EUR 30.46 For Business Accounts Only

ALHOKAIR AB | New low for earnings in FY19, downgrade to N

Macro headwinds overshadow Alhokair’s efforts. Further improvement in earnings is hindered by Saudi’s dropping LFL (-14.1% y-o-y in 9MFY18), which we see as sustainable in FY19, as well as the higher Saudisation costs to comply with the MoL’s Jan-18 decree, enforcing full Saudisation in apparel stores as of Sep-18. We downgrade our rating to Neutral and cut our 12M TP by 30% to SAR32.0/share, assuming lower FY19-22: i) EBITDA margins by 2.7ppt, and ii) sales/sqm by 12%, to reflect a delay in reaping the benefits from the network optimisation, due to a weaker-than-expected spending outlook in Saudi, offsetting 50bps lower WACC, as we use Alhokair’s target debt weight (1/3). Our FY19 earnings estimate of SAR300mn (-c12% y-o-y) is 48% below consensus, implying that the market is overlooking headwinds. Alhokair trades 19% above peers, on a FY19e P/E of 20.4x.

Weak demand hinders recovery. We expect the drop in Saudi store yields to sustain in FY19, albeit at a lower rate of 4.4% vs. 12.2% in FY18, amid no signs of a spending pickup. The pressure we see on Saudi’s LFL stems from a drop in malls’ traffic, as cautious spending prevails, as well as low productivity of the newly-hired Saudi salesforce, noting that, until Alhokair complies with Saudisation/Feminisation requirements, some stores may be understaffed. Over FY19-23e, Saudi yields should gradually recover from the FY19 bottom (+2.7% p.a.), as the optimisation plan pays off, similar to the recovery in overseas yields (+c1% y-o-y in 9MFY18).

Saudisation wipes out efficiency measures. We look for pressure in FY19 EBITDA margin to 12.6% vs. 14.1% in FY18, as Alhokair raises its store-level Saudisation rate to 100% (vs. the current 60%), by replacing 4k expat salesforce, costing a maximum of SAR100mn (11% of FY18e EBITDA), as per guidance. This should also delay the recovery in EBITDA margins, driven by the restructuring efforts and turning overseas profitable (FY22e on EBIT level vs. guidance of end-FY19), to FY20e.

Cinemas launch not a game changer. We do not factor in Alhokair’s plan to open 7 movie theatres over the next 3 years, pending licensing. Market consensus is that the first cinema in Saudi will be opened by 4Q18. Although shopping might not remain the sole entertainment source in Saudi, Alhokair is well-positioned to benefit from the series of impending changes, including allowing women to drive, Feminisation, and Saudisation efforts, given its strong market position.