ksa restaurant sector - الرئيسيةmec.biz/term/uploads/5767l_6002-28-04-2013.pdf · ksa...

KSA RESTAURANT SECTOR

Turning meals into profits Restaurant operators better positioned in KSA than food producers Initiate on Herfy with a HOLD

28th April 2013 Coverage Universe

Herfy

Recommendation HOLD

Target Price (LC) 119.10

P/E 13 17.6

EV/EBITDA 13 13.4

80

90

100

110

120

130

140

TASI Hefy Almarai

Sector Coverage Asjad Yahya, CFA +9714 3199 768 ayahya @shuaa.com Taher Safieddine, CFA +9714 3199 785 [email protected]

HIGH AFFINITY FOR MEAT MAKES SAUDI ARABIA AN ATTRACTIVE QSR MARKET High earning capacity, a young, fast growing population base and long stretches of extremely hot weather, which encourage the tendency to seek entertainment indoors, make Saudi Arabia a very attractive market for the Quick Service Restaurant (QSR) industry. This is further supported by a relatively high affinity for meat in the country, with consumption per person per annum in KSA at 52.3 kilos, well ahead of the global average of 38.7 kilos. Moreover, while Saudi Arabia ranks favorably in terms of market share of chained consumer foodservice within a regional context, a comparison with developed markets suggests there is room for further growth. Thus, given the attractive fundamentals of the QSR industry in Saudi Arabia, all major food chains, ranging from Pizza Hut to McDonald’s, currently have significant presence in the country, with new names continuing to enter the market each year. In addition to the restaurant chains, the strong underlying fundamentals of the sector are also starting to attract sophisticated institutional investors, with the Carlyle Group acquiring a 42% stake in Saudi-based Alamar Foods in 2011. Alamar acts as a master franchise operator of Domino’s Pizza and Wendy’s hamburgers in the MENA region. NON-CRITICAL NATURE OF INDUSTRY HELPS AVOID PRICE REGULATIONS The consumer sector is widely seen as a key means of capitalizing on the attractive demographics in KSA (rapidly growing population with high earning capacity). However, following the Arab Spring in particular, the country’s government has started relying on food price controls as a key means of appeasing its citizens. The most significant example in this regard is that of the dairy industry, with the government reversing product price increases by Almarai in both 2011 and 2012. In contrast, fast food is not considered a “necessity”, despite its growing popularity and as such the industry remains free from pricing regulations. Moreover, QSR operators enjoy the ability to enhance the overall pricing of their portfolio without raising list prices by introducing new “value added” product ranges. This can either be in the form of variations of existing offerings, such as the “Mega Mac” burger from McDonald’s (which is the upsized version of the Big Mac) and the Triple Whopper by Burger King, or a completely new, relatively expensive line introduced for a limited time (the “Turkish” burger currently being offered by McDonald’s is a good example). In fact, we feel that the ability to adopt this strategy is a key reason why Herfy has managed to increase yields at its restaurants from SAR 2.7mn in 2010 to SAR 3.5mn last year, despite the fact that it has not increased product prices over the past 3-4 years. HERFY OFFERS EXPOSURE TO THE ATTRACTIVE QSR SECTOR, HOWEVER SHARES FULLY PRICED Herfy is the dominant local QSR operator in Saudi Arabia, benefiting from one of the widest network of restaurants in the country and ranking as one of the top two burger fast food companies in KSA by sales volume.Moreover, the company intends to solidify its position as the leading local player with an aggressive expansion plan that envisions opening of 20-25 new stores every year for the foreseeable future against a total of 200 stores at the end of 2012. In addition, the company operates bakeries & bakery shops, a rusk factory and a meat factory in Saudi Arabia and is increasing its presence in the wider region through franchised restaurants (12 stores in total at this stage in UAE, Kuwait and Bahrain). As such, the company offers investors a well-balanced means of gaining exposure to the attractive QSR sector in Saudi Arabia. However, following the 32% run-up in the past twelve months (15% YTD), we feel that the growth prospects of the company are already factored into its stock price. Our DCF-based analysis of the company suggests a fair value of SAR 119.10/share, translating into 6.3% upside potential from the recent closing price of SAR 112.00/share. Peer-based comparison also supports our analysis, with relative valuation suggesting a fair value estimate of SAR 113.25/share, based on average 2013 P/E and EV/EBITDA industry multiples. We thus initiate coverage on Herfy with a HOLD recommendation and a Target Price of SAR 119.10/share.

Company Price (LC) Recommendation Target Price (LC) %upside/(downside)

Herfy 112.00 HOLD 119.10 6.3%

KSA Restaurant Sector

April 28th, 2013 2

Table of Contents

Table of Contents .................................................................................................... 2

KSA Quick Service Restaurant sector snapshot .................................................... 3 An attractive market for QSR industry ................................................................................................................................................ 3 KSA largest market in the region; data suggests further room for growth ........................................................................... 4 Non-critical nature of industry means little, if any regulations on pricing ............................................................................ 5 Regional listed QSR companies outperform peers ........................................................................................................................ 6

Herfy Food Services Company (Herfy)

The story in charts ................................................................................................... 8

Valuation ................................................................................................................. 9 DCF preferred valuation methodology .............................................................................................................................................. 9 Relative valuation supports our DCF-based Target Price .......................................................................................................... 10

Solidifying position as largest local player ......................................................... 12 A key player in the KSA fast food industry ....................................................................................................................................... 12 Enjoying competitive cost advantage .............................................................................................................................................. 13 Expansion plans to refocus on restaurant business from 2013 ............................................................................................... 13

