Q2 earnings in-line, outlook subdued



Saudi Airlines Catering announced its Q2 2017 results, which came largely in line with our estimates. Revenue slipped 3.4% y-o-y to SAR551.1mn (our estimate: SAR568mn), while net profit fell 7.6% y-o-y to SAR131mn, in line with our SAR130mn estimate, but below consensus estimate of SAR139mn. The company’s financials have been under pressure due to a weak economic scenario for the airline industry. There are further risks for the company with the planned launch of a budget carrier by Saudia, ongoing contract renewal negotiations and rising receivables, which we believe will remain an overhang on the stock performance in the near term. Nevertheless, with limited capex requirements, the company generates healthy free cash flows, and with no debt obligations, is able to maintain a strong dividend payout. Catering raised its dividend from the previous quarter to SAR1.5 per share in Q2, which we believe was the primary reason for yesterday’s sharp stock price rise. Though growth is expected to remain subdued till the business cycle picks up, the stock offers an attractive dividend yield of ~6.4% (H1 dividend annualized) at the current market price. We have a Neutral rating on the stock with a target price of SAR89.

Key takeaways:
•?Revenue declined 3.4% y-o-y to SAR551.1mn, due to lower catering revenue from airlines other than Saudia and decline in airline equipment sales to Saudia.

•?Despite the lower revenue, gross and operating profit improved slightly as fixed and variable costs declined, resulting in higher gross and operating margin.

•?Nevertheless, net income fell 7.6% y-o-y to SAR131mn. In addition to SAR3.5mn zakat and tax provision related to prior years, we believe the lower net income was due to higher other expenditure.

•?The company announced a dividend of SAR1.5 per share for Q2 2017, taking the H1 2017 dividend to SAR2.75, indicating an annualized dividend yield of ~6.4%.

Valuation:
Saudi Airlines Catering stock has fallen sharply over the past few months, down ~16.5% YTD, despite the stock’s surge yesterday. We have lowered our estimates on the company taking into account the potential increase in market share of budget airlines as well as the weak economic scenario for the airline industry. We rate the stock Neutral as our weighted average (DCF:50% and PE: 50%) target price on the stock comes to SAR89. However, with limited capex requirements, the company raised its quarterly dividend from SAR1.25 per share in Q1 2017 to SAR1.50 per share in Q2 2017 (down from SAR1.75 in Q2 2016), offering an attractive annualized dividend yield ~6.5%.


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