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RESEARCH  GCC

EQUITY REPORT 

Saudi Telecom Company (7010.SE) OVERWEIGHT


Quarterly Update
CMP SAR 40.50
Target SAR 51.24 • Saudi Telecom Co. (STC) reported revenues of SAR 38,343 million during
Upside 26.5% 9M10, up 1.6% YoY.
• Net profit declined 9.3% YoY to SAR 7,151 million from SAR 7,881 million.
• We have maintained our FY2010 sales estimate at SAR 52.61 billion. Net
MSCI GCC Index 425.24 profit estimate for the year has been revised upwards by 7.2% due to higher
Tadawul All Share Index 6,457.18 other income during 9M10.
• We are maintaining our OVERWEIGHT rating on STC with a revised DCF
target price of SAR 51.24, implying an upside of 26.5%.
Key Stock Data

Sector Telecom Overview


Reuters Code 7010.SE
Bloomberg Code STC AB Equity
Net Out. Shares (bn) 2.000 SAR Million 2008A 2009A 2010E 2011E 2012E
Market Cap (SAR bn) 81.000
Market Cap (USD bn) 21.603 Operating Revenues 47,469 50,780 52,612 53,146 54,235
Avg. 12m Vol. (mn) 0.852 EBITDA 21,743 20,612 19,908 19,738 19,817
Volatility (30 day) 8.823 EBITDA Margin (%) 45.8% 40.6% 37.8% 37.1% 36.5%
Volatility (180 day) 21.037
Net Profit 11,038 10,863 9,895 9,466 9,254
Net Profit Margin (%) 23.3% 21.4% 18.8% 17.8% 17.1%
Stock Performance (%) Adjusted EPS (SAR) 5.52 5.43 4.95 4.73 4.63
52 week high / low (SAR) 48.00 / 34.30 Total Assets 99,762 109,587 116,301 119,867 124,144
RoAE (%) 30.0% 27.3% 22.6% 20.3% 18.9%
1M 3M 12M
Absolute (%) 1.3 1.5 -9.0 Revenues
Relative (%) 1.2 -0.9 -16.1 Operating revenues increased 1.6% to SAR 38,343 million during 9M10 from SAR
37,751 million in the same period last year. On a segmental basis, revenues from GSM
Shareholding Pattern (%) services comprising of mobile, 3G services, prepaid cards, international roaming, and
messages were up 1.2% to SAR 25,344 million from SAR 25,046 million. Revenues
Public Investment Fund 70.00
from the Public Switched Telephone Network (PSTN) segment rose 3.5% to SAR 7,514
General Organization for Social
Insurance - Saudi Arabia 7.00 million, whereas Data segment revenue dropped 1.9% to SAR 5,243 million. Meanwhile,
unallocated revenues (comprising items that could not be linked with the main operating
Public Pension Agency 6.60
segments) more than doubled to SAR 242 million from SAR 103 million in the year-ago
Public 16.40 period.

Expenses
Saudi Telecom and Tadawul All Share Index
Operating expenses advanced 10.2% to SAR 30,390 million from SAR 27,575 million.
Access charges jumped 17.0% to SAR 6,224 million, while Repair and maintenance
expenses scaled up 33.9% to SAR 1,615 million. Other charges were up 28.6% to SAR
1,650. Depreciation and amortisation charges increased 13.5% to SAR 6,428 million,
whereas employee costs dropped 4.5% to SAR 2,219 million. Administrative and
marketing expenses increased 5.9% to SAR 7,999 million from SAR 7,552 million. As a
result, the cost-to-income ratio expanded 622 bps to 79.3% from 73.0%.

Call us on +973 17549499 or email us at research@taib.com


TAIB RESEARCH

Profitability
Net profit declined 9.3% to SAR 7,151 million from SAR 7,881 million due to capital investments required for the construction of new
grids and the expansion of existing ones. As a result, adjusted annualised earnings per share dropped to SAR 4.77 from SAR 5.25.

Peer Comparison
For a peer comparison of telecom companies in Saudi Arabia, we have considered Zain Saudi and Etihad Etisalat (Mobily).

