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FT noted this weekend that “one counter-intuitive pick” among commodities [for investors looking for portfolio protection against an oil supply crisis] may be aluminum,” production of which is “notoriously energy-intensive (roughly 15.7 Kwh of power is required to make a kg of aluminum from alumina (derived from bauxite), which translates into 40 percent of the cost).” At the same time, the Middle East accounts for 9 percent of global aluminum production, “so any further unrest could lead to disruptions to supplies.” Moreover, analysts note that as base metals from tin (+~91%), nickel (44%) and copper (36%) have surged YoY, aluminum (22%) has lagged. As it is global demand growth is robust enough (+17% annually in 2010 and expected to see 7-8% growth this year per Russia’s RUSAL, the world’s largest producer) to counteract impending production restarts: Barclays, for instance, expects “Chinese output to rise to record levels by Q311 as current price levels drive restarts and new capacity.” Nevertheless it projects the overall stock-to-consumption ratio (7.4 wks 2011F) to remain fairly sticky given demand pressures and the aforementioned energy cost headwind. Finally, some opine that as larger investors and even proposed-ETFs increasingly enter the market, further supply disruptions could ensue as the physical material is stored away in warehouses or as inventory.
MENA CDS activity of late is eerily reminiscent of the risk “contagion” caused by investors questioning Dubai’s debt-servicing capabilities in late 2009 when [irrational] fear spilled-over to Abu Dhabi as well even though the latter’s fiscal integrity was never seriously in question, a fact later confirmed when it underwrote a bailout. But if such objective measures are largely ignored in the market of default probability perception, perhaps it should come as no surprise that more nuanced, subjective ones such as the differences between the historical, social and economic dynamics of say, Saudi Arabia versus Egypt, also fail to be carefully analyzed. Even The Economist’s latest stability rankings, for instance (see chart)–the result of ascribing a weighting of 35% to the share of the population that is under 25; 15% to the number of years the government has been in power; 15% to both corruption and lackofdemocracy indices; 10% for GDP per person; 5% for an index of censorship and 5% for the absolute number of people younger than 25–seem inadequate. An accompanying piece, for instance, notes that in Saudi Arabia (whose marginalized Shia population is, unlike in Bahrain, a relative blip) the unity of unrest seen elsewhere may be structurally unlikely: “Building an opposition movement is difficult in Saudi Arabia. [While] grievances are plenty: about living standards, poor schools, lack of jobs, the government is adept at using repression, propaganda, tribal networks and patronage to divide and weaken any opposition. Middle-class liberals are wary of democratising steps that might give more power to anti-Western Islamists. State-backed clerics have denounced the Egyptian and Tunisian protesters, and issued fatwas against anything similar in Saudi Arabia. Only in the [admittedly oil rich] eastern province—home to a large Shia population—is there much tradition of protest. But community leaders there are cautious, and desperate to avoid any accusations that they are a ‘fifth column’ for Iran.” Barclays too notes that addressing how immediate tensions in the region may unfold is at least partially dependent on a given military: “Bahrain’s military is almost entirely composed of Sunnis and there is a significant foreign element in the ranks as well. Hence, they may be more willing to brutally suppress dissent than their Egyptian counterparts and the regime may not be as concerned about possible splits within the officer corps,” it wrote to clients. That said, perhaps such “nuance” is just noise from the collective market’s point of view. The real concern for Saudi Arabia may not be the emotional state of its Shias but rather the physical soundness of the 18-mile-wide strait Bab el-Mandab.
China’s recent decision to extend a 35 percent temporary tax and a 75 percent special tax on the export of fertilizer including urea and diammonium phosphate (DAP) until next June in order to help control inflation and to guarantee fertilizer production and supply to domestic farmers will likely “create potential supply shortages in both nutrient groups that should cause nitrogen and phosphate prices to go higher, benefitting global nitrogen and phosphate producers,” according to a research note from Barclays Capital. China was responsible for roughly 14% of the global supply of urea in Q12010.
