Egypt Strategy

September 8 2016

Jaap Meijer, MBA, CFA Mohammad Kamal Ziad Itani

Jaap.meijer@arqaamcapital.com Tibor Bokor Xavier Zawisza
+971-4-5071744 Michael Malkoun Michel Salameh
Lemer Salah Emad El Hage
Reham ElDesoki Christine Kalindjian
reham.elsdesoki@arqaamcapital.com
+201011003724

Egypt: assessing the impact of

price/rate hikes and devaluation Impact 200bp rate hike on NIMs and RoE (ALM 12 M)
Banks best positioned, cement worst 80

60
6%

4%

Blockbuster changes in 2016 promise structural change, while raising 40 2%

inflation and interest rates in the short term 20 0%

13% VAT rate in FY 16/17, 14% in FY 17/18, replacing GST of 10%, barely -2%

affects the corporate sector, most of costs to be borne by consumer (20) -4%

Expect an aggressive devaluation to lift FX overhang on most sectors. (40) -6%

We forecast growth of 4-5% as lower consumption growth is (60) -8%

HDB CAE QNBA CIB SCB NBK-E UNB-E Al Baraka
counterbalanced by better investment growth, especially in H2 FY 16/17
VAT impact on our diversified coverage bottom line
We see banks as best positioned (higher interest rates) and cement worst

MNHD

TMGH

MCQE
SWDY
AUTO

SCEM
PHDC

TORA
ARCC
SUCE
JUFO
EGTS
OCDI

SVCE
ESRS
(higher import costs from energy price hikes and import costs)

EFID
Blockbuster changes in 2016 promise structural change, while raising inflation and 0%
interest rates in the short term. Government to implement civil service reform, VAT,
(4%)
energy subsidy restructuring, devaluation, IPOs of companies and offer a Eurobond in
Q4 2016 2017, confirming GoE is serious about reform. (8%)

Adoption of 13% VAT rate in FY 16/17, 14% starting FY 17/18, replacing GST of 10%, (12%)

barely affects the corporate sector, with most of the costs to be borne by the end (16%)
consumer, raising 1.1% of GDP. Egypts sales tax regime is, in essence, already a VAT Devaluation impact to 12 EGP/USD
system. Corporate profits would be mostly unaffected as companies act as tax 15%
collectors on the governments behalf. However, firms need to assess margins in light
(5%)
of demand elasticity as they may not be able to pass on the additional tax, while for
companies producing tax-exempt products/services, P&L costs may increase slightly. (25%)

Expect an aggressive devaluation to lift FX overhang on most sectors, being more of a (45%)
managed float than a free float in the short term. Interest rate hikes will aim to curb
(65%)
dollarization and improve carry trade for portfolio investors. We expect growth of 4-5%
MCQE

SUCE
SWDY

SVCE

JUFO

ARCC

AUTO
ESRS

EFID

TORA

SCEM
ETEL

as lower consumption growth is counterbalanced by better investment growth,

especially in H2 FY 16/17. Impact of higher energy prices
Exempt industries (banking, real estate and consumer staples) should absorb higher
MCQE
SWDY

AUTO

SCEM
PHDC

TORA
ARCC

SUCE
JUFO

OCDI

SVCE
ESRS

ETEL
EFID

costs on non-exempt inputs. Banking and consumer foods are the least impacted (1-
10%
1.5% bottom line impact for banking vs. 2-4% for consumer foods. Developers should (0%)
be affected by higher steel costs. VAT to increase consumer prices for non-exempt (10%)
(20%)
industries (steel, telecoms, neutral on autos). Telco will enjoy a 1-year exemption for (30%)
landline internet services. (40%)
(50%)
Higher energy costs (17-19% increase in electricity costs on energy intensive firms (60%)

depending on usage band, 15-20% on average on mazout/diesel/gasoline) should

Impact of 200bps rate hike
mainly affect cement companies (24-30% average downside to EPS), as the former
represents c.13% of direct costs while the latter is still used by a select number of 4%

producers (Tourah Cement from our coverage) to run their kilns (c.59% of COGS, (4%)
(12%)
implying 58-75% downside to EPS).
(20%)
A potential devaluation will have serious ramifications on margins for Suez Cement (28%)
Group (including Tourah) and Sinai which still partially run on natural gas (USD (36%)
SUCE
MCQE

SVCE
TMGH

JUFO
OCDI

SWDY

AUTO
ARCC
PHDC

EGTS
MNHD

SCEM

EFID

ESRS
TORA
ETEL

8/mmbtu) paid for in EGP converted at the CB official exchange rate of EGP 8.8. Our
calculations suggest 57-59% downside potential to EPS should the pound devalue to
EGP 12 vis--vis the USD.
Ezz Steel stands the most vulnerable to an increase in benchmark interest rates as the All impacts ceteris paribus, i.e. no passing on of additional costs to consumers
group is highly leveraged (net debt/equity and net debt/EBITDA ratios of 2.7x and
12.6x respectively as of Q1 16A) with 82% of borrowings priced over the Egyptian Copyright 2016, Arqaam Capital Limited. All Rights Reserved.
Central Banks corridor rate. Banks are positively geared for higher rates, increasing See Important Notice.
RoE by 2ppt and expanding NIMs by c.20bps with CAE and HDB being most geared for
higher rates (exhibit 27-32).

Approving VAT law a major
milestone after 8 years of
preparation ...
Improvement of tax
administration, expansion
of tax base and contributing
to formalization of informal
sector among benefits of
VAT...
Egypt Strategy
September 8 2016
Egypt Strategy
The Value Added Tax important corner stone of IMF support
It will raise 1.3% of GDP, rising to 2% in FY 17/18, supporting the fiscal consolidation with the
brunt of the cost borne by the end consumer not the corporate sector. However, firms need
to assess margins in light of demand elasticity as they may not be able to pass on the
additional tax.
After eight years since it was first drafted, Egypt finally approved the VAT law in August 2016.
The bill was postponed when the global financial crisis hit Egypt in 2008 and then in the wake
of the social instability that lead to the 2011 revolution.
Although the VAT is essentially an extension of the previous sales tax system, there are
specific differences which render the VAT a better one overall: i) all goods and services are
taxable, unless exempted by law (56 exemptions), versus specific goods and 17 services only
taxed under the sales tax system, thus expanding the tax base; ii) direct and indirect inputs will
be discounted from the VAT, versus direct costs in the sales tax (in addition to machines costs
under both systems); iii) only producers and vendors with an annual turnover of EGP 500k and
all importers will be required to pay VAT, versus a turnover of EGP 54k for producers and EGP
150k for retail and wholesale vendors and all importers under the sales tax system, and SMEs
will be addressed with a separate tax administration law; iv) a new dispute resolution system
has been approved to complement the VAT system, encouraging the resolution of around
150,000 tax disputes worth nearly EGP 48bn; v) the new VAT system, which increases
discounting opportunities, will encourage businesses, big and small, to demand invoicing from
their business partners and suppliers, helping improve SMEs book keeping processes and
contributing to the formalizing of the informal sector.
Although the sales tax rate of 10% was lower than the recently approved VAT rate of 13% (and
14% in FY 2017/2018) the discounting of VAT already paid on indirect inputs could actually
reduce the effective tax burden on some products. Services that were not previously taxed will
witness, on the other hand, an increase in prices, with the magnitude reined in by the
discounting of VAT paid on inputs used to provide the service. The cumbersome nature of the
sales tax system, in being applied to specific goods and services, and at special rates, other
than 10% or in addition to, will be replaced by a more streamlined VAT system removing the
complexity involved in the implementation of the sales tax system.
Tax revenues constitute 65%, on average, of total revenues, with taxes on goods and services
contributing to 29%, on average, of tax revenues and of total revenues.
Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 2
 September 8 2016
Egypt Strategy

