Based on Jadwa forecasts for earnings in 2010, the fair value for the market at the end of this year put at 7,400, implying a gain of 10 percent from the current level, which may not be enough to trigger a significant rise in volumes.
The TASI has underperformed leading global and emerging markets in large part because of the damage to confidence caused by defaults at two large private sector companies and tight credit conditions, though it has outperformed other markets in the GCC (Gulf Cooperation Council). So far in 2010 performance has picked up independently of conditions on global markets, an encouraging sign that investor confidence in the prospects for corporate earnings may be improving, the report added.
The Jadwa report, developed by their Research Department, forecasts that earnings per share will rise by 8.2 percent this year. The multi-investment and petrochemical sectors are anticipated to record the strongest gains, as they recover from low prices for petrochemicals, equities and other assets in 2009. Most of the expected gains in these sectors have already been priced in to the market. In contrast, Jadwa thinks worries about bad loans in the banking sector and land prices for the real estate sector are overdone and views these as two of the most attractive sectors for investors in 2010.
Historically, the TASI has tended to overshoot fair value and there is a chance that this could happen again this year. The key to how far the market deviates from fair value is investor sentiment. This is improving, but given the modest gains for the TASI over 2010, the report does not foresee an overwhelming surge of enthusiasm for the market as has happened in previous years. A consistent flow of new listings and a possible revision to the method of foreign investor participation in the market that would lift inflows would boost confidence, but this could be offset by a fairly weak performance by global markets and a weakening global economic recovery. The clearest sign of a recovery of investor confidence would be the TASI continuing to rise amid consistently higher volumes.
Market performance
It was little over one year ago that the TASI touched its medium-term low. The TASI hit 4,130 on March 9, 2009 its lowest level since November 2003. At that time global markets were at or around multi-year lows, oil prices were around $45 per barrel and the global economy was at its weakest. Subsequently, the TASI has climbed by 62 percent to stand at 6,700 on March 20.This ascent has not been smooth. Until the middle of May the TASI surged in line with other global markets as it became clear that the worst had been avoided for the global economy, rising by 46 percent until May 13.
Then news emerged about the defaults at two high-profile local businesses. Though neither company was listed, the unexpected defaults had a serious impact. They raised concerns about the health of other private sector companies and the exposures of the banking sector, and badly damaged investor and consumer confidence. After a period of trading sideways while other markets continue to rise, the TASI dipped and spent the bulk of the summer below its level of May and June. An opaque partial settlement of the debts of one of the defaulting companies with its local creditors, combined with reasonable third quarter results, lifted the TASI through September and October to a high for the year of 6,568 on Oct. 24.
The market then slipped back as the ongoing lack of availability of credit hindered businesses and concerns emerged over dollar weakness. From early November until the end of the year the TASI traded in a fairly tight range aside from a blip at the time of the announcement of the Dubai World debt standstill. The TASI remained reasonably stable over the first two months of 2010, though this came against a backdrop of a decline in global markets and suggested an improvement in investor sentiment. Rising oil prices and renewed vigor in global markets have supported a consistent rise throughout March and on March 13 the TASI surpassed its 2009 peak.
Recent gains come amid low volumes, a clear indication that investor confidence remains fragile. The total volume of transactions over the three months to the end of February was on par with the monthly average for the first eight months of 2008. The average daily number of transactions in January was the lowest for five years, at just over 73,000. Indicators such as mutual fund ownership and the reduction of the proportion of trading accounted for by retail investors also point to a lessening of local investor interest in the market.
Rising share prices have pushed valuations up. From a long-term low of 9.6 in the first quarter of 2009, the 12-month trailing price-to-earnings (P/E) ratio reached 17.8 at the end of last year. The price-to-book (P/B) ratio also made a strong recovery, from 1.55 in the first quarter to around 2 at the end of the year. The bulk of the rise in valuations came in the second and third quarters, as fourth quarter earnings were affected by large provisions for bad loans at many commercial banks. The modest gain in the market so far this year has pushed the P/E ratio to 18.2 and the P/B to 2.15. Eight companies are currently trading below book value compared to 27 one year ago, the Jadwa report said.
In comparison to global developed and emerging markets, the TASI has underperformed. The TASI jumped 62 percent from its low last March compared with gains of 71 percent for the US S&P 500 and 107 percent for the MSCI emerging markets index over the same period. Yet on a valuation basis, the TASI is on a par with leading emerging markets. It is also trading at a large premium over regional markets (the TASI was the best performing stock market in the GCC last year). The high valuation of the Saudi market is not a cause for concern. It is in line with historical trends and reflects the home bias of the large domestic investor base and the high level of dividends awarded by local companies.
Earnings per share growth declined by 16.6 percent in 2009. The media and publishing sector experienced the largest fall owing to a downturn in advertising revenues. Much lower average prices caused petrochemical earnings to plunge. The insurance sector recorded another loss in 2009, though this was well down on the previous year as more of the new start-ups moved into profitability, as did dominant insurance provider Tawuniya, which suffered major losses on its investment portfolio in 2008. Banks ranked around the middle of the sectoral earnings table.
Hotels and tourism recorded the largest gain in 2009, the result of a one-time land sale by one of the two listed companies in the sector. Telecoms recorded the next strongest set of results owing to surging demand for mobile phones and a strong take up of related applications. The multi-investment sector returned to profitability after notable investment losses in 2008 by the dominant player, Kingdom Holding. The other two sectors where earnings per share rose last year were energy and utilities and agriculture; consumption of products from both sectors is little affected by an economic slowdown, the report said.
