Saudi Arabia remains vulnerable to increases in food prices due to its high dependence on imports, NCB Capital said in its report on food, noting that inability to fully pass on higher costs to consumers will exert pressure on the margins of food companies. It said any rise in global food prices remains a key concern for Saudi Arabian food companies due to their exposure and reliance on this as a key raw material. Although the report foracast that food prices to fall in 2012, it said in the longer term, inflation will be the norm, citing the Food and Agriculture Organization (FAO) report which said that prices of soft commodities over the coming decade will on average be 15-30 percent higher than over the past decade. Saudi food imports are set to more than double to SR132 billion by 2020 from SR63 billion in 2010. The reliance on imports is set to remain given that domestic production is restricted due to the scarcity of water and unfavorable weather conditions. Between the 1970s and 1990s, the Saudi government policy was for self-sufficiency in key crops. However, this has been abandoned with the current aim to work alongside countries which have fertile land but lack the financial investment required to benefit from this, NCP Capital said. The recent rise in global food prices has seen the profitability of Almarai and Savola, the two largest listed players in the Saudi food sector, severely impacted. Margins of both companies declined in 2008 and 2011e by an average of 200bps YoY due to higher raw material costs. COGS account for a major share of revenues for Almarai (61 percent) and Savola (84 percent). On the whole, Saudi food players have historically been able to pass on cost inflation to end consumers. However, with overall Saudi inflation remaining relatively high and with the recent geopolitical developments in the region, this has become increasingly difficult. In July 2011, Almarai increased prices on its 2 liter milk bottle from SR7 to SR8, however a week later it was forced to abandon this due to government intervention. If this is a sign of a change in government policy, this could make it harder for local food companies to mitigate food inflation by passing it on to end consumers, thus hurting their profit margins. Companies will have to be innovative and efficient in their use of raw materials, as well as cut costs elsewhere in order to protect margins, the report said. In 2007/2008, prices of key food commodities increased by up to 150 percent with many commentators stating that higher than average prices are here to stay. Coming after a decade of depressed prices, the inflation since 2006 has been unusually protracted and broad-based. Over the past 12 months, prices of most soft commodities increased by an average of 24 percent. Basic economics lie at the centre of the food problem with demand outstripping supply. On the demand side, there has been a sharp increase in global demand for core staple food items, combined with the inability to keep supply levels increasing at the same rate. These two factors, coupled with poor weather conditions and high transport costs, pushed average food prices up by around 75 percent between January 2007 and April 2008 with cereal prices increasing by as much as 150 percent in the same period. In the past 12 months, FAO price index reached an all time high of 238 in February 2011 before falling to 215 in November 2011. According to the Saudi Ports Authority, Saudi Arabia imported 20 million tons of food items in 2010 (equivalent to 80 percent of the volume consumed) and up from 15 million tons in 2006. The reliance on imports is due to the scarcity of water and adverse weather conditions which make domestic agricultural production difficult. At SR63 billion in 2010, food and agricultural imports accounted for 15.8 percent of overall imports into KSA and grew by 19 percent YoY. According to the Economist Intelligence Unit, food imports are set to more than double to SR132 billion in 2020. Given its reliance on imports, the Kingdom remains vulnerable to a rise in global food prices. The Saudi government has undertaken various initiatives to control inflation and ensure food security; however, imported inflation and the recent weakening of the US dollar pose a risk to domestic food prices. The Saudi government faces the challenge of limiting inflation amid a spike in global food prices. Food prices account for a 26 percent weight in the consumer price index used to measure inflation in the Kingdom, thus any increase in food prices substantially impacts overall inflation in Saudi Arabia. To counter this challenge, the government has undertaken a series of measures. The government has been actively tracking retail prices of key food products such as barley, milk, wheat, sugar and flour. This is done by continuous inspections and imposition of penalties on retailers that increase prices without a valid reason.
