best is yet to come buy -...

Research Department Egypt - Petrochemicals

SIDPEC Company Report - Initiation 23 February 2010

Sidi Kerir Petrochemical Co. 1

Best Is Yet to Come Buy Established on the strong foundations of supplying local demand

rather than solely depending on export markets The market is pricing in very bearish outlook; positives such as

stable and high margins, strong cash flow generation, high dividend yield, and risk-free balance sheet not priced in

Initiate coverage with a Buy and TP of EGP17.5 (36% upside) Dual advantages: Unlike its GCC peers, Sidi Kerir Petrochemical Company (SIDPEC) is a cost-advantaged producer that does not depend on export markets. Large domestic demand and the fact that it is the sole producer in Egypt obviate the dependency on exports. Stable and high profitability profile: The company’s profitability profile is impressive and comparable to the best of its GCC peers. Its feedstock advantage is sustainable in the foreseeable future as the recent round of energy price hikes has ruled out price increases for natural gas used as feedstock. Strong balance sheet, cash flow generation, and dividend yield: SIDPEC has a track record of shareholder-friendly cash usage. It has utilized cash flows to strengthen the balance sheet and pay cash dividends. High margins, low capex, and a debt-free balance sheet leave the company with ample room to keep paying cash dividends from future free cash flows. We estimate SIDPEC will generate around EGP13.0/share in distributable cash flows over the next five years. Its dividend yield has consistently remained close to 10%. Strong earnings rebound this year: We forecast an EPS growth of 22% and sales growth of 20% this year due to improved operating rates and a rise in petrochemical prices. We are significantly above consensus in our forecasted numbers. We forecast an EPS of EGP1.76 for 2010e—37% above consensus. We see significant upsides even if prices fall 10%, which makes SIDPEC stand out in the petrochemical space. Market pricing in all negatives: The market is currently pricing in all the stock’s downsides such as no capacity expansion and low earnings growth due to impending taxes. Based on the Gordon Growth Model, SIDPEC should be trading at a PE multiple of 10.0x assuming only a 6.5% earnings growth and 70% payout ratio. With the current multiple at 7.5x, we feel the market’s outlook is too bearish. Valuation: We initiate coverage on SIDPEC with a Buy rating and TP of EGP17.5/share (34% upside). We use a weighted average to arrive at SIDPEC’s TP by assigning 50% weight to the market-based relative valuation and 50% to the DCF valuation. Capacity expansion is the biggest upside catalyst. We estimate the feedstock supply agreement would add EGP3.4/share or 20% to our TP.

Key Performance Indicators 2009a 2010e 2010c 2011e 2011c

Revenue (EGPm) 1,683 2,020 1,684 2,013 1,822

EBITDA (EGPm) 815 1,003 822 992 895

EBITDA Margin 48% 50% 49% 49% 49%

Net Income (EGPm) 759 924 681 774 615

EPS (EGP per share) 1.45 1.76 1.30 1.48 1.17

EPS Growth -24% 22% -10% -16% -10%

P/E 7.20 7.39 10.02 8.81 11.10

EV/EBITDA 5.50 5.82 7.10 5.89 6.53

Dividend Yield 18% 9% 9% 8% 10% a = announced, e = HC estimates, c = consensus estimates

Target Price (EGP) 17.5 Market Price (EGP) 12.91 Upside 36.0% Listed on EGX Bloomberg Code SKPC EY Reuters Code

SKPC.CA

Market Cap (EGPm) 6,825 Market Cap (USDm) 1,241 Net Cash (EGPm) 985 Enterprise Value 5,849 Foreign Ownership Limit - Foreign Ownership Level - Daily Turnover (EGPm) 6.0 Daily Turnover (USDm) 1.1

Shareholder Structure Free Float 23.0% Social Insurance 31.0% ECHEM 20.0% Others 26.0%

Price Performance Chart

Lovetesh Singh

+91 9772 755 777

[email protected]

* Disclaimer See Page 44

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Table of Contents Summary Sheet 3 Consensus Comparison 4 Investment Case 5 Valuation 9 Egypt’s Petrochemical Evolution 14 Egypt’s Petrochemical Market Overview 17 Drivers, Company Characteristics, and Assumptions 21 Risks 26 Financial Model 27 Appendix 1: Company Profile 30 Appendix 2: Ethylene and Polyethylene Basics 33 Appendix 3: Egypt Energy Market Overview 39

Petrochemicals


Summary Sheet

2006 2007 2008 2009 2010e 2011e 2012e 2013e 2014e

Income Statement

Revenue 1,969 2,084 2,119 1,683 2,020 2,013 2,140 2,296 2,425

Revenue Growth 6% 2% -21% 20% 0% 6% 7% 6%

EBITDA 1,202 1,332 1,127 815 1,003 992 1,076 1,197 1,300

EBITDA Growth 11% -15% -28% 23% -1% 8% 11% 9%

EBIT 1,030 1,164 959 648 836 825 909 1,030 1,133

EBIT Growth 13% -18% -32% 29% -1% 10% 13% 10%

Net Income 1,001 1,166 1,003 759 924 774 865 988 1,098

Earnings/Share (EPS) 1.91 2.22 1.91 1.45 1.76 1.48 1.65 1.88 2.09

EPS Growth 16% -14% -24% 22% -16% 12% 14% 11%

Dividend/Share (DPS) 1.28 1.79 2.10 1.82 1.23 1.03 1.15 1.32 1.46

Dividend Payout Ratio 67% 81% 110% 126% 70% 70% 70% 70% 70%

Dividend Yield (%) 6% 9% 11% 18% 11% 7% 8% 9% 10%

Margins

EBITDA Margin 61% 64% 53% 48% 50% 49% 50% 52% 54%

EBIT Margin 52% 56% 45% 39% 41% 41% 42% 45% 47%

Net Income Margin 51% 56% 47% 45% 46% 38% 40% 43% 45%

Balance Sheet

Cash and Cash Equivalents 1,288 1,427 1,166 985 1,781 2,350 2,965 3,643 4,381

Total Debt 150 14 9 4 0 0 0 0 0

Net Debt 966 1,247 1,152 976 1,776 2,350 2,965 3,643 4,381

Net PP&E 1,468 1,305 1,145 994 803 656 511 368 393

Total Assets 3,422 3,424 3,385 2,633 3,192 3,615 4,106 4,661 5,440

Shareholder Equity 3,422 3,424 3,385 2,633 3,192 3,615 4,106 4,661 5,440

Book Value/Share 4.59 5.02 4.83 4.45 4.95 5.77 6.67 7.71 9.18

LTD/(LTD + Equity) -6% -1% 0% 0% 0% 0% 0% 0% 0%

Cash Flow Statement

Operating Cash Flow/Share 2.72 2.49 1.98 1.52 2.80 2.16 2.37 2.65 2.92

Distributable Cash Flow/Share 2.67 2.49 1.96 1.49 2.76 2.12 2.33 2.61 2.87

Capex/Sales 1% 0% 0% 1% 1% 1% 1% 1% 1%

Depreciation/Sales 9% 8% 8% 10% 8% 8% 8% 7% 7%

Key Ratios

Current Ratio 3.31 4.11 3.70 21.47 6.22 7.80 9.15 10.65 12.29

Return on Capital (ROC) 34% 37% 33% 26% 33% 23% 22% 22% 20%

Return on Equity (ROE) 42% 44% 40% 32% 36% 26% 25% 24% 23%

Return on Assets (ROA) 31% 33% 28% 23% 30% 21% 20% 20% 19% Source: HC Securities estimates

Petrochemicals


Consensus Comparison

Consensus HC Estimates

2010e 2011e 2012e 2010e 2011e 2012e

Sales 1684 1822 1795 Sales 2,020 2,013 2,140

EBITDA 822 895 885 EBITDA 1,003 992 1,076

Net Profit 681 615 746 Net Profit 924 774 865

EPS 1.28 1.17 1.41 EPS 1.76 1.48 1.65

Consensus Vs. HC Estimates

2010e 2011e 2012e

Sales 20% 10% 19%

EBITDA 22% 11% 22%

Net Profit 36% 26% 16%

EPS 37% 26% 17% Source: Zawya Dow Jones, HC Securities estimates

Petrochemicals


Investment Case High domestic demand and presence of large export market ensures peak capacity utilization Stable and high profitability profile comparable to GCC peers Shareholder-friendly cash usage track record with debt-free balance sheet; we estimate EGP13.0/share in

cumulative distributable cash flow in the next five years Robust profitability, matching Middle Eastern peers Profitability and returns generated by the company is comparable to the best of its peers. As shown in chart 1.1, SIDPEC has averaged a net income margin of 46% over the last six years. SIDPEC’s profitability is even better than Saudi petrochemical giant Saudi Basic Industries Corporation (SABIC) and is comparable to Industries Qatar. SIDPEC pays more for its feedstock than its GCC peers, but still maintains the same profitability. The main reason SIDPEC is so profitable is that it focuses on cost advantaged facilities in Egypt. SABIC is a more diverse company and has some non-advantaged companies in Europe and the US. Industries Qatar has a steel business in its fold where the company does not have any cost advantage. SIDPEC owes some of its profitability to its tax structure, aggressive debt reduction, lower general and administrative costs as a percentage of sales, and positive interest income. Chart 1.1: Net Income Margin Movement Compared to Peers

Net Income Margin and EPS Net Income Margin Comparison (Average 2003–2008)

Source: Company reports, HC Securities estimates Product in deficit local markets ensure high operating rates and remove export market dependency Local demand for basic polymers is much higher than installed production capacity in the country, which implies that local producers like SIDPEC need not depend on exports. Almost two thirds of local demand is fulfilled by imports, and the gap between local demand and supply is expected to keep widening as no new capacity is expected to come on line in the next three years. Close proximity to large export markets like Europe and Turkey gives SIDPEC another outlet for its products aside from the local market. The presence of both the local deficit market and nearby export market ensures that SIDPEC operates its plant at near peak capacity most of the time. Chart 1.2 shows the supply demand estimation for Egypt. Operating rates of ethylene and polyethylene will continue to be at their peak, stabilizing the company’s sales volume. We forecast an operating rate of 95% for ethylene and 100% for polyethylene.

