Buoyant long-term retail expectations in Saudi Arabia despite hurdles

With high levels of consumer spending in 2015 and early 2016, and despite recent macroeconomic pressures, Saudi Arabia’s retail sector is widely acknowledged to be a bright spot in an otherwise challenging current economic landscape. Over the past decade the industry has posted growth of 12% on an annual basis, according to data from a December 2015 report from consultancy McKinsey, on the back of steadily rising purchasing power among Saudi households and, concurrently, rapid investment in the Kingdom by domestic and international retailers alike. The most pressing hurdle to ongoing sector expansion is the regional macroeconomic situation, which has resulted in a decrease in government spending and reduced subsidies for electricity and fuel. This in turn has had a negative impact on retail expenditure across the region.

Indeed, according to data compiled by the Saudi Arabian Monetary Agency, in the first quarter of 2016 the value of point-of-sales (POS) transactions in the Kingdom was SR43.51bn ($11.6bn), down from around SR46bn ($12.3bn) in both the third and fourth quarters of 2015, and more than SR49bn ($13.1bn) in the first two quarters of 2015. It is important to note that spending was buoyed during the first quarter of 2015 by a two-month salary bonus for all public sector workers and some private sector workers following the ascension to the throne of King Salman bin Abdulaziz Al Saud in January 2015. The number of POS transactions declined from a total of 120.95m during the last quarter of 2015 to 119.68m in the first quarter of 2016.

Working Hard

The Kingdom’s retail sector also faces various challenges related to implementing best practices in merchandising and logistics, which have the potential to be exacerbated by retailers’ recent efforts to set up shop in underserved second- and third-tier cities. Lastly, issues related to workforce development and the rapid uptake of e-commerce – the latter of which is considered to be a major area of focus for the sector – are key challenges moving forward. “We see a shift from luxury items towards medium-tier items,” Samir Abdulhadi, managing director of the Mawarid Distribution and Trading Group, a major retailer in the Kingdom, told OBG. “This is the result of a decrease in dispensable income due to the rising cost of living.”

Despite these issues, most domestic players are broadly optimistic about the future. According to the UAE-based Middle East Council of Shopping Centres (MECSC), as of late 2015 Saudi Arabia’s retail market was valued at around SR170bn ($45.3bn), making it the single largest retail sector in the region by a considerable degree, accounting for an estimated 63% of the SR270bn ($72bn) GCC-wide retail market. Furthermore, according to data from McKinsey, the number of Saudis employed in the retail industry doubled between 2010 and 2014, which bodes well in a country like Saudi Arabia, where at the end of 2015 the median age was 29.

The sector’s impact is expected to grow for the foreseeable future. Indeed, according to McKinsey’s forecasts, the Kingdom’s retail and wholesale trade has the potential to triple in value and employ an additional 800,000 nationals by 2030. In a speech at an industry event towards the end of 2015, Mohammad Alawi, president of the MECSC and the CEO of Red Sea Markets, a Jeddah-based shopping mall development company, told the press, “Global investors find the GCC’s retail market, and the Saudi sector in particular, extremely attractive.”

Retail History

While the period of rapid expansion that led to the development of the modern retail sector in Saudi Arabia did not begin until the late 1990s and early 2000s, a handful of the Kingdom’s largest domestic retailers have been active in the country for a considerably longer period of time. Al Othaim Holding, which operates a network of supermarkets, was initially established in Riyadh in 1956. In 1978 Panda, a supermarket operator that is today known as Panda Retail Company, was formed in the capital. Jarir, which deals in non-essential goods, was launched in Riyadh in 1979 and listed on the Saudi Stock Exchange in 2003. Today, Jarir is active throughout the Gulf region.

Meanwhile, Fawaz Al Hokair, which has holdings in the fashion and apparel segments, was established in Riyadh in 1989. Dar Al Bandar Trading, which operates under the brand the Landmark Group, was established in Bahrain in 1973 and entered Saudi Arabia in the early 1990s. Today the firm is one of the largest retailers in the GCC region, boasting a significant presence in the Kingdom.

Rising Incomes

A rapid expansion in retail demand in the Kingdom during the late 1990s and early 2000s was linked to strong economic growth throughout the Gulf region in this period – as a result in part of high oil prices and correspondingly high levels of public sector investment by GCC governments – combined with rising levels of retail awareness among Saudi nationals as a result of widespread internet access and an uptick in foreign travel. The steadily increasing purchasing power of Saudi nationals has been perhaps the primary driver of retail sector growth in the country over the past decade and a half.

According to data from Euromonitor International, from 2006 through to 2011 Saudi Arabia’s total annual disposable income increased from $103.27bn to $191.93bn, which represents a growth rate of nearly 86% overall and a compound annual growth rate (CAGR) in excess of 10%. This is largely a result of rising public sector salaries in the 2000s in particular, though also over the past five years.