Financial Outlook .................................................................................................. 15 Restaurant business to drive top line growth ................................................................................................................................ 15 Margins to come under pressure in near term, improve over the longer term ................................................................. 16 Healthy EBITDA growth; franchise income to rise faster, but contribution will remain limited .................................. 17 Capex peaking in 2012-2013; debt gearing to remain low ....................................................................................................... 17 Net income growth to outpace revenue growth; dividend payout ratio to remain high ............................................. 18

Financial Statements ............................................................................................ 19


April 28th, 2013 3

KSA Quick Service Restaurant sector snapshot

An attractive market for QSR industry High earning capacity, a young, fast growing population base and long stretches of extremely hot weather, which encourage the tendency to seek entertainment indoors, make Saudi Arabia a very attractive market for the Quick Service Restaurants (QSR) industry. This is further supported by a relatively high affinity for meat in the country, with consumption per person per annum in KSA well ahead of the global average. In fact, in its Q1-13 results conference call, Almarai indicated that it has witnessed a decline in demand for cheese and butter in Saudi Arabia, with the segment recording a YoY decline in revenues in the country. The company attributed this reduction in significant part to the growing consumption of fast food, which in turn has lowered demand for cheese in particular within households. Given Almarai’s position as the largest dairy company in KSA, this serves as a strong positive indicator for the health of the QSR industry in the country. Key consumers of meat (ranking out of 177 countries)

Rank Country Meat consumption per person/year (kg)

1 Luxembourg 136.5

2 USA 125.4

3 Australia 115.7

4 New Zealand 115.7

5 Spain 110.2

6 French Polynesia 108.9

7 Austria 103.1

8 Israel 99.1

9 Canada 98.7

10 Bahamas 98.1

11 Denmark 97.8

12 Kuwait 97.4

13 Saint Lucia 95.4

14 Ireland 94.1

15 Iceland 94.0

46 UAE 68.7

68 Saudi Arabia 52.3

World Average 38.7

Source: FAO, The Economist, SHUAA Capital


April 28th, 2013 4

KSA largest market in the region; data suggests further room for growth Industry data indicates that Saudi Arabia is the largest fast food market in the region. Currently estimated around the USD 4bn mark, the QSR market size in the country is projected to grow to USD 4.5bn by 2015 by Euromonitor, translating into a 2013-2015 CAGR of 6%. The Carlyle Group similarly projects QSR sales at a CAGR (2010-2014) of 5% in the Kingdom. Breakdown of QSR market share in GCC

KSA, 60-65%

UAE, 20-25%

Others, 10-20%

Source: Gulf Organization for Industrial Consulting, SHUAA Capital

Market penetration data for the QSR industry in Saudi Arabia also supports expectations of further growth in the sector. While the country ranks favorably in a regional context in terms of market share of chained consumer foodservice, a comparison with developed markets suggests there is room for further growth. Chained foodservice as % of total foodservice outlets Chained foodservice as % of total foodservice sales

43

37 34

31 30

23

-

5

10

15

20

25

30

35

40

45

50

Canada USA Taiwan Norway UK Saudi Arabia

58

52

44 39 39

34

-

10

20

30

40

50

60

70

Canada USA Japan Finaland UK Saudi Arabia

Source: Euromonitor, SHUAA Capital Source: Euromonitor, SHUAA Capital

Given the attractive fundamentals of the QSR industry in Saudi Arabia, all major food chains, ranging from Pizza Hut to McDonald’s, currently have significant presence in the country, with new names continuing to enter the market each year. In addition to the restaurant chains, the strong underlying fundamentals of the sector are also starting to attract sophisticated institutional investors, with the Carlyle Group acquiring a 42% stake in Saudi-based Alamar Foods in 2011. Alamar acts as a master franchise operator of Domino’s Pizza and Wendy’s hamburgers in the MENA region.


April 28th, 2013 5

Non-critical nature of industry means little, if any regulations on pricing The consumer sector is widely seen as a key means of capitalizing on the attractive demographics in KSA (rapidly growing population with high earning capacity). However, following the Arab Spring in particular, the country’s government has started relying on food price controls as a key means of appeasing its citizens. The most significant example in this regard is that of the dairy industry, with government reversing product price increases by Almarai in both 2011 and 2012. In fact, these price caps serve as a key reason for our HOLD recommendation on the stock. In contrast, fast food is not considered a “necessity”, despite its growing popularity, and as such the industry remains free from pricing regulations. The impact of this difference is aptly demonstrated by the trend for gross margins at Almarai and Herfy - two key players in the Saudi dairy and burger fast food industries, respectively - over the past few years. While both companies have witnessed a downward trend, mainly due to rising raw material costs, the decline has been much more significant for Almarai, as it faced greater difficulty in passing on the higher costs to consumers. Herfy’s gross margins more stable than that of Almarai

30%

32%

34%

36%

38%

40%

42%

2009 2010 2011 2012

Herfy Almarai

Source: Herfy, Almarai

Note that despite the absence of direct regulatory restrictions, fast food companies in KSA have generally avoided raising list prices due to ever-increasing competition. Instead, companies continually introduce new “value added” product ranges to enhance the overall pricing of their portfolio. This can either be in the form of variations of existing offerings, such as the “Mega Mac” burger from McDonald’s (which is the upsized version of the Big Mac) and the Triple Whopper by Burger King, or a completely new, relatively expensive line introduced for a limited time (the “Turkish” burger currently being offered by McDonald’s is a good example). In fact, we feel that the ability to adopt this strategy is a key reason why Herfy has managed to increase yields at its restaurants despite the fact that it has not increased product prices over the past 3-4 years. Herfy: restaurant yields increasing despite absence of price hike

