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“Sell the news” could theoretically apply to the sudden rash of Saudi equity related articles of late highlighting bullish managers such as Mark Mobius and John Burbank (to that end we’ve been bulls for years; see archive) as well as the domestic Tadawal’s (TASI) underlying fundamentals including (i) a [forward] p/e of around 14.5 (all time historical highs are just over 15); (ii) a relative [dividend] yield versus local debt/peer payouts (i.e. ~0.6 percent on 1y government debt and a projected payout of 3 percent from the MSCI Emerging Markets Index, though admittedly myriad GCC countries sport a higher yield including Qatar, Abu Dhabi and Bahrain–all of which have lower premiums as well) and (iii) an impending invitation to foreign investors with an eye towards ultimately garnering MSCI ’emerging’ status.
That said even though the TASI looks to be stalling against 7800-8000 resistance after recently making 40-month highs, the long term retains its same promising premise–a fast growing (2.1 percent annual population growth versus the 1.2 percent global average) young and more economically/politically inclusive demographic underpinned by an oil and gas export-fueled investment boom that has spillover effects on other sectors (construction, building) and is itself a function of government spending, well capitalized banks (whose foreign liabilities have fallen in recent years against a large (15 percent) savings pool and moreover a generally non-interest bearing deposit base) with low exposure to European funding sources (and subsequent liquidity tightening) and an inherent competitive advantage particularly in the production of fertilizer, aluminum, steel and petroleum-based products. In a sense most if not all of these factors are intertwined and dependent upon one another, which is either comforting or not depending upon one’s perspective. Saudi PMI remains comfortably expansionary (~60) and in lockstep with aggregate demand/wage supportive fiscal spending (+ ~2.4 percent forecast in 2012 on top of a 23 percent increase in 2011), for instance, while credit volatility is also smoothed by the state via deposit growth. As I related to someone recently one cannot understate the role that public sector deposits in Saudi Arabia play in supporting liquidity. Over the past 5 years Saudi banks have exhibited loan to deposit ratios ~80 percent at extremely low volatility relative to GCC peers. However, even during cautionary periods for the sector (i.e. the latest European bank/funding crisis) wherein Saudi commercial banks have increased their central bank deposits, government deposits in the banking sector have risen in kind, smoothing an otherwise net contraction in credit growth (% change y/y government deposits with local banks have trended upwards since February 2010) as gross private sector credit continues to rise (to this end the latest consumer borrowing data sits at +21.8% y/y, a record high). The catalyst supporting the state driven dynamic is rising net foreign assets (NFAs) which in turn drives broad money growth (M3) and finally the money multiplier, meaning Saudi equities could theoretically still be ‘cheap’ for quite some time.
Buffeted by an “unparalleled infrastructure, flexibility in production volumes and policy machinery”, all of which make it per Barclays “the key player at the margin of the oil market” Saudi Arabia remains relatively insulated contra developed market-derived contagion–more so than any other GCC economy. Increasing non-hydrocarbon imports, for instance, are a proxy for improving and resilient domestic demand driven chiefly by expanding private sector credit (9.8% y/y in October, compared with 8.7% in September) within a domestic banking system comparatively unconstrained by the high loan-to-deposit ratios (inversely correlated with liquidity) observed in UAE, Qatar and Oman, or the significant reliance on funding from European banks (and hence external funding base exposure to that sector’s ongoing deleveraging) seen in the UAE and Qatar (on the contrary funding remains largely based on customer deposits in Saudi Arabia at ~70% of total assets in 2011h1 versus 57.9 GCC avg). To that end we remain intrigued (see our original thesis from last March) by the Saudi banking sector heading in 2012, home to nearly one-third of Global Finance’s recent “Safest Emerging Markets Banks” Top 20 rankings. This doesn’t necessarily come as a surprise given capital adequacy (CAR) and non-performing loan (NPL) dynamics matched only by Qatar in terms of dual attractiveness while liquid asset ratios—i.e. cash, central bank certificates of deposit, interbank deposits and high-grade fixed income securities—are over 50% for certain Saudi banks (2x those seen by other GCC institutions). And while one weakness of the sector in our view remains its credit/funding concentration (i.e. a predominantly corporate profile), banks such as Banque Saudi Fransi are targeting a larger retail base and the lower cost deposits and higher interest margins which come with it.