Additionally, the government’s Saudiisation programme, which aims to encourage nationals to seek private sector jobs, has resulted in pay jumps for many Saudis. This has led to dramatic growth in consumer expenditure over the past decade. From 2006 to 2015 total consumer expenditure in the Kingdom nearly tripled from $86.4bn to $246.9bn. According to the latest data from Euromonitor International, Saudi Arabia continues to have the highest consumer expenditure in the GCC region.

Recently, the Kingdom, along with other oil-reliant countries, have seen a slight decline in retail demand. According to a report on global consumer trends from US-based media research firm Nielsen, in the first quarter of 2016 consumer confidence in the Kingdom declined slightly compared to the previous quarter, though it remained well above the company’s “optimism baseline” for the Middle East region at large. Meanwhile, the percentage of Saudi survey respondents that believed their country was in an economic recession jumped 10 percentage points in the first quarter of 2016 to 63% in total.

Recent Developments

In September 2015 the Saudi Arabian General Investment Authority (SAGIA) announced that it would allow foreign investors to own 100% of retail and wholesale businesses for the first time in the Kingdom’s history. The increase, up from the previous 75% cap on foreign ownership, is in line with the government’s current drive to diversify its economy away from hydrocarbons revenues. Attracting new investors is considered to be a central component of this effort. As of mid-2016 SAGIA was in the process of drawing up a new regulatory framework for foreign investors, which is expected to be released sometime before the end of the year (see Trade & Investment chapter).

The rule change has already yielded results, with LuLu Hypermarket, a UAE-based supermarket chain, announcing in early 2016 new plans to expand its footprint in Saudi Arabia. Abu Dhabi-based daily The National reported in January 2016 that the firm’s expansion plan was a direct result of the new 100% foreign ownership limit. Vijay Nandakumar, head of corporate communications for LuLu Hypermarket, told the daily, “We were one of the first companies to benefit from the easing of restrictions. We only moved into the country in August 2010, but have six hypermarkets there now, after opening in Dammam recently.” LuLu’s expansion plans involve opening four more hypermarkets before the end of 2016, two in Jeddah and one each in Hofuf and Hail.

While the new rule is widely expected to stimulate additional activity in the retail sector in the coming years, some companies have reportedly held back due to the current lull. “There will certainly be more foreign direct investment as a result of the [100% foreign ownership] rule change,” Mohamed Tomalieh, an equity research analyst at Riyadh-based investment company NCB Capital, told OBG. “But it is an open question as to when this will take place. Given the slowdown, some corporates have been delaying their expansion plans.” Furthermore, despite the pullback in regulation, other challenges to establishing a business in the Kingdom, including the Saudiisation policy and high operation costs, could prompt retail brands to stick to the established route of entering the market through partnerships with franchisers rather than directly.

Hours Of Operation

For the past few years the retail sector has been at the centre of a series of public debates about whether or not the government should mandate hours of operation for retailers. The discussion was reignited in July 2016, when Saudi Arabia’s Ministry of Labour and Social Development (MLSD) recommended that the government require retail shops to close their doors at 9.00pm. There is currently no mandated closing time for retail operations, and the majority of stores remain open until 2.00am or 3.00am.

The recommendation was based on a study that looked at how the state might encourage nationals to participate in the retail industry, and particularly to encourage young Saudis to establish new retail shops of their own. Since 2013 expatriates have made up some 66% of the Kingdom’s total private sector workforce, and retail shops account for the majority of small and medium-sized enterprises in the country. The MLSD study indicated that by enforcing a nationwide 9.00pm closing time for shops, the country’s large youth population would be more willing to establish and operate retail stores. However, the idea was quickly criticised on the basis that many Saudis do the bulk of their shopping at night so as to avoid the high temperatures that are common in the Kingdom during daylight hours and the frequent mandatory closing of shops at prayer times during the day. Furthermore, a study conducted by the Chamber of Commerce in Jeddah found that 72% of customers in the city were in the habit of going shopping after 9.00pm, meaning that any decision to reduce opening hours could lead to significant economic losses.

Since 2013, when the plan was first proposed, the MLSD and other government entities have carried out additional studies and made various proposals with regard to the shop closing initiative. As of mid-July 2016 the ministry was studying the most recent version of the proposal, under which coffee shops, entertainment centres and restaurants would be exempt from the new rules. Indeed, a range of different types of retail outlets, including grocery stores and supermarkets, have been exempted from the proposed regulation since it was introduced in 2013. “The logic behind the proposed 9.00pm closure is to attract Saudis to work in retail shops, so they will have the same hours as other currently favoured jobs. But, of course, retailers that sell discretionary products, in particular, would be negatively impacted by this change, as it could potentially mean fewer working hours daily,” Tomalieh told OBG.

