GCC Investment Strategy and Sectors Outlook for 2006

Published March 20th, 2006 - 07:48 GMT

Global Investment House – Kuwait - GCC Investment Strategy and Sectors Outlook for 2006 –  Liquidity levels in GCC economies are rising fast on the back of high oil prices,. This is also accompanied by rising economic growth, rising government surpluses and increased investments in infrastructure development in the GCC countries. The main beneficiaries of this are the listed companies and family owned business groups who benefit from the trickle down effect leading to strong corporate earnings growth. The rising per capita income coupled with positive demographic is likely to usher more investments in the riskier asset classes such as stocks and mutual funds. We expect inflation to rise on the back of increase in the salaries & benefits and also governments’ increased spending levels.


GCC stock markets had a phenomenal bull run over the last 3 years, with many witnessing steep appreciation in stock prices. Regional valuations were stretched, led by <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />Saudi Arabia, UAE and Qatar. These markets, however began correction since the beginning of the year. At current valuations, Kuwait market looks attractive compared to other regional bourses. At current price levels, many stocks represent a good buying opportunity and provide a case of careful stock selection and accumulation. The liquidity in the market and trading activity may take a hit as the upcoming IPOs, rights issues and capital increases suck out liquidity from the markets in 1H06. Using the proceeds of capital expansions and favorable interest rate scenario in the region, we expect more big-ticket acquisitions by the regional companies.


Corporate earning seems to be trailing the growth shown by the markets. Market Cap to GDP Ratio is very high in Qatar and UAE indicating stretched valuations. We believe Large-Cap stocks to perform better on the back of consolidation activity in the region and  expansion overseas. The call of the day is security selection based on fundamental analysis and professional research, strategic sectoral asset allocation, adequate diversification across markets/sectors and a longer-term investment horizon.


Investment Theme for Oil Sector


Huge investments are required in the oil sector and it is estimated that around US$500bn is needed in the Middle East alone for oil exploration, development, refining and pipelines/tankers during 2005-2030. Going forward, we also expect increased private sector involvement in the energy sector. However, heavy dependence on oil in the GCC countries continues to remain a stress factor and concern especially considering the sustainability of this growth in the long term. We believe that there is going to be a wave of energy related IPOs and Funds as the government divests its stake in the sector. Industry giants like SABIC are expected to expand worldwide in order to be industry leader in petrochemical segment.


Oil prices have once again breached the US$60/b and have grown by almost 8% so far in 2006. This can be attributed to the market concerns over the supply disruption from Nigeria and uncertainty of oil production from Iran. The situation in Iran could change the apple-cart. The global oil demand is estimated to grow by 1.62mn bpd or 1.9% to 84.6mn bpd in 2006. In the short term, we believe that the oil prices will continue to remain high on the back of current scenarios in Nigeria and Iran, coupled with the maintenance at Murban in the UAE that cut production by 150,000 bpd.


Oil prices climbed  about 50 percent in 2005 due to strong demand, driven by economic growth and tight production capacity in OPEC and non-OPEC countries. The driving force behind the rising oil prices has been the militant threats against oil companies in Nigeria and the growing disagreement between the West and Iran, which is OPEC's second-biggest producer after Saudi Arabia. Going forward, we believe that the oil prices would remain in the vicinity of US$50/b during 2006, which implies another excellent year for GCC economies. The world oil demand will grow by 1.9% to average 84.8mn bpd for 2006, due to  improving economic conditions from USA and Asia (especially China and India). However, there are concerns about the demand in the second quarter of 2006, where seasonality declines are witnessed every year.