2,681

3,047

3,487

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2010 2011 2012

Revenue per restaurant (SAR'000)

Source: Herfy


April 28th, 2013 6

Big Mac index suggests fast food is cheap in Saudi Arabia The Economist’s Big Mac index, which maps the burger’s price in various countries against their respective GDP/capita to estimate Purchasing Power Parity, interestingly suggests that fast food is cheaply priced in Saudi Arabia, both in a regional and a global context. Although the tool is generally utilized as an informal means to assess which countries’ currencies are over or undervalued, the use of the Big Mac price alone for this purpose provides good insight into the pricing structure within the Saudi fast food industry. Big Mac index suggests fast food is cheap in KSA

Norway

Egypt

KuwaitPakistan UAE Qatar

KSA

-

1

2

3

4

5

6

7

8

9

- 20,000 40,000 60,000 80,000 100,000

Big

Mac

pri

ce (U

SD)

GDP per capita (USD'000) - 2011

Source: The Economist

The attractive pricing of fast food relative to the earning power in Saudi Arabia further supports expectations of healthy growth in the sector, with the possibility of upward revision in price another potential catalyst for boosting revenues.

Regional listed QSR companies outperform peers The GCC markets include two prominent listed QSR companies, namely Herfy and Kuwait-based Americana. Both companies have outpaced their regional peers in the wider food sector. The greater pricing power enjoyed by these companies, coupled with lower regulatory risk, is likely to have been a key catalyst for this outperformance. QSR sector stocks outperforming peers

42.7

33.328.3 27.0

17.912.8

1.2

-18.1

-30.0

-20.0

-10.0

0.0

10.0

20.0

30.0

40.0

50.0

Am

eric

ana

Her

fy

Savo

la

Agt

hia

SAD

AFCO

Hal

wan

i

Alm

arai

Nad

ecTTM

ret

urns

(%)

Source: Bloomberg, SHUAA Capital


April 28th, 2013 7

Bloomberg Herfy AB Herfy Food Services Company Reuters 6002.SE Premier player in an attractive industry, but prospects priced in 28th April 2013 Recommendation: HOLD

Current stock price (SAR) 112.00

52-week range (SAR) 76.36-118.00

YTD performance 15.2%

Number of shares (‘000) 33,000

Free Float (%) 32.1

Market Cap (SAR mn) 3,696

Market Cap (USD mn) 986

Div. Yld 2013P 3.4%

Current Price: SAR 112.00 Country: Saudi Arabia

Target Price SAR 119.10 Sector: Consumer

Recommendation: HOLD Exchange: Tadawul

LEADING PLAYER IN KSA FAST FOOD INDUSTRY Herfy is the dominant local QSR operator in Saudi Arabia, benefiting from one of the widest network ofrestaurants in the country and ranking as one of the top two burger fast food companies in KSA by salesvolume. Moreover, the company intends to solidify its position as the leading local player with an aggressiveexpansion plan that envisions opening of 20-25 new stores every year for the foreseeable future against a totalof 200 stores at the end of 2012. In addition, the company operates bakeries & bakery shops, a rusk factory and ameat factory in Saudi Arabia and is increasing its presence in the wider region through franchised restaurants(12 stores in total at this stage in UAE, Kuwait and Bahrain). Herfy remains 100% owned by Saudi nationals, a factthat helps it tap into strong patriotism in KSA. In fact, the brand is heavily promoted as 100% local-owned, withanecdotal evidence indicating that a significant portion of Saudi customers have developed strong loyalty tothe brand due to this factor. ENJOYING COMPETITIVE COST ADVANTAGE Herfy enjoys a competitive edge over its peers, particularly international chains, in terms of its cost structure.This advantage is driven by a number of factors, the most significant of which include: 1) vertical integration ofsupply chain, with all meat requirements fulfilled by Herfy’s own meat processing plant and a significant portionof bread requirement through its bakeries and 2) absence of royalty fees, which local arms of internationalchains have to pay. As a result, the company is able to attractively price its product range withoutcompromising on quality. In fact, our discussion with representatives of McDonald’s in KSA indicates that one ofthe key reasons the international fast food chain is forced to maintain relatively low prices (even by regionalstandards) is the pricing structure at Herfy. HEALTHY CAPEX PROGRAM TO TRANSLATE INTO STRONG GROWTH Herfy witnessed a marked increase in capital expenditure in 2012 (SAR 158mn vs. SAR 103mn in 2011) as a resultof investment on a new bakery plant at an estimated cost of c. SAR 120mn, which has expanded total bakerycapacity at the company by 5 times. The current year is anticipated to record a similar sized capital expenditure(SAR 150mn) as the company opens 20 new large restaurants. Moreover, Herfy’s growth plan calls for 20-25 newstore openings every year over the foreseeable future. We thus expect the combination of 1) operationalimprovement in existing facilities (particularly in restaurants that opened in recent years and the new bakeryplant) and 2) continued healthy capital expenditure (focused mainly on restaurant expansion) to translate intohealthy 2012-2017 CAGRs of 17.9% and 19.0% for revenues and net income, respectively. For 2013 in particular,we project top line growth of 20.5% and net income growth of 15.7% YoY. INITIATING COVERAGE ON HERFY WITH HOLD AND TP OF SAR 119.10/SHARE Although we like Herfy’s business model and the segment of the overall consumer sector that it operates in, wefeel that the market has largely factored in the growth prospects of the company (up 32% TTM and 15% YTD).Our TP of SAR 119.10/share is based on DCF analysis covering the 2013-2017 period (WACC: 11%, TerminalGrowth: 3.0%). We have also conducted a relative valuation exercise as a sanity check, which yields a slightlylower fair value estimate of SAR 113.25/share. We thus initiate coverage on the stock with a HOLDrecommendation.

