KSA RESTAURANT SECTOR Turning meals into profits

Transcription

1 KSA RESTAURANT SECTOR Turning meals into profits Restaurant operators better positioned in KSA than food producers Initiate on Herfy with a HOLD 28 th April 2013 Coverage Universe Herfy Recommendation HOLD Target Price (LC) P/E EV/EBITDA HIGH AFFINITY FOR MEAT MAKES SAUDI ARABIA AN ATTRACTIVE QSR MARKET High earning capacity, a young, fast growing population base and long stretches of extremely hot weather, which encourage the tendency to seek entertainment indoors, make Saudi Arabia a very attractive market for the Quick Service Restaurant (QSR) industry. This is further supported by a relatively high affinity for meat in the country, with consumption per person per annum in KSA at 52.3 kilos, well ahead of the global average of 38.7 kilos. Moreover, while Saudi Arabia ranks favorably in terms of market share of chained consumer foodservice within a regional context, a comparison with developed markets suggests there is room for further growth. Thus, given the attractive fundamentals of the QSR industry in Saudi Arabia, all major food chains, ranging from Pizza Hut to McDonald s, currently have significant presence in the country, with new names continuing to enter the market each year. In addition to the restaurant chains, the strong underlying fundamentals of the sector are also starting to attract sophisticated institutional investors, with the Carlyle Group acquiring a 42% stake in Saudibased Alamar Foods in Alamar acts as a master franchise operator of Domino s Pizza and Wendy s hamburgers in the MENA region TASI Hefy Almarai NONCRITICAL NATURE OF INDUSTRY HELPS AVOID PRICE REGULATIONS The consumer sector is widely seen as a key means of capitalizing on the attractive demographics in KSA (rapidly growing population with high earning capacity). However, following the Arab Spring in particular, the country s government has started relying on food price controls as a key means of appeasing its citizens. The most significant example in this regard is that of the dairy industry, with the government reversing product price increases by Almarai in both 2011 and In contrast, fast food is not considered a necessity, despite its growing popularity and as such the industry remains free from pricing regulations. Moreover, QSR operators enjoy the ability to enhance the overall pricing of their portfolio without raising list prices by introducing new value added product ranges. This can either be in the form of variations of existing offerings, such as the Mega Mac burger from McDonald s (which is the upsized version of the Big Mac) and the Triple Whopper by Burger King, or a completely new, relatively expensive line introduced for a limited time (the Turkish burger currently being offered by McDonald s is a good example). In fact, we feel that the ability to adopt this strategy is a key reason why Herfy has managed to increase yields at its restaurants from SAR 2.7mn in 2010 to SAR 3.5mn last year, despite the fact that it has not increased product prices over the past 34 years. Sector Coverage Asjad Yahya, CFA Taher Safieddine, CFA [email protected] HERFY OFFERS EXPOSURE TO THE ATTRACTIVE QSR SECTOR, HOWEVER SHARES FULLY PRICED Herfy is the dominant local QSR operator in Saudi Arabia, benefiting from one of the widest network of restaurants in the country and ranking as one of the top two burger fast food companies in KSA by sales volume. Moreover, the company intends to solidify its position as the leading local player with an aggressive expansion plan that envisions opening of 2025 new stores every year for the foreseeable future against a total of 200 stores at the end of In addition, the company operates bakeries & bakery shops, a rusk factory and a meat factory in Saudi Arabia and is increasing its presence in the wider region through franchised restaurants (12 stores in total at this stage in UAE, Kuwait and Bahrain). As such, the company offers investors a wellbalanced means of gaining exposure to the attractive QSR sector in Saudi Arabia. However, following the 32% runup in the past twelve months (15% YTD), we feel that the growth prospects of the company are already factored into its stock price. Our DCFbased analysis of the company suggests a fair value of SAR /share, translating into 6.3% upside potential from the recent closing price of SAR /share. Peerbased comparison also supports our analysis, with relative valuation suggesting a fair value estimate of SAR /share, based on average 2013 P/E and EV/EBITDA industry multiples. We thus initiate coverage on Herfy with a HOLD recommendation and a Target Price of SAR /share. Company Price (LC) Recommendation Target Price (LC) %upside/(downside) Herfy HOLD %