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Chart 1.2: Ethylene and Polyethylene Supply/Demand Outlook

Ethylene Supply Demand Polyethylene Supply Demand

Source: CMAI, HC Securities estimates Shareholder friendly cash usage track record

SIDPEC has utilized the strong cash flows generated over the past few years to strengthen the balance sheet and return cash to its shareholders through cash dividends. As chart 1.3 shows, the company has aggressively paid down its debt and was debt free by the end of 2008. The percentage of cash flows paid back to shareholders has increased steadily to 100% of the operating cash flows in 2008 from around 25% in 2003, averaging over 70% for the past six years. Besides paying down debt and dividends, the company has also built up substantial cash reserves. SIDPEC has cash reserves of around EGP1 billion, which covers its entire cash requirement for the next three years. With no debt down payments and limited capital expenditure until capacity expansion started, the company was left with ample room to keep paying cash dividends from future free cash flows. We estimate SIDPEC will generate around EGP13.0/share in distributable cash flows from 2010e to 2014e, which represents around 70% of our target price. With healthy cash flow generation, an unlevered balanced sheet, and a good amount of cash reserves, the company can easily accommodate the additional capex requirement for capacity expansion without denting dividends. Hence, most of this cash flow is expected to return to shareholders in the form of cash dividends or may be share buybacks. Chart 1.3: Cash Flow Management

Cash and Debt Movement Future Cash Generation

Source: Company reports

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Cumulative Cash generation per shareCash generation as % of target price

Petrochemicals


Sole ethylene and polyethylene producer in Egypt SIDPEC is the sole producer of ethylene and polyethylene in Egypt. Both these products serve the large end market and hence their demand tracks GDP growth. We forecast a plastic consumption growth rate of 7% in the next five years, which means future expansions will have a ready market to serve. As shown in chart 1.4, per capita plastic consumption in Egypt is low, which indicates its future potential growth. Egypt is still in the initial stages of the plastic consumption life cycle, which is marked by the sharp increase in the consumption of plastic, as it is used as a substitute for traditional packaging materials like glass and paper. Historically, plastic consumption in Egypt has risen more than the overall GDP of the country. Egyptian resin consumption has high leverage with the economy and is growing at around 2.0x to GDP growth. Our economists forecast Egypt’s GDP growth rate at 5%. Applying a conservative multiple of 1.4x, we arrive at a plastic consumption growth rate of 7% for Egypt. Chart 1.4: Egypt’s Plastic Consumption Growth Rate

GDP and Plastic Growth Rate in Egypt (2003–2008) Per Capita Plastic Consumption

Source: CMAI

More upsides and current price factoring in all the negatives We have arrived at a target price for SIDPEC using a weighted average. We assign 50% weight to the market-based relative valuation and 50% to the DCF valuation; giving equal weight to the value from fundamentals and investors’ risk tolerance as measured by the current trading multiple. Our target price of EGP17.5 represents a 36% upside from current levels. We therefore initiate coverage on SIDPEC with a Buy recommendation. Table 1.1 Target price for SIDPEC

Valuation Approach Fair Value Weight Weighted Value

Market Based PE multiple 17.6 50% 8.8

DCF 17.4 50% 8.7

Target Price 17.5

Current Market Price 12.9

Upside Potential 36% Source: HC Securities estimates Product price sensitivity SIDPEC’s stock is sensitive to product price changes. Product prices are the main contributor to the variability in sales and earnings. They not only determine the sales but also feedstock prices for SIDPEC and hence affect its margins and profitability. Table 1.2 shows our target price sensitivity to the product price changes. It is clear that target price movement is correlated with product price movement. Even if prices fall 10% from the current level, the stock still has much upside potential.

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Table 1.2: Product Price Sensitivity of Target Price

Price Change 2010e EPS Target Price Upside from Current Share Price Deviation from Our Target Price

-10% 1.54 16.39 26% -6%

-5% 1.65 16.96 30% -3%

0% 1.76 17.48 34% 0%

5% 1.86 17.95 38% 3%

10% 1.95 18.36 41% 5% Source: HC Securities estimates Planned capacity expansion is an upside catalyst Earnings are highly geared towards capacity expansion. With its low production asset base at present, any increase in capacity would lead to a sharp increase in earnings potential. Based on our estimates, capacity expansion could add 25% to our target price of EGP17.5/share. The company has planned capacity expansion of 460,000 tons per year for ethylene and 260,000 for polyethylene, which are larger than the company’s current installed capacity. Based on our estimates, the announced capacity expansion is valued at around EGP3.4/share. It is clear from the current valuation that the market is not factoring in any capacity expansion. We believe the end of the feedstock supply agreement would represent a major catalyst for the stock and could lead to sharp jumps in valuation. Chart 1.5: Impact of Capacity Expansion on TP

Source: HC Securities estimates

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Valuation Current stock price factors in all the negatives; we believe stock price has more upside from here on out We initiate with a target price of EGP17.5 (34% upside) and a Buy recommendation Capacity expansion could boost out target price by 20% SIDPEC stock price factoring in all negatives and trading at historical low multiples SIDPEC’s stock price is trading at a historically low multiple at the moment, clearly factoring in all the negative news related to the company (chart 2.1). This rather unimpressive performance is mainly due to the company’s failure to fully realize its growth potential by expanding capacity. Delay in securing feedstock supplies for capacity expansion and the impending taxes has weighed down the stock. However, we believe the current market price represents an attractive entry point. With all the negative news factored in, we think the stock has more upside potential from here on out. We believe at the current price, the market is not fully factoring in the positive aspects of the company like high and stable profitability margins, high returns, defensive sales volumes, independence from export markets, robust balance sheet, and strong cash flow generation. Chart 2.1: Historical Stock Price and PE Multiple

SIDPEC’s Market Performance SIDPEC’s Traded PE Multiple

Source: Bloomberg Relative valuation, trading at much steeper discount We believe SIDPEC is trading at a much steeper discount than warranted based on the peer group trading PE multiple. Even after considering its lower earnings growth, we think the stock is trading at far too low a multiple. We believe the stock should be trading at a PE multiple of 10.0x, according to the Gordon Growth method. Even after assuming low earnings growth rate of 6.5% due to income taxes, the company should be trading at 10.0x due to its superior payout ratio. Table 2.1: PE multiple as per Gordon Growth Formula Table 2.1: PE Multiple as per Gordon Growth Formula

Gordon Growth Valuation

Dividend Payout Ratio (a) 70%

Cost of Equity (k) 13.50%

Expected EPS Growth Rate (g) 6.5%

Warranted PE Multiple = a/(k-g) 10

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Chart 2.2: Earnings Growth vs. 2010e fwd PE Multiple of Major Chemical Companies

Source: Bloomberg The chart above shows a market based PE multiple valuation. Applying a PE multiple of 10.0x results in a share price of EGP17.6 compared to the current share price of EGP12.91. Table 2.2 SIDPEC Relative Valuation

Market PE Multiple Based Valuation

Market-Based PE Multiple 10.0x

2010e EPS 1.76

Target Share Price 17.6

Current Share Price 12.9

Upside Potential 37% Source: HC Securities estimates DCF Valuation We have carried out the DCF based valuation of SIDPEC based on five years of explicit forecasted period and five years of trend forecasting. Terminal value of the cash flows is calculated using the Gordon Growth Model. The following assumptions were used in the DCF model:

Table 2.3: DCF Model Assumptions

Assumptions

Risk Free Rate 8.50%

Beta 0.8

Market Risk Premium 6.50%

Cost of Equity 13.50%

Terminal Growth Rate 1%

Debt 0

Capacity Expansion Plans Not Included We have not included the capacity expansion plans of the company in our DCF model. There is still uncertainty surrounding the timing of the plant. Also, we have assumed that the company would not raise any debt until it starts constructing the new plant. We arrived at a DCF-based share price of EGP17.4, representing an upside potential of 34% from the current share price of EGP12.91.

SIDPEC

Nan Ya Plastics

Celanese

BASF

Industries Qatar

Formosa Plastics

SABICFormosa chemicals

Lanxess

Dow ChemicalYansab

Mexichem

Sipchem

Arkema

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Table 2.4: DCF Valuation of SIDPEC

Output Summary Assumptions NPV of Cash Flows 7,352 WACC 13.51%

Net Debt 2010e 1,776 Terminal growth rate 1.00% Equity Value 2009e 9,128 TV/Total NPV 28.56% Number of Shares 525

Price per Share 17.4

Current Share Price 12.9

Upside/(Downside) Potential 35%

DCF Model 2010e 2011e 2012e 2013e 2014e 2015e 2016e 2017e 2018e 2019e Terminal

Free Cash Flow Calculation

Sales 2,020 2,013 2,140 2,296 2,342 2,389 2,437 2,485 2,535 2,586

Sales Growth -0.3% 6.3% 7.3% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0%

EBIT 836 825 909 1,030 993 956 975 994 1,014 1,034

EBIT Margin 41% 41% 42% 45% 42% 40% 40% 40% 40% 40% Tax 0 (194) (216) (247) (199) (191) (195) (199) (203) (207)

Tax as a % of EBIT 0.0% 20% 20% 20% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0%

NOPAT 836 631 693 783 795 764 780 795 811 827

Depreciation 167 167 167 167 167 167 167 167 167 167

Gross Cash flow 1,003 798 860 950 962 931 947 962 978 994

Increase in Working Capital 271 362 (4) (14) (17) (5) (5) (5) (5) (5)

Chg in WC as a % of Inc. Sales 5143% 3% 9% 10% 10% 10% 10% 10% 10%

Interest Tax Shield -1 0 0 0 0 0 0 0 0 0

Capex (21) (21) (22) (24) (47) (48) (49) (50) (51) (52)

Free Cash Flow 1,253 1,140 833 912 898 879 893 908 923 938 7,452

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Cost of Capital 13.51%

PV of Cash Flow 1,104 885 570 550 477 411 368 330 295 264 2,099

NPV of Cash Flows 7,352

Number of Shares 525

Long-Term Growth Rate 1.0% Source: HC Securities estimates

Sensitivity Analysis DCF based valuation contains several assumptions that change over time and thus impact the target share price. Below are the sensitivity tables for the most important assumptions which are expected to change most.

Table 2.5 DCF Sensitivity Tables

Debt-to-Capital Ratio Beta 0.7 0.8 1.0 1.1

0.0 17.88 17.19 15.99 15.47 0.1 18.44 17.75 16.56 16.04 0.2 18.94 18.26 17.09 16.57 0.3 19.39 18.73 17.56 17.05

The company’s capital is all equity and hence not at its optimal capital structure. We believe it is waiting for the capacity expansion to take any debt on its balance sheet, which would lower capital cost and be positive for the stock.