Urea is formulated by a reaction between liquid anhydrous ammonia–a form of nitrogen–and carbon dioxide at high temperature and pressure. And in a write-up on Saudi Arabian Fertilizer Company (SAFCO), TAIB Securities, a brokerage, reiterated that producers in the Middle East are at a particular cost advantage in terms of production given their relatively cheaper access to raw material like natural gas (ranging from S$0.70 /MMBTU to US$1.5/MMBTU per one estimate, versus $4.5 and rising, for instance, on the New York Mercantile Exchange). In addition to SAFCO, Arab Potash and Qatar Industries are regional players that, as one analyst notes, are not only attractive given their dividend yields but also may trade at a discount to global producers. Finally, producers in Pakistan (namely the country’s two dominant firms, Fauji Fertilizer and Engro) both expect strong final quarters due in part to peak demand (stabilized by post-flood recovery and state-run farming subsidies) augmented by yet another supply shortage in the run-up to Rabi season that producers say is a direct result of the government’s gas curtailment policy in which gas has been diverted to power plants. That shortage will be met through imports, though for Engro in particular the gas shedding policy may curtail projected earnings related to the opening of its new plant. Yet Karachi’s JS Global Capital kept the firm as a ‘buy’ recently, concluding that “although the fertilizer industry was hit hard in August with depressing urea offtake (down 8%YoY in 8M2010) due to the floods, we expect the numbers to improve in the coming months.”
Investment firm Kuwait Projects Co.’s (KIPCO) seven-year, $500 million benchmark bond–which featured a fixed 8.875% rate and were priced at a spread of 608 bps above the USD mid-swap curve, fetched orders in excess of $3.3 billion this past week, signaling further maturation of the Gulf’s debt markets. The bond was not only the first to come out of Kuwait this year, but it was also the first international bond of the year to be issued by a Gulf-based private sector firm. KIPCO owns stakes in 50 companies and operates in 21 countries, and this past spring announced that it would “move ahead with plans to sell pension products worth up to $500 million in the Middle East over the next five years, and launch an insurance firm in Algeria [later in the year].”
Earlier this year the IMF stated that debt securities form just 3% of the Middle East and North African (MENA) capital markets–compared with an average of 42% across the rest of global capital markets. However, the credit crisis has ironically spurred the market’s growth, as domestic banks became more risk averse and reticent to enter into the discounted syndicated loans that were viewed as a cheaper alternative to paper, and which had hitherto greased the region’s economic wheels. Borrowers also took to the fact that debt issuances could be targeted to a wider market of buyers–such as pensions and insurance companies–than could syndicated loans, given not only their relative liquidity, but also the fact that they could be denominated in various currencies. Per Dr. Nasser Saidi, Chief Economist of the Dubai International Financial Centre (DIFC), debt markets in fact are the holy grail of the region’s long-term social and economic development:
“Money has been coming in from oil but now we have matured and are looking at economic integration. We have to make that transformation and for that we have to break the link between oil and investments. The price of oil can lead to a cycle of boom and bust and that can be broken by the debt markets.”
The worry, however, centers around the viability of sustained demand. If the “new normal” is indeed accurate, then emerging and frontier debt–both sovereign and corporate–will truly need to replace or at least coincide with more mature, developed issuance.
Wonderful piece in Euromoney regarding the dichotomy of opinion among international investors in the ME vis a vis the research capabilities of the region’s domestic investment banks and equity research houses, most of which have found themselves “struggling to meet their debt obligations.” While many portfolio managers still swear by local expertise, others are more skeptical, noting that research is only as valuable as the individual analyst standing behind it, and that the downturn has led to an exodus of some of the best talent.
Some other interesting points are made in the article that form the foundation of frontier investing and stand repeating:
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“As businesses in the Middle East continue to move away from the family owned and operated model and place greater portions of their companies in the hands of public shareholders, a higher level of corporate transparency, scrutiny and research will be required. With increased coverage from both local and global firms, Middle Eastern equity markets will become deeper and more liquid as time goes on.”
- “Despite the recent setbacks in the region’s financial sector, [Mahdi Mattar, head of research and chief economist at the Dubai-based Shuaa Capital] still believes in the growth opportunities that the Middle East presents, ‘with valuation at discount, especially after the severe sell-off of last year, and the regional equity markets offering some highly attractive value plays'”.
- Will Manuel, head of [Central Eastern Europe, Middle East and Africa] equity research at HSBC, “says that the [ME’s] prospects are good, as equities in the GCC and Egypt become a large bloc of the global emerging market benchmark indices, such as the MSCI Emerging Markets Index. As more Middle Eastern stocks move into the emerging market benchmarks, increased trading volume in the Gulf region is bound to follow, particularly among institutional investors.”
Interesting comment by S&P Fund Services lead analyst Alison Cratchley, made to Business Intelligence Middle-East, on the possibility of an impending correction across MENA markets:
“Relative to other emerging markets, the MENA region significantly underperformed (12.7% rise compared with 37.8%) in the six months to the end of June 2009. This probably reflects investors’ perception that the MENA region is highly leveraged to a U.S. recovery due to its dependence on oil revenues, whereas other emerging markets are supported by robust domestic demand.”
