• Raise FV, but remain Neutral on challenging outlook & full valuation We raise our FV by 12% to SAR54.5 (3% downside) on better-than-expected 9M16 results and DCF rollover. We remain Neutral as we believe achieving earnings growth will be tough in the coming two years, as feed imports increase, and revenue trends weaken. In addition its valuation is full, with the stock trading in line with global dairy peers (2016e P/E of 21x) despite a muted earnings growth outlook (flattish 2017-18e bottom-line) and declining returns.
• Good 9M16 numbers, but unlikely to sustain Almarai’s operational performance YTD (recurring 9M16 earnings +8% Y-o-Y) has exceeded expectations, as initial guidance of SAR500mn cost impact from subsidy reforms and higher feed imports was too high (probably will end up closer to SAR 200mn for the year) on commodity benefits and some mitigation measures. We believe this performance is not sustainable, given: - Cost impact of increasing feed imports to 100% (cSAR400-500mn over 2017-19e) from c70% currently; it did not hit Almarai this year as no incremental imported feed was utilised (inventory being accumulated)
- Poultry recovery turned a corner, with losses expanding 53% Y-o-Y in 9M16, pushing the breakeven target to 2018e at best, in our view, due to frozen imported poultry competition, higher energy costs and slower spending reducing the incentive to shift to pricier fresh poultry (2x price) - Subsidy risk (no formal cancellation) – payment of imported feed subsidy slowed (cSAR100mn received in 9M16 vs. cSAR300mn booked in 2015); flour for KSA bakery production is also subsidised (at over half market prices) - Risk of further increases in petrol/diesel and utility prices
• What would make us more positive i) a price increase in fresh dairy (prices unchanged since 2008) could be a game-changer to outlook, albeit unlikely in the short term, given aggressive competition and low commodity prices; ii) fast poultry recovery (mortality issues resolved, frozen prices recovered lately); and iii) continued strong bakery performance (new products aided by Hail plant reopening in 3Q16; 9M16 revenue +20%, net income +98%).

Hatem Alaa, CFA
Nada Amin