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Against the lingering backdrop of an overextended China (and by extension, Brazil et al.) and Friday’s shockingly moribund U.S. NFP report (as Zero Hedge tweeted, ‘less than six weeks until Jackson Hole…’) now is the time for portfolio managers to truly discriminate among emerging and frontier markets and specifically consider reducing exposure to high-beta names that are likely all-too uncomfortably correlated to the kick-the-can, er, ‘risk on’ trade.  Per Barclays, Qatar ’20 and ’30 sovereigns, for instance, as well as quasi-sovereign corporate names like Rasgas and Qtel are likely to benefit in the near-term not only from their hitherto underperformance (~20bp spread widening YTD) but from ever-improving macro fundamentals (21.5% y/y GDP, CA surplus 25.3%/GDP in June, a seemingly perpetually subdued, GCC-low 2% annualized headline inflation rate projected for 2011 and GCC-leading annualized export growth) as well as the implementation of the recently announced National Development Strategy 2011-16 ($USD226bn budget) that analysts expect will “boost the non-oil sector activities, particularly on the investment side.”  Furthermore fiscal stimulus in Qatar (money supply growth up 29.9% y/y in April versus GCC average of 17.3%) and its corresponding deposit growth (up 18.2% y/y) remains muted and quite manageable in the context of a budget breakeven oil price (now ~$40/b) more than half that of say, Saudi Arabia, while credit trends (bank credit to the private sector in Qatar expanded by 5% y/y in April versus a GCC forecast of 8.6% y/y in 2011 as post Arab-Spring liquidity mean reverts) also look positive.

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Saudi Arabia’s recent pullback shouldn’t overshadow the fact that while net credit issued during April reached SAR3.2bn, well below the SAR7.4bn in March, YTD figures are still more than double the amount seen during the same period last year–an upward trend in extended private sector credit that analysts expect to persist in the near-term against the backdrop of King Abdullah’s hitherto mandated fiscal expansion plans (i.e. a new housing loan guarantee scheme by the Real Estate Development Fund and an increase in wages).  A sneaky way to tap this phenomenon as well as the Kingdom’s ever-impending paradigm shift in mortgage financing could be through Oman-listed Al Anwar Ceramics (AACT.OM) which, per Fincorp, an investment research firm, “enjoys a 50% market share in Oman and is seeing growing acceptance of its products in markets such as Saudi Arabia and Abu Dhabi, where demand for ceramic tiles remains robust.”  In fact, per one observer the GCC region remains a net importer of ceramic tiles, with factors that fuel demand including opening up of property ownership, growth in tourism, and the growing young population that props up demand for housing units.   A game changer for AACT, so to speak, came recently when the firm was allocated natural gas by Oman’s Ministry of Oil and Gas (in lieu of the firm’s originally-planned use of costly liquefied petroleum gas) sufficient for its 3 million square meter expansion which, per EFG Hermes, an investment bank should help bump gross profit margins going forward.  “The recent allocation of gas coupled with a cash flush balance sheet has increased AACT’s prospects of organic growth over the next three years [whereas] the lack of gas allocation would have challenged the company’s ability to expand organically,” it wrote to clients.  To date this year AACT has achieved 7% y/y growth in sales revenue and a 5.4% increase in net profit; its current ~10 p/e at projected 2012 EPS indicates some 33% upside in the stock versus current levels.