Investment Theme for Banking & Financial Services

Stability in economic growth along with low inflationary environment has helped Central Banks to maintain a prudent and healthy banking system in the region. The interest rates of regional economies are pegged to the US dollar, but a rising interest rate scenario could cause margin improvement and could also have a fall-out on the volume borrowings from banks. Also, strong growth in non-interest income through fees and commissions is very likely for the GCC banks. In particular, higher brokerage fees relating to buoyant stock markets, investment management fees, fees on margin loans and trade financing fees. Moreover, ample liquidity on the back of soaring oil revenues led to double digit growth in deposit base in the regional banking sector. We expect Banking Deposits to GDP to decline to around 50% levels due to increased investments in other asset classes. Also, rising loan to deposit ratio adds pressure to the risk-weighted assets impacting the capital adequacy ratios of individual banks.


Strong economic growth leads to an unprecedented loan growth in all GCC countries. Growth markedly evident especially in the higher-yielding consumer segment which experienced high double-digit growth. Banks will increase their focus on high-margin personal lending going forward. We expect lending to the private sector to increase the private sector funding for expansion of the corporates both regionally and internationally. Personal lending rise owing to demographic changes.  Construction lending on a rise owing to housing and other real estate projects. Asset quality robust in most of the banking sectors in GCC. However, provisioning seems to adequate with coverage ratio at comfortable levels.


Investment Theme for Telecoms

In order to meet the current telecommunication needs, GCC countries are focusing on mobile telecommunications services. In GCC countries, mobile penetration rates exceed fixed-line penetration, primarily because of rapid and cost-effective deployment. Especially by the pre-paid segment. Going forward, we believe that lower mobile penetration rates still provides significant growth opportunity in the region.


High ARPUs in markets such as Qatar, Kuwait, UAE etc. provide the players operating in these countries a strong base for cash flow generation. Also, strong macroeconomics and demographic profile support the telecom sector growth. Telecom liberalization commitment is a requirement for WTO accession which makes it imperative for GCC countries to commit to open their telecommunications sector, which has impacted the sector significantly. Over the last 6 years GCC countries witnessed a wave of market liberalization which resulted in the privatization of many incumbent telecommunications operators. Also new operators were allowed to provide telecom services through the issuance of new licenses.


Currently, Bahrain is the most liberalized country in telecom sector liberalization. UAE, Saudi Arabia and to some extent Kuwait are the few to show signs of liberalization activities. Mobile segment witnessing competition as new entrants are entering the GCC telecom market. Mobile competition accompanied by a surge in market penetration, leading to decreased ARPUs and increased growth in subscriber numbers. Prepaid category driving growth in subscriber acquisition. Increased usage of value-added services e.g. Data and content to add to the growth in voice segment. Increased multimedia convergence would lead to cross-selling of service offerings. Going forward, we foresee ARPU dilution which will directly affect the margins of telecom players. Advent of competition (new licenses are expected to come up in UAE and Qatar in 2006) to affect market share of incumbent operators.


Investment Theme for Real Estate

GCC is blessed with a conducive environment for a flourishing real estate sector. Government grants of land at major discounts has been the single most important factor for the proliferation of big ticket projects across the region. Also, allowing freehold of property by foreigners in some of the markets has been a big plus to the sector. Pro-privatization approach by some of the governments, booming stock markets facilitated raising of money for the private sector, rapid emergence of a previously non-existent mortgage banking also played significant roles in increasing investment activity in the sector. Low lending rates, thanks to the fragmented and competitive banking industry, increasing popularity of real estate funds which invest in the region and lastly, a favorable geopolitical scenario compared to the past also contributed to the sector growth.


Within the GCC, yields in 2004-2005 have been relatively higher in Jeddah, Riyadh and Qatar. Industrial and offices segment outperformed the residential segment in terms of yields across the GCC. Increase in rental rates has been the highest in Qatar at around 75%. Among the various segments, the rental rate increase was more for the offices segment. On an absolute basis, rentals are the highest in Kuwait and the lowest in Muscat. Though we have seen rapid appreciation in prices, this cannot be called a bubble as similar capital flows into the sector are expected to continue, especially as institutional exposures increase. This would happen once the real estate markets in the region mature, of which we are already seeing signals. For instance, secondary sale premiums have shrunk in the UAE, to about 5-10% in 2005 from 25% in 2003, and the banks are increasingly getting reluctant to finance the premiums.


