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Transcription

1 吀䠀䔀夀䔀䄀刀䄀䠀䔀䄀䐀 刀攀 挀漀 瘀攀 爀 礀 圀漀 爀搀 䌀甀 氀 瀀 䘀䤀 一䐀䤀 一䜀吀䠀䔀刀䤀 䜀䠀吀䘀䤀 吀 䤀 一 㠀 䔀堀 倀 伀 䔀氀 攀挀琀 椀 漀渀 猀 䜀爀 漀眀 琀 栀 刀攀 昀 漀爀 洀 䔀 䤀 渀挀 䴀 氀 甀猀 椀 漀渀 倀愀 猀猀椀 䘀氀 漀眀 瘀攀 猀 䤀 倀伀 猀 伀椀 氀倀 爀 椀 挀攀猀

2 Table of Contents Executive Summary 2 Strategy Themes 4 Sectors 14 Country Analysis 39 Coverage Tables 84 Contacts & Disclaimer 94

3 Executive Summary The Year Ahead - Executive Summary This year s EFG Hermes Year Ahead Book is the first to be based on our expanded coverage of Frontier Markets and MENA Small & Mid-Caps. We now cover 229 stocks in 14 markets, up from 154 stocks in nine markets at end of 216 and expect to broaden our coverage further in 218. We have also broadened our macro-strategy coverage to include key frontier markets, complementing our bottom-up work. While the rise of index-tracking strategies looks unstoppable in developed and major emerging markets, we think that there is a strong case to be made for fundamental research for investors in MENA and smaller emerging and frontier markets. The book begins with our key strategy assumptions for 218, followed by the MENA Top 2 List and our top FEM Buy ideas. Our sector teams then present their views and stock picks for 218, followed by macro-strategy analysis of nine major MENA and FEM markets. The book concludes with a full coverage table. Our 218 strategy views are based on two key variables USD and oil prices The USD and oil prices are likely to trade within a narrow range in 218, rather than setting a clear price trend. For the dollar, a rising FFRR will be balanced by the likelihood of a widening fiscal deficit as the Trump administration pushes through tax cuts. For oil, we think that the changing shape of the future s curve reflects concerns over rising supply and weaker demand growth in the medium term, limiting upside risks, in spite of OPEC action. China still a big factor we expect continued heavy investments in FEM Industrial commodity prices are likely to be weaker in 218, as China s government focuses on quality rather than quantity for future growth. Side effects of such policies include rising nitrogen fertiliser prices and good long-term growth in demand for natural gas. We think that China will continue to invest heavily in key Frontier Emerging Markets (FEM), supporting growth and improving infrastructure. We keep an eye on the risk that such capital flows could leave FEM currencies looking overvalued. Index events: All eyes on Kuwait and Saudi Arabia for upgrades The continuing rise in passive-managed funds is likely to ensure a big bang for pending and potential FTSE and MSCI upgrades for Kuwait and Saudi Arabia (passive flows will be well over USD1bn for the latter). Vietnam, a major frontier market, still has work to do on FOLs before it can join the watchlist for an MSCI upgrade. We also think that new benchmarks for investing in smaller emerging and frontier markets will emerge over the next few years. Tensions within MENA are likely to mean that regional markets trade at a discount to EM peers Political overhangs partly explain the big valuation discrepancies between FEM countries in late 217. Elections will be in focus in 218, notably in Pakistan, where the ruling party had a difficult 217. The political timetable could also affect reform momentum in Egypt, Nigeria and, potentially, Lebanon, while investors in Saudi Arabia will be looking for clarity on the government s plans to revive growth after a difficult few years. 2

4 Executive Summary Egypt is our top pick for 218 Within MENA and FEM, our top country pick is Egypt, where falling interest rates and accelerating growth will drive strong stock performance. We also like Kuwait, where the FTSE upgrade is a key driver, supported by strong growth, and in FEM Nigeria, where last year s devaluation, the recovery in oil prices and attractive valuations, together, promise good returns. Neutral on Saudi Arabia and UAE, and Qatar a non-starter until GCC relations improve In MENA, we are Neutral on the biggest market, Saudi Arabia, believing that valuations are not attractive enough, given the uncertain growth outlook we think the market should be traded around index announcements and other newsflow. We are also Neutral on the wellowned UAE market. With Qatar being one of the worst performing markets of 217, value has clearly opened up, but we think that a lasting recovery in this market is unlikely until the political outlook in the Gulf has improved. Pakistan is cheap, but for a good reason, and Vietnam could take a breather at high levels Elsewhere, in FEM, we look for more clarity on FX and politics before becoming more bullish on the admittedly-cheap Pakistani market. We think some of the froth needs to come off the Vietnamese market before becoming more bullish there and think that Kenyan stocks are not accurately pricing in banking sector and growth risks. 3

