Investor attention continues to home in on the woes of developed markets. Not a surprise as that is where most of the money invested is at stake. This focus, the fear, confusion and paralysis it brings along are impeding most global investors to take potions in frontier markets.
Given that the allocation to this little known new world only represents a tiny part of global portfolios if at all, the perception towards these new markets is often simplified. Just think about the fact that these ‘fresh economic pastures’ consist of more than 60 economies of which only 25 are included in the Frontier Markets indices, maybe it’s just all a bit too much to handle for most.
For the record, above we are referring to global investors because many of the Arab and African markets are considerably up this year thanks to their local investors who are living in an environment of growth in which the possibilities and expectations almost seem to belong to an entirely different world. Why would they invest elsewhere? They are feeling the growth and are living the dream.
Those amongst us who can pull their heads out of the sand will encounter fundamentals in the frontier world that are very hard to resist, especially now in times of stark contrast between the economic realities at both ends of the development spectrum.
This week we take a closer look at the fundamentals of the MENA (Middle East and North Africa)region and explain why we believe these markets are ready for take-off.
Hesham Saad, our Head of Mena Equities, provides us with a compelling perspective on the financial sector and market valuations in general. By now, it has become fair to assume that the banking sector can be regarded as the barometer of an economy. If you would allow us to use the metaphor of the canary in the coal mine, the bird in the MENA mine would again be happily chirping away.
Imagine a world with low debt and high growth levels
Let’s start with the chart below. It shows the level of external debt outstanding as a percentage of GDP and the forecasted GDP growth for each country. In Europe and the US we can only dream of these kind of ratios. It is really no surprise that, in contrast with a couple of months ago, there are hardly anymore nasty headlines about Dubai. Arguably, the magnitude of the issues at hand in the Eurozone have dwarfed those of the emirate, and with reason when you realize that the UAE is in much better shape in terms of solvency.
Also worth pointing out are the amazing realities of Saudi and Qatar. The main conclusion from the below slide is very simple: the MENA has sustainable external debt levels while their economies are growing at envious rates. This is even true for both Egypt and Morocco.
MENA banks can and will lend more
With the next picture we illustrate the degree of solvency in the MENA banking sector.
The capital adequacy ratio tells us how much defaulted loans a bank can cover instantly before having to seek funding. These ratios are more than double those typically found in the developed world (and let’s not forget the fact that many banks in the US and Europe had to be saved recently by printing fresh debt!).
The high level of coverage for non-performing loans (NPL) is essentially a result of zealous provisioning activity in the recent past, this was generally imposed by local governments. In addition, the sustainable loans to deposit ratios will allow most banks to increase lending to local businesses which will in turn boost their margins and underpin further earnings growth in the banking sector.
At the same time, as it becomes easier for businesses to borrow, we see will more capital expenditure which in turn fuels higher economic growth.
Attractive PE ratios (Price Earnings) supported by high Earnings growth
PE ratios mean nothing without considering the magnitude of earnings growth. Again, in the MENA region we find compelling levels with overall PE ratios between 10 -15 x. Especially attractive are UAE and Egypt. Jordan stands out but this is a very small market with the bulk of this number based only on a couple of companies. Again, for further perspective, most of these markets boast earnings growth in excess of 10%, these are attractive numbers for the world we live in today! You would and should expect higher PE ratios for this level of growth and the higher ratios will be achieved through higher stock prices. Simple as that.
Companies can and will borrow more from banks
Another way of conducting a health check on the stock market is by looking at debt vs assets together with return on equity (ROE). Again, this looks like a picture from another world when you consider that debt/equity ratios hardly even reached 30%. The same conclusion can be drawn as from the previous slide about the banking sector: companies can and need to borrow more from banks. They can because we are seeing very healthy credit scores across the board. This will further support the economy.
