Saudi Arabia Key themes The disposable income, which has already been under pressure due to slowdown in government spending, will face additional headwinds from the recent announcements regarding cut in some allowances for public sector employees, hurting the top-line of consumer stocks. Further, cost presssures may escalate for retailers due to some potential visa restrictions/ faster pace of nationalization. Implications Revenue and cost pressures will weigh on profitability of retailers and other consumer stocks. Based on our initial understanding, we factor in the likely impact from these developments into our estimates for consumer stocks. However, post the recent sell-off, we believe the consumer stocks are reasonably priced and risk-reward is favourable for investors who can ride the volatile period. Ratings and target prices Stock Rating Price Target Jarir OW SAR99.3 Al Othaim OW SAR84.0 Al Hokair OW SAR33.5 extra OW SAR20.3 Almarai N SAR60.0 Savola OW SAR37.1 Herfy N SAR71.0 In the current environment, we prefer stocks with higher revenue visibility. Hence, Almarai and Al Othaim top our pecking order as relatively safer stocks, which have high/ near complete exposure to non-discretionary products. In the discretionaryretail space, Jarir is our preferred pick as 40% of its revenue is from books/ stationary segment, which has higher margin and relatively lower sensitivity to discretionary spend. Positioning amidst uncertainty Research Department Nivedan Reddy Patlolla, CFA Tel +966 1 211 9423, patlollan@alrajhi-capital.com Saudi consumer stocks witnessed steep correction over the past one month. The recent announcements regarding cut in some allowances for public sector employees was the key trigger for sell-off in consumer stocks and also for the broader market. We outline our thoughts as follows: (a) Disposable income, the primary revenue driver for consumer stocks, which has been weighed down by slower government spending, will face additional headwinds from these announcements. Discretionary retailers (e.g. electronics, fashion etc.) will face higher impact while nondiscretionary retailers (e.g. grocery) and food/ agriculture sector companies will remain relatively insulated due to secular demand for their products, despite a tough macro environment. For instance, Jarir s Q3 revenue growth was much below estimates, pointing to pressure on consumer spending from lower disposable incomes. (b) Cost pressures for retailers are likely to escalate, as nationalization of jobs (including some retail/ sales categories) may receive a renewed push, according to some media reports. (c) Long term risks also persist volume growth from 2018 may be weighed down by likely implementation of VAT. While the situation is still evolving, based on our initial understanding, we have factored in the impact of cut in allowances, long term impact of VAT and cost pressures into our estimates and target prices. (d) While the current risk-reward looks favourable for most of the consumer stocks, investors will have to note that an element of uncertainty (both on the downside and upside) will always characterise a period of transformation, when companies and customers alike get adjusted to new initiatives/ developments, sometimes inducing sharp stock price volatility. Risks and catalysts: Primary risk to our estimates is higher than expected negative impact on disposable incomes, either from effective cut in allowances being higher than estimates or from fresh austerity measures which may be unveiled later. Impact of VAT on retail volumes is also uncertain, especially in the backdrop of lower disposable incomes. On the other hand, the key upside trigger is a sharp and quick uptick in oil prices (for e.g. if OPEC reaches a deal including key non-opec players during the upcoming meet in November, that is better than market estimates), which will ease liquidity and may lead to higher government spending and/or easing of austerity measures. How should investors position: Post the steep correction in the broader markets recently, we believe value is emerging in consumer stocks. However, given the persisting risks, investors with a bias for safety should stick to staples with high revenue visibility like Almarai and Al Othaim. While we have factored in the impact of cut in disposable income into our estimates and target prices, the downside risks remain higher for discretionary-retail stocks like Jarir, Al Hokair and Extra. However, investors with a higher risk appetite and sanguine view of consumption patterns will find the current valuations appealing for these stocks and can position themselves accordingly for the medium term. Please see penultimate page for additional important disclosures. Al Rajhi Capital (Al Rajhi) is a foreign broker-dealer unregistered in the USA. Al Rajhi research is prepared by research analysts who are not registered in the USA. Al Rajhi research is distributed in the USA pursuant to Rule 15a-6 of the Securities Exchange Act of 1934 solely by Rosenblatt Securities, an SEC registered and FINRA-member broker-dealer.
