GCC equities likely to outperform global markets in H2 of this year

UAE has a 2010 net debt/equity ratio of 83 per cent. (JOSEPH CAPELLAN)

Equities should continue to outperform as an asset class this year particularly during the first half, said Credit Suisse's Global Strategy report.

GCC equities are likely to experience neutral to negative sentiment in the first half and improvement in the second half, forecasts the report.

This is because of the banking sector, which is likely to continue to see high credit costs and marginally lower margins.

Credit Suisse report said global economic measures including policy tightening and interest rate hike in the second half of 2010 may lead to a bear market in late 2010.

"However, by the second half of 2010, we think credit costs will be normalising, coupled with a return to balance-sheet growth [especially in Qatar and Saudi Arabia]. We think any global interest rate hikes in the second half would be a significant positive factor, especially for Saudi banks, which are most sensitive to changes in spreads. Given that the banking sector accounts for 50 per cent of GCC market cap, we think that GCC equities are unlikely to outperform global equities until the banking sector's outlook improves," said the report.

Global investors' focus

Two thirds of the outstanding projects in Saudi Arabia and Qatar are in infrastructure, oil and gas and are well funded compared with 66 per cent of outstanding projects in real estate in UAE. In addition, we expect most regional economies to see strong in GDP growth (nominal and real) in 2010 estimates with no apparent funding issues in the near term.

Earnings outlook

Qatar remains the best play on profitability and also offers attractive dividend yields. Qatar's return on equity (RoE) remains not only the highest in the GCC, but also worldwide.

On Credit Suisse estimates, Qatar's 2010 RoE is estimated to be 17.7 per cent. Within the GCC, Kuwait and Qatar have the highest 2010 estimated dividend yields of 4.7 per cent and 4.5 per cent respectively. Except Saudi Arabia, GCC's earnings growth is likely to be the lowest among its global emerging markets peers in 2010.

While most of the GCC has been negatively affected by the credit crisis, the study says that Qatar and Saudi Arabia are relatively more secure. Qatar has benefited from strong government support, while Saudi Arabia has benefited from strong banking regulations and an under-levered economy.

GCC trades at a discount

While the GCC region is currently trading at 2010 estimated price-to-earnings (P/E) discounts of 8.1 per cent and 20.7 per cent to Europe, Middle East and Africa (Emea) ex-GCC and EMF, respectively, the region remains at a 40–50 per cent premium on 2010 estimated enterprise value/earnings before interest, taxes, depreciation and amortisation (EV/EBITDA) to Emea despite the zero per cent corporate tax rate in the GCC. This is mainly owing to the significant leverage with 2010E net debt/equity the highest globally (on a regional average basis) at 73 per cent.

In order to compare "like-for-like", if we assume a deleveraging by 40 per cent through rights issues at current equity prices the region would trade almost in line with the Emea region (i.e the region would not look cheaper on a 2010 estimated price-to-book (P/B) ratio basis anymore with a lower than currently estimated RoE. In other words, the region might be looking cheap versus Emea peers, but adjusting for leverage, the discount would be removed.

Equity issuance

From being the least levered in the world – at nine per cent of net debt to equity in mid 2007, GCC equities are currently the most levered, with 2010 net debt to equity of 73 per cent. Moving forward, we think this will imply more equity issuance/funding and an increased risk of dilution for shareholders.

Higher cost of funding

Distinction between quasi government and corporate bonds is likely to be blurred. Following Dubai World's debt restructuring reports, the study said that the market was likely to price quasi government bonds (in the GCC, especially in the UAE) on a par with corporate bonds. This is also reflected in the current credit default swap (CDS) spreads, with five-year Dubai CDS still quoting 130 bps higher than levels before the announcement. "We think this is likely to lead to higher funding costs for corporate borrowers in the GCC. The analysis reveals that every 100bps increase in borrowing costs is likely to reduce 2010 earnings by five per cent in the UAE and 7.2 per cent in Saudi Arabia," the report said.

Funding costs

The cost of funding for the GCC banking sector has been declining qoq this year, with Saudi banks averaging just 0.7 per cent annualised in third quarter of 2009.

Rates are unlikely to go any lower and more likely to go higher from here. Hence, a key theme for 2010 will be the higher cost of funds for the banking sector, which will likely be partially passed on to the corporate and consumer sectors, said the report.

The study acknowledges the upside risk to its estimates. "Our economic growth and twin [fiscal and current account] balance estimates are based on our Credit Suisse oil price forecasts. Since average 2009 and current oil prices are higher than the Credit Suisse forecast, we see some upside risk to our forecasts," said the report.