Admittedly the conservative asset growth and high risk aversion within the Saudi banking sector is largely a function of environment; aside from timeless speculation surrounding succession the Kingdom’s macro viability, for instance, remains intrinsically wedded to its swing-production power within OPEC and the ensuing, relative size and stability of its energy receipts which tie neatly in with the comparative, aforementioned liquidity of its banks’ funding base (the government remains a major and/or majority shareholder of banks such as Samba Financial Group). Indeed recent oil production cuts (from a peak of 9.9mb/d in August) during oil’s near-convergence earlier this year to the estimated fiscal breakeven oil price are symptomatic of an increasingly pragmatic state that, against an Arab Spring/Euro Malaise backdrop remains keen on fiscal expansion (25% y/y in 2011 and, despite official rhetoric of easing next year most analysts still envision spending momentum to continue with the overall effect being the state’s budget surplus will remain static if not increase slightly in 2012) and thus as ardent as ever in supporting a defacto price floor in crude (though citing non-OECD demand trends in particular, many energy analysts argue a reprise of oil’s post-Lehman price crash would be quite remote anyway) which should help translate into ‘backwardated’ markets for the appreciable future and thus even larger coffers for the Kingdom to tap.
While Saudi Arabia’s state-run energy company Saudi Aramco (which currently charges its petrochemical companies $0.75/mmbtu) is still likely to increase the price sought (to $1-$1.25) for ethane (which comprised 70 percent of total feedstock–i.e. the basic raw material that is converted into another product in a chemical process–for petrochemical makers last year) at some point in the near-term (despite recent ambiguity) given the realities of tighter supplies, not only does the sector’s marked, global cost advantage remain intact–the average global market price for the gas is 6x higher at roughly $4.50 per million BTU–but it looks set to meet rising Chinese demand (which comprised roughly one-third of global needs in 2010 from one-quarter in 2006) as the Kingdom plans to invest some $100bn within the next five years to boost output to more than 80 million (from 60) metric tons/year (used, in turn, in the manufacture of numerous products such as synthetic rubber, synthetic fibers and plastics). Two firms in particular, SABIC and Sipchem, down approximately -0.4 and -14.6% YTD respectively in response likely to regional capacity additions and Chinese monetary normalization, should benefit given fairly sticky projected gross margins in the face of a feedstock price rise: the former has both higher fixed costs (in cost of sales) and a more diverse downstream capabilities compared to peers which has hitherto allowed it more robust pricing power, while the latter finally finally seems ready to capitalize on the fruits of its latest expansion. Meanwhile, while analysts with Al Rahji Capital, a regional investment bank, note that China is in the midst of adding substantial capacity, at the moment its trade imbalance has never been so pronounced and furthermore “it will take a few more years for these capacities to come on-stream.” China’s petrochemical imports grew 42.3% in 2010 to $324.5bn after a dip in 2009 and per observers three specific drivers should indirectly underpin this trend going forward: “1) China‟s huge government spending on infrastructure (its government has allocated $1.3 trillion for infrastructure development over the next five years in the 12th Five Year Plan announced in the early 2011); 2) increasing domestic consumption which is expected to grow by 2 to 3 percent over the next five years; and 3) continuing housing construction (the government plans to build approximately 36 million affordable housing units by 2015).”
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.