5 Strategy Themes MENA & FEM Investment themes for 218 No breakouts for oil and USD in 218; China slowdown may weigh on global growth Active-to-passive shift continues in EM good for Qatar, supports big-bang upgrade in KSA China s outbound investment important for FEM supporting expensive currencies? Elections in Pakistan, Egypt in 218, leading up to Nigeria in 219; MENA overhang will stay in place USD: Will interest rate hikes support the USD in 218? The USD index lost 9% YTD, despite the interest rate differential between the US and the rest of the world; however, the USD is still 18% above the 214 lows, and plenty of EM currencies are still below their longterm average REER, which could mean that, despite the strong interest rate expectations, the USD might not outperform EM currencies in aggregate. The dot plot implies three rate hikes in 218, which support the USD in theory against major currencies; however, the potential for tax reforms, and implied US higher budget deficit, could counteract the higher US rates. In the MENA region, we still see no risk to the GCC pegs in the short and medium terms, despite the emergence of an offshore discount for QAR. OMR is the GCC currency at greatest risk, but a move looks unlikely in 218. In Egypt, we believe that some mild appreciation against the USD is possible in 218; we see USD/EGP17 as a reasonable level. Elsewhere in FEM, PKR remains in focus, due to recent CA deterioration and reserve burn a currency move is likely to be linked to the political timetable. Nigeria still has to unify the various NGN rates, but the biggest move is behind us. KES looks somewhat expensive on a REER basis (well above average), but ample reserve coverage is likely to mean another year of USD-KES stability at this level. Figure 1: Dots imply three hikes in 218 FOMC dots and Fed funds futures for year-end Figure 2: Despite the drop, the USD is still 18% above the 214 lows DXY index (USD index) 3. FOMC Dots Median Fed Funds Futures - Latest Value % % % Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Source: Bloomberg Source: Bloomberg 4

6 Strategy Themes Oil will trade in range; we estimate USD57/bbl avg. for Brent We have not changed our oil price forecasts for 218 and 219 for this yearbook, preferring to stay slightly conservative we expect Brent to average USD57/bbl in 218 and USD6/bbl in 219, with falling inventories balancing incremental supply from US producers. We note that oil prices for prompt delivery have moved to a significant premium in the past six months, justifying some conservatism. Moreover, analysis from the NY Fed suggests that much of the recovery in prices the mid-217 slump has been driven not by supply management (in spite of continuing headlines about OPEC-Russia cooperation), but by demand. Global growth expectations have been revised upwards in recent months, implying a continuing demand effect in 218, but we warn that Chinese demand growth may be less healthy, following the recent CPC Congress. Figure 3: Clear shift in future curve in late 217 Brent crude futures in USD/bbl (current is CO1) Nov-16 May-17 Aug-17 Nov Figure 4: Demand was the driver of oil prices in 2H17 Cumulative drivers of 217 YTD Brent crude price Demand Residual Supply Oil price Current 1yr 2yr 3yr 4yr 5yr Dec 13-Jan 27-Jan 1-Feb 24-Feb 1-Mar 24-Mar 7-Apr 21-Apr 5-May 19-May 2-Jun 16-Jun 3-Jun 14-Jul 28-Jul 11-Aug 25-Aug 8-Sep 22-Sep 6-Oct 2-Oct 3-Nov 17-Nov Source: Bloomberg Source: Fed NY Fed Oil Price Dynamics Report China slowdown possible, but investment in FEM still critical We suspect that the post-cpc congress period will mean a greater focus on the quality of Chinese growth rather than the rate of growth over the next few years. This will have an indirect impact on emerging and frontier markets. Our materials team highlights the impact of tighter environmental regulations in China on the nitrogen fertiliser market, and a greater emphasis on clean fuel will support long run demand in the currently well-supplied natural gas market. In the short term, demand for industrial metals may be relatively soft as China continues to move away from its investment-heavy growth model. However, China will continue to be a major investor in emerging and frontier markets, in support of its Belt and Road Initiative (which itself supports Chinese exports of goods and construction services). The data show that investment, which is heavily-weighted in favour of financing for construction contracts, has slowed down slightly in 217. This may be because of timing factors our 217 data are for 1H and also because of the CPC Congress itself. However, we expect this flow of funds to remain strong. It is worth bearing in mind that the amounts involved are very small, relative to total Chinese investment at home, but are significant for recipient economies, notably Pakistan. 5

7 Strategy Themes Figure 5: Chinese investment in MENA & FEM is debt-heavy Aggregate Chinese debt & equity investment in projects (USDbn) Figure 6: Is China money supporting expensive currencies? Real Effective Exchange Rate (current level premium to LT avg.) 5 Debt Equity e -2-3 BD KE PK VN KW BH TZ PE PH MO NG CR RO TN CO EG AR Note: Data for 11 MENA & FM countries, 217 is annualised 1H17 data Source: Bloomberg Note: Highlighted countries discussed in detail below Source: Bloomberg, EFG Hermes calculations China supports FEM growth, keeping currencies higher for longer Chinese investments are an important source of short-term balance of payments financing, but with debt dominating Chinese financial flows into many FEM and MENA markets, interest and principal payments will weigh on external balances in the medium term. Real Effective Exchange Rates (REER) for a number of FEM markets point to overvaluation. REERs are not definitive proofs of overvaluation for example, Vietnam s premium to its long-run average may point to past productivity gains but they are suggestive. We currently think that PKR requires some FX adjustment in the short term, while other FEM currencies, such as KES, may be vulnerable if current trends continue. Politics: Pakistan overhang in 1H18; MENA discount to linger Political factors add to the macro risks for a handful of MENA and FEM countries in 218. The run-up to Pakistan s general elections is already creating uncertainty, given the ruling PML-N s ongoing troubles, keeping us cautious on inexpensive Pakistan stocks until 2H18 at the earliest. There is less uncertainty about the outcome of Egypt s presidential elections in 1H18, and we are bullish on that market, but we may see some increase in market volatility around the polls. Elsewhere in MENA, Crown Prince Mohamed bin Salman s consolidation of power in Saudi Arabia is complete, but tensions between Middle Eastern powers is likely to ensure that MENA equities in aggregate trade at a discount to EM peers. Turmoil surrounding Kenya s elections appears to have dissipated, and our focus is now on growth and credit quality. Nigerian elections will not take place until 219, but pre-election positioning may be a factor in market performance in late

