Almarai. Building on Success. Key Data. Highlights

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1 Almarai Building on Success Key Data Current Price* Avg. Value Traded per Day SAR 157 SAR 23.5 million 52-Week High Market Cap SAR 177 SAR 18,055 million 52-Week Low Current Number of Shares SAR million Reuters Bloomberg 2280.SE ALMARAI AB Ownership Structure Privately Held: 69% Public: 31% * As of November 16, Sources: Zawya and NBK Capital Rebased Performance Nov-08 Feb-09 May-09 Aug-09 Nov-09 Almarai MSCI KSA (DOM) * Price Close as of November 15, 2009 Key Ratios 2Q2009 EBITDA a SAR million 3Q2009 EBITDA a SAR million a = actual, f = forecast. Sources: Reuters and NBK Capital Analysts Samir Murad, CFA T E. samir.murad@nbkcapital.com 2008 a 2009 f 2010 f 2011f 2012f P/E EPS Growth 36% 19% 11% 8% 13% EV/ EBITDA EBITDA Margin 25% 27% 27% 26% 26% EBITDA Growth 30% 25% 13% 11% 12% Dividend Yield 2.2% 2.5% 2.8% 3.0% 4.3% ROAE 27% 25% 22% 21% 20% 4Q2009 EBITDA f SAR million 1Q2010 EBITDA f SAR million Wadie Khoury T E. wadie.khoury@nbkcapital.com Highlights 12-Month Fair Value: SAR 200 Recommendation: Buy-Risk Level: 3** Reason for Report: Initiation of Coverage Almarai is the largest integrated dairy company in the world and the leading producer of fresh dairy products in the GCC. With a 28% share of the GCC dairy market, Almarai clearly dominates the industry, as Almarai s market share is close to three times the size of its closest rival. Almarai has proved it is able to leverage the strength of its brand power and the reputation for high-quality products to drive growth in sales. Almarai boasts remarkable distribution capabilities as it serves all six GCC countries on a daily basis with fresh dairy products. Being vertically integrated allows Almarai to produce more than 95% of its requirement of fresh raw milk from its own farms. This ensures the high quality of the most important production ingredient for the company. In addition to fresh and long-life dairy products, Almarai markets a range of food and beverage products that includes fruit juice, cheese and butter, and prepackaged bakery goods. Almarai s product mix is set to expand following its recent acquisition of HADCO (which specializes in poultry products) and the company s plan to expand organically into the infant formula market. Almarai is financially strong; sales have grown at a CAGR of 25% and EBITDA margins have remained stable at levels close to 26% over the past four years. With a net debt-toequity ratio of 0.8x (post HADCO acquisition), Almarai s financial leverage is acceptable. Moreover, the company has consistently paid out cash dividends in the past three years with a payout ratio of 40%. Almarai s sales increased by 15% in 9M2009, a result that is relatively weaker than the company s performance in 2008, but the expansion in the EBITDA margin to 27.5% led to a 23% increase in net income in 9M2009. We arrived at a 12-month fair value for Almarai of SAR 200 per share by using two valuation methods: discounted cash flow (DCF) and peer comparison based on forward PEG (price-to-earnings ratio to growth) multiples. With an upside potential of 27% compared to the latest closing price, we initiate coverage on Almarai with a Buy recommendation. From our subjective criteria for risk, we have assigned Almarai a risk rating of 3 on a scale of 1 to 5. ** Please refer to page 31 for recommendations and risk ratings. nbkcapital. com

2 Contents EXECUTIVE SUMMARY... 3 VALUATION... 4 BULLS VS. BEARS... 8 The Dairy Market Macro level drivers of milk consumption Company OVERVIEW Financial Statement Analysis Major Forecast Assumptions nbkcapital. com 2

3 Executive Summary Almarai is the largest integrated dairy company in the world and the leading producer of fresh dairy in the GCC. With a 28% market share of the GCC dairy market, Almarai clearly dominates the industry, as its share is almost three times the size of its closest rival. Since the early 90s, Almarai has undergone a series of acquisitions and restructuring projects to become the lowest cost producer of dairy products in the GCC. In addition to fresh and long-life dairy products, Almarai markets a range of food and beverage products that includes fruit juice, cheese and butter, prepackaged bakery goods, and some other non-dairy products. Almarai s product mix is set to expand following the company s recent acquisition of HADCO (which specializes in poultry products) and the company s plan to expand organically into the infant formula market. One of Almarai s major competitive advantages lies in its strong and well-recognized brand and its reputation for producing high-quality products in the GCC. Almarai s farms are the cornerstone behind the success of the company s dairy business as they ensure the quality of the most important ingredient, fresh raw milk. In addition, the farms reduce Almarai s reliance on third-party suppliers. Another inherent strength of Almarai is its distribution facilities, which enable the company to serve short shelf-life products on a daily basis, to more than 42,000 shops across the GCC. Almarai is a financially strong company as it has a track record for double-digit growth in sales and consistent EBITDA margins. Almarai s sales increased at an impressive CAGR of 25% over the past four years, almost tripling between 2004 and EBITDA margins remained relatively stable, hovering around 26% since Almarai s net debt-to-equity ratio is at an acceptable level of 0.8x (post HADCO acquisition), while the interest coverage ratio (EBITDA divided by finance charges) currently stands at 9.7x. Moreover, Almarai has consistently paid out dividends in the past three years with a payout ratio of 40%. From a valuation standpoint, using a combination of discounted cash flow (DCF) and peer comparison based on forward PEG multiples, we believe that the fair value of the share is SAR 200. This represents a 27% upside potential from yesterday s close, hence our Buy recommendation. From our subjective criteria for risk, we have assigned Almarai a risk rating of 3 on a scale of 1 to 5. nbkcapital. com 3

