Introduction
The energy and petrochemical industry in Saudi Arabia is ranked among the world’s most vibrant in the global energy sector. The energy sector mainly comprises the oil and gas sector which is dominated by the national oil company, Saudi Aramco. The petrochemical sector on the other hand has approximately more than 70 billion dollars worth of investment projects underway. One of the big players, Arabia Basic Industries Corporation, holds a considerable size of planned projects in the coming decade. The energy and petroleum sectors constitute approximately 17% of the total value traded at the Tadawul Stock Exchange (Tadawul, 2010). The energy sector is extremely small in this respect because the oil business is nationalized.
The petrochemical sector thus remains the only viable investment vehicle. It comprises fourteen listed companies where the five largest are; Saudi Basic Industries Corp. (SABIC), Rabigh Refining and Petrochemical Co. (Petro Rabigh), Saudi Arabia Fertilizers Co. (SAFCO), Saudi Kayan Petrochemical Company (Saudi Kayan), and Yanbu National Petrochemical Company (YANSAB), listed in descending order of size by market capitalization. Their respective market capitalizations are SABIC with SAR 247.5 billion; Petro Rabigh with SAR 31.098 billion; SAFCO with SAR 30.25 billion; Saudi Kayan with SAR 27.3 million; and Yansab with 18.7875 billion (Tadawul, 2010). These companies not only represent the bulk of the petrochemical sector but that of the entire bourse as well.
The petrochemical sector performed excellently as compared to the Tadawul exchange’s averages and other sectors’ figures. SABIC and Saudi Kayan, which represent the petrochemical sector report 60.19% and 80.67% value traded changes respectively, being way ahead of the index. Similarly, the year saw the petrochemical sector constituting the majority of the value traded, at 23.73% of total traded value. In the same spirit among SAFCO is among the top price gainers in the first quarter of 2010 reporting a share price increase of 21.28% as compared to the index change of 11.1% (SAFCO, 2009, para. 5). In the same period, Saudi Kayan and SABIC are still in the top value traded companies with 5.77% and 20.61% respectively. This indicates that the petrochemical sector is performing well ahead of industry and bourse trends (Tadawul, 2010).
However, the energy sector is comprised of only two companies, is National Gas & Industrialization Co (GASCO) & Saudi Electricity Company (SEC). The national gas and industrialization Co. is comprised of investments from companies such as Saudi Factory for gas cylinders, National Company for industrial gases, Natural gas Distribution Company, East gas Limited company, Gas Equipment Limited Company, and Glass union Arabian company. This makes it be financially stable and able to deal with market fluctuations.
Industry analysis
The Saudi petrochemical industry is the result of the venture to add value to natural gas and oil in the 1970s. Growth started with the integrated strategy for petrochemicals by Saudi Arabia in the early 1980s whereby a remarkable growth occurred towards the end of the century due to increased oil prices and increased production of ethane. The industry was established on the downstream industry, with the incorporation of SABIC as a petrochemical entity that would utilize the fossil fuel raw materials available. In the wake of this venture, more companies were set up to contribute to the reduction of the Kingdom’s reliance on upstream oil ventures.
In the short term and medium term, growth is going to be underpinned by global competitiveness. To achieve this, the industry has opted for a number of growth strategies that include product diversification; joint ventures with big industry players; investment in research and development; and diversification of downstream ventures.
Saudi Arabia has moved from being an importer of petrochemicals as the situation was three decades ago, to being the biggest exporter with a 7% of the globe’s market of basic petrochemicals. Saudi petrochemical companies export to more than a hundred countries. The demand for the SAR is bound to keep increasing, leading to its strength against other global currencies.
The petrochemical industry is cyclical in nature with the global feedstock prices being volatile and sluggish intermittently. The upward cost pressure emanates from increased oil and natural gas prices. Supply capacity constraints among the suppliers of these raw materials also play an inflationary role. The domestic competition in the Saudi petrochemical market is minimal; firstly because all the producers place priority in the export market and secondly due to the fact that the downstream diversification options have not been optimized.
On the global scale, however, the Saudi industry faces competition that it is able to handle through establishing its competitive advantage. The root of Saudi’s petrochemical competitive advantage lies in low-cost energy and feedstock. The high affinity of global multinationals for Saudi petrochemical ventures also assures the industry of a guaranteed and increasing consumer base globally. On the other hand, the energy industry with the exception of the National Gas and Industrialization Company, which is more part of the petrochemical industry, the Saudi Electricity Company dates back to 1999. It is therefore a new company as compared to the others in the petrochemical industry.