Terminal Growth Rate Cost of Capital 9% 10% 11% 12% 13% 14% 15%

0% 23.6 21.6 20.0 18.7 17.6 16.6 15.8 1% 24.7 22.5 20.6 19.2 17.9 16.9 16.0 2% 26.1 23.5 21.4 19.7 18.4 17.2 16.3 3% 28.1 24.8 22.4 20.4 18.9 17.6 16.6

Source: HC Securities estimates

Petrochemicals


Target price of SIDPEC We use a weighted average to arrive at a target price for SIDPEC. We assign 50% weight to the market-based relative valuation and 50% to the DCF valuation; giving equal weight to the value from fundamentals and investors’ risk tolerance. We initiate coverage on SIDPEC with a Buy recommendation and target price of EGP17.5/share (36% upside). Table 2.6: Target price of SIDPEC

Valuation Approach Fair Value Weight Weighted Value

Market-Based PE Multiple 17.6 50% 8.8

DCF 17.4 50% 8.7

Target Price 17.5

Current Market Price 12.9

Upside Potential 36% Source: HC Securities estimates Upside catalysts and valuation sensitivity The big upside catalyst for the company will be executing its capacity expansion plans. As this is larger than the company’s current installed capacity, it can more than double production and earnings capacity overnight. Approving the capacity expansion could add 20% to the target price based on its present value. Based on DCF, the plant could add EGP3.4/share. Assuming a three-year construction time, even if the plant is given the go ahead and construction starts in 2010, it is expected to come on stream in 2013 at the earliest. It is clear from the current valuation that the market is not discounting any capacity expansion. Further delays are not a risk to the company valuation as the expansion is not included in our valuation and numbers. Chart 2.3: Target Price Sensitivity to Upside Catalysts

Target Price Sensitivity to Capacity Expansion Target Price Sensitivity to Product Prices

Source: HC Securities estimates SIDPEC’s stock is sensitive to product price changes. Product prices are the main contributor to the variability in sales and earnings. Product prices determine sales and feedstock prices and hence SIDPEC’s margins and profitability. The table below shows our target price sensitivity to the product price changes. It is clear that the target price movement is almost perfectly correlated with the product price movement.

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Table 2.7: Sensitivity to Price Changes

Price Change 2010e EPS Target Price Upside from Current Share Price Deviation from our Target Price

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-5% 1.65 16.96 30% -3%

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10% 1.95 18.36 41% 5% Source: HC Securities estimates Owing to the perfect correlation with the EPS of the company, expected price changes become the most important factors in determining the profitability of the company. The table below shows our international price forecasts. For SIDPEC we have used prices 5% above international prices to reflect the additional costs for exporters like transportation and handling and tariffs. We are not factoring in any price increase in 2011e as we believe increase in demand will be balanced out by the increase in supplies this year. However, prices may rise due to cost pressure if crude oil and naphtha prices kept rising. This means that the price risk remains on the upside. Table 2.8: Petrochemical Prices

Unit 2009 2010e 2011e 2012e 2013e 2014e

Ethylene USD/ton 739 1,143 1,102 1,169 1,258 1,337

LLDPE USD/ton 1,128 1,349 1,338 1,424 1,528 1,614

HDPE USD/ton 1,115 1,326 1,341 1,429 1,534 1,620

International Price Change

Ethylene -43% 45% -2% 6% 8% 6%

LLDPE -22% 9% 3% 6% 7% 6%

HDPE -24% 13% 1% 7% 7% 6%

Average Price Change -30% 23% 1% 6% 7% 6%

Crude Oil Prices USD/bbl 62 77 78 81 84 87

Crude Oil Price Change 24% 1% 4% 4% 3% Source: CMAI

Petrochemicals


Egypt’s Petrochemical Evolution Egypt has the potential to become a petrochemical hub but the sector has not been given much attention Twenty-year petrochemical development plan has faced delays: phase I plants are now expected to come on

line in late 2010e and 2011e Major impediments are cost escalations, delay in feedstock agreements, and tax on petrochemical plants Egypt should have been developed as a major petrochemical hub in the Mediterranean region due to its abundant natural gas reserves, location advantage, proximity to European and Turkish markets, and cheap labor. However, the lack of focus on downstream industry in initial years delayed execution of the petrochemical plants thereafter. Flip-flopping policies and delays in finalizing feedstock agreements have undermined efforts to become a net exporter in petrochemicals. Egypt is likely to remain a net importer of basic petrochemical products in the foreseeable future as demand continues to outstrip local supply. Chart 3.1: Egypt Net Import of Plastics Including PP, PE, and PVC

Source: CMAI Echem and future petrochemical development The government announced in 2000 its intention to accelerate the development of the downstream petrochemical industry along with the energy sector. The Egyptian government launched a twenty-year petrochemical expansion plan with an ambitious target of building 24 petrochemical projects. The plan was aimed at changing Egypt’s status from a net plastic importer to a net exporter. To execute its petrochemical plan, a separate government holding company, Egyptian Petrochemical Holding Company (Echem), was established in 2002. Prior to Echem, the responsibility for Egypt’s petrochemical sector was vested with the Egyptian General Petroleum Corporation (EGPC). Echem launched the government’s petrochemical expansion plan, which was planned to be executed in three different phases. The initial estimated investment in plant was thought to be around USD10 billion.

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Table 3.1: Original Twenty-Year Plan

Phase I Phase II Phase III

Planned Execution date 2002–2008 2009–2015 2016–2022

Envisaged Investment (USD billion) 3.5 3.3 3.3

Number of Plants and Projects 8 10 10

Major Project areas Linear Alkyl Benzene (LAB) PTA Vinyl Complex

Propylene and Polypropylene Aromatics Complex Propylene and Polypropylene

First Olefin Complex Second Olefin Complex Third Olefin Complex

Acrylic Fibers Polyester Styrene Complex

Styrene Complex Ethoxylates Butadiene

Methanol Ethylene Expansion S B Latex

PVC Expansion Detergents

Polyester Source: EChem

The government has also identified six major sites for future plants and has allocated more than 26 million square meters of land for them. These areas satisfy the criteria sought by investors in terms of size, terrain, infrastructure, access to roads, utilities, local labor, and proximity to the coast. Chart 3.2: Sites and Land Size Allocated by Government for Petrochemical Projects

Source: EGAS presentation Unfortunately, the twenty-year master plan hit the roadblocks. All of the plants experienced cost escalations and only one of eight came on stream on schedule. Phase-I of the plan coincided with a vast capacity build up undertaken by the GCC countries, which created a shortage of skilled labor, machinery, and equipment in the region. Most of the projects are now going to come on stream well into 2010 and after. Delays in executing phase I has raised serious concerns.

Petrochemicals


Table 3.2: Status of Phase I

Company Product Capacity (‘000 tons)

Initial Est. Cost (USDm)

Revised Cost (USDm)

Current Status Expected Start-up Date

E-LAB Linear Alkyl Benzene 100 230 500 Started 2Q08

E-Methanex Methanol 1300 560 950 Under construction 1H10

Egyptian Propylene and Polypropylene Co. (EPP)

Propylene and PP 400 450 750 Under construction 2H10

E-Styrenics Polystyrene 200 150 300 Under construction 1H11

1st Olefin Complex Ethylene 400 1500 1700 Gas agreement is pending

Not before 2013

E-DME Dimethyl Ether (DME) 200 Under construction 1H11

Alex Fibre Company Acrylic Fiber 1st Train 18 75 150 Started 1H06

Alex Fibre Company Acrylic Fiber 2nd Train 18 Under construction 2H09

Alex Fibre Company Acrylic Fiber 3rd Train 18 Under construction 1H10

MOPCO Urea and Ammonia 1400 Not in Original Plan

800 Under construction 1H12

Egyptian Indian Polyester Co. (EI-PET)

Polyester 315 200 400 Under construction 1H12

Source: Various News Sources Cost escalations caused many projects to be subsequently delayed. The cost of the complete plan rose in 2006 to USD15 billion from USD10 billion. The cost of first phase has also gone up to USD4.6 billion from USD3.5 billion. The subsequent recession and financial crisis made borrowing more difficult, which also caused delays. The inability to finalize the feedstock supply agreement has been the biggest hindrance to the project. The first olefins complex was scheduled to come on stream by the end of 2008, but could not secure the agreement for the feedstock supply. This complex is now expected to come on stream in 2013 at the earliest. Echem’s efforts to develop two olefin complexes using the gas from the Western Desert and the Mediterranean Sea have so far remained in the planning stage. The government has removed incentives to invest in petrochemical projects and imposed taxes on petrochemical producers, including those located in free zones. The tax rate is expected to be around 20%, according to sources in the industry. SIDPEC’s tax breaks are also going to end in 2010 despite objections from industry players. With these delays in critical agreements and uncertainties over policies and feedstock supplies, petrochemical development in the country is expected to remain sluggish, leaving the country a net importer of petrochemical products. However, this implies that existing producers like SIDPEC will continue to operate at higher utilization rates and the damage done by the global recession and upcoming Middle Eastern facilities will be muted on Egyptian petrochemical operators.

Petrochemicals


Egypt’s Petrochemical Market Overview Egypt petrochemical demand is expected to grow at 7% for the next five years leading to high operating rates Subsidized feedstock available, leading to high profitability; feedstock prices lower than west but higher than GCC Completely consolidated market structure with SIDPEC being the lone producer of ethylene and polyethylene Egypt’s petrochemical industry is growing faster than GDP The petrochemical industry in Egypt is growing rapidly as the market size of petrochemical products has increased over tenfold in the past five years. The growth in the petrochemical market has outpaced the growth in the general economy. Plastics serve the vast end market and hence tend to grow along with the GDP. However, as Egypt is in the growth phase of plastic consumption, its growth rate is higher than the general economic growth rate. Chart 4.1: Egypt’s Petrochemical Market Size

Source: Doing Business in Egypt: A Country Commercial Guide for US Companies Per capita plastic consumption in Egypt is quite low, which reflects the future potential growth of the industry. The difference between per capita consumption of plastic in Egypt and developed economies is evident. This difference indicates the room for growth in plastic consumption in Egypt. There are three phases the of plastic consumption life cycle for any economy: growth, maturity, and decline. Egypt is in the growth stage of the plastic consumption life cycle, which is marked by a sharp increase in the consumption of plastic as it is used as a substitute for traditional packaging materials like glass and paper. Other developed regions are in the maturity or decline phase. Low plastic consumption also indicates that its growth will remain higher than general economic growth rates. This room for growth in plastic consumption is reflected in the historical growth rate of the plastic consumption in the country. As shown in chart 4.2, the growth of plastic consumption in Egypt is far higher than the growth rate in the general economy. This should not be surprising as the plastic consumption in developing economies is highly geared to economic growth. Egyptian consumption of resin is growing at around 2.0x to GDP growth, which is far higher than the 1.0–1.2x multiplier experienced by more mature economies. We believe plastic growth in Egypt will remain strong in the forecasted period due to low consumption and the fact that it is still in the early stages of the plastic consumption cycle,

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Chart 4.2: Resin Consumption Patterns and Growth Rates of Plastic Consumption

Per Capita Plastic Consumption by Region Rate of Growth, GDP, and Plastics in Egypt (2003–2008)

Source: CMAI Egypt’s ethylene and polyethylene supply/demand Domestic production of both ethylene and polyethylene is expected to remain constant in Egypt as no new plants are expected to come on stream during the forecasted period. At the same time, as the economy grows, the demand for plastic products will increase. We believe all incremental demand for plastics in the country will be fulfilled by imports. At present, almost two thirds of local demand is fulfilled by imports. In Egypt the demand growth rate has minimal impact on capacity utilization of existing plants as the net importer status in the nearby future implies that the local producer will continue to operate at their peak capacity. Demand for ethylene is tied to the local plastic production. Ethylene capacity in the country is just sufficient to meet local demand. All of the ethylene production in the country is utilized in the production of polyethylene and PVC. Egypt—being a net importer of both—is expected to run its plastic manufacturing facilities at close to full capacity, which means ethylene facilities will need to run at a high operating rate to fulfill the demand of ethylene. Chart 4.3: Egypt Ethylene Consumption Pattern and Outlook

Egypt Ethylene End Usage Ethylene Outlook for Egypt

Source: Company reports, CMAI, HC Securities estimates With the delay of the first olefin cracker as well as related downstream polyethylene facilities, we believe the country will maintain the status-quo in the supply/demand of ethylene. However, if there is any additional demand like PVC expansion, then it has to be fulfilled through imports. We believe the operating rate for ethylene is expected to remain close to 95%.