2 Table of Contents Table of Contents... 2 KSA Quick Service Restaurant sector snapshot... 3 An attractive market for QSR industry... 3 KSA largest market in the region; data suggests further room for growth... 4 Noncritical nature of industry means little, if any regulations on pricing... 5 Regional listed QSR companies outperform peers... 6 Herfy Food Services Company (Herfy) The story in charts... 8 Valuation... 9 DCF preferred valuation methodology... 9 Relative valuation supports our DCFbased Target Price Solidifying position as largest local player A key player in the KSA fast food industry Enjoying competitive cost advantage Expansion plans to refocus on restaurant business from Financial Outlook Restaurant business to drive top line growth Margins to come under pressure in near term, improve over the longer term Healthy EBITDA growth; franchise income to rise faster, but contribution will remain limited Capex peaking in ; debt gearing to remain low Net income growth to outpace revenue growth; dividend payout ratio to remain high Financial Statements April 28 th,

3 KSA Quick Service Restaurant sector snapshot An attractive market for QSR industry High earning capacity, a young, fast growing population base and long stretches of extremely hot weather, which encourage the tendency to seek entertainment indoors, make Saudi Arabia a very attractive market for the Quick Service Restaurants (QSR) industry. This is further supported by a relatively high affinity for meat in the country, with consumption per person per annum in KSA well ahead of the global average. In fact, in its Q113 results conference call, Almarai indicated that it has witnessed a decline in demand for cheese and butter in Saudi Arabia, with the segment recording a YoY decline in revenues in the country. The company attributed this reduction in significant part to the growing consumption of fast food, which in turn has lowered demand for cheese in particular within households. Given Almarai s position as the largest dairy company in KSA, this serves as a strong positive indicator for the health of the QSR industry in the country. Key consumers of meat (ranking out of 177 countries) Rank Country Meat consumption per person/year (kg) 1 Luxembourg USA Australia New Zealand Spain French Polynesia Austria Israel Canada Bahamas Denmark Kuwait Saint Lucia Ireland Iceland UAE Saudi Arabia 52.3 World Average 38.7 Source: FAO, The Economist, SHUAA Capital April 28 th,

4 KSA largest market in the region; data suggests further room for growth Industry data indicates that Saudi Arabia is the largest fast food market in the region. Currently estimated around the USD 4bn mark, the QSR market size in the country is projected to grow to USD 4.5bn by 2015 by Euromonitor, translating into a CAGR of 6%. The Carlyle Group similarly projects QSR sales at a CAGR ( ) of 5% in the Kingdom. Breakdown of QSR market share in GCC Others, 1020% UAE, 2025% KSA, 6065% Source: Gulf Organization for Industrial Consulting, SHUAA Capital Market penetration data for the QSR industry in Saudi Arabia also supports expectations of further growth in the sector. While the country ranks favorably in a regional context in terms of market share of chained consumer foodservice, a comparison with developed markets suggests there is room for further growth. Chained foodservice as % of total foodservice outlets Canada USA Taiwan Norway UK Saudi Arabia Chained foodservice as % of total foodservice sales Canada USA Japan Finaland UK Saudi Arabia Source: Euromonitor, SHUAA Capital Source: Euromonitor, SHUAA Capital Given the attractive fundamentals of the QSR industry in Saudi Arabia, all major food chains, ranging from Pizza Hut to McDonald s, currently have significant presence in the country, with new names continuing to enter the market each year. In addition to the restaurant chains, the strong underlying fundamentals of the sector are also starting to attract sophisticated institutional investors, with the Carlyle Group acquiring a 42% stake in Saudibased Alamar Foods in Alamar acts as a master franchise operator of Domino s Pizza and Wendy s hamburgers in the MENA region. April 28 th,

