The recent boom in agriculture commodity prices, plus the inability of industry players to raise prices of products such as fresh milk and laban in Saudi Arabia for years, has increased pressure on some dairy companies’ margins over the past two years.
However, the January industry-wide price rise of fresh milk and laban in Saudi Arabia, as well as similar increases in the UAE, will translate into an earnings boost for dairy producers in 2008, a recent equity research said.
The report by Shuaa Capital said the current GCC inflationary environment and the continuous increase of prices of dairy products will help Almarai – the Gulf’s largest integrated food and dairy producer, operating out of Saudi Arabia – to boost both the top line and the bottom line at about 20 per cent for the 2007 to 2012 period.
Shuaa capital said revenues and net income of Almarai is expected to top SAR8.8 billion (Dh8.6bn) and SAR1.5bn respectively by 2012.
For 2008, it forecast year-on-year net income growth of 24.6 per cent to SAR831m on the back of 24.8 per cent year-on-year revenue growth to SAR4.7m resulting from the implementation of price rise in the dairy side of the business.
Propelled by this expected growth, the firm has given Almarai a ‘buy’ recommendation based on a target price of SAR164.5 per share, implying a 21.4 per cent upside to the current market price.
Shuaa Capital said growth will be further fuelled by the rise in health conscious behaviour of consumers, low interest rate environment and the increasing consumer awareness across the GCC of inflationary pressures on various economic sectors, including food.
Almarai also benefited from the boycott of Danish products in 2006, which adversely affected Sadafco, its arch competitor. After the publication in European media, including Danish press, of caricatures viewed as highly inflammatory to Muslims, Danish products and dairy companies were boycotted by many Saudi Arabian consumers in 2006.
This led to profound changes in the Saudi dairy market dynamics.
The boycott was especially bad for imported brands such as Lurpak and Puck, and Sadafco, whose Danish shareholders had inexplicably exited years ago.
Sadafco, which had an estimated market share of about 70 per cent in 2005 with its Saudia brand, was estimated to have lost more than 10 percentage points of market share in this segment in 2006.
This, in turn, led Sadafco to an estimated seven percentage point market share loss during the same period on the total liquid milk segment, although the company managed to retain its market leadership, ahead of Almarai. The main beneficiaries of Sadafco’s misfortune were Almarai, Safi-Danone and Jamjoon-Foremost, which were all able to expand their market share.
With about two-thirds of its revenues generated in the country, Saudi Arabia is Almarai’s main market. The retail value of the Saudi dairy industry was estimated by IMES Consulting at $2.4bn (Dh8.9bn) for the year 2006, and encompasses products such as milk, laban, yogurt, labneh, cream, butter, ghee, cheese, milk powder, condensed milk and evaporated milk.
The Kingdom is the largest dairy producer in the region, followed by the UAE. It is also the largest consumer, as estimated total consumption of dairy products in Saudi Arabia was 3.58 million LME (liquid milk equivalent) tonnes in 2006, versus 0.75 million LME tonnes for the UAE market.
This comes as no surprise as the population of Saudi Arabia represents around two thirds of the Gulf’s total population, and represents the largest consumer base in the region. However, in terms of raw milk production as of 2005, Saudi Arabia represents just about 0.2 per cent of total global fresh milk production, far behind top producing regions such as the European Union and the United States, which are responsible for a combined 42 per cent of global milk production for that same year. So, although Saudi Arabia is the largest dairy producing country in the region, it is still a small player on the global scale.
Saudi Arabia’s dairy sector, however, has been witnessing a steady, although not stellar growth, according to Shuaa Capital.
“The reason is fairly simple: its growth is a reflection of both consumer food habits and population growth,” it said.
“With food consumption habits witnessing only gradual change and a population expanding at a rate of around three per cent per annum in the Kingdom, growth in the dairy sector cannot – at least in volume terms – be expected to be stellar.”