Stock Selection
The five biggest companies that are; SABIC, Petro Rabigh, SAFCO, Saudi Kayan, and Yansab are all feasible for investment since they carry the buy recommendation. Of particular interest though are SABIC, Petro Rabigh, and SAFCO; which are to be evaluated for investment viability.
Financial analysis
SABIC
This is one of the top manufacturers of downstream petrochemical products. The company owes its strength to domestic investment affiliations; dedicated research and technology efforts; and a high target international expansion plan. SABIC is also posed as the world’s most profitable petrochemical company. KPMG places it to become the biggest petrochemical producer in the world by 2015, having been cited as the top in the Asian and Middle Eastern industry and fourth globally.
In the period ended 31st March 2010, the following was detailed on SABIC’s official website; the Return on assets of 6.93%, return on assets at 6.09%, and return on equity of 14.35%. These were rated 4/5 as per industry comparisons. Projections for earnings for 2010 are based on new and increased production capacity coupled with international forecasted GDP growth. The market consensus reports are estimating the SABIC 2010 net profits at SAR 17 billion. The capitalization outlook for SABIC is indicated by; the debt-equity ratio of 92.4X, and the total liabilities to total assets ratio of 62.5X. Both these ratios rank 4/5 as per global market comparisons.
Petro Rabigh
This is essentially a joint venture for Saudi Aramco and Japan’s Sumitomo. The two firms are blue-chip companies in the industry. The competitive advantages and resources of both these companies make Petro Rabigh an extremely innovative company with huge potential for capacity and strategic growth. Saudi Aramco is a refinery with a relatively sizeable capacity that makes it immune to the market supply pressures that are encountered by other companies. On the other hand, Sumitomo offers to the venture advanced and superior technology; and infrastructure, and leeway into global markets (Bloomberg, 2010). Details from the Companies website indicate that by the end fiscal year ending 31st March 2010, Petro Rabigh recorded -1.35% returns of assets and -13.07 returns on equity. The rating of these results was rated 2/5 in industry comparisons.
Projections for earnings for 2010 are based on new and increased production capacity coupled with international forecasted GDP growth. The market consensus reports are estimating the SABIC 2010 net profits at SAR 17 billion.
The capital status of Petro Rabigh as indicated by; debt-equity ratio of 331.6X, and total liabilities to total assets ratio of 83.2X;.ranks 5/5 and 4/5 respectively as per global market comparisons.
SAFCO
SAFCO concentrates on the production of fertilizer targeting the Saudi Arabia, Asia, Europe, and North American markets. Having been instituted in 1965, the corporation produces other products as well; they include urea on large scale, sulfuric acid for industrial use, ammonia, and melamine. Quite notably, it is partly owned by SABIC to the tune of 42%, as a move by the kingdom to coordinate the expansion of the fledgling fertilizer industry. SAFCO went on the record as the first fertilizer manufacturer in the Kingdom of Saudi Arabia.
The company has grown to become one of the top petrochemical companies in the world as per the turnover and capacity. Recent and projected expansions are in the ammonia sector, as per the SAFCO IV project. In the same period, SAFCO reported a return on assets of 6.93%, return on assets of 19.22% and return on equity of 16.46%. These were rated 5/5 as per industry comparisons (Bloomberg, 2010).
SAFCO’s financial projections are made in the light of assumptions of lower capacity utilization rate from 2010 onward, lower average fertilizer prices as compared to 2008, and lower other income. It is expected that the bottom line of the Company will have a negative CAGR of 10.1% during 2008-12. While the profitability is expected to recover and stabilize after 2009 onwards at an average level of SR2.3bn-3.0bn till 2012 on account of forecasted recovery in fertilizer prices from current levels and increase in income from Ibn Baytar, an associate
The capitalization outlook for SAFCO is indicated by; debt-equity ratios of 3.9X, and total liabilities to total assets ratio of 18.8X. Both these ratios rank 2/5 and 1/5 as per global market comparisons.
- GASCO: the company mainly deals with transportation, filling, and marketing LPG, both butane and propane gases. It also markets cylinders, tanks, and tanks transportation equipment. This put the company in a good position as the demand for these commodities continues to increase globally.
- SEC: the company, incorporated in 1999, has a paid-up capital of SR 33,758,632,650. Its formation was after a cabinet order to merge all small electricity companies in the central, eastern, western, and southern regions.
