saudi electricity co · 2009. 10. 28. · saudi electricity co neutral a monopoly undermined by...

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 [email protected] 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


Investment scenarios

Valuation can increase significantly with better tariffs

Historical and expected price performance (three scenarios)

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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.


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.


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.



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)


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




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.


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


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.


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


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


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.


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


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



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


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)


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.



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)


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.



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


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


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.



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)


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


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



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


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


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.



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


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.



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%


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




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)


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.


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

)



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


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.


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.


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)


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)



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)


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


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).


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


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%.


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



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


^ Capitalized interest is not part of the income statement, but it is provided here for illustration purposes. Please refer to page 24 discussion


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


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

range of company specific and market risks. Target prices are based on a methodology chosen by the analyst as the best predictor of the share price over the 12 month horizon

OTHER DEFINITIONS

NR: Not Rated. The investment rating has been suspended temporarily. Such suspension is in compliance with applicable regulations and/or in circumstances when NCB Capital is acting in an advisory capacity in a merger or strategic transaction involving the company and in certain other situations

CS: Coverage Suspended. NCBC has suspended coverage of this company NC: Not Covered. NCBC does not cover this company IMPORTANT INFORMATION

The authors of this document hereby certify that the views expressed in this document accurately reflect their personal views regarding the securities and companies that are the subject of this document. The authors also certify that neither they nor their respective spouses or dependants (if relevant) hold a beneficial interest in the securities that are the subject of this document. Funds managed by NCB Capital and its subsidiaries for third parties may own the securities that are the subject of this document. NCB Capital or its subsidiaries may own securities in one or more of the aforementioned companies, or funds or in funds managed by third parties The authors of this document may own securities in funds open to the public that invest in the securities mentioned in this document as part of a diversified portfolio over which they have no discretion. The Investment Banking division of NCB Capital may be in the process of soliciting or executing fee earning mandates for companies that are either the subject of this document or are mentioned in this document. This document is issued to the person to whom NCB Capital has issued it. This document is intended for general information purposes only, and may not be reproduced or redistributed to any other person. This document is not intended as an offer or solicitation with respect to the purchase or sale of any security. This document is not intended to take into account any investment suitability needs of the recipient. In particular, this document is not customized to the specific investment objectives, financial situation, risk appetite or other needs of any person who may receive this document. NCB Capital strongly advises every potential investor to seek professional legal, accounting and financial guidance when determining whether an investment in a security is appropriate to his or her needs. Any investment recommendations contained in this document take into account both risk and expected return. Information and opinions contained in this document have been compiled or arrived at by NCB Capital from sources believed to be reliable, but NCB Capital has not independently verified the contents of this document and such information may be condensed or incomplete. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on the fairness, accuracy, completeness or correctness of the information and opinions contained in this document. To the maximum extent permitted by applicable law and regulation, NCB Capital shall not be liable for any loss that may arise from the use of this document or its contents or otherwise arising in connection therewith. Any financial projections, fair value estimates and statements regarding future prospects contained in this document may not be realized. All opinions and estimates included in this document constitute NCB Capital’s judgment as of the date of production of this document, and are subject to change without notice. Past performance of any investment is not indicative of future results. The value of securities, the income from them, the prices and currencies of securities, can go down as well as up. An investor may get back less than he or she originally invested. Additionally, fees may apply on investments in securities. Changes in currency rates may have an adverse effect on the value, price or income of a security. No part of this document may be reproduced without the written permission of NCB Capital. Neither this document nor any copy hereof may be distributed in any jurisdiction outside the Kingdom of Saudi Arabia where its distribution may be restricted by law. Persons who receive this document should make themselves aware, of and adhere to, any such restrictions. By accepting this document, the recipient agrees to be bound by the foregoing limitations. NCB Capital is authorised by the Capital Market Authority of the Kingdom of Saudi Arabia to carry out dealing, as principal and agent, and underwriting, managing, arranging, advising and custody, with respect to securities under licence number 37-06046. NCB Capital’s registered office is at 25th Floor, Al-Faisaliyah Tower, King Fahad Road, P.O. Box 22216, Riyadh 11495, Kingdom of Saudi Arabia.

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