4 Valuation The purpose of this valuation exercise is to arrive, through the use of fundamental analysis, at a fair value estimate of the share price that should exist for Almarai in the next 12 months. This does not represent a guarantee that this value is achievable within that time frame, as a wide range of variables and market dynamics affect the market price of an asset. Each investor must use his or her favorite mix of fundamental research, technical analysis, and market intelligence to arrive at an investment decision that matches his or her objectives and tolerance for risk. We arrived at a 12-month fair value for Almarai of SAR 200 per share by using two valuation methods: discounted cash flow (DCF) and peer comparison based on forward PE-to-growth (PEG) multiples. We specified a weight for each method, as shown in Figure 1. The greater weight is assigned to DCF, as this method examines the fundamentals of the company to determine its future cash-generating ability. The 12-month fair value of SAR 200 represents a 27% upside potential from yesterday s close, hence our Buy recommendation. Figure 1 Fair Value per Share Valuation Method Weight Value Our 12-month fair value for Almarai is SAR 200 Discounted cash flow 70% SAR 196 Peer comparison 30% SAR 211 Weighted average fair value 100% SAR 200 Source: NBK Capital Discounted Cash Flow Valuation Our DCF valuation (Figure 2) is based on forecast financial results through The DCF valuation is a function of the following major variables, which have been estimated by our models: Future net operating profit less adjusted taxes (NOPLAT), which is driven primarily by expectations of sales and operating expenses Future changes in working capital Future net expenditures on fixed assets The weighted average cost of capital (WACC), which is a weighted average of our estimated cost of equity and the after-tax cost of debt The long-term expected growth rate in NOPLAT and the expected rate of return on net new invested capital (RONIC) From the forecasted financial results, we extracted the free cash flows that were used in our valuation. We discounted those cash flows to a point in time that is 12 months into the future to obtain an estimate of the value of the company s operations. After subtracting net debt and minority interest and adding the value of non-operating assets, we arrived at a total equity value of SAR 22.5 billion. In order to estimate the value of Almarai s operations, we incorporated a varying WACC into our model. Our selection of a cost of equity of 11% is based mainly on interest rate levels and the operating environment; the selection of 6.5% for the cost of debt is based on historical norms. nbkcapital. com 4

5 Figure 2 DCF Valuation Figures in SAR Millions* Fiscal Year Ends December Forecast Net Operating Profit after Tax 1,479 1,621 1,792 2,004 2,232 Add: Depreciation and Amortization Gross Cash Flow 1,768 1,958 2,185 2,426 2,677 (Incr.)Decr. in Working Capital (184) (178) (208) (216) (251) (Incr.)Decr. in Operating Fixed Assets (1,650) (1,000) (1,000) (1,000) (1,000) Free Cash Flow from Operations (67) ,210 1,426 Terminal Value 32,695 Value of Operations in 12 Months 26,438 Add: Excess Cash 494 Add: Value of Long-Term Investments 1,179 Add: Value of Other Long-Term Assets 40 Less: Total Debt (5,629) Less: Minority Interest (16) Value of Equity in 12 Months 22,507 Per Share Value in SAR 196 * Except per share values. Source: NBK Capital Sensitivity Analysis We performed a sensitivity analysis (Figure 3) on two important inputs for our DCF valuation model: the cost of equity and the perpetual growth rate used in computing the terminal value. Figure 3 DCF Sensitivity Cost of Equity* Growth 4.50% 4.75% 5.00% 5.25% 5.50% 9.9% SAR 218 SAR 224 SAR 231 SAR 240 SAR % SAR 202 SAR 207 SAR 212 SAR 219 SAR % SAR 188 SAR 192 SAR 196 SAR 200 SAR % SAR 175 SAR 178 SAR 181 SAR 185 SAR % SAR 164 SAR 166 SAR 168 SAR 171 SAR 174 Source: NBK Capital Peer Group Comparison With a market capitalization of SAR 18 billion, Almarai is the largest vertically integrated dairy producer in the world. Given the lack of coverage on close comparables to Almarai in the region, we opted to compare the company to similar companies elsewhere in the world. Highlighted in Figure 4 are companies that can offer a basis for comparison for Almarai. We obtained the consensus forward earnings per share (EPS) and the consensus earnings growth estimates for the next three years for each of the companies. The simple average PEG for the sample, excluding outliers, was 1.8. Almarai, in contrast, currently trades at a PEG of 1.4, based on our 2010 forecast EPS and next-two-years earnings growth rate. This shows that Almarai is currently trading at a 26% discount compared with its peers. nbkcapital. com 5

6 Using the simple average PEG, excluding the outliers among the 11 companies in the sample, we estimate the value of Almarai s share at SAR 211, based on a forecast 2010 EPS of SAR 9.9. Figure 4 Forward PEG Comparison Company Market Data Market Cap Price* (USD Millions) 2010 Forecast EPS PEG The average PEG for the sample, excluding the outliers, stands at 1.8 Bright Dairy & Food Co., Ltd , Ausnutria Dairy Corp Parmalat , Dairy Crest Group plc China Mengniu Dairy Co , Danone , Kraft Foods , Vietnam Dairy Products 85, , Glanbia , Dean Foods Co , Wimm-Bill-Dann OAO , Weighted average 1.9 Simple average 3.2 Simple average excluding outliers 1.8 Median 1.6 *Prices in local currency as of November 12, Sources: Bloomberg and NBK Capital nbkcapital. com 6

