Sunday 13, August 2017 by Nabilah Annuar

Investing in Saudi’s consumer staples

Anjali Anand, Senior Manager, Investment Research & Analytics, at Aranca Research provides an insight into the three consumer staples stocks an investor needs to tap into in Saudi Arabia.

Consumer staples, prized for their slow but steady growth in investment portfolios, are generating higher alpha than ever before. They’ve not only been more resilient to the usual market headwinds but also have tremendous potential to grow, bolstered by technological disruptors and a growing consumer base among the world’s emerging market middle class.

Legacy brands, plain vanilla business models, and not nearly as much excitement as the technology space; that pretty much sums up affairs in the consumer staples industry. The same traits, however, make consumer staples stocks a quintessential part of any portfolio manager’s collection. Higher returns, low volatility, and a less capital-intensive profile make consumer staples an especially attractive investment opportunity for the long-term.

If we consider a 15-year historical trend, the MSCI world consumer staples index recorded its highest average annual returns of 7.2 per cent, almost double the MSCI world average annualised returns of 3.4 per cent. It also boasted the lowest volatility, 12.0 per cent vs. the MSCI world average of 18 per cent, which translates to far fewer fluctuations in the stocks’ pricing behaviour.

Conversely, the technology hardware and equipment sector recorded the highest volatility (+27.0 per cent) amongst all other sector indices at an average annualised return of two per cent, turbulence due mostly to the collapse of the tech bubble.

Consumer staples are at an interesting phase

Consumer staples are believed to be stimulating right now as its performance spread widens, while its valuation spread narrows. Since 2000, the MSCI world consumer staples index’s outperformance versus the MSCI world index is noteworthy. The barometer has widened from 1.4x (December 2007) at the beginning of our most recent period of recession to 1.9x (April 2017) right now, way ahead of the historical median (1.6x).

Early 2016 was turbulent for the global equities market, driven by factors such as instability in Chinese equities markets, a slump in global oil prices, disappointing GDP numbers, and corrections in other sectors such as technology, automotive, and banking.

Amid tough market conditions, consumer staples was the primary sector yielding positive returns, and investors flocked to what they’ve always considered a safe heaven. Accordingly, the spread between MSCI world consumer staples and MSCI world index, forward price-earnings ratio (P/E) peaked at 4.8x in January 2016 as investors rewarded consumer staples for its stable performance.

The spread has further narrowed to 1.4x in April 2017, far below the historical average of 2.2x, and we believe the current 1.4x valuation spread offers a noble entry point for long-term investors, as long as they pick the right names.

Consumer staples remained resilient to short-term headwinds

While the Brexit impacted short-term sales growth for global consumer staples; the overall industry is well shielded from such uncertainties. The outlook for consumer spending remains strong for the next couple of years, driven by growth from underpenetrated rural markets, premiumization, growing health awareness, and niche brands. BMI Research forecasts 5.4 per cent annual sales growth for global food and non-alcoholic drinks in 2017 and an annualised average growth rate of 4.4 per cent until 2020.

Structural trends such as population growth, burgeoning middle class, rising urbanisation, increasing disposable incomes among working couples, and above all, a growing disposition among consumers for product and supply-chain innovations and digital disruption in the marketplace (through the emergence of e-commerce) offers multi-year growth potential for consumer staples, especially in the emerging markets vis-à-vis developed economies.

Current Middle East market downturn augurs well for consumer staples

Over the past year and a half, Middle Eastern equity markets have corrected sharply in the wake of slow economic growth, low oil prices, and geo-political tensions. Looking at the valuations, the market is now beginning to look ‘attractive’ with some large cap stocks trading at rock bottom. The current state of high volatility and low returns in the Middle East and Africa (MENA) region is a good spell for investors banking on stable returns in the consumer staple sector.

As stated in the IMF 2017 outlook for the Middle East region, “subdued growth prospects will keep underlying inflation low in the GCC region. Although energy price reforms are expected to temporarily push up headline inflation to about 3.5 per cent in 2016, inflation is expected to drop back to 2.5 per cent in 2017”.

As low inflation drives low consumer spending and growing price competitiveness in the GCC region’s food and beverages industry, it becomes all the more imperative to look for stocks that are fundamentally strong on growth and valuation metrics.

Which Saudi companies will generate the most alpha?

Picking the right stocks is the key to capitalising on the consumer staples theme. Key stocks that seem to strike the right cords regarding fundamental performance metrics, with positive revenue growth trajectory and strong profitability (above peer average EBIT margin  per cent), are—Almarai, Anadolu Efes Biracilik, Coca-Cola Içecek, Ülker Bisküvi Sanayi and Saudia Dairy & Foodstuff Co.

They are among the top 15 consumer staples stocks in the Middle East region by market capitalisation.

On the valuation-return metrics, key stocks Abdullah Al-Othaim, Strauss Group, Saudia Dairy and Foodstuff Company, Shufersal Ltd. and Mezzan Holding Co. are in the favourable zone right now. Among the top 15 consumer staple stocks (in the Middle East, by market capitalisation) they’ve logged higher than peer average (18 per cent) return on equity per cent on lower than peer average (20x) 12-month forward P/E for 2017E.

Future outlook on the top three consumer staples stocks

Saudia Dairy and Foodstuff Company (SADAFCO) have a strong market position in milk, tomato paste and ice-cream, even though the sectors are plagued by challenges such as low consumer spending and intense price competition. Expect a FY18E full-year top-line growth of 11 per cent on a stable margin of 14 per cent. Despite a growing equity base, SADAFCO’s return on total equity has been rising, while its current dividend yield of 3.4 per cent is meaningfully above the MSCI world consumer staples dividend yield of 2.6 per cent. The company’s zero leverage and healthy cash position as well is a positive sign for organic and inorganic growth. On the valuation front, the stock currently trades at a 12-month forward P/E of 14.0x, which is at a six  per cent discount to its historical five-year average P/E of 15.0x.

For Ülker Bisküvi Sanayi, after a subdued top-line growth of three per cent in 2016, sales growth is expected to pick up again. Expect erstwhile levels of 13 per cent on a stable EBIT margin of 11 per cent by the end of 2017, driven by a better price mix from its chocolate segment and below industry-average volume declines in its biscuit segment. The Street expects a 41 per cent jump in earnings per share (EPS) at the end of 2017 to TRY 0.95 per share after a 11 per cent dip in 2016. On the valuation front, the stock currently trades at a 12-month forward P/E of 20.9x, a modest 3 per cent discount to its historical 5-year average P/E of 21.6x.

Almarai, a SAR 58.4 billion ($15.5 billion) integrated food and beverage provider in Saudi Arabia, is looking ahead to invest SAR 2.9 billion per annum between 2017 and 2020 to fuel its capacity expansion plans. The outlook remains poised for 2017, with expected full-year EPS growth of 11 per cent, ahead of eight per cent in 2016 on strong top-line performance. In the near-term, pressure on margins may ease off a little bit as low commodity prices, improved cost management, and restored production savings will offset high fuel and energy prices. Nevertheless, in terms of valuation, the stock currently trades at a 12-month forward P/E of 25.9x which is at a 23 per cent premium to its historical five-year average P/E.