Almarai Company (2280) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to Almarai Q3 2020 Results Conference Call hosted by NCB Capital. I will now hand over to your host, Mr. Nauman Khan. Sir, please go ahead.

Good afternoon, ladies and gentlemen. On behalf of NCB Capital, I would like to welcome you to this conference call with Almarai management regarding the company's third quarter results. Today's speakers are Danko Maras, Chief Financial Officer of Almarai; Ikram Ulhaque, Head of Finance. We will first listen to the management feedback. Following this, we will open the floor to questions. Almarai management, begin your feedback, please.

All right. So good afternoon and good morning, ladies and gentlemen. Welcome to the Almarai earnings conference call for the third quarter of 2020, which is today being organized by NCB Capital. Thank you, Nauman Khan, for arranging this call. As said, I'm Danko Maras, CFO of Almarai; and I'm joined by Ikram Ulhaque, the Head of Finance. This is only on voice. I assume you have downloaded the 2020 third quarter earnings presentation from our website. And for those of you who have not been able to do so, please go to the website, Corporate Investors Earnings Presentation, and you'll find the documents. Hopefully, you hear me well. I'll talk slowly and clearly so that we can go through it, and I will make page references as we go forward. So if we then just go into Page 5 directly and talk a little bit about COVID-19, the pandemic that we are all exposed to. As you know, our strategy is to deliver quality you can trust to our consumers, and it's been our core priority throughout this whole pandemic, ensuring the safety of our employees and our consumers and also ensuring that there is availability of our product on shelves. We are in a different phase at the moment. As you can see, there has been some ease on the restriction that has been happening in the region. As far as Almarai is concerned, we continue to have a complete lockdown in our manufacturing and farming sites. Given the biosecurity issues we have anyway, it is very important for us to continue to ensure that we are reducing the infection risk at the sites that we're having. Our product portfolio is back to precrisis level. So we have been able to introduce back our SKUs that we sort of stopped in the beginning of this phase to ensure availability. You'll see some more promotions in the store and things are becoming a little bit more normal. I will talk more about that in terms of business impact and performance. We are prepared for a second wave. As you can see in Europe, it is happening in many countries again, and we are by no way thinking that this is over. This is probably here to stay for a long time and we are preparing for that. We're back to the head office. From my own personal being, I've been 6 months in Saudi, and I've been working from home. But in August 15, I'm -- I actually went into the office, and we've started to work from the office, about 80% of our staff is under strict protocols to work from the office. So we continue to secure safety and health of our employees. It will be the #1 priority for us and make sure that our products are available in the shelf for our consumers. And I will talk a bit more about what this means for us going forward. If I just move to Page 6, you have seen that we worked on different scenarios. I believe it's wise to work on scenarios. It's a lot of work for a lot of people. But given the unpredictability about what's happening with the economy and the recurrence of the COVID, we believe that this was necessary to do. And we also believe today that the scenario #2 that we have depicted, our economy in recession, is becoming more and more likely. The economics are suggesting that lower disposable income, share of wallet will be smaller because of the VAT introduction and some austerity measures that the government is doing. We also see a lower population coming through, about 400,000 people left in the second quarter, tourism will take time, et cetera. So the share of wallet and the lower population affecting the disposable income and the number of mouth to feed will have an impact for Almarai. And we are preparing for that as we speak so that we are able to mitigate some of the shortfalls we believe might happen next year and mitigate that through efficiency savings that we're doing in our business and also changing the model a little bit to ensure that our productivity is there. I'll talk a little bit more about it piece by piece when we go through the performance on categories and brands, et cetera. But if I just move to the market share position, Page 7. You can see August '20, the Almarai's value share, we continue to be #1 in almost all categories where we are present with the exception of UHT milk. And in almost all of these categories, we also grew with some percentage points from the second quarter. So doing really well on holding our market share positions in the categories where we operate. I think there is a slight to security among consumers. The quality stamp that Almarai has is very much prevalent in the consumers' mind as we continue to live under this particular pandemic. If we look at the business performance, second quarter was very good. Q3, I would say, is no different. You see revenue growth of about 8% in the quarter. It happens to be the same year-to-date. So we are showing an 8% revenue growth year-to-date as well. We are losing out on the operating profit. You only see a 1% growth coming through, and that's affected by mostly our net margin items, the phasing in of our alfalfa costs and the expat levy that we've had as a structural cost that comes into play. Of course, there's some costs due to COVID-19 and also the consolidation that we do with IDJ has had an impact. That deconsolidation effect comes through when you look at the net income. So we are coming back to that, about 7% net income growth in the quarter, which is sort of holding strong to the revenue growth. So that is the deconsolidation of the operations we have in IDJ, but also due to a lower interest cost because of a lower quantum of debt that we are simply deleveraging our balance sheet and having benefits from that as well. Working capital compared to last year is increasing. Some of it is related to inventory conscious choices. If you can see for the quarter, you see that we have a very strong cash flow delivery and movement of working capital. But compared to last year, there is an increase, in particular, on inventory, and I'll come back to that. We're holding firm on capital expenditures, SAR 168 million in the quarter, about SAR 215 million less than last year, and we continue our trend of reducing our investment in CapEx, and I'll show you also some more insights on the development of that. All in all then from revenue down to the cash flow generation, we are increasing SAR 222 million in the quarter to SAR 808 million. And