Figure 1 Summary of change in revenue estimates and target prices CMP New TP % upside Rev growth - New (% YoY) Rev growth - Old (% YoY) FY17E FY18E FY17E FY18E Jarir* 83.3 99.3 19.3% 3.4% 11.0% 9.3% 14.3% Othaim 75.0 84.0 12.0% 10.6% 8.8% 15.8% 10.6% Hokair 24.7 33.5 35.9% -6.2% -2.9% -2.1% 5.1% Extra 16.8 20.3 21.4% -2.4% 8.1% 2.9% 8.8% Almarai* 55.8 60.0 7.7% 9.3% 8.3% 9.7% 8.6% Savola 30.1 37.1 23.1% 4.4% 5.5% 5.2% 6.5% Herfy 65.0 71.0 9.2% 7.9% 9.0% 13.0% 15.6% Source: Al Rajhi Capital; * Note: Refer to our notes on Jarir and Almarai for Q3 results analysis; For Al Hokair, FY17E corresponds to March 2017 fiscal year Figure 2 Summary of assumptions for individual companies Retail Jarir Al Othaim Al Hokair Extra Food Almarai Savola Herfy Source: Al Rajhi Capital Revenue impact Margin/ Profitability Valuation - Approx. 60% revenue from electronics/ mobiles/ computers and peripherals, which is discretionary and hence will get impacted. Some impact on office stationery segment also - No change in store count assumptions, but decrease LFL growth by 5/ 3 ppts in CY17/ CY18 vs. earlier estimates, to factor in impact of cut in disposable income - Majorly focused on non-discretionary grocery retailing with significant chunk from food. Hence we see minimal impact on revenue. Othaim being a low cost grocery retailer, may also benefit from downtrading by customers - Maintain store count additions but cut revenue estimates to factor in likely higher discounts and some hit on volumes - Post Blanco sale, KSA accounts for 87% of revenue. Hence, the impact from cut in KSA disposable income will be meaningful, fashion being a discretionary spend - While Al Hokair retails mid-to-high end brands, the impact will be more on high end brands which also tend to be high margin - We cut the domestic LFL estimates by 4-6 ppts in FY17/ FY18 - We also expect discounts to trend up in the short to medium term as a meidum of sales push - Exposure to electronics, mobiles and white goods makes it susceptible for meaningful revenue pressure in the current environment when disposable income is under pressure - Maintain store count, but trim LFL growth 2-6 ppts over CY17/CY18 - Non discretionary products with secular demand, we marginally lower revenue estimates - Savola's retail operations (Panda) will face revenue pressure due to some exposure to discretionary products especially in hypermarkets. We note the divergence in performance over the last few quarters of Savola vs. Othaim (which is majorly focused on supermarket format) - Further, Sugar operations will continue to face pressure due to continuing restructuring and also due to likely depreciation of Egyptian Pound - QSR restaurants are susceptible to decline in disposable incomes. The last few quarters points to this trend - We lower the store count addition by 5 restaurants each in CY17/ CY18 and also lower LFL growth by 5 ppts in CY17/ CY18, as we now expect flattish per-storerevenue in next two years, due to sharper slowdown in consumer spending - Decline in LFL revenue to induce margin compression due to negative operating leverage - New visa restrictions and a faster push towards nationalization (in retail/ sales categories) will weigh on opex pyramid - However, Jarir has the lowest salary expense (as % of revenue), which makes it more resilient to cost pressures vs. peer group. Majority of margin impact from lower LFL and higher discounts - Othaim has high salary expense relative to revenue (7.8% of revenue) and hence increased salary expenses due to visa restrictions / nationalization will impact profitability - We build for higher visa costs and faster pace of nationalization and together with increase in discounts, margin estimates for CY17/CY18 drop by 40bps/ 60bps leading to 15%/ 20% cut in PAT estimates respectively - Decline in LFL to induce margin compression due to negative operating leverage, especially at store level - Decline in LFL and higher discounts are the major source of cut in margin/ profitability estimates, as Al Hokair has better salary expense (5.2% of revenue) vs. the peer group. However, visa restrictions and nationalization will lead to cost pressures in absolute terms - Expect 50-100 bps margin cut in FY17/FY18 - Margin will be impacted by multiple headwinds like lower LFL revenue of extant stores, increased discounts, and likely wage pressure due to visa restrictions and faster pace of nationalization - Among our retail coverage, Extra is the