Alhokair Impressive but limited upside

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Vol th RSI10 Fawaz Abdulaziz Alhokair ALHOKAIR AB: Saudi Arabia US$1.778bn 30% US$1.408mn Market cap Free float Avg. daily volume Target price 91.4 4.1% below current Consensus price 83.92 11.

1 Vol th RSI10 Fawaz Abdulaziz Alhokair ALHOKAIR AB: Saudi Arabia US$1.778bn 30% US$1.408mn Market cap Free float Avg. daily volume Target price % below current Consensus price below current Current price as at 11/8/2012 Underweight Neutral Overweight Key themes We expect the retail sector in Saudi Arabia to continue its growth momentum on the back of everincreasing population, improving education, and changing lifestyle. Alhokair holds a strong position in the Saudi fashion market. The company will continue to grow through M&A activities, roll out of new stores, and reap the benefits of the new upward trends in retail. Implications Alhokair is one of our preferred stocks in the retail sector. On the operational front, the company has been performing well with sound financials. We expect M&A activities, new store launches, and healthy same-store sales to drive the company s growth over the near-term. However, the share price has recently rallied and offers limited upside. Performance Earnings Period End (SAR) 03/11A 03/12A 03/13E 03/14E Revenue (mn) 2,575 3,203 4,090 4,705 Revenue Growth 24.1% 24.4% 27.7% 15.0% EBITDA (mn) EBITDA Growth -3.3% 77.3% 15.9% 8.0% EPS EPS Growth 36.6% 41.4% 19.7% 11.2% Valuation Price Close MAV10 MAV50 Relative to SASEIDX (RHS) 08/11 11/11 02/12 05/12 Source: Bloomberg P/E (x) 01/09 01/10 01/11 01/ Research Department Majed Alsolaim Tel: , alsolaimm@alrajhi-capital.com Alhokair Impressive but limited upside Alhokair delivered robust Q1 (April-June 2012) results, posting impressive year-over-year sales growth of 19.4%, driven by strong like-for-like sales and new stores. Further, the company was able to improve its gross margin level to 47% and achieved 12.8% growth in operating profit. The company recently announced its decision to acquire NESK Group, which will add 120 stores with more than ten brands to its portfolio. Thus, we believe Alhokair s international operations coupled with acquisition of local brands, will spur the company s near term growth. We have revised our forecasts on the back of strong Q1 results to arrive at a new target price of SAR91.4 (old: SAR62.5). However, our new target does not offer an upside potential. Therefore, we downgrade our rating to Neutral. Revenue surpasses expectations: Alhokair achieved a y-o-y sales growth of 19.4%, spurred by the launch of new stores and improvement in same-store sales (SSS) growth, which was above our estimate of 16%. The company continued to increase its stores to reach a total of 1,206 worldwide. We expect Alhokair to launch around 200 stores in In the domestic market, the company expanded its store footprint and brought its store count to 996. Alhokair achieved 3.9% y-o-y SSS growth, which was driven by the fast-growing apparel market in the Kingdom. We expect revenue growth of 25% y-o-y this year due to the Ramadan and Eid season with SSS growth of 5.0%. Healthy margins: Alhokair improved its gross margin by 80bps y-o-y to reach 47% in Q1 this year. Further, the company s SG&A costs increased marginally by 60bps to reach 30% mainly due to its international expansion program. We expect gross margins to remain stable for the remainder of the year, supported by growth in international stores which typically carry higher margins. We also expect SG&A expenses to remain at the same levels due to foreign exchange depreciation against the US dollar and sales growth. Inorganic expansion will serve as key growth driver: Alhokair continues to focus on expansion, opening 1,206 stores till now and is set to add 200 more stores soon. The company recently signed an agreement to acquire NESK Group for the trading project LLC (Al Jedaie) in a deal worth SAR730mn. This acquisition will add 120 retail shops to its portfolio, which will significantly raise Alhokair s market share in the Kingdom. However, we have not considered this transaction in our model since it is yet to be finalized. Valuation & Conclusion: We have revised our forecasts for Alhokair and set a new target price of SAR91.4 (old target: SAR62.5). Given the YTD rise in Alhokair s share price, we believe the stock is overpriced (current price: SAR95.25) and does not offer an upside potential. Thus, we downgrade our rating from Overweight to Neutral. Alhokair trades at an EV/EBITDA multiple of 9.6x and a forward PE ratio of 12.4x, offering a dividend yield of 3.1%. Disclosures Please refer to the important disclosures at the back of this report. Powered by Enhanced Datasystems EFA Platform 1