that's a good delivery on the free cash flow, I would say. If we look at each consecutive quarter in the year 2020, it's been fairly strong on all 3 quarters on the cash flow delivery. So we feel good about that in this environment where earnings streams are being challenged by the COVID pandemic. If I start with the sales bridge. You can see the 8% growth being broken down on Page 10. And in very simple term, it's mostly volume. The like-for-like growth is 6%, of which volume is 5% and price is about 1%. That relates predominantly to the price increases in juice, but also a little bit in dairy. The 2% in others that 1 or 2 of you have asked previous call, what is that? That's Premier Foods, which, essentially, is volume related as well. It's an acquisition. So we should actually move it into volume and price. But prior years -- prior quarters, it did not have any comparators, but we will add it in going forward. And the other part is alfalfa sales that we are doing on export, which has a jump in the quarter. And you should see that as something very patchy. It's coming and going. So it doesn't represent any sustainable number behind it. So think of it as a 1% in Premier Foods being volume moving into the volume column in the future. If we look at it in regions, you can see it was a little bit more dim picture last quarter. But here, you can see there's only 1 region or country, which has a negative growth, but the rest of the region is growing in various sorts. KSA being the biggest one in absolute terms, it's 5%; other GCC, about 4%, which Oman is negative with -- sorry, Yemen is negative with 9%; and then the others, good growth in the quarter from both Egypt and Jordan of 19% and 23%, respectively. If you break that down into more country specifics and quarter-by-quarter -- I will need to correct myself, it was Oman. I was just confusing myself there. So if you look -- if we start with Oman, you see the negative growth coming through. It is the effect we've had in -- especially in the dairy area where we're negative all 3 quarters and we are at year-to-date negative growth in that area, about 11%. But for the rest of the region countries, strong delivery in KSA continues to be strong; Egypt, very strong as well in the quarter; and the others, as I mentioned, the alfalfa and Premier Food is delivering a strong number in the quarter as well. If we look at categories, we also see a nice table showing you respective quarter and the growth coming through. Fairly good delivery in Long Life Dairy, Fresh Dairy and Foods. We tend to have had a very good delivery also in Poultry. You see it's good but it's less good than what it has been before. And we see a shift of trend in Bakery where we've had fairly good growth throughout the quarters. But in the third quarter, we actually had negative growth. And year-to-date, we are at the breakeven in terms of top line growth. And that has very much to do with the fact that a lot of the product assortments in Bakery are single-serve and impulse. It is baked rolls, swiss rolls and impulse purchases. And one of the key reasons for the third quarter being affected is, as we mentioned, the back-to-school did not happen, and you put normally in those single serves in the back pack. It had a significant effect. It also has an effect on our profitability because small product packaged as one-on-one have higher margins than multitude of products. So we both had a revenue impact in the quarter and a profitability impact from Bakery. It remains to be seen whether something happens with schooling in the fourth quarter. We are watching this carefully. And we don't think structurally that there is anything wrong with the Bakery segment per se, but it is severely impacted by the circumstances in the pandemic that we have to consider, of course. The same thing with traditional trade channel growth or channel growth per se, some interesting developments in the quarter. You see that we're growing very well on modern trade and traditional trade. You can see the swings that we've been referring to in previous quarter where modern trade was very strong in the first quarter and traditional trade growing in the second quarter and in the third quarter, you are seeing a fairly good growth on both modern trade taking over. However, on foodservice, although it looks red, I have to say we are starting to see some form of a rebound in the foodservice area. So it's less negative than before. It's almost breakeven in the third quarter. So some reverse back to the foodservice channel is definitely in the making. And hopefully, we will continue to see more of that coming through in the fourth quarter. Moving into ESG issues. You can again see here the development that we have in our area of sustainability environment and governance, some key points being highlighted on the left side where we are continuously improving our performance indicators on ESG issues. That doesn't mean that we are becoming complacent in any way or form, we work a lot on this area and we have more to do to reach better levels. But the industry average or sector average, you see in the vertical orange line items that are highlighted on the right side, we continue to strive towards more compliance on ESG issues going forward. So this is good in delivering ongoing despite the hardship we have around in our environment. Financial performance, if I go back and a little bit more specific, if I could just take your time for a moment there. I've talked a little bit about the revenue growth already. So on the operating profit, only 1%. To be more specific, it's the higher cost of imported alfalfa, it's juice ingredient cost, it's higher labor costs. We have some losses in Premier Foods that are -- because of foodservice and then it's also the IDJ consolidation that I referred to. And part of that gets reversed when we look at net income. So you get up to about 7% on the growth for the net income exacerbated in a positive way due to the deleveraging that we have also on our balance sheet. If you look at it by segment, you can look at Dairy & Juice first: revenue growth, about 9%; but the income growth was only about 6%, if you look below on the profit margin. This is mainly driven by the higher alfalfa and our juice ingredient cost, labor and high depreciation charges are mostly from IDJ where we are consolidating IDJ. The second one is Bakery where you see the revenue decline of 7%. This is because of this mix issue with single-serve products not picking up in terms of revenue, but also then having an effect on our category profit, which decreased with about 17%. The third line is Poultry, higher revenue growth of about 7% mainly driven by volume. And due to very high fixed cost leverage in poultry operation as we are running close to full capacity, this revenue growth even after adjusting for higher trade support costs resulted in a bottom line growth of about 21% year-on-year, and that's still