First quarter earnings to dictate GCC markets’ direction
<?xml:namespace prefix = v ns = "urn:schemas-microsoft-com:vml" /><?xml:namespace prefix = w ns = "urn:schemas-microsoft-com:office:word" />Global Investment House – <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />Kuwait – GCC Market Review – March 2006 - In Jan-06 it was UAE, in Feb-06 Qatar nosedived and now in March-06, it was the turn of Saudi Arabia to be gripped by the bearish sentiments. Saudi Arabia and Kuwait benchmark indices reported double digit losses and contagion effect spread to their markets. Bahrain market too lost around 6.6% followed by UAE which reported a monthly decline of 2% in Mar-06. In terms of YTD gains, only Oman (+9.8%) and Saudi Arabia (+2.1%) are managing to stay in the black.
However, the market was expecting some kind of correction as the valuations in the market looked stretched. But the declines has provided a silver lining as at current price levels, many stocks represent a good buying opportunity and provide a case of careful stock selection and accumulation. Moreover, the conditions that were present in order to provide strong support to market are still there. We expect that the strong earning momentum in 1Q-2006 results is likely to provide the much needed push to the market. Primary markets in the GCC region, however, seems to be unfazed by the activities in the secondary markets and oversubscription continues to break all barriers. Besides, we are also seeing strong investors attention towards the funds route especially the private equity funds who invest in the companies prior to the listing and give investors advantage of getting larger pie in the company rather than getting smaller allocation in the IPOs.
Table 01: Index Performance
|
Country |
Measured by |
|
Index Close |
MTD Growth (%) |
YTD Growth (%) |
Source : Respective Stock Exchanges and Global Research
Investing pre-IPO to garner the maximum returns
In the last two years, the liquidity in the GCC economies has improved substantially and the capital markets witnessed increased depths, both in terms of the number of listed companies as well as market capitalization. The corporates are witnessing good earnings momentum, which is likely to be sustained on the back of buoyant economy and tremendous business opportunities in the region. The year 2005 in particular was good for the GCC region as the countries witnessed strong fiscal positions due to high oil prices. The capital markets observed improved primary market activity, which increased the number of companies listed on the GCC stock exchanges from 492 at the end of 2004 to 579 in 2005.
The primary markets evoked special investors’ attention as the private businesses and the governments of the region tapped the primary market to unlock the value of their investments. This also improved the performance of the secondary markets in terms of increasing the trading activity especially by the retail investors. Out of all GCC markets, the UAE bourses witnessed the most oversubscriptions, led by Aabar Petroleum which was oversubscribed by a massive 800 times. Aldar Properties was also oversubscribed by 448 times and generated US$103bn in terms of funds committed. Among others, Arab International Logistics was oversubscribed by 80 times and Finance House witnessed a 75x oversubscription. This high level of oversubscriptions explains the elevated initial opening price and the subsequent performance of many of the newly listed stocks. According to the reports, the public share sale of Emirates Integrated Telecommunications Company (EITC), the Emirates’ second telecoms operator, was oversubscribed by 167 times.
However, with the strong oversubscription levels, have come out the report of strong bank financing which has taken the turn of abuse of the system by some investors and banks. Last year, the UAE central bank warned some banks for offering leverage far in excess of the permitted level 5 times. The central bank's circular had directed banks not to provide loans to investors greater than five times the investment made by the investor as there have been instances where a banks offered leverage in excess of 12 times.
In order to smoothen the functioning of the capital markets, the GCC region is witnessing a change in the regulatory framework with the supervisory institutions introducing new capital market laws to improve the investment climate in their respective countries e.g. Central Bank of UAE has decided to effect a 10 per cent rise in loan ceilings extended by banks against mortgages of corporate shares to 80 per cent of the market capitalization. However, in a major move, the UAE authorities are contemplating to fix a ceiling on the maximum allotment in IPO subscriptions. With the new rule that limits the maximum allotment expected to come into force, small and medium investors stand to gain.