Year Revenues (SAR mn) EBITDA(SAR mn) Net Profit(SAR mn) EPS (SAR) P/E(x) EV/EBITDA(x)

2012 842 227 181 5.49 20.4 16.2

2013P 1,014 274 210 6.35 17.6 13.4

2014P 1,205 324 249 7.53 14.9 11.3

2015P 1,422 385 303 9.19 12.2 9.5

80

90

100

110

120

130

140

TASI Hefy

Sector Coverage Asjad Yahya, CFA +9714 3199 768 ayahya @shuaa.com Taher Safieddine, CFA +9714 3199 785 tsafieddine @shuaa.com


April 28th, 2013 8

The story in charts

Improved utilization and capex to drive top line growth Capex to focus on restaurant openings

842

1,014

1,205

1,422

1,661

1,914

-

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2012 2013P 2014P 2015P 2016P 2017P

SARm

n

Restaurants Meat Factory Rusk Factory Bakeries & other

200 220

240 265

290 315

-

50

100

150

200

250

300

350

2012 2013P 2014P 2015P 2016P 2017P

Num

ber

of

stor

es

Restaurant yields to continue to increase Margins under pressure in short term as new stores open

2,681 3,047

3,487

3,905

4,315 4,660

5,010 5,336

-

1,000

2,000

3,000

4,000

5,000

6,000

2010 2011 2012 2013P 2014P 2015P 2016P 2017P

SAR'

000

20%

22%

24%

26%

28%

30%

32%

34%

2012 2013P 2014P 2015P 2016P 2017P

Gross Margin EBIT Margin

EBITDA growth to marginally outpace revenue growth Margin improvement & lower financial costs to support NI growth

26.7%

26.8%

26.9%

27.0%

27.1%

27.2%

-

100

200

300

400

500

600

2012 2013P 2014P 2015P 2016P 2017P

EBITDA (SARmn) - LHS EBITDA Margin (%) - RHS

19.5%

20.0%

20.5%

21.0%

21.5%

22.0%

22.5%

23.0%

-

100

200

300

400

500

2012 2013P 2014P 2015P 2016P 2017P

Net Income (SARmn) - LHS Net Margin (%) - RHS

Source: Herfy, SHUAA Capital

2012-2017 CAGR: 17.9%

2012-2017 CAGR: 18.0% 2012-2017 CAGR: 19.0%

2012-2017 CAGR: 9.5%

2012-2017 CAGR: 8.9%


April 28th, 2013 9

Valuation We initiate coverage on Herfy Food Services (Herfy) with a HOLD recommendation based on a fair value target of SAR 119.10 per share, implying 6.3% upside potential to the current share price of SAR 112.00 per share. Our target price is based on DCF methodology, with global peer analysis presented as well to serve as a sanity check for our valuation exercise.

DCF preferred valuation methodology Herfy is expected to pursue an aggressive expansion plan in the coming years, with 20-25 new stores set to open each year for the foreseeable future, compared to 200 restaurants at the end of 2012. In addition, the company is anticipated to ramp-up production at the new bakery plant established in 2012 (only one out of four lines at the plant is currently operational). Keeping this in view, we feel that DCF analysis is the most appropriate valuation methodology to capture this growth. The table below presents the main inputs for our DCF analysis. Key inputs for DCF analysis (SARmn)

Details 2013P 2014P 2015P 2016P 2017P

EBITDA (adjusted for taxes) 267 315 375 439 504

Add: Franchise income 3 4 6 9 12

Less: change in working capital (10) (11) (13) (12) (16)

Less: capital expenditure (150) (125) (105) (90) (86)

Free Cash Flow 109 184 263 345 413

WACC 11.0%

Terminal growth rate 3.0%

Source: SHUAA Capital

Our WACC is based on a Cost of Equity of 12.0%, after tax cost of debt of 4.0% and debt-to-capital ratio of 12:88. Details of DCF valuation

Detail Value (SARmn) % of EV

PV of explicit forecast 912 23.0%

PV ot Terminal 3,052 77.0%

Enterprise Value 3,965

Add: 2012 net cash 2

Less: 2012 EOSB (36)

Equity Value 3,931

Shares outstanding (mn) 33

Value per share (SAR) 119.1



April 28th, 2013 10

The table below presents a sensitivity analysis for changes in the assumptions for the WACC and terminal growth rate:

WACC

Term

inal

gr

owth

rate

10% 11% 12%

2.5% 131.20 113.70 100.60

3.0% 138.60 119.10 104.80

3.50% 147.20 125.30 109.40


Relative valuation supports our DCF-based Target Price Relative valuation based on average 2013 P/E and 2013 EV/EBITDA multiples yields a very wide range for the fair value estimate of Herfy, with an equal weighted approach implying an equity value of SAR 113.25/share for the company. Peer based comparison thus yields a slightly lower fair value estimate than our DCF-based Target Price of SAR 119.10/share, reaffirming our view that the current share price has largely factored in the growth prospects of the company.

Detail Fair Value Weighting Weighted fair value/share

P/E 2013P 141.00 50% 70.50

EV/EBITDA 2013P 85.50 50% 42.75

Fair value per share (SAR) 113.25

Upside potential 1.1%


The table below lists the peers utilized for the purpose of this exercise.