Exhibit 1: Breakdown of Tax Revenues Exhibit 2: Tax Revenues Growth

16% 80%
100%
90% 14%
60%
80% 12%
70% 40%
10%
60%
8% 20%
50%
40% 6% 0%
30% 4%
-20%
20%
2%
10% -40%
0%
0%
12/13 13/14 14/15 15/16prelim. 16/17proj. -2% -60%
13/14 14/15 15/16prelim. 16/17proj.
General Taxes Sales Taxes Customs Taxes Other Taxes
General Taxes Sales Taxes Other Taxes Customs Taxes (RHS)

Source: Ministry of Finance, Arqaam Capital Research Source: Ministry of Finance Arqaam Capital Research
*
VAT to have mixed impact, The Ministry of Finance indicated it expected to generate additional revenues of EGP 20-
negative on consumption 25bn from the implementation of the full-fledged VAT, constituting 1.3% of GDP in FY
growth in the short 2016/2017, which is expected to total EGP 3.2tn, and based on an expected growth rate of 4-
term...better revenues in 5%. The additional revenues are expected to rise to 2% in FY 2017/2018 as the rate rises from
the long term when 13% to 14%, implementation efficiency improves and economic growth inches up.
economic growth recovers
While it will be difficult to generate an in-house estimate of the additional revenues, we
believe the VAT is a double edged sword. The new system will negatively impact
consumption growth for the higher income groups, fueling a large portion of the consumption
growth (together with the informal sector) as the tax is consumption based and newly taxed
services and some products will be priced at higher levels. This income group will bear the
brunt of the reforms in the short term, attempting to render their consumption more efficient
to weather the inflation storm while maintaining lifestyle choices.

The silver lining, fortunately, is:

i) there will not be a significant spike in inflation given that many companies have
already passed on the increase in costs from the higher FX component and higher
inflation in Q2 2016 onwards, limiting their ability to increase prices further in the
short term;

ii) many companies could potentially wait for the impact of the other reforms,
especially the devaluation, delaying an increase in prices pending better visibility
of the entire impact on costs;

iii) the informal sector, a big driver of consumption, will consume goods and services
that have not witnessed a price increase (vendor is below the VAT eligibility
benchmark of EGP 500 thousand annual turnover) or the exemptions will result in
minimal or no additional cost to the vendor.

We expect the budget deficit to decline from the 11-12% expected in FY 2015/2016 to
around 10-10.5% in FY 2016/2017 as the government aims to restructure its historically rigid
wages and increase investment and social spending to compensate for its tighter fiscal
policies.

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 3
 September 8 2016
Egypt Strategy

For banks, given that most inputs and all outputs are currently sales tax exempt, and will be
Impact per sector
VAT exempt, we only estimate a 3.6% increase in non-staff costs that will be borne by the
unexpected impacts
banks themselves. This translates into a c.2% post-tax impact on net profits (see exhibit 3) for
pure-banking plays (CIB, CAE, QNBA in that order) and would be a worst case scenario, as non-
staff costs do include some depreciation (not significant for banks) as well as some non-credit
related provision costs (usually tax-related).

Exhibit 3: VAT impact on banks: 1-2.7% bottom line hit for pure banking plays*
Costs C/I ratio
Total
Non-staff Current Impact Effective NP NP
Ticker Bank Income Total Non-staff Pro-forma
costs (10% sales (worst tax rate (EGPm) impact
(EGPm) (EGP m) (% total) (14% VAT)
(EGP m) tax) case)
COMI EY CIB Egy pt 10,807 2,670 1,584 59.3% 24.7% 25.2% 2.2% 28.0% 4,730 (0.9%)
CIEB EY CA Egy pt 2,290 812 429 52.8% 35.5% 36.1% 1.9% 23.7% 1,037 (1.1%)
HDBK EY HDB 1,855 985 544 55.3% 53.1% 54.2% 2.0% 27.5% 575 (2.5%)
FAIT EY Faisal 2,283 754 380 50.4% 33.0% 33.6% 1.8% 47.1% 794 (0.9%)
SAUD EY Al Baraka 1,117 430 263 61.1% 38.5% 39.4% 2.2% 46.3% 265 (1.9%)
QNBA EY QNB Al Ahli 7,244 2,518 1,636 65.0% 34.8% 35.6% 2.4% 24.3% 3,192 (1.4%)
ADIB EY ADIB Egy pt 1,544 867 471 54.4% 56.1% 57.2% 2.0% 65.4% 219 (2.7%)
CANA EY Suez Canal Bank 746 394 104 26.3% 52.9% 53.4% 1.0% 100.0%
MART EY UNB Egy pt 561 261 58 22.3% 46.4% 46.8% 0.8% 36.8% 160 (0.8%)
NBKE EY NBK Egy pt 1,634 496 283 57.1% 30.3% 31.0% 2.1% 35.1% 576 (1.2%)
HRHO EY EFG 1,618 1,092 151 13.8% 67.5% 67.8% 0.5% 28.0% 385 (1.0%)
Source: Company Data, Arqaam Capital Research

A similar situation arises for consumer staples (Juhayna) with dairy products tax exempt
under both regimes. Juice, however, will see a slight increase in end-consumer costs (from
general tax rate of 10% to general VAT rate 13-14%). Given the small 3.6% increase for juice,
and largely tax exempt inputs for dairy, we see limited impact. Consumer discretionary (EDITA)
will see a marginal change in tax rates (from a sales tax of 5% to a VAT rate of 14% for the end
consumer), but the change in tax mechanism will mean that input taxes cannot be deducted
and thus must be borne by the firm. Again, given that most of these inputs are tax-exempt, we
expect EDITA to pass any increase on to the end consumer through their price migration
strategy, we expect to see minimal effects.

While cement will remain subject to the current 5% taxation rate (with most input costs
being tax exempt given that clinker is produced by cement firms themselves), end-consumer
prices for steel firms will increase significantly (8% sales tax rate increasing to 14%). On the
other hand, changes to the tax credit mechanism mean that some input taxes paid by these
firms can now be deducted from output VAT, but we expect the effect to be minimal as most
input costs are tax exempt (iron-ore as raw materials for steel-makers). Nevertheless, we
expect minimal margin compression for Ezz Steel given the producers strong pricing power in
the domestic market (quality, brand image).

For real estate firms, land and unit sales (and purchases) are tax exempt under both regimes.
As such, input costs must be borne by the developers. We factor in a 6% increase in steel costs
and add to that an increase in tax rates for contractors (from 2.5% to 5%). Developers whose

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 4
 September 8 2016
Egypt Strategy

land costs make up the majority of cost of sales (and already exhibiting high margins) will see
margins more protected. Margins at MNHD show most resilience, thanks to ultra cheap land.

For autos, there are effectively no rate changes (see Exhibit 4) however, input taxes can only
be offset against base rate VAT due (the additional rates, 1% for <1.6L and 15% for locally
assembled cars >1.6L and 30% for imports >2.0L, cannot be offset). As such, the margin (or
value added) must be high enough for base rate VAT collected to sufficiently absorb input
taxes (i.e. significantly discouraging pure car dealerships and encouraging more extensive car
assembly). The majority of vehicles sold by GB Auto are already subject to 15% sales tax, we
expect minimal effect on GB from the VAT tax implementation.