Strong Fundamentals

Saudi Arabia’s large population, robust purchasing power and rising reputation as an important destination for a range of foreign brands points to continued retail growth for years to come, despite the recent period of slower oil prices. Indeed, retail activity is expected to remain largely resilient due to the fact that consumer products, many of which are everyday and necessary items, are more insulated from macroeconomic shocks. “We see that the sector continues to grow,” Rakan El Hoshan, CEO of business solutions provider Hoshan Group, told OBG. “Even in a slowing economy, demand for office solutions is increasing.”

Furthermore, unlike in the UAE, the GCC’s other major retail market, the Kingdom’s retailers do not rely primarily on tourists and visitors to drive consumption. Indeed, retail consumption in Saudi Arabia is driven almost entirely by the local population. As of the end of 2015 the population had reached 31m, some two-thirds of which were Saudi nationals, according to the General Authority for Statistics. This figure is equal to around 62% of the total population of the Gulf region; as of the end of 2014 the six GCC member states had a total population of about 50m, according to data published by the GCC Centre for Statistics. However, thanks to the ease with which the local population is able to travel around the GCC, competition for Saudi shoppers from other countries is somewhat strong. Dubai in particular offers a wide variety of family-oriented lifestyle and entertainment options and has the added attraction of offering brands that Saudi Arabia may not have.

The Kingdom’s population growth rate has slowed somewhat in recent years but is still considerable by international standards. Indeed, from 2004 through to the end of 2015 the nation’s population grew by around 39%, which represents a CAGR of 2.8% over the period. The Kingdom’s high rate of growth points to continued demand growth for retail products of all sorts in the coming years.

Youth Bulge

Additionally, as previously mentioned, a significant percentage of the nation’s population is young and relatively affluent. More than 66% of Saudi residents are between the ages of 15 and 59, and the median age, as noted above, is 29 years, according to a January 2016 report from Abu Dhabi-based The National. The country ranked 11th out of 185 countries on Global Finance magazine’s 2015 index of the wealthiest countries in the world, which measures wealth as per capita GDP based on purchasing power parity (PPP). With around $56,253 in GDP PPP per capita in 2015, the Kingdom ranked just below Switzerland and above Bahrain.

Challenges

While these robust fundamentals indicate positive conditions for retail growth for some time to come, in the short term the sector faces several challenges. Oil revenues, which account for around 80% of the government’s total income, have dropped off since mid-2014, as oil prices fell from a high of around $115 per barrel in June of that year to around $47 per barrel in September 2016. This is not expected to impact consumption directly. “Low oil prices and any decline in purchasing power has not affected high-end retail, especially in clothing,” Loai Naseem, CEO of apparel firm Lomar Thobes, told OBG. “Whether in major cities, such as Jeddah and Riyadh, or satellite cities, spending is stable, although volumes may marginally shrink.”

This slowdown has exerted some pressure on government accounts. In late 2015 the state announced that the government planned to run a SR326bn ($86.9bn) budget deficit in 2016, which would be equal to around 16% of GDP, down slightly from the 2015 deficit of SR367bn ($97.8bn), or equal to 15% of GDP. The impact of spending cuts is expected to be far reaching. For example, public expenditure on transport and infrastructure was forecast to decrease by around 63% in 2016.

Significantly, in June 2016 the state announced that it planned to reduce the public sector wage bill significantly by 2020, as part of its National Transformation Programme (NTP), which was formally approved in the same month. The aim of the move is to cut public spending and shift toward more balanced public and private sector employment levels. In 2015 public sector wages cost the state some SR450bn ($120bn) in total, or just under half of all government expenditure for the year. Under the recently announced plan, Saudi Arabia is looking to reduce this figure to 40% over the next four years. It was recently announced that public sector wages would be frozen, with bonuses and allowances being cut. Pay for ministers was also reduced by 20% and Consultative Council members by 15%. This could have negative implications for the population’s purchasing power, as over two-thirds of Saudi workers are currently employed by the state.

To make up for the impending decline in public sector employment, the government aims to ramp up its efforts to encourage nationals to seek employment in the private sector. Indeed, under the NTP, which aims to prepare the Kingdom for a new era of cheap oil, the government is looking to facilitate the establishment of 450,000 new private sector jobs by 2020. This follows on more than a decade of Saudiisation efforts, which have resulted in a considerable expansion of Saudi Arabia’s private sector, even during the current volatile economic period. According to the SABB/HSBC Saudi Arabia Purchasing Managers’ Index, which tracks economic output, employment and prices among private sector companies, the Kingdom’s private sector has seen continuous expansion since 2014, albeit it at a slightly slower pace than previously.

