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Buy Dubai debt

Dubai has come a long way in a short period of time. From being shunned by investors after it infamously requested a debt standstill from creditors in November 2009, the emirate has made a number of painful cuts and significant restructuring of key companies.

The emirate has matured considerably, swallowed its pride, shunned projects that did not add value and brought down debt during the period.

Unrest around the emirate has also made it look better than its peers, such as Bahrain and Egypt, and the support down the road from Abu Dhabi has shored up investor confidence.

Still, creditors (especially those who had to take a haircut in the 2009 standstill) have long memories. They have been watching the emirate's every move, gleaning hints from the statements of government officials and observing with some relief how the authorities and government-related entities (GREs) have made their debt payments and rollovers with no-hiccups.

Which is why analysts are far more sanguine about the debt mountain Dubai entities have to climb in 2012.

All eyes will be on Dubai next year as it works its way through its debt pile of $14bn. But analysts say it's a good time to buy the emirate's debt.

"The $14 billion wall of debt maturities at Dubai GREs next year is not nearly as daunting as the headline number suggests," a JP Morgan analyst noted in a report.

Most analysts are now taking a far more optimistic view of Dubai's debt pile, than they did a few years earlier, when the emirates famously restructured its debt in November 2009, leading shocked investors to shun Dubai debt.

Even as early as May this year, the International Monetary Fund was worried that the emirate's high debt had raised its fiscal vulnerability.

"The debt sustainability analysis indicates that Dubai's debt may become unsustainable in the absence of policy change," the IMF said in a note earlier in the year.

"Despite gradual fiscal consolidation projected in the baseline scenario, Dubai's government debt is estimated to increase to 41 percent of GDP by the end of 2016. In the absence of fiscal consolidation (i.e., without policy change compared to 2005-09), however, it is projected to reach 53 percent by 2016."

A lot has changed since then.

One, compared to some of the EU states and a number of vulnerable countries across the world, Dubai's prospects looks promising.

Second, and this is most important, the arrival of the Arab Spring has meant that Abu Dhabi will ensure financial stability in the country, rather than risk any excuse for a political outbreak.

Third, the recent sell off in much of emerging market debt due to global economic concerns, presents a buying opportunity in Dubai debt or any other debt that's directly or indirectly linked to oil riches.

Indeed, Exotix, the fixed income frontier market boutique bank, has upgraded Dubai Holding Commercial Operations Group ( DHCOG ) as one of its top five picks for the fourth quarter.

"We believe the dramatic sell-off in DHCOG 's outstanding bonds (i.e. DUBAIH'12,'14,'17) is unwarranted and presents an attractive buying opportunity. DHCOG 's 2017 fixed-rate bond (DUBAIH'17), for example, has fallen from a price of 84.8 (9.5% yield) on 1 August to 68.5 today (14.5% yield), which represents a price drop of 19%," said an Exotix research note to clients.

The last time DHOCG reached such yields was during the Dubai World standstill in 2009.

"At this price we feel that the market is unfairly erasing most of the progress Dubai Inc's GREs, such as DHCOG , have made since the standstill crisis (i.e. the yields on DIFC and Jafza's sukuks have also shot up recently), and ignoring the vast improvement in DHCOG 's credit profile since 2009."

Better but not great

While a shadow of the heady days of the economic boom of 2002-2007, Dubai's economy has recovered with much of the excesses and leverage and non-performing loans washed away, leaving a business-minded state that is much leaner and with great infrastructure.

There is no doubt that Dubai has benefited from the unrest in Bahrain and Egypt with tourist traffic and hotel occupancy rising.

But it's also true that the emirate remains vulnerable to a severe global economic downturn.

Read: UAE Outlook Darkens

"Risks are tilted to the downside, says Deutsche Bank's Oztruk. "The [GCC] bloc will not remain immune to a full-blown global recession and an abrupt drop in oil prices with the UAE potentially the main underperformer."

Still, sister emirate Abu Dhabi has shored up significant reserves with Brent crude remaining well above $100 this year and is likely throw yet another lifeline if things get hairy for Dubai.

JP Morgan notes that Dubai Holding Commercial Operations, DIFC Investments and JAFZA are expected to make their bond payments on maturity without the need to resort to help from the Dubai Financial Stability Fund (DFSF).

"These entities expect to meet bond maturities via a combination of operating cash generation, asset sales and refinancing. Accessing DFSF appears to be more of a Plan B," noted the report, adding that only the $3.3 billion of JAFZA and DIFC could be 'considered challenging'.

DHOCG, which includes Jumeriah Group, Du, TECOM, Dubai International Capital and Dubai Group as its entities, has gone through a severe shake up.

In June, the company sold a 14% stake in its Axiom Telecom operations to Qatar's Al Mannai Corporation, and repaid a CHF 250mn Swiss bond in full and on time, which was widely seen as a key gauge of the emirate's financial health.

"We expect management to continue to dispose of these assets in the near to mid-term," says Exotix. "We believe that combined with DHCOG 's healthy free cash flow generation from its core operations, the liquidation of these valuable telecom assets should provide more than adequate liquidity to fulfil its US$2.4bn in public debt maturities through 2017."

Dubai government debt

The fixed-income investor also picks Dubai government bonds as one of its top five picks for the fourth quarter, suggesting that while there may be strong similarities between the debt issues of EU states and Dubai, the emirate has the sympathetic Abu Dhabi at its side, as opposed to the EU states which have to contend with a reluctant Germany.

Chart 8: MENA sovereign yields



"Dubai government bonds have fallen sufficiently for us to promote them back to our Top-5. Z-spreads on Dubai's 2020s are nearly 600, which in our model is consistent with a B+ rating (ie in the company of Georgia, Sri Lanka, Albania and Senegal), notwithstanding Dubai's residual vulnerabilities as it recovers from its own crisis," says Exotix.

Watch out for Nakheel

The frontier market bank is also suggesting Nakheel's extreme makeover has made it a corporate debt to watch out for. Exotix has a hold recommendation for the real estate giant that once symbolised Dubai's ambition, but now is a reminder of its real estate excesses.

While the company's trade claims have fallen from $16.1 billion before the restructuring to $4.1 billion now, the Nakheel 2016 bond is trading at a yield of 20.5% due to lack of transparency, and risk-off in global markets, making it less than attractive than its peers DHCOG and Emaar.

Exotix argues that although the government has hedged itself by not guaranteeing Nakheel 2016 and stating that it is under no obligation to support the company, Nakheel has received US$10.2bn in total bail-outs from the Dubai government to-date and the commitment of a further US$2.4bn on 25 August.

"Thus, we believe there is a strong likelihood that Dubai will continue to support Nakheel from a liquidity-perspective going forward, which factors in these precedent funding commitments and our belief that the emirate seeks to avoid a repeat of the public embarrassment and the severe credit and equity market damage it experienced during the DW/Nakheel standstill of late 2009," says Exotix.

Moreover, Nakheel's prospectus states that the Dubai Financial Stability Fund (DFSF) has committed to contributing $2.4 billion to the company, which could serve as a security blanket for its 2016's $3.8-billion obligation.



Conclusion

The optimistic international investor view on Dubai is yet another indicator that the emirate is returning fully to the international market and gaining investors as confidence improves.

While the gloomy global market conditions could upset Dubai's recovery, for now analysts are divided between total world economic doom to lethargic growth. The second - and more likely - scenario means Dubai is in a much better condition than many other frontier markets to improve its economic prospects, and pay off its debts.

© alifarabia.com 2011