Exhibit 4: VAT impact on others if not passed on to consumers (worst case)

Ticker Company Revenues* COGS* Capex VAT rate Sales tax rate VAT Sales taxes Difference Earnings Impact on EPS Impact on TP
JUFO EY JUFO 1,120 806 160 14% 10% 21 15 (6) 340 (1.8%) (0.5%)
AUTO EY AUTO 12,842 10,854 571 14% 10% 198 142 (57) 367 (15.4%) (3.0%)
SWDY EY Elsewedy Electric 8,339 7,739 450 14% 10% 21 15 (6) 1,904 (0.3%) (0.1%)
ESRS EY Ezz Steel 19,388 17,848 796 14% 8% 104 60 (45) 762 (0.5%) (0.1%)
ARCC EY Arabian Cement Egypt 721 218 75 5% 5% 21 21 - 214 0.0% 0.0%
MCQE EY Misr Cement Qena 671 41 22 5% 5% 30 30 - 189 0.0% 0.0%
SCEM EY Sinai Cement 333 - 56 5% 5% 14 14 - (150) 0.0% 0.0%
SVCE EY South Valley Cement 286 - 750 5% 5% (23) (23) - 48 0.0% 0.0%
SUCE EY Suez Cement Company 1,205 235 90 5% 5% 44 44 - (241) 0.0% 0.0%
TORA EY Tourah Portland Cement 269 - 99 5% 5% 9 9 - (295) 0.0% 0.0%
MNHD EY Madinet Nasr Housing 1,250 598 14% 10% 91 65 (26) 398 (6.6%) (4.8%)
OCDI EY Six of October 2,608 1,572 14% 10% 145 104 (41) 629 (6.6%) (7.3%)
TMGH EY Talaat Mostafa 6,740 4,322 14% 10% 338 242 (97) 1,617 (6.0%) (5.7%)
EGTS EY Egyptian Resorts 336 143 14% 10% 27 19 (8) 148 (5.2%) (2.8%)
PHDC EY Palm Hills Developments 3,917 2,020 14% 10% 266 190 (76) 1,254 (6.1%) (4.9%)
EFID EY Edita 2,663 1,596 459 14% 5% 85 30 (55) 431 (12.7%) (8.0%)

Source: Company Data, Arqaam Capital Research; *

Exhibit 5: Impact on EPS if fully absorbed by corporates Exhibit 6: Impact on TP if fully absorbed by corporates
0% 0%

(2%) (1%)

(4%) (2%)
(3%)
(6%)
(4%)
(8%)
(5%)
(10%)
(6%)
(12%)
(7%)
(14%) (8%)
(16%) (9%)
OCDI
MCQE

ARCC
SUCE

SWDY

ESRS

EFID
TMGH
JUFO

AUTO
SVCE

MNHD
PHDC
SCEM

TORA

EGTS

OCDI
ARCC

MCQE

SUCE

SWDY

ESRS

EFID
TMGH
JUFO
SVCE

AUTO

MNHD

PHDC
SCEM

TORA

EGTS

Source: Company Data, Arqaam Capital Research Source: Company Data, Arqaam Capital Research

Lastly, for telecoms, (TE) there is little change for base rate taxes (15% sales tax vs. 14% VAT)
but an additional 8% VAT rate is being proposed, which will increase end-consumer prices
significantly. This will likely be offset given a 1-year exemption for landline internet services
(previously 5% sales tax) before attracting the general VAT rate of 14%. We expect some
margin impact in this sector, though Telecom Egypt is sheltered by relatively high EBITDA
margins of >30%. As per management commentary however, the VAT should be passed over
to the consumer and should not have a material impact on the consumer behavior and no

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 5
 September 8 2016
Egypt Strategy

impact on TE realised margins. The Egyptian telecom sector lags behind global average
contribution to GDP (<1.5% of the total GDP). As per the last 2 years of TE experience,
consumer behavior does not change with bad quality or even an increase in prices from
mobile.

Exhibit 7: Flow-chart of VAT impact on key P&L components

Inputs Outputs Costs End-price
(goods/services purchased) (goods produced/services rendered) (borne by corporate) (borne by consumer)

Product/service is
No change No change
sales tax / VAT exempt
Attracts no sales tax
(purchase is tax exempt)
Inputs (COGS, and will be VAT exempt Typical
Product/service No change^, Typically +3.6%
non-staff costs case
attracts VAT / sales tax possibly -9%^^ (on rate chg)
excl. D&A), Capex Attracts sales tax (creating scenario
borne by
a tax credit) and will attract
consumer
VAT (creating similar credit) Applies to
Product/service is Typically +3.6%
No change banks, real
sales tax / VAT exempt (no output VAT*)
Firms are unable to deduct sales tax estate,
paid from tax due on certain output dairy product
products (e.g. cement/clinker, steel) producers,
for VAT, these are replaced with
snack foods, contracting services

Source: Arqaam Capital Research, previous Egyptian GST law and new VAT law; * no VAT due on products sold from which to deduct VAT paid;
^For autos and mobile telecom services, tax deductions only allowed from base rate VAT due and not additional rate (see Ex. 2) possibility of cost sharing
^^ for cement and steel industries, sales tax paid can now be deducted from tax due, allowing reduced costs on some inputs of up to 9% (=1/1.10-1)

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 6
 September 8 2016
Egypt Strategy

Exhibit 8: New VAT rates versus previous GST rates

Sales Tax VAT Notes
General tax levels
All goods/serv ices 10.0% 13.0%* this is 'base rate' VAT (56 items ex empt)
Capital goods (ex cl. passenger cars/busses)** 5.0% 5.0%
Ex ported goods/serv ices -- ex empt under both
Key exemptions
Fruits, v eg, grains, spices, dairy products, meats -- -- ex empt under both
Electricity and unrefined energy commodities -- -- ex empt under both
Raw materials (quarries, mines, minerals, paper) -- -- ex empt under both
Products and serv ices of free zones -- -- ex empt under both
Banking
Banking transactions -- -- ex empt under both
FX dealing at ex change bureaus and banks -- -- ex empt under both
Non-banking transactions regulated by EFSA -- -- ex empt under both, Includes leasing
Insurance and re-insurance activ ities -- -- ex empt under both
Consumer staples
Dairy products/deriv ativ es -- -- ex empt under both
Juice 10.0% 14.0%
Snack foods incl. dough-based cakes (not bread) 5.0% 14.0% VAT net against sales tax
Cements/construction
Cement (incl. clinker) 5.0% 5.0% current rate set in 2010 law ^^
Iron/steel bars and rods for building 8.0% 14.0% current rate set in 2010 law ^^
Real estate
Sale/rent of land/buildings -- -- ex empt under both
Contracting and construction w orks 2.5% 5.0%
Autos
Passenger cars <1.6L 15.0% 1.0% plus base rate VAT (=15%)^
Passenger cars >1.6L, <2.0L 30.0% 15.0% plus base rate VAT (=29%)^
Passenger cars >2.0L (locally assembled) 30.0% 15.0% plus base rate VAT (=29%)^
Passenger cars >2.0L (imported) 45.0% 30.0% plus base rate VAT (=44%)^
Telecoms***
Mobile serv ices 15.0% 8.0% plus base rate VAT (=22%)^
Fix ed line serv ices 5.0% 14.0% landine internet ex empt for 1y r
Source: Arqaam Capital Research; * general rate goes up to 14% starting Jul 2017 ** sales tax reduced from 10%
to 5% in Q2 2015 on capital goods which, since 2005, can be used to offset tax collections (as in VAT);
^ input VAT taxes (VAT paid on inputs) can be deducted from base rate VAT collected (not additional amounts)

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 7

Electricity price hike part of
annual medium term plan
to restructure subsidies
Electricity price hike impact
on inflation is indirect from
commercial activitieswhen
included in Aug CPI could
raise it above 14%...
Egypt Strategy
September 8 2016
Egypt Strategy
Assessing the impact of a potential increase in energy costs
Total electricity subsidies have spiraled on subsidies to natural gas being directed to
produce electricity. Average price hikes of 35% will not result in significant increase in
inflation
Government should move soon on prices of other energy products (15-20%), excluding
80-octane gasoline and LPG (used by the lower income group), to continue to reduce the
subsidy bill
Dynamics of the energy market in Egypt are set to change significantly over the course of
FY 2016/2017, and more into FY 2017/2018, as the production and imports balances
slowly change in favor of Egypt
Cement is hit the hardest as an intense energy user
Electricity Price Restructuring
This years step is part of an annual medium term program that commenced in July 2014 to
restructure electricity subsidies for industrial, commercial and household sectors. Total
electricity subsidies have risen from EGP 8.6bn in FY 2012/2013 to EGP 30.1bn in FY
2015/2016, with an expected decline to EGP 29.0bn in FY 2016/2017. The increment in
previous years was a result of the increase in rising subsidies to natural gas being directed to
produce electricity. Although the consumption breakdown is not publicly available but power
is mostly directed to the industrial sector, then commercial, with the latter exceeding the
industrial sector in consumption in summer and night time periods, and lastly the household
sector. The upward change in electricity prices this year averaged 35% for the industrial and
household sectors and 11% for the commercial sector.
The government has been attempting in recent years to unravel the complex web of
subsidies and cross subsidies between several products and between different government
entities. The detangling of state subsidies between the Ministries of Petroleum, Electricity
and Finance is allowing the government to have better visibility of the actual magnitude of
subsidies, and, therefore, their management, as part of government finances, especially in
this phasing out period.
With power utilities constituting around 2.5% of the overall consumer price index (CPI)
weight, the change in electricity pricing would not significantly impact the annual headline
inflation per se, with the bigger impact coming from the potential hike in prices from the
services and retail sectors, constituting at least 20% of the CPIs weight. We expect annual
th
headline inflation for August (to be announced on September 8 ) to inch up above 14% if the
full impact of the electricity price hike is reflected.
Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 8
 September 8 2016
Egypt Strategy

