A promising market: Spending power is rising and consumer preferences are shifting to formal retailing

While international brand penetration is increasing, Saudi Arabia’s vast potential for retail has yet to be fully realised. A combination of favourable demographics, rising incomes, and strong consumer confidence and appetite makes the country one of the most promising growth markets for retail globally. Although the local industry has a challenging operating environment and unique social dynamics, in both the short and the long term, the rewards for investment in the sector should be high.

STRONG POTENTIAL: Dubai might have one of the highest international brand penetrations in the world and myriad options when it comes to shopping malls, but it is Saudi Arabia that offers the strongest growth potential in the region. “If you look at the markets of the GCC, Saudi Arabia is by far the most attractive for profits and size,” said Jayant Khosla, CEO of Landmark Group Saudi Arabia. “Many international brands use the UAE as a hub and place to launch brands, but if you look at volume and gross profits, you cannot ignore the case of Saudi Arabia.”

The case for the Kingdom is quite simple. The population of the country, at 29.99m in 2013, is the largest on the Arabian Peninsula. Growing at a rate of 2.7% in 2013, according to the Central Department of Statistics and Information (CDSI), it offers a sizeable consumer base for retailers. More importantly, it is a young population with growing wealth. In 2010, 66.6% of the population was between the ages of 16 and 64, according to figures from the UN. By 2015 this figure will be 67.7%. This working-age cohort is also benefitting from a growing level of disposable income. As per figures from the Economist Intelligence Unit (EIU), this is expected to grow at a compound annual rate of 10.3% between 2011 and 2017, reaching $10,800 per head in the latter year.

The general performance of the Saudi economy and the growth of the private sector (which contributed 58.8% to real GDP in 2012) will undoubtedly support the retail environment. In 2012 real GDP grew at 5.13%, with private sector growth at a slightly higher 5.5%. GDP per capita is expected to increase from $16,267 in 2010 to $22,725 in 2015. Such strong growth and potential revenue generation have allowed the government to not only spend on infrastructure and services, but also on efforts to bolster the incomes of Saudi citizens.

RISING SPENDING POWER: There have been a number of programmes to support wage growth and sustainable employment opportunities for nationals. For example, the Saudiisation programme known as Nitaqat has had a significant impact on spending power in the local market. Introduced in 2011, the programme had helped place 600,000 nationals in employment by the first half of 2013. Furthermore, according to Adel Fakieh, the minister of labour, it had also led to substantial pay increases of at least SR3000 ($800) for more than 1m Saudis and helped to reduce the unemployment rate by 0.7 percentage points to 11.7% by mid-2013.

“Saudi Arabia is the biggest market in the GCC and has a sophisticated taste in brands. The purchasing power of Riyadh alone is equal to the entirety of the GCC,” Khalid Al Sehaibany, the general manager of Hamat Property Management, told OBG.

The general rise in spending power has also been supported by a robust credit environment. Consumer loans have been growing steadily, increasing by 20.5% in 2012 to SR292bn ($77.8bn). General consumer loans (non-housing and car) accounted for 67.3% of this total. Credit card loans have also been growing. In 2012 they rose by 2.6% to reach SR7.98bn ($2.1bn), according to the Saudi Arabian Monetary Agency (SAMA). This is also reflected in the use of cards in the retail environment. Point-of-sale transactions increased by 23.6% to SR122.2bn ($32.6bn) in 2012.

SAMA has worked hard to control personal indebtedness via measures such as a cap on personal loans (excluding housing) of 33% of income. Consumer debt stands at approximately $44 per head per month, a similar figure to the US. However, given the diverging per-capita incomes, the debt-to-income ratio in the country is higher. It is unlikely to cause any problems, however, with the overall non-performing loan ratio at 2.5% in 2012, and the country’s banks adequately covered with strong provisions for bad loans (see Banking chapter).

Furthermore, inflation is unlikely to put any pressure on consumers in the near future. In January 2014 the annual level dropped to 2.9% from 3% in December, the lowest rate since April 2007, according to the CDSI. Food and beverages was a leading driver at 5% year-on-year (y-o-y), while housing and utilities was at 3.7%. For full-year 2014, inflation is expected to average 3.5%, rising to 4% in 2015, according to analysts polled by Reuters, and is unlikely to have a major impact on consumer spending.

HEALTHY DEMAND: In the medium term demand is likely to be supported by retail spending by tourists and pilgrims. In 2012, for example, pilgrims travelling to the Kingdom to perform the Hajj and Umrah spent a total of $16.5bn, or around 3% of GDP. While construction work has led to a reduction in pilgrim numbers for the next season, growth should pick up.

It is clear that the appetite for retail spending remains undiminished in the Kingdom. According to the latest MasterCard consumer confidence index, published in August 2013, sentiment remains strong, standing at 93.3 (out of a possible 100). Consumers are confident about the economy (a score of 97.1), employment (96.2) and regular income (95.7). Saudi Arabia fares well compared to the region, standing well above the Middle East aggregate score of 78.5 in the second half of 2013.