8 Strategy Themes Will passive AUMs continue to rise in 218? There is no slowdown in sight in the continued shift to passive investments, be it in the US or internationally. EPFR Global data show that passive GEM funds received cusd5bn YTD, while active GEM funds received cusd1bn YTD only. Going back to 214, there is clear evidence that while in-aggregate active GEM funds lost AUMs, passive funds received a total inflow of USD7bn, most of which came in 216 and 217. Looking at ETF flows, it is obvious that cost is a key consideration for money allocation, as ETFs with lower expense ratios are grabbing the bulk of the EM ETFs flows. The shift to passive is good for Qatar, which is a heavy UW by active managers and is also supportive of the Saudi upgrade, as it increases the size of the guaranteed bid as a result of index inclusions, regardless of how active managers will position. The active-passive shift could have a negative impact on popular markets such as the UAE, as market flows reflect the shift from actively-managed funds, in which the UAE is OW, to passive-managed funds, in which by definition the UAE is at benchmark weight. Figure 7: Passive-to-active shift continued in 217, with passive GEM funds receiving 5x the active GEM funds inflows YTD Cumulative flows into GEM funds since January 214 in USDmn Figure 8: passive AUMs account for c.36% of total EM AUMs, according to EPFR Global data AUMs in USDbn (LHS), passive AUMs as % of total (RHS) 8, Active Passive 9 Passive USDbn (USDbn,LHS) Active AUMs (USDbn,LHS) Passive AUMs as % of total GEM funds AUMs 4 6, 4, 2, % 3 25% 2 15% 1 (2,) 1 5% (4,) Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Aug-1 Jul-2 Jun-3 May-4 Apr-5 Mar-6 Feb-7 Jan-8 Dec-8 Nov-9 Oct-1 Sep-11 Aug-12 Jul-13 Jun-14 May-15 Apr-16 Mar-17 Source: EPFR Global, EFG Hermes Source: EPFR Global, EFG Hermes 7

9 Strategy Themes Valuations and index flows Big discrepancies in FEM Vietnam looking pricey, Pakistan, Nigeria and Egypt looking cheap EG looks best-placed for 218, looking for clarity in PK & NG, consolidation in VN Kuwait & KSA set for more index newsflow in 218; both are under-owned, but local offer in question Vietnam is a slow burner for MSCI upgrade longer-run question about future of FM benchmark Valuations: PK, EG & NG are cheap; VN is looking pricey Frontier and MENA valuations are widely dispersed going into 218, even when taking into account differences in expected growth (ranging from a EPS CAGR of 8% for Morocco to 23% for Vietnam). Pakistan, Nigeria and Egypt are grouped together, trading at a hefty discount to EM, FEM and MENA peers. This discount reflects perceived macro and political risk, though we note that the three markets are at different stages of the cycle. Nigeria is the most geared to the recent rally in oil prices, but the authorities still have work to do in bringing various exchange rates into equilibrium. Pakistan faces political uncertainty in 1H18 and also needs to reduce pressure on PKR (the State Bank of Pakistan said on 8 December after the PKR weakened that such a market-driven adjustment would reduce this pressure), but the long-run story looks robust. Egypt's FX market is functioning more smoothly, and we expect sharp cuts in interest rates from early 218 as inflation drops. We think that all three markets offer good value, but see greater risks in Pakistan and Nigeria at this stage. Figure 9: Egypt, Pakistan & Nigeria looking cheap 217 PE vs EPS CAGR (all consensus for MSCI indices) Figure 1: Vietnam is literally off the charts Trailing PB multiple vs. 12m forward ROE (all consensus for MSCI indices) 217 PE 22 Markets Aggregates PB 4.5 Markets Aggregates 2 BD 4. BD QA OM MENA AE EM KSA KE FEM 8 NG 8% 1 12% 14% 16% 18% EPS CAGR Note: Chart excludes Vietnam (26x 217PE, 23% EPS CAGR) and Morocco (19x PE, 8% EPS CAGR) Source: Bloomberg KW EG LK Big discount on key FEM markets PK FEM EM EG KSA 1.5 KW MENA NG OM PK 1. QA LK AE 1 15% ROE 2 25% MA Note: Chart excludes Vietnam (5x PB vs. 23% ROE) and Kenya (3.7x PB vs 31% ROE) Source: Bloomberg At the other end of the spectrum lies Vietnam, which offers good growth at a very high multiple. Recent price action suggests over-exuberance in the Vietnamese markets, and we look for a correction to bring prices back in line with the admittedly strong fundamentals. Kenya also trades at a premium, having shrugged off political turmoil, slower growth and an interest rate cap. We think this premium is difficult to justify, given concerns about credit quality and high fiscal deficits. Valuation differences could be ascribed partly to index composition. The above charts use the MSCI country indices and aggregates, which reflect the investible universe for foreign investors. In Vietnam, the index is skewed by heavyweight VNM, which trades at the high multiple typically seen for staples; high ROE stocks Safaricom and COMI dominate in Kenya and Egypt, respectively. Investors should be aware of index composition, but not let such factors outweigh macro factors and valuations when comparing markets. 8

