Jul 08 2003
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NCB In Focus: Saudi Equity Market Outperforms Global Market during the First Half of 2003
|Weekly Commentary (July 4, 2003) |
Saudi Equity Market Outperforms Global Market during the First Half of 2003
Taking STC into account, combined market capitalization increased from SR332 billion at the end of December 2002 to SR477 billion on 30th June 2003, giving an absolute increase of SR145 during the first-half of the year. The near-term outlook suggests a range bound market activities in combination with profit taking actions, so as to buy on dips and sell on up ticks, would likely to be the market pattern during the upcoming summer holidays season. However, it remains to be seen as far as the positive impact of establishing a Stock Market Commission (SMC) and a Saudi Stock Exchange thereby bringing on more joint-stock companies to the trading list which would further deepen the market.
Market Buoyed by Strong Fundamentals
On the corporate front, the combined net-profit of the 69 listed companies is expected to rise by nearly 45.3% to an annualized SR27.6 billion in 2003, from an actual SR19 billion in 2002. Larger profitability gains by STC, SABIC, SAFCO and Savola are the prime factors behind this surge. The market appears to have partially factored in such a remarkable profitability growth, as evidenced from the level of price earnings multiples (PE) ratios. On 30th June 2003, the forward looking price earnings multiple (PE) for the whole market amounted to 17.29 times in comparison to 18.03 PE at the end of December 2002, indicating more room for upside moves in prices if investors were still prepared to bid for earnings on the same basis that prevailed last December. (table 2). Excluding the 9 listed banks, being the deposit takers, the remaining 60 listed companies are adequately capitalized as their combined debt expanded by 3.7% to SR155.4 billion in the 12-month to March 2003 and accordingly their debt to equity ratio stood at 1.08 in the same period.
The combined annualized market average return on equity was 14.7% in the first quarter of this year, with cement being the most profitable sector at 23.9% (ROE), followed by banks at 20.8%, industrial sector at 14.3%, and services sector at 5.3% in the 12-month to March 2003. The strong rally this year has resulted in a lower dividend yield at 3.2% on 30th June 2003 in comparison to its level of 4.6% in December 2002, as profitability growth has yet to reflect in the dividend payouts because of the yearly disbursement practice followed by most listed companies. The market average price-to-book value ratio was 2.54 on 30h June 2003, compared with 3.0 at the end of December 2002, reflecting a temporary expansionary effect on the book value because all earnings were still appearing on the balance sheets and not paid out as cash dividends (table 2).
On the economy front, the Kingdom’s economic fundamentals are also expected to remain strong for the remainder of this year. Back in May 2000, the average 3- month riyal deposits rate stood at 6.806%, and now it is around 1.60% as of June 2003, hence cheap credit available for the private sector and the expanding consumer loans segment should continue to keep robust consumption going forward. In addition, the 25 basis points cut in the Fed rate in late June this year would further make available cheap money to the private sector for capacity expansion, at a time when inflation has really disappeared as a major problem on the economic horizon. The Kingdom’s nominal GDP is expected to rise by around 2.2% this year. Meanwhile, Brent crude average price remains around $27 a barrel on the spot market and the Kingdom is expected to record a fiscal surplus of around SR50 billion in 2003. As a result, strong growth is expected to remain across some sectors of the domestic economy which likely support the equity market. With total foreign reserves amounting around 375 billion at the end of April 2003, the Kingdom’s balance of payment is expected to record yet another year of current account surplus at around $11 billion in 2003, thus elevating the Kingdom status as a net provider of capital to the rest of the world. In all, economic fundamentals and corporate finances of this year are pointing towards more gains for the equity market.
The Increasing Market Depth and Turnover
Investment activities in the Saudi market rose sharply during the first six months of this year, with market turnover increasing by around 177.2% to SR214.5 billion in the January-June 2003 period, from SR77.4 billion in the same period a year ago. For the whole of 2003, market turnover is expected to surpass SR400 billion, indicating substantial commission income for the banks which provide stock trading facilities. With 210 million shares worth SR59.4 billion, trading activity in STC stocks represented nearly 27.7% of the total market, followed by industrial stocks 23.5%, worth SR50.5 billion (table 3). The 360% increase in the traded value of electricity shares to SR35.5 billion appears to have been overdone during the first six months of this year while an accelerated selling of this stock seems to be a real possibility in the coming months, which is likely to drag its share prices down.
