We place Agthia ‘Under Review’ until the final details of the planned subsidy changes are announced (likely by mid-September). While the stock is down c23% since the news, and although we like the management team (it has already started implementing mitigation initiatives), we believe calling a bottom is difficult given that several factors are involved and many of which are out of the company’s control. Also, expected FTSE-related outflows of cUSD9mn in Sept will not help the stock’s short-term share price performance.
• Flour and feed subsidies in Abu Dhabi to be eventually removed The Abu Dhabi gov’t is negotiating with Agthia to eventually remove subsidies on animal feed and flour (in place since 2007). Under the current programme, it sells flour and feed (c59% of 2015 revenue, c51% of gross profit) at fixed prices that are below the rest of the UAE (c35-40% on average now) guaranteeing the leadership position for Agthia’s Grand Mills brand in Abu Dhabi (over 90% market share), which represents c85% and c95% of flour and feed sales, respectively. The subsidy averaged cAED300mn per annum. With the subsidy gone, Agthia’s product prices could automatically adjust upwards to match prices in the rest of the country, but the impact is not as simple.
• Two variables that will determine the exact impact on Agthia Competition reaction – competitors were nearly absent in Abu Dhabi since 2007 given Agthia’s price advantage; with this gone, we expect competitors to aggressively target market share by offering incentives such as discounts. However, Agthia has the advantage of long-standing relationships with key clients that may be difficult to replicate. Agthia’s strategy – we believe it may retain some price discounts (at least temporarily) to protect market share and deter competition; also marketing spend has been negligible for flour and feed, but we expect this to change. Other mitigating initiatives are increased focus on B2C sales, exports (very small; Africa, other GCC) and cost-cutting.
• Some other considerations i) The extent of the subsidy cut with mgmt hinting that certain products (nearly 50 feed SKUs) and sales channels (bulk of revenue is B2B) could keep the subsidised price for some time; ii) timing of implementation (announcement expected in September with implementation likely in 4Q16 at the earliest); and iii) plans for further capacity additions in flour and feed – Agthia was looking to increase feed capacity (c150k tpa) in 2017 and flour in 2018 but plans are on hold Downside may appear limited but there are no guarantees Mgmt estimates a worst-case scenario of a 20% reduction in flour volume and 30% for feed. Assuming a c30% cut to our 2017e flour and feed gross profit (c20-25% volume impact), that would lower our 2017e earnings by c30% and implies that the stock is trading at c16x 2017e earnings in line with its historical trading multiples. However, such a scenario does not factor in the potential pick-up in SG&A costs as Agthia increases marketing for its flour & feed products.

Hatem Alaa, CFA
Nada Amin