• Cut FV by 14% to account for more cautious outlook; maintain Sell We cut our FV for Al-Khodari by 14% to SAR8.60, down from SAR9.99, implying 17% downside potential; hence, we maintain our Sell rating. The stock has underperformed the general market index YTD (-32% YTD vs. -8% for TASI), reflecting the increased uncertainty and risks surrounding the operating environment in the Kingdom. The cut in our valuation was mainly due to lower assumed contract awards for 2016-18e, which we expect to reflect negatively on its reported revenue and profitability margins.
• Management sees increased challenges over short term During the 2Q16 conference call, management reiterated its view that the prevailing market challenges are set to continue in the short term, with a cut in contract awards (on reduced capital spending by government and private sector), weak bidding, and slow receivables collection. These factors reflected negatively on revenue and profitability margins in 2Q16 and are expected to continue to do so over the medium term, in our view. Management mentioned that there is room for further negative variation orders (in the size of at least c5% of the remaining work on ongoing projects). This is in addition to reduced new bids and slower execution. Please click here to view Al-Khodari’s 2Q16 results conference call highlights.
• Net losses over the coming three years on lower awards, margin compression We cut our contract awards assumptions to reflect a more cautious sector outlook in the short and medium-term in the Kingdom. We lower our new contract estimates to SAR180mn for 2016e (1H16: SAR70mn) and SAR550mn for 2017e, down from SAR500mn and SAR900mn, respectively. We expect revenue to shrink by c7% in 2015-19e, on lower contract awards and slow project execution and gross profit margin to contract by 4.3pps, over the same period. Al-Khodari’s successful cost cutting programme is expected to partially absorb the margin shock, with EBITDA margin expected to shrink by c140bps in 2015-19e.

Mai Attia
Sara Boutros