5 Noncritical nature of industry means little, if any regulations on pricing The consumer sector is widely seen as a key means of capitalizing on the attractive demographics in KSA (rapidly growing population with high earning capacity). However, following the Arab Spring in particular, the country s government has started relying on food price controls as a key means of appeasing its citizens. The most significant example in this regard is that of the dairy industry, with government reversing product price increases by Almarai in both 2011 and In fact, these price caps serve as a key reason for our HOLD recommendation on the stock. In contrast, fast food is not considered a necessity, despite its growing popularity, and as such the industry remains free from pricing regulations. The impact of this difference is aptly demonstrated by the trend for gross margins at Almarai and Herfy two key players in the Saudi dairy and burger fast food industries, respectively over the past few years. While both companies have witnessed a downward trend, mainly due to rising raw material costs, the decline has been much more significant for Almarai, as it faced greater difficulty in passing on the higher costs to consumers. Herfy s gross margins more stable than that of Almarai 42% 40% 38% 36% 34% 32% 30% Herfy Almarai Source: Herfy, Almarai Note that despite the absence of direct regulatory restrictions, fast food companies in KSA have generally avoided raising list prices due to everincreasing competition. Instead, companies continually introduce new value added product ranges to enhance the overall pricing of their portfolio. This can either be in the form of variations of existing offerings, such as the Mega Mac burger from McDonald s (which is the upsized version of the Big Mac) and the Triple Whopper by Burger King, or a completely new, relatively expensive line introduced for a limited time (the Turkish burger currently being offered by McDonald s is a good example). In fact, we feel that the ability to adopt this strategy is a key reason why Herfy has managed to increase yields at its restaurants despite the fact that it has not increased product prices over the past 34 years. Herfy: restaurant yields increasing despite absence of price hike 4,000 3,500 3,000 2,500 2,000 1,500 1, ,487 3,047 2, Revenue per restaurant (SAR'000) Source: Herfy April 28 th,

6 Big Mac index suggests fast food is cheap in Saudi Arabia The Economist s Big Mac index, which maps the burger s price in various countries against their respective GDP/capita to estimate Purchasing Power Parity, interestingly suggests that fast food is cheaply priced in Saudi Arabia, both in a regional and a global context. Although the tool is generally utilized as an informal means to assess which countries currencies are over or undervalued, the use of the Big Mac price alone for this purpose provides good insight into the pricing structure within the Saudi fast food industry. Big Mac index suggests fast food is cheap in KSA Big Mac price (USD) Norway Pakistan UAE Qatar Kuwait KSA Egypt 20,000 40,000 60,000 80, ,000 GDP per capita (USD'000) 2011 Source: The Economist The attractive pricing of fast food relative to the earning power in Saudi Arabia further supports expectations of healthy growth in the sector, with the possibility of upward revision in price another potential catalyst for boosting revenues. Regional listed QSR companies outperform peers The GCC markets include two prominent listed QSR companies, namely Herfy and Kuwaitbased Americana. Both companies have outpaced their regional peers in the wider food sector. The greater pricing power enjoyed by these companies, coupled with lower regulatory risk, is likely to have been a key catalyst for this outperformance. QSR sector stocks outperforming peers TTM returns (%) Americana Herfy Savola Agthia 17.9 SADAFCO 12.8 Halwani 1.2 Almarai Nadec Source: Bloomberg, SHUAA Capital April 28 th,