very, very impressive in terms of delivery. Moving over to cash and balance sheet. If I take a few moments there, you can see on the capital investment I referred to before that we are putting tight control of the development of our capital expenditure and we continue to reduce our rolling 12-month ratio as a percent of sales to 7%. I believe it was somewhere around 8% in the previous quarter. So we continue to hold. That does not in any way mean that we are compromising on our maintenance or replacement investments that are necessary for our business. We just simply don't have significant investments in projects as we had in the past. So this is more a fair reflection of where we should be. The free cash flow as a result of everything, if we just take a rolling 12-month basis again, we highlighted last quarter about SAR 2.9 billion annualized. Here, we are now at SAR 3.1 billion. And part of that comes from an increased operating cash flow. Selling has a significant movement in working capital. The CapEx you see there, SAR 1.5 billion, is depreciation of our bio assets and PPE. And then we actually have a debt movement, about SAR 1.8 [Audio Gap] of SAR 3.1 billion. This all has an effect on ratios that if we start looking at the net debt trend on the left side on Page 22, you can then see that [Audio Gap ] that simply means that our net debt-to-EBITDA ratio has come down to 2.8x. We've talked about reaching 2.5 to 2.7x net debt EBITDA. I think 2 quarters ago, we said 12 to 18 months. Now last quarter, we said 12, and now we say 6. And I would not be surprised if we are even able to manage to get to that level even earlier. It's a very, very good cash flow generation and attesting our net debt position delivery. So we are very happy with that, of course. You can also see the net debt and equity ratio improving with the retained earnings going up and net debt going down. On EBIT and EBITDA margins, we are increasing the net sales, as you can see there, and the ratios are slightly decreasing from last year, '18, '19, to the 12 months rolling. Some of the cost items we've talked about and one at a -- sort of the point for interest if we were to not include the IDJ business, which we should, but if we were to sort of exclude that from the metrics here, we will be completely flat in terms of the margin generation on both EBIT and EBITDA. Our debt majority profile on Page 23 is very much matching our cash flow delivery. And so we feel very good about that. It was a little bit over 4 years. Last quarter, we moved it slightly down to 3.93. The composition of it is firm. We're not changing it. There is no structural debt maturing until next year in October. And at the moment, we are not borrowing anything. We are actually trying to optimize surplus cash that we are having due to some rigidness of our borrowing arrangement. So the cash flow is, as we see it, not of a particular concern for us at the moment. But you never know what comes going forward, so we are holding our relationships very firm with our banks. And this is basically on Page 24 making the same reflection on the strength of our balance sheet. We have significant opportunities. If you would like to do acquisitions, we have SAR 5.9 billion of facilities in place should we need it. And we also have about SAR 591 million of cash at hand, which is the conscious choice. Given the fears and anxiety we have about the pandemic, we wanted to have a little bit more cash in hand to be more secure. Page 25 is about our shares. I will not comment then, that's up to you and the analysts to comment on our share performance. The summary of this, the key takeaways. If you look at the third quarter, some of you have asked questions about the effect on the VAT. Yes, we saw a significant increase 1st of July. It did not affect our consumption and purchases in the first 2 months, I would say. What we are starting to see, however, is that there's some softness in the end of this period. And I think it has to do with the consumer insight that the share of wallet is actually diminishing everything [Audio Gap] The early signs of the scenario that we are planning for in 2021 might even come in the fourth quarter. So very difficult to predict. As I was saying in the beginning, we have to have our scenarios, but we do start to see some softness and impacts due to the unemployment and disposable income that is becoming more and more prevalent, I would say, in the environment where we're operating in. We have to be tight on our cost control. Alfalfa and the COVID-related cost pressure is there. So we do it by being very, very strict on our operating expenses. Some of it is of course one-offs, but not the alfalfa phase-in, the expat levy cost that we have. So we need to mitigate that. The interesting part to perhaps put in mind is the foodservice channel rebounding, and it will be interesting to see what happens for all of us I think in the fourth quarter. It would be very interesting for anyone to go out and see if the restaurants are actually opening up or closing down depending on what actually happens with the development of COVID-19. Our cash flow generation is strong. Liquidity funding plans are firmly in place to manage current environment. We feel good about that and our balance sheet position. If we look at the key challenges and opportunities, we've done the pricing on our products. We've done product rationalization post the VAT introduction. We're still trying to understand the implications of the VAT introduction. For us, very important to land in the right kind of price points, and that's still work that is going on. Sometimes you have to do some downsizing or upsizing and reach those price points. So I would say, the very sudden instructions to do VAT increases in July is now being worked through more diligently with the team in Almarai to make sure that we have the right price points in the marketplace. Subsidy continues to be of relevance for us to mitigate. We are considering that in the productivity initiatives we're taking for the scenario planning. So we're also able to mitigate some of the phase-out impacts on the subsidies. Import duties, we've talked about before. We don't believe there is anything materially impacting us from a cost point of view in the region. What it could actually do is to give us a competitive advantage. We believe that that's the case for some of our fresh dairy range, but also our locally produced poultry range. Hopefully, we'll see we'll deliver in the next 6 months or even in shorter time period, we'll come down to 2.5 to 2.7x, we believe. And we continue to build on this scenario planning to rationalize our operating model in the next few quarters. We predominantly think the hardship will come in 2021. And what is happening now in the marketplace is perhaps a precursor to what will come in 2021. We might be wrong and the revenue comes back and everything is good, but then we are [Audio Gap]

