Volatility Returns to Regional Markets
It has been a volatile week in the Mena region with UAE and Saudi weakening. We anticipate current weakness will be transitory and see opportunities to reposition in a number of our holdings whilst also gradually lowering cash levels.
Over last week positive momentum in global equity markets continued with the S&P 500 Index now up 5.8% year-to-date. Although US market performance has primarily been driven by expected policy measures being introduced by the Trump administration, corporate profitability of US companies was better than expected with 0.82% positive surprise coming from reported numbers for 2016. For regional markets, dividend season remains in focus with Saudi, Egypt and Morocco performing poorly over last one week. On a year-to-date basis the UAE market is up by 5% and MENA markets are up by 1.3%, yet these markets have underperformed emerging markets index which are up by 9%.
The UAE market over the past week witnessed a spike in volatility triggered largely by mid-small cap names, sentiment was also impacted by the Arabtec results. The market appears to be consolidating with investors waiting for better entry levels in blue chip names that are due for dividend payment. Egypt after a strong start for the year is witnessing some correction, the Egyptian currency has appreciated from 19.0 to 15.8 against US Dollar but remains volatile and currency repatriation is still a slow and lengthy process. We continue to keep close eye on Egypt with regard to future positioning in the MENA space. Oil price was flat during the past week, with oil price hovering at around USD 55 per barrel. The rig count continues to increase and stood at 602 last week (previous week at 597). The oil inventory in US touched 52-week high of 518 mn barrels with a 0.5 mn barrels increase in inventory reported last week. So far, implementation of OPEC production cut remains as per the schedule, however oil production in US is inching higher with stable oil prices. It is expected that US oil production could increase by 0.5-1.0 mn barrels in 2017.
Last week we attended an investor conference in Riyadh and Dubai, we met with more than 50 companies from the region. Our key take away from these meetings was that the Saudi government remains committed and focused to deliver on the promised reforms. Specifically, the power sector will witness progress on a privatization framework, insurance and healthcare are two other two sectors where we expect reforms to have meaningful impact.
Our meeting with Saudi corporates indicated that the general level of uncertainty and caution has reduced compared to last year, however the resultant clarity is largely to do with the expected movement in cost structure, rather than growth outlook in line with the fiscal balance program along with 2017 budget. With regard to flow of outstanding payments, the Ministry of Finance has indicated that payments will be cleared within 60-days from the receipt of an invoice, however, due to multiple government counterparties being involved payment arrear issues have still not been fully addressed.
Uncertainty also remains with regard to the impact of the imposition of expat levies and increase in fuel and utility tariffs in the second half of 2017. The establishment of the Citizen’s Account to directly subsidise the lower income class through direct cash transfers implies that tariff revisions could be sharp and are expected to create an environment of weak consumer sentiment. Focus among corporates continues to be on driving cost efficiencies to defend margins, however, there will likely be a higher cost of doing business in KSA as costs associated with employing expatriates steadily mounts. Our anecdotal discussions on an exodus of expatriates was telling, but partly corroborated by discretionary revenues outperforming staples.
Privatisation of healthcare remains a top priority of Saudi policy reform and will drive sector growth over the next five years. The Saudi government will implement so called “corporatisation” of the healthcare sector by transferring responsibility to a network of public/private companies with the government maintaining a regulatory and supervisory role in the future. Privatisation of pharmacies and laboratories has already started with privatisation of government hospitals to follow as the next step. Government receivable issue is expected to be resolved during the first half of this year and several players including Saudi German and Habib Hospital are reported to have started to receive cash from the government.
Tasnee has signed a definite agreement to sell its TiO2 subsidiary Cristal to Tronox in return for USD 1.67 bn cash and a 24% shareholding in Tronox. The transaction is expected to close before Q1-18, but still subject to regulatory approval. We view it as a win-win deal for both Tasnee and Tronox. Post deal Tronox will be the world’s largest TiO2 producer with greater pricing power, the cash component received by Tasnee will help the company to deleverage its balance sheet and the divestment of its TiO2 business will unlock the value of their petrochemical assets, which currently trade at a significant discount to the peer group.
In the UAE, Arabtec announced that it has received approval in principle from SCA for the recapitalisation program announced last week. The recapitalization program includes an AED1.5 bn right issue and a capital reduction of up to 4.5 bn shares of Arabtec. In Qatar, Ooredoo announced Q4 2016 net profit of QAR 361 mn which was below market expectations. Q4 2016 net profit was flat as compared to the same period last year despite a 3.4% YoY increase in revenues. Flat Q4 2016 net profit was due to FX losses, excluding FX losses net profit was up by 2.8% y-o-y. EBITDA increased 7.2% YoY while margins improved by 1.37% YoY for the same period. In Kuwait, Zain group announced Q4 2016 net profit of USD106 mn. Net profit was down by 11% y-o-y mainly due to FX losses from Sudan. A 60% depreciation of Sudanese currency resulted in a decline in earnings and also an earnings miss. The key positive for Zain Kuwait is the expected full year dividend of KWD 35/share, yielding 7.1%.
Funds & portfolio positioning
For our dividend mandates we continue to be skewed towards UAE and Qatar in anticipation of collecting annual dividends. For growth mandates we see strong fundamentals and good valuations in the UAE whilst in the wider MENA space we see valuations as reasonable with earnings guidance for most corporates remaining intact. We are revisiting our underweight call on Saudi with a number of positive catalysts such as June MSCI EM watch list inclusion, good progress on a potential Aramco IPO, move to introduce a t+2 settlement cycle and the Saudi government’s steady push to reach out to foreign governments and investors as evidenced by the Saudi King’s month long visit to Asia. Performance of the funds and portfolios slipped last week as UAE and Saudi markets continue to witness some correction. Overall performance of the growth and income mandates is slightly below benchmark while our aggressive mandates continue to outperform the broader index.
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