Leading Dubai corporates thirsty for expansion

The ambitious growth strategy of Dubai has paid off with the emirate emerging as a financial, services and tourism hub as well as an oasis of relative stability in a troubled region, says a report.

In the report called “Dubai Inc: Credit Overview and Relative Valuation”, Lehman Brothers said it maintains a positive outlook on Dubai’s quasi-sovereign issuers as they are enjoying “solid support from the government yet are being encouraged to transform themselves into successful standalone companies”.

“Most of Dubai’s major corporates are in the initial stages of development and are thirsty for capital.

“On a fundamental basis, the sector remains attractively priced and offers value from a yield perspective. However, given the emirate’s ambitious growth strategy, there is a risk that continued heavy supply could weigh on technicals.”

About the drivers of growth, it said much of it has been driven by real estate, with double-digit annual revenues in the sector among the highest in the world.

The property boom is being driven by the demographics of the region (high population growth rates), strong regional liquidity and rising demand from expatriates.

Given the supply/demand mismatch (there was a shortage of 20,000 residential units in 2007), prices in the sector look likely to remain elevated over the next couple of years, after which, a large number of properties that are currently under construction, should be near completion.

“Tourism, which already accounts for 30 per cent of Dubai’s gross domestic product, shows no sign of abating with the growing tourism-oriented real estate developments and increased airline services (the world’s largest airport is currently under construction in the city).

“The government is keen to double annual footfall from eight million to 15 million by 2015,” it said.

“While the corporates are closely watched by the sovereign, they operate as commercial entities and are not subject to interference in their operations,” said the report.

“Sovereign support dictates the basis on which most credits trade. This is also reflected in ratings, with most entities in Dubai rated A+/A1 irrespective of whether they operate ports (DP World), run free zones (Jafz), build properties (Dubai Holding COG) or provide utilities (Dewa),” it said.

“However, underlying credit quality differs vastly among these names, with some like DP World being well established, cash-flow positive powerhouses and others like Dewa weighed down by ambitious investment plans that require constant external financing.

About the potential risks, the report says although a real estate sector slowdown has long been expected, it has yet to materialise. However, when new supply hits the market over the next couple of years, there could be a softening in the sector and a shift in focus to other developing stories in the region.

“The rapid pace of development is putting increased strain on the price and availability of construction material and on the supply of labour, both of which could cause a significant growth impediment,” it said.

The report also looks at the business prospects and outlook for some of the government-owned entities.

About Emirates airlines, the report said over the years the company’s performance has been among the best in the industry. “At a time when the cost of fuel has been eroding the bottom lines of airlines worldwide, Emirates has consistently reported greater profitability, with net earnings up 60 per cent in 2007,” it said.

Emirates benefits from the strategic location of Dubai as a vital transportation hub – nearly half the airline’s passengers are those who make connections in Dubai.

“In line with the rising demand for its services (traffic increased by 17 per cent in 2007), the company has an aggressive growth strategy and is seeking to increase capacity by 20 per cent in the coming year alone. Leverage levels remain low on sound earnings and a solid cash position ($739 million),” it said.

According to the report, DP World is the top rated company (A1/A+).

The acquisition of CSX ($1.5 billion) in 2005 and P&O ($6bn) in 2006 propelled DP World into the big league of port operators. Today, with 42 terminals in 22 countries, it has one of the most geographically diversified portfolios among its peers, said the report.

“The company’s growth has been driven by its dominant position in the fast-growing markets of the Middle East, Africa and Asia. Operating performance in 2007 was a testament to growth in the business – throughput increased by 18 per cent, revenue by 32 per cent and EBITDA by 56 per cent over 2006,” said the report.

Origin and Destination (O&D) traffic comprises 76 per cent of DP World’s total throughput. By comparison, trans-shipment accounts for the bulk of the traffic for PSA and HPH at their main ports of Singapore and Hong Kong, respectively.