2 Corporate summary Share information Valuation Fawaz Abdulaziz Alhokair Company is a leading fashion retailer in Saudi Arabia, with a market cap of US$1.7bn. The company primarily sells a wide gamut of fashion items such as luxury apparel, sport wear, shoes, bags, and fashion accessories. Alhokair is a franchisee for 50 international brands such as Zara, Gap, Marks & Spencer, and Aldo. Market cap (SAR/US$) 6.67bn / 1.778bn 52-week range Daily avg volume (US$) 1.408mn Shares outstanding 70.00mn Free float (est) 30% Performance: 1M 3M 12M Absolute 13.4% 15.8% 91.3% Relative to index 8.5% 19.1% 75.6% Major Shareholder: Fas Company 49% Abdulmajeed Abdulaziz Alhokair 7% Source: Bloomberg, Al Rajhi Capital Period End 03/11A 03/12A 03/13E 03/14E Revenue (SARmn) 2,575 3,203 4,090 4,705 EBITDA (SARmn) Net Profit (SARmn) EPS (SAR) DPS (SAR) EPS Growth 36.6% 41.4% 19.7% 11.2% EV/EBITDA (x) P/E (x) P/B (x) Dividend Yield 2.6% 2.1% 2.1% 3.1% Competition is not an issue Saudi offers a lucrative market for retailers Alhokair will benefit from fast growing young population Alhokair number of stores reached 1206 Saudi Arabia, with a population of 28 million, offers a lucrative market for retailers. A rapidly growing population, especially a burgeoning young population (50% population is below 20 years), plays a significant role in stimulating the Saudi retail market. The neighboring GCC countries also have a similar demographic profile of a growing young population. Apparel (mainly footwear and children s clothing) is one of the fastest growing segments in the GCC retail market. The ever-changing lifestyle of the Saudi youngsters (including a shift toward western casual clothing) is one of the key factors, which is fueling growth for this segment. We believe Alhokair is best placed to benefit from this growth trend and capture a bigger market share. Ongoing store expansion Alhokair continued to pursue its store expansion strategy and increased its store count to 1,206 in Q ( from 800 stores in December 2010), encompassing a retail space of approximately 280,000 sq mt. The company seeks to roll out around 200 new stores this year. The company currently operates mainly in Saudi Arabia and has presence in countries such as the US, Egypt, Jordan, Kazakhstan, Morocco, Georgia, and Azerbaijan through its subsidiaries. Figure 1 Number of stores by country and store size in sq. mt. Entity Stores Size Azerbaijan 9 3,386 Egypt 85 13,238 Georgia 23 8,995 Jordan 37 7,489 Kazakhstan 27 10,161 KSA ,795 Morocco USA 27 3,274 Grand Total ,487 Management sources state that Alhokair has lined up plans to foray into five new countries Pakistan, Armenia, Libya, Belarus, and Turkmenistan in to support the company s rapid growth over the near-term. Disclosures Please refer to the important disclosures at the back of this report. 2

