Bullish case for Saudi shares
Saudi Arabia will be the best performing Gulf stock market in 2009 as Saudi banks are least dependent on offshore wholesale funding in the Euromarkets as the MTN market is still not open to emerging markets bank borrowers plus there are no structural property or finance issues in Saudi Arabia, unlike Dubai’s external debt or Kuwaiti investment companies

By Matein Khalid

It is fatal to rely on price/earnings ratios amid economic recession, a credit crunch and the beginning of a commercial banking provisioning cycle. This is particularly true in the GCC since low disclosure and creative accounting makes forecasting earnings difficult in boom times, impossible in a bear market. However, if the analogy with US, European or emerging markets indices is any guide, it is not unreasonable to assume a 50- 70 per cent fall in earnings from their 2008 peak. If so, it is dangerous to assume that the GCC equities index is cheap at nine times trailing earnings, even through the current valuation metrics are the lowest since 2002.

Lack of data
Apart from epic earnings risk during the world’s first synchronised global recession in living memory, it is imperative to remember that many GCC listed companies were founded in the past decade and there is simply not enough statistical data points to make accurate judgements on margins, EPS growth or even correlations to local indices (correlations among GCC markets, of course, have risen dramatically since the 1990’s due to the proliferation of regional funds). Margins are even more difficult than earnings to forecast because borrowing costs, accounting treatments and treatment of impaired assets vary so dramatically among countries, sectors and even blue chips. This is the reason price to tangible book value and cash flow metrics might prove a far more reliable proxy for valuation than proforma earnings.

It is obviously not prudent to invest in high beta shares (banking, insurance, commodities, property developers) during a deep global recession, particularly if there is debt on the balance sheet. Yet, since the volatility of all major global equities markets have surged since the collapse of Lehman Brothers (and are unlikely to drop any time soon!), it is best to seek deep value themes across the GCC equity market universe. This is the reason I believe telecom firms with low (ideally no) balance sheet leverage who pay dividends from operating earnings and are not exposed to high risk, non GCC emerging markets are probably the only safe haven in the current financial storm. Consumer goods is a naturally defensive sector and it is no coincidence that liquidity flows into GCC consumer shares have surged. In essence, fear, not greed, rules the roost in the GCC equities markets.

It is also important to stay clear from GCC firms whose profitability is linked to oil prices, property values, construction and bank borrowing, which have been the kiss of death for the global financial markets since summer 2008. Strong cash flows, low price to tangible book value, recurrent earnings, conservative leverage, international best practices disclosure are non-negotiable criteria for investment in the current bearish market scenario. It is also prudent not to buy shares exposed to the mood swings of global fund managers or the global business cycle as domestic consumption themes will clearly outperform. It is even prudent to pay valuation premiums for domestic consumption shares (telecom, utilities, food) that have predictable cash flows and no refinancing risk.

Betting on Saudi Arabia
I believe Saudi Arabia will be the best performing Gulf stock market in 2009. Why? One, the recent cabinet changes by King Abdullah suggests a deepening commitment to economic reforms in the kingdom, highlighted by Riyadh’s accession to the WTO, liberalisation of capital markets and a strategic policy to attract FDI. Two, regional asset allocators continue to overweight Saudi shares in a GCC/ MENA portfolio. This is the reason Saudi Arabia has consistently outperformed Morgan Stanley Capital International (MSCI) GCC index since November. Three, Saudi interbank rates are barely 1 per cent, the lowest in the Gulf. This demonstrates that Saudi banking has the least systemic risk in the region and banking counterparties do not hold cash. Four, Kuwait, UAE, Qatari banks are all plagued by losses on loans related to property and equities. Kuwaiti real estate loans are a third of all loans. UAE’s mortgage banks Amlak and Tamweel are no longer operational. The Qatari sovereign wealth fund was forced to buy the toxic assets of Qatari commercial banks. Bahraini banks booked huge losses on subprime mortgage CDO’s and credit default swaps in the US. However, Saudi bank loan books are not as hit by property losses as elsewhere in the Gulf. Mortgages are a mere one per cent of GDP. Loan deposit ratios means Saudi Arabia is the most underleveraged banking system in the GCC. Saudi banks are least dependent on offshore wholesale funding in the Euromarkets as the medium term note market is still not open to emerging markets bank borrowers.

There are no structural property/finance issues in Saudi Arabia, unlike Dubai’s external debt or Kuwaiti investment companies. Five, the current rise in oil and gas prices to $45 Brent is bullish for Saudi Arabia, which will do its best to ensure Nigeria, Iran, Venezuela and Angola boost compliance with past OPEC production cuts. Saudi Arabia does not want a spike in oil prices nor will it allow a free fall, as in the 1980’s when Sheikh Yamani punished overproducers by flooding spot black gold markets with Ghawar Light. While I would avoid high beta, globally exposed Saudi shares like SABIC or Al Rajhi, I believe defensives in telecoms (Saudi Telecom) or domestic consumption (Savola) should outperform GCC banks, as the liquidity data from the GCC stock exchanges suggests. The MSCI Gulf index trades at 9 times trailing index, largely incorporates the $600bn wealth destruction in the GCC and the epic fall in oil prices, corporate earnings and global economic growth. It is not inconceivable that most Gulf states will run current account deficits if oil prices slide to $30, as happened in the 1990’s. However, the Tadawul could then bottom at 3000- 3200 and trade in a range as high as 5000. It is still premature to overweight Gulf equities or any equities, I am convinced that Saudi Arabia will be the winner stock market in the Gulf in 2009.

The author is a renowned investment banker based in Dubai

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