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Hammadi 4Q18: Earnings drop 42% mainly on margin pressure from Nuzha Hospital; below EFGe

Net income: SAR17.7mn, -42% Y-o-Y, -17% Q-o-Q,  -24% vs. EFGe
Revenue: SAR228mn, +21% Y-o-Y, -9% Q-o-Q,  -12% vs. EFGe
Gross Profit: SAR59.6mn, -20% Y-o-Y, -8% Q-o-Q,  -26% vs. EFGe
Operating income: SAR31.6mn, -21% Y-o-Y, +30% Q-o-Q, -16% vs. EFGe
Al Hammadi posted preliminary 4Q18 results with net income dropping 42% Y-o-Y mostly on cost pressure post the launch of the new Nuzha Hospital (in Feb 2018), as well as higher finance expenses (doubled Y-o-Y). Earnings were surprisingly down sequentially (mimicking revenue trends) and missed our estimate by 24% on a combination of a top-line miss and weaker-than-expected margins. 2018 earnings declined 17% Y-o-Y to SAR89.8mn 
Revenue growth remained strong (+21% Y-o-Y) propelled by the new hospital launch, as well as continued ramp up of occupancy at the company’s two older hospitals. Additionally, the pharmaceutical distribution operation, Pharma Serve (wholly-owned subsidiary of Medical Support Services Co.; fully acquired by Al Hammadi in 1Q18), has also been a strong driver of revenue growth (started booking revenue from SAR347mn two-year contract to supply vaccines to the government in 3Q18). During 2018, total revenue grew 26%, on volumes as the number of outpatients rose 13% Y-o-Y (c751k), while inpatient growth was stronger at 19% (25.6k) as well as first-time consolidation of Pharma Serve. 
Margins expectedly remained pressured: Gross margin contracted c13pp to 26.1% (EFGe 31.0%) with gross profit recording a c20% Y-o-Y decline (-26% vs. EFGe), mainly on cost pressures from Al Nuzha hospital (depreciation charges +77% Y-o-Y in addition to higher salaries, etc.). The EBIT margin contracted a less drastic c7pp to 14.0% (in line) as SG&A costs (net of other income) declined 19% Y-o-Y (we believe there could be some IFRS cost restatements this quarter that led to the drop). EBIT was accordingly down 21% Y-o-Y and came in c16% below our forecast for the quarter. 
The significant margin pressure is expected to persist at least through 2Q19 and will begin to diminish by the end of the year as occupancy of the new hospital improves, in our view. We have a Buy rating on the name as we do not see the current numbers being representative of the company’s true earnings power as utilisation is low (on large capacities added over 2015-18).

Nada S. Amin, Hatem Alaa, CFA, Ahmed Moataz
Al Hammadi Company For Development and Investment : SAR25.35 as of 7 Mar. 2019, Rating: Buy, TP: SAR30.00/share, MCap: USD811mn, ALHAMMAD AB/4007.SE