We maintain our Overweight rating on SGS with a revised PT of SAR37.2 (from SAR44.5). Operating efficiency, growth in flight activity and attractive dividend yield of 6.1% are the key advantages of the stock. However, the recent development of delayed payments from Flynas is a key risk going forward. The stock is trading at PE 12.8x, lower than peer group average of 15.4x.
Umrah pilgrims to reach 8.5mn in 2019: Religious tourism is a key focus of Vision 2030 and its related programmes. By 2030, Hajj and Umrah pilgrims are expected to reach 5mn and 30mn, respectively. In 2018, Hajj pilgrims reached 2.4mn, broadly meeting the target set for 2020. For Umrah, the number of pilgrims reached 6.8mn in 2018, growing 3.6% yoy with a target to reach 8.5mn in 2019 (+20% yoy). YTD, Umrah pilgrims reached 5.7mn, recording growth estimated at 5.4% yoy. As more than 82% of pilgrims come to Saudi by air, we believe Umrah growth will a key factor in supporting the airline business.
SGS flights to grow 4.7% to 375,100 in 2019: We expect the ongoing growth in the number of Umrah and Hajj pilgrims, along with the increase in the fleet size of Saudia, Flyadeal and Flynas, will lead to a CAGR of 3.5% in the number of flights between 2019f and 2023f. Saudi carriers are expected to increase their fleet size by 130% by 2026f, adding 146 aircraft. Saudia is planning to increase its fleet to 200 planes (+35%) by end-2020 from 148 planes in 2018. Flyadeal is planning to increase its fleet from 11 to 25 planes (+127%) by 2023f. Flynas also plans to expand its current fleet of 32 planes by purchasing 80 planes by 2026f. However, due to pricing pressure, we expect revenues to grow marginally by a CAGR of 1.7% between 2019 and 2023. Based on our estimates, the average price/flight stood at SAR7,130 in 2018 compared with SAR7,515 in 2017 (-5.1% yoy). We estimate prices to decline further by 3.7% yoy to SAR6,864 in 2019 and to reach SAR6,173 in 2023f.
Efficiency to support margins: We expect SGS gross margins to improve to 30.5% in 2019 from 26.8% in 2018, mainly driven by the implementation of efficiency programs and discontinuation of the cost of living allowance. The company paid a cost of living allowance in 2018, in line with a country-wide initiative following the increase in utility prices and the introduction of VAT. The total cost of the programme was SAR72mn in 2018. Additionally, we believe the company might benefit from a reversal of the expat levy invoice, which was announced in 2019.