Financial Performance of Telecom Companies


Zain Saudi Mobily STC
2009 9M10 2009 9M10 2009 9M10
(SAR Million)
Sales 3,004 4,207 13,058 11,542 50,780 38,343
% YoY change N/A 99.5% 21.0% 21.2% 7.0% 1.6%
EBITDA -1,073 122 4,837 4,216 20,612 14,381
% YoY change N/A -112.1% 27.5% 27.1% -5.2% -9.2%
Net Profit -3,099 -1,838 3,014 2,753 10,863 7,151
% YoY change N/A -24.7% 44.1% 40.3% -1.6% -9.3%
Total Assets 27,830 27,961 30,926 34,776 109,587 111,502
% YoY change 4.4% 3.3% 13.7% 14.7% 9.8% 6.4%
Shareholders' Equity 8,622 6,586 12,243 14,121 42,035 44,679
% YoY change -26.4% -32.9% 25.5% 26.2% 11.7% 10.0%

Ratios:
Total Assets Turnover Ratio 0.11 0.20* 0.45 0.47* 0.49 0.46*
EBITDA Margin -35.7% 2.9% 37.0% 36.5% 40.6% 37.5%
Net Profit Margin -103.2% -43.7% 23.1% 23.8% 21.4% 18.6%
RoAE -30.5% -32.2%* 27.4% 27.8%* 27.3% 22.0%*
RoAA -11.4% -8.8%* 10.4% 11.2%* 10.4% 8.6%*

Market Indicators:
Adj. EPS (SAR) -2.21 -1.75* 4.31 5.24* 5.43 4.77*
P/E (x) -3.37 -4.26 12.54 10.30 7.46 8.50
Adj. BVPS (SAR) 6.16 4.70 17.49 20.17 21.02 22.34
P/BV (x) 1.21 1.58 3.09 2.68 1.93 1.81
Current Market Capitalisation (SAR Million) 10,430 10,430 37,800 37,800 81,000 81,000
* Annualised
TAIB RESEARCH

New Projects and Updates


In December, STC announced its pre-qualification bid for Syria’s third mobile operator license, along with four other telecommunications
companies. In November, STC signed multi-million Euro frame contracts with Alcatel-Lucent for expanding its broadband access
network in Saudi Arabia. Leveraging on Alcatel-Lucent’s leading VDSL2 and GPON technologies, STC will be able to provide state-of-
the-art, bandwidth-demanding applications to its customers and expand network reach. Earlier, during the same month, STC signed an
exclusive deal to provide fixed-line and mobile phone as well as Internet connections for all the stations on the Mashair railway line.

Risks and Concerns to Valuation:

™ STC’s top-line growth is heavily dependent on its ability to position itself in a highly competitive Saudi telecom market. The
company has been losing market share following the entry of Zain Saudi, the third mobile operator in the country. However,
the company has been quite proactive in rolling out new products, implementing efficient customer-oriented value-added
services and expanding its customer base in order to retain its leadership position. Accordingly, our forecasts factor in the
earnings from expansion initiatives and innovative offerings. Any delay in implementing the initiatives or slowdown in
product innovation may affect our estimates.

™ Our estimates may need revision if ARPU declines at a faster than expected pace.

Valuation Methodology:

We have used the DCF valuation method to arrive at the fair value of STC, as discussed below:

Assumptions:

(i) Risk free Rate (Rf) of 3.21%, equivalent to 12-months average yield on 10-year US T-bill.
(ii) Levered Beta of 0.84
(iii) Terminal growth rate of 2.0%

Based on the above assumptions and the Capital Asset Pricing Model (CAPM), we have arrived at a Cost of Equity of 9.71% and
a WACC of 8.48%.
TAIB RESEARCH

DCF Calculation

DCF Valuation (FCFF Model)