Regarding the thesis that “the outlook for [GCC investment banking] is broadly positive” as “the region’s investment and project finance needs are growing enormously,” Global Finance notes this month (“Banking on Stability”) that “after M&A, fees from debt capital markets operations (DCM) constitute the largest portion of investment banking fees in the Middle East.”  The piece quotes Mohammed Ali Beyhum, executive general manager at Lebanon’s Bank Med, who opines that the “Islamic bond, or sukuk, markets could hold great promise in 2011.”  Analysts in general have been calling for a sukuk ‘convergence’ of sorts ever since Dubai’s debt crisis, which some observers blame for unfairly calling into question the entire premise of Islamic financing structures.  “It is important to note that during 2010, the sukuk market lagged the conventional bond market, as the former was hit by the aftermath of Dubai’s debt restructuring and the accompanying series of defaults on high-profile sukuk issuances,” Beyhum said.  And recent regional turmoil may have only added further fuel to market discrepancies as well as to upside resurgence: Markaz, a Kuwaiti asset management firm, reported earlier this month that yields on Dubai’s Islamic bonds had dropped to a five-month low, leading a GCC sukuk rally, on speculation that UAE and Qatar would be spared from protests that toppled the governments of Egypt and Tunisia.  To that end, a recent New York Times article stated that while uncertainties “may have lowered appetite for sukuk introductions and made issuance more costly by raising premiums,” the long-term trend appears in tact.  Per Paul-Henri Pruvost, an analyst with S&P, while Malaysia accounted for nearly 80 percent of last year’s issuances, activity in the Gulf [in Saudi Arabia, Qatar and UAE in particular] is destined to flourish given not only the region’s “huge pipeline of [planned] government projects and infrastructure,” but also the need to “develop a more solid fund-raising market for Islamic banks and insurance companies . . . typically constrained in terms of the asset classes they can invest in.”  One U.S.-based law firm, in fact, projected that by next year already GCC-based Shariah-compliant financing will account for nearly one-third of the global market, up from 12.5% five years ago.  Said Pruvost: “These institutions in the Gulf and Asia are trying to make their balance sheets very liquid, so they are very hungry for this kind of instrument.”  Finally, it will be important for investors to weigh the long-term effects of recent measures taken by Qatar’s Central Bank, which earlier this year banned Islamic banking in conventional institutions, and the possibility of related policies in surrounding countries.  At first blush, the move (designed purportedly to squash co-mingling of conventional and Islamic funds) would appear to greatly benefit a handful of domestic Islamic banks such as Qatar International Islamic Bank (QIIB), whose shareholders gave approval earlier this month for a sukuk issuance later this year.

FT noted “analysts expect that Japanese utilities will scramble for crude, thermal coal and liquefied natural gas (LNG) as replacements [for the shut down of at least 9,700 megawatts of nuclear capacity.”  Meanwhile UK wholesale gas prices for delivery next winter (“an indicator of LNG as Britain is a large importer of super cooled gas”) surged to record highs (since November 2008) of 74.85 pence on Tuesday; SocGen, for one, theorized that half of Japan’s loss in nuclear capacity will be need to be replaced by gas which equates to roughly one extra tanker carrying 145,000 cubic meters of LNG a week.  The French investment bank further projected an aggregate extra demand of 5 billion cubic meters (bcm) this year and 2 bcm above pre-quake levels (around 88 bcm) for the foreseeable future (UBS, using a more worst-case scenario analysis, used a ceiling of 12 bcm).  That said, many analysts don’t foresee a problem given global overcapacity that the International Energy Agency pegged at 200 bcm in 2011.  Qatar and Russia (the world’s biggest LNG and gas exporters, respectively) in particular will supply Japan with extra LNG cargoes, reporters note (Japan, in fact, is a fairly sizeable trading partner for GCC countries given its energy needs; an estimated 20 percent of Qatar’s LNG exports are already shipped there); as to the former, we remain intrigued by Nakilat as a proxy on the industry’s performance going forward and wonder whether its downtrend is due for a respite.  Per Rasmala, an investment bank, the company enjoys longstanding relationships with its upstream partners, the two state-controlled Qatari LNG giants Qatargas and Rasgas, and strong government support (the state owns 17% of Nakilat shares).  Moreover as the world’s largest LNG ship owner, with almost double the capacity of its nearest competitor, Nakilat’s wholly-owned vessels (which contribute nearly 90% of gross revenues) “incorporate the latest in shipping technology with significantly more capacity, lower operating costs and greater safety than conventional ships” according to analysts.  Yet the firm recently posted full-year net profit of QR665mn ($182.69 million) in 2010, up 13% on QR589mn registered in 2009 but short of consensus estimates (as was its 0.75 riyals per share cash dividend).  Additionally analysts expect wholly owned charter revenue to have “limited growth because . . . it is only the portion of the price paid by the charterers that corresponds to Nakilat’s operating expenses that is allowed to rise in accordance with U.S. CPI.  This results in a situation whereby revenue for the wholly owned ships increases by only the same amount as [forecast increases] in operating expenses.”  Operating margins, therefore, may have a fairly sticky ceiling regardless of spot LNG shipping rates.

