November 215 1 Leading a promising market, expansion plans to unlock potential growth. We initiate with an Overweight recommendation and a PT of SAR 114.8 per share, taking into account a cautious outlook on retail indicators. Recommendation Overweight Current Price* (SAR) 99. Target Price (SAR) 114.8 Company Description Upside / (Downside) 15.9% Saudi Arabia Hardware Company is the largest total-solution home improvement superstore in Saudi Arabia. operates retail outlets in *prices as of 16 November 215 12 cities throughout the Kingdom of Saudi Arabia (KSA). Spread over 2,5 Key Data to 22, square meters (sqm), the outlets house over 45, products. Market Cap(mn) 2,35 Headquartered in Riyadh, the company was established in 1985. It debuted on YTD % 4% the Tadawul stock exchange in May 215. 52 Week (High ) 148.2 operates in a highly fragmented market with significant room to 52 Week (Low) 77. capture market share: The non-grocery retail market is highly fragmented with a relatively large number of sub categories in place, the largest of which being Shares Outstanding (mn) 24. the electrical appliances due to relatively higher unit prices. is one of few retailers in the market that house a full set of sub categories mainly associated Key Financials with hardware and home improvement products. Total market for hardware and home improvement in Saudi Arabia is estimated to stand at around SAR SARmn (unless specified) FY14 FY15E FY16E 18 bn as of FY214 and is projected to continue growing at a pace between Revenues 1,84.8 1,271.1 1,471.2 3.5% and 4% annually after recording 4.6% CAGR for the period from FY28 EBITDA 144.5 16.9 186. to FY213. currently holds around 6% estimated market share and is in a EBIT 12.1 13.4 15.6 position to capture further market share given the current fragmented state of the market. This gives the company the opportunity to expand from two fronts, Net Income 11. 121.4 141.1 capturing market share from fragmented small retailers and expansion towards EPS 4.6 5.1 5.85 new areas around the kingdom. Growth in household formation in the kingdom is the main long term growth driver to consider for : Favorable demographics and the government s expansive housing plans are expected to be the principal drivers for the home retailing industry. On the other hand, a cautious outlook on retail growth trends (i.e. disposable income, average customer spending, footfall, and Units Per Transaction) is warranted given the current macroeconomic environment. Growth in the number of households is expected to continue at a relatively high pace compared to other regions. We consider household formation to be the main growth driver for, keeping an eye on trends related to this variable is decisive in identifying growth trajectory for the company. As we stand, the number of households is expected to grow 2.4% CAGR for the five year period between FY213 and FY218. Lack of international exposure keeps the company dependent on local retail and real estate indicators for forward growth perspectives. Uncertain real estate outlook not a concern, stands to benefit from higher levels of affordability in the housing market: An environment with relatively lower real estate unit prices could increase the pace of growth in household formation given a higher rate of affordability. From s perspective, the important figure to consider is the addition of homes to the market as well as the demand for home renovation, with rentals having less of an impact than ownership, given the higher level of investment on home improvement from ownership compared to rentals. Providing housing solutions to citizens along with lower costs in building materials contribute to household formation growth in the kingdom and can possibly be focal catalysts in the company s long term growth potential. Robust growth in same store sales and expansion in the number of stores to push growth figures going forward: disclosed double digit growth in same store sales YoY for Q3-215 as well as for the nine months period ending Sep -215 for FY215. The company did not disclose the exact figures. Continued growth from same stores sales alone is quite impressive taking into consideration the relative slowdown in total value of real estate transactions in the kingdom, the company s ability to record growth in a slower environment demonstrates s ability to capture further market share in a fragmented market. Double digit growth in same store sales is not sustainable on the long term we expect the trend to decline at a certain point in the medium term. On the other front, was able to open three stores in 215 so far, with an additional store on the pipeline by the end of the year or Q1-216. Expansion plans away from the central region in the kingdom and towards other regions could further spur the company s growth outlook. We estimate the company will be able to maintain its current pace in growing the number of stores, Key Ratios SARmn (unless specified) FY14 FY15E FY16E Gross Margin 23.2% 23.1% 23.