Foreigners are starting to enter the markets
The graph below show net foreign flows over the past few weeks for MENA markets. it is clear that foreign investors are starting to see the value in these markets. You ill certainly notice that there is a disproportionate share of the flows that went into Egypt. This can maily be explained do to the fact that Egypt is a larger constituent of emerging market indexes and therefore these inflows are not always due to active investment decisions but rather come on the back of flows into emerging markets as a whole. The real entry of foreign buyer still needs to happen. The fundamentals pretty much assure us that it will happen and it may be very soon.
I hope you agree with us that these fundamentals can not be ignored. If this won’t encourage more investors to allocate more of their portfolios to the MENA region, we wonder what will…
Finally, as we have been speaking about the banking sector, here are 2 of favourite investments in the region’s financial center:
National Bank of Abu Dhabi (NBAD):
many foreign investors still live in the belief that the UAE is in deep trouble, Dubai may seem challenged but Abu Dhabi is in a position of much strength. NBAD’s numbers reflect that. We also like this bank as it has proven to have an excellent management team. NBAD is also increasingly tapping into the opportunities in the wider MENA territory. National Bank of Abu Dhabi is the second-largest bank in UAE, with market shares of 14% in loans and 12.4% in deposits.
The Abu Dhabi Investment Authority holds a 70.48% stake in the bank. NBAD enjoys strong funding support from the government, with government deposits constituting 64% of its deposits, and government and public sector loans amounting to 39% of the total loan book. NBAD has announced a strong 1Q10 results with a net profit of AED 1.03 billion compared to AED 770 million in 1Q09 (+34% YoY) and AED 429 million in 4Q09 (+140% QoQ). While net interest income continued its steady growth at 13% YoY and 1% QoQ, non-interest income improved significantly by 56% YoY and 42% QoQ, on the back of higher fee/commission income and impressive investment portfolio gains. Fee and commission rebounded strongly during 1Q10 increasing by 49% YoY probably due to higher income from fund management segment.
NBAD’s overall loan quality is the most resilient among the large UAE banks; NPL to loan ratio of 1.30% andprovision coverage of 161% as of March 2010 reflects the strong credit standards of the bank. Geographically, NBAD has full-scale operations in the UAE and Egypt, and branches in major globalfinancial centres, and has applied for a license in Qatar, leaving only Saudi untouched within the GCC.
NBAD also has presence in Sudan, Libya and potentially Jordan & Morocco.We especially like NBAD and expect it to be the best performing in the market over 2010 due to its defensive profile and cheap valuation.
Commercial Bank Qatar:
Many foreign investors were suspicious if Qatar stratospheric GDP growth numbers and hence also about the main financial insitutions. While the economic growth is real, CBQ is the least leveraged of the 3 major banks in the country and we are compelled by its high net interest margins.
Qatar’s real GDP growth is expected to be c.18.5%yoy this year – fastest in the world, backed by a 25% current account surplus. Against this robust macro backdrop CBQK loan growth is expected to be in the 10%-15% yoy range for FY10E-12E period.
CBQK is the least leveraged among the top three big banks in Qatar with assets/equity at just about 4.9x 09A affording it a higher wholesale funding on balance-sheet at 17% of assets vs. just 2%-4% for QNB / DBK as per FY09 data. CBQK, despite its >100% L/D ratio, has the highest Net Interest Margin of 3.0% avg. FY10E-12E due to higher asset yields underpinned by its bigger private corporate exposure on the lending book and funding cost benefit due to $1.6bn of wholesale debt raised at favorable cost in FY09.
With higher exposure to the private corporate sector vs. peers, the largest credit cards franchise in Qatar and increasing focus on private banking opportunities also give CBQK the highest fee yields among the three Big banks in Qatar.
This was a simple overview of the investment opportunity in the MENA markets. if you would like to discuss this in further detail, don’t hesitate to get in touch.
Our weekly fact sheets and updates can be found on our website www.silkinvest.com we hope they will provide you with more detailed insight into what is going on in the markets and economies of Africa, The Middle East and Central Asia.
With kind regards from the Silk Invest Team
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