Please hold the line. The conference will resume shortly. Ladies and gentlemen, please hold the line. The conference will resume shortly.

Yes. Hello, again. This is Danko. I heard that my line was muted for some reason. Hopefully, I managed to go through the presentation for you. And I would be ready to take questions and answers now.

[Operator Instructions] Our first question comes from Mohamed Torki, HSA.

Yes. Just I saw that revenue of Fruit Juice increased 5% in the -- here for Q3. And you mentioned that there was increase in the average price. I would like to understand how much was the average increase in the prices and how has the volume changed during the quarter.

Thank you for your question, Mohamed. Hopefully, I heard you right about average pricing going up. We have about 1% of the total of the 8% is price. And the rest, you would predominantly refer to volume. Almarai has, during the 3 quarters this year, delivered predominantly volume growth with the exception of one category, which is the Juice category, where you might have heard before that we decided to take out sugar in our recipe and replace it with white grape concentrate, which has a higher cost, but it was an attempt to avoid the sugar tax that was introduced in 2019. And there, we are mitigating some volume shortfall strategically with price. So we do see revenue growth in Juice, but we do have it through price and not through volume. That question came also around VAT, if we've done price increases beyond the VAT introduction. And the answer to that is no. We have made sure that we pass along the 10% increase that came through in the 1st of July, but not trying to gain anything from that because of -- we felt it was hard enough to make sure that we could get the price increase through and not lose out on the VAT introduction by taking part of that ourselves. So hopefully that answers your question.

Yes. Just for Fruit Juice, you -- there was no additional increase in the prices here on Q3, right?

That's correct because...

And...

That's correct. You are right. On the Juice part, we decided not to do any price increases. And that has to do with the competitive situation that we are in and the fact that we are gaining market share. So here, I don't want to disclose too much to all of you about our strategy versus competition. But it's important for us to establish strong market share position in Juice and have affordable price point for consumers on the Juice area. And therefore, we decided not to do a price increase on the Juice side. However, if we look at Almarai, in total, the VAT introduction in July is a complete follow-through and has no impact for Almarai, plus or minus.

Yes. Yes. If you can just comment about Q3 volume growth in Juice. That's it.

Specifically, in Q3 for Juice, maybe, Ikram, can you -- do you have that? Specifically on the Juice part, you can say that's...

We don't disclose volume numbers in detail. And remember, Juice includes both Egypt and KSA. So our disclosure doesn't go to that level. But as Danko said, and you can see the trend on Slide 11 or 12, you can see the trend, which has followed through. And basically, it's the pricing. As you mentioned, we haven't done the price increase in Juice, especially on single-serve because it's a difficult product. And you'll see more developments that we will be launching. We will go more towards the SAR 2 or the SAR 1 price point. So yes, as I said, we don't go into those specifics, yes.

That's good for me to know also. Ikram, thank you.

No worries.

Our next question comes from Adnan Farooq, Jadwa.

I have three questions. The first one is regarding the Poultry segment. The margins declined quarter-on-quarter, and I'm assuming that's because of the change in mix between retail and foodservice segment. Can you tell us how was the contribution of the retail segment in the third quarter as compared to how it was in the first quarter and second quarter? This is the first question. The second question is on your export markets, which export markets have led to this growth in export sales? And how much of the growth in Food and Long Life Milk segment was driven by these export markets? And third and the last question is regarding your strategy in Oman. Given the new competitor, I understand that -- how are you planning to make up for the decline? Or do you think it will be difficult for you to recapture the market share that you have lost?

Thank you for your three questions. I think on the first one, I would say, yes, in terms of the mix. But for me not to say too much yet to make sure that I'm not disclosing more than I should, maybe, Ikram, can you take number one and two, and I will take number three?

