Reform momentum under Vision 2030 remains strong and is moving in the right direction, with important indicators like private sector contribution to GDP in real terms showing significant growth. New reform initiatives are being rolled-out under the Vision Realization Programs (VRPs), while updates from the Council of Saudi Chambers reportedly do show that economic reforms have shown positive results.
- What is your view for GCC capital markets, and to which markets do you expect to increase / decrease allocations in the near future?
A steep decline in oil prices during November 2018 dampened investor sentiment during the month, resulting in mixed performance of GCC markets. However, in terms of YTD (year-to-date) 2018 performance, the GCC markets continue to remain in the positive territory with a gain of around 10% owing to double digit gains recorded by Qatar and Abu Dhabi as well as mid-single digit gains in Saudi Arabia and Kuwait. Dubai remains the biggest drag for the overall performance with a YTD 2018 decline of more than 20%. Recent performance in the GCC was swayed by the movement in oil prices that witnessed one of the biggest monthly drop since the financial crisis. That said, the correlation has seen a significant drop since the last wave of decline in oil prices. This was primarily due to efforts by local governments in supporting the non-oil economy and a significant spending focused on key non-oil sectors like education, healthcare and on building human capital.
The recent upgrade by MSCI and FTSE has a significant bearing on asset allocation by institutional investors in the region. Saudi Arabia’s upgrade and the possibility of Kuwait being added to the MSCI index puts these markets at par with UAE and Qatar in the GCC. The upgrades should lead to additional liquidity in the these markets with consensus estimates of around USD 50 billion of passive investment flows in Saudi Arabia and around USD 2 billion in passive flows for Kuwait. In terms of market trends, Dubai has declined more than 20% since the start of the year while Qatar has a growth of more than 20%. Between these two extremes lies Saudi Arabia and Kuwait with mid-single digit returns. We believe that the upcoming inclusion makes blue chips in these markets an attractive investment opportunity. In terms of sector, banks continue to remain the key driver of market growth. However, leading names from other sectors in these markets should be an attractive proposition. In addition, the single digit valuation of Dubai makes stock picking a good opportunity in an apparently oversold market. That said, the lack of liquidity could limit exposure to certain markets including Dubai.
- What is the biggest factor impacting GCC stock markets at the moment?
GCC markets continue to reel under pressure from a weak real estate market, especially in Dubai. Localization efforts have affected the residential segment while softer business climate has impacted the corporate occupancy. Moreover, despite efforts to diversify the economy, oil still has a significant bearing on government spending with its apparent impact on oil related stocks. The decline in oil prices over the past four years has forced governments to take drastic measures to streamline finances. Although some of these measures may have temporary slowdown in the economy, like the implementation of VAT, the longer-term benefits outweigh the current costs.
- What is the biggest risk or threat in the coming weeks?
Risks to the GCC markets are primarily linked with the trends in global markets. The ongoing trade war between the US and China is affecting global growth rates and with talks of imposition of tariffs on increasing number of goods, the situation is expected to intensify.
Moreover, the risks related to rate hikes in the US is affecting global flow of capital from Emerging Markets to Advanced Markets. Higher rates are also affecting currency pegs in the GCC, although banks stand to benefit from it as seen from the higher NIM (net interest margin). In addition, the fragile growth in Europe with higher downside risks related to uncertainty related to Brexit, Italy’s growing issues on the fiscal front and more populist governments are affecting policy making in the region, making it unattractive for some investors. Also, the continued pressure on oil prices due to oversupply concerns will make it difficult to arrive at a consensus in terms of production policy. The upcoming OPEC meeting during the first week of December should provide direction on oil prices in the near term.
- How have Q3 earnings been so far across the region?
Aggregate Q3-18 earnings for GCC-listed companies was up marginally by 1% y-o-y (year on year). Earnings in almost all the markets was positive with the only exception of UAE. Dubai recorded the biggest y-o-y drop in Q3-18 earnings at 10%, while in Abu Dhabi the decline was marginal at -1.1%. On the other hand, Oman and Qatar recorded double digit earnings growth while in Saudi Arabia it was almost flat.
