Arabtec Holding - BUY with a target price of AED2.40 (Upside Potential: 25.0%)

• Order book showing strength

• Saudi Arabia, Abu Dhabi to drive growth

• Margins to come under pressure

• Receivables management cause of concern

Dubai with 43% backlog remains the largest market amidst efforts towards geographic diversification

At the end of 2Q10, Dubai with a total backlog of AED5.3bn continues as Arabtec’s largest market and accounts for 43% of its backlog. The pace of project execution in Dubai however, continues to be slow due to liquidity issues while the risk of cancellation looms. Qatar with a 28% contribution to the backlog is the second largest market while Abu Dhabi at 20% is third. Saudi Arabia stands at 6%, primarily impacted by the cancellation of AED1.25bn Lamar Project in 2Q10.

Order wins indicate expansion outside Dubai. At AED6.95bn YTD, this represents 1.2x of our projected FY10 revenues

Arabtec has won new orders worth AED6.95bn YTD across MENA region with 75% of these orders coming from outside Dubai. Ras al Khaimah with 36% of the new awards is the highest source, followed by Qatar at 22% and Abu Dhabi at 13%. Saudi Arabia so far this year has remained elusive to Arabtec. This is primarily due to the combined impact of a high level of attractiveness of the market resulting in competition from both local and international players, as well as, project awards being delayed. Management still hopes for large awards after Ramadan.

Higher competition resulting in downward pressures on margins

Earlier, Arabtec was able to generate significantly high margins due to the construction boom and limited competition due to scarce availability of lesser experienced construction companies. However, over a period of time, some of the local and international players have made a strong foot hold in their area of expertise. This together with the current slowdown in the market has resulted in a price-driven market structure which is driving margins down and may inturn impact future margins.

Valuation

The value of Arabtec’s shares derived from the weighted average of the DCF and relative valuation methods is AED2.40/share. The stock closed at AED1.92/share on the Dubai Financial Market at the end of trading on 19th September 2010, which implies that the weighted average value of Arabtec’s shares is at a premium of 25% to the share’s current market price. Currently, Arabtec’s shares are trading at a P/E multiple of 5.1x and 5.9x for 2010 and 2011 respectively. We therefore recommend a ‘BUY’ on the Arabtec Holding stock at its prevailing price levels.