7 Bloomberg Herfy AB Herfy Food Services Company Reuters 6002.SE Premier player in an attractive industry, but prospects priced in 28 th April 2013 Recommendation: HOLD Current stock price (SAR) week range (SAR) YTD performance 15.2% Number of shares ( 000) 33,000 Free Float (%) 32.1 Market Cap (SAR mn) 3,696 Market Cap (USD mn) 986 Div. Yld 2013P 3.4% Current Price: SAR Country: Saudi Arabia Target Price SAR Sector: Consumer Recommendation: HOLD Exchange: Tadawul LEADING PLAYER IN KSA FAST FOOD INDUSTRY Herfy is the dominant local QSR operator in Saudi Arabia, benefiting from one of the widest network of restaurants in the country and ranking as one of the top two burger fast food companies in KSA by sales volume. Moreover, the company intends to solidify its position as the leading local player with an aggressive expansion plan that envisions opening of 2025 new stores every year for the foreseeable future against a total of 200 stores at the end of In addition, the company operates bakeries & bakery shops, a rusk factory and a meat factory in Saudi Arabia and is increasing its presence in the wider region through franchised restaurants (12 stores in total at this stage in UAE, Kuwait and Bahrain). Herfy remains 100% owned by Saudi nationals, a fact that helps it tap into strong patriotism in KSA. In fact, the brand is heavily promoted as 100% localowned, with anecdotal evidence indicating that a significant portion of Saudi customers have developed strong loyalty to the brand due to this factor TASI Hefy ENJOYING COMPETITIVE COST ADVANTAGE Herfy enjoys a competitive edge over its peers, particularly international chains, in terms of its cost structure. This advantage is driven by a number of factors, the most significant of which include: 1) vertical integration of supply chain, with all meat requirements fulfilled by Herfy s own meat processing plant and a significant portion of bread requirement through its bakeries and 2) absence of royalty fees, which local arms of international chains have to pay. As a result, the company is able to attractively price its product range without compromising on quality. In fact, our discussion with representatives of McDonald s in KSA indicates that one of the key reasons the international fast food chain is forced to maintain relatively low prices (even by regional standards) is the pricing structure at Herfy. HEALTHY CAPEX PROGRAM TO TRANSLATE INTO STRONG GROWTH Herfy witnessed a marked increase in capital expenditure in 2012 (SAR 158mn vs. SAR 103mn in 2011) as a result of investment on a new bakery plant at an estimated cost of c. SAR 120mn, which has expanded total bakery capacity at the company by 5 times. The current year is anticipated to record a similar sized capital expenditure (SAR 150mn) as the company opens 20 new large restaurants. Moreover, Herfy s growth plan calls for 2025 new store openings every year over the foreseeable future. We thus expect the combination of 1) operational improvement in existing facilities (particularly in restaurants that opened in recent years and the new bakery plant) and 2) continued healthy capital expenditure (focused mainly on restaurant expansion) to translate into healthy CAGRs of 17.9% and 19.0% for revenues and net income, respectively. For 2013 in particular, we project top line growth of 20.5% and net income growth of 15.7% YoY. Sector Coverage Asjad Yahya, CFA Taher Safieddine, CFA INITIATING COVERAGE ON HERFY WITH HOLD AND TP OF SAR /SHARE Although we like Herfy s business model and the segment of the overall consumer sector that it operates in, we feel that the market has largely factored in the growth prospects of the company (up 32% TTM and 15% YTD). Our TP of SAR /share is based on DCF analysis covering the period (WACC: 11%, Terminal Growth: 3.0%). We have also conducted a relative valuation exercise as a sanity check, which yields a slightly lower fair value estimate of SAR /share. We thus initiate coverage on the stock with a HOLD recommendation. Year Revenues (SAR mn) EBITDA(SAR mn) Net Profit(SAR mn) EPS (SAR) P/E(x) EV/EBITDA(x) P 1, P 1, P 1, April 28 th,

8 The story in charts Improved utilization and capex to drive top line growth Capex to focus on restaurant openings SARmn 2,000 1,800 1,600 1,400 1,200 1, CAGR: 17.9% 1,422 1,205 1,014 1,661 1,914 Number of stores CAGR: 9.5% Restaurants Meat Factory Rusk Factory Bakeries & other Restaurant yields to continue to increase Margins under pressure in short term as new stores open SAR'000 6,000 5,000 4,000 3,000 2,681 3, CAGR: 8.9% 4,315 3,905 3,487 4,660 5,010 5,336 34% 32% 30% 28% 26% 2,000 24% 1, % 20% Gross Margin EBIT Margin EBITDA growth to marginally outpace revenue growth Margin improvement & lower financial costs to support NI growth CAGR: 18.0% 27.2% 27.1% 27.0% 26.9% 26.8% CAGR: 19.0% 23.0% 22.5% 22.0% 21.5% 21.0% 20.5% 20.0% EBITDA (SARmn) LHS EBITDA Margin (%) RHS 26.7% Net Income (SARmn) LHS Net Margin (%) RHS 19.5% April 28 th,

9 Valuation We initiate coverage on Herfy Food Services (Herfy) with a HOLD recommendation based on a fair value target of SAR per share, implying 6.3% upside potential to the current share price of SAR per share. Our target price is based on DCF methodology, with global peer analysis presented as well to serve as a sanity check for our valuation exercise. DCF preferred valuation methodology Herfy is expected to pursue an aggressive expansion plan in the coming years, with 2025 new stores set to open each year for the foreseeable future, compared to 200 restaurants at the end of In addition, the company is anticipated to rampup production at the new bakery plant established in 2012 (only one out of four lines at the plant is currently operational). Keeping this in view, we feel that DCF analysis is the most appropriate valuation methodology to capture this growth. The table below presents the main inputs for our DCF analysis. Key inputs for DCF analysis (SARmn) Details 2013P 2014P 2015P 2016P 2017P EBITDA (adjusted for taxes) Add: Franchise income Less: change in working capital (10) (11) (13) (12) (16) Less: capital expenditure (150) (125) (105) (90) (86) Free Cash Flow WACC 11.0% Terminal growth rate 3.0% Source: SHUAA Capital Our WACC is based on a Cost of Equity of 12.0%, after tax cost of debt of 4.0% and debttocapital ratio of 12:88. Details of DCF valuation Detail Value (SARmn) % of EV PV of explicit forecast % PV ot Terminal 3, % Enterprise Value 3,965 Add: 2012 net cash 2 Less: 2012 EOSB (36) Equity Value 3,931 Shares outstanding (mn) 33 Value per share (SAR) Source: SHUAA Capital April 28 th,

