Higher than Expected Increase In Natural Gas Prices, Further Lower Aracemco’s Target Price.

Higher than Expected Increase In Natural Gas Prices, Further Lower Aracemco’s Target Price.

·         The GoE decision to slash natural gas subsidies sharply increasing natural gas price for the ceramic industry to USD7/mmBtu from USD3/mmBtu effective second half FY14, a USD1 more than our worst case scenario expectations.

·         We already factored an increase to US$4/mmBtu in our last update on Aracemco dated April 30, 2014 effective second half FY14; and then we ran two scenarios factoring the 5% increase in income tax in the first scenario while exercising a natural gas price increase to USD6/mmBtu in the second scenario in the update we issued dating June 17, 2014.

·         The company already in place plan towards shifting the ceramic tiles production process to Dry Milling Technology, which is expected to significantly absorb a large portion of the expected increase in energy cost, leading to 75% and 1% increase in energy cost during FY14 and FY15, respectively compared to 23% increase and -18% drop in energy cost during FY14 and FY15, respectively in our latest update.

·         Natural gas price of US$7/mmBtu along with the additional 5% income tax on Aracemco are the most fierce factors that negatively affected the target price while Aracemco could have a room for increasing tiles and sanitary prices, albeit we conservatively did not introduce any further increase in prices in our forecasts. We will discuss the possibility of final product increases with management and reflect any change in its assumptions in 1H FY14 update.

·         Based on the above-mentioned facts, our target price drops to EGP29.52/share, a 18.4% lower than the current market price leading to a downgrade in our recommendation to Sell.

Financial Summary

FY ending Dec.	2013a	2014f	2015f	2016f	2017f	2018f
Revenues (EGP mn)	453	527	658	693	720	747
EBITDA Margin	34.6%	28.9%	35.3%	35.5%	35.5%	35.5%
EPS (EGP)	2.45	2.51	4.20	4.59	5.17	5.44
DPS (EGP)	2.00	2.43	4.20	4.59	5.17	5.44
PER	14.8	14.4	8.6	7.9	7.0	6.6
DY	5.5%	6.7%	11.6%	12.7%	14.3%	15.0%
EV/EBITDA	6.7	7.1	4.4	4.1	3.8	3.6
Net Debt (EGP mn)	0	13	10	7	5	0
Net Income (EGP mn)	93	156	171	192	202	212

Higher than Expected Increase In Natural Gas Prices, Further Lower Aracemco’s Target Price.

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