10 Strategy Themes 218 flows focus on Kuwait, and KSA; still early for Vietnam Investors should keep an eye on Kuwait and Saudi Arabia in 218 (more details in the country section). As both countries are expected to see newsflow related to index inclusion, be it from FTSE (Mar 218) and/or FTSE (Jun 218). The inclusion of Saudi Arabia, in particular, should help bring MENA closer to its full potential within EM, leading to more allocations to the region from active GEM funds as well. However, the pace of changing allocations could be dampened by geopolitical uncertainties. Figure 11: MENA is still below its full potential in EM Saudi inclusion and Aramco s IPO would change this 25% MENA as % of EM GDP MENA's weight in MSCI EM MENA as % of Total EM Mcap 2 15% 1 5% Oct-4 Feb-5 Jun-5 Oct-5 Feb-6 Jun-6 Oct-6 Feb-7 Jun-7 Oct-7 Feb-8 Jun-8 Oct-8 Feb-9 Jun-9 Oct-9 Feb-1 Jun-1 Oct-1 Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 Oct-12 Feb-13 Jun-13 Oct-13 Feb-14 Jun-14 Oct-14 Feb-15 Jun-15 Oct-15 Feb-16 Jun-16 Oct-16 Feb-17 Jun-17 Source: Bloomberg, IMF, MSCI, EFG Hermes In Mar 218, we expect FTSE to announce that the pending Kuwaiti upgrade will be done over two phases (Sep 218 and Mar 219), resulting in a weight of c.5% for Kuwait in FTSE EM and cusd8mn worth of inflows. We also see a higher chance next year for MSCI to place Kuwait on the watchlist for a potential EM upgrade. Finally, Kuwait will also benefit from a potential upgrade to EM for Argentina, which is currently the largest country in MSCI FM. For Saudi Arabia, a favourable upgrade decision by both MSCI and FTSE will depend on the ease of trading, once the buy orders pre-validation moves from custodians to brokers in Jan 218. If the move, rules and regulations around it are seen as workable for brokers and investors, Saudi Arabia should receive the nod from both FTSE (Mar 218) and MSCI (Jun 218), with implementation likely in Mar 219 for FTSE and May 219 for MSCI, split over two phases or more, in our view. Saudi Arabia could account for 2.2% of MSCI EM and 2.7% of FTSE EM, seeing USD8.5bn and USD4bn of passive inflows, respectively, at current AUMs. Given the relatively low foreign ownership in Kuwait and Saudi Arabia, it is safe to assume a decent amount of pre-positioning ahead of such events in both markets. It is still early for Vietnam to be considered for an upgrade cycle to EM, but we expect that ongoing IPO activity will increase the investibility of this market, and newsflow on an upgrade may pick up in 218. Low foreign ownership limits and uneven disclosure are the biggest obstacles to EM status for Vietnam, with the former creating a large discrepancy between the investible market for foreigners and the underlying market. 9

11 Strategy Themes Figure 12: Top 15 names by total FTSE and MSCI estimates passive flows for Saudi Arabia (c8 of total passive inflows expected) Est. FTSE flows Est. MSCI flows Est. total 3MADVT Flows / ADVT (USDmn) (USDmn) (USDmn) (USDmn) (x) SABIC AB 565 1,42 1, RJHI AB , NCB AB , STC AB SAMBA AB ALMARAI AB MAADEN AB SECO AB RIBL AB ALINMA AB BSFR AB YANSAB AB SAFCO AB SAVOLA AB KAYAN AB Source: MSCI, FTSE, EFG Hermes estimates 1

12 Strategy Themes MENA Top 2, Sell ideas and country weights We remain OW Egypt, Kuwait, Neutral UAE and UW Qatar We upgrade Saudi Arabia to Neutral from UW on expansionary budget, index inclusion newsflow Our country weighted portfolio delivered 1 total return vs. 2% for MENA, MENA Top 2 +21% MENA Top 2 list - additions: QNB, Budget and TAWUNIYA; deletions: Bupa, Mezzan and Extra MENA Sell ideas - additions: DXBE and DAMAC; deletions: QIB and Maaden Figure 13: Top 2 outperformed in 217, sell ideas lost outperformance on Maaden s rally since June USD Total return in % Top 2 MENA Sell Ideas 3 25% 2 15% 1 5% -5% -1-15% Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Source: Bloomberg, EFG Hermes Figure 14: EFG Hermes country weights Rating New weight Current weight Index weight Mcap ADVT P/E (x) P/B (x) ROAE (%) % % % (USDbn) (USDmn) 217e 218e 219e 218e 219e 218e 219e 218e KSA Neutral 54% 49% 54% UAE Neutral 15% 16% 15% Egypt OW 14% 16% 2% Kuwait OW 12% 15% 8% Qatar UW 5% 5% 12% Morocco UW 4% Oman UW 1% Bahrain - 1% Lebanon UW 1% Jordan UW 1% Tunisia MENA 1,62 1, EM Source: Bloomberg, MSCI, EFG Hermes estimates DY (%) 11

