCBC Research estimates
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 24
F I NA N CI AL P E R F O R MA N C E
We forecast a decline in net income over 2010-13e, mainly driven by depreciation expenses,
which will rise due to increased capital expenditure. Over 2014-16e, we expect depreciation
expense to decline, which will allow net income to rise with EBITDA.
Exhibit 29: We expect a decline in net income driven by rising depreciation charges
-
500
1,000
1,500
2,000
2,500
3,000
2007 2008 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E0
2
4
6
8
10
12
Net income Net margin % (RHS)
(SR
mn)
Source: Company, NCBC Research estimates
Capitalized interest It is important to note that SEC’s income statements do not show any interest expense as all
debt raised is used for capital expenditure; thus all interest charges are capitalized on the
company’s balance sheet. However, the company discloses the amount of capitalized interest
every year.
Interest coverage ratio is expected to decline sharply as debt levels rises significantly; hence
interest on that debt. However, the coverage is still at a reasonable level given the stability of
the business and the full backing the company has from the government.
Exhibit 30: Expected decline in interest coverage due to rising debt 2007 2008 2009E 2010E 2011E 2012E 2013EEBITDA SR mn 7,486 7,508 8,421 9,120 10,186 10,501 10,697
Interest on debt SR mn 634 613 1,541 1,805 2,367 2,741 3,129
EBITDA/Interest SR mn 11.8 12.2 5.5 5.1 4.3 3.8 3.4
Source: Company, NCBC Research estimates
Capitalized interest becomes part of the asset cost and is depreciated over the life of the asset.
Thus, part of the depreciation expense pertains to interest of previous years. Since depreciation
is a non-cash item, this interest does not have any impact on our FCF calculations; hence, it
would have no impact on our valuation. However, we adjust capital expenditure for the
capitalized interest, to avoid double counting, as the cost of debt is factored in our discount rate.
For financial forecasting, we do not adjust the capitalized interest; however, we present the
amount that we expect to be capitalized below the net income line (Please refer to the financials
section).
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 25
F I NA N CI AL P E R F O R MA N C E
Dividend The Saudi Arabian government has waived its rights to dividends from 2001 until 2009 and
extended the waiver in 2009 for another 10 years (provided dividends do not exceed 10% of
par). The company has maintained fixed dividends per share (paid to the public only) at SR0.7
over the past decade and we expect it to maintain the same level of dividends, going forward.
Capital expenditure and financing Due to rising peak demand in the Kingdom, SEC’s current capacity will not be sufficient to meet
the growing demand in future. As a result, the company has planned to expand its generation,
transmission and distribution capacities.
According to the company’s latest sukuk prospectus, SEC plans to spend more than SR130bn
over 2009-13e, mostly for generation projects, but also for transmission and distribution
projects.
To finance these projects, SEC has to raise external finance. In 2009, the company issued
sukuk, borrowed from banks and export financing companies, and received a loan from the
government (through the Public Investment Fund).
Exhibit 31: SEC will increase debt level in order to finance capital expenditure 2008 2009E 2010E 2011E 2012E 2013E 2014ECapex SR mn (22,154) (33,092) (32,222) (28,140) (24,625) (20,805) (16,855)
Gross cash SR mn 1,232 1,898 2,023 2,155 2,283 2,419 2,557
Gross debt SR mn 10,204 31,408 51,499 67,814 73,156 70,969 75,175
Equity SR mn 48,553 49,421 49,889 50,322 50,519 50,879 51,889
Debt-to capital % 17.4 38.9 50.8 57.4 59.15 58.24 59.16
Source: Company, NCBC Research estimates
By end-2008, debt-to-capital ratio was only 17%, which allowed the company to raise debt
easily in 2009. We expect SEC’s debt to increase from SR10.2bn to SR31.4bn in 2009e (or
from 17% debt-to-capital to 38%). Our model indicates that SEC’s target debt-to-capital
structure should be around 50%.
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 26
Appendix
SEC’s generation projects
Exhibit 32: Capacity and commissioning dates of SEC capacity expansion projects Project description 2009E 2010E 2011E 2012E 2013E 2014E Total (MW)Al-Guba Power Plant Expansion 55 55
Al-Guba Power Plant Extension 55 55
Al-Jouf/Arar Expansion. 60 60
Al-Quraya power plant (CC) gas part 1,950 1,950
Al-Quraya power plant (CC) steam part 1,255 1,255
Al-Shuqaiq 1,200 1,200
Al-Wajh Expansion 30 30 60
Al-Wajh power plant 90 90
Duba Expansion 45 45
Faras power plant 508 508
Jazan Expansion 192 192
Najran air cooling 60 60
PP 10 1,320 660 1,980
PP 10 steam part 990 990
PP8 480 480
Qurayate Power Plant Expansion 120 25 145
Rabigh Gas Plant (New Units) 960 960
