Long-term Growth Drivers Intact

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Elinor Rice
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1 abdullah Al OTHAIM markets co. Long-term Growth Drivers Intact key data Fair Value per Share (SAR) 95.0 Closing Price (SAR)* week High / Low (SAR) / YTD / 12-month Return -14% / -8% P/E (TTM) 13.2 Shares Outstanding (million) 22.5 Market Cap (SAR million) 1,901 Free Float 42.5% Reuters / Bloomberg Code 4001.SE / AOTHAIM AB *Prices as of August 01, Sources: Bloomberg and NBK Capital key metrics 2011A 2012F 2013F 2014F EPS (SAR) EPS Growth -7% -3% 29% 12% P/E Dividend Yield 0.0% 4.1% 4.7% 5.3% EV/EBITDA Revenue (SAR million) 4,091 4,377 4,929 5,416 Revenue Growth 16% 7% 13% 10% EBITDA (SAR million)* EBITDA Growth 9% 1% 19% 8% EBITDA Margin 5.9% 5.6% 5.9% 5.8% *includes associates income and other income/expenses. Prices as of August 01, Sources: Othaim and NBK Capital quarterly forecasts SAR million 3Q2011A 2Q2012A 3Q2012F 4Q2012F Revenue 1,136 1,061 1,222 1,081 EBITDA* *includes associates income and other income/expenses. Sources: Othaim and NBK Capital Rebased Performance Aug-11 Sep-11 Nov-11 Dec-11 Feb-12 Apr-12 May-12 Jul-12 Othaim Tadawul Sources: Bloomberg and NBK Capital Ashish Jain T E. ashish.jain@nbkcapital.com Samir Murad, CFA T E. samir.murad@nbkcapital.com Highlights 12-Month Fair Value: SAR 95.0 Recommendation: Accumulate - Risk Level: 3** Reason for Report: 2Q2012 Results Update We expect performance to improve gradually over the second half of the year despite a weak first-half. 2Q2012 results were weaker than our expectations. Revenues rose 3% YoY to SAR 1.06 billion (6% lower than our forecast), and operating profit declined 19% YoY to SAR 35 million (16% lower than our forecast). The drop in the gross profit margin (GPM) by 110 bps YoY to 6.9% coupled with slower sales growth led to a significant decline in operating profitability YoY. Delays in opening new stores drove slower sales growth as well as put pressure on margins. Othaim opened only two stores during 1H2012 compared to the 11 stores planned for FY2012. The GPM was adversely impacted by the preopening costs associated with setting up new stores and the second round of major salary increases in the last two years. The company is also facing some pressures arising from competition, which is taking a toll on like-for-like sales growth. New store openings should improve sales growth and profitability in 2H2012. We believe the opening of new stores in the pipeline will help sales growth recover. As new stores gain productivity, profitability should also improve, in our view. Therefore, we expect a better performance during 2H2012 and a further rebound in sales growth and profitability over Overall, we have decreased our 2012 revenues and operating profit forecast by 4% and 23%, respectively. Following slow 4% YoY sales growth and a 22% YoY decline in operating profit in 1H2012, our new forecasts project 7% YoY top-line growth with a 11% YoY drop in operating profit for However, our longer-term outlook on the company remains unchanged. We continue to view the Saudi grocery retail industry favorably and expect Othaim to carry on reaping the benefits of the attractive and promising industry. We reduced our fair value (FV) to SAR 95.0 from SAR per share but maintained our Accumulate recommendation, which represents a 12% upside from the last close. The reduction in FV mainly stems from our lower EPS estimate for 2013, and hence, lower peer valuation. In the backdrop of near-term weakness, the catalyst for the stock could be the progressive rebate in 4Q2012. We did not incorporate the rebate in our 2012 forecasts due to the lack of visibility; however, the rebate could surprise on the upside. Additionally, the merger with OREIDCO was not approved by shareholders; therefore, our forecasts and valuation remain on a standalone basis. **Please refer to page 5 for recommendations and risk ratings. nbkcapital.com