Commercial Bank of Qatar (CBQ), the country’s second-biggest lender by assets (and third by market value), advanced to 83.9 riyals yesterday on news of the Fed’s larger-than-expected $600 billion in Treasury securities purchase order, which along with roughly $300 billion of reinvestment of maturing assets will take the central bank through next June.  “Qatar’s market is reflecting what happened globally,” Haissam Arabi, CEO of Dubai-based asset manager Gulfmena Alternative Investments, told Bloomberg. “It will continue an upward trend.”  Per expected, Qatar’s bank have responded in kind with the economy at large, which is expected to grow roughly 18% this year in real terms after 9% growth in 2009 (see graph, right).  Against this backdrop, per its 1H2010 results public sector loans and advances grew 4% while customers’ deposits grew by 16%; furthermore, the non-performing loan ratio, on a 90 day basis, fell to 2.67% from 3.56% from year-end 2009.  The bank remains well capitalized (its capital adequacy ratio of 19.2% is well above the Qatar Central Bank’s required minimum level of 10%).  Looking ahead, the bank’s conservative risk management (loan loss coverage of 161%) and initiative towards lowering expenses (cost to income ratio fell 300 basis points) should help CBQ continue to grow.  Yet Bank Audi sal in Lebanon reiterates that long term “a thorough steering of the economy to avoid bubbles related to overheating conditions, a progress in economic diversification away from the oil and gas sector, along with a further improvement of Qatar’s institutional profile, would constitute key success factors for the country’s growth and development trajectory at large.”

Antoine van Agtmael (pictured), the Chairman and CIO of Emerging Markets Management (EMM), and whom Bloomberg credits with coining the term “emerging markets” back in 1981, opined that while equities among developing nations are probably fairly valued (the corresponding MSCI trades at 12.8x estimated earnings for 2010, compared with its four-year average of 12.1), small caps in said markets are still lagging (6.2x after doubling last year) and may see increased interest from institutions going forward.  He also mentioned Qatar and Saudi Arabia in particular among those “frontier” countries where market sentiment may currently lag inherent value: 

“Qatar may be one of the most attractive among the smallest developing nations known as frontier markets, van Agtmael said, citing the pace of economic growth, the development of the Middle Eastern country’s real estate market and its gas reserves.  The investor also favors Saudi Arabia, saying the nation is a ‘huge economy with huge oil reserves.'”

Two industries to keep an eye on in each country, respectively, continue to be real estate and banking.  While commerical prices in Qatar fell between 20-30% in 2009, for instance, they are likely to stabilize in the second or third quarter of this year according to DTZ, an industry consultant, whereupon they should trend up again on the back of the overall economy’s expected, LNG-fueled 16% growth, as well as the overall industry’s cemented and collective distrust for “Dubai’s flawed, speculative building model.”  Furthermore, government endorsed consolidation in the property development market may ultimately concentrate the allocation of revenues going forward, leading to higher enterprise values.

As for Saudi Arabia, Silk Invest hinted to investors last week an impending paradigm shift in the kingdom’s mortgage financing practices that likewise could be a boon for future cash flows in both the region’s financial and property management sectors:

“A Saudi mortgage law, which has been in planning stages for almost a decade, is likely to be passed in a few months from now. The implementation of the mortgage law is expected to drive Saudi housing demand and prices as more people access the market. If the law is finally put into place, it could usher in a new boom period for mortgage financing in Saudi Arabia, an area traditionally avoided by financial institutions due to a lack of proper regulation.”

According to Abdulla Salatt, chairman of the company’s fertilizer unit (QAFCO), Industries Qatar–the country’s largest firm by market cap–will increase production of urea (used as a nitrogen-release fertilizer) and related products to supply growing global demand with a specific focus on South America, and in particular, Brazil.  “We are thinking of sending more products to Brazil because it is a big agriculture country, consuming a lot of urea, and we see their appetite for urea opening up year after year,” Sowaidi told reporters.  The company is currently contemplating a proposed $610 million plant which would increase urea production to 5.6 million tons/year by 2012, up from the current rate of 3 million.  Upon completion the fertilizer unit would hold 15% of global urea production, say analysts.  Urea has the highest nitrogen content of all solid nitrogenous fertilizers in common use (46.7%).

The company overall is still reeling from recession, as last month it announced a 47% drop in 9 month profit due largely to decreased demand for petrochemicals, fertilizers and steel, as well as new capacity across the region.  In 2008, the fertiliser unit alone accounted for almost half of the firm’s total profitability.  That said, the future looks bright.  Bloomberg noted that petrochemical production in Qatar, which is the holder of the world’s third-biggest natural gas reserves, is expected to rise to 4.3 million tons a year by 2015, an increase that would parallel an increase in natural gas output to 23 billion cubic feet by 2014.  Moreover, analysts maintain that by 2013, income from the natural gas sector and the petrochemicals business will be more than double that of Qatar’s oil revenue.  As for urea, it could be the lynchpin for the company’s ROE going forward: “If Qafco can guarantee the sale of this new urea capacity, this should be very positive for the company’s revenues and bottom line,” said Hala Fares, an analyst for Shuaa Capital, an investment bank, on Thursday.  “Fertilizer prices are relatively stable currently, so any increase in sales volumes should reflect positively on revenues. Any improvement in fertilizers prices should further increase revenues.”  Additionally, Last month EFG Hermes, an Egyptian investment bank, projected that it remained “positive” on fertilizer price estimates for 2010.