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Demand for polyethylene is linked to the general economic conditions. Being in the initial stages of the plastic consumption cycle, we believe the demand for plastics will grow faster than the general GDP growth rate in Egypt. We forecast a CAGR of 7% in polyethylene consumption for the next five years. With no new facility expected to come on stream during this period, imports are expected to fulfill the gap between supply and demand. With a deficit market and being the sole producer of polyethylene in the country, we believe SIDPEC will continue to run its plant at full capacity. Chart 4.4 shows the supply/demand outlook for polyethylene in Egypt Chart 4.4: Egypt’s Polyethylene Supply/Demand Outlook

Source: Company reports, HC Securities estimates Feedstock supply and cost advantage With its abundant natural gas reserves, Egypt’s vision to become a net exporter of petrochemical products is based on the feedstock driven strategy. Current and planned facilities in Egypt are based on ethane/propane as feedstock. However, the lack of gas separation and processing facilities limit the feedstock availability for the domestic petrochemical expansion. Unlike its Middle Eastern peers, petrochemical producers in Egypt do not enjoy a fixed cost structure. An ethane and propane mixture, supplied by GASCO, is priced based on the weighted average formula that bears ethylene and polyethylene prices. Hence the feedstock cost in Egypt can be described as floating rather than fixed. This formula ensures a considerable profit margin to the producers. It is revised every month based on monthly spot prices. The whole formula in itself is reviewed by the Ministry of Petroleum every three years. Doing the back calculation on the basis of earnings and margins earned by the SIDPEC, we estimate that the ethane supply contract in Egypt is higher than Middle Eastern facilities but lower than the market price of US and Western Europe. As per our estimates, SIDPEC has paid between USD1.33/mmbtu and USD5.5/mmbtu for its natural gas feedstock in the past five years, as shown in chart 4.5. We estimate they will pay around USD4.0/mmbtu for feedstock in 2010e and afterwards feedstock prices will increase in tandem with petrochemical prices to reach close to USD5.0per mmbtu in next five years. However, if the price of petrochemical products rises much more sharply, feedstock costs could also rise faster. The feedstock advantage of the company appears to be sustainable as its costs are already flexible. This formula not only allow SIDPEC to maintain a strong global cost advantage but on the other hand ensure higher economic benefits to the government in cyclical up-terms, when petrochemical prices increase, which means gas suppliers are sharing the profitability in case of prices rise. We believe Egypt will continue to provide natural gas for feedstock at subsidized prices as it is planning to increase the country’s petrochemical output and needs to attract foreign players to set up joint ventures. The natural gas required for heating and other purposes does not fall under the category of subsidized gas. The price hike for natural gas used for heating purposes has already been implemented in 2008.

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Chart 4.5: Expected Feedstock Costs and Margins on Products

Cost of Natural Gas Used as Feedstock Sales Price Minus Cash Cost of Products

Source: HC Securities Estimates Egypt’s market structure is monopolistic Market structure of most of the commodity chemicals is fragmented at the global level. However, in Egypt tight government control has resulted in a monopolistic market structure. SIDPEC is the only producer of ethylene and polyethylene in the country. While there is complete consolidation at the producer level, end market structure remained highly fragmented with more than 1,500 plastic manufacturers in the country. The table below compares the market consolidation of Egypt with other major regions. Table 4.1: Degree of consolidation - Chemical Capacity Shares for the Top Three Producers (%)

Global North America Southeast Asia Western Europe Latin America Japan Egypt

Ethylene 11.4 35 45 26 64 41 100

HDPE 14.9 49 45 61 69 79 100

LLDPE 24.5 60 65 45 80 61 100

PVC 13.9 63 45 45 88 65 100 Source: CMAI Threat of imports from nearby GCC countries Free market pricing in the local market, the proximity to Turkish and European markets, and the freedom to sell in the domestic or export market ensures SIDPEC can always sell its products at fair international prices, thereby mitigating any threat of dumping. Egypt has the advantage of being close to Europe, allowing it to export to the market there. Middle Eastern producers are burdened by additional transportation and logistics costs when they export to Europe as they need to pass through the Suez Canal. Outlook Petrochemical demand in the country will remain robust, increasing 7% annually as per our estimates. With no new facilities coming up in the basic ethylene and polyethylene segment, the gap between supply and demand will continue to widen. Incremental demand for the plastics will be met with imports, which will keep the prices in the local market at the international level. Strong local demand and proximity to large export markets will make local producers keep running the plant at the peak capacities. Feedstock price arrangement appears sustainable ensuring high margins for the producers.

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Petrochemicals


Drivers, Company Characteristics, and Assumptions Product prices are the main driver of sales and earnings as sales volume is more or less constant Large current and future cash will generate positive interest income making earnings grow faster than sales after 2011e SIDPEC has high and stable profitability, stable sales volume, debt free balance sheet, and strong cash flow generation Sales/net income trends and forecasts SIDPEC’s sale and net income are showing different trends going forward. While sales is expected to bounce back after 2009 and keep increasing at a CAGR of 7%, net income is not going to increase much until the end of 2011e. After increasing in 2010e, net income is expected to fall again in 2011e because of the 20% taxes applied that year. After falling again in 2011e, net income will show a much higher growth rate than sales. After taking into account taxes, net income will grow 15% per annum after 2011e. Net income’s superior growth rate is due to the positive interest income which will keep increasing going forward as cash keeps accumulating at the company’s balance sheet. Chart 5.1: Sales and Net Income Trend and Forecasts

Sales and Earnings Trends of SIDPEC Sales and Earnings Growth Rate of SIDPEC

Source: Company reports, HC Securities estimates

The two main drivers of the company’s sales and profitability are sales volume and product prices. In the absence of interest costs, taxes and other charges all change in the top line and go directly to the bottom line. Changes in these two variables mainly determine SIDPEC’s earnings. Chart 5.2 shows the percentage changes in volume sold and prices. SIDPEC’s volumes are more or less constant. Other than the occasional shutdowns, SIDPEC generally operates its plant at full capacity. This leaves prices as the main determinant of profitability and sales growth. Most declines in 2009 can be attributed to a drop in product prices. Going forward, we forecast that SIDPEC will operate its plant at full capacity while the only factor of volatility would be product prices and the positive impact of interest income.

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Petrochemicals


Chart 5.2: Trend of Sales Volume and Product Prices

Indexed Movement of Volume and Prices Percentage Change in Volume and Prices

Source: Company reports, HC Securities estimates Balance sheet strength is a source of positive interest income The company has a strong balance sheet with a large amount of cash and no debt. It has used its strong operating cash flows in 2003 and 2008 to pay all of its debt ahead of schedule. This was a very good move by the company to deleverage its balance sheet before heading into the recession. SIDPEC now has cash of EGP985 million from under EGP100 million in 2003. Cash at the company represents around 15% of its total market cap. Chart 5.3: Sound Cash flow Management by the Company

Cash and Debt Movement EPS Impact of Net Debt Reduction

Source: Company reports, HC Securities Deleveraging the balance sheet has not only reduced the operating leverage but it has also helped increase the company’s EPS on the back of net interest income. As shown in the chart above, from being a deep drag on the EPS in 2003, interest income started to contribute to EPS by 2005. Net interest in 2007 and 2008 has contributed 5% to total EPS. With complete down payment of debt by 2009 we believe interest income will support EPS going forward. Returns profile and comparison to peers SIDPEC’s profitability and returns generated are comparable to the best in the sector. Chart 5.4 shows SIDPEC’s margins as well as those of its regional and global peers. Average net income margins from 2003–2008 was 46% and was next only to Industries Qatar. The EBITDA margin of the company was highest at 59%.

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Petrochemicals


SIDPEC can make up its higher cost of feedstock by controlling other costs. Its sales and administrative costs are at 1% to sales while both Industries Qatar and SABIC are at around 5%. The company’s proximity to its export market and a ready local market help improve its netback prices by lowering logistics and transportation costs. Net interest income further adds to the bottom line. Chart 5.4: Margin Comparison of SIDPEC to Global and Regional Peers

Net Income Margin Average from 2003 to 2008 EBITDA Margin Average from 2003 to 2008

Source: Company reports Impressive profitability is reflected in the return generated by the company on its equity and capital employed. The chart below compares the ROE and ROCE of SIDPEC with its regional and global peers. SIDPEC tops the list of both return measures.

Chart 5.5: Return Comparison of SIDPEC to Global and Regional Peers

Average Return on Equity Average from 2003 to 2008 Average Return on Capital Employed Average from 2003 to 2008

Source: Company reports Dividends healthy and steady SIDPEC has a vast amount of cash flow that it generates from its operations. High margins, zero debt, and limited capital expenditure leave companies with a large amount of free cash flow to pay cash dividends. As shown in chart 5.6, SIDPEC’s dividend yield is far higher than other chemical companies. As compared to its peers, SIDPEC’s dividend yield is quite high, which clearly shows that the market is not factoring in the cash flow generation and high cash dividend payout of company fully. Going forward, assuming a payout ratio of 70%, the company’s dividend yield will be healthy and steady.

