• Apply aggressive FV cuts to reflect weaker LFL trends Subsidy reforms in a low oil price environment, coupled with limited wage growth, will take their toll on KSA’s otherwise robust discretionary spending trends. The three-month rolling average for the value of point-of-sale transactions and ATM withdrawals fell in February 2016 for the first time since 2008. We cut FVs for the four names under coverage c40% on average as we raise cost of equity and lower earnings on weaker like-for-like (LFL) sales trends. Near-term store opening plans remain largely intact (with the exception of Al Hokair that is slowing rollout), but this could change if weak market conditions persist. Key sector risks include implementation of early store closure (bulk of shopping takes place post-5:00 pm, but market will likely adjust similar to the shift to a Friday-Saturday weekend in 2013) and increased push to boost Saudisation at a time of slowing demand. The direct impact of higher energy and transport costs post subsidy reforms is fairly low for names discussed in this note.  
• 1Q16 results won’t be a catalyst… We expect KSA discretionary stocks to continue to perform weakly in the coming month due to a likely lackluster 1Q16 earnings season. We expect 1Q16 earnings for the four discretionary retailers under coverage to drop c12% Y-o-Y on average, partly as 1Q15 was a high comparable base as February 2015 saw the payment of a one-off two-month bonus ordered by King Salman to all public sector employees, with several private sector companies following suit.  
• …But some names are worth a look thereafter: Al Hokair & Herfy We recommend accumulating positions in select names post 1Q16 results, namely clothing retailer Fawaz Al Hokair (BUY, FV SAR66) and fast-food operator Herfy (BUY, FV SAR86), given greater affordability and cultural dynamics (shopping and dining out are typical entertainment outlets). Al Hokair should see earnings growth in FY16/17, even if KSA operation falters as restructuring efforts at international operations (9M15/16 losses of SAR147mn) bear fruit; achieving breakeven could alone drive c20% Y-o-Y growth (we assume +12%). Herfy should also benefit from a large increase in store count (+45%) over 2014-15 with emphasis on higher-yielding standalone formats (12-18 months to breakeven). Both stocks are trading at multi-year low valuations (2016 P/E): Herfy at 13.2x (40%+ discount to peers) and Al Hokair at 10.0x.
• Large-ticket items are at greater risk; cautious on electronics retailers While electronics retailers are also trading at multi-year lows, we are cautious on players in the space as growth visibility is weak as consumers rationalising spending will hit bigger-ticket items first, in our view. We prefer Jarir (NEUTRAL, FV SAR127), given its impressive returns and exposure to higher-margin books and supplies that could still grow, albeit at a slower pace. eXtra (NEUTRAL, FV SAR24) still faces repercussions of the closure of some stores during the 2014 mega-sale. While we are positive on the recent management reshuffle, restructuring efforts will likely be challenging in the current environment.

Hatem Alaa, CFA
Nada Amin