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1) What are the biggest risk factors for MENA markets in the coming weeks/months?
Apart from a backlash as a result of concerns over global growth and the US/China trade talks, there are two key risks that are pertinent to the region. The first, a fundamental factor, is that government projects and planned spending announced across the GCC do not start to materialise. Many investors and businesses have been operating on thin or negative margins for the best part of two years, and it will be hard to maintain this for much longer. The second, a technical factor, is increased speculation on Saudi Arabia and Kuwait’s EM index inclusions, leading to increased volatility.
2) What are your views on UAE markets? Do you expect to increase/decrease your equity allocations in the next 3 months?
Our investment approach is bottom-up. We take the macro story into consideration, but our aim is to find not only the right company, but also the right price. We believe that given our long-term investment horizon (3-5 years) we give ourselves an edge over other investors in MENA markets, by buying great companies (assets) that are going through rough times or a turnaround at attractive prices. Having said that, we currently see attractive opportunities in the UAE, where we have an overweight position.
3) What would be the main catalysts for UAE markets in 2019?
Compared to others in the region, the UAE market is more mature in terms of infrastructure, so growth will be more difficult to achieve from current levels. The prevailing trend will be towards efficiencies and cost reductions, which explains the banking sector consolidation we have seen in the past two years, and which we expect will continue and spread to other sectors. Meanwhile, the market still has a lot of room for improvement in terms of transparency and minority shareholder protection. These factors, along with opening up foreign ownership limits (potentially even to reach 100 percent), will be the leading catalysts in the short-term.
4) What could boost liquidity on UAE markets in your opinion? What types of reforms have helped and would help going forward?
The ultimate remedy for liquidity would be: transparency and minority shareholder protection; developing a more sophisticated asset management ecosystem (pension funds, revamping the UAE gratuity system to defined pension plans, forcing banks and insurance companies to allocate their investment portfolios to asset managers); and removing foreign ownership limits.
5) 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)?
We are mostly focused on bottom-up stories, but if we had to pick one sector it would be energy in Egypt. The country is at the cusp of turning from gas importer to exporter, after recent discoveries in the Mediterranean. In addition, the liberalisation of the energy sector is at the heart of the reform programme agreed with the IMF. Both have created massive opportunities for the private sector.
6) If you were to pick one regional stock that you think will outperform over the next six months, which one would it be (and why)?
Egypt Kuwait Holding. It is attractively valued in the Egyptian energy sector. When we invest in Egypt we look for strong management, a strong balance sheet, strong growth, a promising sector and, most importantly, attractive valuations based on our investment horizon (3-5 years). Egypt Kuwait Holding fits all these criteria. Recently, after finishing the seismic study that they embarked on last year, the company revealed huge gas reserve potential at its Offshore North Sinai (ONS) concession, which holds up to 2.35 TCF (trillion cubic feet) of gas and 112mn bbl (barrels) of condensates – about 10x its existing P1 natural gas reserves of 218 bcf (billion cubic feet, announced in September 2018). The company’s management has said that it will probably partner with a strategic player to develop these fields or even divest the concession, which we expect will unlock more value going forward. We expect the company to report strong earnings growth of 20 percent-plus during the next two years, largely on the back of newly classified gas reserves in the ONS concession. Meanwhile, its other business units should benefit from elevated fertiliser prices, higher tariffs on electricity in Egypt, increased adoption of natural gas as an energy source across the country and expansion of petrochemical production. The company’s balance sheet remains strong with a net cash position.
7) To which markets do you expect to increase/decrease your equity allocation in the near future (3 months)
We are likely to reduce our equity allocation in Saudi Arabia, hold steady in the UAE, increase exposure in Egypt, hold steady in Qatar and increase allocation in Kuwait.
8) What do you expect from the EM inclusion of Saudi Arabia?
The benefits for the Saudi market will be considerable, but mostly over the medium- to long-term as the market achieves greater visibility and increased liquidity. We have already started to see the positive prospects of inclusion with a much improved regulatory framework and increased transparency by listed companies. Over the short-term, the market will be supported by passive flows, which we expect to be at least partially met by local sellers.
9) How have Q4 earnings been for the banking sector in the region?
The banking sector benefited significantly last year on the back of net interest margin expansion and lower cost of risk due to the adoption of IFRS 9 (International Financial Reporting Standards). Bottom line earnings were also good.
10) Do you expect more mergers among banks in the region? Particularly in Saudi Arabia and the UAE?
For now, when growth is limited, the focus will be on efficiencies and cost reduction – this will more than likely lead to further consolidation of the sector. The creation of large balance sheets to support ambitious growth plans in Saudi Arabia will also be a major factor. Another driver for mergers is the digitalisation push, which requires economies of scale to justify high costs. Banks no longer compete only with other banks, but with fintechs and other technology companies, too. The challenge is to leverage data as capital to drive future growth, and not just lending. The reality is that during the next 5-10 years, small banks will find it nearly impossible to compete if they do not join forces. If there is one sector where size really matters, more than ever before, it is the banking sector. We believe the consolidation phase has only just begun.
(Editing by Gerard Aoun and Michael Fahy)
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