The cement sector saw a 30.1% decline in the value of its shares traded to SR14.5 billion during the January- June period of 2003, indicating an oversold situation, as investors were worried about the negative fallout of the war in Iraq on the demand for cement. However, the strong growth in the demand for cement is still intact which should induce buying interests for stocks of cement companies (chart 2).
The market turnover ratio, as measured by the 12- month trailing value of shares traded as a percentage of total market capitalization, reached 57.3% in June 2003, up from 47.6% in the 12-month to December 2002 as the listing of STC has largely contributed to the accelerated market activities. Ten years ago, the market had a turnover of SR17.4 billion while its ratio to market capitalization was only 8.8%, suggesting an expansion of more than twelve folds for the value of shares traded and around 6.6 times in terms of its ratio to the market capitalization.
In most developed markets, the turnover ratio normally exceeds total market capitalization, while trading in the Saudi stock market is still considered moderate as only 51% of the total 2.27 billion supply of shares were tradable. The average value per transaction rose by 17% to SR170,239 in the first six months of this year, from SR145,503 in the same six months of last year. The average value has expanded more than three times from SR54,321 in 1993. The market depth, measured by the market capitalization as percent of GDP, has expanded from 40.4% in the 12-month to December 2002 to 67.2% in June 2003 (table 4& 5). This reflects more investors are now using the Saudi stock market as a vehicle for their investments.
The market rose across the board in the last six months, with the largest gain of 129.6% recorded for the Saudi Telecom, followed by the Saudi Electricity Company registering a 74.4% rise. Meanwhile, the prices of industrial companies increased by 35.9%, services sector companies by 22.4%, cement sector 19.5%, and agricultural sector was up 17.5%. Bank stocks, which represent nearly 32% of the total market, recorded the lowest gain of 13.1% in the first six months of this year, as investors perceived that the 45 year low interest rates might impair banks’ profitability.
Meanwhile, the listing of STC provided a window of opportunity for diversification and high return. The March-June period has proved to be the most exuberant for all stocks, capturing more than two thirds of the total gain during first half of 2003 (table: 6).
Saudi Telecommunication Sector
The Saudi Telecommunication Company (STC), with market capitalization of SR117 billion as of 30th June 2003 and representing nearly 25% of the total market, was the star performer so far this year. Share prices of STC, rose more than 129.6% since it started trading in mid February 2003, brining an incremental wealth impact of around SR66.1 billion for the investors, while the 20% Company’s shares held by the general public reaped around SR13 billion out of the total gain made so far this year. Trading activity in STC shares was very intense as the 60 million shares allocated for the general public changed hands around 3.5 times after the trading started. Share prices of STC rose around 30% in June alone and around 68% since March, yet still have the room to go up considering its potential profitability growth. With the expected annualized netearnings of SR8 billion for the whole of 2003, STC share prices, were being bided for 15.21 times the earnings comparison to the overall market average PE of 16.91 at end of June 2003, suggesting more room for upside moves. However, it remains to be seen how much the company would decide to distribute cash dividend from this year’s projected earnings per share of around SR26.6 and its impact on investors’ capacity to bid for higher price earning multiples.
The Banking Sector
The nine listed banks, which together constituted nearly 32.1% of the total market, gained nearly 13.1% in the first six months of this year, with nearly the entire gain realized in the March-June period. Investors are concerned about the impact of low interest rates on banks’ profitability, while ignoring the fundamental fact that a significant part of bank assets were still placed in high yielding consumer loans and government bonds. Bank stocks began their slide early this year moving in the negative territory by mid March 2002. They started recovering following the release of better than expected first quarter results reported by the 9 listed banks. Factors contributing to the weakness of banks’ share prices early this year included continued weakening trend emanating from last year along with lower interest rates environment and the fear of the adverse effect of the war in Iraq on the financial industry in the Kingdom. While the nine listed banks were still making 20.8% return on equity capital, share prices of the middle sized banks, however, under performed in relation to the overall market and the sector itself. With a forward looking PE of 16.58 and dividend yield of 4.5%, bank stocks were being quoted at 3.54 times the book value at the end of June 2003. Share prices of Bank Al-Jazirah, and Bank Al-Rajhi were considered to be overvalued on the basis of their forward looking PE ratios in relation to the market average and the average for the sector itself. Elsewhere, prices of other bank stocks are just at par with the overall market average.