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Petrochemicals


Chart 5.6: SIDPEC Dividend Yields

2008 Dividend Yield Comparison SIDPEC Dividend Yield and Risk-Free Rates of Egypt

Source: Company reports, HC Securities estimates Strong future cash flow generation could return to shareholders in various forms To capture the cash generation of the company completely we look at the cumulative distributable cash generated instead of the cash dividends, which only takes into account the cash paid back to the shareholders. Chart 5.7 below shows that over the next five years the company will generate cash equal to EGP11.2/share. We defined distributable cash flow as operating cash flow minus capital expenditure. This implies that the company is going to generate cash equal to its present market capitalization in the next five years only. With its unlevered balance sheet and low capital expenditure, much of this cash can return to shareholders in the form of cash dividends or share buybacks.

Chart 5.7: Cumulative Distributable Cash Flow Generated by SIDPEC

Source: HC Securities estimates Defensiveness in sales volume and ability to switch between domestic and export market We forecast very little changes in the sales volume of the company while all earnings changes are derived from price changes. The main source of defensiveness of the sales volume is the presence of large domestic as well as nearby export markets. The company can easily shift its sales to the domestic market in case of weakness in export markets. Product deficit in the local market ensures that it can sell the entire product it can produce.

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Petrochemicals


SIDPEC has produced close to its full capacity in the past five years. Local sales of polyethylene have steadily declined from 62% in 2004 to below 50% in 2007 before picking up in 2008. This shows the company’s remarkable ability to sell its products with ease in the local as well as export market and yet depend on neither. Chart 5.8: Sales Volume ( in ‘000 tons) by Product and Market


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Petrochemicals


Risks Fall in energy prices SIDPEC, like its regional peers, derives its cost advantage from lower-priced feedstock. Any correction in the energy prices would decrease this cost advantage, lower the margin, and hence profitability. Marginal cost producers of petrochemical products are naphtha based producers and their feedstock cost is linked to international crude oil prices. Doubling crude oil prices has increased product prices as well, which is helping SIDPEC’s margins. Fall in energy prices Any fall in product prices due to oversupply in the market or fall in energy prices leads to a corresponding drop in SIDPEC’s earnings. SIDPEC’s earnings are almost perfectly correlated with product prices and any fall or rise in prices would lead to corresponding change in bottom line. Gas supply prices revision The Egypt government has said that the price of natural gas used as feedstock is not going to increase and the recent hike in gas prices would only affect the natural gas used for the heating purpose. Nonetheless, SIDPEC lacks long-term gas price contracts like its regional peers and is exposed to changes or hikes in the natural gas used for the feedstock purpose as well. Failure to secure gas supply for capacity expansion Failure to secure additional gas for capacity expansion is not a risk to the valuation here as we have not included any capacity expansion into our numbers. Failure to secure gas supply for expansion will hurt the expansion plans of the company, severely restricting its ability to raise its production and earnings. Dumping by Middle Eastern companies The threat of dumping of products from regional gulf companies is real but mitigated by the free pricing structure of the local market. Nonetheless, dumping can distort prices and affect local sales of the company in at least the short term, if not on a consistent basis. Proximity to large export markets such as Turkey and Europe also mitigate the sales volume destruction due to dumping in the local market Cyclicality SIDPEC produces commodity chemicals, which make its earnings cyclical. Global commodity product prices are determined the energy prices, industry operating rates, and supply/demand conditions. Although a ready local market for its products reduces the sales volume volatility as the company is not dependent on exports, prices are set internationally and linked to global economic conditions. Any downfall in demand could loosen the supply/demand balance thereby putting downward pressure on prices. Operating risks In addition to normal business risks, petrochemical producers are also exposed to the other operating risks. Petrochemical plants include handling and processing of dangerous materials including explosives and flammable substances. The company is dependent on external suppliers for its key raw materials. Operating petrochemical plants includes several unit operations and inherently involves the risk of interruption from operating problems.

Petrochemicals


Financial Model

Income Statement 2005 2006 2007 2008 2009 2010e 2011e 2012e 2013e 2014e

Gross Revenues 1,702 1,969 2,084 2,119 1,683 2,020 2,013 2,140 2,296 2,425

Cost of Goods Sold (653) (740) (723) (939) (820) (956) (961) (1,000) (1,030) (1,053)

Gross Margin 1,049 1,229 1,361 1,181 863 1,063 1,052 1,140 1,266 1,372

Sales, General, and Admin. Expenses (25) (27) (30) (54) (49) (61) (60) (64) (69) (73)

SG&A as % of Sales 1% 1% 1% 3% 3% 3% 3% 3% 3% 3%

Depreciation Expense (174) (173) (167) (167) (167) (167) (167) (167) (167) (167)

Operating Income (EBIT) 850 1,030 1,164 959 648 836 825 909 1,030 1,133

Interest Expense (60) (45) (28) (24) (0) (1) 0 0 0 0

Interest Income 35 50 72 67 64 49 89 117 148 182

Investment Income (30) 1 0 0 0 40 54 55 56 57

Foreign Exchange Gain/Loss 0 (3) (15) 0 (1) 0 0 0 0 0

Provisions 0 (1) (1) (0) (0) 0 0 0 0 0

Prior Year Expense 0 (1) 0 0 0 0 0 0 0 0

Prior Year Income 0 2 2 0 3 0 0 0 0 0

Other Income 0 0 0 1 37 0 0 0 0 0

Other Expense 0 (13) (11) 0 0 0 0 0 0 0

Income Before Taxes/Zakat 795 1,021 1,185 1,003 752 924 968 1,082 1,234 1,372

Tax / Zakat Provision 0 (20) (19) (0) 7 0 (194) (216) (247) (274)

Taxes as % of Income Before Tax 0% 2% 2% 0% -1% 0% 20% 20% 20% 20%

Net Income 795 1,001 1,166 1,003 759 924 774 865 988 1,098

Unusual Items After Tax 0.00 0.28 0.37 0.36 0 0 0 0 0 0

Net Income After Unusual Items 795 1,001 1,167 1,003 759 924 774 865 988 1,098

Net Income ex Unusual Items 795 1,001 1,166 1,002 759 924 774 865 988 1,098

EPS 7.57 1.91 2.22 1.91 1.45 1.76 1.48 1.65 1.88 2.09

Number of Shares (Diluted) 105 524 525 525 525 525 525 525 525 525

Dividend Per Share 5.29 1.28 1.79 2.10 1.82 1.23 1.03 1.15 1.32 1.46 Source: HC Securities estimates

Petrochemicals


Cash Flow Statement 2005 2006 2007 2008 2009 2010e 2011e 2012e 2013e 2014e

Operating Activities

Net Income before Tax and Minority Interest 795 1,001 1,167 1,003 759 924 968 1,082 1,234 1,372

Depreciation and Amortization 174 173 167 167 167 167 167 167 167 167

(Increase) Decrease in Accounts Receivable 53 1 (11) (13) (11)

(Increase) Decrease in Inventories (9) (1) (10) (7) (5)

Increase (Decrease) in Accounts Payable 317 2 15 11 8

Change In Operating Activities (99) 202 (14) (123) (90) 361 1 (5) (9) (8)

Change in Provisions 53 51 (11) (11) (37) 0 0 0 0 0

Other Current Assets 0 0 0 0 0 0

Other Non-current Liabilities 0 0 0 0 0 16 0 0 0 0

Cash Flows from Operating Activities 922 1,426 1,310 1,037 798 1,468 1,136 1,243 1,393 1,532

Investing Activities

(Increase) Decrease in PPE (48) (29) (4) (7) (17) (21) (21) (22) (24) (25)

(Increase) Decrease in Investments 0 0 (27) 0 0 0 0 0 0 0

Other Cash Inflow (Outflow) 0 0 0 0

Cash Flows from Investing Activities (48) (29) (32) (7) (17) (21) (21) (22) (24) (25)

Financing Activities

Dividends Paid During the Year (555) (671) (940) (1,104) (956) (646) (542) (606) (691) (768)

Increase (Decrease) in Short-Term Loans 0 0 0 0 (5) (0) (4) 0 0 0

Increase (Decrease) in Long-Term Loans (31) (179) (184) (174) 0 (4) 0 0 0 0

Issuances (purchases) of Equity Shares 0 0 0 0 0 0 0 0 0 0

Other Fin. Cash Inflow (Outflow) 0 0 0 0 0 0 0 0 0 0

Cash Flows from Financing Activities (587) (850) (1,124) (1,278) (961) (651) (546) (606) (691) (768)

Effect of Exchange Rates on Cash 0 3 (15) (14) (1) 0 0 0 0 0

Increase (Decrease) in Cash and Equivalents

Net increase (Decrease) in Cash and Cash Equiv. 288 550 139 (261) (181) 796 569 616 678 738

Cash at Beginning of Period 554 842 1,288 1,427 1,166 984 1,781 2,350 2,965 3,643

Cash at End of Period 842 1,393 1,427 1,166 984 1,781 2,350 2,965 3,643 4,381 Source: HC Securities estimates

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Balance Sheet 2005 2006 2007 2008 2009 2010e 2011e 2012e 2013e 2014e

Assets

Cash and Cash Equivalents 842 1,288 1,427 1,166 985 1,781 2,350 2,965 3,643 4,381

Accounts Receivables 127 241 180 117 219 166 166 176 189 200

Other receivables 0 6 23 0 8 8 8 8 8 8

Total Receivables 127 247 202 117 227 174 174 184 197 208

Total Inventory 193 180 181 241 222 231 232 242 249 254

Advance Payments to Suppliers 0 2 1 9 5 5 5 5 5 5

Due from Sister Companies/Associates 194 189 226 604 113 113 113 113 113 113

Loans to Employees (under one year) 0 0 0 1 1 1 1 1 1 1

Prepaid Expenses ST 0 3 3 3 3 3 3 3 3 3

Other Current Assets 22 15 16 33 15 15 15 15 15 15

Total Current Assets 1,378 1,923 2,056 2,175 1,572 2,323 2,893 3,528 4,226 4,980

Fixed Assets at Cost 1,603 2,316 2,322 2,325 2,325 2,346 2,367 2,389 2,413 2,438

Less: Accumulated Depreciation 0 (879) (1,046) (1,213) (1,377) (1,544) (1,711) (1,878) (2,045) (2,045)

