Almarai held its 1Q2016 conference call on 12 April 2016. Flattish earnings Y-o-Y were attributed to higher utility & transport costs as well as the absence of subsidies; key developments included revised poultry guidance (will not meet target for 2016) and plans to rationalise capex plan. We remain Neutral on Almarai as 2016 earnings growth will prove challenging on higher costs, subsidy changes and the resumption of expansion in poultry losses. Also, the stock trades at a rich 2016e P/E of 23x.
• Bad news for poultry recovery: Division no longer on-track to meet break-even target for 2016 (c110mn birds) given intense pressure from cheaper frozen Brazilian competition. While mortality is reportedly stable, revenue growth slowed to an all-time-low of 6% and losses widened c69% Y-o-Y, exacerbated by higher utility & transport costs. Almarai is running aggressive promotions and reformulating its poultry plan with a focus on reducing fixed costs.
• Cautious on capex spending: Management noted that its SAR21bn five-year capex plan will likely be scaled down (c20-25% in the short term); it could spend cSAR4bn in 2016 (versus originally slated cSAR5bn). This could hit capacity expansion plans (likely for dairy and juice, in our view); no change to ST capex commitments such as Hail bakery plant in 3Q2015
• Price increase talks still ongoing: Since the announcement of subsidy reforms in KSA, dairy companies have been trying to raise fresh dairy prices that remain unchanged since 2008 (SAR3.5/L). Any price increase is unlikely before 2H2016.
• Gross margin pressured on cost pressures, subsidy collection: 1Q16 headline gross margin narrowed c110bps on higher energy costs that were somewhat offset by commodity prices, a trend that is expected to sustain in 2016. More importantly, lack of imported animal feed subsidy (versus SAR31mn in 1Q15) pressured margins; assuming the same subsidy in 1Q16, gross margin would have been flattish. Subsidy collection should improve in subsequent quarters, also cost saving initiatives should begin to pay off; management still expects to mitigate c50% of the SAR200mn anticipated direct cost increase through production and distribution efficiencies.
• Egypt competition intensifying: Egypt revenue growth slowed to 12% after averaging +30% in the past two years due to intensifying competition mainly from the market leader Juhayna, as well as trouble with a juice (50% of revenue) flavour. However, the operation is still profitable and offers strong growth potential. Almarai remains committed to its expansion plans there with planned capex of EGP2.5-3bn for juice, yogurt and milk expansions as well as a dairy farm (4-5k cows).
• 14% Y-o-Y revenue growth was mostly volume driven (+16%): Fresh dairy (+13%) saw extended GCC presence that drove solid volume growth, but management guided for more normalised growth of c10% for the year. Bakery growth was strong at 27% on ramp up of new capacity post-commissioning of the Jeddah plant, while the troubled cheese and butter category saw strong double-digit growth for the first time in six quarters on an upper-trade focus, promotions and new SKUs.
• Now Almarai has presence in all dairy segments: It added milk powder to its product portfolio in 1Q16; the segment represents nearly a third of the GCC dairy market.
• Segment-wise net income: i) dairy & juice (-4% Y-o-Y) was weighed down by EGP devaluation, energy costs, and reduced subsidies; ii) bakery (+134%) was bolstered by new capacity, cost reduction, and a low base in 1Q15 due to fire-related one offs; iii) poultry losses worsened (+69%) on intense competition and cost pressures similar to those seen in dairy; and iv) other segment losses reduced Y-o-Y on better IPNC performance and timing differences in Fondomonte sales.

Nada Amin
Hatem Alaa, CFA