 

According to Trade Arabia, a news source, the Qatar construction sector is poised to grow by 17.6% YOY in 2009, as “gas revenues continue to provide the country with ample funds to re-invest into infrastructure development and construction projects.”

A byproduct of this trend will be a “spillover” into the country’s real estate market, which contributes roughly 10% to Qatar’s GDP, theorizes Muteab Al-Sa’aq, chairman of Trance Continent, a trade-show organization.

In addition to housing units and public installations, Qatar has also seen growth in office space market due to increased demand among global oil and gas companies, the banking and financial services sector, and government ministries and agencies, [Al-Sa’aq] pointed out. Growing tourism has also prompted Qatar to invest in the development of hotels and resorts, with figures released by the Qatar Tourism and Exhibitions Authority (QTEA) estimating a total investment of $17 billion into tourism infrastructure to support the anticipated 400 per cent rise in hotel capacity by 2012. Al Saaq said brand new residential towers were being delivered in and around Doha, with projections of 9,000 new apartments to be available by 2010, while 80,000 new hotel rooms will be finished by 2016. Development at this astounding pace is precedent to the potential of Qatar’s property market despite the challenge of the present economic slowdown. As correction envelopes the region’s real estate sector, “we are expecting Qatar to lead the way as the centre of development for major industries in the Middle East,” he added.

International Petroleum Investment Company (IPIC), an Abu Dhabi-based investment company, announced on Monday that it has been assigned Aa2/AA/AA long term credit ratings by Moody’s, Fitch Ratings and Standard and Poor’s, with a stable outlook.  “While we have no immediate plans to raise external capital, the ratings will facilitate future engagement with the debt capital markets if IPIC wishes to pursue this,” commented its managing director, Khadem al-Qubaisi, who added that the ratings were a means of “reinforcing strong corporate governance principles and enhancing transparency.”  According to one analyst, the ratings are “a signal that [state sovereign] funds are eager to keep spending and [are] willing to borrow to increase their buying power.”

IPIC’s ratings acquisition comes on the heels of a similar move by another Abu Dhabi investment arm, Mubadala Development Corp, which issued its first annual report last week and also recently announced plans to set up a medium-term bond program.  According to news agencies, “both companies have taken on billions of dollars in debt to fuel their growth in recent years, some of which soon needs to be refinanced.  That sets them apart from the secretive and far larger Abu Dhabi Investment Authority (ADIA), which likens itself to a pension fund and is not understood to seek out external sources of funding.”

Most importantly, the move is a another step in the early maturation of Gulf fixed income, on both a state and corporate level.  In March, Abu Dhabi raised the first $3bn of a $10bn sovereign bond program to secure funds for state entities and to help develop a domestic bond market, while Qatar and Bahrain followed suit.  Pundits at the time noted that such benchmarks are vital to the emergence of local credit markets, as corporate issuers in the region can ultimately price their own debt against them.

A recent report issued by Fitch Ratings concludes that the more challenging operating environment has negatively affected prospects for retail banking in the Gulf Cooperation Council (GCC, consisting of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE), although the degree of severity will vary.  Fitch views the potential risks from retail lending as high in the UAE (particularly Dubai) and Oman, moderate in Bahrain, Kuwait and Qatar, and low in Saudi Arabia.

The report notes further that the most negative impact could be realized in the UAE, particularly in Dubai, because the UAE retail sector is the largest in size and UAE retail loans grew the quickest in the GCC.  Dubai’s economy has been hit especially hard by the global recession, as the UAE has an exceptionally high proportion of expatriates, at more than 80% of the population (90% in Dubai).  Expatriate residence visas are nearly always linked to employment in the GCC; rising redundancies are therefore likely to result in higher defaults as expatriates leave, Fitch notes.  Furthermore, the regulation of retail loans is not as tight in the UAE compared with certain other GCC markets.

Risks is also high for Omani banks as their relative exposure to retail lending is the highest in the GCC, at 38.5% of end-2008 banking system loans.  In addition, Fitch views the levels of leverage available to retail customers as among the highest in the GCC, and regulation of the retail sector as not as tight compared with certain other GCC states.  Finally, the negative impact from retail lending will be least severe in Saudi Arabia, where the market is relatively strictly regulated; demand is sustained by a large, growing young indigenous population rather than expatriates; and the local economy has been more insulated from the impact of the global recession than many other GCC states, though declining energy prices are of concern.

JGW

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