After remaining subdued for the whole of 2002 with a minor gain of only 0.4%, share prices of the 24 industrial companies rose nearly 36% in the first-half of this year, the highest gain in three years. With current market capitalization of SR90.1 billion and around 19% of the total market, investors of industrial stocks witnessed a capital gain of SR23.8 billion in the first six months of this year, besides any other gain that would have realized out of distribution of cash dividends and bonus shares. However, increase in the industrial share prices were still lagging behind the sector’s expected annualized profitability growth of 86.8% to SR7.1 billion for the whole of 2003, from the actual SR3.8 billion in 2002, indicating that the index of industrial stocks is poised for further gains in the coming months with the exception of a few overvalued stocks. High profitability growth by SABIC, SAFCO, Saudi Ceramic, Savola-Azizia and Spimaco were the prime movers behind the outstanding performance of the industrial sector this year.
With 38% gain for SABIC stock in the first six months of this year, closing at SR208 was still considered undervalued and quoted at 11.18 PE ratio, around 12% below the sector average while nearly 35% cheaper in relation to the overall market average PE ratio. The price of SABIC stock is expected to rise further in the coming months. However, share prices of SAFCO, Saudi Ceramic and Savola are considered overvalued in relation to their potential income, sector’s PE ratio, price to book value ratio and the overall market average price earnings ratio at the end of June 2003. Share prices of these stocks are, therefore, due for correction in the coming months. Elsewhere, share prices of some other industrial stocks are also due for correction, which include SIDC, Advanced Industries, SISCO, Saudi Cable and FIFCO. At the end of June 2003, the industrial sector average price earnings multiple (PE) was 12.68, the price to book value 1.81, dividend yield 2.4%, leverage ratio 1.55 and return on equity 14.3%, compared with 17.21, 1.40, 2.2%, 1.56 and 8.1%, respectively at the end of December 2002.
Performance of Cement Sector
With domestic sales of cement rising by around 10% from the comparable six-month period of last year while sector’s net-profitability is expected to expand further by around 12% to SR2.4 billion this year, share prices of cement companies gained 19.5% in the first six months of 2003, bringing around SR6.6 billion of wealth gain for investors of cement stocks on top of SR1.7 billion received as cash dividends so far this year. As return on equity reached 23.9% and cash dividend yield was 4.5%, share prices of cement sector were being quoted at 16.64, times of earnings, PE multiple, and 3.97 times the book value at the end of June 2003, compared with 16.23 PE and 3.16 times the book value at the end of December 2002, suggesting that the profitability growth of this year may already have been factored in the current prices of cement stocks. With combined production capacity of 23 million tones, while Qassim and Eastern cement companies have started implementing expansion programs, the Kingdom cement industry is well placed to sustain profitability in the long-term as the domestic and the regional demand would continue to rise slowly to consume any additional capacity.
Therefore, the current valuations of cement companies look attractive for medium to long-term investors who would seek regular income in the form of cash dividends and capital gain in terms of higher stock prices. With PE ratio of 47.03 on 30th June 2003, share prices of Tabouk Cement appears to be overvalued both in relation to the sector average and the overall market average. Elsewhere, prices of all other cement companies seem to fairly reflect the strength of financial fundamentals.
Performance of Other Sectors
The price of electricity company, which has risen 74.4% in the first six months of this year, is generally lifted by speculative moves as the Company has yet to demonstrate a sustainable earnings growth at a time when its share price is being quoted at 90.42 earnings multiple (PE). The price of electricity company is expected to fall not only driven by profit taking, but also on weak financial fundamentals. Elsewhere, share prices of agricultural stocks are also overvalued with PE running at 742.6 at the end of June 2003, even though they are quoted nearly half of their combined book value. These stocks are also due for correction.
Dr. Said Al-Shaikh
Editor & Chief Economist
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