UAE expected to post fiscal surpluses despite crisis

The global crisis will have only a limited impact on the UAE economy, thanks to the huge wealth accumulated during the record surge in oil prices. The country will continue to record fiscal surplus in 2008 and 2009 as it has the lowest break-even oil price in the GCC of $23 (Dh84.48) per barrel against the IMF's baseline petroleum price projection of $68 per barrel for 2009, says a new report.

According to the report by Abu Dhabi Commercial Bank (ADCB), returns on accumulated wealth relative to the country's GDP are substantial and can be used to mitigate the effect of oil price cyclicality and support investments in infrastructure and diversification.

In addition, the risk of rising inflation has subsided and it is expected to decline as oil and commodity prices fall and the US dollar appreciates. Consequently, the government has significant scope to implement expansionary fiscal policies.

According to IMF estimates, inflation is expected to drop to 10.8 per cent next year from 12.9 per cent this year, while the current account surplus would reach $55.3 billion against $60.9bn in 2008. The estimate shows that the current account surplus would reach 22.6 per cent in 2008 and 18.8 per cent next year. While the GDP growth is likely to drop to six per cent in 2009 from seven per cent this year.

The bank says the government-backed projects in infrastructure, power and water will remain secure due to economic demand and political will. Planned infrastructure investments announced by the private sector will not be abandoned; however, the pace of growth may slow down.

The report notes that in the previous cycle, mostly petrodollars were mostly spent on consumption which fuelled growth in Western economies. However, in the current cycle petrodollars were invested regionally boosting productivity. In addition, a rising population and expatriate community will support domestic demand which will stimulate growth in non-oil GDP. The report claims Asia and emerging economies are beginning to replace Western countries as the UAE's main trading partners, providing some protection against the worst effects of the downturn.

The bank said foreign capital has been leaving the country to attend to pressing liquidity issues in home markets and US dollar credit supply to local institutions has diminished. Even when it is available, it is accessible at a much higher cost.

Despite these challenges, the bank believes that the severity of crisis in the UAE is far less than in the Western countries. As IMF estimates that slowdown in the UAE's growth only represents a transition from an expected growth of seven per cent in 2009 to a revised expected growth of six per cent.

Assuaging fears about Dubai's debt, the ADCB report says the emirate's debt has been backed by foreign asset reserves that leaves the country's capacity unimpaired. The bank also believes the recent central bank's measures to inject liquidity in the local financial market were merely precautionary and that the underlying financial system is sound.

The report says that corporate fundamentals in the UAE remain largely intact but overlooked.

BANKING SECTOR

The UAE penetration rate – the ratio of bank assets to GDP – of 172.9 per cent (2007) is lower than the average penetration rate enjoyed by developed countries, emphasising the sector's substantial growth opportunities. In comparison, the euro region reported a penetration rate of 223 per cent for the same period.

The report claims that the sector would greatly benefit from the country's conducive macro-economic environment to sustain future growth. The bank hopes that $360bn worth of real estate, tourism, manufacturing and oil-related investment projects by Dubai and Abu Dhabi in the medium term and low interest rate due to the dollar peg would stimulate credit growth and mitigate other bear factors.

The sector achieved considerable growth between 2004 and 2007, as measured by all key banking parameters with loans up 39.7 per cent, deposits 32.1 per cent, and profitability 38.4 per cent, due to a highly supportive macro-economic environment.

Return ratios within the sector remained strong due to a robust performance by both core banking and non-interest income. The sector maintained a return on equity (RoE) and RoA of 22 per cent and two per cent, respectively, during the same period.

The report says regional consolidation, international diversification of revenue base, growth of Islamic banking and adoption of emerging trends will yield value and steer the sector's growth this year.

"Consolidation will occur due to increased competition from foreign banks once trade barriers are lifted. International expansion will permit banks to diversify their current concentration away from the UAE economy. With the UAE Islamic banking sector growing more rapidly than conventional banks, we expect its market share to increase from 15 per cent to 25 per cent over the next three to five years," says ADCB report.