Sure. No worries, Danko. So I think what happened in Q2, Q3 in Poultry section, we have gone back to pretty much the same channel mix we had in Q1. So for us, Q2 was an operation where we were having between 70% to 75% of our growth was coming through retail channel or our sales were in retail channel. And now, we have gone back to the Q1 numbers, which is between 50% to 55% is from retail. You can say roughly half the sales is in foodservice and half the sales is in retail. So Q2 was a major operation. You saw a huge growth in the profitability, and we're coming back to it. Maybe Q2 was a future scenario where you will see how, as we grow retail volume more and more, the profitability will go up. But that's one of the rationale that why it went back down. So that's on the question number one. Your question two was more around the export sales and how it's driven by. Majority of it is driven through Iraq and majority is coming through UHT sales as well.

Okay. So if I then just talk a little bit about...

[indiscernible]

Please go ahead. Do you want to follow up number two?

Yes. Just to follow up on the question number two. So food sales are driven by core markets and long life sale growth is driven by export markets. Is that correct? Or is it both food and long life growth both are driven by Iraq?

No. The Iraq is -- okay. So if you talk of pure growth, majority is actually coming from KSA. I thought your question was only about where the export sales are centered around. So majority of export sales by themselves are centered on Iraq. If you think of only the growth, I would say, probably 90% of the growth is 95% of the growth is coming from KSA, not even the Gulf region, both for Foods and both for the Long Life Milk.

All right. So if I then just talk briefly on your question number three on Oman. We see ourselves having our home market in the GCC region. So Oman is part of the family. If we think about what is our core region within, which are strategic, it's important for us to hold market share and establish ourselves. And what has happened in Oman, as you know, it's the Mazoon Dairy which is affecting us significantly in our presence in that country. It is very hard to make good business in Oman given the size of the country unless you have the scale. So we are looking for ways to establish ourselves with food security in the whole GCC region. And the notion of Almarai, taking the point about food security in KSA is equally important for us also in the GCC region. And that might not always be the same perception in those countries where we operate, but that's our desire to be with our core competence in our core categories in the GCC region, and Oman is no exception. And we try to find ways to improve profitability, but it's hard when you can't leverage economies of scale in such a large country. So there's more to do. We have no intent to get out of that business. On the contrary, we are having every attempt to find good business opportunities to drive our core categories in that country.

Our next question comes from Mr. Taher Safieddine, JPMorgan.

This is Taher from JPMorgan. A couple of questions from my end. Number one, can we get just some color on what's happening in the long life dairy market? I mean your revenue growth is quite impressive. Are you seeing I mean the substitution maybe away from fresh? Clearly, long life has been growing at a faster growth rate than fresh. How is the promotional or the pricing environment? Are you seeing any aggressive promotions there? That's my first question within products. My second question is on the poultry. I mean what's the strategy into 2021? We understand there's some CapEx or capacity coming through. But is the focus still to push through the retail channel at the expense of foodservice? So that's on the product. And my second question is on the costs. Is it fair to assume that starting next year, these incremental costs from expat levies, alfalfa will start to wind down and potentially maybe could support your operating margins and given it's been 2, 3 years that we've been struggling with cost inflation from different items? So that's my second question. And finally, on the free cash flow, the story keeps getting better and better. Today, Almarai is at 6% free cash year, something that, I mean at least for me, I haven't seen in a very long time. What has opened the door or maybe put pressure on management to further pursue M&A given that organic growth seems more or less to be relatively muted, especially if we're going into a tough 2021? I mean just any thoughts on how do you look at M&A? Is it expanding into geographies, product categories? I'll leave it there.

Thank you for your question. I got to four questions there. So let me see if I can answer three of them, and maybe Ikram can complement then where I fail to put in insights. But on the first one, when it comes to long life dairy, I think it's very hard to say what is the sole reason for the growth. Of course, we want to believe we have good product, product development. It's strategically important for us to move into long life dairy. We're putting in a lot of effort in investing in product development, brand equity positioning, et cetera. It's important for us. But it's also a case of understanding consumer behavior between the fresh and the long life. There's no doubt that people are stocking up differently to what they did pre-corona. So there is definitely a one-off element for which I'm hearing now that we are seeing some destocking that will have an effect on it. The consumer behavior in that aspect, it's very hard to differentiate from what I think is just the consumer preferences overall. So the pandemic definitely plays a role in it. We want to be #1 in the long life dairy. It provides great opportunities for us to grow more, and we want to take a leadership position in that area. So whether it's a temporary flux or not, I would like to believe that we have strong activities in the pipeline, but maybe we are being a little bit helped from the pandemic, further exacerbated by the fact that some of the imported products on long life are not available on shelves. So to be very modest, there might be a couple of things that are helping us there in the category, which is growing anyway, and we are taking market share position in that area. So the more we can do, the better it will be. But strategically, it is a core focus area for us to grow within. On the poultry side, we want to of course grow poultry not only an expansion of the channel, it's a capacity expansion. And my understanding [Audio Gap]

Please hold the line. The conference will resume shortly.

Sorry. Did I get muted again here, perhaps? Did you...

Yes, sir.

Yes. We just lost you at the poultry question.

