Saudi Petrochemicals - NCBC

Valuation: SR20.3/shareValuation methodologyWe have used DCF methodology to arrive at our target price for Saudi Kayan.Cost of Equity (COE) of 14.9%: We have taken the US 10-year Treasury yield of3.81% (as of 25 April 2010) as the risk-free rate, as the Saudi Riyal is pegged tothe US dollar. Special attention is needed in estimating Saudi Kayan’s Beta becauseof 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, toreflect our expectation of a medium-term debt-to-capital ratio of 50%. The leveredbeta is 1.38. We assume an equity risk premium of 8.04% for Saudi Arabia whichincludes a 1.35% premium for the country risk associated with Saudi Arabia.Tax-adjusted cost of debt of 4.4%: The cost of debt for Saudi Kayan is assumedto be 4.50%. After adjusting it for tax rate, cost of debt equals 4.40%.Using the above assumptions, we arrive at a WACC of 9.65%.DCF VALUE OF SR20.3/SHAREFor evaluating Saudi Kayan’s business, we use the DCF analysis with a detailed freecash flow (FCF) estimate out to 2017E. Given the cyclicality of the sector, the eightyearexplicit forecast period covers one business cycle. We then use a terminalgrowth assumption of 2.5% and discount the cash flows using the WACC. We thenarrive at the estimated enterprise value of the company, further adjust for debt,cash, and other payments to derive Saudi Kayan’s equity value and target price.Exhibit 52: Saudi Kayan - Details of DCF ValuationIn SR mn, unless otherwise specifiedSum of present value 18,302.5Terminal value 50,653.5Present value of terminal 28,634.0Enterprise value 46,936.6Less: debt (18,804.6)Add: cash 2,453.9Less: end-of-services indemnities (65.1)Equity value 30,520.8Number of shares (mn) 1,500.0Value per share (SR) 20.3Source: NCBC Research estimatesThe table below indicates the impact of changes in WACC as well as terminalgrowth rate on the DCF target price.Exhibit 53: Sensitivity tableTerminal growth rate (%)1.5 2.0 2.5 3.0 3.57.7 26.6 28.9 31.7 35.1 39.2WACC (%)8.7 21.6 23.2 25.1 27.3 29.99.7 17.8 19.0 20.3 21.9 23.710.7 14.9 15.8 16.7 17.9 19.111.7 12.5 13.2 13.9 14.8 15.7Source: NCBC Research estimates27 April 2010 SAUDI KAYAN – INITIATING COVERAGE53