% Net Margin 1.1% 9.6% 9.5% P/E NA 19.6x 16.8x P/B NA 4.8x 4.1x EV/EBITDA (x) 17.6x 15.7x 13.3x EV/Sales 2.3x 2.x 1.7x Shareholders Pattern Preoffering Postoffering Al Hamidi Contracting Establishment Co. 47.5% 33.% Abrar International Holding Company.5% 17.85% Abdul Rahman Hassan Abbas Sharbatly.5% 17.85% Khalid Mohammed Abdulaziz Al Hamidi.5%.35% Sameer Mohammed Abdulaziz Al Hamidi.5%.35% Haytham Mohammed Abdulaziz Al Hamidi.5%.35% Public.% 3.% Price performance 16 14 12 1 8 6 4 2 SAR 11-May-15 11-Jun-15 11-Jul-15 11-Aug-15 11-Sep-15 11-Oct-15 Source: Bloomberg, Aljazira Capital Sultan Al Kadi +966 11 26374 s.alkadi@aljaziracapital.com.sa
November 215 adding between two and three stores annually with an average store size of around 5,413 sqm. Additionally, disclosed plans to expand in the GCC, specifically Bahrain. Operational maturity of new stores is projected to hit 1% between 12-24 months after opening. Sales per sqm for new stores are assumed to stand at % to 3% less than standing stores. Revenue per sqm is estimated to stand at approximately SAR 9392.5 for FY215 compared to SAR 86.5 for FY214. Sales per store are expected to end the year at around SAR 5.8mn per store annually, compared to SAR 47.2mn for FY214; the 7.6% growth is mainly due to higher same store sales YoY. Strong performance over the past years, consistent double digit growth in top line figures. is positioned to sustain previous growth figures over the short and medium term: During 21 14, s revenue expanded at 17.3% CAGR. Revenues for the nine month period ending Sep 215 recorded a 19.8% growth YoY. The company is estimated to end the year with a strong Q4 set of results and maintain annual revenue growth on the double digit side; at around 17.2% YoY for FY215. For the period between FY215-FY218 we estimate revenues to grow at 17.39% CAGR. Given the current growth stage the company is at, top line growth is a key factor in the direction of for emerging as the main player in the market with the largest market share in the long run. The hardware and home improvement market has room for a market leader to emerge at a more concentrated basis as opposed to the current the fragment state of the market. There are immense prospects for in holding a larger market share; execution of forward expansion plans is the main catalyst to consider. Taking into account the current growth cycle the company is going through, and given the state of the hardware and home improvement market, we would like to see focusing on growing top lines while maintaining gross margins with a lesser emphasis on bottom line growth. Current Debt to equity position enables the company to sustain growth through reasonable levels of leverage going forward, with a D/E ratio expected to stand between.4x and.5x going forward. recently renewed a credit facility with a local bank to be used to finance working capital requirements. Improved margins are expected to be maintained going forward: The period from 211 to 214 witnessed expanding margins, most notably an 8 bps expansion in gross margins. For the 9 month period ending Sep-215, gross margins stood at 23% compared to 23.18% for FY214. Gross margins are expected to recover to levels around 23.1% by the end of the year and maintained thereafter. EBIT and net income margins expanded 2bps and 19bps respectively for the period between FY212 and FY214. The expected Saudization effect on gross margins SG&A (59% of salaries fall under COGS) over time will be more than set off by the expansion in gross margins, so far management was able to control such costs while maintaining Saudization levels in the company. Salaries and benefits attributed to SG&A as a % of total sales have increased from 4.4% in FY213 to 4.9% in FY214 while the average annual salary per employee grew 3.1% in the same period; we should note that we do not regard the issue as a major concern. Saco currently maintains an average of 54 employees per store (81 per store including total employees) at a Saudization rate of around 34.1% as of FY214. s ability to gradually improve margins in the margin sensitive retail sector while maintaining growth figures is a testament to management s ability to take the company forward. Reasonable valuation relative to recent IPOs, underpriced on a forward basis. We initiate with an Overweight recommendation and PT of SAR114.8 per share: is currently trading at FY215E P/E of 19.6x and a FY216E PE multiple of 16.8x against a current retail sector PE of around 19x. The stock was listed on Tadawul at the 12th of May 215 with an IPO price of SAR 7 per share; price reached a high of SAR 148 per share post IPO before dropping to current levels at around SAR 99 per share. Our valuation is based on a 1-year DCF methodology; we arrived at a target price of SAR 114.8 per share with a15.9% upside potential. Sales Growth and Gross Margins SAR (mn) and Annual Sales per Store 6 5 4 3 2 1 2 15 1 5 212 213 214 215F 216F Gross profit margin YoY Growth Store Expansion and Sales Growth 5 45 4 35 3 2 15 1 5 23.6% 15.7% 12.9% 21 21 22 17.2% 3% % 2% 15% 1% 5% % Sales Total market Size and Sales (est. market share) SAR mn 2 18 16 14 12 1 8 6 4 2 39.6 45.8 21 21 22 13.7% 212 213 214 215F 216F 49.3 5.8 51.6 212 213 214 215E 216E 28 28 Annual Sales per store (SAR mn) Revenue Growth %YoY.