Add: Capital Work in Progress 8 31 29 33 46 0 0 0 0 0

Net Fixed Assets 1,611 1,468 1,305 1,145 994 803 656 511 368 393

Other Long-Term Investments 30 30 57 57 57 57 57 57 57 57

Total Long-Term Investments 30 30 57 57 57 57 57 57 57 57

Employee Union Loan (over one year) 0 1 5 7 9 9 9 9 9 9

Total Long-Term Assets 1,641 1,498 1,368 1,210 1,061 869 723 578 435 460

Total Assets 3,019 3,422 3,424 3,385 2,633 3,192 3,615 4,106 4,661 5,440

Liabilities

Current Portion of Long-Term Debt 182 173 166 5 5 4 0 0 0 0

Accounts Payable 217 296 237 502 40 357 358 373 384 393

Accrued Expenses 0 8 7 9 11 11 11 11 11 11

Taxes/Zakat Payable 0 10 8 0 0 0 0 0 0 0

Due To Sister Companies 4 6 12 0 16 0 0 0 0 0

Other Current Liabilities 0 88 71 72 1 1 1 1 1 1

Total Current Liabilities 403 582 501 588 73 374 371 385 397 405

Long Term Debt 370 150 14 9 4 0 0 0 0 0

Tax Provision 5 28 31 25 23 23 23 23 23 23

Deferred Tax Income 0 39 39 39 32 32 32 32 32 32

Other Provisions 165 216 205 189 163 163 163 163 163 163

Total Provisions 170 283 275 253 218 218 218 218 218 218

Total Liabilities and Provisions 942 1,014 790 850 295 591 588 603 614 623

Paid-up Capital 1,050 1,050 1,050 1,050 1,050 1,050 1,050 1,050 1,050 1,050

Legal/Statutory Reserve 116 195 295 412 512 336 956 1,313 1,698 1,557

Reserves 105 105 105 66 15 15 15 15 15 15

Retained Earnings/ Accumulated losses 11 56 16 3 1 277 232 260 296 1,098

Net Profit of the Year 795 1,001 1,167 1,003 759 924 774 865 988 1,098

Total Shareholders' Equity 2,077 2,407 2,634 2,534 2,337 2,601 3,027 3,503 4,046 4,817

Total Liab. & Shareholder Equity 3,019 3,422 3,424 3,385 2,633 3,192 3,615 4,106 4,661 5,440 Source: HC Securities estimates

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Appendix 1: Company Profile Company Description SIDPEC was incorporated in 1997. It is an Egyptian joint stock company, which became operational in September 2000. The company was formed under Law 8 of 1997, which provides special incentives to industries needed for import-substitution and projects depending on gas. It is located in Km 36 Alex – Cairo desert road, Alnahda – Alameria – Alexandria. SIDPEC’s main business is to produce higher-value petrochemical products using natural gas as feedstock. Its main products are ethylene and polyethylene, and the company has remained the sole producer of both in Egypt. The company covers the complete requirement of ethylene in the country and around one third of the local polyethylene demand. SIDPEC has installed annual capacity of 300 thousand tons of ethylene and 225 thousand tons of polyethylene. Ethylene is consumed internally for the production of PE while excess ethylene is sold to The Egyptian Petrochemical Company (EPC), also located in Ameriya petrochemical complex, for its PVC manufacturing. Polyethylene is sold in the local and export market. SIDPEC became Egypt's first petrochemical exporter in 2001. Capital and Shareholding Pattern The company’s authorized capital is EGP5.1 billion at present. Its issued and paid up capital at the time of formation was EGP1.03 billion. The company’s general assembly decided on 25 March, 2004 to distribute a stock dividend worth EGP30 million, thereby increasing paid up capital to EGP1.05 billion. The stock has undergone numerous splits aimed at increasing its liquidity. Originally, the EGP1.05 billion paid up capital of the company was distributed over 10.5 million shares with a par value of EGP100.0. In an extraordinary general assembly held on 4 May, 2005, the company agreed to split the stock in the ratio of 10:1, which would increase total outstanding shares to 105 million with a par value of EGP10.0 per share. The stock split was aimed at increasing the liquidity of the stock just prior to its public offering in August 2005. After its public offering stock underwent another 5:1 split, which took the par value of each share to EGP2.0 and the total number of shares to 525 million. SIDPEC's shareholders include EPC, National Bank of Egypt, Bank of Alexandria, Nasser Social Bank, and National Investment Bank as well as insurance companies and investment funds. Some 23% of its shares are free floated after the IPO on the Cairo and Alexandria Stock Exchanges. Table 6.1: Liquidity of the Stock

Past 12 months Past six months Total Shares Traded ( '000) 235,135 63,901

Value of Shares Traded ('000) 2,520,943 745,486

Number of Transactions 144,531 43,240 Source: EGX Chart 6.1: SIDPEC Shareholding Structure

Source: Company reports, HC Securities

2%

3%

7%

7%

7%

20%

23%

31%

Nasser Social Bank

Misr Insurance Company

National Investment Bank

Ahli Capital Holding

EPC

ECHEM

Free Float

Social Insurance Funds

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Feedstock Agreement As the company was formed under a law that provides special incentives to industries needed for import-substitution and projects depending on gas, SIDPEC enjoyed a feedstock cost advantage like its other Middle Eastern peers. However, feedstock is not available at fixed subsidized cost but it is set according to a formula that link gas prices to global ethylene and P.E prices. This formula was originally set to allow SIDPEC to maintain a strong global cost advantage and on the other hand ensure higher economic benefits to the government cyclical up-terms, when petrochemical prices increase. The feedstock formula is revised every 3 years. We have carried out some back calculations to ascertain the cost of gas SIDPEC is paying for feedstock depending on the margin and income earned. Based on our calculations, we believe the company is paying higher than Middle Eastern facilities but still lower than what the US or other Western peers. The cost of natural gas for the feedstock is expected to remain between USD2.5/mmbtu to USD5.0/mmbtu. Energy Liberalization Policy The recent energy price liberalization policy of the Egyptian government will not have much impact on the cost structure of the SIDPEC as the rise in natural gas prices are set for the energy usage only. Hikes are not meant for natural gas, which is used as raw material i.e. ethane/propane mixture. Also, most of the energy price increases have already been implemented for SIDPEC. The energy liberalization policy was enacted in September 2007 to adjust energy price levels to approximate actual cost by 2010. At the time, non-energy intensive industries received a one-year grace period, while industries deemed energy-intensive such as petrochemicals, cement, fertilizers, glass, and ceramics, were required to pay the higher energy prices immediately. Fuel and energy costs are less than 5% of total revenue. It is the ethane/propane gas—the main feedstock for ethylene production—which constitutes around 65% of the total cost of goods sold (COGS). Since the major component of the cost is not expected to change, we believe energy policy changes are not going to impact the cost structure of SIDPEC. Production Facilities SIDPEC operates one ethane-based cracker, which is integrated to the downstream polyethylene unit. There are other secondary units in the complex for light naphtha and liquid petroleum gases (LPG). One unit for alpha olefins is also present. Toyo Engineering installed in 1998 the ethane cracker under a USD230 million contract. Designed capacity of the unit was 300 thousand tons. In the same year, LLDPE/HDPE and butene-1 plants were built by Samsung of South Korea under a USD250 million contract. The Alpha Olefin plant and the LLDPE unit are licensed from BP Chemicals. The polyethylene unit uses the switch technology from BP where both the grades of polyethylene are produced in the same unit. SIDPEC produces only two varieties of polyethylene HDPE and LLDPE. It does not produce LDPE. Table 6.2

Production Unit Technology Licensed From …

Designed Capacity (‘000 tons) Feedstock Notes

Ethylene Unit ABB Lummus 300 Ethane/Propane Cracker of the plant—the is the main unit

Polyethylene Unit BP 225 Ethylene Downstream unit for converting ethylene to final product

LPG Unit ABB Lummus 50 Exhaust gases from ethylene unit

Captures gases from ethylene unit. Feeds LPG backs to GASCO

Butene - 1 Unit IFP 10 Ethylene Produces naphtha. Used in polymerization reaction for polyethylene production


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Chart 6.2: Process Flow Diagram of SIDPEC Operations

Source: HC Securities

Material Balance SIDPEC is highly integrated as its downstream polyethylene units are fully integrated with its ethylene unit. The ethylene unit provides ethylene for both SIDPEC’s polyethylene and EPC’s PVC production. The ethylene unit was deliberately designed for higher capacity so excess ethylene could substitute for imported ethylene. SIDPEC material balance at 100% of operating rate is presented in the table below. Since the company uses switch technology to produce two varieties of polyethylene and does not provide the breakup of each, we have assumed that it produces half of each. Around 16% of the ethylene production is sold to other sister companies, mainly EPC. Table 6.3: Material Balance of SIDPEC

At 100% Operating Rate

Product Production Consumption Balance % externally sold

Ethylene 300 251 49 16%

LLDPE 113 0 113 100%

HDPE 113 0 113 100% Source: HC Securities estimates

Petrochemicals


Appendix 2: Ethylene and Polyethylene Basics Petrochemicals are derived from some basic source of hydrocarbon, which acts as feedstock to the plant. The most important feedstocks are (i) ethane, propane, and butane, which are derived mainly from natural gas and (ii) naphtha, atmospheric gas oils, and residues, which are derived from crude oil and coal. The most important petrochemical is ethylene, which accounts for around 40% of the global petrochemical trade by volume, and polyethylene, which is the largest end market for ethylene and hence influences the ethylene cycle. Ethylene Ethylene is the simplest and most important petrochemical. It is consumed in the largest quantity and forms makes up 40% of the global petrochemical and polymer industry. Ethylene in itself has no use, but is used in the production of a wide array industrial chemicals and plastics. The table below shows the end-market usage of ethylene.

Table 7.1: End Derivative Demand of Ethylene

Ethylene Derivatives World Ethylene Consumption Typical derivative end usage

Polyethylene 60% Plastic films, containers, coatings

Ethylene Oxide 14% Antifreeze, polyester, detergents

Ethylene Dichloride 12% PVC films, coatings, pipes

Ethylbenzene 7% Polyester packaging, ABS resins

Alpha Olefins 3% Co-monomers, lubes, detergents

Vinyl Acetate 1% Adhesives and packaging

Others 4% Various applications Source: CMAI

Ethylene is a flammable and colorless gas and hence needs to be stored at high pressure and low temperatures. Its physical properties make it difficult and expensive to store and transport, meaning it is limitedly traded. Most of ethylene produced is integrated to the downstream units for further processing into final products. The ethylene cycle is often viewed as a good proxy for the complete global commodity cycle. Production Ethylene is produced by a thermal reaction commonly known as cracking, which includes breaking the bonds in the hydrocarbon chains to produce ethylene monomer. Along with ethylene, a host of other co-products are also produced which needs to be separated from it. Co-products are not waste and can be processed further into other useful chemicals. Typical co-products from an ethylene cracker include propylene, pygas, and C4s. The yield of ethylene and the amount of co-products produced depend on the type of feedstock used for the production of ethylene. The two most common feedstocks for ethylene are ethane and naphtha. Ethane is popular because it gives the highest yield of desired ethylene and the least co-products. While naphtha produces the least ethylene per ton of feedstock and the most co-products, it still remains as one of the most popular feedstock primarily because of its availability and ease of transport. The table below shows the yield of ethylene and co-products using various feedstocks. Table 7.2: Feedstock Requirements and Co-products Produced/Ton of Ethylene

Full Range Naphtha

Mass per Mass of feed Ethane Propane Butane Light Naphtha High Severity Low Severity Gas Oil

Feed 1.29 2.38 2.51 2.98 2.94 3.33 3.85

Ethylene 1.00 1.00 1.00 1.00 1.00 1.00 1.00

Hydrogen 0.11 0.05 0.04 0.05 0.06 0.04 0.04

Fuel Gas 0.08 0.65 0.56 0.51 0.50 0.45 0.43

Propylene 0.04 0.40 0.43 0.46 0.45 0.55 0.62

C4s 0.04 0.10 0.26 0.26 0.23 0.35 0.36

Pygas 0.02 0.16 0.18 0.55 0.52 0.70 0.71

Fuel Oil 0.00 0.01 0.04 0.15 0.18 0.24 0.69 Source: CMAI

Choice of feedstock is one of most important factors to be considered when setting up an ethylene cracker. The type of feedstock decides how much ethylene and other co-products will be produced.