Source: Company Financials, Bloomberg, Reuters, KAMCO Research
- What is your view for the real estate sector in the UAE?
The sentiment towards the UAE real estate sector remains negative, as sales volumes retreat, demand slows, and property prices decrease. Although all segments are showing signs of being in a late downturn stage, prices and rents are likely to continue to decline going into 2019. Dubai RE transactions both in terms of value traded and volumes traded are down close to 50% in 9M-18 as compared to 9M-17, as per our analysis of Dubai Land Department. Residential rents in Dubai are down 9%-10% y-o-y at the end of Q3-18 as per JLL, while office rents are down 13% y-o-y over the same period. In Abu Dhabi, apartment rents are down 6%, while villas witnessed higher pressure as per JLL and declined 13% y-o-y. Office markets in the UAE continues to favor tenants, as landlords look to retain tenants with attractive terms. Thus, overall earnings for the sector are likely to weaken. Developer companies, are likely to feel the pinch of stretched payment schemes on execution and handover, thus delaying the release of cash from escrow accounts that are necessary to fund debt repayments and dividends.
- What is your view for the banking sector in Saudi Arabia?
The sector earnings remained robust with a y-o-y increase of 10% during Q3-18 and 9.9% for 9M-18. Loan book is up 3% YTD compared to -1% in 2017. Although the sector loan growth in 2018 has not been very strong, but it’s better than 2017. Banks benefited from NIM expansions after the rate hikes.
The Catalyst for the sector:
- NIM expansion: The street consensus is for one Fed rate hike in December and at least two more in 2019.
- Government capex spending has not been very strong in 2018, but it is expected to pick up during 2019.
- The banks will benefit from the passive inflows coming from the MSCI EM inclusion.
- Growth in home financing is likely to be one of the primary contributors to the expected lending growth in Saudi banks during 2019.
- The risk, nevertheless, remains on oil price performance, where a decline in oil prices may likely lead to a slowdown or delay in government capex spending, inevitably affecting corporate loan book growth.
- If you were to pick one regional sector that you think will outperform over the next six months, which one would it be (and why)?
The banking sector, as it will benefit from the government spending as well as the expected interest rate hikes, and earnings should come in strong. The Fertilizer pack also looks interesting, as feedstocks are relatively cheaper and product prices are expected to continue to increase.
- What is your view on Egypt? How successful have they been in their multi-year reform program?
The market looked interesting until Q1-18 or so, as interest rate cuts came in and the currency was stable. After moving up by 21.7% in 2017, the EGX as of November 2018 end was down 11.3% YTD. However, since then, the rout of EM currencies and stronger oil prices have affected the market, while the decision to not cut interest rates also added pressure on the Egyptian market. The potential tax increase is also weighing on the market. All the reforms so far in terms of devaluing the pound currency, loosening capital controls, ending energy subsidies, reforming public enterprises and overhauling monetary policy were needed for bringing in economic stability and moving towards ensuring long term growth. However, further the sustainable development plan over 2018-2022, targeting a GDP growth of 8% in 2021/2022 amongst other targets are a step in the right direction.
- How would the EM inclusion for Saudi Arabia help the region?
The EM inclusion of Saudi Arabia should drive foreign ownership of stocks, trading activity on the exchange and the contribution of foreign investors to overall trading activity, higher. Similar to trends witnessed in Qatar and the UAE, Tadawul’s inclusion will definitely make the region equity markets more accessible to institutional investors. According to consensus estimates, around USD 50 Bn of additional passive investment flows are expected post the upgrades. Apart from the benefits of improved liquidity and transparency that will become more evident, ongoing reforms from the GCC region’s stock markets will aid in lifting wider investor confidence and in improving participation from global investors.
(Editing by Gerard Aoun and Mily Chakrabarty )
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