• Cut FV and downgrade to Neutral until earnings visibility improves We cut our FV by 36% to SAR42.0 (10% upside) as we lower our earnings estimates by c31% on average to reflect weaker revenue (FY15/16 LFL of -c4%) and margin trends post lacklustre 4Q15/16 results (barely broke even). While the stock’s valuation is undemanding at c13x FY16/17 earnings (versus 2015-highs of over 20x justified by strong growth prospects then), we downgrade the stock to Neutral from Buy until we see signs of improved earnings, which could prove challenging given slowed discretionary spending trends in KSA and continued losses at intl. ops. We are also concerned by excessive leverage (net debt at 1.8x equity, 3.3x EBITDA) partly due to high inventory.
• Signs of a structural change in KSA’s profitability profile Saudi gross margin fell c11pp in 4Q15/16 on aggressive mark-downs to get rid of end-of-season stock as discretionary spend was impacted by subsidy reforms and slower wage growth (KSA LFL -3.1% Y-o-Y in FY15/16). What is concerning is that its inventory levels did not improve as a result (-3% Q-o-Q) and ended FY2015/16 at an 11-year high (c140 days on hand). While it is unlikely that these deflated margins are the new norm (management indicated that April 2016 margins were flattish Y-o-Y), we believe that the discounting trend may continue in the short term to drive sales.
• Giving up on Blanco? Blanco, a struggling Spanish women’s wear brand acquired in Feb 2014, underwent aggressive restructuring involving store closures, redundancies and a revamp of its clothing line. However, it appears that consumer reception remains weak driving international losses to an all-time high of cSAR90mn in 4Q15/16. Al Hokair’s board is assessing what to do with Blanco and all options are on the table. While a sale is possible, which we would see as positive, it will be hard given the brand’s challenges and we believe it will continue to impair earnings until a decision is reached. The US is slowly improving with EBITDA breakeven expected next quarter; it now only has 22 clothing stores there with openings to focus on indoor kids play areas (ten stores at present, with eight more in the pipeline).

Hatem Alaa, CFA
Nada Amin