Also, the IPO is required to be offered to the investor at par in Saudi & UAE and a minimum of 55% of paid in capital should be offered at the IPO in the UAE. There are reports that this is also being done away with in order to encourage promoters to retain the controlling interest even while going public. The regulators have also directed the newly established firms that have completed their IPOs to refund surplus within two weeks which will help the markets in getting back the liquidity. Besides the Saudi and Oman capital market regulators have tried to evoke interest of retail investor by introducing share split to make markets more liquid.
All these restrictive clauses in new IPO’s such as minimum allotment per application, allocation to all the applicant leaves limited upside potential especially to large investors which are genuinely interested long term investment rather than doing speculative trading activity on the bourses. Also current equities too are trading at high premiums due to limited number of listed securities currently available to investors and they command a liquidity and marketability premium from the investors.
For those investors who are concerned that they might not get a substantial chunk in the IPOs and have to buy stock at higher levels (post-listing), one route can be investing in the company prior to its offering. There are various private equity funds in the region that provide investors with investment opportunities into Pre-IPO deals and equity deals in which there is a reasonable probability of exit via a recognized stock exchange. The information about closed companies is also not available easily to the investors so they can invest in the pre-IPO or private equity funds who can conduct professional research, valuation and evaluation of management, due diligence on the companies, determining purchase/selling price and take decision on the timing of sale of their investments. Investing in the fund offers a wider selection on companies and markets with the investment experts undertaking all the analysis of the companies to be invested in.
There are opportunities in the MENA region as well as other emerging market which these funds can utilize and generate good returns. In the MENA region, the IPO and pre-IPO market in Turkey looks promising in 2006 on the back of increasing investor interest by international investors especially in privatization projects. Accelerating privatization and pre-IPO initiatives in Iran, Egypt & Pakistan market are expected to boost economic activity. The fact that Jordan's IPO market consisted entirely of green-field companies did not deter investors from rushing to subscribe to the shares on offer as evident by the respectable oversubscription figures. Beside, the much talked about economies of India and China still offers attractive opportunities in private equity. In our own backyard the growing GCC region seems to be a hot destination for pre-IPO activity as the oversubscriptions in IPOs are reaching record levels.
Opportunity areas include utilities/ infrastructure with many privatization efforts being initiated in GCC (e.g. projects for power generation, gas distribution, water purification etc) to increase private sector participation. Real Estate sector looks promising with relaxation in ownership allowed by many countries. Health Care sector in MENA is likely to witnessed increased private participation in hospitals, pharmacy chains and specialty care projects. With a number of family businesses thinking of going public and the governments in the region keen on divesting the stake in the booing market, the pre-IPO funds provide an attractive option to the family business and government to divest strategic stakes to the fund. For the investors, investments in Pre-IPO opportunities have resulted in significant gains in recent past and will continue to be rewarding.
Corporate earnings on a roll
Rising oil prices, strong economic fundamentals and growing business confidence in the region have led regional corporate earnings on a growth trajectory over the last couple of years. The regional corporate earnings of 431 companies (reported profits at the time of this report) listed exhibited exuberant a profit growth during the year of nearly 61.4%, while adjusted market capitalization registered a weighted average growth of 116.5% for 2005. This means that the runaway gains by the stock markets have been accompanied by strong growth in profitability. The higher-than-expected profits have encouraged greater investment and higher stock market valuations. Looking at the regional profits by sectors reveals that all the sectors have managed to register double-digit profits in 2005.
Banking sector achieved a growth of 76.0% during the year 2005. The banks showed improved performance on the back of widening spreads in 2005 on back of rising interest rate environment prevailing in the region. Also the management fees, commission, and investment banking activities have benefited the banks on a greater scale as these activities have continued to grow around the region. As a result of these solid performances by regional banks, banks have been expanding further to take advantage of the growing banking opportunities across the region and consolidating to achieve economies of scale. For example, National Bank of Kuwait (NBK) going to Lebanon, Kuwait Finance House (KFH) to Malaysia, where as Commercial Bank of Qatar (CBQ) and National Bank of Oman (NBO) consolidated.