Valuation
A Valuation of these companies’ stocks is required to determine the future market prices of their shares so that the investor can benefit from the capital gains of the most undervalued shares. This valuation is to be made on fundamentals to deliver the intrinsic worth of these shares. The valuations methods differ on suitability and application thus the best method for the scenario of this industry has to be determined.
The alternative usable valuation methods herein are the discounted cash flow model, the dividend discount method, and the earnings growth model. The discounted cash flow method is the most prevalent and incorporates earnings growth together with escalating costs. These elements however make it hard to estimate the intrinsic value of equity. In contrast, the dividend discount technique provides a projection of dividends into the future, based on the average value of previous dividends. This model is suitable for shares with a high dividend yield. It also requires that the entity have a sturdy business outlook so that dividends are guaranteed in the ensuing decade.
Finally, the earnings growth model entails the projection of future earnings using a growth rate, which is either constant or variable. This rate varies with the forecasted business indicators in the specific timeframe. A valid approach that can be used involves using historical performance to determine a return on investment rate. This rate is thence used in the discounting of the forecasted earnings to arrive at a stock value.
The formula for determining the share worth is Present value= Dividend per share/ Discount rate. The discount rate (r) is determined as follows: r= rf + (beta*(rm-rf)). In this case, RF is the risk-free rate while rm expected return on the hat particular industry. Their difference gives the market risk premium. In this case, rf will be the Saudi interest rate, 2%; rm at 2.3%; beta at 0.79 as per world oil refining beta rates. The discount rate will thus be r= 0.02+ (0.79*(0.023-0.02)) = 2.237%. The respective companies’ dividends were SABIC, SAR 1.50: SAFCO, SAR 1.87; and Petro Rabigh SAR 1.50. The respective calculated share prices are therefore SAR 67.05, SAR 83.59, and SAR 67.05. The actual share prices are SAR 80.00, SAR 121.75, and SAR 24.90, respectively.
A comparison of the actual to the intrinsic value indicates that SABIC and SAFCO are overvalued while Petro Rabigh’s market price is way below its real value. Since the client is a speculative investor, Petro Rabigh would be recommended due to the share price growth potential. This would see the investor’s holdings appreciate by 269.3 % shortly.
Prospects
The petrochemical industry is not expected to weather the global economic recession with conditions getting worse. In 2008 exports were $920 million as compared to 2009’s $664 million, which represents a 27.8 fall. In the case that global indicators maintain the downward spiral then the industry is bound to absorb some setbacks.
In line with the recommendation above, Petro Rabigh is the company with the highest foreign investment in Saudi Arabia (Gulf in the Media, 2009, para. 5). To boost its growth prospects the company launched a $1o billion project that will see the production of secondary and tertiary petrochemical products. This is in an attempt to exploit the downstream market while creating jobs in the kingdom. After a troubling period, the industry is expected to undergo a comeback in 2010 and the ensuing years.
Of great importance in this recovery is the role of Chinese demand in this recovery. The fertilizer portion of the market is projected to perform better than its counterparts, of which plastics engineering is expected to have the worst performance. Of concern however are project durations, which are going to experience heavy delays. Particularly alarming is the Petro Rabigh complex, which is lagging with its budgeted costs has also shot up The limited stock of ethane is also a problem that is going to slow the forecasted industry recovery.
The price and availability of this feedstock are encumbering leading to pricing complications for downstream products. The scarcity is so bad to the extent that private entities are not going to be allocated any fresh supplies in the near future. However, Petro Rabigh is well placed for these shortages as they are bent to receive stocks to satisfy their 30% production capacity.
Conclusion
Of these companies, SABIC is the most profitable and is also a giant company. SAFCO on the other hand is also a strong company albeit a little wanting in the resource and capacity capabilities sector. Due to its global affiliations, Petro Rabigh was hard hit by the financial crisis. This notwithstanding, this company represents the best investment vehicle. Not only is the company global, equipped, and well placed in capacity terms, but it also has in place impressive expansion programs, and its dividend policy prices it as the most lucrative buy in the Petrochemical sector, in the Tadawul Stock Exchange.
Reference List
Bloomberg Business Week. (2010). Company Insight Center. Web.
Gulf in the Media. (2009). Saudi Petrochemicals Sector: Current Situation & Future Prospects. Web.
Tadawul. (2010). Saudi Stock Exchange. Web.
SAFCO (2009). SAFCO reports SR 464 million profits in 3q2009. Web.