Exhibit 9: Electricity Subsidies Development

35 16%

30 14%

12%
25
10%
20

EGP Bn
8%
15
6%
10
4%
5 2%

0 0%
11/12 12/13 13/14 14/15 15/16(prelim.) 16/17(proj.)

Electricity Subsidies As % of Total Expenditures (RHS)

As % of Total Subsidies (RHS)

Source: Ministry of Finance, Arqaam Capital Research

Fuel Subsidy Restructuring

Fuel subsidy restructuring Fuel subsidies have historically constituted the lions share of total government subsidies,
vital to redirecting gov accounting for 60% of total subsidies, on average. Since FY 2014/2015 this average has
spending to social aspects dropped to 35%, as the government increased subsidies to food commodities and public
and investment services (transportation, social housing, social welfare etc).

The government had commenced the energy subsidy restructuring program in 2008, when it
changed prices for gasoline, diesel, mazot, kerosene and natural gas. It paused until 2014 due
to the external and internal shocks the economy suffered from and then implemented another
wave of price restructuring in July 2014. The government indicated at the time it aims to
restructure subsidies significantly to reduce subsidies overall, while better targeting the less
privileged income groups and monitoring the consumption of the different products through a
smart card system to gauge market demand for the different products and prevent smuggling.

Exhibit 10: Subsidies Development Exhibit 11: Energy Subsidy Breakdown

250 0.7
100%
0.6
200 90%
0.5 80%
150 70%
0.4
EGP Bn

60%
0.3
100 50%

0.2 40%
50 30%
0.1
20%
0 0 10%
11/12 12/13 13/14 14/15 15/16(prelim.) 16/17(proj.) 0%
11/12 12/13 13/14 14/15
Food Fuel
Electricity Other (social services, sector support) LPG (Butane Gas) Diesel Gasoline Mazot Natural Gas
Fuel Subsidy/Total Subsidies (RHS)

Source: Ministry of Finance, Arqaam Capital Research Source: Ministry of Finance Arqaam Capital Research * Natural gas was taken
* out of fuel subsidy group and treated separately starting FY14/15. ** Detailed
data not available after FY14/15

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 9

Government aims to cover
65% of cost with energy
price hike
Timing of fuel subsidy
restructuring a judgment
call
Expect a breakthrough in
natural gas in FY2017/2018
as ENI production comes
online, geared towards local
consumption
Egypt Strategy
September 8 2016
Egypt Strategy
The government has already implemented the registration and issuance of smart cards phase,
and has yet to launch the use of the smart cards at the individual level. But we understand that
it is already monitoring the exchange of petroleum products throughout the production and
distribution phases to prevent smuggling. We believe that the government will move soon on
prices of energy products, excluding 80-octane gasoline and LPG (used by the lower income
group), to continue to reduce the subsidy bill, redirecting the resources towards other social
and investment spending.
Although the government had a golden chance to reduce energy subsidies in recent years
when oil prices were lower, the turbulence, created by the FX shortage in the official market
and the tourism shock, undermined the governments willingness to administer more shocks
to the economy. The balance of payments crisis and rising budget deficit, however, have
forced the government to get back on track to continue with its expenditure restructuring
program.
We expect a 15% to 20% increase, on average, in petroleum products prices, including 92-
octane, diesel, and mazot, given that their current sale prices only cover around 57%, on
average, of their actual cost, with the government seeking to raise that ratio to 65%, at least.
Such a move is expected to positively impact GDP by 0.5% in FY 2016/2017, rising to 2.0% in
FY 2017/2018 as the subsidy restructuring program continues and more savings are created
to be redirected to social spending and investment.
Timing of the price increase will be more, in our opinion, a judgment call than a timing
mandated by specific objective factors. We believe that the sooner the step is taken, the
better from a fiscal standpoint and to contain the inflationary impact of fiscal reforms in a
limited period of time. The other argument, on the other hand, would be to spread out the
fiscal reforms to reduce the severity of their impact from a social perspective and not
undermine public tolerance of these necessary reforms. Either way, we expect the move on
energy prices to occur in the second or third quarter of FY 2016/2017.
While reliable production and consumption figures of petroleum products are not publicly
available, government sources had indicated that consumption of petroleum products is
expected to decline by 4% in FY 2016/2017, to 39 million tonnes, as consumption of mazot
declines by 20% (replaced by coal in the cement sector), and consumption of diesel and
gasoline rises by 3% and 7% respectively. With Saudi Arabia providing around 700,000 tonnes
of petroleum products each month (at competitive prices), and local refining capacities set to
increase over the course of 2017 increasing the production of high quality diesel, the import,
and therefore overall, cost of energy is expected to start a downward trajectory, with global oil
prices fairly stable in the short to medium term as global growth remains relatively subdued.
For natural gas we expect that a breakthrough will occur in late 2017 and throughout 2018 and
beyond, when ENIs production of natural gas will commence, significantly reducing the gas
import bill. The import cost has jumped with the cost of renting the infrastructure necessary to
transport and regasify liquefied natural gas to pump it into the national grid to supply power
stations and the industrial sector mainly. The current cost of natural gas to the industrial sector
is around USD 7.15/mBTU, given the high cost of imports, shipping and gasification unit rental,
and we do not expect a reduction in gas prices in the near future as the government aims to
Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 10
 September 8 2016
Egypt Strategy

allow the private sector to ultimately secure its own energy resources once the infrastructure
is completely in place.

With these changes, the dynamics of the energy market in Egypt are set to change significantly
over the course of FY 2016/2017, and more into FY 2017/2018, as the production and imports
balances slowly change in favor of Egypt. This should reduce the impact of future energy price
hikes as the general cost level declines.

Cement producers would be the most affected by rising energy costs (24-30% average
downside to EPS): Electricity represents c.13% of direct expenses for cement companies. Our
calculations assume a 17-19% increase in electricity costs on energy intensive firms depending
on usage band (17-18% for 132-220Kv, 19% for 66-11Kv) implying c.21% average downside to
EPS for cement stocks under coverage. In parallel, we apply a 15-20% increase on
mazout/diesel/gasoline costs which primarily affect Tourah Cement as the firm still operates
its kilns on heavy fuel (c.59% of COGS, implying 58-75% downside to EPS).