7 Risks Expansion Risk Almarai has taken on an aggressive expansion strategy since the acquisition of Western Bakeries in The company s expansion plan involves entering into new markets through acquisitions and joint ventures as well as developing new products organically. Though Almarai has so far been able to successfully launch new products and integrate companies with a different product mix, this past performance is not a guarantee for future success. Accordingly, any new venture or acquisition by Almarai will carry its own challenges. The development of a new product such as infant formula is a sensitive choice to consumers. Consumers tend to be selective when it comes to purchasing products for babies. Although Almarai is recognized for quality products, the launch of this product category may present Almarai with challenges that are not within its comfort zone. Herd Health Risk The company s largest source of revenues comes from dairy sales, for which raw milk is the main ingredient. Accordingly, maintaining a healthy herd is of utmost importance in order not to disrupt dairy sales. An outbreak of a contagious disease within the herd could interrupt the milk production cycle, resulting in lower sales. The company aims to control this threat by following a closed herd policy (which involves separating the herd according to its disease susceptibility level), regular vaccinations given to the herd, and frequent veterinarian visits. Also, Almarai maintains its herd in six different farms to mitigate this risk. Product Contamination Just like any other food manufacturing company, Almarai s products could be exposed to foreign contaminating agents. In the event a contaminated product gets out to the public, it could have an adverse effect on the reputation of the company. Consumers would become discouraged, which would lead to a drop in sales. However, Almarai has put in place sophisticated quality control measures to minimize the probability of such risks, a feature of the company that we experienced firsthand when we visited Almarai s facilities. Commodity Exposure Direct materials (ingredients, feed, and packaging costs) represent the bulk of Almarai s costs. The prices of such materials have seen lots of fluctuations recently and may continue to do so in the future. The company attempts to reduce this risk by hedging a portion of its exposure, limiting the effects of the fluctuations in commodity prices. Exchange and Interest Rate Risks Several of the company s purchases are denominated in a foreign currency. Although the Saudi Riyal is pegged to the US dollar (limiting some of its exposure), many of the purchases are denominated in Euros. An unfavorable shift in currencies could increase purchase prices and costs. Furthermore, some of Almarai s debt is variable. As a result, increases in interest rate movement could be an additional burden to the company. Swine Flu Pandemic The swine flu pandemic could potentially cause a decline in the number of visitors to Saudi Arabia, which can impact Almarai s sales in the short term. nbkcapital. com 7

8 Bulls vs. Bears Bulls Almarai is a strong regional brand. The company s products are recognized throughout the GCC for their high quality and freshness. Almarai has the largest market share in the GCC dairy market, and is the largest integrated dairy producer in the world. Almarai boasts very strong distribution capabilities. It serves short shelf-life products to more than 42,000 shops in all six GCC countries on a daily basis. As a vertically integrated dairy producer, Almarai is able to produce 95% of its milk inhouse. This effectively reduces the company s reliance on external suppliers and allows Almarai to internally maintain the quality of its products. The GCC region has relatively low milk consumption per capita, as well as a young and growing population. This allows plenty of room for growth in the dairy market going forward. Powdered milk represents a large portion of the milk market in the GCC. With fresh milk being the superior product, one could argue that fresh milk sales in the GCC could see further growth by taking away market share from powdered milk. Almarai hedges against short-term fluctuations in commodity prices. This helps support the constant margins the company has displayed over the years. The company has strong fundamentals. It maintains high operating margins (EBITDA margins of 26%) and produces strong cash flows from operations (CFFO). Milk is an important consumer staple, for which demand will not fall sharply due to changes in the macroeconomic environment. Almarai s milk production from cows is amongst the highest in the world with a rolling herd average yield of 12,570 liters per cow. Western Bakeries is the market leader of bakery products in Saudi Arabia. Also, Almarai s joint venture with Vivartia (7Days) will allow the company to increase market share in the baked goods market. This joint venture represents a strategic investment by Almarai, as Vivartia could have been a formidable competitor, had it partnered with another local organization. The International Juice and Diary Company (IDJ) a new Joint Venture (JV) between Almarai and Pepsi will give Almarai exposure to emerging and high-growth markets in Asia, Africa, and the Middle East (ex. GCC). With Pepsi s strong global distribution network, and Almarai s product knowledge, this venture could prove to be very beneficial in the long term. Almarai invests resources into understanding consumer purchasing behavior. The company focuses on product packaging designs, and undertakes extensive feasibility studies before embarking on a new product category. nbkcapital. com 8

9 Bears Almarai s direct material costs include cattle feed, cheese, and juice concentrate, which makes the company vulnerable to commodity price fluctuations. Direct exposure to the inflation of food prices could potentially affect margins going forward. In 2008, direct materials accounted for 44% of total sales. Pricing of Almarai products is a challenge in Saudi Arabia (70% of total sales). The price of products needs to remain at consumer friendly values (i.e., multiples of SAR 1 since the use of change is not widely accepted in Saudi Arabia). Hence, any increase in the cost of production could eat into the margins of some products. This is referred to as the one riyal problem. Based on the Almarai s recent history, we have felt that the company has been successful in addressing this issue, yet that may prove challenging moving forward. Almarai has an aggressive history of organic expansion and acquiring new companies. This is reflected in its negative free cash flow balance since The juice market, the fastest-growing segment of the company s current product line, has relatively low barriers to entry and is highly competitive. The swine flu pandemic could potentially cause a decline in the number of visitors to Saudi Arabia, which would impact Almarai s sales in the short term. nbkcapital. com 9