(in SAR Million) 2010E* 2011E 2012E 2013E 2014E
Operating Profit (EBIT) 3,767 11,291 10,994 11,093 11,028
Zakat on EBIT 331 993 967 975 970
Effective Tax Rate 8.8% 8.8% 8.8% 8.8% 8.8%
NOPAT 3,436 10,298 10,027 10,118 10,058
Add: Depreciation and Amortisation 1,760 8,447 8,823 9,192 9,532
Less: Capex 3,023 10,842 11,037 11,363 11,501
Less: Change in Net Working Capital 1,251 477 425 457 671
Operating Free Cash Flows to Firm (OFCFF) 922 7,427 7,389 7,490 7,418
Non-Operating Income -53 1,813 1,869 1,948 1,995
Tax on Non-Operating Income -5 159 164 171 175
Add: Non-Operating Cash Flows (After Tax Non-Operating
Income) -49 1,654 1,705 1,776 1,820
Free Cash Flow to Firm (FCFF) 873 9,081 9,094 9,267 9,238
WACC (Ko) 8.48% 8.48% 8.48% 8.48% 8.48%
Present Value / Discount Factor 0.9799 0.9032 0.8326 0.7675 0.7075
Long-Term Growth Rate (g) 2.00%
Terminal Multiple 15.73
Nominal Terminal Value 145,349
Present Value of Free Cash Flows 855 8,202 7,571 7,112 6,536
* 2010E excludes 9M10A

Calculation of Equity Value and Fair Value Per Share

NPV of Free Cash Flows (during Explicit Forecast Period) 30,277


Terminal Value:
Residual Cash Flow (FCFF of 2014E) 9,238
WACC 8.48%
Long-Term/Terminal Growth Rate (g) 2.00%
Divided by Capitalisation Rate (WACC - g) 6.48%
Equals Nominal Terminal Value 145,349
Implied Multiple of 2014E EBITDA 7.07

Times PV/Discount Factor 0.71


Present Value of Terminal/Residual Value 102,833

Enterprise Value 133,110


Implied Multiple of 2014E EBITDA 6.47

Less: Market Value of Long-term Debts 30,624


Equity Value 102,486
Net shares outstanding (Million) 2,000
Fair Value Per Share (SAR) 51.24
* figures in SAR Million unless specified
TAIB RESEARCH

Sensitivity Analysis

The following tables present a sensitivity analysis, showing the probable nominal terminal value, discounted terminal value and
enterprise value, given different growth rate and WACC assumptions. The shaded area represents the most probable outcomes.

Sensitivity Analysis of Nominal Terminal Value (SAR Million)


Long-Term Growth Rate
Discount Factor 1.00% 1.50% 2.00% 2.50% 3.00%
7.48% 143,924 156,725 171,860 190,033 212,260
7.98% 133,619 144,637 157,497 172,703 190,960
8.48% 124,690 134,280 145,349 158,269 173,545
8.98% 116,880 125,307 134,942 146,062 159,041
9.48% 109,991 117,459 125,925 135,603 146,774

Sensitivity Analysis of Discounted Terminal Value (SAR Million)


Long-Term Growth Rate
Discount Factor 1.00% 1.50% 2.00% 2.50% 3.00%
7.48% 105,912 115,332 126,470 139,843 156,200
7.98% 96,408 104,358 113,637 124,608 137,781
8.48% 88,217 95,002 102,833 111,973 122,781
8.98% 81,091 86,938 93,622 101,337 110,342
9.48% 74,841 79,922 85,683 92,268 99,870

Sensitivity Analysis of Enterprise Value (SAR Million)


Long-Term Growth Rate
Discount Factor 1.00% 1.50% 2.00% 2.50% 3.00%
7.48% 136,926 146,346 157,483 170,857 187,213
7.98% 127,049 134,999 144,278 155,249 168,422
8.48% 118,493 125,278 133,110 142,250 153,058
8.98% 111,010 116,856 123,541 131,256 140,261
9.48% 104,408 109,490 115,250 121,836 129,437
TAIB RESEARCH

Investment Opinion

Saudi Telecom continues to be the main telecom operator in Saudi Arabia with presence across nine countries and a global
customer base of over 100 million. The company accounts for 70.9% of the total telecom sector revenue, as of September 30, 2010.
Furthermore, STC has the key advantage of a diversified portfolio of services and presence in the relatively less penetrated
broadband market. The company claims a 70% share of the country’s broadband and data services market. It is investing in network
infrastructure to provide enhanced services in terms of faster internet connectivity and multimedia interactive services. The company
is concentrating on boosting investment in the LTE technology. STC recently signed multi-million Euro frame contracts with Alcatel-
Lucent for expanding its broadband access network.