2 2H2012 EXPECTED TO BE BETTER THAN 1H2012 Othaim s recent results (1H2012) were weaker than expected primarily due to slower sales growth and gross profit margin (GPM) contractions. We expect sales growth to gradually recover as the opening of most of the new stores planned for 2012 is being pushed to 2H2012. We remain optimistic about the company s performance over the second half of the year and 2013 as new stores come on line and start becoming productive, although we expect sustained pressure on the GPM, albeit less than we have seen recently. Slower sales growth in 1H2012 and continued competitive pressure do not provide much visibility for the progressive rebate that usually provides a boost to the GPM in the fourth quarter. We did not incorporate the rebate in our forecasts, which, if materializes, could surprise on the upside. Figure 1 2Q2012 Financial Performance SAR million 2Q2011A 2Q2012A YoY change 2Q2012F Variance Slower sales growth and margin contraction; weakerthan-expected results Total revenues 1,025 1,061 3% 1,130-6% Gross profit % na na Gross profit margin 8.0% 6.9% Operating profit % 42-16% Operating profit margin 4.3% 3.3% 3.8% Net profit % na na Sources: Othaim and NBK Capital Revenues: Slower growth recently due to delays in store openings; gradual recovery expected over 2H2012 Othaim s revenue growth slowed to 3% YoY in 2Q2012, significantly below our expectations; the slowdown was mainly driven by delays in opening new stores. Othaim opened only two supermarkets during 1H2012 against the planned opening of 11 stores for FY2012. Like-for-like (LFL) sales growth also slowed during 2Q2012. The company attributed competitive pressures, such as Lulu s new hypermarket in Riyadh and Tamimi moving to target a more mid-income customer base similar to Othaim s target segment, as the reasons for slower LFL sales growth. Othaim is still looking to open nine supermarkets during the 2H2012, and we believe this should help the company recover sales growth from the low levels recorded in 1H2012. Therefore, we see more room for growth going forward, especially over 4Q2012 and 2013 as new stores start gaining productivity. Overall, we have reduced our FY2012 revenue forecast to SAR 4.38 billion (7% YoY growth and 4% lower than our previous forecast) due to the weaker-than-expected performance in 1H2012. However, we expect revenue growth to rebound to 13% YoY in Gross profit margin: Pressure expected to ease with new stores gaining productivity GPMs from the grocery business (excluding rental income) recorded a decline of more than 100 bps YoY in each of the previous two quarters. Pre-opening costs associated with new stores and the increase in salary costs due to the ongoing Saudization (known as Nitaqat locally) initiatives were the main reasons cited by the company for the contraction in GPMs. Going forward, we expect pressure on the GPM to ease a bit, mainly as new stores come on stream and start adding to profitability. In addition, we did not incorporate the target-based progressive rebate in our model given the slower sales growth seen during 1H2012. However, as we learned from management, the company is recalibrating its sales target for FY2012 with nbkcapital.com 2

3 suppliers. Therefore, a higher-than-expected pick-up in sales could trigger a rebate, and 4Q2012 GPM could surprise on the upside. Given the contraction in the margins in 1H2012 and continued pressure arising from salary increases, we have reduced our FY2012 GPM to 7.2% (70 bps decline YoY) compared to our earlier forecast of 8.1%. Other forecast changes Our other forecast changes are relatively insignificant and are mostly aligned to the trends witnessed during 1H2012. Among them, worth mentioning is the share of income from associates (primarily Othaim Real Estate Investment and Development Company). We have increased our FY2012 income from associates forecast to SAR 18 million from SAR 13 million forecast earlier following the increased visibility of the company s operation and the recent financial performance. Overall, we have reduced our operating profit forecast by 23% to SAR 140 million (11% lower YoY) and net profit forecast by 20% to SAR 145 million (3% lower YoY). Figure 2 Summary of Forecast Changes SAR million 2011A 2012F Old Value New Value YoY change Change from Old Value Weaker 1H2012 primarily led to the downward revision in our forecasts; however, we expect the second half to be better Revenues 4,091 4,563 4,377 7% -4% Gross profit % -14% Gross profit margin 7.9% 8.1% 7.2% Adj. EBITDA (incl other income) % -13% EBITDA margin 5.9% 6.1% 5.6% Operating profit % -23% Operating profit margin 3.9% 4.0% 3.2% Net profit % -20% Sources: Othaim and NBK Capital Valuation We arrived at a new 12-month fair value (FV) for Othaim of SAR 95.0 per share (compared to the previous SAR 102.5) by using two valuation methods: discounted cash flow (DCF) and peer comparison based on forward PE multiples. We cut our EPS estimate for 2013 by 9%, which mainly drove the peer valuation, and hence, our new FV lower. Our new 12-month FV of SAR 95.0 represents a 12% upside potential from yesterday s close; hence, our recommendation remains Accumulate. Figure 3 Fair Value per Share Valuation Method Weights Old Value New Value % Change Our new 12-month fair value for Othaim is SAR 95.0 per share Discounted cash flow 70% SAR SAR % Peer comparison (PE) 30% SAR 91.1 SAR % Weighted average fair value 100% SAR SAR % Source: NBK Capital nbkcapital.com 3

