Planning to invest in Saudi equities? Defensive stocks are a safe bet now

Al Rajhi Capital expects company earnings estimates to be gradually revised lower into H1

  
A man checks his mobile phone next to a screen with Saudi Stock Exchange (Tadawul) prices in Riyadh, Saudi Arabia September 16, 2019. REUTERS/Stringer

A man checks his mobile phone next to a screen with Saudi Stock Exchange (Tadawul) prices in Riyadh, Saudi Arabia September 16, 2019. REUTERS/Stringer

Rising concerns over the coronavirus outbreak have resulted in volatilities and net declines in Saudi Arabia’s stock market as it digests the impact on company earnings, the Riyadh-based Al Rajhi Capital said in a new report. 

“We expect earnings estimates of companies to be gradually revised lower in H1 2020 before they likely stabilize or pick up towards the end of the year,” the report said.

The Saudi Tadawul index closed down 7.8 percent on Monday in its fourth straight day of losses, leaving its year-to-date loss at 24.7 percent. However, on Tuesday, it jumped 7.1 percent to 6762 points.

“Overall, we recommend not buying into dips as we expect sustained correction,” the brokerage added.

Adding to the volatility, oil prices fell this week after Saudi Arabia slashed its official selling price for crude for April and planned to raise production significantly next month.

The Saudi move caused Brent futures to drop 22 percent to $37.05 a barrel on Monday. However, oil prices climbed for a second day on Wednesday, lifted by hopes that US producers will cut output, but gains were limited compared with Monday's crash after Saudi Arabia and Russia triggered a price war, Reuters reported.

The fall in oil price is expected to have a cascading effect on the local economy, Al Rajhi Capital said.

Apart than oil, Saudi companies exposed to Asian markets for exports, raw material imports from China, and the ones with high debt, high valuation multiples, government receivables and those linked to travel and tourism are likely to be the most affected.

Defensive and dividend stocks

The brokerage said holding defensive and dividend names in consumer staples, telecom services, cement and retail banks, might be a safer bet.

The report noted that 2020 could be a challenging year for banks due to the expectations of a decline in interest rates translating to lower NIMs (net interest margins) and a weak economic situation leading to marginally higher cost of risk.

“Though loan growth was guided to be around the mid-single digit on an average, this can be guided lower if oil weakness and corona virus implications continue,” the brokerage said.

For now, one could factor a flat growth in 2Q and 3Q and a gradual recovery in 4Q lending implying overall lending growth of 1-2 percent in 2020, it said.

The downside risks for banks include a decline in mortgage lending activities if the government decides to lower the subsidies given for mortgages; lower loan growth as business get impacted due to lower demand; lower money supply leading to lower deposit growth; further rate cuts leading to lower SAIBOR and NIMs; and higher cost of risk as businesses weaken.

However, some names could have strong support given healthy dividends, the brokerage said, adding it favoured retail over corporate banks.

In petrochemicals sector, the overall sales volumes can weaken due to lower demand given that the majority of the sector sells to Asian economies, the report noted.

“Add to already existing supply-side pressures, all product prices are likely to contract further. Expectations of a recovery in H2 2020 will likely now shift to H2 2021.”

However, there would be support for companies that can pay dividends, such as Advanced Petrochemical and Yanbu National Petrochemical.

There are also strong reasons to own Aramco stock as the company should pay the promised dividends, and given that the eligible shareholders  is less than 1.7 percent, “the actual cash outflows for dividends is only a paltry $1.27 billion.” 

Among cement companies, the brokerage recommended holding names with zero debt and high dividends. Among companies with dividend yields of 6+ percent are Saudi Cement, Qassim and Arabian.

In consumer space, the virus scare and falling oil prices will lead to supply and demand issues as consumer and government spending both could be under pressure, the report said.

“In our view the worst impacted in consumer space will be electronics retailers as they will be hit due to supply disruptions.”

Grocery retailers will remain defensive due to non-cyclical nature of the business while discretionary retailers will have a rough time.

Negative on hospitality and tourism

In the hospitality and tourism sectors the temporary suspension of Umrah visas and reduced leisure tourism will have an adverse impact on hotel occupancy rates.

The temporary suspension of Umrah visas and domestic restrictions on travel could also have a negative impact on telecom revenues. However, the sector in general could be viewed as a relatively defensive bet.

On the other hand, building materials suppliers, such as Saudi Ceramics, that face higher competition from Chinese exports could benefit.

(Reporting by Brinda Darasha; editing by Seban Scaria)

(seban.scaria@refinitiv.com)

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