Company Country Market Cap (USDm) P/E (x) EV/EBITDA (x) EV/Sales (x) Div. yield (%) ROAE (%)

TTM 2013 2014 TTM 2013 2014 2013 2013 TTM 2013

McDonald's USA 100,199 18.5 17.4 15.9 11.0 10.7 10.0 3.9 3.2 36.8 39.1

Yum! Brands USA 29,315 19.8 21.3 17.4 11.4 11.5 9.8 2.3 2.1 80.3 62.0

Burger King USA 6,416 N/A 22.9 20.0 16.8 13.5 12.5 7.3 1.1 10.6 21.9

Wendy's USA 2,123 28.4 28.9 25.6 9.2 8.9 8.3 1.2 3.0 0.2 3.1

Jack in the Box USA 1,549 19.6 22.2 17.7 8.4 8.4 7.5 1.2 N/A 15.8 16.5

AFC Enterprises USA 795 26.8 23.9 20.6 15.2 14.1 12.6 4.3 N/A 126.7 N/A

McDonald's Japan Japan 3,692 28.4 28.8 23.7 8.2 8.5 7.8 1.1 1.1 7.7 7.2

Americana Kuwait 2,737 16.5 12.1 10.2 7.9 6.7 5.9 0.9 4.1 15.2 N/A

Average 22.6 22.2 18.9 11.0 10.3 9.3 2.8 2.4 36.7 25.0

Median 19.8 22.5 18.8 10.1 9.8 9.0 1.8 2.5 15.5 19.2

Herfy KSA 986 20.4 17.6 14.9 16.2 13.4 11.3 3.6 3.4 37.7 36.5



April 28th, 2013 11

Herfy trades at a premium to its regional “Food Producer” peers For the purpose of the relative valuation exercise, we have utilized Herfy’s peers in the global QSR industry, rather than the broader consumer sector, thus excluding regional Food Producers such as Almarai and Agthia to determine the relevant industry-based multiples. As evident from the table below, Herfy trades at a premium to such regional companies on all relative valuation metrics (P/E, EV/EBITDA and EV/Sales). Given the combination of 1) a more favorable regulatory environment, with no restrictions on product pricing and 2) significantly higher profitability (as reflected by RoAE), we feel that Herfy’s premium valuation is justified. Herfy trades at a premium to regional Food Producers

Company Country Market Cap (USDm) P/E (x) EV/EBITDA (x) EV/Sales (x) Div. yield (%) ROAE (%)

TTM 2013 2014 TTM 2013 2014 2013 2013 TTM 2013

Almarai KSA 6,826 17.6 16.9 13.7 13.2 13.1 11.2 3.1 2.0 19.5 6.9

Savola KSA 6,040 15.6 14.2 12.2 12.1 11.5 10.4 1.1 3.4 17.9 17.4

SADAFCO KSA 602 14.5 14.2 12.5 10.2 9.8 8.6 1.4 4.5 20.2 21.4

NADEC KSA 416 16.2 14.6 12.4 8.4 7.6 6.9 1.4 4.2 8.9 9.7

Agthia UAE 423 12.5 13.6 10.8 8.5 8.9 7.4 1.0 1.9 11.5 9.5

Juhayna Egypt 818 17.4 15.8 12.9 10.4 8.5 6.8 1.7 3.2 11.0 18.9

Average 15.6 14.9 12.4 10.5 9.9 8.6 1.6 3.2 14.8 14.0

Median 15.9 14.4 12.4 10.3 9.3 8.0 1.4 3.3 14.7 13.5

Herfy KSA 986 20.4 17.6 14.9 16.2 13.4 11.3 3.6 3.4 37.7 36.5



April 28th, 2013 12

Solidifying position as largest local player

A key player in the KSA fast food industry Herfy is the one of the largest fast food chains in Saudi Arabia, benefiting from the widest network of restaurants in the country. Moreover, industry data also indicates that Herfy, along with McDonald’s, ranks as one of the top two burger fast food companies in KSA by sales volume, making it the largest local player in the sector. In addition to managing 200 restaurants (20 owned and 180 leased) in Saudi Arabia (as at end of 2012), Herfy also operates bakeries & bakery shops, a rusk factory and a meat factory. Moreover, the company has presence in the wider region through a total of 12 franchised restaurants in Kuwait, UAE and Bahrain. Restaurants in KSA, however, remain the biggest source of the company’s revenues, a trend that is likely to continue in the foreseeable future.

Ranking of fast food companies by outlets (2012) Herfy 2012 revenue breakdown

-

50

100

150

200

250

Herfy Kudu KFC McDonald's Burger King

Restaurants83%

Meat Factory3%

Rusk Factory2%

Bakeries & other12%

Source: Euromonitor, SHUAA Capital Source: Herfy

Herfy remains 100% owned by Saudi nationals, a fact that helps it tap into strong patriotism in KSA. In fact, the brand is heavily promoted as 100% local-owned, with anecdotal evidence indicating that a significant portion of Saudi customers have developed strong loyalty to the brand due to this factor. Moreover, Savola and Herfy’s founder Ahmad Hamad Mohammad Al Saeed remain the two largest shareholders of the company. Herfy shareholding structure