I'm sorry. I don't know why this is happening. But answer is, we'd rather grow retail significantly and then on top of that, foodservice. Any day of the week, we take the profit contribution from both on a diluted margin basis than having a very high margin and only having a lower absolute. So the more we can expand, the better it will be. So it's a question of us expanding our capacity, and that is what we are doing at the moment. There's no extra announcements on investments in that area. It's something that we put a lot of emphasis on. On the free cash flow, it's very nice to see the yield. I agree with you, and I've been around for many years, and then it clearly is the strength of Almarai. I don't think the cash flow drives M&A strategy. It's more about us taking advantage of potential industry consolidation scenarios because of the pandemic that we can grow. Our strategy to grow through acquisition will have to make industrial sense. And we are currently looking at our strategy and might expand into interesting areas, but they are all part of our objective of growing Almarai in a way that sort of makes industrial sense for us. And it is my hope that we are able to find those opportunities and use the cash flow that we generate into M&A rather than then eventually dividending it back to the shareholders. So that will be our core objective. We certainly have the firepower, but we have to find the right targets and maybe the situation in the environment today will allow us to find something. On the cost increases, I'll leave that question to Ikram, who has the history. I think that's perhaps easier.

So Taher, in terms of cost increases, the main issue is the government, the reforms -- on the labor reforms. This is the last year. So this is now finished. So like-for-like, you will see a similar number, which is disheartening to see on the labor reforms. On the subsidy issue, this is where we probably see a negative impact. As you're aware, the subsidy were taken away on the feed subsidy. You didn't see the impact -- they were done on the 24th of December 2019. The fact that you haven't seen any impact in 2020 of the subsidies is because we follow the accrual system and the subsidies are going to last us until about Q4 anyway. So Q1, you will -- sorry, in 2021, there is an impact of around SAR 150 million to SAR 160 million of the subsidy on non-green product, which is corn and soya, which for the dairy sector which is likely to hit not Almarai in that monetary term, but it will impact the total dairy industry as well.

Okay. But just to understand, sorry, from expat levies will wind -- will taper off after this year, right? I mean in terms of increases, there's nothing beyond 2020.

Correct. Correct. Correct.

Our next question comes from Saul Rans, Morgan Stanley.

Two questions, please. The first question was that you mentioned in your prepared remarks that in the month of September, you perhaps saw some softening of consumer demand in Saudi compared with the level in July and August. Maybe you could just elaborate a little bit on what form that softening took. Was it lower volumes or low -- evidence of down trading, people looking for promotions more aggressively? And any indications you can give about what kind of categories that is perhaps starting to impact? And then my other question was just regarding your poultry business. Have you seen any change in the availability of frozen imported product into Saudi during Q3? And you have any greater push from importers into the kingdom to push products into the market? Those are my two questions.

Well, thank you for the questions. I'll start with the first one on September. How is that visible for us? Well, first of all, I think we are continuing to see, as you see in the quarter, good growth coming through. But what we started to see was increased competition in pricing so that in the marketplace, we could see some of our competitors starting to push on price. So I think the value component is becoming more important, and we have to be mindful of that in Almarai. It's not that we are creating value propositions only. I think we need to have premium offerings and mainstream and mass market, but there is an increased -- it's more tense on the competition in what we've seen it before. We also see some of our expected numbers are not necessarily coming in to the same great delivery across the board. So it's nothing sort of alarming, but we're seeing something that we didn't see before. And maybe I should just stop and not say more than that. But it would be interesting to see how this sort of pans out in the fourth quarter. The bakery side was more affected, but I think that had a lot to do with the postponement of the back-to-school event, which clearly could come back in the fourth quarter, if they actually open up the schools. So those are the things that we are seeing. Is there any more sign? It's just early sign. And based on that, we are just flagging what that might mean for us. Of course, we should prepare for price offerings to consumers that satisfy all the different needs. We just think that if -- there's no scientifics behind this. But when you do a VAT increase of 10%, up to 15% in a very sudden move, it sometimes doesn't hit home immediately among consumers. So they continue to have the same consumer behavior for a month or 2, and then they start realizing, now, we've got to look for more value packs. So we are now preparing promos where you have buy 10 and get 2 for free as a way to mitigate that sort of value concept that is developing. We're putting a lot of emphasis into that kind of promotional activities because I think it is hitting home now that the disposable income is coming down for a lot of people. So that's the sort of signs that we see for the time being. And we'll see how it develops in the fourth quarter, if it continues to escalate or maybe stop. It's very difficult, as you know, to predict in the current environment. On the poultry side, can you take that one, Ikram?

Sure. No. Yes. You're right. We haven't seen any major push from any of the competition. The pricing is remaining intact. We haven't seen a major push into promotions either. And that's why the market share, the whole trend is pretty much intact. There hasn't been any abnormal activity we have observed.

[Operator Instructions] We have a question from Michel Salameh, Citi.

Can you give us more color on IDJ in Egypt? And what's happening in terms of the market dynamics and the internal consolidation that you're seeing at IDJ?