% 2.% 15.% 1.% 5.%.% 212 213 214 215F 216F Total market Size sales 2
November 215 Downside risks to valuation: Retail Indicators has an exclusive long term distribution agreement with ACE International 6 for the supply of Ace s products in Saudi Arabia placing at a favorable 49.3 5.8 position in the market. The agreement includes having exclusive distribution 5 rights in Bahrain conditioned on the ability of to set a store by the end of 4 215. Otherwise, exclusive distribution rights for Bahrain will be lost. The ability to expand in the GCC will provide with multiple channels for long term 3 22 growth, losing such opportunities will put minor pressure on forward growth 2 potential. 1 6. 6.8 Execution risk, the company s inability to execute expansion plans at estimated pace would put pressure on our valuation. Sales Per Store Est Market Share % trades at thin volumes making it relatively difficult to unlock potential (SAR mn) 214 215E capital gains for investors. Further slowdowns in the real estate market in terms of number of transactions would put pressure on the hardware and home improvement market, capping s top line growth potential. and store size and sales per sqm 16, 13,984 The emergence of a strong or dominant online retailer operating in the same 14, market would result in slower growth and possibly loss of market share on the 12, long run. 9,662 1, 8,594 Upside risks to valuation: 8, 5,413 If the company is able to execute expansion plans at both a higher pace and/ 6, or a larger scale than estimated, price per share at our current valuation would 4, be undervalued. 2, A pick up in the real estate market at higher transaction levels along with a - higher rate of household formation compared to estimates will push hardware and home improvement market growth figures upwards, deeming Average Size per store (sqm) Sales per Sqm (SAR) undervalued as a result. This can be a result of MOH s (Ministry of Housing) efforts to provide housing to citizens taking place in the medium term. and Home depot Inc Sales per store and It is highly unlikely that can eventually emerge as the Home Depot of Saudi est. market share (FY214) Arabia with a similar market share position and/or have similar sales per capita. mainly 16 due to the major difference in level of sophisticated demand exhibited by both the 14 137.6 average consumer and home improvement market as a whole. This comparison was 12 an attempt to exhibit the comparatively low level of maturity of the consumer and the 1 Saudi home improvement market in an effort to show how far the market can go on 8 the long term and the extent to which can benefit and potentially emerge as 6 49.3 market leader in a less fragmented market environment. 34.2 Current (215E) At Retail Multiples 4 2 6. Market size FY214E (SAR bn) 18. 911.6 Sales Per Store (SAR mn) Est Market Share % Sales Per Capita FY214 for total market (SAR) 658.4 2859.3 Sales per capita for company (SAR) 46.5 954.7 Sales (SAR mn) (assuming comparable sales per capita) Sales (SAR mn) (assuming comparable market share) 1271.1 2611.8 1271.1 687.6 Number of Stores 194 Sales Per store (SAR mn) 5.8 134.1 Total Size of stores (sqm) 135,33 1,879,983 Sales Per sqm (SAR) 9,462.5 13,884 Source: Bloomberg, company reports, Aljazira Capital Growth Potential: a Look at Domestic Population figures and company specific retail indicators 14 12 1 8 6 4 2 1242.7 216.8 39.7 14.5 14.5 954.7 Pop / number of stores Sales per capita (SAR) Pop / total size (sqm) 3
