Dubai:
We expect volatility to be the key player next year in Saudi given that it will be a yet another news-driven year. The year will focus on two important events — reforms and index inclusion. Government has targeted a series of reforms for 2018, and the success of implementation of these reforms will be closely monitored by the investors. We are likely to witness 5 per cent VAT inclusion, hike in electricity tariff, increase in selective fuel prices and revised foreign workers/dependents fees. All these would weaken the consumer’s purchasing power and increase the cost of operations for the corporates. The impact could be felt more by the small business entities, especially if their receivable cycle is long dated. Revenue generation could be impacted by increased cost for companies and earnings outlook could get murkier. Although, government is planning to roll out a cash handout programme, which will compensate lower-income citizens, we suspect the benefit to be limited, thus weighing negatively on the consumers. However, we anticipate the market dynamics to yet again shrug-off the underlining fundamentals, and take cue from a potential /favourable upgrade decision by both MSCI (June 2018) and FTSE (March 2018). Market expects passive funds to the tune of $9 billion (MSCI-EM) and $4 billion (FTSE) to flow in, we expect sizeable pre-positioning ahead of these events given the low foreign ownership in Saudi. Furthermore, events unfolding such as momentum in oil price, fed rate hikes, diplomatic geopolitical talks and domestic developments related to corruption crackdown will continue to influence the market in a big way. The government is keen on making a drastic progress on the socio- economic front such as women driving, introduction of cinemas, and allowing tourist visa, thus reiterating the willingness in building a progressive economy, much to the likes of investors. The listing of Aramco could add a boost, but we have less clarity on the timeline and the size of the IPO. We see too many moving parts for Saudi next year, some favourable and some not so, nonetheless market- moving volatility can be exciting, providing a buying opportunity for mispriced-securities.
Grab an oar!
On the banking sector, we expect net profit growth to be 5 per cent in 2018E (similar to 2017E). Note that banking sector net profit grew at a modest 3 per cent YoY in 9M2017, driven by margin expansion to the tune of 18 bps, denying a full pass through of Fed rate hikes to the yields. Although, we anticipate margin expansion theme to continue (+20bps) in 2018, however we are unlikely to see sporadic growth in lending. Despite an expansionary budget for 2018, we anticipate that an increased momentum in banking sector growth is faint, up until 2019. Accordingly we expect lending growth to remain depressed (+2 per cent in 2018) given the dampening economic environment and will be predominantly be driven by short-term funding needs of small to mid-sized corporates. While we expect liquidity to be intact, incremental asset growth could come from investments in government sukuk (+7 per cent YoY) given the weak credit appetite. Furthermore, we suspect margin expansion in 2018 to be offset by higher operating expenses (additional levies) and elevated provisioning levels (incremental IFRS 9 provisioning), thus partially knocking off the earnings growth. On valuations, Saudi banks’ trade at 1.2x P/B 2018E, with an implied RoE of 12.5 per cent, broadly in line with MSCI EM-banks (1.2x, RoE 13.3 per cent), hence we see limited scope for expansion. Relative to their history, Saudi banks trade well below the long-run average P/B (1.6x), with a 20 per cent discount to the historical RoE’s, and we suspect an expansion of RoE in the medium term is remote. On the stock-specific front, stick with solid franchises, resilient fundamentals (not swayed by elevated provisions), heavy index weight that could attract significant QFI as MSCI inclusion nears and the one which has grossly underperformed the benchmark index in 2017. We like Al Rajhi.
—The author is a vice-president at Shuaa Capital and can be reached at im@shuaa.com.