Several fund managers quoted, including Shakeel Sarwar, Head of Asset Management at the Manama (Bahrain)-based SICO, an investment bank, as well as Mashreq Bank’s Ibrahim Masood, concurred with this cautious sentiment, citing the region’s potentially unsustainable rally to date, low liquidity levels, as well as its perceived correlation with U.S. equity markets, which are considered equally overbought by many estimates. Last Friday, for example, the equity-only put/call ratio saw its most-stretched level since December 20, 2007, with more than twice as many call options being traded as put options–a possible sign of institutions’ collective desire to reduce risk.
Per hospitality research firm STR Global and Deloitte & Touche Middle East, Middle East hotels in 22 cities in the region during the first half of 2009 witnessed an average 10.9% decrease in occupancies and a 17.2% drop in revenue per available room (RevPAR), an industry benchmark. Among the worst RevPAR performers were Dubai (down 35%) and Muscat (16.6%), while other cities outperformed tremendously, including Abu Dhabi (3.2% increase), Jeddah (11.5%) and Beirut (125.2%).
According to its Assistant Chief Executive for Business Development and Government Relations Barrak al-Subeih, Zain’s possible decision to sell its African operations would be made in order to “look for expansion opportunities in other areas with higher growth rates, such as the Middle East or the Far East.” Hitherto, the Kuwait telecom firm has spent upwards of US$12 billion in Africa since 2005 (when it purchased Celtel International), including roughly $3b in Nigeria alone, the continent’s most populous nation, while continuing to expand and operate in 23 countries across the Middle East and Africa. Per Bloomberg, Zain has around 40.1 million subscribers in Africa, a figure that constitutes nearly 62% of its client base. Additionally, more than half of its $7.4 billion of annual sales in 2008 came from Africa.
The strategy of chasing higher growth rates is not without concern, however. A study published last year by Booz & Company, a global management consultancy, concluded that most markets in the GCC were quickly reaching “saturation levels”. Further growth, it noted, would thus have to adopt strategies that address both the scale and scope of their services. In terms of scope and growing revenues, operators must extend and diversify their business to include offerings that go beyond basic telecom services. “As for extending scale, operators must acquire and/or pursue strategic alliances, either with local or international players, to create a much sought-after critical mass,” remarked Ghassan Hasbani, a Booz VP. And as for scope, he continued, operators must extend and diversify their business to include offerings that go beyond basic telecom services.
Yet as of late, at least, Zain has shown a propensity for both. Two months ago it expanded its scale in West Bank and Gaza (a region with a paltry 35% penetration rate) through a 56% ownership stake in Paltel. And several weeks ago the company announced the implementation of ZAP–a new service allowing customers to make cross-border payments and transfers between Kenya, Tanzania and Uganda with no extra charge.
Interesting piece on the challenges facing Middle East telecoms in light of a recent study that forecasts average revenue per user (ARPU) in sub-Saharan Africa and South Asia–regions where future market share lies–to drop by half by 2013.
For Middle East mobile telecom firms such as Zain, Qtel, STC and Etisalat, most of their recent growth has come from emerging markets with high population and relatively low rates of penetration, such as sub-Saharan Africa and South Asia. But these operators are now challenged to boost profitability, as average revenue per user (ARPU) levels in such markets have been dramatically decreasing, because of increasing competition, price reductions, and a second wave of customers who are predominantly lower-income.
Much like uber-competition among German banks turned out to be a bad thing, one wonders if consolidation in the Arab telecom market will ultimately not only be inevitable, but also beneficial.
Financial Times notes today that “Bahrain will add to efforts by the Arab Gulf states to create an active bond market in the region by raising more than $1bn in a debt sale.” Abu Dhabi and Qatar have already sold $6bn worth of bonds in the past few months, the piece remarks, and are expected to issue more (and at longer maturities) along with Kuwait and Dubai. The country will sell $500m in sharia-compliant five year bonds—referred to as sukuk—at the end of May.
Bahrain’s bond market, while admittedly small, is nevertheless viewed as the only real bond market of the six Gulf states. This is because the region, already flush with oil revenue, hitherto had little need for it. Currently, outstanding debt constitutes only roughly 10% of the region’s GDP. But it is hoped that a thriving state bond market will help pave the way for benchmarks against which corporate issuers in the region can price their own debt.
JGW
Frontier Markets 