Broadly speaking The Economist noted last week that governments throughout the Middle East, in addition to their traditional subsidies undercutting food and fuel inflation, are now going above and beyond in a rather cynical attempt to “buyoff economic discontent” and perhaps also halt local bourses’ YTD decline. Yet as the accompany chart shows, ensuing fiscal positions are anything but uniform. Import covers for oil importers such as Eygpt and Tunisia, for instance, should be watched closely. On the other hand, despite the relative enormity of its SAR135bn (USD36bn, 8% of GDP) package to tackle structural challenges facing the economy, including unemployment, housing, education, and general household welfare announced earlier this month, Saudi Arabia’s “largesse” may in fact be cost efficient if for no other reason than rising oil prices (Economist notes that “each $1-a-barrel increase in the price of oil adds about $3 billion to the Saudi treasury, implying that the increase in oil prices this year could add roughly $100 billion to revenues; in turn, net foreign assets (NFA) rose 7.4% y/y in January which analysts see averaging 4% annually this year) will offset much of it: nonetheless, analysts with Barclays project that “the package will increase spending by 14% and will reduce the fiscal surplus from an original forecast of 6.4% to 2.6% of GDP” while “raising the fiscal breakeven oil price of Saudi Arabia to around US$79 b/d (up from US$69.1).” Moreover, they point out, “implementation risks [of the fiscal package] are non-negligible if not accompanied by additional legal and regulatory changes (notably on the housing front), and significant improvement in the efficiency of public spending.” Notably, “the problem of [a] supply shortage of lower and middle income housing” will likely lead to “continued short-term pressure on property prices, particularly for developed land and apartments,” despite a 40% capital injection into the country’s Real Estate Development Fund (REDF), whose mandate is to provide interest-free loans to help citizens construct their own homes and/or purchase apartments, guarantees for housing loans given by commercial banks to citizens under certain conditions, and finally additional funds pledged to the General Housing Authority “to speed up the awarding of housing units to needy families.” With this in mind, Saudi banks remain an attractive sector, especially since M3 (broad money supply) growth trends (up 8% y/y in January and a function of the aforementioned NFA growth), coupled with below-historical average velocity (0.72 compared with 1.03 over the past decade) and rising bank system assets suggest further scope for lending–especially to an increasingly robust manufacturing sector (PMI up 14.4% y/y in January). Saudi American Bank Group, which [correctly] warned last December that the ever-impending mortgage law was still some time away, noted recently that Saudi banks’ average loan-deposit ratio currently stands at around 80 as opposed to 100 percent or more in other Gulf countries.”
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.
Deloitte’s recent projection that “the number of mergers and acquisitions in the Middle East [should] double in 2011 as regional economies expand and governments spend on infrastructure” may mean that merger arbitrage–in which a given target company’s stock price should eventually rise to reflect the agreed per-share acquisition price, while the acquirer’s price should fall to reflect what it is paying for the deal–could become an effective short-term, regional and/or sector-based strategy in the coming years. “Merge-arb” may also seek to capitalize on the spread at a moment in time based on a perceived probability of a given deal being approved, and/or how long it will take the deal to close, versus market perceptions.
As always, the devil is in the timing of it all. The Saudi insurance market, for instance, is “ripe for M&A” but “awaits a nod from the central bank,” according to Ali Al-Subaihin, chief executive of the kingdom’s biggest insurance firm, Tawuniya. “Consolidation is bound to happen, if it does not happen this year, it will happen next year or the year after. The catalyst would be for the regulator to intervene and suggest that some firms merge or for some firms to seek the regulator’s approval to merge,” he told a recent summit. Takeovers would be a welcome market response to the government’s overly aggressive push to license new firms amidst surging demand for protection & savings and health insurance (with the country’s population projected to reach 45 million by 2020, analysts opine that the demand for insurance products, especially medical and motor insurance, will only escalate further; to that end, per capita expenditure on insurance is rose 31 percent last year). Per a Reuters piece, “the pace of licensing may have been too abrupt to allow the new players to become quickly profitable, industry analysts say, forcing many to consider mergers or become acquisition targets.”