During August, STC announced the launch of new points-of-presence (PoPs) in eight countries. Through the internet-enabled PoPs,
STC will offer international Wholesale IP Transit Service using its extensive connectivity with internet access points and various
peering arrangements with major global carriers and backbone providers. Such a network expansion will enable STC’s domestic and
regional customers to enjoy global reach, in addition to further improving the overall quality of internet, data, and voice services.
During December, STC tendered the pre-qualification bid for Syria’s third mobile licence. Syria has a population of around 20 million
with a growth rate of 2.4% that is among the highest in the world. The country has 10.4 million mobile subscribers, including prepaid
cards, according to the Telecom Ministry. On the other hand, increased contributions from affiliate in Bahrain (Viva) will strengthen
STC’s position, while overseas acquisitions will provide sufficient head room for growth, going forward. Even though intense domestic
competition has affected growth, geographical expansion, technological improvements, innovative product offerings, and growth in
value-added services will sustain STC’s leadership.

We had updated STC on September 14, 2010 with an OVERWEIGHT recommendation (target price of SAR 51.59 indicating a 28.3%
upside). Currently, the company’s stock is trading at a P/E multiple of 8.19x and 8.56x on 2010E and 2011E earnings, and at a P/BV
multiple of 1.81x and 1.78x on 2010E and 2011E BVPS, respectively. The stock has underperformed the TASI index, losing 8.2%
since the beginning of this year as against the latter’s gain of 5.5%. Considering the above factors, we have arrived at a price target
of SAR 51.24, implying an upside of 26.5% over the closing price of SAR 40.50 (as of December 08, 2010). Accordingly, we
reiterate our earlier OVERWEIGHT rating on Saudi Telecom.
TAIB RESEARCH

Financial Statements

Consolidated Income Statement


(SAR Million) 2008A 2009A 9M09A 9M10A 2010E 2011E 2012E
Operating Revenues 47,469 50,780 37,751 38,343 52,612 53,146 54,235

Operating Expenses
Government charges -5,542 -5,664 -4,227 -4,257 -5,790 -5,822 -5,914
Access charges -6,131 -7,494 -5,321 -6,224 -8,396 -8,747 -9,197
Employee costs -6,164 -6,772 -2,324 -2,219 -3,070 -3,101 -3,165
Depreciation and amortization -6,408 -7,799 -5,662 -6,428 -8,188 -8,447 -8,823
Administrative and marketing expenses -5,762 -7,614 -7,552 -7,999 -10,783 -10,972 -11,278
Repairs and maintenance -2,128 -2,623 -1,206 -1,615 -2,402 -2,480 -2,530
Total operating expenses -32,134 -37,967 -27,575 -30,390 -40,892 -41,855 -43,241
Operating Income 15,335 12,814 10,177 7,953 11,720 11,291 10,994

Other Income and Expenses


Cost of early retirement program -675 -811 -808 -314 -431 -435 -444
Finance costs -1,432 -1,385 -1,033 -1,496 -1,838 -1,591 -1,588
Commissions and interest 624 362 240 305 368 372 380
Other, net -1,809 1,151 237 1,879 1,762 1,441 1,489
Other income and expenses, net -3,293 -683 -1,363 374 -139 -213 -163

Net Income before Minority interest, Zakat and


Tax 12,042 12,130 8,813 8,327 11,581 11,079 10,831
Provision for Zakat -376 -335 -265 -87 -174 -166 -162
Provision for Tax -457 -642 -449 -607 -845 -808 -790
Net Income before Minority interests 11,210 11,154 8,099 7,633 10,563 10,105 9,878
Minority interest -172 -290 -218 -483 -668 -639 -624
Net Income 11,038 10,863 7,881 7,151 9,895 9,466 9,254
TAIB
TAIB RESEARCH
RESEARCH

Consolidated Balance Sheet


(SAR Million) 2008A 2009A 9M09A 9M10A 2010E 2011E 2012E
ASSETS
Current Assets
Cash and cash equivalents 8,061 7,710 5,860 6,335 7,663 7,736 8,593
Accounts receivable, net 8,120 11,461 9,317 10,397 12,884 13,306 13,876
Prepayments and other current assets 2,765 3,492 3,272 3,689 4,287 4,898 5,445
Total Current Assets 18,946 22,663 18,449 20,422 24,833 25,940 27,914

