In this note, we cut FVs for fresh dairy producers Almarai (-32%) and Nadec (-54%) and downgrade them to Neutral, given the vagueness on the future of direct subsidies, a proposed phase-out of fodder cultivation and the impact of higher utility and fuel prices. We maintain our FV and Buy rating on SADAFCO, which is our top KSA dairy pick for the following reasons:
• No direct subsidies: Game-changer for fresh dairy producers if removed Many questions remain unanswered on the proposed local fodder cultivation ban by 2019 (whether for all feed types, in certain regions, etc.) as a consultation period on the matter is ongoing (to end Mar-2016). The likely impact on fresh dairy producers is grave. However, Almarai is better-placed to weather this, given greater import reliance (c70% vs c30% for Nadec) and overseas agricultural land ownership (c33-40% of feed imports). Almarai estimates a cSAR200mn impact on 2016 earnings if the ban is passed with no assessment of the impact from Nadec. The impact will differ each year depending on how fast the target of full feed importation is reached. We believe there is a risk of imported animal feed subsidies being phased out in the medium term (Almarai: SAR295mn in 2015 or 15% earnings; Nadec: SAR81mn, 55%); imminent elimination is unlikely, given the three years until the ban is applied that will likely serve as an adjustment period, in our view.
• Likely limited impact of higher electricity, petrol and diesel prices Direct impact from higher electricity, petrol and diesel prices is relatively high for fresh dairy names: Almarai estimates it at SAR200mn (10% of 2015 earnings) and cSAR70mn for Nadec (48%). There is additional impact of SAR100mn for Almarai and SAR30-40mn for Nadec should suppliers (mainly packaging) raise prices, which may not materialise in our view. SADAFCO has not quantified the impact, but confirmed it will be limited, given its smaller size of operations and distribution network, as well as fewer daily trips per vehicle due to the longer-shelf life of its products. A key risk is if the government initiates further utility and fuel price hikes in the coming years.
• Track record of price increases Impact of stated and potential subsidy reforms could be largely offset if a product price rise is granted, with fresh milk prices unchanged since 2008. SADAFCO has a clear track record of raising prices when costs rise (upped prices for key long-life milk SKUs +20% when SMP prices spiked in 2013-14).
• No debt versus high leverage for fresh dairy names SADAFCO is also unexposed to the risk of higher interest rates as it runs a debt-free balance sheet, with its cash pile increasing 3.4x since 31 Mar. 2015 aided by lower capex and stronger operations. Almarai and Nadec are one of the highest leveraged names in our consumer coverage: net debt/EBITDA (2015) of 3.3x and 3.7x, respectively, with net debt/market cap at 122% for Nadec. Almarai is better-positioned with c60% of its LT borrowings hedged.

Hatem Alaa, CFA
Nada Amin