13 Strategy Themes Figure 15: MENA Top 2 List Close TP Upside Rating Perf. MCap ADVT PE (x) PB (x) DY (%) (LCL) (LCL) 217 (USDbn) (USDmn) Juhayna Egypt % Buy 57% Eastern Co. Egypt % Buy 174% CIB Egypt % Buy 3% Ezz Steel Egypt % Buy 11% N/M Nasr City Housing Egypt % Buy -1% Budget Saudi KSA % Buy -15% Al Othaim KSA % Buy Al Rajhi Bank KSA % Neutral 2% Samba KSA % Neutral -7% Tawuniya KSA % Buy 13% YANSAB KSA % Buy 12% Humansoft Kuwait % Buy 37% NBK Kuwait % Buy 17% Zain Group Kuwait.4.5 9% Buy QNB Qatar % Buy -19% QEWC Qatar % Buy -26% FAB UAE % Neutral 2% DIB UAE % Buy 9% DP World UAE % Buy 38% Aldar Properties UAE % Buy -15% Source: Company data, EFG Hermes estimates Figure 16: MENA Sell ideas Close TP Upside Rating Perf. MCap ADVT PE (x) PB (x) DY (%) (LCL) (LCL) 217 (USDbn) (USDmn) Chemanol KSA % Sell -2% N/M N/M N/M.9 - DAMAC Properties UAE % Sell 34% DXB UAE.7.7 9% Neutral -48% N/M N/M N/M.8 - Etisalat UAE % Neutral -12% Source: Company data, EFG Hermes estimates 12

14 Strategy Themes FEM Top picks and Sell ideas Egypt in recovery is our favourite market for 218, with Nigeria as runner-up Vietnam needs a correction to take froth off the market; looking for FX and political clarity in Pakistan Kenya looks expensive, given banking sector stress; Kuwait is an index-flow story We like Egyptian and Nigerian banks, consumer names in Egypt and Vietnam Oil sector is a hedge against possible PKR and KES weakness Figure 17: FEM Top picks Close TP Upside Rating Perf. MCap ADVT PE (x) PB (x) DY (%) (LCL) (LCL) 217 (USDbn) (USDmn) Eastern Company Egypt % Buy 174% CIB Egypt % Buy 3% Kenolkobil Group Kenya % Buy NBK Kuwait % Buy 17% Zain Group Kuwait.4.5 9% Buy Zenith Bank Nigeria % Buy 68% FBN Holdings Nigeria % Buy 119% OGDC Pakistan % Buy -4% MCB Bank Pakistan % Buy -15% MWG Vietnam % Buy 75% Note: Vietnam stocks close and target prices are in VNDs Source: Company data, EFG Hermes estimates Figure 18: FEM Sell ideas Close TP Upside Rating Perf. MCap ADVT PE (x) PB (x) DY (%) (LCL) (LCL) 217 (USDbn) (USDmn) KCB Group Kenya % Sell 43% CBK Kenya % Sell 47% Bank Sohar Oman % Sell 7% Engro Foods Pakistan % Sell -58% VCB Vietnam % Sell 39% Note: Vietnam stocks close and target prices are in VNDs Source: Company data, EFG Hermes estimates 13

15 Sectors Financials 15 Consumer 21 Materials 25 Real Estate 29 Telecom 31 Healthcare 35

16 Financials Sector MENA Financials: Key Buys CIB in Egypt: Strong play on the recovery in lending demand from large corporates, which we expect to drive loan growth from mid-218, particularly CIB. Strong track record in mobilising low-cost deposits, very resilient credit quality and both have a sizeable buffer of provisions and capital. We also expect CIB to maintain above-sector ROEs (27% for CIB and 34% for CAE) and assume a slight decline in the next two years. NBK in Kuwait: Best play on investment spending in Kuwait, excess provisions and an already high cost of risk because of precautionary provisions requested by the CBK means that cost of risk should be stable next year despite IFRS9 implementation in Jan 219. NBK is also a beneficiary of rate hikes via higher net interest margins. ENBD in the UAE: ENBD is a key beneficiary from interest rate hikes, which will be positive for net interest margins. We also expect cost efficiency gains for ENBD because of a strong focus on digitalisation. Tawuniya and Walaa in KSA: We prefer exposure to Saudi Arabian insurers vs. Saudi Arabian banks: Insurers offer better visibility on revenue growth, particularly in the motor business. Frontier: Key Buys Zenith Bank and First Bank in Nigeria: Zenith is our top pick in Nigeria on a risk-reward basis because of its leading deposit market shares, low balance sheet leverage, high capitalisation and strong costs discipline. First Bank is our preferred risk play in Nigeria. Relative to its tier-i peers, FBNH is trading at a forward P/B discount of over 5, despite stabilisation in its risk outlook and clarity in its capitalisation. We do not believe this is a failed institution. MBB in Vietnam: Relatively strong corporate governance, which is reflected in its broad beneficial ownership structure and highly independent Board. Furthermore, we are encouraged by its strong potential for ROE expansion, on the back of lower risk charges and continued strong credit growth. Key Sell: Co-op Bank in Kenya: We do not believe current valuations accurately reflect the structural decline in its profitability because of moderation in growth and decline in margins, which are being exacerbated by increasing macro and sector level risks (political impasse, reduced government spending, slowdown in agricultural sector). 15