Given the triumvirate of growing population, income and confidence, it is hardly surprising that Saudi retailers have been performing so well. According to Al Rajhi Capital, retail stocks have been offering the best prospects on the Saudi stock exchange, giving year-to-date returns of 55% for the first 10 months of 2013. The sales of the 12 listed retail firms grew by 17.48% to SR21.9bn ($5.8bn) in 2013, while net profits increased by 13% to SR2.96bn ($789.1m). The market capitalisation of these firms accounted for 3% of the entire bourse.

While enthusiasm for retail stocks was beginning to wane by the end of the year, and Al Rajhi Capital suggested some might be slightly overvalued, Saudi Arabia is still seen as one of the most promising retail markets in the world. In the 2013 Global Retail Development Index, prepared by consultancy A.T. Kearney, Saudi Arabia ranked 16th globally. Sales across the retail industry grew by 11% in 2013, according to A.T. Kearney. Moreover, growth is unlikely to falter significantly in the medium term. Al Rajhi Capital expects the retail industry will grow at 9% per year over the next five years. According to the EIU, the biggest winner will be the electronic appliances and house-ware segment, which is predicted to grow at a rate of 12.1% between 2012 and 2017. This will be closely followed by clothing, which is expected to increase at a compound growth rate of 11% in the same period, and food retail, at some 7.9%.

ELECTRONICS: Indeed, the standout performer seems to be the electronics segment. Jarir Marketing, a book, stationary and electronics retailer, was the top performer among listed retail companies in 2013. It recorded annual sales growth of 13% to SR5.24bn ($1.4bn) in 2013, while net profits grew by 14.65% to SR653.3m ($174.2m). This growth came from existing outlets, as the company had not opened any new stores for five successive quarters to the end of September 2013, according to Al Rajhi Capital. Much of the firm’s solid growth for the first nine months of the year was based on a 40% y-o-y increase in the sales volume of electronic goods.

Abdulkarim Al Agil, CEO of Jarir Marketing, told OBG that the firm does not expect to open any stores in 2014, but plans to double the number of shops in the next five to six years, including regional expansion to Egypt, Oman, Kuwait and Qatar. Al Agil is also bullish about the prospects in the local market. “The book industry isn’t going away as there will always be a demand for physical books, but e-books are making it tougher. The market may be declining, but you can make up by gaining greater market share and diversifying your business. The young and growing population makes the retail business very attractive here. As young people grow older and start to make more money, they will buy even more goods,” he said.

KEY GROWTH SEGMENTS: Growth in the company’s electronics range is in line with wider sector trends. Indeed, the third-best listed performer in 2013 was also an electronics retailer. The United Electronics Company recorded sales of SR3.39bn ($903.8m), an increase of 12.3% on 2012. Profits were also up by 5.49% to SR167.3m ($44.6m). The second-best performer for the year was Fawaz Abdulaziz Al Hokair Company, whose main line of business is fashion retail. The firm recorded sales of SR4.65bn ($1.2bn), an increase of 45.4% on 2012, and profits of some SR580.5m ($154.8m).

Apparel is also considered a strong and growing segment of Saudi Arabia’s retail environment. According to Khosla, “Fashion retail is a standout performer in the market, and value fashion is the best performer.” The most successful brands for Al Bandar Trading, the Landmark Group’s Saudi Arabian arm, are all in the value to middle-income brand bracket. According to Khosla, 70% of its revenue comes from mid-range and value brands (such as Max, Home Centre and Centrepoint). This is indicative of a shift in the market. Saudi consumers are increasingly looking to branded products and the shopping mall environment, even in the lower-income segment. Al Rajhi Capital’s December 2013 report on the Saudi retail sector notes, “With consumer preferences shifting to large store formats, the organised sector will be the major beneficiary of rising disposable income in the Kingdom.”

This is true for both retailers and mall developers. Khosla is confident of the need for more organised retail. “If more malls are built, they’ll easily be filled,” he told OBG. “There are growth opportunities all around the Kingdom and investors need to look beyond the three major markets of Riyadh, Jeddah and Dammam. If the opportunity is right, we’ll take up to 40% of the space in a given mall.” The company, which has hitherto focused on developing retail franchises, has plans to build its own malls in the country under Landmark’s Oasis brand. The company is looking to develop three neighbourhood malls.

RETAIL SPACE: Mall space across the Kingdom is expected to increase substantially in the next five years. In the capital, the supply pipeline is significant. There were 1.25m sq metres of leasable retail space in Riyadh in 2013, according to Jones Lang LaSalle (JLL). This is expected to grow by 36% or 454,000 sq metres by 2016. One of the biggest players in this regard will be Fawaz Al Hokair, adding 174,000 sq metres of space in two developments.

However, the biggest player, in terms of new additions, will be Majid Al Futtaim, the Dubai-based developer. The company has appointed Faithful+Gould to manage the construction of the North Riyadh Mall project, a super-regional mall with around 150,000 sq metres of gross leasable area in the up-and-coming northern suburbs of the city. The project is expected to be completed by 2018.

