Small and mid-cap stocks will gain in confidence

EFG-Hermes prefers a combination of attractively valued blue-chips and higher growth mid-cap stocks for investment this year.

"With an increasing number of Western institutions entering the market, we remain with our view that the focus of attention will move increasingly towards less liquid small and mid-cap names over H2-2008.

"We have already witnessed this occurring in select names, especially for companies exposed to various industrial and consumer end-markets. However, the strong performance has been driven largely by a handful of transactions. In our view, this trend will continue as investors seek to widen their exposure in the UAE to outside the traditional real estate and bank sectors."

Within Dubai, EFG suggests exposure to the real estate and recommends Arabtec and Union Properties. Arabtec continues to benefit from the combination of a lack of qualified contractors in the region and an increasing demand for their services, it said.

"The subsequent shift in pricing power has helped raise margins to super-normal levels. We also view Arabtec's ability to expand geographically very positively, while its recent acquisition of Target gives the company potential to expand into related sectors.

 "Given our view of a longer construction cycle, we expect to see continued margin improvement and sustained levels of high earnings growth. We expect shares to see supportive news flow over the coming months regarding further contract wins in Dubai and Abu Dhabi."

Arabtec's shares are one of the cheapest at just 10.0x 2008e and 7.4x 2009e, EFG said.

Developer Union Properties benefits from its high- quality developments and an extremely well-regarded brand at a time of rising real estate prices.

"Over H2-2008, we expect supportive news flow regarding an expansion of the company's land bank.

"The use of completed contract accounting results in distorted P/E multiples of 23.3x 2008e and 3.4x 2009e," it said.

Shares of Emaar Properties are better placed to outperform in H2-2008 as first-time revenue recognition from international operations, excluding the US, and from the Downtown Burj Dubai project begin to contribute to overall earnings more meaningfully, resulting in significantly higher earnings growth in 2009e.

Emaar's shares remain fundamentally undervalued, EFG said, and trade on just 9.3x 2008e, 5.9x 2009e P/E.

"Thematically we continue to favour Aramex and Air Arabia. While shares are expensive on a P/E basis we note that the growth outlook for both stocks is unrivalled.

"Aramex's valuation [17.3x 2008e and 13.0x 2009e P/E, 33 per cent EPS growth CAGR 2008-10e] is particularly cheap on a growth adjusted basis.

"We believe the forthcoming announcement of a small- to medium-sized acquisition in Asia will help provide positive news flow for the shares."

Air Arabia shares may appear expensive at 22.6x 2008e and 20.6x 2009e P/E, but "our forecasts do not currently incorporate the new hub in Rabat, Morocco; a third hub in Nepal, via a JV with low-cost carrier Fly Yeti; a soon to be announced fourth hub either in Egypt or the Levant; and the addition of three planes more to the fleet this year than we had expected".

Arabtec and Aramex are also best placed to benefit from any potential increase in foreign ownership limits, as both shares are currently 49 per cent held by non-UAE investors. Among banks, EFG favours Emirates NBD.

"We continue to believe revenue and cost synergies will be the main driver for Emirates NBD (13.8x 2008e and 11.7x 2009e P/E). Over H2-2008, we hope to see further details on the integration strategy, in particular on cross-selling and plans for the branch network."

The investment bank also likes Tabreed, which benefits from the current construction boom due to its clear market leadership in district cooling. With long-term contracts in place with about 20-year maturities, Tabreed also offers excellent earnings visibility. "However the company is presently at a nascent stage of its overall growth profile, marked by significant capacity build-up costs. Therefore, we believe shares should be viewed over a long-term horizon, not one limited to H2-2008.

"Near-term earnings multiples are rich at 30.9x 2008e and 27.6x 2009e P/E but do not fully reflect the company's substantial long-term growth potential – indeed our forecasts incorporate EPS growth of 30 per cent CAGR 2007-11e."

Among the stocks listed on the Abu Dhabi Securities Exchange, EFG likes etisalat (14.7x 2008e and 13.7x 2009e P/E), "which we see benefitting from an attractive portfolio mix of value [from the mature UAE business] and growth [from the company's presence in Egypt, Saudi Arabia, Pakistan, and to a lesser degree Nigeria and other African markets].

"We are also encouraged by the improved transparency as a result of the company's first investor day. Shares would be greatly boosted from being opened to foreign investors and we hope to see further information on this over the year."

The investment bank said it is turning "increasingly positive" on Abu Dhabi Islamic Bank and National Bank of Abu Dhabi as fundamentals have shown a marked improvement within both banks and "we see room for positive earnings revisions going forward".