November 215 Valuation Metrics: Our DCF based valuation methodology is based on 1-year explicit cash flows to reduce the sensitivity of our valuation to terminal value with the following key assumptions; Terminal growth rate is taken at 2.8%. 2-year weekly raw sector beta of.8 (Bloomberg). Risk free rate is taken at 3.3%. KSA total market risk premium is taken at 13.8% from Bloomberg. Hence, the equity risk premium is calculated at 1.5%. Capital Assets Pricing Model (CAPM) is used to calculate cost of equity at 11.7%. Cost of debt is taken at 3.2%. Weighted average cost of capital (WACC) is calculated at 8.4%. Based on our DCF valuation, our 12month price target for stands at SAR 114.8 per share, against current market price of SAR 99 per share, we initiate our coverage on the company with an Overweight recommendation Amount in SARmn, unless otherwise specified 211 212 213 214 215 216 Cash and cash equivalents 14.7 13. 14. 5.2 179.8 241.2 Accounts receivables 11.2 9.1 11.5 11.6 13.3 14.8 Inventories 28.5 322.5 417.7 53.4 68.8 653.6 Prepayments and other receivables 3.5 31.8 55. 73.8 9. 17. Non-current Assets Property and equipment 9. 97.3 18.1 153.8 189. 2. Pre-operating expenses 13.4 11.3 8.4 9.6 12.1 12.9 Current Liabilities Short term debts and Bank Overdrafts 81.4 73.2 11.5 14.1 189.2 239.9 Trade payables 78.3 91.5 114.9 147.9 176.1 24.6 Accrued expenses and other liabilities 16.7 18.7 39.5 39.7 46.6 53.3 Zakat and income tax provision 4.1 5.7 5. 7.9 7.9 7.9 Non-current liabilities Medium-term borrowings 28.3 13.1 32.7 21.9 75.3 68.5 Employee termination benefits 18.8 2.8 24.4 27.8 32.6 37.3 Total equity 168.8 215.6 268.3 378.3 499.7 584.3 Income Statement (in SAR mn, unless specified) 211 212 213 214 215F 216F Sales 672.5 831.1 961.3 1,84.8 1,271.1 1,455.4 Cost of sales (521.9) (642.3) (742.5) (833.4) (977.5) (1,118.3) Gross profit 15.6 188.8 218.7 1.5 293.6 337.1 Selling, marketing, general and administrative expenses (9.) (14.3) (112.3) (131.4) (163.) (185.8) Operating income 6.5 84.4 16.5 12.1 13.7 151.3 Finance and bank charges (2.9) (4.5) (2.4) (6.2) (4.8) (5.6) Other income 1.8 2.4 2.9 3.7 3.9 4.4 Other income, net (1.1) (2.1).4 (2.5) (.9) (1.3) Income before non-controlling interests, zakat and income taxes 59.4 82.3 16.9 117.6 129.8 15.1 Zakat and income tax (4.3) (5.5) (4.2) (7.6) (8.4) (9.) Net income 55.2 76.8 12.7 11. 121.4 141.1 Cash Flow Statement (in SAR mn) 211 212 213 214 215F 216F Cash Flow from Operating Activities 48.6 71.1 51.6 49.8 96. 155. Cash Flow from Investing Activities (42.4) (21.8) (3.4) (78.8) (68.7) (74.2) Cash Flow from Financing Activiites 1.6 (51.) (2.2) 2.2 147.2 (19.3) Source: Company Reports, Aljaizra Research 4
RESEARCH DIVISION AGM - Head of Research Abdullah Alawi +966 11 26 a.alawi@aljaziracapital.com.sa Jassim Al-Jubran +966 11 26248 j.aljabran@aljaziracapital.com.sa Senior Talha Nazar +966 11 26115 t.nazar@aljaziracapital.com.sa Sultan Al Kadi +966 11 26374 s.alkadi@aljaziracapital.com.sa BROKERAGE AND INVESTMENT CENTERS DIVISION General manager - brokerage services and sales Ala a Al-Yousef +966 11 26 a.yousef@aljaziracapital.com.sa AGM-Head of Sales And Investment Centers Central Region Sultan Ibrahim AL-Mutawa +966 11 26364 s.almutawa@aljaziracapital.com.sa AGM-Head of international and institutional brokerage Luay Jawad Al-Motawa +966 11 26277 lalmutawa@aljaziracapital.com.sa AGM-Head of Qassim & Eastern Province Abdullah Al-Rahit +966 16 3617547 aalrahit@aljaziracapital.com.sa AGM- Head of Western and Southern Region Investment Centers & ADC Brokerage Abdullah Q. Al-Misbani +966 12 66184 a.almisbahi@aljaziracapital.com.sa AGM - Head of Institutional Brokerage Samer Al- Joauni +966 1 2 6352 s.aljoauni@aljaziracapital.com.sa RESEARCH DIVISION AlJazira Capital, the investment arm of Bank AlJazira, is a Shariaa Compliant Saudi Closed Joint Stock company and operating under the regulatory supervision of the Capital Market Authority. AlJazira Capital is licensed to conduct securities business in all securities business as authorized by CMA, including dealing, managing, arranging, advisory, and custody. AlJazira Capital is the continuation of a long success story in the Saudi Tadawul market, having occupied the market leadership position for several years. With an objective to maintain its market leadership position, AlJazira Capital is expanding its brokerage capabilities to offer further value-added services, brokerage across MENA and International markets, as well as offering a full suite of securities business. RATING TERMINOLOGY 1. Overweight: This rating implies that the stock is currently trading at a discount to its 12 months price target. Stocks rated Overweight will typically provide an upside potential of over 1% from the current price levels over next twelve months. 2. Underweight: This rating implies that the stock is currently trading at a premium to its 12 months price target. Stocks rated Underweight would typically decline by over 1% from the current price levels over next twelve months. 3. Neutral: The rating implies that the stock is trading in the proximate range of its 12 months price target. Stocks rated Neutral is expected to stagnate within +/- 1% range from the current price levels over next twelve months. 4. Suspension of rating or rating on hold (SR/RH): This basically implies suspension of a rating pending further analysis of a material change in the fundamentals of the company. 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