4 FINANCIAL STATEMENTS Balance Sheet (SAR million) Historic Forecast Fiscal Year Ends December ASSETS Cash Total Receivables, Net Total Inventory Total Current Assets Property/Plant/Equipment, Total - Net 948 1,083 1,119 1,157 1,206 1,259 1,328 Goodwill and Intangibles Other Assets TOTAL ASSETS 1,480 1,667 1,811 1,972 2,138 2,377 2,542 LIABILITIES & EQUITY Accounts Payable ,034 Short-Term Debt Other Current Liabilities Total Current Liabilities ,038 1,116 1,217 1,307 Long-Term Debt Other Liabilities Total Liabilities 1,031 1,136 1,134 1,188 1,235 1,345 1,445 Total Equity ,032 1,097 TOTAL LIABILITIES AND EQUITY 1,480 1,667 1,811 1,972 2,138 2,377 2,542 Income Statement (SAR million) Historic Forecast Fiscal Year Ends December Total Revenue 3,519 4,091 4,377 4,929 5,416 5,975 6,505 Operating Expenses (3,322) (3,858) (4,154) (4,660) (5,126) (5,660) (6,165) Depreciation/Amortization (50) (75) (83) (88) (93) (100) (108) Operating Income Finance Charges (5) (13) (12) (11) (8) (4) (3) Income from Associates Other 9 (4) Taxes (4) (4) (4) (5) (5) (6) (6) Net Income Cash Flow Statement (SAR million) Historic Forecast Fiscal Year Ends December Cash from Operating Activities Cash from Investing Activities (283) (209) (129) (135) (152) (163) (187) Cash from Financing Activities (42) (87) (43) (140) (147) (105) (187) Net Change in Cash (62) (2) Sources: Othaim and NBK Capital nbkcapital.com 4

5 RISK AND RECOMMENDATION GUIDE RECOMMENDATION UPSIDE (DOWNSIDE) POTENTIAL BUY MORE THAN 20% ACCUMULATE BETWEEN 5% AND 20% HOLD BETWEEN -10% AND 5% REDUCE BETWEEN -25% AND -10% SELL LESS THAN -25% RISK LEVEL LOW RISK HIGH RISK Disclaimer The information, opinions, tools, and materials contained in this report (the Content ) are not addressed to, or intended for publication, distribution to, or use by, any individual or legal entity who is a citizen or resident of or domiciled in any jurisdiction where such distribution, publication, availability, or use would constitute a breach of the laws or regulations of such jurisdiction or that would require Watani Investment Company KSCC ( NBK Capital ) or its subsidiaries or its affiliates to obtain licenses, approvals, or permissions from the regulatory bodies or authorities of such jurisdiction. The Content, unless expressly mentioned otherwise, is under copyright to NBK Capital. 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7 KUWAIT DUBAI ISTANBUL CAIRO

Operating Profitability Weakens

Air arabia Operating Profitability Weakens May 16, 2011 Key data Fair Value per share (AED) 0.75 Closing Price (AED) * 0.73 52-week High / Low (AED) 0.90/0.72 YTD / 12-month return -11%/-19% P/E (TTM)