10 The Dairy Market With a market cap over SAR 18 billion, Almarai is the leader in the GCC dairy market. Though the company has been focusing on expanding its product range, Almarai s highest contribution to revenue comes from the sales of dairy products within Saudi Arabia. Dairy sales make up 78% of the company s total revenue with 70% of Almarai s total sales derived from the Saudi market. Dairy Sector The dairy market in the GCC was estimated at USD 2.8 billion in 2008, with Saudi Arabia taking up 63% of the total market. Almarai holds a 28% market share, clearly dominating the dairy industry in the GCC. Almarai s market share is close to three times the size of the second most dominant player, Nestle (10% dairy market share). Other big players in the GCC dairy market are AlSafi, Saudia, and Nadec. Figure 5 Company Market Share in the Dairy Sector Almarai 28% Almarai is the dominant regional player in the dairy market Other* 38% Nestle 10% Friesland 4% Nadec 5% Saudia 6% Al Safi 9% Sources: Almarai and NBK Capital *Companies with market share less than 4% The dairy products are broken up into three main categories milk, laban, and zabadi, which, in turn, are further broken down into subcategories. The dairy market in the GCC is dominated by milk, taking up 63% of the total dairy market, then by laban, with a 26% market share, and finally by zabadi, with an 11% market share in the region. nbkcapital. com 10

11 Figure 6 Market Share of Dairy Products Zabadi 11% Milk Powder 22% Fresh Laban 22% Recombined Laban 4% Long Life Milk 20% Fresh Milk 21% Sources: Almarai and NBK Capital 1. Milk (fresh, long life, powdered) This is the largest segment of the dairy market, with 61% of the market share consumed by Saudi Arabia. Almarai holds the largest market share with 21%, with Nestle following close behind at a 16% market share. Almarai dominates the fresh milk market in the region, while Nestle dominates the powdered milk category. Furthermore, Almarai has recently become the market leader in the flavored long-life milk sector, surpassing Al Safi, to take up a 23.6% market share in In the plain long-life milk sector, Almarai comes in second with an 18.4% market share, well behind the market leader, Saudia, which holds a 38.2% market share in the region. The powdered milk section takes up a 36% market share in the milk market, the largest market share of the milk products. Figure 7 Breakdown of Milk Market with Company Market Share of Fresh Milk Market Long Life Milk 31% Milk Powder 36% Fresh Milk 33% AlRawabi 10% Almarai 45% Al Ain 10% Al Safi 9% Nada 5% Other 20% Soucres: Almarai and NBK Capital nbkcapital. com 11

12 2. Laban (a yoghurt drink) As the second largest category in the dairy market, laban can be divided into two subcategories, fresh and recombined. Fresh laban is the larger of the two forms, and accounts for 86% of the laban market in the GCC, while the recombined laban holds the remaining 14%. Almarai holds a 50% market share of the fresh laban market. The largest markets for recombined laban are in the UAE and Oman. In the GCC, Saudi Arabia is the largest consumer of laban, making up 73% of the market. Almarai has the most dominant position in the GCC laban market, holding a 42.5% market share, with Al Safi a distant second, at 13.7% market share (Figure 8). Figure 8 Breakdown of Laban Market with Company Market Share of Fresh Laban Market Almarai 50% Recombined Laban 14% Fresh Laban 86% Other 16% Al Safi 16% Nadec 10% Danone Activia 5% Nada Dairy 4% Sources: Almarai and NBK Capital 3. Zabadi (a local form of yoghurt) This is a single product line, with the largest consumer in the region being Saudi Arabia, holding a 53% market share. UAE comes in as the second largest consumer, with a 27% market share of zabadi in the GCC. Almarai is the largest player with a 36% market share three times the size of the next largest player, Al Safi. nbkcapital. com 12

13 Figure 9 Almarai Market Share of Zabadi Market Other* 35% Almarai 36% Unikai 4% Milco 5% Nadec 8% Al Safi 12% Sources: Almarai and NBK Capital *Companies with market share less than 4% Juice Sector This sector can be divided into several markets, with the largest three consisting of juice drinks (44% of juice market), fresh juice (36% of juice market), and long life (15% of juice market). In the GCC, Saudi Arabia holds the largest position with a 63.7% market share, with the UAE falling in second, with a market share of 16.3%. There is no clear market leader, as competition in this industry is very high. The top three players, in descending order, include Rani, Rabie, and Almarai. The fresh juice market is led by Almarai, holding a 26.5% market share. Figure 10 Company Market Share in Juice Sector Rani 13% Rabie 12% Other* 55% Almarai 10% Nadec 5% Suntop 5% Sources: Almarai and NBK Capital *Companies with market share less than 5% Cheese Market The cheese market can be broken down into several subcategories. The product with the largest market share is jars (43% of cheese market), then triangles (22% of cheese market), and then squares (8% of cheese market). Tins and slices each contribute 10% of the cheese market, with the remainder of the market covered by blocks and tubs. More than nbkcapital. com 13