On a quarterly basis the earnings data were more encouraging. After five consecutive quarters of decline in year-on-year terms, earnings per share were up in the final quarter of 2009. Not surprisingly, the main gains were recorded in petrochemicals and multi-investment, the sectors most immediately and severely impacted by the financial and economic crisis of one-year earlier. With the impact of the plunge in prices of petrochemicals, equities and other assets dropping out of the annual comparison, both of these sectors are expected to be among the leading performers in 2010.
Overview by sector
After a tough year in 2009, the banking sector is expected to perform better this year, with earnings per share growth forecast at 10 percent. Owing to high profile defaults by two private sector companies and concern about the health of other borrowers, banks greatly increased their provisions for bad loans during 2009. It seems likely that most banks did the bulk of their provisioning last year, though total provisions as a proportion of bad loans are below 100 percent, compared to an average for the previous five years of over 160 percent, so there is still likely to be a significant amount of additional funds set aside in 2010. Uncertainty about borrower creditworthiness also caused banks to scale back lending last year and build up huge deposits with SAMA (Saudi Arabian Monetary Agency) that are currently earning interest of just 0.25 percent. As the economic recovery gains traction we think that bank lending growth is likely to pick up, which will further support earnings.
The Jadwa report said earnings per share for the petrochemicals sector will benefit from higher prices and production and are forecast to grow by 55 percent this year. Recovering global demand should ensure that prices are well above their average for last year. Higher prices alone are likely to result in a sharp jump in earnings per share growth in the first two quarters of this year. In addition, production is expected to commence or be ramped up at Yansab (Yanbu National Petrochemical Company), Saudi Kayan Petrochemical Company, Rabigh Refining and Petrochemical Co. and SABIC (Saudi Basic Industries Corp.) joint ventures in the Kingdom (Sharq) and in China (Tianjin).
Higher output and intensifying competition among existing and new cement producers will push prices down and as a result earnings per share are expected to fall by 10 percent in 2010. While strong investment spending by the government should stimulate demand for cement, two new plants and expansions at existing producers are scheduled for completion this year. Furthermore, margins will be squeezed by the clinker inventory, which is currently at an all-time high. High levels of inventory freeze resources and force companies to borrow to meet short-term working capital needs, incurring more financing charges in the process, while suspending old kilns to minimize the buildup of inventory causes fixed production costs to increase and erodes earnings. Some producers will start to post revenues this year from their investments in the production of premixed concrete and precast panels.
Earnings per share for the retail sector are set to rise by 10 percent as listed retailers continue to expand their number of outlets and consumer spending picks up.
According to Jadwa, earnings per share for the energy sector to fall by 10 percent in 2010. Saudi Electricity Co. (SEC), which dominates the sector, is undergoing major restructuring in an effort to maintain profitability in the face of a state-imposed electricity tariff. The government's decision in late 2009 to give up its share of SEC's dividends for another 10 years should help the balance sheet. But high plant utilization to meet demand (growing at around 8 percent annually) is accelerating the depreciation of machinery and equipment and the high cost of servicing a growing debt is taking a toll on earnings. Shareholders are almost certain to receive dividends regardless of the company's performance.
For the agriculture sector as a whole, earnings per share growth is forecast at 10 percent, though this masks a significant distinction between food processors and agricultural producers. The former are expected to enjoy another year of strong performance in 2010, with the largest (Almarai and Savola) set to benefit from expansion through organic growth, diversification into new product lines and synergies from mergers and acquisitions. In contrast, agricultural companies will continue to suffer from the withdrawal of subsidies and a likely increase in the costs of agricultural inputs and labor.
Tough competition means that earnings per share for the telecoms sector are expected to shrink by 5 percent. Growth in mobile phone take up will slow given the very high penetration rate (162 percent at the end of September).
Greater use of insurance and the move of more recently founded companies into profitability will cause earnings per share for the insurance sector to rise. The recent floods in Jeddah drew attention to the importance of insurance against natural disasters, a market that is set to grow considerably.
The recent restructuring of Kingdom Holding, which accounts for nearly 90 percent of the market capitalization of the multi-investment sector, is expected to resulting in earnings per share growth for the sector of around 85 percent. Actions including the receipt of a donation of Citigroup stock worth SR2.2 billion, a 41 percent reduction of capital and the use of the company's general reserves to write off losses incurred in 2008 should transform the financial fortunes of Kingdom Holding.
A recovering local and global economy should lift prices and sales volumes of manufactured products resulting in earnings per share growth of 15 percent for the industrial investment sector. Mining company Maaden, which constitutes almost half of the sector by market capitalization, gained significantly from the surge in gold prices last year and should benefit from higher average prices and production this year. A better outlook for local and external demand is expected to reflect favorably on this year's result across the sector.
The strengthening economy is expected to generate earnings per share growth of 15 percent for the building and construction sector in 2010.
Earnings per share growth of 10 percent is anticipated for the real estate sector owing to ongoing strong demand.
Jadwa expects earnings per share growth for the transport sector of around 5 percent this year.
The improving economy should encourage businesses to lift their marketing and advertising budgets this year, which will contribute to 20 percent growth in earnings per share for the media and publishing sector. Tough conditions in 2009 encouraged some media companies to diversify into new lines or to cut costs, which are likely to be reflected in higher margins.