Non-Current Assets
Property, plant and equipment, net 44,382 52,737 52,021 54,142 54,291 57,397 60,307
Intangible assets, net 31,695 29,222 29,631 32,084 32,134 31,422 30,726
Equity method and other investments 2,452 2,533 2,534 2,482 2,589 2,669 2,764
Other non-current assets 2,287 2,433 2,129 2,372 2,454 2,439 2,433
Total Non-Current Assets 80,816 86,924 86,313 91,081 91,468 93,927 96,230
Total Assets 99,762 109,587 104,762 111,502 116,301 119,867 124,144

LIABILITIES AND EQUITY


Current Liabilities
Accounts payable 6,649 7,657 4,914 7,143 7,428 7,558 7,748
Other payables 4,335 4,819 4,773 4,233 5,579 5,870 6,203
Accrued expenses 5,762 6,205 6,212 6,150 6,353 6,488 6,657
Deferred revenues 2,248 2,081 1,977 2,082 2,130 2,125 2,142
Borrowings 3,905 8,579 8,341 8,664 9,105 8,185 7,546
Total Current Liabilities 22,899 29,341 26,218 28,271 30,594 30,226 30,296

Non-Current Liabilities
Borrowings 28,081 22,711 24,204 21,960 22,939 23,403 23,990
Employees’ end of service benefits 2,738 2,844 2,881 3,109 3,181 3,559 3,981
Other payables 3,482 3,859 3,818 4,778 5,195 5,268 5,512
Total Non-Current Liabilities 34,301 29,414 30,903 29,847 31,316 32,229 33,483
Total Liabilities 57,200 58,755 57,121 58,118 61,910 62,455 63,778

Equity
Authorized, issued and outstanding shares 20,000 20,000 20,000 20,000 20,000 20,000 20,000
Statutory reserve 8,233 9,299 9,043 10,000 10,000 10,000 10,000
Retained earnings 10,526 13,552 12,357 15,352 16,187 18,570 20,898
Financial statements translation differences -1,121 -816 -773 21 21 21 21
Other reserves 0 0 0 -695 -695 -695 -695
Equity attributable to equity holders 37,638 42,035 40,626 44,679 45,514 47,896 50,225
Minority Interest 4,924 8,798 7,014 8,705 8,877 9,516 10,141
Total Liabilities and Equity 99,762 109,587 104,762 111,502 116,301 119,867 124,144
TAIB
TAIB RESEARCH
RESEARCH

Consolidated Cash Flow Statement


(SAR Million) 2008A 2009A 9M09A 9M10A 2010E 2011E 2012E

Net income 11,038 10,863 7,881 7,151 9,895 9,466 9,254

Adjustments to reconcile net income to net


cash provided by operating activities:
Depreciation and amortization 6,408 7,799 5,662 6,428 8,188 8,447 8,823
Doubtful debts expense 914 1,508 1,160 1,216 1,566 1,624 1,701
Earnings from investments accounted for under
the equity method -45 -80 -64 -57 -57 0 0
Losses on sale/disposal of property, plant and
equipment 420 113 129 -905 -905 0 0
Losses on disposal/sale of other investments 0 -682 0 0 0 0 0
Changes in:
Accounts receivable -4,061 -4,849 -3,676 -2,916 -2,989 -2,046 -2,271
Prepayments and other current assets -1,379 -727 -507 -197 -795 -611 -547
Other non-current assets 1,929 -145 159 60 -21 15 6
Accounts payable 3,567 1,008 -451 2,142 -229 131 189
Other payables 1,047 767 768 485 2,934 363 578
Accrued expenses 176 443 486 52 148 135 169
Deferred revenues 332 -167 -272 -61 49 -5 16
Employees’ end of service benefits 806 106 143 265 337 377 422
Net cash provided by operating activities 21,149 15,956 11,419 13,663 18,121 17,895 18,342
0
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures -16,278 -15,637 -12,964 -7,736 -9,854 -10,842 -11,037
Intangible assets, net -19,235 1,782 943 -3,509 -3,559 0 0
Equity method and other investments -30 0 0 -108 -694 -79 -95
Dividends received from investments accounted
for under the equity method 16 23 23 0 0 0 0
Proceeds from sale of property, plant and
equipment 58 290 221 1,664 1,664 0 0
Net cash used in investing activities -35,468 -13,542 -11,777 -9,689 -12,443 -10,921 -11,132