14 75% of the market is occupied by three players Almarai, Kraft, and Fromageries. Within this industry, Almarai is the leader only in the cheese jars and cheese slices market, with 36.2% and 35.6% market share, respectively. Figure 11 Company Market Share in Cheese Market Other 15% Almarai 28% Arla Foods 9% Fromageries 23% Kraft 25% Sources: Almarai and NBK Capital * Companies with market share less than 3% Bakery Products Since the acquisition of Western Bakeries in 2007, Almarai gained access to the prepackaged bakery market, operating under the locally dominant brand, L Usine. The market the company operates in includes products such as prepackaged cakes, pastries, bread, dough, and ma amoul. Cake products make up the largest portion of revenue for L Usine. It has a 29% market share in Saudi Arabia, with Switz following close behind with a 20.2% market share. In the Saudi pastry market, L Usine has control over the market with an 82% market share. The largest sales category by volume for L Usine is prepackaged bread. In that market, L Usine occupies a 57.6% market share in Saudi Arabia, with Al Rashed following at a distant second, holding a 15.4% market share. nbkcapital. com 14

15 Macro level drivers of milk consumption Low Milk Consumption per Capita According to the Tetra Pak Dairy Index 2008 report, the global consumption of liquid dairy products has reached 258 billion liters in The Tetra Pak Dairy Index 2008 states that emerging markets (including the Middle East, Pakistan, India, and China) have contributed 96% of the total growth in dairy consumption over the past four years, with the Middle East reporting a growth of 5% in Tetra Pak expects the global milk consumption to grow at a rate of 2.2% in the coming three years, with emerging markets being the catalyst. Figure 12 shows that the consumption of packed milk per capita in the GCC and Levant stands at 25 and 10 liters per capita, respectively. From Figure 12, we can see that this falls well below the levels in the developed countries. This essentially highlights the relatively low-penetration level of packed white milk consumption in the GCC and Levant, a sign that there is still much more room for growth in the liquid dairy industry. Figure 12 Milk Consumption per Capita Middle Eastern countries have very low milk consumption per capita compared to developed nations Sources: Tetra Pak Index 2008 and International Dairy Federation Young and Growing Population A young and growing population has a great deal of importance in the development of the dairy market. By examining anticipated changes in demographics, one is able to formulate an outlook regarding their impact on the consumer base. Naturally, a young population will yield high future growth in the consumer base, as more people become productive members of society. According to the UN Population database, by 2010, 29% of the GCC population will be under 15 years of age, and almost 50% will be under the age of 25. Total population is expected to grow at a CAGR of 2.1% between 2010 and nbkcapital. com 15

16 Figure 13 GCC Population (2010 Estimates) % of the GCC population is under 15 years old Population (thousands) Sources: United Nations Population Database and NBK Capital High Wealth in GCC Growth in the GCC dairy industry needs to be supported by a growing consumer base with a strong purchasing power. GDP per capita is a common indicator that captures the wealth of a country or region. Figure 14 shows that the GDP per capita level of the GCC is much higher than other emerging markets but falls below that of the developed nations. Since the GCC markets have zero personal income tax, one could argue that the disposable income in the GCC could be at par with the developed world. Figure 14 GDP per Capita (2008) Source: International Monetary Fund (IMF) nbkcapital. com 16

17 Company OVERVIEW Company Background Established in 1976 as a fresh milk and laban producer, Almarai expanded its operations through a series of developments to become the lowest cost producer of dairy products in the region, and the largest integrated dairy company in the world. Currently occupying 28% of the total market share in the GCC dairy market, the dairy producer recently began to expand its product lines and regional reach through organic growth and acquisitions. This move is slowly redefining the company from a GCC dairy producer to a major player in the food and beverages industry across the Middle East. Almarai s organic growth began in the early 90s, as the company s corporate structure shifted from a cluster of small decentralized plants and farms to an establishment of large centralized plants and farms. With the change in structure, a continued investment in technology and a well-established distribution framework, the company is now able to serve fresh products to more than 42,000 retail outlets in six GCC countries on a daily basis. After a 30% initial public offering to GCC nationals in 2005, Almarai began expanding its operations into bakery goods through the acquisition of Western Bakeries (which operates under the brand L Usine) and its subsidiary, International Baking Services Limited, in Almarai developed further plans to expand its product line in The company has recently acquired Saudi Arabian-based Hail Agricultural and Development Company (HADCO) in a share swap transaction. The acquisition is meant to add grain and poultry-related products to Almarai s already expanding product line. In addition, Almarai plans to add another product line, baby food, following the completion of a feasibility study to assess the growth potential in this market. Despite focused ambitions on increasing its product line, Almarai also plans on extending its dairy product reach in the Middle East. In 2009, Almarai purchased a 75% stake in Teeba Investment for Developed Food Processing, a Jordan-based company responsible for producing dairy products and juices. Within the same year, Almarai also acquired 100% of International Company for Agro-Industrial Products (Beyti), an Egypt-based dairy and Juice Company. The Teeba investment was sold to International Dairy and Juice Limited (IDJ), a joint venture with Pepsi Co. The acquisition of Beyti is expected to be sold to IDJ in the last quarter of Products 1) Fresh dairy This includes short-life products produced from fresh raw milk. Almarai is the market leader in the fresh dairy market within the GCC, and this product category makes up the largest portion of the company s revenue. The fresh dairy products sold by Almarai include the following: a. Laban This fresh liquid yogurt beverage comes in four different sizes (2 L, 1 L, 500 ml, and 200 ml) and in three forms (full fat, low fat, and skimmed). In 2008, Almarai launched a new product named Trim laban for health conscious consumers. Almarai dominates the laban market within the GCC region. b. Fresh Milk Almarai distributes and sells fresh milk across the GCC on a daily basis. Fresh milk is sold in four sizes (2 L, 1 L, 500 ml, and 200 ml), and in five different forms including full fat, low fat, skimmed, Vetal (a low-fat version enriched with calcium and proteins), and flavored. Almarai is the largest seller of fresh milk in the GCC. c. Fresh Zabadi This is a plain yoghurt product, made from 100% fresh milk. It comes in nbkcapital. com 17