Current Trends

These pressures are expected to play out in the retail sector in a variety of ways. Non-essential retailers, such as luxury goods manufacturers, will likely be hit harder than supermarkets and other food and beverage sellers, as certain segments of consumers begin to cut back on discretionary spending. Similarly, given subsidy cuts to transportation, agricultural production and other segments that have long been buoyed by government spending, retail prices have the potential to contribute to price fluctuation in the years to come. “Broadly, it seems that non-essential retailers will face heavier winds going forward compared to mass grocery retailers,” Sultan Al Kadi, an analyst at the Riyadh-based investment services company Aljazira Capital, told OBG. “Consumer spending patterns will definitely change as retailers and producers react to the new environment. For example, retailers may either charge higher prices, absorb higher costs to maintain sales or even lower prices to gain market share as others hike prices.”

Regardless, as evidenced by the slight decline in POS receipts in the first quarter of 2016, the Kingdom’s current period of economic volatility has already had a somewhat negative impact on consumer confidence. According to the Thomson Reuters/Ipsos Saudi Arabia Primary Consumer Sentiment Index, which aggregates measures of job confidence, economic expectations, investment climate and current personal financial conditions, consumer confidence in Saudi Arabia has been more volatile in 2015-16 than in any other prior period back to 2011. Indeed, in the 12 months through to end-June 2016 alone the index swung by as much as nine percentage points, with most of the volatility occurring in the first half of 2016. “Lower government revenues and increased regional instability are hurting consumer confidence right now,” Abdulhadi told OBG, “However, we expect a turnaround later in the year as the Kingdom’s economy continues to be resilient and promising.” Nonetheless, the impact of declining consumer confidence has not played out evenly across the retail economy. Tomalieh told OBG, “Retailers selling discretionary products have revised down their store expansion plans in recent years. For companies selling consumer staple products we have seen strong and continuous growth, supported by stable organic growth levels in comparison to firms selling discretionary products.”

Driving Rapid Growth

Despite the current dip in consumer confidence, the expansion of Saudi Arabia’s retail market has driven substantial market expansion both on the ground and on the internet. According to international real estate consultancy JLL, a significant amount of new retail space is expected to come on-line in the near future. Indeed, Riyadh’s stock of quality retail space is expected to increase by an estimated 60% through to 2020.

As of the end of 2015 the Kingdom’s capital was home to an estimated 1.41m sq metres of shopping space, primarily located in malls and high-end retail complexes, with an additional 514,000 sq metres set to be added by the end of 2017. Meanwhile, in Jeddah an additional 352,000 sq metres of gross leasable space is forecast to come on-line by the end of 2017. This will bring the city’s total to 1.42m sq metres, up from 1.07m at the end of 2015.

While the expansion of physical retail space is likely to continue for the foreseeable future, some players are simultaneously looking online for new business. Although reliable, up-to-date data on the size of Saudi Arabia’s e-commerce market is not readily available, a recent report by the Ireland-based research company Research and Markets indicates that the digital retail segment is expanding faster than brick-and-mortar sales. Muhammed Al Agil, the CEO of the Saudi-based company Jarir Investment, told OBG, “There are major opportunities for retailers in the area of e-commerce in Saudi Arabia, driven in large part by the Kingdom’s young population.”

Estimates from Go-Gulf, a UAE-based digital services provider, put the 2015 value of e-commerce revenues in Saudi Arabia at $5.9bn, up from $5.1bn the previous year. Go-Gulf forecasts that this figure could nearly double by 2020, reaching $10.9bn. Consumer electronics was the single largest category of retail products purchased online in the Kingdom in 2015, with a total value of $1.81bn. This was followed by clothing and shoes, with estimated e-commerce revenues of $1.6bn in 2015; special-interest products at $1.42bn; furniture and home appliances with $669.9m; and food, cosmetics and pharmaceuticals at $409.8m. Non-Arab expatriates accounted for the majority of online retail transactions in the Kingdom in 2015, with around 59% of total purchases, followed by Saudis at 32% and Arab expatriates accounting for the remaining 9%.

Outlook

While the sustained low price of oil, declining government expenditure and global economic headwinds could contribute to diminished retail sector growth in the short term, domestic players and market watchers alike expect to see strong expansion for years to come. Indeed, Saudi Arabia remains considerably undersupplied in retail outlets in comparison to the majority of its neighbours, though there are signs that it is catching up quickly. With a large youth population and strong disposable income levels, the Kingdom’s reputation as a major destination for top-tier mall developers and retailers is on the rise. Tomalieh told OBG, “Compared to other sectors in Saudi Arabia, retail is doing relatively well at the moment, supported by the store expansions. Which is not to say that there are no challenges. Nonetheless, the Kingdom’s retail industry is clearly on a long-term growth path.”