10 The table below presents a sensitivity analysis for changes in the assumptions for the WACC and terminal growth rate: WACC 10% 11% 12% Terminal growth rate 2.5% % % Source: SHUAA Capital Relative valuation supports our DCFbased Target Price Relative valuation based on average 2013 P/E and 2013 EV/EBITDA multiples yields a very wide range for the fair value estimate of Herfy, with an equal weighted approach implying an equity value of SAR /share for the company. Peer based comparison thus yields a slightly lower fair value estimate than our DCFbased Target Price of SAR /share, reaffirming our view that the current share price has largely factored in the growth prospects of the company. Detail Fair Value Weighting Weighted fair value/share P/E 2013P % EV/EBITDA 2013P % Fair value per share (SAR) Upside potential 1.1% Source: SHUAA Capital The table below lists the peers utilized for the purpose of this exercise. Company Country Market Cap (USDm) P/E (x) EV/EBITDA (x) EV/Sales (x) Div. yield (%) ROAE (%) TTM TTM TTM 2013 McDonald's USA 100, Yum! Brands USA 29, Burger King USA 6,416 N/A Wendy's USA 2, Jack in the Box USA 1, N/A AFC Enterprises USA N/A N/A McDonald's Japan Japan 3, Americana Kuwait 2, N/A Average Median Herfy KSA Source: Bloomberg, SHUAA Capital April 28 th,

11 Herfy trades at a premium to its regional Food Producer peers For the purpose of the relative valuation exercise, we have utilized Herfy s peers in the global QSR industry, rather than the broader consumer sector, thus excluding regional Food Producers such as Almarai and Agthia to determine the relevant industrybased multiples. As evident from the table below, Herfy trades at a premium to such regional companies on all relative valuation metrics (P/E, EV/EBITDA and EV/Sales). Given the combination of 1) a more favorable regulatory environment, with no restrictions on product pricing and 2) significantly higher profitability (as reflected by RoAE), we feel that Herfy s premium valuation is justified. Herfy trades at a premium to regional Food Producers Company Country Market Cap (USDm) P/E (x) EV/EBITDA (x) EV/Sales (x) Div. yield (%) ROAE (%) TTM TTM TTM 2013 Almarai KSA 6, Savola KSA 6, SADAFCO KSA NADEC KSA Agthia UAE Juhayna Egypt Average Median Herfy KSA Source: Bloomberg, SHUAA Capital April 28 th,

12 Solidifying position as largest local player A key player in the KSA fast food industry Herfy is the one of the largest fast food chains in Saudi Arabia, benefiting from the widest network of restaurants in the country. Moreover, industry data also indicates that Herfy, along with McDonald s, ranks as one of the top two burger fast food companies in KSA by sales volume, making it the largest local player in the sector. In addition to managing 200 restaurants (20 owned and 180 leased) in Saudi Arabia (as at end of 2012), Herfy also operates bakeries & bakery shops, a rusk factory and a meat factory. Moreover, the company has presence in the wider region through a total of 12 franchised restaurants in Kuwait, UAE and Bahrain. Restaurants in KSA, however, remain the biggest source of the company s revenues, a trend that is likely to continue in the foreseeable future. Ranking of fast food companies by outlets (2012) Herfy 2012 revenue breakdown Bakeries & other 12% Rusk Factory 2% Meat Factory 3% Herfy Kudu KFC McDonald's Burger King Restaurants 83% Source: Euromonitor, SHUAA Capital Source: Herfy Herfy remains 100% owned by Saudi nationals, a fact that helps it tap into strong patriotism in KSA. In fact, the brand is heavily promoted as 100% localowned, with anecdotal evidence indicating that a significant portion of Saudi customers have developed strong loyalty to the brand due to this factor. Moreover, Savola and Herfy s founder Ahmad Hamad Mohammad Al Saeed remain the two largest shareholders of the company. Herfy shareholding structure Public, 32.1% Ahmad Hamad Mohammad Al Saeed, 20.3% Savola Group Company, 47.6% Source: Bloomberg, SHUAA Capital April 28 th,