3 NESK acquisition to augment market share Given the mild competition in the Saudi Arabian apparel industry, we believe Alhokair can maintain its dominant position in the Saudi market. Although major competitors such as Alshaya, Alsawani, and Albandar are currently enhancing their market presence, we feel that the Saudi market has the bandwidth to accommodate more players. Alhokair announced that it has inked an agreement to acquire NESK Group for the trading project LLC (Al Jedaie) for SAR730mn after completing financial and legal due diligence. The transaction will be finalized after NESK completes the conditions stated in the agreement. The acquisition will be financed through a long term loan. NESK operates a number of leading brands in the Kingdom such as Mango, Stradivarius, Okaidi, Jerry Weber, Woman Secret and others. Following the completion of the acquisition, Alhokair will add 120 retail shops to its number of stores and substantially increase its market share in the Kingdom. However, we have not included this acquisition in our model since it is yet to be finalized. Q2 estimates: Decent results expected Coinciding with the Holy Ramadan season and the start of a new academic year, we expect Alhokair to report a strong top-line growth of 25% y-o-y in Q2. Moreover, we expect a net profit growth of 10.7%, which is driven by manageable administrative and marketing expenses, and higher revenues. We expect revenue growth above 25% y-o-y in Q2 Figure 2 Alhokair: 2011Q1A (June) vs Q1E (June) VS 2012Q1A & 2011Q2A (Sept ) vs. 2012Q E (SAR) mn 2011Q1A (June) 2012Q1E (June) 2012Q1A (June) YOY % chg. 2011Q2A (Sept) 2012Q2E (Sept) YOY % chg. Total Revenues % 1, , % Gross Profit % % Gross profit margin 46.2% 45.0% 47.0% 45.0% 45.0% Operating Profit % % Net Income % % Valuation: We estimate a DEP fair value of SAR89.4, and SAR95.9 using multiples Alhokair is priced-in for now We have used two valuation methods to study the company: long-run EVA and comparative multiples analysis. For the multiples analysis, we used EV/EBITDA and PE ratios. We have been selective and conservative in choosing large multinational companies as benchmarks. Using the average of the benchmarked companies PE and EV/EBITDA ratios for 2012, we estimate a fair share price of SR95.9 for Alhokair. We have assigned a 30% weight to this method. Figure 3 Hokair: comparative multiples analysis Coompany Market Sector P/E EV/EBITDA Debenhams plc NYSE Retail (Apparel) The Gap Inc. NYSE Retail (Apparel) Inditex SA (ZARA) MCE Retail (Apparel) Macy's, Inc. NYSE Retail (Department) ALHOKAIR & Co TASI Retail (Apparel) Source: Bloomberg, Al Rajhi Capital Disclosures Please refer to the important disclosures at the back of this report. 3

4 In the long-run DEP method of estimating Alhokair s fair value, we used a WACC of 9.8%. Using our core assumption of a competitive advantage period of 25 years, we estimate Alhokair s fair value per share at SAR89.4. Figure 4 weighted average cost of capital assumptions Paticulars Risk-free Rate 1.5% Market Risk Premium 12.5% Adjusted Beta 0.94 Cost of Equity 11.8% Pre-tax Cost of Debt 4.0% Effective Tax rate 6.0% After-tax Cost of Debt 3.8% Target D/(D+E) 25.0% WACC 9.8% Source: Bloomberg, Al Rajhi Capital We have set a target price of SAR91.4 for Alhokair We set our target price per share at SAR91.4. We have arrived at this target price by assigning a weight of 70% to the long-run EVA method (SAR89.4fair value per share), and 30% to multiples (SAR95.9 fair value per share). This implies a downside potential of 1.8%. Thus, we downgrade our rating from Overweight to Neutral. Risks associated with our assumptions It is important to highlight that our valuation relies heavily on forecasts, which are uncertain. We have taken several assumptions including growth (i.e. the opening of new stores), gross margin, cost of capital, and market trends to predict the future performance. Based on our research, we have tried to arrive at the most accurate assumption. However, the company s actual performance may deviate from our forecasts depending on the emerging macroeconomic or microeconomic factors. Competition is another factor that could affect our assumptions. New entrants and a consequent shift in business models of current rivals could cause a drastic change in the entire retail market, and in our estimates. Disclosures Please refer to the important disclosures at the back of this report. 4