17 Financials Sector Figure 1: Financials Key themes for 218 per country (to be continued) Country Key themes Top picks/top Sell ideas Middle East Saudi Arabia (Banks) Loan growth should improve, driven by slight improvement in economic growth and a pickup in retail appetite, as the lifting of ban on female drivers boosts consumer spending Investment book growth for banks is likely to be a key theme in 218 as gov't issues domestic debt to fund budget deficit Spread improvement to hinge on higher US rates and domestic liquidity conditions. With at least two Fed hikes likely in 218, Saudi Arabian banks should be key beneficiaries We expect credit quality to remain under pressure and provisioning to be higher, owing to weak macro and incremental IFRS 9 provisioning SABB: Superior returns profile, leverage to US rates, solid trade franchise and solid capitalisation underpin our positive view BSF: Strong culture of credit risk mgmt., a well-capitalised balance sheet and decent div. yield Saudi Arabia (Insurance) In the ST we see headwinds for insurers stemming from a weak macro, which is affecting labour market, car sales and causing corporates to resist increases in premium rates Looking ahead, we believe there are better opportunities for motor-focused insurers arising from lifting of the ban on female drivers in 2H18 and stricter motor insurance enforcement, which should add SAR1bn to annual premiums by 22 Growth outlook in medical subject to the enforcement of medical insurance on Saudis working in the private sector and initiatives to widen the mandatory insurance net; however, timing remains unclear Tawuniya: A multi-line insurer, with unmatched scale offers better growth prospects than Bupa and an enduring competitive edge over small insurers Walaa: Mid-sized, motor-focused, with good underwriting discipline and ambitions for growth in P&C UAE Qatar (Banks) Stronger loan growth prospects on a gradual pick-up in investment spending in Abu Dhabi and uptick in private sector spending linked to Expo 22 in Dubai Higher interest rates to drive spreads. We do not see risk to liquidity as we approach end of 217 on a better liquidity position compared to a year ago Banks likely to post positive JAWS, as cost growth is kept in check, due to growing automation of processes and increased focus on digital banking Scope for provision release is lower as NPL ratios approach normalised levels. Strong general provision buffer to help mitigate incremental provisioning due to IFRS 9 Public sector driving credit growth. Investment spending plans not affected by GCC embargo on Qatar. Loan growth at c1 in 218 Spreads have been very resilient in 217, as expensive GCC deposits were replaced by cheaper public sector deposits. We assume a less benign outlook for spreads and factor in c15bps decline next year Credit quality could come under some pressure next year (hotels, real estate). But ultimate owners are Qatari VIPs with very deep pockets, and we do not expect, as a result, a large increase in defaults ENBD: Offers exposure to Dubai's favourable macro, is a key beneficiary of rising interest rates and expect the bank to make efficiency gains as the bank focuses on digitalisation RAKB: Earnings recovery story, driven by provisioning normalisation QNB: Better loan growth outlook in Qatar as it has a large market share in public sector. Strongest credit rating in Qatar allows for lower funding costs vs. peers. Low risk loan book due to significant gov t exposure Qatar (Insurance) Premium growth in Qatar in in mid-single digits. Mandatory health insurance is a potential catalyst for premium growth, but the authorities have not set any particular timeline for implementation Due to the small size of the Qatari insurance market, the largest insurer, QIC, has focused on expansion in developed markets; thus, allowing QIC to gain product depth, something that GCC/developing markets lack. 73% of GWP are international, with its global reinsurer, Qatar Re, accounting for 43% of GWP Source: EFG Hermes estimates QIC: Strong de-rating post 3Q17 losses linked to USD hurricanes. These were one-offs, and profitability should normalise in 4Q17. QIC has lagged the re-rating of reinsurers stocks, which corrected at the time of the hurricanes, but have, since then, bounced back, with higher premium rates being a positive catalyst for the industry 16

18 Financials Sector Figure 2: Financials Key themes for 218 per country (to be continued) Country Key themes Top picks/top Sell ideas Middle East Kuwait Visibility on the loan growth story for Kuwait banks in context of the GCC: high single-digit loan growth, driven by gov t expenditure Upside risks for net interest income: rate hikes are positive for NIMs (floating rates, CASA deposit mix of c5) Cost of risk already elevated due to precautionary provisions requested by the Central Bank; most banks have a large stock of excess provisions, and they are well-placed for the upcoming implementation of IFRS9 NBK: Strongest profitability in Kuwait, largest market share in large corporate/multinationals lending, strong credit-risk culture Jordan Loan growth, at 8%, has been decent, with construction and industry being the main drivers. It is, however, difficult to see a meaningful improvement in 218, in light of the weak macro outlook and growing liquidity constraints Deposit growth has been quite weak at -1% Y-o-Y, with LDR at 73%, a level not seen since 28 The Central Bank is tightening interest rates to prevent dollarisation and follow the US rate increases. This should be positive for spreads, but could weigh on credit quality of the retail segment Arab Bank: Our preferred bank in Jordan. It offers a liquid and wellcapitalised balance sheet; it should benefit from higher US rates, and it offers exposure to the fast-growing Egyptian market Lebanon Loan growth has been weak in 217, and the political instability is a blow to confidence. We expect further deceleration in loan and deposit growth rates Potential rate hikes in the US are an upside risk to earnings, as banks hold a large amount of ST USD liquidity. However, banks might need to increase rates in USD deposits due to political risks, and the impact on net profit could be lower compared to previous rate hikes Banks used last year's large non-recurrent gains to clean up balance sheets: goodwill has been written off, and banks added very conservative provisions last year, ahead of IFRS9 implementation. NPL coverage is above 1 for banks under coverage None. We like BLOM Bank, as a defensive bank, very wellcapitalised and with high ROE (17%). However, we would avoid Lebanon, for now, until there is clarity on the political scene Oman Loan growth momentum is subdued at mid-single digits, as weak macro has dented both retail and corporate lending appetite. Competition from international banks on projects' financing in Duqm zone and Sohar region is fierce. Retail regulatory caps put a ceiling on retail growth NIM outlook is improving marginally as better liquidity has released some of the pressure on funding costs. Some banks have managed to pass on part of the deposit costs to borrowers, which gave an uplift to asset yields Fee income is still sluggish, due to regulatory restrictions on collecting fees on some retail products in and also weak volume growth Credit quality holding up well, despite weak macro. Recoveries, on the back of legacy NPLs for Bank Muscat, easing of some provisioning rules for other banks, have helped keep cost of risk under control Bank Muscat: Unrivalled market leader, defensive play with high capitalisation, strong provisioning buffer and sound credit quality. Its valuation is attractive, in our view, and it is best-placed to cope with current macro challenges in Oman Source: EFG Hermes estimates 17