most at-risk from cost pressures as its salary expense (7% of revenue) is high relative to peers and EBIT margin is slim (just 1.5%) - Introduced 15% discount (previoulsy none) on target multiple to the average of developed market peers, to factor in headwinds to profitability and cash flows from both revenue and cost pressures - New TP at SAR99.3 per share. - No change in target multiple. Even as cost pressures lead to dent in profitability, we expect premium valuation to sustain given high revenue visibility - New TP at SAR84.0 per share. - Introduced 15% discount (previoulsy none) on target multiple to the average of EM peers, to factor in lower revenue visibility - New TP at SAR33.5 per share. - Introduced 10% discount (previoulsy none) on target multiple to the average of developed market peers, to factor in new revenue and cost pressures - New TP at SAR20.3 per share. - Largely maintain margin/ profitability estimates - No change to target multiple or DCF assumptions, TP raised marginally to SAR60.0 per share. Neutral rating - Margin pressure mainly from lower revenue growth in retail and sugar ops. Wage pressure in retail ops will also contribute - We factor in 50-70 bps EBIT margin cut vs. earlier estimates in CY17/ CY18 - Major impact on margin from lower LFL growth - Herfy's wage expenses are relatively lower at 4.8% of revenue, hence visa restrictions/ nationalization of jobs will not significantly impact operations - Expect 50-80 bps EBIT margin decline in CY17/ CY18 vs. earlier estimates - No change to target multiple or DCF assumptions - New TP at SAR37.1 per share. - Introduced 5% discount (previoulsy none) on target multiple to factor in headwinds to revenue from cut in disposable incomes - New TP at SAR71.0 per share. Neutral rating Disclosures Please refer to the important disclosures at the back of this report. 2
Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Summary of assumptions Disposable income under renewed pressure The recent announcements relating to cut in some allowances of public sector employees have cast a shadow on consumer stocks as the quantum of effective reduction in wages will directly impact disposable income. Allowances contributed to ~25% of the overall public sector wages in 2015 which is a significant portion (refer table 3). Figure 3 Allowances form significant portion of wages, approx. 25% in 2015 (SAR mn) Salaries Allowances Wages Total Allowances as % of total wages 2000 82,969 19,572 4,417 106,959 18.3% 2001 85,194 19,931 4,897 110,022 18.1% 2002 86,080 20,434 4,841 111,354 18.4% 2003 90,142 21,478 4,813 116,433 18.4% 2004 97,968 24,101 5,235 127,304 18.9% 2005 104,148 27,675 5,357 137,180 20.2% 2006 121,878 33,302 6,189 161,368 20.6% 2007 129,480 35,120 6,289 170,888 20.6% 2008 137,495 37,756 5,853 181,104 20.8% 2009 146,284 52,237 4,568 203,089 25.7% 2010 155,111 64,167 4,632 223,910 28.7% 2011 162,768 69,475 4,667 236,910 29.3% 2012 202,989 59,849 5,709 268,547 22.3% 2013 229,905 68,772 4,177 302,854 22.7% 2014 234,569 75,215 4,394 314,178 23.9% 2015 239,393 79,223 4,268 322,884 24.5% Source: Argaam For e.g., if the effective cut in allowances is 25%, then this represents SAR20bn (~11% of overall POS transaction value over the last 12 months) cut in effective wages. From the time the government spending has slowed down (due to fall in crude oil prices), the revenue growth of consumer stocks has been declining due to lower disposable incomes. Especially, revenue of discretionary retail stocks (Jarir, Al Hokair, Extra) correlates highly with that of POS transaction value which has been in a downtrend. Further, we also note the declining trend of Wholesale and Retail GDP (which also includes hotels and restaurants) is reflected in the declining revenue growth of retailers. However, staples (Almarai, Al Othaim, Savola, Herfy) fare better with much lower volatility and steady revenue growth. Figure 4 High correlation between discretionary retail and POS transaction value growth Figure 5 Low correlation between staples and POS transaction value 5 4 5 4 3 R 2 : 78% 3 R 2 : 19% - - - -3 - Source: SAMA, Al Rajhi Capital Aggregate revenue growth - discretionary retail (% YoY) POS transaction value (% YoY) Source: SAMA, Al Rajhi Capital Aggregate Food revenue growth (% YoY) POS transaction value (% YoY) Disclosures Please refer to the important disclosures at the back of this report. 3
Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Figure 6 Revenue growth of consumer companies tracking underlying GDP trend 25.0% 16.0% 14.0% 12.0% 15.0% 8.0% 6.0% 4.0% 5.0% 2.0% -2.0% Aggregate Food & Retail revenue growth (% YoY) GDP growth - Wholesale & Retail Trade, Restaurants & hotels segment (RHS) Source: CDSI, Al Rajhi Capital Overall, we believe the revenue growth of discretionary-retail and staples will bottom out in 2016 and 2017, as majority impact of slowdown in discretionary spending (on a YoY basis) will be witnessed during this time. From 2018, we expect gradual recovery (in part due to the low base by the end of 2017), but expect the revenue growth rates to be below the trend witnessed during the 2011-2014 period, when oil prices were much higher. Figure 7 Aggregate revenue growth of discretionary retail Figure 8 Aggregate revenue growth of staples 35.0% 16.0% 3 25.0% 30.4% 23.7% Discretionary retail: Jarir, Al Hokair, Extra 14.0% 14.2% 13.9% Staples: Almarai, Al Othaim, Savola, Herfy 12.4% 15.0% 12.4% 10.9% 8.7% 7.8% 9.0% 12.0% 10.4% 11.1% 5.0% 8.0% 7.2% 7.7% 7.5% 7.6% -5.0% -2.8% -0.3% 2011 2012 2013 2014 2015 2016e 2017e 2018e 2019e 6.0% 2011 2012 2013 2014 2015 2016e 2017e 2018e 2019e Source: Al Rajhi Capital Source: Al Rajhi Capital Margin to be weighed down While revenue hit does translate to margin compression by way of negative operating leverage for most companies, we also note that retailers may face additional cost pressures if some of the job categories (mainly staffed by low-cost expatriate workers) face visa restrictions which are likely to be implemented (source: Argaam). This assumes increased significance in the current scenario, especially when hiring freeze is imposed on public sector jobs as part of recent announcements. We note that the cost of an average expat worker in retail industry is around SAR2,000 (source: CDSI), while the minimum wage for hiring nationals would be more than double (source: media). For some of the companies like Al Othaim, Extra and Savola, salary as a % of revenue is high as compared to their EBIT margin. Hence, even a small increase in overall wage expense will have a meaningful impact on profitability. Other companies like Herfy, Jarir and Al Hokair are relatively better off on this metric compared to their peer group, even though they also will be impacted in absolute terms. Disclosures Please refer to the important disclosures at the back of this report. 4
Figure 9 Wage expense & margin for companies with retail operations (CY15) Salary as % of revenue EBIT margin Net profit margin Othaim 7.8% 3.5% 3.8% Extra 7.0% 1.5% 1.3% Savola 6.4% 3.9% 6.8% Hokair 5.2% 9.2% 8.5% Herfy 4.8% 19.3% 18.8% Jarir 1.5% 12.7% 13.0% Source: Company data, Al Rajhi Capital Risks and Catalysts We believe the situation post the recent announcements is still nascent and further understanding of the impact will unravel over the next few quarters. While we base our estimates as per our initial understanding, there could be both downside and upside risks to our estimates, which we have outlined below. Risks: Primary risk to our estimates is higher than expected negative impact on disposable incomes, either from effective cut in allowances being higher than estimates or from fresh austerity measures which may be unveiled later. Impact of VAT on retail volumes is also uncertain especially in the backdrop of lower disposable incomes. Catalysts: Sharp and quick uptick in oil prices (for e.g. if OPEC reaches a deal including key non-opec players during the upcoming meet in November, that is better than market estimates), which will ease liquidity and may lead to resumption of higher government spending and/or easing of austerity measures. Figure 10 Summary of estimates CMP Revenue (SAR mn) EPS (SAR) RoE (%) P/E (x) EV/E (x) FY17E FY18E FY17E FY18E FY17E FY18E FY17E FY18E FY17E FY18E Jarir 83.3 6,236 6,923 8.0 9.1 42.3% 43.8% 10.3 9.2 9.8 8.7 Othaim 75.0 7,708 8,387 5.7 6.0 19.6% 18.7% 13.2 12.5 7.3 7.0 Hokair 24.7 6,825 6,627 2.5 2.6 17.9% 16.1% 9.9 9.6 7.3 6.8 Extra 16.8 3,572 3,859 1.2 1.6 8.7% 11.9% 13.9 10.3 7.2 6.1 Almarai 55.8 16,340 17,694 2.9 3.3 17.6% 18.4% 19.1 17.0 12.0 10.8 Savola 30.1 25,904 27,326 2.6 3.2 12.3% 13.9% 11.5 9.5 5.5 5.0 Herfy 65.0 1,203 1,312 4.7 5.6 25.6% 27.3% 13.7 11.6 9.7 8.3 Source: Al Rajhi Capital; Note: For Al Hokair, FY17E corresponds to March 2017 fiscal year Disclosures Please refer to the important disclosures at the back of this report. 5
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