13 Enjoying competitive cost advantage Herfy enjoys a competitive edge over its peers, particularly international chains, in terms of its cost structure. This advantage is driven by a number of factors, the most significant of which include: 1) vertical integration of supply chain, with all meat requirements fulfilled by Herfy s own meat processing plant and a significant portion of bread requirement through its bakeries and 2) absence of royalty fees, which local arms of international chains have to pay. As a result, the company is able to attractively price its product range without compromising on quality. The table below presents a price comparison of flagship burger meals for Herfy and its key competitors. While the company ranks favorably even on the basis of listprice comparison, it regularly offers discounts (such as a reduction in price to SAR 10/meal over selected weekends), further adding to its cost advantage. In fact, our discussion with representatives of McDonald s in KSA indicates that one of the key reasons the international fast food chain is forced to maintain relatively low prices (even by regional standards) is the pricing structure at Herfy. Herfy s prices among the cheapest in the sector Company Meal List Price (SAR) Herfy Big Herfy with Cheese combo 16 McDonald's Big Mac meal 16 Burger King Whopper meal 18 Hardee's Swiss & Mushroom meal 20 Kudu Phillysteak 20 Source: Company data, SHUAA Capital Expansion plans to refocus on restaurant business from witnessed a sharp increase in Herfy s capital expenditure program. The spike resulted from investment on a new bakery plant at an estimated cost of c. SAR 120mn, which has expanded total bakery capacity at the company by 5 times. The plant will produce bread and cake items and introduce new product ranges in Herfy s portfolio such as croissants and cupcakes, which will be sold to retail customers. However, the company is planning to slowly expand utilization of the plant, with only one out of the four lines at the plant operational at this stage. With production of hamburger buns underway since 2012, the production of sliced bread at the new plant is anticipated in Q313, while the last two lines will become operational at a later stage. Annual capital expenditure (SARmn) P April 28 th,

14 Herfy s hefty capital expenditure program is set to continue in 2013, with the company anticipated to incur another SAR 150mn in the current year. However, the focus of the expenditure is anticipated to shift back to the restaurant business. While the last two years witnessed a slowdown in restaurant expansion due to investment on the bakery plant, annual store openings are expected to return to the 2025 range in the foreseeable future in particular is expected to stand out in terms of capital expenditure as the company intends to open 20 large stores, each equipped with a wide range of facilities, including drive throughs and separate family sections. 40% of the planned restaurants this year will be opened in Herfy s home market of Riyadh, while some openings will be aimed at previously untapped cities, such as Taif and Medina. Restaurant expansion to pick up pace from 2013 again Year P Total number of restaurants Annual restaurant openings April 28 th,

15 Financial Outlook Restaurant business to drive top line growth We expect a combination of 1) operational improvement in existing facilities (particularly in restaurants that opened in recent years and the new bakery plant) and 2) continued healthy capital expenditure (focused mainly on restaurant expansion) to translate into revenue CAGR of 17.9%. For 2013 in particular, we expect the company to maintain the trend of double digit revenue growth seen in recent years and project the top line to stand at SAR 1.0bn, translating into 20.5% YoY growth. Revenues to grow strongly (SARmn) 2,000 1,800 1,600 1,400 1,200 1, , CAGR: 17.9% 1,661 1,422 1,205 1, Restaurants Meat Factory Rusk Factory Bakeries & other Herfy s restaurant business is expected to be the primary driver of the company s top line growth over our forecast period. Growth in the segment, in turn, is anticipated on the back of 1) planned expansion in number of stores and 2) continued improvement in the yields per restaurant. The company is expected to open 2025 stores each year over the foreseeable future, with our model factoring in a CAGR of 9.5% for number of restaurants. In the meantime, the revenues per restaurant metric has demonstrated strong growth in recent years, despite the fact that the company has not raised product prices in the past 34 years. The increase in yield is explained by 1) introduction of new, higher value product ranges and 2) increasing number of customers per restaurant, which is driven by a combination of a growing population and increasing preference for fast food in KSA. With these factors set to continue in the foreseeable future, we anticipate further improvement in revenue generation per restaurant. Thus, we forecast revenue CAGR of 19.2% for Herfy s restaurant business. April 28 th,