Yes. I think Egypt is performing well when you look at the growth numbers from Egypt. At the same time, if I think -- if we look on a like-for-like basis in an underlying currency, it's about 7% growth. And we are of course happy with that, but we were expecting much more in Egypt. And we are dealing with some operational issues that has to do with of course the COVID-19 is affecting Egypt, but it's also a question of streamlining our operations. And at the moment, we have our business in Egypt going through a transformation change in terms of the productivity levers that they are driving and trying to improve them. And they are doing an absolutely fine job. But it's suppressing our underlying profitability a bit. So even if you're seeing a lot of good growth coming through, some of the one-off costs that are being incurred affects the profitability, and the denominator and numerator has a very dilutive effect even if we are consolidating it into Almarai. Finding the right growth opportunities in the segments that we're in, in Egypt is work that they are undertaking at the moment. I think they're doing a really good job in finding their way in doing that. But it's very clear that we, together with Pepsi, have worked with hard efforts together with management to ensure that we have the right cost structure for the business in Egypt. The fact that there are such a large population, there is a huge potential for us, we believe, in Egypt, if we get the value propositions right for the consumer offerings. And that's the work that is currently being done. So I wouldn't express concerns about Egypt. It's just something they have to go through in terms of driving operational efficiency and then finding the right growth strategy for the respective categories that we're in. I don't know if you want to add anything to that, Ikram.

No. No. I can't. [ It's your turn ]. Go on.

Right. And on the higher inventory levels, is that just to be the new normal as part of the food security program for Saudi, in general, and the GCC?

Not really if you ask me. But there is also some history that I think Ikram is very suited to answer. But I think we can be much better on inventory than where we are today. But Ikram, please feel free to add your comment.

Sure. Look, I think the increase in inventory is coming from twofold. I think that's the question you're referring to, just to be -- the loss due to COVID. Is that the question?

Yes.

Okay. So the inventory increase is coming from twofold. Number one, it's driven by the COVID-19 issues, and we want to make sure that we have enough stock cover to make sure any delays in containers and how the world supply chain is coming back online. And you can imagine, there will be some pockets which will feed some stress. So this is just to make sure that we are carrying slightly higher cover, but we're fairly comfortable that we'll come back to normality within 1 or 2 quarters. But we just don't want to take any risk, especially during this part of -- as you go into the winter. So this was mainly on -- the half of the growth is coming from our foods and our juice inventory coming on normal business. The second part is coming from our farming inventory. Farming inventory in absolute terms in tonnage, it is coming down. But sadly, what is happening is we are replacing a low-cost inventory with a high-cost inventory. As we are consuming more and more of our locally produced alfalfa and replacing it with imported alfalfa, it is costing us double. So although we are reducing our stock, every time we're replacing 1 ton of stock, it's costing us virtually double the amount. So quantity is coming down, but the value is actually starting to go up slightly. That means that we will probably continue this drive to reduce our stock cover over the next 1 or 2 years. Currently, we are still carrying between 26 to 27 months of stock cover for alfalfa. We are planning to reduce it down to maybe 1 to 1.5 years over the next 1 or 2 -- probably over the next 12 months. And you saw the sales in export, which is driven by alfalfa. And that's -- again, that's one of the initiatives we are taking to reduce the stock cover. We are fairly comfortable in our supply chain mechanics now, and we feel that we don't need to carry the 2 or 2.5 years of stock cover that we were forced into when we moved from the forage ban in KSA.

And how much of the locally grown alfalfa do you still carry?

We'll be exhausting our stock -- forecasted to exhaust our stock by the end of the year. We -- more than likely, we have nothing. We will have next -- actually, we will have nothing coming on 1st of January 2021.

Our next question comes from [ Ingram Jiwani ], [indiscernible] Financial.

Could you please shed some light on your mitigation strategy regarding the subsidy phase out? And can we expect further price increases in the coming periods in this regard? And what's the main reason for the lower market share of fresh milk and UHT milk during the period from Jan to August?

I think that was a little bit difficult for me to hear your questions. I think the strategy around the elimination of the subsidy is quite simple. If I understood your question right, what are we doing at mitigation? And the answer is that I believe pricing is suppressed because of subsidies, especially in the fresh area. And the more subsidies disappear, if they do, we need to mitigate through pricing to normalize the demand and supply like in any country. I think Saudi is #38 in the world when it comes to pricing of milk. So there's been a correlation between relatively low pricing and the subsidy that you receive for it. So longer term, it should be pricing. It's not easy to do pricing in this region, but it's not easy to do pricing anywhere in the world. It's a challenge in the U.S. or in Sweden or in France. And so we also have to work on our cost structure and our productivity measures. And the initiatives that we are having initiated because of the pandemic is also there to mitigate effects on the evolution of subsidies that come through in the long run. So they are sizable enough, and I hope I will be able to come back to you and talk a little bit more about the specifics of the productivity initiatives that we are doing, but I don't want to do that yet. I want to wait a little bit. When we are a bit more firm on them, I will be very happy to explain that. But as in any company, I think if you do have a suppressed pricing because you receive subsidies, at the end of the day, it's a zero-sum game and should be for an FMCG business that should have normal returns on their margin. But the way to deal with it is simply to deal with pricing. And then, of course, we cannot afford to have inefficiencies and price that in the marketplace. We have to be very tight in our cost structure as well. On the second question, I'm afraid I didn't hear it. But maybe, Ikram, did you hear that one?