18 three different sizes of 170, and 400 gram, and a 1-kg pack sold only in Oman, Qatar, and the UAE. It also comes in three different forms (full fat, low fat, and skimmed). It is the number one selling yoghurt brand in the GCC. d. Yoghurt and Desserts These products include ghishte (fresh cream), labneh (a rich and creamy dairy product), fruit-flavored yoghurt snacks, and custard desserts. 2) Food and Beverages The product line includes altered fresh milk products, fruit juices, and non-dairy products. a. Long-life Dairy This includes products like flavored and non flavored UHT milk (fresh milk that has been heated for sterilization purposes), evaporated milk (dehydrated fresh milk, packaged in a can), and whipping and sterilized cream (higher in fat milk products). b. Fruit Juices Almarai sells more than 10 flavors of fresh juices. These products come in bottle sizes for individual and family consumption. c. Processed Cheese and Butter Almarai has a wide range of processed cheese products: namely, jarred cheese (spread cheese), triangle cheese (soft white spreadable cheese), sliced cheese, tin cheese (processed cheddar cheese), block cheddar, halloumi cheese (soft white cheese), cream cheese, and feta cheese. Almarai dominates this cheese market in the GCC. Almarai s butter products come in different-sized blocks, both in salted and unsalted flavors. d. Non-dairy Foods These include a tomato paste product. It comes in a single 135-g container. 3) Bakery Business Almarai s acquisition of Western Bakeries in 2007 increased the company s product line to include bakery goods. These products are sold under the L Usine brand name. Furthermore, its 65% joint venture with Chipita (a Greek Company) enabled Almarai to further increase operations of baked goods under the brand name of 7Days. Western Bakeries (L Usine) The company has a recognized platform in the Saudi baked food market. The company is seeking to expand the reach of the L Usine products to other GCC countries. Some of the major L Usine products include the following: a. Cake L Usine is the top-performing brand in the cake category within the Saudi Arabian market. Cake is the largest contributor to revenue from bakery goods. These products come in several flavors, and include cup cakes, Swiss rolls, pound cake, layer cake, slice cake, twinkie cake (flavored dough, stuffed with cream), and pie cake. b. Pastries This product category includes croissants (plain, zaatar, and cheese), and puffs (soft layered pastries with flavored fillings). c. Breads the L Usine brand occupies more than half of the Saudi market in the sandwich bread product line. The different breads sold include Arabic bread, sandwich bread (comes in different flavors in both white and brown forms), burger buns, and cluster rolls. d. Other Products These include items such as sambousa (triangular pastry, either fried or baked, stuffed with various fillings such as meat and cheese), ma amoul (cookie stuffed with dates that comes in different sizes), waffles (dual-wafer dessert with syrup in the middle), and dough (sold in ready-to-bake forms). JV Chipita (7Days) Since Vivartia is one of Europe s most recognized brand names in the baked goods market, Almarai s joint venture with Vivartia gave the company access to the following products under the 7Days brand name: nbkcapital. com 18

19 a. Croissants Sold as a packaged product, these carefully selected croissants come in plain, stuffed, or chocolate-coated flavors. It also sells plain mini-sized croissants for snacking on. This is a leading product in its market. b. Swiss Rolls Pastry rolls (vanilla or chocolate flavored) with different fruit or vanilla stuffings. c. Cake Bars These are a dual-layered pastry cake (vanilla or chocolate flavored) with vanilla or fruit spread in between. Farms During our visit to Almarai s farms, we noted that the cleanliness and the organization of the herd were commendable. This was a testament to the attention that is given to Almarai s most important production ingredient, fresh raw milk. Creating a home for more than 100 thousand cows in the middle of the desert is an impressive sight to witness. To keep the cows cool and protected from the heat of the scorching desert sun, the cows are kept in barns where they are regularly misted. Another astonishing aspect of our visit to the farms was the low number of the human workforce that we came across, which is a result of the high level of automation that the farms are equipped with. Almarai currently has six farms, with a total herd capacity of 55,000 milking cows in 2008 (the Al Danah super farm alone has 22,000 milking cows). Almarai s herd capacity more than doubled within a span of five years, driving milk production levels to 674 million liters per year. The six farms operated by Almarai produce 95% of the company s requirement of fresh raw milk, which allows the company to ensure the high quality of the most important ingredient. Production Facilities Almarai has two dairy manufacturing facilities located 130 kilometers away from Riyadh. The establishment of the second production facility in 2005 enabled Almarai to consolidate production and long-haul distribution. Its current factory footprint reaches 171,550 square meters. Combined, these two facilities are responsible for Almarai s entire production of fresh dairy, long-life dairy, cheese, butter, and fruit juice. Almarai has two bakery production facilities located in Jeddah. The company s initial foothold into the market was through the acquisition of Western Bakeries in Almarai currently has a customer base of 33,000, up from 25,000 in Its second bakery business includes the joint venture with Vivartia. Transportation Facilities With more than 12,000 employees, Almarai currently operates 97 sales depots and caters to 42,000 retail customers spread across the six GCC countries. After the milk is manufactured, Almarai uses the 500 trailers, 54 tankers, and 2,000 sales vans under its possession to distribute its products to the sales depots. The fleet covers 80 million kilometers, making 80,000 trips annually, to store the product in the 30,000 fridges owned by Almarai. Almarai s bakery business has expanded to reach 625 routes within Saudi Arabia. nbkcapital. com 19