5 We expect revenues to exceed SAR 4 bn this year Income Statement (SARmn) 03/10A 03/11A 03/12A 03/13E 03/14E Revenue 2,074 2,575 3,203 4,090 4,705 Cost of Goods Sold (1,161) (1,435) (1,755) (2,238) (2,587) Gross Profit 914 1,139 1,447 1,852 2,118 Government Charges S.G. & A. Costs (675) (877) (1,022) (1,349) (1,575) Operating EBIT Cash Operating Costs (1,757) (2,268) (2,658) (3,459) (4,023) EBITDA Depreciation and Amortisation (78) (45) (119) (128) (138) Operating Profit Net financing income/(costs) (43) (32) (18) (22) (5) Forex and Related Gains Provisions Other Income Other Expenses Net Profit Before Taxes Taxes (11) (15) (36) (34) (31) Minority Interests 1 (3) (1) (2) (2) Net profit available to shareholders Dividends (140) (175) (140) (140) (210) Transfer to Capital Reserve 03/10A 03/11A 03/12A 03/13E 03/14E Adjusted Shares Out (mn) CFPS (SAR) EPS (SAR) DPS (SAR) We expect revenues growth above 27% this year Growth 03/10A 03/11A 03/12A 03/13E 03/14E Revenue Growth 9.9% 24.1% 24.4% 27.7% 15.0% Gross Profit Growth 14.4% 24.7% 27.1% 28.0% 14.4% EBITDA Growth 87.7% -3.3% 77.3% 15.9% 8.0% Operating Profit Growth 128.9% 9.5% 62.5% 18.2% 8.0% Net Profit Growth 68.2% 36.6% 41.4% 19.7% 11.2% EPS Growth 68.2% 36.6% 41.4% 19.7% 11.2% Margins 03/10A 03/11A 03/12A 03/13E 03/14E Gross profit margin 44.1% 44.2% 45.2% 45.3% 45.0% EBITDA margin 15.3% 11.9% 17.0% 15.4% 14.5% Operating Margin 11.5% 10.2% 13.3% 12.3% 11.5% Pretax profit margin 11.6% 13.0% 15.1% 14.0% 13.4% Net profit margin 11.2% 12.3% 14.0% 13.1% 12.7% Other Ratios 03/10A 03/11A 03/12A 03/13E 03/14E ROCE 16.9% 19.4% 24.5% 23.1% 21.2% ROIC 27.0% 21.8% 33.2% 31.1% 28.6% ROE 23.7% 28.9% 35.8% 33.5% 29.9% Effective Tax Rate 4.4% 4.5% 7.4% 6.0% 5.0% Capex/Sales 6.0% 2.5% 8.6% 7.3% 5.0% Dividend Payout Ratio 60.5% 55.3% 31.3% 26.1% 35.2% Alhokair trades on a PE of 12.4x and EV/EBITDA of 9.6x Valuation Measures 03/10A 03/11A 03/12A 03/13E 03/14E P/E (x) P/CF (x) P/B (x) EV/Sales (x) EV/EBITDA (x) EV/EBIT (x) EV/IC (x) Dividend Yield 2.1% 2.6% 2.1% 2.1% 3.1% Disclosures Please refer to the important disclosures at the back of this report. 5