Exhibit 12: Impact on EPS- electricity Exhibit 13: Impact on TP- electricity
0% 0%
(5%)
(10%)
(10%)
(20%)
(15%)
(30%) (20%)

(40%) (25%)
(30%)
(50%)
(35%)
(60%)
(40%)
(70%) (45%)
OCDI

OCDI
ARCC

ARCC
MCQE

MCQE
SUCE

SUCE
SWDY
SWDY

ESRS

ESRS
EFID

EFID
AUTO

AUTO
JUFO

JUFO
SVCE

SVCE
PHDC

PHDC
SCEM

SCEM
TORA

TORA
ETEL

ETEL

Source: Company Data, Arqaam Capital Research Source: Company Data, Arqaam Capital Research
*for cement producers, electricity represents c. 13% of direct costs on average

Exhibit 14: Impact on EPS- mazout/diesel (+15%) Exhibit 15: Impact on TP- mazout/diesel (+15%)
0% 0%
(1%)
(10%)
(2%)
(20%) (3%)
(4%)
(30%)
(5%)
(40%) (6%)

(50%) (7%)
(8%)
(60%)
(9%)
OCDI

MCQE

ARCC

SUCE
ESRS

SWDY

EFID
AUTO
JUFO

TORA**
PHDC

SVCE

SCEM*
ETEL

OCDI

ARCC

MCQE

SUCE
SWDY
ESRS

EFID
AUTO
JUFO

SVCE
PHDC

SCEM

TORA
ETEL

Source: Company Data, Arqaam Capital Research Source: Company Data, Arqaam Capital Research
*higher implied transportation costs **TORA continues to operate on mazout

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 11
 September 8 2016
Egypt Strategy

Exhibit 16: Impact on EPS- mazout/diesel (+20%) Exhibit 17: Impact on TP- mazout/diesel (+20%)
(0%) 0%

(10%) (2%)

(20%) (4%)

(30%) (6%)

(40%) (8%)

(50%) (10%)

(60%) (12%)

OCDI
OCDI

ARCC

MCQE
MCQE

ARCC

SUCE
SUCE

ESRS

SWDY

EFID
ESRS

SWDY

AUTO
EFID
AUTO

SVCE
JUFO

PHDC
SVCE
JUFO

PHDC

SCEM
SCEM

TORA
TORA

ETEL
ETEL

Source: Company Data, Arqaam Capital Research Source: Company Data, Arqaam Capital Research

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 12
 September 8 2016
Egypt Strategy

Assessing the impact of a potential devaluation

The CBE will likely devalue aggressively when it has secured enough FX ammunition
Most companies are affected by higher import prices, though not necessarily a game
changer for consumer names as they already sourced in the parallel market. ElSewedy
Electric is the sole net beneficiary of a potential devaluation
Over time we expect local producers to benefit from the devaluation due to a changing
competitive landscape

The Devaluation

Our expectations proven We had argued in March 2016 that the success of the devaluation would require large
right, availability is key to injections of foreign currency to cover the increased demand by the corporate and household
deval success sectors and that a mere depreciation of the rate will not be sufficient to unlock the much
needed FX inflows. And we were right..

Arriving at the same scene six months later, we now believe that the CBE will likely devalue
aggressively when it has secured enough FX ammunition to meet the knee jerk spike in
demand that is expected to occur once the EGP/USD is officially changed and restrictions on
obtaining FX in the official market are eased.

Exhibit 18: Avg. Official and Parallel FX Rates Exhibit 19: Equity Inflows and FX Rate
9.0 14.0 1300 13
1250
8.8 13.0 12
1200
8.6 12.0 11
1150
8.4 11.0 1100

EGP/USD
10
USD Mn
EGP/USD

EGP/USD

1050
8.2 10.0
9
1000
8.0 9.0
950 8
7.8 8.0 900
7
7.6 7.0 850
800 6
7.4 6.0
Apr-15

Apr-16
Feb-14

Sep-14

Feb-15

Sep-15
Jun-14

Jun-16
Jul-14

Jul-15

Jul-16
Dec-14
Mar-14

Dec-15

Mar-16
Oct-14

Aug-15

Aug-16
Nov-15
Jan-14

Jan-15

Jan-16
May-14

May-15
Sep-15

Feb-16
Jan-16

Mar-16
Dec-15

Jun-16
Jul-15

Aug-15

Jul-16

Aug-16
Oct-15

May-16
Nov-15

Apr-16

Avg. Official Rate Avg Parallel Rate (RHS) Cumulative Flows Parallel FX Rate (RHS)

Source: Bloomberg, Arqaam Capital Research Source: Bloomberg, EPFR Global, Arqaam Capital Research

While the real FX rate based on rigorous calculations could be significantly below the current
rates in the parallel FX market (latest avg rate of EGP 12.7/USD), we believe that the much
needed portfolio investment, the key game changer in the current balance of payments crisis,
will not flow to the Egyptian equity and debt markets unless an aggressive devaluation takes
place, satisfying the perception that the EGP is finally not overvalued.

Since early 2016, the EGP lost 14% of its official value, stabilizing at EGP8.88/USD in the
official market, while losing 48% in the parallel market. A further 24-35% devaluation (to
between EGP11 and EGP12 to the USD) could imply an overall devaluation of 41- 54% in
2016, which could indeed satisfy investors need for the security of knowing that the EGP is

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 13
 September 8 2016
Egypt Strategy

finally close to its real free market value. The exhibit above shows investment inflows to the
equity market gradually declined since 2014 as the average parallel FX rate rose, and investors
lost confidence in the official FX market, rising again following the March 2016 devaluation,
and more so with rising expectations of an imminent and aggressive devaluation the curious
case of pressing the right confidence buttons.

Expect aggressive deval to We do believe, however, that such an anticipated aggressive devaluation would not be in the
reflect real mkt price and form of an immediate free float, but rather a managed float, pending a build-up of foreign
lure investmentsa reserves to help support a free float later on, while gradually weaning the public off the idea
managed float approach of a stable FX rate. The CBE Governor had announced in March 2016 that the CBE aims to
rather than a free float in implement a flexible exchange rate system, and reemphasized this being the ultimate goal in
the short term several appearances thereafter.

We emphasize that while the FX rate is important, the key factor in the success of this move
will totally rely on the injection of ample liquidity in the market to satisfy pent up demand by
the household and corporate sectors. We believe that a move to devalue the EGP could
occur once the additional FX funding is secured, which we consider to potentially be the
additional funding that Egypt and the IMF are working to secure prior to the IMF Boards
approval of the USD 12bn financing deal. We will further discuss anticipated funds below,
but we expect the coming days, or weeks at the most, will witness significant movement on
monetary policy once enough ammunition is secure.

Going forward we expect the balance of payments to improve as tourism and remittances
recover, albeit gradually resulting in a current account deficit of around 3.5% of GDP in FY
2016/2017. We expect, however, that the capital account will recover at a faster pace as
portfolio and foreign direct investments rise following the resolution of the FX overhang,
generating an overall balance of payments surplus that would help replenish the CBEs
international reserves.

Assessing the impact per stock only medium term benefits as it alters the
competitive landscape for local producers, expect initial margin squeeze

In our coverage space, ElSewedy Electric is the sole net beneficiary of a potential devaluation
in the EGP through (i) the groups turnkey contracts denominated in FC (includes EUR 785m
and USD 485m contracts signed with Siemens and the Angolan Ministry of Electricity and
Water respectively, a combined 53% share of backlog), (ii) exports (wires, cables and electric
products) and revenues from international operations in the GCC and Africa (c.50% of group
top line) priced in USD (or GCC currencies pegged to the USD), and (iii) receivables in hard
currency (c.45% of total coming from the fast-track project). Our calculations suggest c. 8-12%
upside to forward EPS in the event of a 25-37% weakening of the Egyptian pound vis-a-vis the
USD.

A potential devaluation to around EGP 12 will have serious ramifications on margins for Suez
Cement Group (including Tourah Cement) and Sinai Cement which continue to partially run
their kilns on natural gas (USD 8/mmbtu) paid for in EGP converted at the CB official exchange
rate of EGP 8.8. Our calculations suggest 57-59% average downside potential to EPS should the
pound devalue to EGP 12 vis--vis the USD. On the other hand, we calculate 25% downside
potential to EPS for Arabian Cement through (i) higher cost of debt (90% in USD), (ii) partially
Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 14
 September 8 2016
Egypt Strategy

offset by alleviated fuel costs as ARCC primarily runs on coal (75% of fuel needs) for which it
currently sources USD from the parallel market at EGP 12.5-12.7.