16 Number of restaurants Revenues per restaurant (SAR 000) , CAGR: 9.5% CAGR: 8.9% ,000 4,660 4, ,905 4,000 3,487 3,047 3,000 2,681 5,010 5, , , Margins to come under pressure in near term, improve over the longer term Our discussion with management indicates that new restaurants typically take 612 months for normalization of operations. Thus, the negative impact on margins of the planned opening of 20 large stores this year is likely to offset continued improvement in existing operations, translating into largely stable gross margins in That being said, we expect modest improvement in gross margin from 31.6% in 2012 to 32.3% by 2017 as utilization of facilities improves. Moreover, Selling & Marketing expenses are expected to trend upwards in the medium term as a percentage of sales as the company introduces new means of increasing the popularity of the food chain. In fact, the one day, 50% discount across its entire menu offered by the company last year, the first in its history, is a good example in this regard. General & Administrative expenses, on the other hand, are likely to remain stable as percentage of revenues, in line with the historical trend. Margins to improve modestly over longer term 34% 32% 30% 28% 26% 24% 22% S&M expenses to trend higher in medium term 6.0% 5.5% 5.0% 4.5% 4.0% 20% Gross Margin EBIT Margin 3.5% 2011 S&M expenses as % of revenues G&A expenses as % of revenues April 28 th,

17 Healthy EBITDA growth; franchise income to rise faster, but contribution will remain limited We expect Herfy to post EBITDA CAGR of 18.0% over the period, mainly as a result of healthy top line growth. Moreover, the company is expected to continue witnessing very strong growth in franchise income in the coming years ( CAGR: 40.2%). Herfy currently has a presence in Kuwait, Bahrain and UAE through franchisees in these countries, which operate a total of 12 branches at this stage. Income from this business is reported as part of Other income and has grown significantly from SAR 0.7mn in 2011 to SAR 2.1mn in 2012 and is expected to maintain a strong upward trajectory in the coming years. That being said, contribution of franchise income to Herfy s bottom line is expected to remain limited, rising from 1.2% in 2012 to 2.7% by EBITDA growth to marginally outpace revenue growth Franchise income to rise sharply in coming years CAGR: 18.0% 27.2% 27.1% 27.0% 26.9% CAGR: 40.2% % 4 EBITDA (SARmn) LHS EBITDA Margin (%) RHS 26.7% 2 Capex peaking in ; debt gearing to remain low As highlighted earlier, Herfy is planning to build 20 large restaurants this year, which is expected to result in 2013 being another year of heavy capital expenditure. Moreover, while the following years are expected to witness 2025 new store openings per annum, a mixture of rented and selfowned properties is likely to keep annual capital expenditure at lower levels. Over the longer term (2017 and for our Terminal Value calculation), we assume capital expenditure to be largely in line with annual depreciation at 4.5% of revenues. Capex slowing down from 2014 onwards Debttoequity ratio to trend down % 12% % 10% 10% 8% 6% % 4% 20 0% Capital expenditure (SARmn) LHS Capex as % of revenues RHS 2% 0% Herfy maintains a very conservative balance sheet, with debttoequity ratio standing at only 11.2% in Given that the company is expected to remain free cash flow positive throughout our forecast, this ratio is projected to drift downwards in the coming years. April 28 th,

18 Net income growth to outpace revenue growth; dividend payout ratio to remain high Given the combination of a modest improvement in margins, a decline in financial costs (relative to EBIT) and a sharp increase in franchise income, net income CAGR is expected to stand at 19.0%, surpassing the top line CAGR of 17.9% over the same period. For 2013 in particular, we anticipate net income of SAR 210mn, translating into 15.7% YoY growth. Net income growth to exceed revenue growth CAGR: 19.0% 23.0% 22.5% 22.0% 21.5% 21.0% 20.5% 20.0% 19.5% Net Income (SARmn) LHS Net Margin (%) RHS Herfy has historically maintained a relatively high dividend payout ratio (2011: 61.4%, 2012: 58.0%). Given the healthy cash flow generation profile of the company, we expect this trend to continue and project a payout ratio of 60.0% for our forecast. For 2013 in particular, we anticipate a dividend of SAR 3.80/share, translating into a dividend yield of 3.4%. Note that 2013 is the only year where the dividend payout is expected to exceed the company s Free Cash Flow. However, given the combination of 1) a strong balance sheet, 2) manageable capital expenditure plan and 3) strong free cash flow generation (average Free Cash Flow yield of 7.1% over forecast period), we feel that Herfy can easily maintain the current dividend payout levels for the foreseeable future. Strong Free Cash Flow generation to support high dividend payout ratio (SARmn) 2013P 2014P 2015P 2016P 2017P Free Cash Flow Dividend DPS (SAR) Dividend payout ratio 59.8% 59.7% 59.8% 59.9% 60.2% Source: SHUAA Capital April 28 th,