Rabigh Gas Plant (New Units). 720 720
Rabigh steam Power Plant – 1&2 1,260 1,260
Rabigh steam Power Plant – 2. 630 630
Rabigh steam power Plant-1 630 630
Rafha Power Plant Expansion. 30 30
Sarorah Expansion 48 48
Shaibah Steam Plant 397 397
Shaibah Steam Plant. 794 794
Tabarjal Expansion 25 25
Tabuk Expansion 120 120
Tabuk Expansion. 120 120
Tihama Expansion 120 120
Total (MW) 3,353 3,400 1,574 2,517 1,315 2,820 14,979
Source: Company, NCBC Research estimates
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 27
Financials
Key financials
(SR mn) 2008 2009E 2010E 2011E 2012E 2013E
Income statement Total revenue 22,289 23,726 25,289 26,934 28,537 30,233 % change 7.0 6.4 6.6 6.5 6.0 5.9 Cost of revenue (14,563) (15,073) (15,948) (16,540) (17,844) (19,363)
Gross profit 7,726 8,652 9,341 10,394 10,693 10,870 G&A (217) (231) (221) (208) (192) (174)
EBITDA 7,508 8,421 9,120 10,186 10,501 10,697 % change 0.3 12.2 8.3 11.7 3.1 1.9
Depreciation expense (6,744) (7,329) (8,589) (9,711) (10,539) (10,791)EBIT 764 1,093 531 475 (38) (94)
Other income 340 360 509 531 801 1,025 Profit before Zakat 1,104 1,452 1,040 1,006 763 930
Zakat expense - (36) (26) (25) (19) (23)Net income 1,104 1,416 1,014 981 744 907
% change (21.8) 28.2 (28.4) (3.3) (24.2) 22.0 Capitalized interest ^ 613 1,541 1,805 2,367 2,741 3,129 Balance sheet Cash 1,232 1,898 2,023 2,155 2,283 2,419
Current assets 23,778 24,399 25,075 25,542 26,747 28,038 Net fixed assets 118,212 143,975 167,608 186,036 200,122 210,136
Equity investments 2,160 2,520 3,029 3,560 4,362 5,386 Total assets 145,382 172,791 197,735 217,294 233,513 245,979
Current liabilities 39,593 43,370 46,694 48,372 57,581 70,290 Total debt 10,204 31,408 51,499 67,814 73,156 70,969
Non-current liabilities 47,033 48,592 49,653 50,786 52,257 53,841 Total liabilities 96,830 123,370 147,846 166,971 182,995 195,101
Shareholders' equity 48,553 49,421 49,889 50,322 50,519 50,879 Total equity & liab 145,382 172,791 197,735 217,294 233,513 245,979 Cash flow statement Cash flow from op. (a) 18,461 13,461 13,312 13,035 20,759 24,701
Cash flow from inv.(b) (22,668) (33,451) (32,731) (28,671) (25,426) (21,830)CAPEX (22,154) (33,092) (32,222) (28,140) (24,625) (20,805)
Cash flow from fin.(c) (150) 20,656 19,544 15,768 4,795 (2,735)Debt 379 21,204 20,091 16,315 5,343 (2,187)
Dividends (529) (547) (547) (547) (547) (547)Net chg. in cash (a+b+c) (4,357) 666 125 132 128 136
Cash at start of the year 5,589 1,232 1,898 2,023 2,155 2,283 Cash at end of the year 1,232 1,898 2,023 2,155 2,283 2,419
Source: Company, NCBC Research estimates
^ Capitalized interest is not part of the income statement, but it is provided here for illustration purposes. Please refer to page 24 discussion
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE 28
F I NA N CI AL S
Key financials (contd.)
(SR mn) 2008 2009E 2010E 2011E 2012E 2013E
Per share ratios (SR) EPS 0.27 0.34 0.24 0.24 0.18 0.22 Div per share 0.70 0.70 0.70 0.70 0.70 0.70 Book value per share 11.7 11.9 12.0 12.1 12.1 12.2 Valuation ratios (x) P/E 42.6 33.2 46.4 48.0 63.3 51.9
Implied P/E 44.8 34.9 48.8 50.4 66.5 54.5 P/BV 1.0 1.0 0.9 0.9 0.9 0.9
EV/sales 3.3 3.1 2.9 2.8 2.6 2.5 EV/EBITDA 9.9 8.8 8.1 7.3 7.1 6.9
Dividends yield % 6.2 6.2 6.2 6.2 6.2 6.2 Profitability ratios (%) Gross margins 34.7 36.5 36.9 38.6 37.5 36.0
EBITDA margins 33.7 35.5 36.1 37.8 36.8 35.4 EBIT margin 3.4 4.6 2.1 1.8 (0.1) (0.3)
Net profit margins 5.0 6.0 4.0 3.6 2.6 3.0 ROE 2.3 2.9 2.0 2.0 1.5 1.8
ROA 0.8 0.9 0.5 0.5 0.3 0.4 Liquidity ratios Current ratio 0.6 0.6 0.5 0.5 0.5 0.4 Quick Ratio 0.5 0.4 0.4 0.4 0.4 0.3
Interest coverage 12.2 5.5 5.1 4.3 3.8 3.4 Sector specific SEC capacity (MW) 34,470 37,823 41,223 42,797 45,314 46,629
Purchased capacity (MW) 4,772 4,772 4,772 4,772 6,672 9,872 Total capacity (MW) 39,242 42,595 45,995 47,569 51,986 56,501
Energy sales (Gwh) 182,916 194,150 208,037 222,874 237,797 253,691 Utilization (load factor) % 60.1 58.8 58.3 60.4 59.0 57.9
Source: Company, NCBC Research estimates
25 October 2009 SAUDI ELECTRICITY COMPANY - INITIATING COVERAGE
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NCBC INVESTMENT RATINGS
Overweight: Target price represents expected returns in excess of 15% in the next 12 months Neutral: Target price represents expected returns between -10% and +15% in the next 12 months Underweight: Target price represents a fall in share price exceeding 10% in the next 12 months Price Target: Analysts set share price targets for individual companies based on a 12 month horizon. These share price targets are subject to a
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OTHER DEFINITIONS
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CS: Coverage Suspended. NCBC has suspended coverage of this company NC: Not Covered. NCBC does not cover this company IMPORTANT INFORMATION
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