NCB Capital maintains positive outlook for Saudi food and agriculture sector

Updating its Q1report on theSaudi Food and Agriculture sector, NCB Capital, the GCC’s leading wealth manager and the Kingdom’s largest asset manager, gives the sector a positive outlook due to growth in demand supported by a young and growing population, and expansions into new segments. 

Rating the two market leaders Almarai and Savola, Farouk Miah, Head of Equity Research at NCB Capital, said: “We remain Overweight on Savola with a PT of SR57.5 and remain Neutral on Almarai with a PT of SR68.6. However, volatility in global food prices, reliance on imports and a lack of pricing power are key concerns. 

“At Savola, earnings outlook of the firm remains strong with growth coming from store expansion and margin increase at the Retail business (Panda), coupled with capacity increases at the Food business (edible oil and sugar).  The stock price has doubled since our move to Overweight in 4Q11, hence the remaining upside is limited to 16%”. 

“On the other hand, at Almarai, 2013E is expected to remain muted due to slower than expected revenue growth, delays in the Poultry business moving to profitability and costs from expansions pressuring margins. The long term potential remains with expansions in existing businesses and new ventures to support growth. Execution risk and limited pricing power remain the key concerns.” 

The report states that this year to date there has been stability in global food prices which should in theory support margins for the Saudi food sector. However NCB Capital notes that much of these gains at Almarai are being negated by costs from its expansions. Longer term volatility and increases in global food prices remain a key risk for Saudi food companies given the majority of their raw materials are imported, coupled with limited pricing power which leads to margin pressure. 

“For both Almarai and Savola, the earnings growth outlook remains strong off the back of aggressive expansion plans in existing/new businesses, as well as high single digit organic growth, added Mr. Miah. We believe both firms are well positioned to take advantage of the potential of growth for their respective sectors.” 

“However, our Valuation on Savola remains favourable to Almarai. Savola is currently trading at 15.2x 2013E P/E against Almarai on 17.1x P/E. We believe the valuation on Savola remains attractive, although the multiple has expanded by around 17% in the past six months,” concluded Mr. Miah. 

Ratings Summary 

SAVOLA

Strong growth outlook remains, although upside becoming limited

NCB Capital remains Overweight on Savola with a PT of SR57.5. “The earnings growth outlook remains strong with the Retail segment expected to benefit from continued double-digit revenue growth coupled with margin expansion. Capacity increases in the Food segment should support growth here. The recent rally in the stock has limited our upside, although enough remains for us to maintain our Overweight rating.” said Mr. Miah. 

NCBC Expects Savola to record net income growth of 21% YoY in 2013E

From a combination of store and margin expansion at Panda and increased sales volumes at the Food business, NCB Capital expects Savola to record net income growth of 21% YoY in 2013E to SR1,637mn. Beyond this, the capacity expansions in the Food business and continued margin expansions and opening of new stores at Panda should lead to net income CAGR of 13.2% in the coming five years for Savola.

Proportion of group EBIT from Retail to almost double by 2018E

Due to high single organic growth, opening of 15+ stores per year and margin expansion off the back of economies of scale coming through, the growth outlook of the Retail business remains strong. In 2012 14% of EBIT was from the Retail business – NCB Capital expects this to increase to 26% by 2018E. Thus Savola will be increasingly reliant on the outlook of this business. 

Food sector outlook remains susceptible to volatility

Given essentially Savola’s role as a “refiner” of sugar and edible oil, NCB Capital believes the profit outlook of this business remains susceptible to the outlook of the sugar and edible oil commodity markets. This is particularly the case for Sugar where a developed market for both raw and refined sugar largely dictates prices. 

Growth will come from strong regional demand for edible oils and sugar

For the Food business we believe growth will come from strong demand in the region for edible oils and sugar which will be captured by capacity increases at Savola’s Saudi based plants. “As mentioned in our previous update, we believe management intends to increase its Saudi sugar capacity from 1.2mn tons to 1.6mn tons and in Edible Oils from 0.4mn tons to 0.55mn tons in the coming 24 months,” highlighted Mr. Miah. “Although, in our model we conservatively expect it to take 36 months before this expansion is complete. We believe the incremental capacity will be primarily used for exports and to target B2B sales.” Exposure to international markets, and margin pressure from global food price volatility, remain the key concerns. 

We remain Overweight although margin of safety becoming limited

NCB Capital remains Overweight on Savola due to its strong earnings outlook and attractive 2014E P/E of 13.6x. “However, we note that in the last six months the 12 month forward P/E multiple for Savola has expanded from 11.5x to 13.5x, reducing the discount vs. global peers from 25% to around 12% only,” explained Mr. Miah. 

ALMARAI

Returns expectations move to 2014E

NCB Capital remains Neutral on Almarai with PT decreasing slightly to SR68.6. “We believe 2013E will be another muted year with expectations of returns from its investments moving to 2014E,” said Mr. Miah. “The Poultry division is expected to remain loss making in 2013E (vs. previous expectation of break-even) which we believe will hurt sentiment re potential returns on upcoming investments. Additionally, 2013E is expected to record further margin contraction due to higher than expected costs from expansion.” 

Margin contraction to lead to muted results in 2013E

NCB Capital expects Almarai to record revenue growth of 16.5% in 2013E, with EBIT margins of 15.8% and net margins of 13.5%, leading to 7.8% YoY growth in net income of SR1,553mn. “Despite reasonable sales growth YoY, we believe higher than expected costs and lower than expected returns regarding its expansion plans will result in margin pressure. This is despite lower raw material prices which should enable margin expansion,” noted Mr. Miah. 

Delay in Poultry progress a key disappointment

Previous management guidance was for the Poultry business to break-even in 2013E, however NCB Capital believes higher than expected mortality rate as well as other factors will lead the business to remain loss-making in 2013E. With this venture consuming more than SR4bn in capex and expected to account for 19% of sales by 2017E, this delay in progress is disappointing. Additionally, NCB Capital believes the read-across from the delay here could be the lower expected returns expected on its overall SR15bn+ capex programme. 

Relying on investments for growth

“We believe Almarai will be highly reliant on the returns from its on-going SR15.7bn capex programme for future growth. Alongside its expansion into the Poultry business, it is looking to expand capacity for dairy and juice, as well as investing in new segments. Although organic growth in existing businesses remains in high single-digits, we believe the level of success on new investments will play a key role on the financial outlook of the firm,” highlighted Mr. Miah.