19 Financial Statements Income Statement (SAR mn) Year to December P 2014P 2015P Restaurants , ,235.0 Meat Factory Rusk Factory Bakeries & other Total Revenues , , ,421.9 Cost of sales (482.3) (575.7) (695.9) (823.0) (968.3) Gross Profit Selling & Marketing expenses (34.5) (36.4) (48.7) (62.7) (66.8) G&A expenses (38.9) (43.7) (53.8) (63.3) (74.6) Management fees (4.5) (5.6) (6.7) (7.9) (9.3) Income from operations Financial charges (0.5) (0.9) (1.2) (1.3) (1.4) Other net Income before zakat Zakat (3.6) (4.6) (5.5) (6.6) (8.0) Net income EPS (SAR) 4.44* 5.49* DPS (SAR) 2.73* 3.18* *: Adjusted for latest bonus shares April 28 th,

20 Balance Sheet (SAR mn) Year to December P 2014P 2015P Cash & cash equivalents Accounts receivable Inventories Prepayments and other receivables Total Current Assets Investment properties Deferred charges PP&E Total NonCurrent Assets TOTAL ASSETS ,182.7 Current maturity of long term borrowings Accounts payable Accrued and other liabilities Zakat payable Total Current Liabilities Longterm borrowings Employee termination benefits Total NonCurrent Liabilities TOTAL LIABILITIES Share capital Retained earnings & other reserves TOTAL SHAREHOLDERS' EQUITY April 28 th,

21 Key Ratios Year to December P 2014P 2015P Growth Revenues 22.2% 18.8% 20.5% 18.8% 18.0% EBITDA 19.6% 20.4% 20.8% 18.3% 18.9% Income from Operations 19.8% 21.8% 15.9% 18.5% 22.0% Net Profit 18.0% 23.5% 15.7% 18.6% 22.1% Shareholders' Equity 15.6% 18.6% 20.1% 19.7% 20.7% Number of restaurants 9.3% 6.4% 10.0% 9.1% 10.4% Margins & Profitability Gross Margin 31.9% 31.6% 31.4% 31.7% 31.9% EBIT Margin 20.9% 21.5% 20.6% 20.6% 21.3% EBITDA Margin 26.6% 26.9% 27.0% 26.9% 27.1% Net Margin 20.7% 21.5% 20.7% 20.6% 21.3% RoAE 35.8% 37.7% 36.5% 36.1% 36.7% RoAA 27.0% 28.0% 27.1% 27.1% 27.9% Leverage Net cash/(debt) (SARmn) Debttoequity 9.4% 11.2% 9.7% 8.3% 7.0% Efficiency Restaurants (total number) Revenues/restaurant (SAR'000) 3,047 3,487 3,905 4,315 4,660 Valuation EPS (SAR) DPS(SAR) P/E (x) Fair value based P/E (x) Dividend yield (%) 2.4% 2.8% 3.4% 4.0% 4.9% EV/EBITDA (x) EV/Sales (X) April 28 th,

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23 Research Asjad Yahya, CFA Taher Safieddine, CFA Client Services: 800 SHUAA (74822) UAE only +971 (4) International Sales Trading Desk: +971 (4) April 28 th,

24 This document has been issued by SHUAA Capital for informational purposes only. This document is not and should not be construed as an offer or the solicitation of an offer to purchase or subscribe or sell any investment or subscribe to any investment management or advisory service. This document is not intended as investment advice as to the value of any securities or as to the advisability of investing in, purchasing, or selling any security. SHUAA Capital has based this document on information obtained from sources it believes to be reliable. It makes no guarantee, representation or warranty as to its accuracy or completeness and accepts no responsibility or liability in respect thereof or for any reliance placed by any person on such information. All opinions expressed herein are subject to change without notice. This document may not be reproduced or circulated without the prior written consent of SHUAA Capital psc. April 28 th,