EGP devaluation is not a game changer for consumer names: Prior to Q2 16A consumer
staples were given priority USD allocation from the central bank in order to fund their imports
(c.30% of Juhaynas COGS). However, drained USD liquidity left food producers with no choice
but to go to the black market for their foreign currency needs, JUFO procured 80% of its USD
needs at the black market rate (EGP 12-13/USD) in Q2 16A.

Another round of EGP devaluation would in our view have limited impact on consumer names,
and might actually be a positive catalyst if foreign currency liquidity is restored at banks and
food producers were again given priority allocation. EDITA have adopted a price migration
strategy in order to preserve profitability, however, Juhayna and DOMTY have chosen a more
traditional approach through increasing selling prices gradually which will take a few quarters
before restoring profitability. GB Auto have been struggling with FX challenges for more than
year, and have been increasing prices (20%+) since Q4 15A, another round of devaluation
should take its toll on margins, but more importantly if USD availability is restored in Egypt,
competitors would be able to secure imports again and thus exhausting GBs ability to increase
prices without losing market share.

Exhibit 20: Impact on EPS- devaluation to 11 EGP/USD Exhibit 21: Impact on TP- devaluation to 11 EGP/USD
10% 12%
5%
8%
0%
(5%)
4%
(10%)
(15%) 0%
(20%)
(4%)
(25%)
(30%)
(8%)
(35%)
(40%) (12%)
ARCC
MCQE

SUCE
SWDY

ESRS
ARCC

EFID
MCQE

AUTO
SUCE

JUFO

SVCE
SWDY

SCEM
ESRS

TORA
EFID

AUTO
JUFO
SVCE

SCEM

TORA

ETEL
ETEL

Source: Company Data, Arqaam Capital Research Source: Company Data, Arqaam Capital Research

Exhibit 22: Impact on EPS- devaluation to 12 EGP/USD Exhibit 23: Impact on TP- devaluation to 12 EGP/USD
15% 15%

5% 10%

(5%) 5%
(15%)
0%
(25%)
(5%)
(35%)
(10%)
(45%)
(15%)
(55%)
(20%)
(65%)
ARCC
MCQE

SUCE
SWDY

ESRS

EFID
AUTO
JUFO

SVCE

SCEM
TORA
ETEL
ARCC
MCQE

SUCE
SWDY

ESRS

EFID

AUTO
JUFO
SVCE

SCEM
TORA
ETEL

Source: Company Data, Arqaam Capital Research

Source: Company Data, Arqaam Capital Research

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 15
 September 8 2016
Egypt Strategy

Significant impact on Inflation and Interest Rates

Inflation could hit 18-20% towards year end

We see higher interest rates given negative rates currently

Expect a significant rise in With the implementation of current and expected reforms we expect inflation to rise
inflation to 18-20% due to significantly, partially due to higher changes in prices, and more so due to the negative
reforms and negative impact of the base effect, resulting in inflation rates close to 18-20% towards the end of 2016
impact of base effect and early 2017. We note that such levels for annual headline inflation, while reason for
concern, will not reflect the actual magnitude of price changes and inflation changes will be
more realistically reflected by the monthly changes in headline and core inflation. As evident
from the exhibit below the monthly changes in headline and core inflation have been more
subdued and stemming from the one-off and seasonal factors affecting inflation, especially
changes in food items prices, than inherent inflationary pressures resulting from higher
economic growth.

Reforms negative impact on While we present below the impact the expected recipe of policy actions will have on listed
inflation short livedbase stocks, mostly negative on cost of goods, and ultimately, trading prices, we note that this
effect to linger in impact will be short lived, in tandem with monthly inflation spikes, and the inflationary wave
2017monthly changes should gradually dissipate until the summer of 2017 when we expect another move on
more indicative of energy prices and the higher VAT rate of 14% kicks in.
inflationary pressures
Exhibit 24: Core and Headline Inflation
20% 16%
14%
15%
12%
10% 10%

5% 8%
6%
0% 4%
-5% 2%
0%
-10%
-2%
-15% -4%
Nov-12

Nov-13

Nov-14

Nov-15
Jan-14

Jan-15

Jan-16
Jan-12

Jan-13

Sep-14

Sep-15
Sep-12

Sep-13

May-14

May-15

May-16
May-12

May-13
Jul-12

Jul-13

Jul-14

Jul-15

Jul-16
Mar-12

Mar-13

Mar-14

Mar-15

Mar-16

Fruits & Veg. (m/m) Core inflation (mom)

Urban Headline Inflation Urban Headline Infl. (m/m, RHS)
Core Inf. (y/y, RHS)
Source: CAPMAS, Central Bank of Egypt, Arqaam Capital Research

Expect cumulative rate hike
of 1-3% in Q4 2016 to
improve EGP attractiveness
and carry trade more than
to curb inflation
Given the abovementioned factors, we expect that the CBEs hike of corridor interest rates,
within a range of 1-3% possibly, will be aimed at raising returns on the EGP for the
household sector and foreign investors targeting the carry trade profit, rather than a tool to
combat inflationary pressures. The more aggressive the hike, the more inviting the situation
will be for foreign investors.

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 16
 September 8 2016
Egypt Strategy

Exhibit 25: Interest Rates Development Exhibit 26: Yield Curve

18%
16%
17%
14%

12% 16%

10% 15%
8%
14%
6%
13%
4%
12%
2%

0% 11%
Oct-10

Oct-11

Oct-12

Oct-13

Oct-14

Oct-15
Apr-10

Apr-11

Apr-12

Apr-13

Apr-14

Apr-15

Apr-16
Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

Jan-15

Jan-16
Jul-10

Jul-11

Jul-12

Jul-13

Jul-14

Jul-15

Jul-16
10%
3-Months 6-Months 9-Months 1-Year 5-Years 7-Years 10-Years
CBE Overnight Interbank Rate Headline Urban Inflation
Core Inflation CBE Overnight Depoit Rate Feb-16 Mar 2016 (pre-deval) Apr-16 Sep-16

Source: Central Bank of Egypt, Arqaam Capital Research Source: Reuters, Arqaam Capital Research

Treasuries rates have risen significantly in recent months, and will rise even further in the
coming quarter, presenting a very lucrative opportunity for debt investment, once the
overhang of the FX situation is lifted. There are 3 Monetary Policy Committee (MPC) meetings
before the end of the year (Sep 22, Nov 17 and Dec 29), and we expect the rate hikes will be
more frontloaded than not.

Assessing the impact of a rise in benchmark interest rates banks gain on

higher asset yields, corporates are impacted due to rising cost of servicing
debt

The Egyptian banks should be very well positioned for higher interest rates as asset yields
increase more than the cost of funds, increasing NIMs and average RoE, certainly in the
medium term, with the caveat that higher interest rates could trigger losses on investments
qualified as available for sale. CIB has previously been caught wrong-footed in Q4 15A and Q1
16A holding long-duration HFT and AFS positions on which it booked significant revaluation
losses through OCI. (AFS) and through P&L (HFT), eroding its capital base (>3% CET1 across
Q4/Q1) and forcing a cut in its dividend payout ratio; the bank has now reclassified a large
portion of this same AFS portfolio as HTM, reflecting its true intention of holding to maturity
and recouping valuable capital that repositions CIB for strong RWA growth (expected following
the IMF deal).

Overall we see CAE and HDB as best positioned. We have run 3 scenarios in absence of bank
disclosure about the impact of interest rate changes:

1) We apply a 200bps interest rate hike over the interest rate gap over 12 months based
on YE 15A disclosures and find that HDBs and CAEs balance sheets are best geared
for higher rates. Based on its FY 15 balance sheet, CIB would have barely benefited
from hikes; however, CIB shortened durations of assets and reduced sovereign
holdings (41% of interest earning assets down from the peak of 52%). Sovereign
exposures at CIB have fallen from a peak of 52% of interest earning assets in Q1 15A

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 17
 September 8 2016
Egypt Strategy

to 41% at end Q1 and Q2 16A). Overall RoE increases by 3.2ppt for CAE and 4.2ppt for
HDB.
2) We calculate the so called endowment effect as 200bps over shareholders equity.
This should increase NIMs by 12-27bps and increase earnings by 7.1-24.8% and RoE by
2ppt (obviously), with the lowest benefits for CIB due to its higher asset/equity ratio.
3) We calculate a revised endowment effect as 200bps over non-interest bearing
liabilities (chiefly current account deposits and shareholders equity). This is a good
proxy for the long-term effects on NIMs and RoE.