Table 02: GCC sector profits for 2005 (US$mn)
|
Sector |
2005 |
2004 |
% Growth |
|
Banks |
14,391 |
8,177 |
76.0 |
|
Investment |
3,779 |
1,777 |
112.7 |
|
Insurance |
1,560 |
668 |
133.4 |
|
Real Estate |
2,222 |
976 |
127.8 |
|
Hotels & Tourism |
125 |
79 |
59.1 |
|
Telecoms |
6,004 |
4,772 |
25.8 |
|
Services |
3,441 |
2,241 |
53.5 |
|
Industrial |
7,852 |
5,561 |
41.2 |
|
Cement |
1,672 |
1,206 |
38.7 |
|
Agricultural/Food |
91 |
33 |
174.7 |
|
Total |
41,136 |
25,489 |
61.4 |
Source: Global’s Research
Investment companies have also been able to utilize the buoyant mood of the market to strengthen revenue streams, including investment income, commissions and advisory services fees, building on placement and management fees. We believe investment companies have benefited the most from the exuberant gains in the regional markets in the past few years, profiting on the rise in nearly all asset classes. Overall, the investment sector witnessed an earnings growth of 112.7% in 2005 as compared to the previous year. On the other hand, Real estate sector has also produced exceptional results, reporting an increase of 127.8%. Despite the increasing interest rate environment across the region, the real estate companies continued to benefit from the infrastructural developments and regulatory reforms around the region. Developments from select GCC government on allowing foreigners to own real estate have boosted the overall growth in respective countries. In addition, what has also benefited the real estate companies is the growing expatriates in the region, which thus increased the demand for rental properties. In addition, significant increase in tourism and travel have boosted the earnings of the Hotels and Tourism sector companies by 59.1% in 2005.
But the sector which has started to gain ground in GCC has been the Insurance sector, reporting the highest growth of 133.4% in 2005. The growth can be attributed to excellent investment yields as a result of improved stock market gains. Insurance companies in the GCC invest about 40-50% of their total investments in equity, which have in turn resulted in huge returns reflected in yearly profits. Telecom sector on the other hand achieved growth of 25.8% in 2005 compared to the corresponding period last year. The telecom penetration rates have increased dramatically in the last year or so. Going forward, we believe the telecom sector will continue to grow at above-average growth rate and mainly due to the expansion of regional operators outside the GCC countries. For example, MTC in CELTEL and Etisalat in Pakistan
Regional economies are building their foundations, with governments using the massive liquidity to stimulate growth and launch streams of development projects, benefiting the economy moving forward, which will trickle down to further improve in corporate earnings. Moreover, in our “GCC Strategy” report we have forecasted profitability growth of 32% for Saudi Arabia, 29% for UAE, 26% for Kuwait, 25% for Qatar, 25% for Bahrain and 17% for Oman.
Qatar market outlook
Strong economic growth, buoyant crude oil prices, excess liquidity, opening of the market for foreign investors and growing corporate earnings were the major factors which staged a dramatic bull run at DSM during the year 2005. Global’s DSM Index posted a massive yearly gain of 83.45% on top of 47.56% gain witnessed in 2004. The General Index of DSM registered a gain of 70.2% in 2005. The major development of the year 2005 was the opening of the market for foreign investors. A law that allows expatriates and non-resident foreigners to trade on the DSM had been made effective from April 3, 2005. In anticipation of this development the market started moving up significantly since the beginning of the year 2005, though the actual law came into effect from April onwards. The rally in the market was liquidity driven and purely of speculative nature. At the end of the year the DSM’s M-Cap stood at QR317.2bn (US$87.1bn), which shows addition of a colossal sum of QR170bn (US$46.7bn) or a massive gain of 116% to the investors’ wealth during 2005.
