• Up FV on DCF rollover; valuation at discount to QSR peers; Buy We raise our FV 6% to SAR91/share (23% upside), mainly as we roll over our DCF. We reiterate our Buy rating, which remains one of our preferred KSA names due to solid earnings visibility (KSA fast food spending could be relatively resilient in the current environment – meal price is less than SAR20 on average). Also, the stock is trading at a discount to QSR peers (c17x 2017e P/E vs. peers’ 21x). Key risks to our call are greater-than-expected pressures on store yields and margins (higher staff costs).
• Still believe focus on larger standalone stores will bear fruit Herfy has been aggressively expanding its network (+56% since 2013 to over 320 stores currently). Store openings will slow to 20-30 a year, given weaker spending, but the company still aims to have a network of 500 stores in the Kingdom. Focus has mostly been on standalone locations (c80% of openings since 2014) that are more costly and take longer to mature (1.5-2 years), but once they do, their store yields are higher. The company has also been trying to accelerate openings outside the central province (mainly Riyadh), where the bulk of stores are located (c60%). It is also planning to raise its meat processing capacity through building a larger plant (four-times larger) by 2018-19 (cSAR200mn capex) to meet growing needs of the restaurant network and increase third-party sales (c3% of revenue) that have been flattish to declining for three years.
• Yield trends improving, but we do not expect a 2017e recovery Restaurant yields have been on a downtrend since 2014 (although pace of decline has been easing as of late; reversed a seven-quarter decline in 3Q16), partly due to Herfy’s aggressive store rollout and slower consumption trends. While we do not expect a reversal in 2017e, we see lesser risk for QSR LFLs vs. other discretionary retailers. We also think the company has the tools to manage margins via introducing new higher-priced menu items and/or raising prices (unlikely in the ST, last price increase was in 4Q13), especially as Herfy remains cheaper than its core competition (c10-15% lower than McDonald’s).

Hatem Alaa, CFA
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