The bank expects the interbank rate to increase by 25bps due to the tight liquidity conditions, thereby, exerting pressure on the net interest margin (NIM).

MARKETS UNDERVALUED

Global sentiment has been the main driver for markets and selling pressure is now materially over-extended. In addition, while the crisis in fact effects developed countries the UAE markets have lost almost half their value. The report believes that at the current levels, the UAE markets are highly undervalued.

The report has benchmarked RoE and P/E multiples for the UAE index against various indices in developed, regional and emerging economies.

An average index trades at a P/E multiple of 8.6x with average RoE of 14.5 per cent while the UAE index offers a lower P/E multiple of 6.5x and a significantly higher average RoE of 15.3 per cent, suggesting potential upside from current levels.

The ADCB report says the Emirates NBD shares are trading at around 178 per cent discount from its current market price. Maintaining its 'buy' rating, ADCB has estimated ENBD's fair value of Dh10.30.

Emirates NBD, which posted a net interest income of Dh1.4bn in the third quarter, earnings growth is expected to remain flat in the near term due to the ongoing liquidity crunch, subdued capital markets and the increase in impairment charges. However, the long-term growth prospects of the bank is good as integration process remains on track, with completion expected in the second quarter on 2009, says the report.

ADCB forecasts the bank will post net profit of Dh4.65bn by the end of this year against Dh3.946bn last year.

NBAD has also been rated 'Buy' by ADCB with a fair value estimated at Dh17.08.

ADCB said NBAD's earnings growth to slow as probable increases in its provisions over the next four to six quarters will impact earnings. ADCB believe the company's funding mix and government support will help it to weather the effects of the present crisis.

Despite current tight liquidity, NBAD was able to borrow $550m from four major international banks. Moreover, it has no exposure to CDOs, SIVs, or the US sub-prime mortgage market. We regard NBAD as a value investment-based on its sound asset quality, high NIM, and sustained increases in its core business.

The report has also rated First Gulf Bank 'buy' as a low-risk and high quality play.

Despite strong fundamentals, the FGB's share price has almost halved over the past few months. "In our view, FGB's shares currently trade at a significant discount to our estimated fair value and offer a share price upside potential of 79.9 per cent," says ADCB forecast. FGB's fair value has been estimated at Dh20.90.

The Union National Bank's fair value is estimated Dh5.99 with "Buy" recommendation. ADCB believes that the UNB will continue to record moderate growth based on its sound asset quality, high NIM and sustained increases in its core business.

The report says that the UNB will borrow Dh1bn before the end of this year to fund growth in advances.

"We expect UNB's funding mix and government support to help it withstand the effect of current crisis," says the report.

Dubai Islamic Bank's earnings growth could drop due to the credit crunch, slowing domestic economic growth and the company's exposure to the slowing real estate sector through various subsidiaries, says ADCB.

It retains positive long-term outlook on DIB due to its strong fundamentals, large branch network, established expertise in the rapidly expanding Islamic banking sector and strong capitalisation. DIB's high capital adequacy ratio of 12.3 per cent ensures it has substantial funds available for its aggressive expansion and diversification strategy.

While headwinds being faced by the company are dampening earnings growth, the report believes the current share price fails to capture the bank's high growth potential in the long term. DIB has been recommended 'Buy' with fair value estimated at Dh6.68.

ADIB shares currently trade at a discount to estimated fair value and offer a share price upside potential of 50 per cent. It maintains 'Buy' rating on the stock. According to ADCB report, ADIB's fair share price is Dh4.98.

The bank earns around 30 per cent of its operating income from outside the UAE and this is believed to increase further. However, ADIB has significant exposure to the real estate sector through its subsidiary Burooj Properties. Sharjah Islamic Bank is also rated 'Buy' and fair share value is projected at Dh2.61. SIB is likely to continue reporting moderate growth in profits due to its diversified revenue base and broad product portfolio.

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