Savola Group Company, 47.6%

Ahmad Hamad Mohammad Al

Saeed, 20.3%

Public, 32.1%



April 28th, 2013 13

Enjoying competitive cost advantage Herfy enjoys a competitive edge over its peers, particularly international chains, in terms of its cost structure. This advantage is driven by a number of factors, the most significant of which include: 1) vertical integration of supply chain, with all meat requirements fulfilled by Herfy’s own meat processing plant and a significant portion of bread requirement through its bakeries and 2) absence of royalty fees, which local arms of international chains have to pay. As a result, the company is able to attractively price its product range without compromising on quality. The table below presents a price comparison of “flagship” burger meals for Herfy and its key competitors. While the company ranks favorably even on the basis of list-price comparison, it regularly offers discounts (such as a reduction in price to SAR 10/meal over selected weekends), further adding to its cost advantage. In fact, our discussion with representatives of McDonald’s in KSA indicates that one of the key reasons the international fast food chain is forced to maintain relatively low prices (even by regional standards) is the pricing structure at Herfy. Herfy’s prices among the cheapest in the sector

Company Meal List Price (SAR)

Herfy Big Herfy with Cheese combo 16

McDonald's Big Mac meal 16

Burger King Whopper meal 18

Hardee's Swiss & Mushroom meal 20

Kudu Phillysteak 20

Source: Company data, SHUAA Capital

Expansion plans to refocus on restaurant business from 2013 2012 witnessed a sharp increase in Herfy’s capital expenditure program. The spike resulted from investment on a new bakery plant at an estimated cost of c. SAR 120mn, which has expanded total bakery capacity at the company by 5 times. The plant will produce bread and cake items and introduce new product ranges in Herfy’s portfolio such as croissants and cupcakes, which will be sold to retail customers. However, the company is planning to slowly expand utilization of the plant, with only one out of the four lines at the plant operational at this stage. With production of hamburger buns underway since 2012, the production of sliced bread at the new plant is anticipated in Q3-13, while the last two lines will become operational at a later stage. Annual capital expenditure (SARmn)

83

103

158 150

-

20

40

60

80

100

120

140

160

180

2010 2011 2012 2013P



April 28th, 2013 14

Herfy’s hefty capital expenditure program is set to continue in 2013, with the company anticipated to incur another SAR 150mn in the current year. However, the focus of the expenditure is anticipated to shift back to the restaurant business. While the last two years witnessed a slowdown in restaurant expansion due to investment on the bakery plant, annual store openings are expected to return to the 20-25 range in the foreseeable future. 2013 in particular is expected to stand out in terms of capital expenditure as the company intends to open 20 large stores, each equipped with a wide range of facilities, including drive throughs and separate family sections. 40% of the planned restaurants this year will be opened in Herfy’s home market of Riyadh, while some openings will be aimed at previously untapped cities, such as Taif and Medina. Restaurant expansion to pick up pace from 2013 again

Year 2010 2011 2012 2013P

Total number of restaurants 172 188 200 220

Annual restaurant openings 18 16 12 20



April 28th, 2013 15

Financial Outlook

Restaurant business to drive top line growth We expect a combination of 1) operational improvement in existing facilities (particularly in restaurants that opened in recent years and the new bakery plant) and 2) continued healthy capital expenditure (focused mainly on restaurant expansion) to translate into 2012-2017 revenue CAGR of 17.9%. For 2013 in particular, we expect the company to maintain the trend of double digit revenue growth seen in recent years and project the top line to stand at SAR 1.0bn, translating into 20.5% YoY growth. Revenues to grow strongly (SARmn)

842 1,014

1,205

1,422

1,661

1,914

-

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2012 2013P 2014P 2015P 2016P 2017P

Restaurants Meat Factory Rusk Factory Bakeries & other


Herfy’s restaurant business is expected to be the primary driver of the company’s top line growth over our forecast period. Growth in the segment, in turn, is anticipated on the back of 1) planned expansion in number of stores and 2) continued improvement in the yields per restaurant. The company is expected to open 20-25 stores each year over the foreseeable future, with our model factoring in a 2012-2017 CAGR of 9.5% for number of restaurants. In the meantime, the revenues per restaurant metric has demonstrated strong growth in recent years, despite the fact that the company has not raised product prices in the past 3-4 years. The increase in yield is explained by 1) introduction of new, higher value product ranges and 2) increasing number of customers per restaurant, which is driven by a combination of a growing population and increasing preference for fast food in KSA. With these factors set to continue in the foreseeable future, we anticipate further improvement in revenue generation per restaurant. Thus, we forecast 2012-2017 revenue CAGR of 19.2% for Herfy’s restaurant business.

2012-2017 CAGR: 17.9%


April 28th, 2013 16

Number of restaurants Revenues per restaurant (SAR’000)

200 220

240 265

290 315

-

50

100

150

200

250

300

350

2012 2013P 2014P 2015P 2016P 2017P

2,681 3,047

3,487 3,905

4,315 4,660

5,010 5,336

-

1,000

2,000

3,000

4,000

5,000

6,000

2010 2011 2012 2013P 2014P 2015P 2016P 2017P

Source: Herfy, SHUAA Capital Source: Herfy, SHUAA Capital

Margins to come under pressure in near term, improve over the longer term Our discussion with management indicates that new restaurants typically take 6-12 months for normalization of operations. Thus, the negative impact on margins of the planned opening of 20 large stores this year is likely to off-set continued improvement in existing operations, translating into largely stable gross margins in 2013. That being said, we expect modest improvement in gross margin from 31.6% in 2012 to 32.3% by 2017 as utilization of facilities improves. Moreover, Selling & Marketing expenses are expected to trend upwards in the medium term as a percentage of sales as the company introduces new means of increasing the popularity of the food chain. In fact, the one day, 50% discount across its entire menu offered by the company last year, the first in its history, is a good example in this regard. General & Administrative expenses, on the other hand, are likely to remain stable as percentage of revenues, in line with the historical trend.

