EUR 40.66 For Business Accounts Only

India and Saudi M&A to bear fruit; Reiterate OW

A dividend play with room for further upside. We raise our TP by 16% to AED3.48/share on: i) the acquisition of two Saudi distributors, lowering distribution costs and eliminating the risk of Saudi receivables ageing previously assumed, ii) the divesture of non-core, low-margin businesses, bringing 2017 non-core revenue to 8.4% vs. 13% in 2016, and iii) expectations for a recovery in India. Although all-in-all not a growth play, RAK is committed to sustaining at least 60% dividend payout; we assume a 2018 DPO of 75% (in line with the 2015-17 average), yielding 6.7%, 2x industry peers backed by a 2018e FCF yield of 8.1%. We also think further value could be unlocked from a demand revival in Saudi and monetisation of idle land.

India profit recovery on track with scope for additional upside. In 2017, RAK completed two acquisitions in Morbi, with a combined tile capacity of 10mn sqm, bringing total capacity to 18mn sqm by 2019. The rationale is to improve margins by reducing outsourcing and via proximity to India’s main consumption centre in the North. India’s tile segment contributed 6% of the group's 2017 gross profit, a higher-than-expected pickup in the segment’s gross margin by 50bps p.a. over our forecast horizon (vs. our flattish assumption of 19%) would add 5% to our TP.

Risk of margin dilution from destocking factored in. RAK’s total inventory stood at AED1,215mn, as of 4Q17, equivalent to 227 days (141 days of which is finished goods). We foresee 2022 (terminal year) finished goods at 85 days, on par with the industry, with the excess AED300mn being sold at a 50% discount to net realisable value. This implies that our forecasts factor in AED150mn over our 5-year forecast horizon (vs. AED138mn write-offs during 2015-17), without which our EBITDA margin estimates would have been c100bps higher. According to management, a pickup in the Saudi market would help lower the stock of finished goods. However, we rule this out until we see signs of a revival in construction demand.

Long-awaited update on Al Hamra land is imminent. Management stated that it intends to update the market on the status of its 270k sqm beachfront land in Al Hamra during 1H18. At book, this land is worth AED1/share (not in our valuation).