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Increasing exposure to Saudi Arabian Stocks

02 Jun 2009

Morgan Stanley recently issued a report advising investors to increase their exposure to Saudi Arabian stocks. Jonathan Garner, Managing Director and Head of Global Emerging Market Strategy, Morgan Stanley and one of the authors of the report, discusses why this recommendation was made and assesses the health of the Saudi Arabian banking sector.

What led you to make the recent recommendation for investors to increase exposure to Saudi Arabian stocks?

The key reason we are advising and recommending investors to increase exposure here is a very straightforward one. The region had underperformed the broad emerging markets benchmark quite substantially, by over 20% in dollars since October. This was the trough for the overall emerging markets benchmark and in our previous report we had been quite cautious so we wanted to reintroduce the concept of building exposure to the region. Not least because our economic research suggests a fairly good degree of resilience in terms of the growth profile for the region compared to other parts of the world and this is crucial given the underperformance. Now what is happening with the company earnings valuations, the Arabian markets were trading at about 13 times 2009 P/E and for a return on equity of about 18%. This is structurally higher than the other emerging markets. The emerging markets benchmark as a whole is only trading at 5% valuation discount but for ROE that’s currently 14%. It will likely head down to around 12 so it looks like on an ROE adjusted basis, the Arabian region is significantly cheap again. In terms of preference within the region, we’ve talked about Qatar, Abu Dhabi and Saudi Arabia as being our preferred spots and Dubai, Kuwait and some of the smaller countries in the region are less attractive. In our overall EM coverage, we have had a preference for Egypt but that has now changed and has been downgraded to equal weight from overweight.

Which are your preferred stocks?

We had previously mentioned three of them; Qatar Water and Electric, Qatar Telecom and Telecom Egypt. Our Saudi Arabian coverage is rolling out at the moment and we have recently published an initiation piece on Saudi Telecoms, dated May 18^th. This covered Mobily and Saudi Telecom and Mobily is overweight rated.  We also released a report on SABIC (Saudi Basic Industries Corp) which is structurally cheap compared to other petro-chemical companies and is overweight rated.

In what way have Saudi Arabian equity markets been opened up to foreign investors?

The most significant liberalization to date in Saudi Arabia has been in August 2008, when the regulator (CMA) announced non-GCC investors would be allowed to gain exposure to the local market through swap agreements. Previously non-GCC investors were not allowed to invest at all. In 2007, the CMA also lifted the ownership level restriction on investment in Saudi Arabia by GCC residents to 49%. We believe the trend towards increased market access will continue and we have seen a lot of interest from our global clients in doing that. Certainly we have set up the infrastructure to be able to do business going forward so this is a very important change.

You mentioned in the report that a concern was the banks’ exposure to real estate. Is this also true of Saudi Arabia?

It is most of a concern in relation to Dubai. We argue that the Saudi Arabian banks are not dependent on foreign funding, which has turned out to be quite an important vulnerability for Dubai banks. They also have low loans to deposit ratios, are highly liquid and as a result, they have the least direct exposure to real estate in the region. In addition, we don’t think there has been the kind of oversupply in real estate in Saudi Arabia that is present in somewhere like Dubai. The inter-bank rates have come down quickly in Saudi Arabia and it has got such a liquid and healthy banking system it would point to that country as being a preferred area. We need to do more on the banking and property sector and we will eventually have dedicated coverage there.

Do you think Government spending on Economic Cities and infrastructure will further stimulate the economy?

Yes the Economic Cities are very important. For GDP growth it is probably going to be something like flat year on year in Saudi Arabia. This is a good outcome in a world that’s having its most severe recession in 60 years. There are various ways this has been achieved and the ability to engage in counter-cyclical fiscal policy and those projects are a key part of it. The total size of the fiscal stimulus and the public sector investment programme in the 2009 budget is increasing public spending by 16 percent on education, health and infrastructure. Our global clients show an intense interest in increasing exposure, it is the largest and most liquid market in the region by far. It is also the most diverse in terms of sectors and so it does present a significant new opportunity set for clients.

What are the challenges and opportunities?

It depends a lot on your view on oil. We do expect it to move ahead sequentially from this year into next, which should help growth and the ability to engage in counter-cyclical policies, a point I mentioned that has been quite impressive in Saudi Arabia. There is quite a degree of heterogeneity  in the region. Dubai is a very different investment proposition from Saudi Arabia, both economically and in stock market terms so one of the challenges is for each country to reposition itself as an investment destination in a drastically different global environment, particularly one where the property sector globally is unlikely to be springing back to life. Being able to focus on public sector, investment infrastructure, developing manufacturing businesses where needed and leveraging the natural resource availability that the region has into further diversification of the economy are all important.

Source: Cityscape Intelligence