Exhibit 27: NIM and RoE impact 12M ALM gap (Scenario 1) Exhibit 28: NIM and RoE impact endowment effect (scenario 2)
80 6% 35 3%

60 4% 30
2%
40 2% 25

2%
20 0% 20

-2% 15
1%

(20) -4% 10
1%
(40) -6% 5

(60) -8% 0 0%
HDB CAE QNBA CIB SCB NBK-E UNB-E Al Baraka HDB UNB-E QNBA CAE CIB SCB NBK-E Al Baraka

Source: Company Data, Arqaam Capital Research Source: Company Data, Arqaam Capital Research

Exhibit 29: NIM and RoE impact full endowment (Scenario 3) Exhibit 30: Impact PPP (Y) vs. NP (X) Scenario 1
80 12.0% 30%
HDB

70 25%
10.0%
20%
60
8.0% 15%
CAE
50
QNBA
10%
40 6.0%
5% CIB

30 0%
4.0%
-50% -40% -30% -20% -10% 0% 10% 20% 30% 40%
20 -5%
SCB

NBK-E
2.0% -10%
10
UNB-E

-15%
0 0.0% Al Baraka

NBK-E CAE SCB QNBA CIB HDB UNB-E Al Baraka -20%

Source: Company Data, Arqaam Capital Research Source: Company Data, Arqaam Capital Research

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 18
 September 8 2016
Egypt Strategy

Exhibit 31: Impact PPP (Y) vs. NP (X) Scenario 2 Exhibit 32: Impact PPP (Y) vs. NP (X) Scenario 3
14% 30%
NBK-E
SCB
HDB
12%
25%
HDB
10%
UNB-E
20%
SCB CAE
8%
QNBA QNBA
15%
CAE
6% NBK-E Al Baraka CIB Al Baraka
UNB-E
CIB 10%
4%

5%
2%

0% 0%
0% 5% 10% 15% 20% 25% 30% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Source: Company Data, Arqaam Capital Research Source: Company Data, Arqaam Capital Research

Leveraged companies will feel the impact of higher rates

We expect well over 300bps increase in MPR, but the impact on corporates should be less
pronounced as loans are priced more on 3M interbank rates. In our coverage space, ESRS is
mostly affected, while for most companies impact on EPS is between 4-12%.

Ezz Steel stands the most vulnerable to an increase in benchmark interest rates as the group
is highly leveraged (net debt/equity and net debt/EBITDA ratios of 2.7x and 12.6x respectively
as of Q1 16A) with 82% of borrowings priced over the Egyptian Central Banks corridor rate. A
potential +200bps widening in rates would raise our WACC by +92bps implying -36% downside
to fair value.

We calculate +40bps change in WACC for consumer names translating into a 6-8% downside
to TPs. GB Auto is highly leveraged and should be the one most affected by interest rate hikes

Exhibit 33: Impact of a +100bps rise in interest rates on EPS Exhibit 34: Impact of a +300bps rise in interest rates on EPS
1% 5%
(1%)
(3%) (5%)
(5%)
(15%)
(7%)
(9%)
(25%)
(11%)
(13%) (35%)
(15%)
(17%) (45%)
(19%)
(21%) (55%)
OCDI

MCQE
ARCC
OCDI

SUCE
MCQE
ARCC

SWDY
SUCE

ESRS
EFID
TMGH

JUFO
AUTO
PHDC
MNHD
SWDY

SVCE
ESRS
EFID
TMGH

SCEM
JUFO
AUTO
SVCE
PHDC

MNHD

TORA
SCEM

EGTS
TORA
EGTS

ETEL
ETEL

Source: Company Data, Arqaam Capital Research Source: Company Data, Arqaam Capital Research

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 19
 September 8 2016
Egypt Strategy

Civil service reform

Civil service size and wage
bill ballooned after 2011
revolutionwork force
became mostly inefficient
With Egypts bureaucracy ailing from the ballooning of the civil service size to nearly 6 million,
with higher additions to the work force occurring following the 2011 revolution, the wage bill
has grown exponentially in recent years. The governments wage bill rose from EGP 96.3bn in
FY 2010/2011 (7.0% of GDP) to EGP 212.0bn in FY 2015/2016 (7.6% of GDP). The FY 2016/2017
budget projects a decline in the overall % to GDP to around 7-7.3% with the implementation of
the civil service reform law.

Exhibit 35: Wage Bill Development Exhibit 36: Growth of Wages, Total Exp. & Total Rev.
30%
40%
35%
25%
30%

20% 25%
20%
15% 15%
10%
10%
5%
0%
5%
-5%
-10%
0%
08/09 09/10 10/11 11/12 12/13 13/14 14/15 15/16 16/17
08/09 09/10 10/11 11/12 12/13 13/14 14/15 15/16 16/17

Wages/Total Expenditure Wages/GDP Wages Growth Total Exp. Growth Wages Growth Total Rev. Growth

Source: Ministry of Finance, Arqaam Capital Research Source: Ministry of Finance, Arqaam Capital Research

The impact of the new law, replacing the previous complicated web of cumbersome
regulations, will be mostly visible in the:

i) Delinking of the fixed and variable parts of civil servants salaries, allowing the government
better control of the growth in wages. Wage growth jumped from 13% in FY 2010/2011 to 28%
the following year, averaged 17% in the period FY 2012/2013 to FY 2014/2015, before
declining to 10% in FY2015/2016 and a projected 5% in FY 2016/2017;

ii) Closing of the loopholes through which hiring and promotion were processed, leading to an
increase in the number of civil servants over time, and undermining efficiency and
productivity;

iii) Changing promotion benchmarks and criteria to be more performance based; and

iv) Improving the complicated regulations governing taxation and calculation of wages, both
their fixed and variable components, which had led in recent years to larger portions of
government wages being non-taxable with limited government ability to control such
increments.

Civil service reform to As the chart and aforementioned notes indicate, the structural change brought about with
improve efficiency and the implementation of the law is geared more towards improving the efficiency of the civil
productivity more than service, rather than reducing its cost significantly. The average wage to GDP ratio has been
reduce wage bill mostly stable around the 7% level and will continue to hover around that level following
implementation of the new law. But what the new law ushers in is the ability to control the

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 20
 September 8 2016
Egypt Strategy

wage bill and restructure the hiring, management and termination processes of the civil
service workforce, giving the government more power over its historically rigid expenditures
and, more importantly, improving the efficiency and productivity of the bureaucracy. This
latter factor specifically has been a major drag on economic growth, undermining most macro
and microeconomic changes made in recent years, and is being cited as one of the major
impediments to sustainable growth.

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 21
 September 8 2016
Egypt Strategy

In conclusion.
Strong winds of change are blowing through Egypt in one of the hottest summers in a long
time. A flurry of economic and social reforms is being implemented to address long standing
structural issues undermining economic growth and raising Egyptians standard of living.

We had previously presented the governments expected economic reform program,

indicating that the list of reforms included: i) civil service reform law; ii) VAT law; iii) a
devaluation; iv) energy price hikes; v) a Eurobond; and iv) IPOs of some state financial and
energy institutions. In addition to the macro impact, these policy actions will have an impact
on various sectors and listed stocks. We present below the potential impact of the actual and
expected policies, using different scenarios to show stocks sensitivity to the various changes.

In their entirety we expect the reforms will roll out an aggressive devaluation, fiscal reforms
(VAT, energy and wages restructuring) and a deepening of the stock market through the
offering of public stakes in financial and energy institutions. The short term cost will be
higher inflation and interest rates while the balance of payments gradually recovers, with
tourism and remittances improving over the course of 2017 and onwards. The potential
impact of the fiscal reforms on GDP will be significant in the current and following fiscal
years, with more gains to be made as the economy overcomes the historic period of malaise.