Health insurance accounts for over 40% of the overall market and is expected to grow, according to a report by RNCOS, an industry researcher, “as the increasing involvement of private companies develops the scope for insurance cover, and as foreign nationals and foreign pilgrims are obliged to take out insurance. In addition to this, the most recent introduction of compulsory health insurance for private employees, irrespective of the size of the company they are working with, will further boost the health insurance market in the country.” General insurance, which accounts for the majority of insurance premiums, is expected to grow at 13 percent annually until 2013 on the back of rising motor, property, engineering, energy, liability and aviation insurance.
Looking broadly across the entire region, premiums in the GCC rose by 28 percent in 2009 to $10.6 bn, though penetration rates still have room to converge. “Insurance penetration–aggregate insurance premiums over GDP–stands at 1 percent for the GCC countries. In contrast, the developed insurance markets in the US and Europe register penetration rates in the range of 5-15 percent,” per one consultant. “[And] Saudi Arabia’s penetration rate is a tiny 0.6 percent, which is dwarfed by that of the UAE at two percent.”
Saudi Arabia’s impending “mortgage law”, which has been in the planning stages for nearly a decade, was further delayed earlier this month when the Shoura Council, Saudi Arabia’s principal advisory body appointed by King Abdullah, announced that it would not vote on the measure until late September following the holy month of Ramadan and then the Eid al-Fitr holiday.
Per a Deutche Bank research note from April, total outstanding home finance provided by the private sector in Saudi Arabia aggregates to less than 1% of GDP, compared with well over 50% in most developed countries, and approximately 6% in Kuwait and 7% in the UAE. Furthermore, the Bank estimates that Saudi Arabia will need 1.2 million additional housing units by 2015, and that based on market assumptions, when the new mortgage law is ultimately enacted it will contribute to incremental demand of approximately 55,000 additional units per year.
Against the backdrop of a rapidly rising population that is set to exceed 26 million within the next three years, analysts forecast that long-term residential housing demand in Saudi Arabia will remain strong going forward, as almost 40 percent of the population is under the age of 14, and personal disposable income is projected to grow at a compound annual growth rate of 6.5 percent (reaching approximately SR659b, or $176b, by 2013). And since it’s estimated that upwards of 30% of all consumer spending in rich economies is home-related, estimates published by BMI, a consultancy, earlier this year forecasting average annual private consumption growth of 7.92% between 2011 and 2014 that will outperform the average GDP growth over the same period (see graph, below) could be understated.
Either way, it seems daft to continue to write-off Saudi Arabia’s overall economic well-being as wholly-dependent on exported commodities. Moreover, if the Kingdom ever chose to address its chronic unemployment and income inequality issues, consumer figures would truly accelerate.
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.”
Per Abdulaziz Z. Mahasen, managing Partner at Optimead, a Rijadh-based consultancy:
Saudi Arabia, the Arab world’s largest economy, is in no rush to raise interest rates and will keep plowing its oil revenue into kick-starting growth. The kingdom, the world’s largest oil exporter, last year announced that it would spend $400 billion on infrastructure over a five-year period to bolster the economy, the largest stimulus package in the [G20]. The country is allocating almost $70 billion to investments this year, a 16% increase on 2009. Rising oil prices, which have rebounded to about $75 a barrel from less than $35 in February, are also likely to boost growth in 2010].”
The view echoes that of those observers wh0 foresee static rates during the year across the region’s dollar-pegged Gulf economies–Saudi Arabia, UAE, Bahrain, Qatar and Oman–given that historically their tightening has coincided roughly with the Fed’s. Aside from that, however, central bank Governor Muhammad al-Jasser noted to Bloomberg that low inflation and tepid loan demands are not condusive to a rate hike. Credit may begin to flow by the spring or summer, however, as domestic banks especially should have a better handle by then on the increase of NPLs forecasted in November.
JGW
Frontier Markets 