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AOTHAIM AB | A challenging year ahead; Downgrade to Neutral

Stretched valuation, with tough base to beat. Demand on groceries should ease in 2021e, on normalised consumption patterns, further magnified by spending pressures, that triggered market-wide promotions, which started to reflect on Al-Othaim’s 2H20 LFL sales (-5-10%). Yet, we expect Al-Othaim to maintain flat 2021e sales, despite 2020 high base, as expansions resume, while benefiting from trading down activities, due to its clear value proposition (loyalty programme >c75% of sales), with earnings falling c23% y-o-y, on rising cost pressures. As we roll over our DCF, we raise our 12M TP by 38% to SAR124/share, yet downgrade our rating to Neutral, post the stock price rally, trading at c33x on a 2021e P/E, above peers’ 20x.

Positioned to reap benefits. Al-Othaim is resuming its aggressive expansions in Saudi, which were hindered by COVID-19 disruptions, targeting 23 stores in 2021 (vs. +11 in 2020). This favourably positions the company to displace unorganised retail, although market consolidation is stalling, with only few players exiting, unable to comply with efforts to formalise the market or adverse market conditions. That said, we look for a 5% y-o-y decline in 2021e Saudi’s sales/sqm, with room for recovery beyond by 1.6% p.a., on ramping up new additions, coupled with market share gains.

Margins to normalise from high base. We expect 2021e EBIT margin to normalise at 4.7%, below 2019 level of 4.9%, pressured by the higher promotions and labour costs (last expat fees’ hike in 2020 and higher Saudisation decision). EBIT margin reached an all-time high of 5.9% in 2020, boosted by: i) scale benefits, with higher rebates and lower promotions, and ii) government support (SAR12-14mn expat and PoS fees waivers), mitigating the rent discounts granted. Margin pressures should be partially countered by: i) cost controls, ii) yields recovery, iii) negotiation efforts, on higher bargaining power, and iv) breakeven of Egypt’s operations in 2021.

Expect dividend cut in 2021e, despite solid FCF generation. Al-Othaim’s sustainably healthy cash generation (-19 days in 2020), recovery of store yields, and broadly stable margins, beyond 2021e, should drive up FCFF c11% over 2021-25e. However, we see 2020 DPO of 120% as a one-off, assuming a lower DPO of 93%, on average, over 2021-25e, with room to increase thereon, as expansions decelerate.