19 Financials Sector Figure 3: Financials Key themes for 218 per country (to be continued) Country Key themes Top picks/top Sell ideas Asia Vietnam Strong loan growth to sustain in 218, as banks continue to grow their retail books Upward revision in foreign ownership (FO) limits. In Vietnam, FO of banks is currently limited to 3, but there have been some suggestions from the regulator that they may be open to increasing this limit. A decision to increase FO limits would be a big positive for all banks. On the current domestic/foreign splits in ownership, we would note that ACB, MBB and VCB are currently 7/3, 8/2 and 79/21, respectively Lower loan loss provisions in 218: most banks looking to fully provide for their VAMC exposures in 217 ROE expansion in 218e to 16% from 12% in 217e, on the back of continued growth in the balance sheet, stable margins, cost control and lower provision MBB: i) Scope for higher EPS consensus like-for-like, our 218 and 219 EPS est. are 21% and 59% above consensus, due to our expectation for MBB s risk charge to fall to.36% by 219 from 1.35% in 216; ii) good corporate governance: its broad beneficial ownership structure has prevented concentration of power in a few hands, and this is reflected on the structure of its Board: only four of the 11 members are insiders, and the chairman is an independent Pakistan Loan growth momentum has been unaffected by the political instability, as China-Pakistan Economic Corridor (CPEC) continues to drive credit demand, while banks push for consumer and SME lending to mitigate spread pressure Spread pressure should ease gradually as the majority of the asset book reflects the current low interest rate environment Recovering loan growth and maturity of government securities would put pressure on capital ratios; we expect banks to raise capital ratios through non-dilutive capital issues MCB: Merger with NIB should drive strong revenue and cost synergies, while NIB's NPL book provides significant potential for recoveries, amongst the most well-capitalised bank in the country Source: EFG Hermes estimates 18

20 Financials Sector Figure 4: Financials Key themes for 218 per country (to be continued) Country Key themes Top picks/top Sell ideas Africa Egypt Net interest margins peaked in 217: we expect margin compression in 218 of c3bps. Decline in rates will be gradual, and full normalisation of margins will take place over a period of at least three years Delay in the recovery of capex loans to 219; we expect 218 loan growth to be driven by short-term/working capital loans Credit quality has been very resilient, so far, but we expect banks will continue to add conservative provisions, as long as we remain in a high interest rate environment. Cost of risk should normalise starting 219 CIB: High ROE (c3, and declining only moderately to c27). A key play on loan growth recovery in Egypt. We also like: CAE (highest ROE in the sector, at c34% in 218e) Baraka offers room for re-rating, with the bank trading at a P/E of just 3x, c2 discount to BV and ROE of c24% Morocco Credit growth momentum improving on higher investment loans and the end of the deleveraging of real estate developers. The recovery is unlikely to bring loan growth rates beyond the 4-6% range Risks for net interest margins on the downside as recovery in lending demand will drive some tightening in liquidity, and as competitive pricing pressures continue, particularly in the corporate segment NPL ratios in the domestic market have peaked: we expect only a slight decline in provisioning costs in 218, as Central Africa poses a downside risk to credit quality ATW: Leading franchise in retail and corporate segments. Abovesector average ROE. Recent acquisition of Barclays Egypt is accretive to returns and EPS Nigeria Asset quality deterioration. Although international investors now have access to FX, not all domestic corporations and households have access Return of loan growth. In 218e, we forecast loan growth of 7.2% Y-o-Y (vs. -.3% Y-o-Y in 217e). The bulk of this growth will be driven by the re-pricing of FX loan from the official to the NAFEX rate Macro challenges. Oil revenues contribute more than 65% of total govt. revenue. Non-oil revenue collection of less than 3% of GDP. Nigeria is over-reliant on oil revenues because the informal sector contributes 65% to GDP, the highest in SSA. Moreover, despite its low debt-to-gdp (16.8% as at 216), Nigeria has a very high debt service ratio (66% in 216) due to low non-oil revenue generation. This makes the raising of external debt very challenging, which will limit the ramp-up in infrastructure development projects Wide valuation gaps. Tier-1 bank valuations range from.4x (FBNH) to 2.5x forward BV (Stanbic IBTC). With the risks of a systemic default in these banks behind us, we see value in the discounted banks Zenith Bank: Dominant market share should enable it to continue earning strong margins (we estimate an average of 6.1% over the next five years). The bank is in an ideal position to benefit from any potential turnaround in topline growth due to a reduction in its operational leverage, after the implementation of successful cost rationalisation strategies implemented over a three-year period Tanzania Radical policy shift. The current administration has presided over a structural clean-up, driven by: i) aggressive anti-corruption drive; ii) stricter tax collection; iii) clean-up of public sector institutions through the termination of civil service workers with inadequate qualifications, termination of senior ministerial/local govt. officials for incompetency or corruption, and, finally, detailed internal audits Policy shift has resulted in a deterioration in asset quality. Encouragingly, we see 217 as the peak in the deterioration of bank asset quality Strong potential structural growth. Banking penetration ranks the lowest in our frontier universe. With a 216 total assets/gdp ratio of 29%, asset penetration in Tanzania is the third lowest in our frontier universe and is only 2pps higher than the most underpenetrated banking system (Uganda, 27%). According to IMF, Tanzania s real GDP growth rates (between 216 and 221 at 7%) are amongst the highest in our frontier universe, reflecting the country s growth trajectory from a low base CRDB: We project a strong recovery in earnings (33% p.a., e) from the normalisation of impairments (cost of risk of 1.3% by 221e vs. 3.5% in 217e), an improvement in operating performance (cost-toincome ratio to improve to 62% by 221e from 65% in 217e) and an attractive valuation (217e P/B of.6x vs. target price multiple of 1.3x) Source: EFG Hermes estimates 19