Exhibit 37: Key Fiscal Reforms Impact on GDP

Key Fiscal Reforms Objective 2016/2017 Impact 2017/2018 Impact
(as % of GDP) (as % of GDP)

Contain the wage bill and

Civil Service Law introduce performance 0.50 0.75
based payment structure

Electricity tariff increase by 35% Improve efficiency of the

on avg. for households, energy sector and 0.64 0.93
commercial and industrial users rationalize consumption

VAT implementation and Expand tax base and

1.25 2.00
revision of excise taxes improve revenue collection

Introduce simplified tax regime Improve revenue collection

for SMEs & a new tax dispute & efficiency of tax 0.15 0.90
settlement scheme authorities

Licenses, transfer of banks Expanding government

0.20 0.7-0.8
dividends and IPOs revenue sources

Sale of urban communities' and Improve access to land and

0.06 0.10
selected government lands strengthen property rights

Source: Ministry of Finance, Arqaam Capital Research

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 22
 September 8 2016
Egypt Strategy

Impact on Economic Growth

It is clear from the above that FY 2016/2017 will be a blockbuster year with more reforms
implemented in the span of months than in decades in Egypts recent history. Why we do we
think it is for real this time: simply because it has become a necessity for Egypt to survive.
The luxury of waiting and passing on the buck exists no more and it is do or dieliterally.

Blockbuster year for reforms While posing a stellar two years in the life of reform, 2016 and 2017 will be somewhat
at the cost of higher difficult years for corporates, consumers, and the government. Corporates and consumers
inflation and interest will have to adjust and take in stride the higher cost of goods in some sectors, which will lead
ratesconfirming to a squeeze in margins and attempts to pass on the higher costs to consumers. The higher
commitment to reform at income groups, especially, will bear the brunt of reform, as higher costs eat into disbursable
last incomes, at a time when wage growth will lag significantly in the private sector, at least in the
very short term until economic growth picks up.

Consumption growth Private consumption growth averaged 3.3% in FY 2013/2014, inching down to 2.3% in FY
declines in FY 16/17 from 2014/2015, and recovered to around 6% in 9M FY 2015/2016. We expect consumption growth
the higher inflation, to decline to around 3% again in FY 2016/2017, as the higher inflation impacts the higher
rebounding thereafter income groups consumption growth, possibly rebounding in FY 2017/2018 as economic
growth recovers from 4% in FY 2016/2017 to over 5% in FY 2017/2018.

The government will have to adjust as well to a quicker pace of reforms, and what we hope
to be the next phase of reform in 2017, the micro phase, where broader reforms in the
sectors are implemented, changes to the investment law are enacted, and the general
management of the economy experiences real in-depth change. This latter will be very
difficult, we expect, and will take time. Lots of time. But the government will need to realize
that previous multiple disappointments have deeply scared investors, both local and foreign
alike, and much will be needed to make a deep dent in confidence.

Exhibit 38: PMI and FX Rates Exhibit 39: Quarterly GDP Growth
55 14
14%
13 12%
50 10%
12 8%
6%
45 11
4%
EGP/USD

2%
10
0%
Points

40 9 -2%
-4%
8 -6%
35 -8%
7 -10%
-12%
30 6
Q1 10
Q2 10
Q3 10
Q4 10
Q1 11
Q2 11
Q3 11
Q4 11
Q1 12
Q2 12
Q3 12
Q4 12
Q1 13
Q2 13
Q3 13
Q4 13
Q1 14
Q2 14
Q3 14
Q4 14
Q1 15
Q2 15
Q3 15
Q4 15
Q1 16
Q2 16
Q3 16
Apr-14

Apr-15

Apr-16
Sep-13

Feb-14

Sep-14

Feb-15

Sep-15

Feb-16
Jul-13

Jun-15
Mar-14

Jun-14
Jul-14

Mar-15

Jul-15

Mar-16

Jun-16
Jul-16
Dec-13

Dec-14

Dec-15
Oct-13

Oct-14

Oct-15
Aug-13

Aug-14

Aug-15

Aug-16
Jan-14

Jan-15

Jan-16
Nov-13

Nov-14
May-14

May-15

Nov-15

May-16

Investment Net Exports Private Consumption

Benchmark PMI EGP/USD (Parallel, RHS) EGP/USD (Official, RHS) Public Consumption Real GDP Growth

Source: Emirates NBD/Markit, Arqaam Capital Research Source: Ministry of Planning, Arqaam Capital Research

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 23
 September 8 2016
Egypt Strategy

PMI data shows corporate In terms of corporate sector resilience, we note that PMI survey results released by Emirates
sector still able to adjust NBD in cooperation with Markit research firm shows how the FX situation and lack of
and absorb changes in confidence is affecting the general economy. Looking at the PMI, as a time series, shows the
economy, especially FX corporate sector was negatively affected by the February 2015 FX restrictions, and then the
situation subsequent wave of uncertainty in November 2015 and the devaluation in March 2016. The
worst time was the summer of 2015 when management of the FX situation was challenging, to
say the least.

Once, however, the shocks pass, the corporate sector adjusts and recovers, sourcing FX mostly
from the parallel market, and the index has been gradually improving since March 2016,
despite the rise in costs. The survey results indicate that the increase in input costs has been
passed on to consumers and the companies output and export orders have improved. The July
2016 PMI signaled an improvement in the corporate sector, 48.9 points, before declining to 47
points in August where the FX crunch was more felt as pre-devaluation confusion took its toll
on FX availability in the parallel market as well.

Exhibit 40: Banks Credit Growth by Sector

%
24
22
20
18
16
14
12
10
8
6
4
2
0
-2
Nov-12

Nov-14

Nov-15
Nov-13
Jan-12

Jan-13

Jan-16
Jan-14

Jan-15
Sep-14

Sep-15
Sep-12

Sep-13
May-13

May-14
May-12

May-15

May-16
Jul-13

Jul-14

Jul-15
Jul-12
Mar-12

Mar-13

Mar-14

Mar-16
Mar-15

Industry Trade Services Unclassified Sectors (Mainly Households) Agriculture

Source: Central Bank of Egypt, Arqaam Capital Research

Data on banks credit growth also shows resilience in credit growth from the household,
industry and services sectors. Household credit growth is back to the 5% level, similar to pre-
2011 average, services credit growth is recovering and credit growth of the industrial sector
was improving until 2016 when the FX crunch tightened growth.

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 September 8 2016
Egypt Strategy

So Whats Next:

Incoming funds will help At this point all eyes are on the CBE, waiting for the devaluation bell to finally ring. We
CBE take deval step, which expect the devaluation timing will be linked to when the CBE is able to secure enough FX
will succeed only with resources to inject sufficient cash into the official system to meet pent up demand, clear the
increased FX availability backlog of portfolio investors and stand the test of supplying the corporate and household
sectors through banks. We expect this to be coupled with a step-relaxation of the restrictions
for corporate FX transactions at banks, and for the household sector as more FX is channeled
to the official market as confidence rises. We expect this transition phase to take a few
weeks, with the parallel market gradually withering away.

The government and CBE are set to receive USD 1bn from the World Bank in the second half
of September, as well as USD 0.5bn from the African Development Bank (a delegation from
the bank is coming to Cairo around that time). More funds are expected from the Gulf and we
anticipate support from China and other international financial institutions as well. Around
USD 3-5bn will be secured from the international bond offering which could be executed
sometime over the next month. During this period, we expect the IMF board will meet to
formally approve the financing deal and disburse the first tranche of USD 2.5bn.

We reiterate our belief that there is now a golden opportunity for the government to
convince investors that it is indeed serious about reform and moving on to more pending
micro reforms. The devaluations success will be the first true litmus test..we have our
fingers crossed that they will come through.

Egypt Strategy Copyright 2016, Arqaam Capital Limited. All Rights Reserved. See Important Notice. 25
 September 8 2016
Egypt Strategy

Important Notice
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