Yes. No, I can only understand something about fresh milk market share, but I didn't understand the question either. If you can please repeat the question.

Yes. The lower market share for fresh milk and UHT milk is on Slide 5 -- Slide 7, I think.

Correct.

What are -- pardon?

Sorry. I -- sorry, I think the question is...

Yes. What are the reasons for the lower market share of fresh milk and UHT milk and poultry in...

Okay. I think that is an illusion because in the last quarter, it was -- no, we were actually increasing it. So relative to the previous quarter, we are showing increased market share in fresh milk and UHT milk. But then versus last year, maybe you have a better insight on that, Ikram?

No. I'm -- no. you are spot on. So what is happening is market share because we are giving a point in ton, maybe we can give an MAT, which would cover a more weighted average market share. Depending on certain promotions, especially during winter times that some of the dairy producers were on or some of the excess milk, some of the market shares can fluctuate. It fluctuates between 1 or 2 percentage points range. And to mind you, if you think of our UHT, it's one of the highest growth we are seeing this year. We're growing at 20% plus, and it'll be growing in the core market. Yet the market share, as you can see, is remaining flattish compared to last year, for example, or even slightly behind. So as Danko said, the market share has been improving since last quarter. It's looking better, but perhaps it's better to look at a trend ratio, how this is working out. And it's better to look into a range in the trend, less than minus 3, 4 points. If you see our detailed Investor Relation presentation, you will see it fluctuates quite a lot. Foods, depending on the promotional activity, one competition is running. For 1 or 2 months, you will see a drop, and then it bounces back up again. So if you think of a tight range, we haven't seen any major change in the market share. If you see on each participant as well, we haven't seen a change in the market dynamics. And I think that's probably more relevant than that.

Okay. Should we have one more question perhaps?

Our last question comes from Mathew Menezes, Millennium.

So just I'd like to be clear on alfalfa. So what's going through your P&L at the moment? Is it the low-cost alfalfa or the alfalfa that's coming in at double the price?

Currently, around 80% of our cost is based on imported alfalfa. Around 20%, if I take the full average for the year, will be around, what you call, a locally produced alfalfa. So next year, this is what we've been saying. Next year, everything will be imported alfalfa. So if you want to compare 2021 versus 2020, there's likely to be, let's say, between a SAR 40 million to SAR 50 million hit mainly because we are switching -- I mean we have been -- we have switched already to importation, but the consumption has been delayed. And the P&L is running on consumption, not on importation.

Okay. Okay. So incremental, SAR 40 million to SAR 50 million...

Incremental is correct. Correct.

Okay. Perfect. And then do you have anything on -- just to share on the eggs. It seemed like an interesting idea that you spoke about last set of results.

Not more than -- that we are still very encouraged with what we're seeing in the marketplace. Our pilots and our trials are very interesting. We have not dismissed the idea of expanding in that area. There seems to be a consumer preference and the benefit, the halo effect of the brand so that the absolute premium pricing on eggs is when you have free-range chickens organically positioned. We are not in that range of the ultra-premium pricing, but we are on a premium pricing, a little bit above the sort of the mainstream offering because we have good quality on the eggs, it's Class A eggs, which follows this labeling that you do. So nothing dismissed yet. Too early to tell. Encouraged with the first effects we're seeing. Consumers seem to like it and associate it with the regular poultry brand. So I hope to be able to come back to you a little bit more when we know more.

We have no further questions. Dear speakers, back to you for the conclusion.

Well, thank you very much. And sorry if some of my speech disappeared here in the technology here. But hopefully, the number speaks for themselves in the presentation you have ahead of you. The first 9 months of the year have been I think very strong from Almarai despite a very, very challenging environment. There's no doubt, we are no exception to the challenges that everybody is exposed to at the moment. And in particular, if you deal with food and beverages, things that you have to put in your mouth has to be very safe. So despite the hardship, I think we are very proud about our ability to deliver what has been done here in the first 3 quarters. And the third quarter was no exception with VAT being introduced and the commercial impediments that are associated with that. So an additional strong quarter, good growth in our core GCC region. We see good delivery on many of our categories and channels. What we want to flag to you I think is this robust performance. We are pleased with that, but we remain cautious for the balance of the year and also year 2021 due to those external economic challenges that I think are facing our industry. And that's primarily driven by a population decline that we expect, lower GDP growth due to COVID-19, labor reforms, unemployment, disposable income. So in order for us to manage that, we are developing multiple scenarios to mitigate potential impact in our bottom line. And we will roll that out throughout the year and the rest of the year until next year to make sure that our consumers get a supply of top-quality products and while we maintain a very healthy return to U.S. shareholders. That's our core objective. So with that, thank you very much for listening into our call today, and let's talk again in the fourth quarter coming up. Thank you very much, everyone, and goodbye.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you all for attending. You may now disconnect.