Margins to improve modestly over longer term S&M expenses to trend higher in medium term

20%

22%

24%

26%

28%

30%

32%

34%

2012 2013P 2014P 2015P 2016P 2017P

Gross Margin EBIT Margin

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

2011 2012 2013P 2014P 2015P 2016P 2017P

S&M expenses as % of revenues G&A expenses as % of revenues


2012-2017 CAGR: 9.5% 2012-2017 CAGR: 8.9%


April 28th, 2013 17

Healthy EBITDA growth; franchise income to rise faster, but contribution will remain limited We expect Herfy to post 2012-2017 EBITDA CAGR of 18.0% over the 2012-2017 period, mainly as a result of healthy top line growth. Moreover, the company is expected to continue witnessing very strong growth in franchise income in the coming years (2012-2017 CAGR: 40.2%). Herfy currently has a presence in Kuwait, Bahrain and UAE through franchisees in these countries, which operate a total of 12 branches at this stage. Income from this business is reported as part of “Other income” and has grown significantly from SAR 0.7mn in 2011 to SAR 2.1mn in 2012 and is expected to maintain a strong upward trajectory in the coming years. That being said, contribution of franchise income to Herfy’s bottom line is expected to remain limited, rising from 1.2% in 2012 to 2.7% by 2017.

EBITDA growth to marginally outpace revenue growth Franchise income to rise sharply in coming years

26.7%

26.8%

26.9%

27.0%

27.1%

27.2%

-

100

200

300

400

500

600

2012 2013P 2014P 2015P 2016P 2017P

EBITDA (SARmn) - LHS EBITDA Margin (%) - RHS -

2

4

6

8

10

12

14

2012 2013P 2014P 2015P 2016P 2017P


Capex peaking in 2012-2013; debt gearing to remain low As highlighted earlier, Herfy is planning to build 20 large restaurants this year, which is expected to result in 2013 being another year of heavy capital expenditure. Moreover, while the following years are expected to witness 20-25 new store openings per annum, a mixture of rented and self-owned properties is likely to keep annual capital expenditure at lower levels. Over the longer term (2017 and for our Terminal Value calculation), we assume capital expenditure to be largely in line with annual depreciation at 4.5% of revenues.

Capex slowing down from 2014 onwards Debt-to-equity ratio to trend down

0%

5%

10%

15%

20%

-

20

40

60

80

100

120

140

160

180

2012 2013P 2014P 2015P 2016P 2017P

Capital expenditure (SARmn) - LHS Capex as % of revenues - RHS0%

2%

4%

6%

8%

10%

12%

2012 2013P 2014P 2015P 2016P 2017P


Herfy maintains a very conservative balance sheet, with debt-to-equity ratio standing at only 11.2% in 2012. Given that the company is expected to remain free cash flow positive throughout our forecast, this ratio is projected to drift downwards in the coming years.

2012-2017 CAGR: 18.0%

2012-2017 CAGR: 40.2%


April 28th, 2013 18

Net income growth to outpace revenue growth; dividend payout ratio to remain high Given the combination of a modest improvement in margins, a decline in financial costs (relative to EBIT) and a sharp increase in franchise income, 2012-2017 net income CAGR is expected to stand at 19.0%, surpassing the top line CAGR of 17.9% over the same period. For 2013 in particular, we anticipate net income of SAR 210mn, translating into 15.7% YoY growth. Net income growth to exceed revenue growth

19.5%

20.0%

20.5%

21.0%

21.5%

22.0%

22.5%

23.0%

-

100

200

300

400

500

2012 2013P 2014P 2015P 2016P 2017P

Net Income (SARmn) - LHS Net Margin (%) - RHS


Herfy has historically maintained a relatively high dividend payout ratio (2011: 61.4%, 2012: 58.0%). Given the healthy cash flow generation profile of the company, we expect this trend to continue and project a payout ratio of 60.0% for our forecast. For 2013 in particular, we anticipate a dividend of SAR 3.80/share, translating into a dividend yield of 3.4%. Note that 2013 is the only year where the dividend payout is expected to exceed the company’s Free Cash Flow. However, given the combination of 1) a strong balance sheet, 2) manageable capital expenditure plan and 3) strong free cash flow generation (average Free Cash Flow yield of 7.1% over forecast period), we feel that Herfy can easily maintain the current dividend payout levels for the foreseeable future. Strong Free Cash Flow generation to support high dividend payout ratio

(SARmn) 2013P 2014P 2015P 2016P 2017P

Free Cash Flow 109 184 263 345 413

Dividend 125 149 182 219 261

DPS (SAR) 3.80 4.50 5.50 6.65 7.90

Dividend payout ratio 59.8% 59.7% 59.8% 59.9% 60.2%


2012-2017 CAGR: 19.0%


April 28th, 2013 19

Financial Statements Income Statement (SAR mn)

Year to December 2011 2012 21013P 2014P 2015P

Restaurants 572.8 697.3 859.1 1,035.6 1,235.0

Meat Factory 24.4 26.9 29.9 33.0 36.3

Rusk Factory 13.1 12.9 13.0 13.2 13.3

Bakeries & other 98.3 104.8 112.4 123.1 137.2

Total Revenues 708.6 842.0 1,014.4 1,204.9 1,421.9

Cost of sales (482.3) (575.7) (695.9) (823.0) (968.3)

Gross Profit 226.2 266.4 318.5 382.0 453.6

Selling & Marketing expenses (34.5) (36.4) (48.7) (62.7) (66.8)

G&A expenses (38.9) (43.7) (53.8) (63.3) (74.6)