6 Balance Sheet (SARmn) 03/10A 03/11A 03/12A 03/13E 03/14E Cash and Cash Equivalents Current Receivables Inventories ,047 Other current assets Total Current Assets 914 1,199 1,420 1,859 2,086 Fixed Assets ,060 Investments Goodwill Other Intangible Assets Total Other Assets Total Non-current Assets ,174 1,360 1,456 Total Assets 1,897 2,174 2,594 3,219 3,542 Short Term Debt Accounts Payable Accrued Expenses Dividends Payable Other Current Liabilities Total Current Liabilities Long-Term Debt Other LT Payables Provisions Total Non-current Liabilities Minority interests Paid-up share capital Total Reserves ,098 1,484 Total Shareholders' Equity 1,094 1,095 1,402 1,798 2,184 Total Equity 1,114 1,126 1,425 1,823 2,211 Total Liabilities & Shareholders' Equity 1,897 2,174 2,594 3,219 3,542 Ratios 03/10A 03/11A 03/12A 03/13E 03/14E Net Debt (SARmn) Net Debt/EBITDA (x) Net Debt to Equity 26.4% 24.7% 23.9% 12.5% 4.7% EBITDA Interest Cover (x) BVPS (SAR) Cashflow Statement (SARmn) 03/10A 03/11A 03/12A 03/13E 03/14E Net Income before Tax & Minority Interest Depreciation & Amortisation Decrease in Working Capital (88) (119) (181) (107) (169) Other Operating Cashflow (142) (153) (167) Cashflow from Operations Capital Expenditure (124) (63) (276) (299) (234) New Investments (98) 30 (31) (3) - Others (6) 23 (6) (12) - Cashflow from investing activities (228) (9) (313) (314) (234) Net Operating Cashflow (33) Dividends paid to ordinary shareholders - (261) (140) (140) (210) Proceeds from issue of shares Effects of Exchange Rates on Cash Other Financing Cashflow 3 9 (9) - - Cashflow from financing activities 3 (236) 5 (94) (210) Total cash generated (28) 32 (12) Cash at beginning of period Implied cash at end of year Ratios 03/10A 03/11A 03/12A 03/13E 03/14E Capex/Sales 6.0% 2.5% 8.6% 7.3% 5.0% Disclosures Please refer to the important disclosures at the back of this report. 6

7 Disclaimer and additional disclosures for Equity Research Disclaimer This research document has been prepared by Al Rajhi Capital Company ( Al Rajhi Capital ) of Riyadh, Saudi Arabia. It has been prepared for the general use of Al Rajhi Capital s clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of Al Rajhi Capital. Receipt and review of this research document constitute your agreement not to redistribute, retransmit, or disclose to others the contents, opinions, conclusion, or information contained in this document prior to public disclosure of such information by Al Rajhi Capital. The information contained was obtained from various public sources believed to be reliable but we do not guarantee its accuracy. 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Al Rajhi Capital or its affiliates may from time to time perform investment banking or other services for, solicit investment banking or other business from, any company mentioned in this research document. Al Rajhi Capital, together with its affiliates and employees, shall not be liable for any direct, indirect or consequential loss or damages that may arise, directly or indirectly, from any use of the information contained in this research document. This research document and any recommendations contained are subject to change without prior notice. Al Rajhi Capital assumes no responsibility to update the information in this research document. Neither the whole nor any part of this research document may be altered, duplicated, transmitted or distributed in any form or by any means. 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"Neutral": We expect the share price to settle at a level between 5% below the current share price and 15% above the current share price on a 6-9 month time horizon. "Underweight": Our target price is more than 5% below the current share price, and we expect the share price to reach the target on a 6-9 month time horizon. 2. Definitions "Time horizon": Our analysts make recommendations on a 6-9 month time horizon. In other words, they expect a given stock to reach their target price within that time. "Fair value": We estimate fair value per share for every stock we cover. This is normally based on widely accepted methods appropriate to the stock or sector under consideration, e.g. DCF (discounted cash flow) or SoTP (sum of the parts) analysis. "Target price": This may be identical to estimated fair value per share, but is not necessarily the same. There may be very good reasons why a share price is unlikely to reach fair value within our time horizon. In such a case we set a target price which differs from estimated fair value per share, and explain our reasons for doing so. Please note that the achievement of any price target may be impeded by general market and economic trends and other external factors, or if a company s profits or operating performance exceed or fall short of our expectations. Contact us Dr. Saleh Alsuhaibani Head of Research Tel : alsuhaibanis@alrajhi-capital.com Al Rajhi Capital Research Department Head Office, King Fahad Road P.O. Box 5561 Riyadh Kingdom of Saudi Arabia research@alrajhi-capital.com Al Rajhi Capital is licensed by the Saudi Arabian Capital Market Authority, License No /37. Disclosures Please refer to the important disclosures at the back of this report. 7

Zain KSA bogged down by high debt

Zain KSA bogged down by high debt Vol th RSI10 Zain KSA ZAINKSA AB: Saudi Arabia US$2.464bn 48.3% US$16.50mn Market cap Free float Avg. daily volume Target price 7.30 12.31% over current Consensus price 7.62 17.2% over current Current