Petrochemicals


Feedstock and Plant Complexity Feedstock selection also determines the complexity of the plant. Ethane-based plants are the simplest and cheapest to construct, while naphtha-based plants are the most complex as they require additional units for separating the significant amount of co-products produced. The complexity and higher operating costs of naphtha-based plants do not necessarily mean that they are cost disadvantaged. The cost to produce a ton of ethylene from a naphtha-based plant is lowered by the significant amount of value generated by the co-products, which offsets the higher feedstock costs. Availability of feedstock is the most important criteria when deciding on the type of cracker as it can override all other considerations. Middle Eastern countries have a large amount of stranded gas reserves, which lead to a dominance of ethane-based crackers in the region. In contrast, Asian countries have a large demand for petrochemical products, but have low local feedstock availability. Hence, most Asian crackers are based on naphtha as it easier to transport and store. Other regions like the US and Europe have infrastructure developed enough to transport both the oil and gas. This has lead to the development of flexible feedstock crackers. These are designed to use both naphtha and gases as feedstock so that they can take advantage of price disparities besides availability. Technology Most of the available ethylene production methods are similar, indicating the maturity of the technology. Several different ethylene technologies are commercially available and can easily be licensed. There are several major licensors of conventional commercial olefin technologies including ABB Lummus, Halliburton (formerly Kellogg Brown & Root [KBR]), Linde, KTI/Technip, Shaw Group’s Stone, and Webster. The various technologies can all be adjusted to provide optimal results for any conditions. Therefore, producers who are building olefin plants often base their selection of a process or technology on two factors: whether the desired technology can be tailored to fit their specific operating conditions and whether it can be implemented at the most competitive capital costs. Feedstock Costs – Middle East Redefining Cost Curve Commodity chemicals are sold in bulk with little differentiation among suppliers. There are limited options available for suppliers to gain a competitive advantage. Some of the options include gaining market share, economies of scale, cost reductions, and logistics advantage. Cost reduction through feedstock has gained increasing importance in the past decade with the emergence of Middle Eastern facilities. Saudi Arabia first entered the ethylene market in the late 1980s with joint venture initiatives with Shell, Exxon, and Mobil. However, Middle Eastern capacity shot up feedstock prices in the other parts of the world jumped at the turn of the century. High oil prices, a sharp increase in US natural gas costs, the emergence of China as a huge demand driver, and the desire to monetize its stranded gas reserves all gave the Middle East a stable and strong reason to invest in petrochemical facilities. Ethane-based crackers in the region have fixed long-term supply agreements for ethane, with their national oil companies for a price ranging from USD0.75/mmbtu to USD1.25/mmbtu in equivalent natural gas costs. This translates to a huge cost advantage over its peers in other regions when oil prices trade at around USD70/barrel and natural gas at around USD5.0/mmbtu. The table below shows the cost of ethylene for various regions. Table 7.2: Cost of Ethylene by Region

Region Feedstock Unit

Feedstock Price (USD) Ethylene Cash Cost (USD /ton) ME Cost Adv.

(USD/ton) Ethylene Margin (USD1000 /ton of

Ethylene ) Middle East - KSA USD/mmbtu 0.75 110 89%

Middle East - Other USD/mmbtu 1.25 175 83%

SIDPEC USD/mmbtu 3.00 350 208 65%

SE Asia - Ethane USD/mmbtu 4.00 390 248 61%

Western Canada - Ethane USD/mmbtu 4.50 410 268 59%

US - Ethane USD/mmbtu 5.00 500 358 50%

Europe - Gas USD/mmbtu 6.00 600 458 40%

US - Naphtha USD/ton 600 910 768 9%

SE Asia - Naphtha USD/ton 590 940 798 6%

NE Asia - Naphtha USD/ton 600 950 808 5%

Europe - Naphtha USD/ton 610 970 828 3% Source: HC Securities Estimates We have created our own ethylene cost curve to show the cost advantage of the different regions. The gaining importance of cost advantage is evident from the steepening cost curve over the years. The cost curve was almost flat in 1990, which implies that

Petrochemicals


almost all facilities in the world had similar costs. But over time, energy prices across globe increased. However, feedstock prices in the Middle East remained more or less the same, giving it a strong cost advantage. The cost curve is expected to steepen by 2013 thereby increasing the cost advantage of Middle Eastern facilities. Chart 7.1: Ethylene Cost Curve

Source: HC Securities estimates Capacity Additions The petrochemical industry has experienced a wave of capacity additions since 2005 and new capacities are expected to keep coming online until 2012. Owing to their lack of cost advantage, the US and Europe have shied away from capacity expansions with the bulk of capacity added in either the cost advantaged Middle East or at the demand center in China. From 2009 to 2012, more than 20 million tons of new capacity is expected to come on stream, with 90% of it coming up in Middle East and China. The charts below show the ethylene capacity distribution change prior to and after the wave and capacity additions. Chart 7.2: Global Ethylene Capacity Distribution by Region

Ethylene Capacity Distribution in 2005 Ethylene Capacity Distribution in 2013e

Source: CMAI

35%

21%

20%

10%

6%5% 4% North America

North East Asia

West Europe

Middle East

South East Asia

Central Europe and CIS StatesSouth America

25%

24%19%

15%

8%4% 3% North America

North East Asia

Middle East

West Europe

South East Asia

Central Europe and CIS StatesSouth America

Petrochemicals


Table 7.2: Global Ethylene Capacity Additions

Company Country Location 2009 2010e 2011e 2012e

Arya Sasol Iran Assaluyeh 1,000 Jam Petrochemicals Iran Assaluyeh 1,320 Kavyan Iran Assaluyeh 2,000 Morvarid Oetrochemical Iran Assaluyeh 125 500 Ilam Petrochemical Iran Ilam 245 490 Persian Gulf Petrochemical Iran Assaluyeh

Gachsaran PC Iran Gachsaran 250 1,000

Kuwait Olefins (TKOC) Kuwait Shuaiba 850

Qapco Qatar Mesaleed 80 Ras Laffan Olefins Qatar Ras Laffan 650 1,300 Qatar Honam JV Qatar Mesaleed 410

Jubail Chevron Phillips Saudi Arabia Al Jubail 300 Saudi Polymers Co. Saudi Arabia Al Jubail 1,200 Petrorabigh Saudi Arabia Yanbu - Rabigh 1,300 Sharq Saudi Arabia Al Jubail 400 1,300 SEPC Saudi Arabia Al Jubail 1,000 Saudi Kayan Saudi Arabia Al Jubail 650 1,350 Yansab Saudi Arabia Yanbu 650 1,300

Borouge II UAE Ruwais 725 1,450 Borouge III UAE Ruwais

BPCL India Assam 110 220 Reliance Industries India Gujarat 1,650

Baotou Shenhua China Inner Mongolia 130 260 Daqing PC China Daquing, Heilong 300 600 Fushun PC China Liaoning 600 800 Sichuan PC China Chengdu, Sichuan 800 Sinopec Wuhan China Hebei 800 ZRCC China Ningbo, Zhejiang 750 1,000 Fujian PC/Sinopec/Aramco/EM China Fushun, China 800 CNOOC & Shell JV China Tianjin 500 500 Major Capacity Additions 7,570 6,630 8,075 9,390 Major capacity Additions as % of Global Capacity 6% 5% 5% 6% Total Ethylene Capacity 137,174 146,483 153,418 157,958 Total Ethylene Capacity Growth Rate 6% 7% 5% 3% Source: CMAI Polyethylene Polyethylene is formed by polymerizing ethylene into long chains of hydrocarbons. Polyethylene is the largest end-market product of ethylene and hence is the key driver of the ethylene cycle. Polyethylene can be classified into three commercial grades: low density polyethylene (LDPE), linear low density polyethylene (LLDPE), and high density polyethylene (HDPE). LDPE is the first commercial grade of polyethylene and has been around since the 1940s. It is considered a mature product with slow demand growth. LDPE is widely used in the applications requiring clarity, inertness, processing ease, sealability, moisture barriers and good electrical properties. It is also commonly referred as “branched” polyethylene or “high-pressure” polyethylene.

Petrochemicals


LLDPE is the newest polyethylene grade, having first commercialized in the 1970s. LLDPE has better tensile, impact, and tear properties than LDPE. It also has excellent low- and high-temperature properties. LLDPE is cheaper and tougher than LDPE. LLDPE is displacing LDPE in applications such as film applications, shrink and stretch wrap, and trash can liners due to its cost and durability. However, LLDPE is not as clear as LDPE. The major end-market for LLDPE is films, followed by injection molding, then rot molding. LLDPE plants are often built to produce HDPE as well and are commonly referred to as “swing” plants. HDPE was first commercialized in the 1950s. It is the most crystalline of polyethylenes and is characterized by a wax-like feel, flexibility, inertness, crack resistance, and relatively high softening temperature. HDPE is the most versatile polyethylene with a range of applications and a low cost of production. The major end-market segment for HDPE is blow molding with applications such as milk bottles, industrial drums, oil bottles, and gas tanks. It is also used in injection molding, film sheeting, and pipe making. A convertor producing many end-market products may choose HDPE as the primary resin due to its range of applications. Chart 7.3: Polyethylene End-Market Usage

Source: CMAI Physical Characteristics Polyethylene resins are either powders or pellets that can be shipped in bulk containers such as railcars, trucks, and ships. As it is solid in nature, it can be easily transported at ambient temperatures and pressure. Due to this ease of transportation, polyethylene can be internationally traded with many less complications and fewer costs. Polyethylene is a mean to move ethylene globally. Supply/Demand Outlook The end-market demand for polyethylene is much more stable than other petrochemicals. The link between demand growth and economic growth is less strong in the case of polyethylene. Demand growth tends to be a function of disposable income, developed economic status, and availability. This is so because polyethylene is mainly consumed in non-durable goods and applications. The main end-uses for polyethylene can be classified into industrials and consumer markets. Industrial applications are required to package and move goods to consumer markets. Consumer applications are generally disposable in nature like food packaging, trash bags, bottles, and coating for paper products. The chart below shows the supply demand outlook as well as the breakdown of polyethylene by type for Middle East.