Management fees (4.5) (5.6) (6.7) (7.9) (9.3)

Income from operations 148.3 180.6 209.3 248.1 302.8

Financial charges (0.5) (0.9) (1.2) (1.3) (1.4)

Other - net 2.5 6.0 7.0 8.3 10.1

Income before zakat 150.3 185.8 215.1 255.1 311.4

Zakat (3.6) (4.6) (5.5) (6.6) (8.0)

Net income 146.7 181.2 209.6 248.6 303.4

EPS (SAR) 4.44* 5.49* 6.35 7.53 9.19

DPS (SAR) 2.73* 3.18* 3.80 4.50 5.50

*: Adjusted for latest bonus shares Source: Herfy, SHUAA Capital


April 28th, 2013 20

Balance Sheet (SAR mn)


Cash & cash equivalents 57.7 60.2 79.1 151.5 281.1

Accounts receivable 20.4 17.4 21.4 25.7 30.6

Inventories 65.2 70.8 85.8 101.5 119.4

Prepayments and other receivables 57.3 60.8 71.0 81.9 95.3

Total Current Assets 200.6 209.2 257.3 360.6 526.3

Investment properties 4.0 4.0 4.0 4.0 4.0

Deferred charges 0.5 0.4 0.3 0.3 0.2

PP&E 381.8 493.4 579.2 628.9 652.2

Total Non-Current Assets 386.3 497.8 583.6 633.2 656.4

TOTAL ASSETS 586.9 707.0 840.9 993.8 1,182.7

Current maturity of long term borrowings 15.0 20.4 21.2 21.8 22.3

Accounts payable 35.6 42.6 51.5 60.9 71.6

Accrued and other liabilities 37.1 44.5 53.6 63.4 74.6

Zakat payable 3.8 4.6 5.5 6.6 8.0

Total Current Liabilities 91.5 112.1 131.8 152.6 176.5

Long-term borrowings 26.2 37.8 39.4 40.5 41.4

Employee termination benefits 29.6 35.5 43.7 51.4 60.7

Total Non-Current Liabilities 55.8 73.4 83.1 92.0 102.0

TOTAL LIABILITIES 147.3 185.5 214.9 244.6 278.5

Share capital 300.0 300.0 330.0 330.0 330.0

Retained earnings & other reserves 139.6 221.5 296.0 419.2 574.2

TOTAL SHAREHOLDERS' EQUITY 439.6 521.5 626.0 749.2 904.2



April 28th, 2013 21

Key Ratios


Growth

Revenues 22.2% 18.8% 20.5% 18.8% 18.0%

EBITDA 19.6% 20.4% 20.8% 18.3% 18.9%

Income from Operations 19.8% 21.8% 15.9% 18.5% 22.0%

Net Profit 18.0% 23.5% 15.7% 18.6% 22.1%

Shareholders' Equity 15.6% 18.6% 20.1% 19.7% 20.7%

Number of restaurants 9.3% 6.4% 10.0% 9.1% 10.4%

Margins & Profitability

Gross Margin 31.9% 31.6% 31.4% 31.7% 31.9%

EBIT Margin 20.9% 21.5% 20.6% 20.6% 21.3%

EBITDA Margin 26.6% 26.9% 27.0% 26.9% 27.1%

Net Margin 20.7% 21.5% 20.7% 20.6% 21.3%

RoAE 35.8% 37.7% 36.5% 36.1% 36.7%

RoAA 27.0% 28.0% 27.1% 27.1% 27.9%

Leverage

Net cash/(debt) (SARmn) 16.4 1.9 18.6 89.1 217.4

Debt-to-equity 9.4% 11.2% 9.7% 8.3% 7.0%

Efficiency

Restaurants (total number) 188 200 220 240 265

Revenues/restaurant (SAR'000) 3,047 3,487 3,905 4,315 4,660

Valuation

EPS (SAR) 4.44 5.49 6.35 7.53 9.19

DPS(SAR) 2.73 3.18 3.80 4.50 5.50

P/E (x) 25.2 20.4 17.6 14.9 12.2

Fair value based P/E (x) 26.8 21.7 18.8 15.8 13.0

Dividend yield (%) 2.4% 2.8% 3.4% 4.0% 4.9%

EV/EBITDA (x) 19.5 16.2 13.4 11.3 9.5

EV/Sales (X) 5.2 4.3 3.6 3.0 2.6



April 28th, 2013 22

This Page was intentionally left blank


April 28th, 2013 23

Research Asjad Yahya, CFA Taher Safieddine, CFA+9714 3199 768 +9714 3199 785 [email protected] [email protected] Client Services: Sales Trading Desk:

800 SHUAA (74822) - UAE only +971 (4) 319-9777 – International [email protected]

+971 (4) [email protected]


April 28th, 2013 24

This document has been issued by SHUAA Capital for informational purposes only. This document is not and should not be construed as an offer or the solicitation of an offer to purchase or subscribe or sell any investment or subscribe to any investment management or advisory service. This document is not intended as investment advice as to the value of any securities or as to the advisability of investing in, purchasing, or selling any security. SHUAA Capital has based this document on information obtained from sources it believes to be reliable. It makes no guarantee, representation or warranty as to its accuracy or completeness and accepts no responsibility or liability in respect thereof or for any reliance placed by any person on such information. All opinions expressed herein are subject to change without notice. This document may not be reproduced or circulated without the prior written consent of SHUAA Capital psc.

ksa restaurant sector - الرئيسيةmec.biz/term/uploads/5767l_6002-28-04-2013.pdf · ksa...

Documents