While there is abundant supply coming to the market, the performance of malls in the capital is mixed. The average vacancy rate across Riyadh was 12% at the end of the third quarter of 2012, a two percentage point increase in the previous six months. Rental rates have been growing slightly in the super-regional malls, with the average rent for line stores across all centres in the capital reaching SR2592 ($691) per sq metre in the third quarter of 2013. JLL expects that rents for select stores in super-regional centres will continue to increase slowly in 2014.

In Jeddah, the retail stock in 2013 had reached 826,000 sq metres of gross leasable area, according to JLL. The market welcomed the addition of the 46,000-sq-metre Flamingo Mall, which was 100% pre-leased upon opening in the second quarter of the year. By 2016, Jeddah is expected to have some 945,000 sq metres of completed stock, with a further 105,000 sq metres of gross leasable area in the pipeline. Galaria (5100 sq metres) and Sairafi 2 (20,000 sq metres) are expected to open in central Jeddah in 2014. The 40,000-sq-metre Kingdom City Mall is also due to open in northern Jeddah in 2017.

The retail environment in the Red Sea port city remains healthy. Vacancy rates are lower than in the capital, averaging 8% across the whole city (and range of malls) in the third quarter of 2013, according to JLL. Rental rates are also holding firm and increasing in some cases. Regional malls witnessed a rise in average rents of 3.5% to SR2475 ($660) per sq metre in the six months to the end of September 2013. Rents in the super-regional malls stood at SR2486 ($663) per sq metre in the same period, while community centres commanded average rents of SR1850 ($493) per sq metre. JLL expects average rents to remain stable into 2014.

E-COMMERCE: The additional mall supply coming to the market shows the strength of the Kingdom’s retail sector. However, it is not only formal outlets that are benefitting from the country’s retail growth. E-commerce is also beginning to take off. According to a report by Saudi Post, the domestic e-commerce industry will reach SR50bn ($13.3bn) by 2015. The report suggests 25% of internet users are already active in e-commerce, visiting 70m e-commerce pages per month. Growth in this area is strong, with Saudi Post pegging it at 9.3% per year at present. The market is currently somewhat fragmented. The biggest player is souq.com with a 13% market share, followed by sukar.com with 8% and Namshi with 7%.

FOREIGN INVESTMENT: For investors looking to tap into retail’s growth potential, the local industry is not without its challenges. “I believe it is easier to penetrate the UAE market,” said Esam Saber, marketing manager for Landmark Group Saudi Arabia. “The problem is the operating environment. But if you have the patience to navigate the investment environment, it is worth it. The biggest challenge is understanding the social dynamics of the market.”

Under the commercial company law, foreign firms must team up with a local partner in a joint venture to enter the market. The international company can take up to a 75% stake in the venture. The franchise brand or concept must also be registered in the Kingdom, a process that can take up to six months.

Nonetheless, although there are cultural considerations for new retail operators, the general business environment is strong. Saudi Arabia ranked 26th out of 189 economies on the World Bank’s 2014 Doing Business Index. Yet in terms of starting a business and enforcing contracts, the Kingdom has some work to do, according to the report.

LABOUR CHALLENGES: The biggest challenge for retailers in the current environment is the availability and cost of labour. A government crackdown on illegal labour was implemented in 2013, with an amnesty period for undocumented migrant workers coming to an end in November 2013. As a result of the policy, which aims to create more job opportunities for nationals, the country is facing short-term labour shortages, and a consequent spike in costs. The strict enforcement of quota and work permit rules that began in March 2013 led to the exodus of almost 1m of the Kingdom’s 9m expatriate workers by November 2013, according to Reuters.

While the biggest impact of this policy has been felt in the construction sector, other industries have not been immune. A study by the Jeddah Chamber of Commerce & Industry found that 3000 franchise branches throughout the Kingdom have been affected by rising labour costs. A report by NCB Capital suggested that the policy will have a short-term negative impact on the retail sector, but that in the medium to long term, local job creation and rising disposable incomes as a consequence of the move would support the industry. Farouk Miah, head of equity research at NCB Capital, argued that the short-term consequences of the policy include “1m fewer expatriates, the negative sentiment from remaining expatriates, a slowdown in new store openings and higher staff costs for companies, leading to pressure on margins”. Although there has been much progress in boosting Saudi participation in the industry, there is still some way to go. According to the Arab News, about 16% of the 1.5m-strong retail labour force is currently made up of Saudi workers.

OUTLOOK: Despite this short-term challenges, the broader outlook for the sector looks promising. Economic and population growth, rising income levels and an undersupplied market all point to growth opportunities for retailers. As the sector migrates to large-scale formal outlets and shifts online, the prospects for additional brand penetration should also improve. While the greatest opportunities will be in the supermarket and fashion segments, there is potential for retail expansion across the board.