CASH FLOWS FROM FINANCING ACTIVITIES


Dividends paid -8,552 -5,943 -4,493 -4,591 -6,559 -7,084 -6,925
Borrowings, net 18,406 -696 559 -666 754 -456 -52
Minority interest 4,908 3,874 2,091 -93 79 639 624
Net cash provided by financing activities 14,763 -2,764 -1,843 -5,349 -5,726 -6,901 -6,353

NET INCREASE IN CASH AND CASH


EQUIVALENTS 443 -351 -2,202 -1,375 -48 74 857
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 7,618 8,061 8,061 7,710 7,710 7,663 7,736
CASH AND CASH EQUIVALENTS AT END OF
YEAR 8,061 7,710 5,860 6,335 7,663 7,736 8,593
TAIB RESEARCH

Financial Ratios

2008A 2009A 9M09A 9M10A 2010E 2011E 2012E


Liquidity Ratios:
Current Ratio 0.83 0.77 0.70 0.72 0.81 0.86 0.92
Quick Ratio 0.83 0.77 0.70 0.72 0.81 0.86 0.92
Average Collection Period (Days) 50 70 63 78 84 90 91
Average Payment Period (Days) 129 165 147 167 166 160 158

Activity Ratios:
Debtors Turnover Ratio 7.25 5.19 5.77* 4.68* 4.32 4.06 3.99
Creditors' Turnover Ratio 2.84 2.21 2.48* 2.18* 2.20 2.28 2.31
Total Assets Turnover Ratio 0.56 0.49 0.49* 0.46* 0.47 0.45 0.44
Equity Turnover Ratio 1.29 1.27 1.29* 1.18* 1.20 1.14 1.11

Profitability Ratios:
EBITDA Margin (GPM) 45.8% 40.6% 42.0% 37.5% 37.8% 37.1% 36.5%
Operating Profit Margin (OPM) 32.3% 25.2% 27.0% 20.7% 22.3% 21.2% 20.3%
Net Profit Margin (NPM) 23.3% 21.4% 20.9% 18.6% 18.8% 17.8% 17.1%
Return on Average Equity (RoAE) 30.0% 27.3% 26.9%* 22.0%* 22.6% 20.3% 18.9%
Return on Average Assets (RoAA) 13.1% 10.4% 10.3%* 8.6%* 8.8% 8.0% 7.6%

Leverage Ratios:
Debt to Equity (D/E) Ratio 0.85 0.74 0.80 0.69 0.70 0.66 0.63
Shareholders' Equity to Total Assets Ratio 0.38 0.38 0.39 0.40 0.39 0.40 0.40
Total Liabilities to Total Assets Ratio 0.57 0.54 0.55 0.52 0.53 0.52 0.51
Current Liabilities to Equity Ratio 0.61 0.70 0.65 0.63 0.67 0.63 0.60

Operating Performance
YoY Growth in Revenue 37.8% 7.0% 7.4% 1.6% 3.6% 1.0% 2.0%
YoY Growth in Operating Profit 21.5% -16.4% -18.7% -21.8% -8.5% -3.7% -2.6%
YoY Growth in EBITDA 30.1% -5.2% -7.8% -9.2% -3.4% -0.9% 0.4%
YoY Growth in Net Profit -8.2% -1.6% -20.2% -9.3% -8.9% -4.3% -2.2%
YoY Growth in Total Assets 45.0% 9.8% 1.7% 6.4% 6.1% 3.1% 3.6%
YoY Growth in Shareholders' Equity 4.9% 11.7% 4.5% 10.0% 8.3% 5.2% 4.9%

Valuation Ratios
Adj. EPS (SAR) 5.52 5.43 5.25* 4.77* 4.95 4.73 4.63
Adj. BVPS (SAR) 18.82 21.02 20.31 22.34 22.76 23.95 25.11
P/E Ratio (x) 7.34 7.46 7.71 8.50 8.19 8.56 8.75
P/BV Ratio (x) 2.15 1.93 1.99 1.81 1.78 1.69 1.61
Current Market Price** (SAR) 40.50 40.50 40.50 40.50 40.50 40.50 40.50
* Annualised
**CMP as on December 08, 2010
TAIB RESEARCH

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increase or diminish. Consequently, investors may not get back the full value of their original investment