O&D is a more profitable business (more pricing power) and tends to be a more stable revenue source than trans-shipment, both for DP World and its clients, said the report.

“Future acquisitions on the scale of those of CSX and P&O seem unlikely, given that DP World now has a presence in a large number of trading hubs around the world. However, the company has stated that it plans to double capacity by 2017 by investing in the expansion of existing ports and the development of new facilities,” said the report.

“We maintain a positive view on the credit on the basis of its growing income, diversified revenue base, strong cash flows ($3bn cash at end-2007) and importance as a key asset in the emirate’s attempt to diversify the economy away from oil,” said the report.

With a market capitalisation of $17bn, Emaar Properties, 32 per cent owned by the sovereign, is one of the largest residential property developers in Dubai.

“Emaar has aggressively expanded outside the UAE through joint ventures in the Mena region and India, and through the acquisition of a West Coast homebuilder in the US. In our view, the international portfolio makes the company less vulnerable to a downturn in the Dubai real estate sector. By 2010, the company expects international operations to account for as much as 70 per cent of revenue.”

“Emaar enjoys high profitability (ROE 19 per cent; gross margin 40 per cent), is well capitalised (equity/assets 68 per cent) and benefits from a relatively large cash balance ($1.28bn), said the report.

“Revenue, which increased at a CAGR of 50 per cent between 2004 and 2007, is likely to be relatively sluggish in the very near term as the company reduces land sales to focus on the development of lifestyle communities. However, the long-term outlook looks positive, with increasing revenues from international ventures as well as a rising share of rental income from the investment property portfolio. Leverage levels have been very low (net debt/EBITDA below 0.5) on account of self-financing of projects via land sales and off-balance sheet funding for overseas joint ventures.”

On Nakheel, the report said “reclaiming land from the sea to build islands in the shape of palm trees, or building a cluster of 300 islands in the shape of the world map 4km out into Gulf waters – these are the kind of developments that the real estate developer Nakheel specialises in.

“Relatively low, albeit rising, leverage levels and fairly strong capitalisation numbers (equity/assets 71 per cent; debt/equity 10 per cent as of end-2007) via the 3.5 billion sq ft government-gifted land bank, add strength to the credit profile.

“Land sales from the land bank also more or less ensure Nakheel’s profitability in the near-term,” said the report.

Home to blue-chip financial services companies from around the world, Dubai International Financial Centre is fulfilling the mandate of establishing Dubai as a regional financial services hub.

DIFC Investments, fully owned by the government, is the revenue-generating arm of DIFC. Its two main lines of business are leasing of commercial/residential space within the financial centre and making investments.

Lease income comprises 28 per cent of revenue and this percentage is expected to increase as the development nears completion. Demand from financial services firms for space in the 110-acre centre in the heart of Dubai remains high.

Jebel Ali Free Zone is a state-owned business park around the Middle East’s largest container port, Jebel Ali.

“Cash flows are fairly stable with lease rentals being the primary revenue source. Tenants are well-established companies (5,750 in total), both multinational (eg, Exxon, Volvo, Schlumberger, Sony) and local.

The investment plan for 2011 sees the company incurring capex of $2.18bn to be used for the development of the “South Zone”, which, once complete, will double existing capacity.

Leverage levels, at 10.5 times net debt/EBITDA as of 2007, are expected to remain elevated in the medium term, resulting in zero to negative cash flows.

The company is set to benefit significantly from new business that are arising out of the integration of the South Zone with the world’s largest airport (currently under construction).

“Once the increased capacity becomes available, we would expect revenues, which totalled $117m in the first half of 2007, to increase significantly.”

“We view Jafz, which has been in business for approximately 20 years, as a low-risk, stable business and with its integration with the port, the new airport and four highways, is well placed to take advantage of economic growth in the region. However, as it ramps up capacity in the near term, high leverage levels will weigh on the credit and strain cash flows,” the report said

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