Films & Sheets 55%

Injection Molding 11%

Blow Molding 12%

Pipe & Conduit 5%

Extrusion Coating 5%

Wires & Cables 2%

Rotomolding 1%

Other 9%

Petrochemicals


Chart 7.4: Middle East Polyethylene Supply/Demand and Breakdown

Middle East Polyethylene Supply Demand ME Polyethylene Breakdown by Type

Source: CMAI Polyethylene capacity is expected to increase throughout 2009, with major additions later in the year. Operating rates have dropped in the initial part of the year but are expected to keep edging up in 2010e. Total demand includes export, which forms most of demand. HDPE makes up around half of polyethylene and is the most versatile of all the three types of PE. LDPE, being the most mature, has the least share in capacity. Capacity Additions As polyethylene acts as a vehicle to move ethylene internationally, polyethylene tends to be built along with ethylene crackers in the same petrochemical complexes. As more and more ethylene is added in cost advantaged regions, polyethylene plants are also added. Around 15 million tons of new capacity will be added globally from 2007 to 2013. Around 60% of the new polyethylene capacities are coming up in Gulf countries while 30% are coming up in Asia. Of polyethylene, around 42% of the new capacity will be made up of HDPE and 35% LLDPE. Capacity additions in LDPE are small and limited to less developed countries. Additions for LDPE are low due to its mature product profile. It is increasingly being replaced with LLDPE.

60%

70%

80%

90%

100%

0500

1,0001,5002,0002,5003,0003,5004,000

'00

0 M

etri

c To

n

Nameplate Capacity Total Demand

Operating Rate, %

HDPE 49%

LLDPE 35%

LDPE 15%

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Appendix 3: Egypt Energy Market Overview Egypt is a significant oil producer and coming up as a rapidly growing producer of natural gas. The energy sector has consistently contributed more than 30% of total external trade in this decade. The downstream petrochemical sector is closely linked to the energy sector for its feedstock supplies. Hence, the development and dynamics of the energy sector has important ramifications for the petrochemical development in the country. Chart 8.1: Egypt Energy and Total Export Development

Source: EIA, IMF The composition of energy sector has changed dramatically over the past 15 years, with natural gas increasingly gaining importance over crude oil. Over the years, the country’s oil production is declining while natural gas is rising sharply. With a more promising outlook, the natural gas sector is now gaining more importance in Egypt’s energy as well as the petrochemical future. Chart 8.2: Production of Hydrocarbons in Egypt

Source: EIA Evolution of Egypt’s Energy Sector Petroleum development in Egypt started as early as 1860, but the first oil production started only in 1910 when Anglo-Egyptian Oilfields, a joint venture between Shell and British Petroleum, began to produce oil from Gemsa field. Anglo-Egyptian Oilfields was the dominant player until 1964 when it was nationalized. General Petroleum Authority (GPA) was established in 1956 by the government to safeguard the country’s interests in the development of its natural resources. GPA was renamed Egyptian General Petroleum Corporation (EGPC) in 1962. EGPC adopted joint explorations policy which was not favored by the international oil companies and the petroleum development of the country remained sluggish. EGPC switched in 1973 to issuing exploration licenses to foreign companies with subsequent

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2003 2004 2005 2006 2007

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Energy exports Total Exports

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sharing of any finds. This model proved so successful that it is continued to date. Changes in the exploration licensing policy bared fruit and by 1976 Egypt became a net exporter of crude oil for the first time. The World Bank urged Egypt to capitalize on its natural gas reserves and so EGPC started to encourage the substitution of oil for gas in 1987. Until 1986 Egypt’s nationalistic policy that gas should be use only by the Egyptian organization discouraged foreign companies to look for gas. They also did not develop the associated gas discovered in the course of oil prospecting. A “gas clause” (under which profit on gas was divided) to remunerate foreign companies for gas discoveries was introduced of 1986. The change in model was successful and Egypt’s dry natural gas production picked up. In the 1990s, crude oil production remained stagnant and began to decline after 1996. Proven oil reserves remained at three billion barrels in the absence of any major new field discovery. In contrast to the crude oil market, natural gas reserves as well as production continues to rise throughout 1990s. EGPC eyed natural gas as key to future export growth and in 2000 Egypt allowed natural gas to be exported for the first time. Egypt’s Energy Sector Structure Over the years Egypt’s energy sector was dominated by state-run EGPC, but to accelerate decision making and facilitate coordination, the energy sector was broken into three more holding companies. These holding companies work under the Ministry of Petroleum and focus on their respective fields of operation.

EGPC has the sole right to import and export crude oil from the country. EGAS was established in 2001 to focus on the development of natural gas reserves of the country. ECHEM is a holding established in 2002 and is assigned to manage Egypt’s petrochemical industry. GANOPE, previously known as the South Valley Development Company (SVDC), was established in January 2003 to promote development activities specifically in Upper Egypt (Sohag, Aswan, Assyout, Qena, Al Wadi El-Gedied). GASCO was established in 1997 to focus on the natural gas transmission, distribution and processing of natural gas. Crude in Egypt With maturing oil fields and no major discoveries in the recent years, the crude oil sector in Egypt has matured and its production is declining annually. Proven oil reserves of crude oil in Egypt remain stagnated at three billion barrels. Declining production, rising domestic consumption, and stagnant oil reserves has pushed Egypt to being a net importer of crude oil for the first time after 1976 according to EIA data. Exploration and Production EGPC and EGAS are the two major holding companies active in the upstream sector. Besides them, International Oil Companies (IOCs) also plays a significant role. IOCs operate on a production sharing basis. Most of the Egyptian crude oil production comes from mature and relatively small fields which are connected to larger regional production systems.

Petrochemicals


Chart 8.3: Crude Oil Reserves and Main Areas of Production

Crude Oil Reserves Main areas of crude production

Source: EIA Egyptian oil production comes from four main areas: Gulf of Suez, the Western desert, the Eastern desert, and the Sinai Peninsula. Gulf of Suez is historically the most important area with around 50% of the total crude production. Oil fields in Gulf of Suez are most mature and are declining rapidly. Declining production from Gulf of Suez is complemented to some extent by the rising production from the Western Desert. Crude Oil production from this area has risen sharply since 2000 and now accounts for around 27% of total production. Consumption While production is declining, domestic demand for petroleum products is rising rapidly. Highly subsidized domestic fuel supply is partly responsible for this sharp increase. According to official figures, the value of government subsidies to petroleum products has increased more than four times to EGP62.7 billion in 2008 from EGP14.3 billion in 2004. Chart 8.4: Crude Oil Production and Consumption

Source: EIA The combination of rising domestic demand and declining production has significantly deteriorated the export position of crude oil as shown in chart 8.5 below.

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Chart 8.5: Energy Subsidy Bill and Net trade Balance of Crude Oil

Egypt Energy Subsidy Bill (in EGP billion) Egypt Crude Oil Trade Balance

Source: EIA Natural Gas in Egypt The natural gas sector is in complete contrast to crude oil in Egypt. Owing to new gas discoveries and infrastructure development, proven reserves, production, and exports increase sharply. Along with rising reserves and production, continued expansion of Arab Gas Pipeline as well as domestic gas grid, Egypt can become a leading supplier of natural gas in the Mediterranean region. Reserves Proven gas reserves of natural gas have nearly doubled to 60 trillion cubic feet compared to 35 trillion cubic feet in 2000, and Egypt ranks one of the top twenty countries in terms of reserves. Chart 8.6: Natural Gas Reserves and Main Areas of Production

Natural Gas Reserves Main Areas of Natural Gas Production

Source: EIA Exploration and Production Natural gas production in Egypt is expanding rapidly with an increase of over 30% from 1999 to 2007. With production rising much faster than consumption and continued expansion of Arab Gas Pipeline, the export of natural gas has increased multiple times to roughly 550 billion cubic feet in 2007 from just around 12 billion cubic feet in 2003. The single most important region for natural gas production is the Mediterranean Sea, which accounts for around three fourths of the total gas production. Fields in this region are non-associated in nature.

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Identifying natural gas a key source of future energy and revenue generation. The Egyptian government established EGAS to accelerate its development in 1997. To maintain its position as net energy exporter, Egypt allowed the export of natural gas for the first time in 2000. Natural Gas Exports vs. Domestic Usage The Egyptian government decided in 2000 to allocate one third of the then proven reserves for domestic market requirements for 25 years, the second third would be for strategic purposes, and the remaining third (plus most gas discoveries after 2001) onward for the export market. Proven gas reserves rose sharply after this policy announcement to almost double by 2003. This arrangement makes surplus gas available for the export market. It prompted Egypt to conclude several export agreements especially in LNG. However, a subsequent increase in prices led to popular backlash at home. In Mid-2008 Egypt’s oil minister said that no new gas export contracts would be made until 2010. This announcement is expected to help in expanding the domestic utilization of the gas. Chart 8.7: Natural Gas Production and Consumption Development

Source: EIA

The Ministry of Petroleum is actively promoting the utilization of natural gas in the domestic economy to displace imported fuel and save on the rising consumption of crude oil, which can be exported more easily. The power sector is the largest consumer with a share of around 55%. It is followed by the industrial sector. Natural gas penetration in the power and industrial sector is quite high with 100% of the fertilizer industry running on natural gas while 70% of total power generation comes from there. The main areas to focus on are the household and transportation sectors who at present are not big consumers of domestic gas and rely more on refined liquid fuels.

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Rating Scale

Recommendation Upside Buy Greater than 20% Hold -5% to 20% Sell Less than -5%

Disclaimer This memorandum is based on information available to the public. This memorandum is not an offer to buy or sell, or a solicitation of an offer to buy or sell the securities mentioned. The information and opinions in this memorandum were prepared by HC Brokerage from sources it believes to be reliable and from information available to the public. HC Brokerage makes no guarantee or warranty to the accuracy and thoroughness of the information mentioned in this memorandum, and accepts no responsibility or liability for losses or damages incurred as a result of opinions formed and decisions made based on information presented in this memorandum. HC Brokerage does not undertake to advise you of changes in its opinion or information. HC Brokerage and its affiliates and/or its directors and employees may own or have positions in, and effect transactions of companies mentioned in this memorandum. HC Brokerage and its affiliates may also seek to perform or have performed investment-banking services for companies mentioned in this memorandum.

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