EUR 35.29 For Business Accounts Only

Limited room for upside; Cut to Neutral

Ultra-stable operations, high earnings visibility priced in. We flag Tabreed as the most defensive name within our UAE coverage, with secured revenues and margins. However, as the district cooling provider currently trades in line with its replacement cost, or at c10x EV/RT*, we cut our recommendation to Neutral, from Overweight. Tabreed trades on a 2020e P/E of c11x, a 17% discount to utility peers, justified, in our view, by its below average 2019-21e EPS CAGR of c6%, notably stemming from its 6% targeted capacity addition. We update Tabreed’s model using a 20-year DCF, assuming no terminal value and accounting only for management’s guided additions. As such, we revise down our TP to AED2.10/share, from AED2.66/share.

Our 20-year DCF model only reflects ongoing and guided contracts. As the bulk of Tabreed’s contracts is signed under a BOOT agreement for 25-30 years, assigning a terminal value for the business assumes the company will be able to replenish its contracting backlog at the same valuation (AED10.2k/RT), uncertain in our view. Accordingly, we opt to only value Tabreed’s ongoing and guided contracts, while gradually phasing out the DC provider’s 1.1mn RT over our forecast horizon. We note that c53% of Tabreed’s consolidated capacity is due to expire by 2035-40.

Margins to continue on an upward trend, boosted by CPI adjustments. Tabreed’s margins are seen expanding by c40bps p.a. during the contracts’ life, thanks to the increase in revenues from capacity charges, underpinned by the annual CPI adjustments. Our numbers are based on 0% CPI in the UAE in 2019, reaching 2% by 2022e and flattish thereafter. We note that the expected increase in EBITDA margin to 51% in 2019 from 48% in 2018 would be chiefly attributed to the implementation of IFRS 16, which results in the reclassification of operating expenses into depreciation and finance costs.

Value accretion from new acquisitions questionable, in our view. Our numbers factor in a total of 70k RT additions over 2019-21e (5k RT of which are from India), acquired at AED10/RT, in line with management guidance and Tabreed’s replacement cost. According to our estimates, 100k RT additions at AED8k/RT will only add c8% to our TP, calculated with a 7% cost of capital, all else constant. This, in our view, limits the potential upside risk to our valuation.