Liquidity situation

Interbank rates have steadily declined across the GCC, having spiked at the height of the global credit crisis.

Planned rate cuts (given the inflation and dollar peg issues the GCC Central Banks face) and liquidity injection/facilities provided by central banks have worked well and have succeeded in bringing down interbank rates. In addition, during Q4 M2 has started to grow again.

The portfolio of Credit Suisse continued to beat the benchmark as its long-only model portfolio has returned -4.7 per cent since its inception on July 17, 2007, to January 4, 2010, versus -34.9 per cent returned for the benchmark MSCI GCC index.

"During CY 2009, our portfolio has generated a 20.8 per cent return, versus 18.8 per cent for MSCI GCC. Since our last portfolio rebalancing on 14 September 2009, our portfolio has generated a 0.6 per cent return, while MSCI GCC has declined by 2.9 per cent. We maintain our current portfolio as our view has not altered significantly over the last quarter. We remain overweight Qatar and Saudi Arabia and retain our underweight stance on Kuwait and selective overweight on UAE," said the report.

UAE's real GDP growth in 2010 is likely to be the lowest in the GCC at 2.1 per cent following a three per cent contraction in 2009. While the economy was affected by lower oil prices and output coupled with a demand slump in real estate in 2009, a strong government response, improving oil market conditions and the general global economic recovery should help the economy record modest growth.

"The team is of the view that real GDP growth should accelerate to five per cent by 2011, but this remains contingent on oil prices and the strength of the global recovery," said the report.

"The domestic banking sector looks well prepared to withstand any crisis as it is adequately capitalised, with CAR exceeding 18 per cent as of third quarter of 2009. While UAE equities may look cheap as stocks are traded 7.2 times of P/E 2010 versus 12.9 times for EMF, it is important to adjust for leverage for a like-for-like comparison. UAE has a 2010 net debt/equity of 83 per cent against the EMF average of 32.3 per cent. If we assume a scenario adjusting for 50 per cent rights issue to reduce leverage to 55 per cent, UAE's adjusted 11 times of 2010E P/E," said the report.

Saudi Arabia is the least geared economy in the GCC (2010 sovereign debt to GDP is only 14.9 per cent), it has one of the highest foreign exchange reserves in the world ($395bn in 2009, 101 per cent of GDP), while falling inflation should help accelerate public spending.

"We prefer domestic plays in Saudi Arabia – banks, consumers and telecom. We also like Sabic as the stock is relatively immune to regional imbalances given that its revenues are derived from developed markets. We continue to believe the banking sector will benefit from interest-rate increases that are likely to begin by mid-2010," said the report.

Saudi Arabia's economic conditions are beginning to improve as higher oil prices boost export revenues and private sector confidence. Credit Suisse's economics team forecast real GDP growth to remain positive at 0.5 per cent in 2009 before rebounding to 2.6 per cent in 2010E and 4.7 per cent in 2011.

The report noted that economists estimate 2010 nominal GDP to return to pre-crisis levels.

The difference between the nominal and real GDP growth rates is owing to oil price movements having a greater influence on GDP than inflation, said the report.


Region's eEonomic outlook bright

In the overall GCC economic scenario, Qatar is set to become the fastest-growing global economy in 2010, forecasts the Credit Suisse's Global Strategy report.

Qatar is not only the fastest-growing economy in the GCC, but also globally. Credit Suisse's Global Economic Team estimates that the global economy will rebound with real GDP growth of 4.3 per cent in 2010E, led by the NJA region (real GDP yoy of eight per cent. They estimate Qatar's 2010 GDP growth to be even higher, at 14.2 per cent. For the other GCC-4 economies, we expect the recovery to be stronger in Saudi Arabia as compared to the UAE and Kuwait.

Qatar is least affected by oil price movements and the UAE most affected.

Since Q4 2008, lower Opec quotas have mandated GCC countries to reduce their crude oil outputs.

Between January and July 2009, Qatar reduced its production the most versus 2008 (15.3 per cent), while Saudi Arabia cut the least (12.8 per cent). Qatar requires the lowest crude oil price for its 2010E fiscal balance to break even, at $53/bbl, while the UAE has the highest break-even price of $67/bbl, the report said.

In 2010, the study expects that all GCC to generate twin surpluses. In particular, it highlights Kuwait's ability to generate high fiscal and current account surpluses, forecasting 8.4 per cent and 26.5 per cent respectively.

 

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