• Reduce FV on SMP move, but current levels not worrying We cut our FV by 13% to SAR164 (31% upside) as we lower earnings from FY17/18 onwards to reflect the recent spike in SMP prices (main input; half of CoGS). SMP prices are up 35% YTD to cUSD2.5k/tonne, a normalised level that is still c50% below 2014 peaks. Current prices are also in line with the lagged average (9-month lag to reflect inventory and purchasing cycle – three-month inventory on balance sheet and typically secure supplies for six months ahead) for FY15/16, which we believe is a good margin base for FY17/18e. We expect FY16/17e will be a peak year for SADAFCO’s margins as it is utilising very cheap SMP inventory (c30% lower than prior year).
• Still a top pick despite weaker earnings outlook SADAFCO still has a quarter or two of good growth before it utilises more expensive SMP. Despite a weaker earnings growth outlook, we reiterate our Buy rating (one of our top KSA consumer picks) as it trades at a large discount to dairy peers (c16x vs. c21x). Also, we reiterate that it is the least exposed KSA food name to subsidy reform risk as: i) it does not receive the direct government support that fresh dairy producers get (imported feed subsidies); and ii) the impact of higher utility and transport costs will likely be muted given a smaller operational scale and distribution reach (less trips per truck due to longer product shelf life). Additionally, it has a liquid debt-free balance sheet (cash: c25% of total assets) with no major investment plans supporting a potential increase in its dividend payout (c50% last year).
• Revenue growth outlook is the main concern While SADAFCO continues to gain share in KSA’s long-life milk market, its top line has fallen for the past two quarters mainly on aggressive price promotions by all players induced by low input costs. We believe promotions will lessen as players utilise more expensive SMP inventory, but weaker structural demand makes the outcome of higher prices uncertain. It is worth noting SADAFCO has been very cautious on marketing spend contrary to competition (SG&A costs flattish to declining in the past four quarters), another trend that could reverse to support revenue.

Hatem Alaa, CFA
Nada Amin