Going forward, an anticipated diversion of investments is expected from current favored destinations like Dubai and Bahrain to Abu Dhabi, Qatar and Oman. Allocation to segments like logistics, hotels and industrial segments are expected to increase. With the diversity in investments and maturing of markets, it is expected that investments in the future would have lower risk and consequently lower returns.  Government initiatives to improve the landscape in places such as Doha and Abu Dhabi could lead to forced housing shifts, worsening the supply crunch in this segment. High quality office space continues to be in short supply, especially in Dubai, Qatar and Saudi Arabia. Shortage of hotels is acute in most of the places, more so in Dubai, Doha, Kuwait and Muscat. Industrial property is set to bring huge returns in the next few years, with the unwavering focus on manufacturing in countries such as Qatar and Saudi Arabia and places such as Abu Dhabi and Sharjah.


Stock Market Outlook:

GCC stock markets came under a strong correction phase since the beginning of the year. While economic fundaments continue to be positive in the region, the market participants seem worried about the liquidity squeeze due to  the issuance of rights shares by many companies and formation of several new companies. This will create a multiplier effect and generate further liquidity in the system, thus leading to a virtuous cycle of growth. Overall, the past few weeks has seen increased volatility in stock prices with a bearish mode in many of the regional stock markets due to growing concerns about expected slowdown in corporate earnings this year and a possible liquidity squeeze. Liquidity is only one of the factors, which has been driving the markets, but important thing is the overall fundamentals and structural changes in the economy which is keeping this liquidity in the economy and is going to be the key factor in driving the stock markets further. Oil prices have been ranging at higher levels, placing the economy on a sound footing. Government’s attitude has become more pro-privatization, which augurs well for the longer term growth of the economy. Increase in liquidity due to an impressive growth in credit off take.


Going forward, we believe that the robust state of the economy, which has prompted the interest rate hike, has created enough wealth to offset any slight pick-up in the rates. Apart from these fundamental factors, we expect the market to get a much-needed leg-up from a more stable geopolitical situation. GCC Union and common market is providing and will provide more trading opportunities. However, the market participants were expecting profit booking as some of the markets looked stretched and the market cap growth had abnormally out-performed the corporate earnings growth. However, in the long-run the market is expected to stabilize but this is high time that  investors should have a careful look at each stock in their portfolio rather than getting panicky at the overall downturn seen by the markets. The liquidity in the market has also taken a hit owing to the IPOs, rights issues and capital expansions undertaken by the corporate/banks in the region. We believe that with the capital expansions and new issues, the free float is likely to increase in the market making the market more liquid and deep. However, we reiterate that the fundamentals of our economies and particularly that of the corporates remain strong. The volatility in the markets are the part and parcel of capital market growth but it is the ability to absorb these shocks which will determine the strength of our markets. The improvement in the macro-economic profile of the GCC region on back of strong petro-dollar surplus has taken liquidity in the economies to unprecedented levels. The financial sector is awash with funds and corporates are taking advantage of the low interest rate scenario (although rising) to borrow at cheaper rates to fund expansion both regionally as well as internationally. The strong corporate performance has given the financial flexibility to the companies in the region to look for investments outside the region. The investment funds and private equity players are getting strong support from the investors in terms of increased investment in both Islamic as well as conventional funds to fund the deal flow. Apart from looking at the interesting opportunities in the region, the investment companies/corporates are looking at other promising markets outside the MENA region to diversify their investment base/revenues. This is crucial as it will hedge their risk of operating in a single market.



Table: Global Research Market Forecasts


Index -2005

Growth- 2005

Index on Mar.14th 06

YTD growth (Mar.14th 06)

Expected Index Target End'06

Growth from Mar.14,06- till Dec. 31, 06E





























Saudi Arabia














Source: Global Research




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