However, late during the year, especially in the third quarter of 2005, Qatar market started witnessing selling pressure, mainly due to stretched valuations which led to profit booking. Apart from that the investors have also increased their attention towards the primary market which has led to flight of liquidity from the secondary market putting further selling pressure in the market. In this process, the Global Qatari index retreated by a massive 21.7% YTD (till March end). We believe that valuation multiples appeared to be stretched as the corporate earnings couldn’t kept pace with the stock market growth. The market discounting multiples such as P/E or P/BV grew much faster than the growth in the corporate earnings which might have resulted in selling pressure. We believe that corrections are healthier for any market as it turns the market from speculative to healthy.
In terms of growth in corporate earnings, the aggregate profit of listed companies grew by 44% for the year 2005 to QR11.4bn as compared to a growth rate of 59.2% achieved in 2004. Among the sectors which saw significant improvement in their profitability included banking sector and insurance sectors which registered a growth of 109% and 99% respectively. Profit of Industrial sector grew by 33% and services sector registered a miniscule growth of 3%. Going forward, we are optimistic about performance of the Cement, Banking, Telecom and Power sector companies in Qatar.
The fundamentals of the economy remain sound. On the macro-economic front, Qatar's GDP reached a record US$34.37bn (QR125.56bn) in 2005 displaying a strong growth of 20.8% over the previous year, according to a report released by the Ministry of Economy and Commerce. The growth was primarily a result of mega projects that have been launched during the previous years. Further to sustain this growth the Government as well as private sector entrepreneurs have announced spate of projects spanning various sectors, apart from the primary Hydrocarbon sector, which are running into trillions of dollar. Such a large scale of project opportunities would definitely offer ample business opportunities for Qatar Inc.
We believe that there is an urgent need on the part of the authorities to increase the depth and breadth of the market by focusing more on institutionalization of the market, disinvesting Government holdings in core companies from Oil & Gas sector and also encouraging private enterprises to go public. Such moves would definitely help the country to have a more mature capital market.
We believe that the valuations of most of the leading Qatari companies are reaching towards realistic levels and they will continue to report another year of sound performance. Therefore, barring short term volatility in the market, medium to long term outlook for Qatar market appears bright.
Market activity
The GCC markets saw 8.6bn shares being traded in Mar-06 as compared to 8.5bn shares being traded in the previous month. However, we expect the trading activity to increase in April-06 as the investors take up new positions after analyzing the corporate earning announcement. The reduction of the par value in Oman had its effect on the trading activity and with Saudi Arabian authorities too going the same way, the volume of shares traded on the bourse is expected to increase substantially.
Table 03: Exchange Activity
|
Country |
Total Volume Traded |
Total Value Traded (US$) |
Market Cap (US$) |
No. of Transactions |
|
Bahrain |
42,300,429 |
57,986,461 |
16,912,073,826 |
2,021 |
|
Kuwait |
3,179,267,000 |
5,681,341,219 |
128,986,984,611 |
122,234 |
|
Oman |
36,843,165 |
203,322,306 |
12,888,311,688 |
23,630 |
|
Qatar |
116,020,623 |
2,010,393,138 |
70,045,792,460 |
131,203 |
|
Saudi Arabia |
638,913,681 |
92,350,925,470 |
788,759,519,849 |
4,419,577 |
|
UAE |
4,643,686,601 |
11,371,200,217 |
209,193,312,910 |
310,929 |
Source: Respective Stock Exchanges and Global Research
The GCC market depth was heavily tilted towards the decliners as 334 stocks reported monthly declines as compared to 117 advancers. The strong sell-off was seen in the Saudi market as only 2 stocks out of 79 listed stocks on the exchange reported monthly gain in Mar-06. Kuwait market too reported an adverse advance decline ratio of 0.15:1.
Table 04: Market Breadth
|
Stock Market |
Advancers |
Volume |
Decliners |
Volume |
Unchanged |
Volume |
Total |
|
BSE |
7 |
4,037,065 |
21 |
38,079,791 |
18 |
183,573 |
46 |
|
KSE |
19 |
181,853,500 |
126 |
2,987,113,500 |
16 |
10,300,000 |
161 |