20 Acquisitions & Joint Ventures International Dairy and Juice Company (IDJ) JV with Pepsi Co. In February of 2009, Almarai created a joint venture with Pepsi Company, whereby 48% is owned by Almarai, and 52% is owned by Pepsi Co. It was established with the intention of taking advantage of the dairy and juice opportunities available outside the GCC market. These areas include Southeast Asia, Africa, and Middle Eastern countries (excluding GCC). The company has already started its expansion phase through two major acquisitions. At the end of 2008, Almarai purchased a 75% stake in Teeba Investment for Developed Food Processing, located in Jordan. The acquisition was later transferred to IDJ in June Almarai signed a binding agreement to acquire a 100% stake in International Company for Agro-Industrial Products, an Egypt-based company. The acquisition took place on in September 2009 for a cash transaction of EGP million. The investment is expected to be sold to IDJ in the fourth quarter of Teeba Investment for Developed Food Processing (Teeba): A Jordan-based dairy producer, established in It is one of the three main dairy producers in Jordan, with a herd size of 1,400 cows of which 800 are milking cows. International Company for Agro-Industrial Products (Beyti): An Egypt-based dairy producer, established in It is one of the main dairy companies in Egypt operating under two brands Beyti and Dallah. Hail Agricultural and Development Company (HADCO) Established in 1982, HADCO is in the business of animal production and development, grain and animal feed plantation, and plant and animal processing. Its main line of business is in poultry related activities, such as hatcheries, broiler farms, slaughterhouses, and meat processing. Almarai acquired 100% of HADCO shares in exchange for new shares issued by Almarai at an exchange of one Almarai share for five HADCO shares plus an additional payment of SAR 0.50 per HADCO Share. The total cost of the transaction amounted to SAR 1,075 million. Western Bakeries L Usine Almarai acquired Western Bakeries in 2007, gaining access to the prepackaged bakery market, operating under the locally dominant brand, L Usine. The market it operates in includes products such as prepackaged cakes, pastries, bread, dough, and ma amoul. Cake products make up the largest portion of L Usine s revenue. The company has a 29% market share in Saudi, with Switz following close behind with a 20% market share. L Usine dominates the Saudi pastry market with an 82% market share. L Usine s largest sales by volume include prepackaged bread. In that market, it occupies a 57.6% market share in Saudi, with Al Rashed following at a distant second, holding a 15.4% market share. Modern Food Industries (MFI) JV Chipita This joint venture is a partnership with Vivartia, the largest food company in Greece. Vivartia operates under the 7Days brand name, mainly selling sweet packaged bakery products such as croissants, cake bars, and Swiss rolls. The brand is recognized for its quality, with a presence in more than 30 countries in Europe, Africa, Asia, and the Middle East. The JV will essentially produce and market 7Days products in the GCC. Almarai has a 65% stake in this joint venture. nbkcapital. com 20

21 Financial Statement Analysis Income Statement Analysis Top-line Trend Analysis Almarai s total sales grew at an impressive CAGR of 28% over the past four years, almost tripling between 2004 and The largest contributor to total sales, and Almarai s main line of business, was fresh dairy. Fresh dairy sales grew at a four-year CAGR of 20%. Despite this solid growth, the contribution of fresh dairy to total sales declined from 63% of total sales in 2006 to 49% of total sales in This can be attributed to two major factors faster growth in Almarai s other existing product lines (i.e., long-life dairy, fruit juice, cheese, and butter), and the expansion into a new product line (i.e., the bakery business). The second-largest contributors to Almarai s total revenue are cheese and butter, which grew at a CAGR of 29% over the last four years. Cheese and butter sales accounted for 20% of the total sales in Long-life dairy sales increased at a CAGR of 30% over the last four years, and the segment currently constitutes the third-largest portion of total sales. Fruit juice, which represented 8% of total sales in 2008, has been the fastest-growing product category, as it increased at an outstanding four-year CAGR of 37%. In 2006, Almarai acquired Western Bakeries, adding prepackaged bakery goods as a new product category. Since then, the bakery line has taken off and accounted for 10% of total sales in Strong growth in Almarai s top line has continued into 2009, as the company posted a growth in sales of 15% in 9M2009. The strongest-performing segment in 9M2009 has been fruit juice, which saw an increase in sales of 26% year on year. On the other hand, fresh dairy saw an increase in sales of 14% in 9M2009, while long-life dairy sales increased by 13% over the same period. Figure 15 Comparison of Sales by Product in 2008 Sources: Almarai and NBK Capital Almarai s operations are focused on the GCC region, with 70% of its sales coming from the Saudi market. United Arab Emirates and Kuwait account for 11% and 7%, respectively, of Almarai s sales. From Figure 16, we can see that exports account for a very small portion of Almarai s sales. nbkcapital. com 21

