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29 March 2024

UAE indices outpace the region in February

Robert McKinnon, Al Mal Capital (SUPPLIED)

Published
By Yazad Darasha

UAE stock markets outperformed regional indices in February with a gain of more than six per cent as Abu Dhabi bank injections and the Dubai Government bond issue increased confidence.

"The outperformance for the UAE markets was driven by the combination of an oversold market and a positive catalyst in the form of the Government of Dubai's bond issuance," said Robert McKinnon, Head of Research at Al Mal Capital.

"However, we are cautious from an investor standpoint until we see the details of how this funding will be distributed. In our view, the funds will surely help the Dubai Government and related entities roll over its dues this year," he said in a research note.

In early February, the Abu Dhabi Government injected fresh capital of Dh16bn into five banks.

"With an average Tier-1 capital adequacy ratio for Abu Dhabi banks at roughly 16.7 per cent following the injections, we feel the bank-heavy ADX should find some support. Additionally, valuations are relatively more attractive for Abu Dhabi banks than their regional peers at 0.7x price/book, compared to 1.3x for Saudi banks and our regional average of 1.2x," McKinnon said.

According to research by investment banking firm Rasmala, following a 10 per cent loss in January, UAE markets gained to become the best-performing in the GCC in February.

Qatar stocks shed 16 per cent of their value last month; Saudi Arabia lost nine per cent; Egypt ended February seven per cent lower; Kuwait and Bahrain both lost five per cent; and Oman made a modest gain of one per cent, Rasmala data show.

"The Government of Dubai's announcement of a $20bn long-term bond programme of which $10 billion (Dh36.73bn) was fully subscribed by the Central Bank of the UAE was critical," said Khaled Al Masri, Partner at Rasmala.

"The bonds have a five-year maturity and will pay a four per cent fixed coupon which should quell speculation by market participants of the ability of Dubai to service its outstanding debt in the short and medium term. As can be expected, the Dubai CDS fell as conditions in the credit market eased noticeably. The three-month Eibor rate closed [February] at 3.375, converging closer to its US counterpart in a sign that liquidity conditions in the interbank market are easing," Al Masri said.

Arabtec and DFM led the rally in Dubai, ending the month higher by 32 and 43 per cent, respectively. Dubai-listed real estate stocks also gained, with Emaar and Union Properties adding five and 15 per cent, respectively. The banking sector's performance was mixed as Emirates NBD lost five per cent while Dubai Islamic Bank ended the month 18 per cent higher.

Al Mal said it expects regional flows to continue into sectors with positive and stable cash flow, conservative revenue recognition, and no immediate financing needs.

Key issues

"Valuation multiples are deceptive in the near term with a justified premium for cash-flow predictability and balance-sheet strength," McKinnon said.

"We have identified four key questions that we feel investors need to consider when allocating a GCC equity portfolio. First, what is the quality of the company's earnings? Secondly, are the business models in a given sector driven by leverage? And could the companies earn an attractive return on invested capital without leverage?

"Third, is there a need for a government 'bailout' and, if so, how dilutive to shareholder value would it be? Finally, is there transparency? As companies compete for access to new capital, better transparency will capture a premium," McKinnon said.

"The level of cash as a component of recognised revenues has a tremendous impact on the quality of earnings. Essentially, in the current environment, uncertainty exists surrounding nearly any future payment stream and the better reported revenues reflect actual payment received the more confidence investors can have that reported results reflect true profitability," he said.

Al Mal estimates that recurring cash earnings represented only 20 to 50 per cent of real estate companies' 2008 reported earnings in the GCC. By contrast, the telecom sector recurring cash earnings are 90 to 120 per cent of reported earnings.

Business models driven by leverage will not return to previous profitability levels anytime soon, Al Mal said.

"In our view, the long-term impact of the global deleveraging process on business models in the region has been under-emphasised by the investment community," McKinnon said.

"In most cases, the discussion seems to surround the deflationary pressure it places on asset prices (real estate and commodities) as the global economy slows and the financial system is simultaneously focussed on reducing leverage ratios.

"We accept this premise, but we feel that the longer-term issue for equity investors is much larger. In our view, the larger concern is the deferred payment model that has placed the burden on the companies to raise short-term working capital financing to fund customer purchases. We feel the ability of companies to finance customer purchases will continue to deteriorate in the long run."

Al Mal expects a trend of improved transparency in the GCC over the next few years. The companies that adapt to new and improved levels of transparency will benefit from better access to capital and premium market valuations, it says.

"Investors should target companies with timely and complete disclosure, combined with regular access to management – that is, quarterly investor conference calls, road shows, and timely release of full financials," McKinnon said.

Saudi prospects

The Saudi Arabian economy's fundamental strengths will not translate into higher earnings on its stock market, Al Mal said.

"Recent consensus appears to be that KSA would offer regional investors relative safety compared to other equity markets in the region. The Saudi economy is unique for the region in terms of the scale and growth of its consumer population, breadth and liquidity of its equity markets, and capacity of its government to invest through the global downturn.

"In fact, Sabic recently announced its intention to do just that. The company plans to invest in growing its market share during the slowdown, taking advantage of its clear global cost advantage.

"However, we feel the fundamental strengths that we discussed will not be fruitful for investors in the near term. Though the market has always enjoyed a premium valuation to regional markets, we feel an 11.3x PE (13.2x 2009E) with a 23 per cent premium to regional valuations is expensive given the index's heavy petrochemical/energy weighting.

"Within the Saudi Arabian market we feel there are some attractive names for investors to focus attention. As we discussed earlier, we feel investors should be shifting their sector exposure to stable cash flow sectors and away from cyclical sectors such as real estate and petrochemicals," Al Mal said.


Sector weights

Overweight: Telecom, utilities, consumer, transport Predictable earnings and strong balance sheets should continue to drive investment flows to the consumer and transport sectors, while stable dividends from the telecom and utilities sectors should provide incentive for future outperformance, Al Mal research said.

"Though the telecom and utilities sectors have yet to attract significant flows year to date, we expect the stable dividend characteristics (roughly six per cent on average) of both sectors to provide a foundation for premium valuations as market volatility continues."

Neutral Weight: Financials, banks, energy/chemicals.

"We see value beginning to shine through in specific names within these sectors. We are beginning to feel more comfortable with some banks, though only where they offer more than adequate capital ratios and a scalable franchise," Al Mal said.

In the case of energy and chemicals, the valuations are certainly attractive for longer-term investors, given the clear regional cost advantage that the sector enjoys. However, we are not yet ready to call a bottom for global energy prices and we expect the sector equity performance to continue to be closely correlated to commodity prices."

Underweight: Real estate, construction, construction materials

Owing to the "significant uncertainty" surrounding the GCC real estate sector, Al Mal expects to see continued outflows from the real estate and related sectors.

"In our view, even at currently depressed levels, the market has yet to fully price in any potential dilution that will accompany needed capital injections over the next 12 months.

"Excluding the need to roll over existing debt facilities, we estimate a further $8 billion (Dh) could be needed in Dubai to fund working capital for already started construction projects," the firm said.