Shuaa capital estimates the actual spending per capita for dairy products is likely to be higher than IMES expectations for the 2007 to 2011 period due to events such as industry-wide prices increases on specific products – such as the one for fresh milk and laban in January 2008.
Other dairy products, such as butter or cheese, on the other hand, will become more expensive overtime, but without the need for a concerted industry effort or action, it added. “In an inflationary environment such as the one currently experienced by GCC countries, it is difficult for end-consumers not to see their bills of various items go up, and dairy products are no exception,” the report said.
The latest inflation data in Saudi Arabia points to a seven per cent increase in prices in January 2008, the highest in about a quarter of a century.
“For some, higher dairy product prices might mean restrained consumption, but all-in-all, we believe the trend is for the Saudi consumer to sustain consumption by increasing spend on dairy products, especially given rising income per capita and improving living standards,” it added.
Currently, the Saudi dairy industry is composed of a few dozen players, but dominated effectively by three: Almarai, Sadafco (a publicly listed company, whose main brand is Saudia), and Al Safi-Danone (a joint-venture between Al Safi Dairy farm and the French dairy group Danone).
For 2006, Shuaa’s calculations suggest Almarai commanded a 19 per cent market share of the total Saudi dairy market in value terms. In 2007, evidence suggests its share has gone up overall and could have now entered the 20 per cent territory.
While Almarai’s dominance in Saudi Arabia is an apparent strength, its concentration in the Kingdom has also become a point of weakness. Almarai, which has been the largest integrated dairy and food producer in the Middle East holding a dominant position in domestic milk, laban, yogurt, and fruit juice segments, has a weaker market share in the UAE, especially in fruit juices.
It does not own any production facility in the UAE and has a limited presence outside of the GCC. The Egyptian market, so far, is largely untapped by the company.
The company is also facing a number of challenges, one of which is the agricultural commodity inflation, which is expected to hurt margins over time.
Almarai’s major cost component is direct material cost and the major cost element within direct material costs are agricultural commodities. “The major issue for the dairy industry recently – and to which Almarai is not exempt – has been steadily rising prices of agricultural commodities, with most notable/publicised of them being corn and soybean,” the report said.
The Saudi dairy market is increasingly dominated by a small number of players, with smaller size players left to play “secondary roles” and finding it increasingly difficult to expand their business successfully.
This, according to the report, is a reflection of discerning consumers demanding brand guarantees of quality, more variety and innovative product offerings and the financial burden created by soaring commodities prices on smaller players.
However, the industry is not highly consolidated as of yet. Some larger players, such as Almarai, have acquired dairy farms in their home market, but these transactions are not very common. The trend of higher concentration among the larger players is expected to continue, as the strong brands become more dominant in consumer minds and scale efficiencies push inefficient players out.
The current Saudi retail spectrum is also characterised by bagalas (small local shops) and large-size retailers/supermarkets. Bagalas leverage their low-cost base to offer competitive pricing of the products they sell, and, hence, still represent the majority of dairy products retail selling points in Saudi Arabia. Lately, larger retail outlets, such as supermarkets and hypermarkets, have been gaining prominence in the Saudi retail space.
Their appeal is based on twin factors of convenience (a huge choice of products sold under the same roof ) and attractive pricing.
The much larger shelf space, superior display, greater visibility and consequent sales potential the larger stores provide comes at a cost from the producer’s perspective; these stores typically demand higher discounts to display products on their shelves compared to bagalas.
Shuaa Capital estimates supermarket chains command a 15 per cent gross margin on the dairy products they sell versus about 10 per cent for bagalas. For Almarai, it is estimated that the proportion of revenues originating from sales to large-size retailers is about a third of the group’s total turnover.
However, the same large scale retailers have a natural propensity to favour stronger brand products in terms of shelf space, while these stronger brands command more negotiating power with the large-scale retailers, resulting in two way pressure on smaller producers’ margins compared to the larger producers. The trend of increasingly prominent large-scale stores is ultimately highly favourable for the larger producers.
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