22 Figure 16 Almarai Sales by Region (2008) Sources: Almarai and NBK Capital EBITDA Margins Cost of Goods Sold (COGS) kept up with Almarai s sales growth, increasing at a CAGR of 29% between 2004 and Almarai has managed to keep gross profit margins relatively stable at close to 43% throughout the years. The largest portion of COGS is direct material costs, making up 44% of total sales in Direct material costs grew at a 31% CAGR from 2004 to 2008, increasing its proportion of total sales by 4.3 percentage points. The largest portion of operational costs, after COGS, is selling and distribution (S&D) expenses, making up 13% of total sales. In absolute terms, S&D grew at a CAGR of 28%, in line with sales and COGS growth. As a result, the trend of S&D remained relatively stable as a percentage of sales between 2004 and The largest contributor to the S&D expenses is employee costs, making up 49% of S&D costs in Other operating expenses include general and administrative (G&A) costs, which have declined slightly from 4.1% to 3.5% of total sales between 2004 and The largest contributor to this decline was the drop in employee-related costs as a percentage of sales. EBITDA grew at a four-year CAGR of 25.3%, following a similar trend to sales and COGS. As a result, EBITDA margins remained relatively stable, hovering around the 26% mark between 2004 and The slight decline in the EBITDA margin after 2004 can be attributed to the minor increase in COGS. The 24% increase in Almarai s EBITDA in 9M2009 outstripped the 15% increase in total sales. This eventually led to an increase in the EBITDA margin from 25.3% in 9M2008 to 27.5% in 9M2008. This improvement in the EBITDA margin can be attributed to an improved gross profit margin and a reduction in general and administrative expenses as a percentage of sales. nbkcapital. com 22

23 Figure 17 EBITDA and EBITDA Margin Trend 1,400 1, % 25.6% 25.0% 26.0% 1, % 30% 25% EBITDA (SAR Millions) 1, % 15% 10% EBITDA Margin 200 5% % EBITDA EBITDA Margin Sources: Almarai and NBK Capital Net Income Net income continued to increase year on year, at a four-year CAGR of 25%. Profit margins, however, declined after 2004 despite a decline in depreciation costs as a percentage of sales. Depreciation and amortization expenses have fallen as a percentage of sales from 10.9% in 2004 to 9.7% in 2008; however, bank charges jumped from 0.9% of total sales in 2004 to 2.5% in This is a result of Almarai s taking on additional debt over the years to fund its expansion and investments. Net profit margins declined from 19.6% in 2004 to hit a low of 16.9% in It recovered since then to 18.1% in Almarai s net income increased by 23% in 9M2009 with the net profit margin expanding to 19.6%. nbkcapital. com 23

24 Figure 18 Net Income and Profit Margin Trend 1, % Net Income (SAR Millions) % % % % % 20% 15% 10% Profit Margin 200 5% % Net Income Net Income Margin Sources: Almarai and NBK Capital Balance Sheet Analysis Liquidity Ratio Analysis Almarai s current ratio reached its peak in 9M2009 of 1.6x. The company has managed to keep its current ratio above 1. On the other hand, the quick ratio has remained relatively constant over the past four years, maintaining an average above 0.5x throughout. As of 9M2009, the company s quick ratio hit a high of 0.9x. Figure 19 Liquidity Ratios M2009 Current Ratio 1.2 x 1.4 x 1.6 x 1.4 x 1.6 x Quick Ratio 0.5 x 0.6 x 0.7 x 0.5 x 0.9 x Cash Ratio 0.1 x 0.1 x 0.2 x 0.2 x 0.2 x Sources: Almarai and NBK Capital Converting Cash The number of days it takes the company to transform receivables and inventory (after payables) into cash has been on the rise. In 2005, Almarai s cash conversion cycle (CCC) was 21 days, increasing to 65 days by The days sales outstanding (DSO) actually improved between 2005 and 2008, dropping from 34 days to 28 days as the company s time to collect receivables improved. The increase in CCC came from the increase in the days inventory outstanding (DIO) and a decline in the days nbkcapital. com 24

25 payable outstanding (DPO). DIO increased year on year, from 84 days in 2005 to 115 days in The jump in DIO took place in 2007 when Almarai acquired Western Bakeries in February 2007, which added a product with a longer shelf life than fresh dairy to Almarai s product mix. At the same time, the drop in DPO from 98 days in 2005 to 78 days in 2008 signals quicker payments by Almarai to its suppliers. Figure 20 Cash Conversion Cycle Days Sales Outstanding Days Inventory Outstanding Days Payable Outstanding Cash Converstion Cycle Sources: Almarai and NBK Capital Debt Serviceability Almarai has continually increased its take on debt since This can be explained by Almarai s goal to expand its product line as well as its geographic footprint. Almarai s debt balance as of 3Q2009 is SAR 4.4 billion (86% of which is long-term debt). The net debt-toequity ratio increased slightly from 0.9x in 2008 to 1.0x in 3Q2009. However, following the acquisition of HADCO the net debt-to-equity is expected to fall to 0.8x. As a result of the increase in the company s debt levels, finance charges went up as well. This led to a decline in the interest coverage ratio (EBITDA divided by finance charges) from 31x in 2004 to 7x in Although this drop in the interest coverage ratio may seem large, we are generally not concerned by it, as an interest coverage ratio of 7x is a very healthy mark. In 9M2009, the interest coverage ratio increased to 9.7x. Return Ratios On the operational side, the company has displayed outstanding results with a return on average equity (ROAE) of 27% and a Return on average assets (ROAA) of 12% in 9M2009 (TTM). A DuPont analysis for Almarai reveals the following: ROAE has been relatively stable, hovering close to 27%. The increases in profit margin and financial leverage offset the decline in asset turnover. Figure 21 DuPont Analysis M2009 The down trend in return ratios is due to declining asset turnover Profit Margin 18.0% 16.9% 17.7% 18.1% 19.1% Asset Turnover 0.8 x 0.8 x 0.7 x 0.7 x 0.6 x Financial Leverage 2.0 x 2.0 x 2.0 x 2.2 x 2.2 x ROAE 28.4% 27.9% 27.0% 27.3% 27.1% ROAA 14.4% 13.8% 13.2% 12.5% 12.1% Sources: Almarai financial reports and NBK Capital nbkcapital. com 25