Earnings growth 2012

Profit growth for GCC should normalize in 2012 after posting (still expectedly) 18 percent rise in 2011. “We see growth figures almost halving in 2012 to 10 percent after adjusting for one-offs posted by UAE banks against unadjusted figure of 7 percent. Growth will decline due to shift of stellar growth from heavy weight countries (in terms of our coverage profits) to low weight ones. Oman and Kuwait should shine with high double-digit growth; Qatar, though no longer in pole position, should see above average growth in 2012,” the Global report said.

From a sectoral perspective, the petrochemical sector which contributed three-quarters to GCC's incremental profits in 2011, is expected to take a back seat and give in to the banking and telecom sectors. Growth in petrochemical sector is expected to be very sluggish post 50 percent rise in 2011 due to anticipation of diminished demand for their products on fears of slowdown in emerging markets and recession in Europe. Banking profits are forecast to pick up pace amidst lower provisions and higher top-line growth and as a result, the banking sector is forecast to exhibit the fastest growth in profits amongst all major sectors.
 
Banking sector

Kuwait and Oman are projected to see the highest growth within the GCC in 2012, Global believes that this growth will be driven foremost by their respective banking sectors. Banking sectors of the remaining members of GCC should also see a healthy rise averaging at around 16 percent.

“We see modest growth of 11 percent coming in from the telecom sector with countries expected to show double digit growth include Qatar, Kuwait and Saudi Arabia. Profit growth story for Qatar and Kuwait is related to growing revenues from their international subsidiaries while that for Saudi Arabia is more home-based; Saudi Arabia still offers an under-tapped market with broadband services offering augmenting revenues,” Global said in its report.

Petrochemical sector profits would, however, lose steam considerably, inching up by just 2 percent due to reasons touched upon earlier. The Kingdom’s petrochemical sector is expected to exhibit a marginal decline in profits while that of Qatar would show handsome growth on diversified end products.
 
Sector outlook

According to Global investors should keep a close eye on Qatar and Saudi Arabia for low risk banking sector investments. UAE banks offer substantially higher upside potential but that does not come without exceptionally higher risk. “We reiterate our fondness of selective Abu Dhabi based banks. While we do not see enticing upside coming from petrochemical stocks. The construction sector should remain in the headlines on excessive infrastructure spending while, despite high upside potential, we remain picky on the available real estate stories within our coverage given the growing associated risks. Our confidence in the construction sector is further bolstered by the geographical diversification of their revenue streams. The cement sector should also see some lime light, piggy backing on the same spending story,” it said.

However, Global sees potential only in the Kingdom-based cement companies where strong demand exists emanating from ongoing projects; while those in Qatar will benefit once actual spending starts possibly two years from now. Global recommends a neutral stance on the petrochemical sector due to a bearish outlook on petrochemical prices; incremental revenues coming from added capacities will be offset by drop in product prices, leading eventually to stunted earnings growth. “While the telecom sector does not earn a bullish stance from our side, we remain opportunistic on the sector which offers some good picks throughout the GCC,” Global said.
 
Return ratios

“We do not expect a change in GCC's average ROE in 2012, as compared to the previous year. As has been the case for quite some time now, Qatar will remain the highest ROE generator, although this time around we expect to witness marked improvement in the ROEs of Kuwait and Oman,” Global said.

On a positive note, it added: “We anticipate an increasing trend in return ratios, going forward as companies cope with existent challenges. It is also interesting to note that the return ratios of GCC members are comparable to that of leading EM and developed economies.
 
Trading multiples

As per Global coverage, the GCC market is trading at a forward 2012e P/E of 9.8x which is markedly much cheaper than most of its international peers. This underpins the fact that GCC markets have undergone noticeable de-rating since previously these used to trade at a premium to the international peers.

Within GCC, UAE seems to be trading at a significant 17 percent discount to the GCC average while Kuwait is trading at a premium of around 34 percent, according to a P/E comparison. However, when adjusted through PEG, KSA seems to be the most expensive market while UAE retains its position as the cheapest one within the GCC.
 
Uncertainty

As expected, GCC markets remained under considerable pressure throughout 2011 from news related to exogenous factors. Albeit the US is now in a much better position, the euro zone crisis still lingers. With economists stating that a recession in Europe is inevitable, we wait to see the repercussions of the ensuing chain of news on GCC markets. If that was not enough, there is a lot being said about drastic softening in the growth of China and India, two leading emerging markets. Moreover, recent sanctions on Iran led it to retaliate with a threat to block off the Strait of Hormuz, which if implemented would share headlines with vaporization of investor sentiment. The implications of this standoff and the resulting geo-political upheaval could be manifold, none of which can be viewed in positive light.

While that takes care of most of the external factors, real estate markets in the UAE are still in poor health and the restructuring of Dubai Group is still underway. Further defaults/restructurings from large conglomerates including those that classify as GREs, will keep UAE high on the risk perception of investors; fortunately the effects of such will be limited to UAE.
 
Re-rating is still possible

Despite the gloomy picture, some events may still propel markets in the right direction. If oil prices move in a positive direction, say above $120 a barrel, regional surpluses will swell further than expectations creating positive sentiment in the market. The petrochemical sector will be the first and the largest beneficiary and has the capacity (market weight) to actually thrust the index forward. Possible MSCI upgrade of UAE and Qatar in 2012 would trigger sizeable interest followed by inflows into these markets. This comes at a very opportune time, when Taiwan and/or South Korea could see a possible upgrade into developed markets, leaving EM indexed funds to scramble for possible replacements.

Regulatory changes, like those relating to increasing of foreign ownership limits and opening the market to foreign owners will lead to significant inflows into the market, more so in the case of Saudi Arabia which is the largest stock exchange in the GCC.

Resolution of asset quality issues of UAE-based banks, a slowdown in corporate defaults and a confirmation from GREs that liquidity positions are in control, would send the right message across. Investors that draw immense riskiness from these factors will see their fears assuaged, inducing a fresh rally in the markets. Similarly, if developmental plans being carried out by governments accelerate and particularly in Kuwait's case, any actual implementation of the announced projects would bring about a sudden and positive shift in outlook of the country.
 
Proposed strategy

If we were to somehow escape the list of risk factors affecting our valuation, Saudi Arabia and Qatar should stand out as the best performing markets in the GCC in 2012. We would put more weight on Saudi Arabia because of its size and its recent under-performance. While UAE offers the highest growth potential, especially after the poor performance in 2011 we believe that the country also has the highest probability to be bogged down by negative news. We continue to remain neutral on Kuwait due to limited growth prospects and lack of enticing investment opportunities, the Global report said.

Global said that given highly uncertain times and expected market volatility, investors should stick to safe stocks (stocks with acceptable recommendations to curtail downside risk) that offer good dividend yield.