21 Financials Sector Figure 5: Net interest margins 218e Figure 6: Earnings growth 218e Qatar Saudi Arabia Kuwait UAE Oman Lebanon Pakistan Vietnam Egypt Nigeria Tanzania Kenya Morocco Qatar Saudi Arabia Kuwait UAE Oman Lebanon Pakistan Vietnam Egypt Nigeria Tanzania Kenya Morocco Source: Company data, EFG Hermes estimates Source: Company data, EFG Hermes estimates Figure 7: Return on average assets 218e Figure 8: Return on average equity 218e 3.5% % % 1..5% Qatar Saudi Arabia Kuwait UAE Oman Lebanon Pakistan Vietnam Egypt Nigeria Tanzania Kenya Morocco. Qatar Saudi Arabia Kuwait UAE Oman Lebanon Pakistan Vietnam Egypt Nigeria Tanzania Kenya Morocco Source: Company data, EFG Hermes estimates Source: Company data, EFG Hermes estimates 2

22 Consumer Sector Consumer Sector Saudi Arabia: Cautious on outlook, with VAT, expat levy and subsidy reforms looming Structural demand growth remained weak in 217 as consumers faced a new reality of subsidy reforms and limited wage growth. The reversal of public sector pay cuts (announced in April and implemented in September) created some positive sentiment for consumption in 2Q17, but did not have a substantial impact on spending trends. We are cautious on the 218e outlook, with more headwinds anticipated, including: i) Imposition of 5% VAT across the GCC starting 1 Jan (c85% of the consumer basket will be exposed to it) ii) Continued implementation of the expat levy first-time imposition of levy on dependents (csar1 a month in July 218, rising to csar4 in 22e) has reportedly been driving a decline in the expat population, which will likely affect food names more than retailers (where the bulk of clientele are nationals). Most corporates did not bear the expat levy on dependents, but will incur extra costs as additional and new levies are introduced for expat employees in 218e iii) More subsidy reforms, with some looming further hikes to fuel pump prices and market consolidation being the theme to watch Market consolidation could be a key driving force, however, as evidenced in the electronics retail sector (our top pick for 217, with extra and Jarir delivering strong earnings growth and share price performance on the back of this), which benefitted from the closure of c3k mobile retailers that could not meet 1 of the Saudisation requirement imposed in end-216. We expect a similar theme to play out for car rental franchise Budget Saudi, as car rental offices will be required to employ only locals in 2Q18e. Other sectors to watch out for a potential consolidation theme are grocery retail and fuel retail. M&A activity also picked up for food names in end-217, with two pending transactions (a first for both companies): i) National Agriculture Development Company (Nadec) and Al Safi Danone (ASD) are looking to merge (estimated valuation of SAR bn), which could nearly double the former s market share ii) SADAFCO is completing due diligence to acquire a controlling stake in Polish company Mlekoma (specialised in milk-powder production), in an effort for vertical integration Top picks: Budget Saudi, Al Othaim and SADAFCO; in other GCC countries, we highlight Humansoft - Budget Saudi should benefit from the abovementioned market consolidation in its short-term rentals segment and, to a lesser extent, from women being granted the right to drive (good for used-car sales). Moreover, free cash flow generation has been strong, with the possibility of a dividend surprise - The second largest Saudi Arabian grocery retailer, Al Othaim, has continued to deliver positive like-for-like (LFL) sales, while expanding its network, with signs of operating cost pressures subsiding in Leading long-life milk producer SADAFCO should benefit from an improving SMP (Skimmed Milk Powder) cost outlook and is the least exposed KSA food producer to subsidy reform risk, with valuation remaining amongst the lowest relative to global dairy peers In non-ksa GCC, our top pick is Kuwait s Humansoft, the leading private university operator in a severely undersupplied market with a best-in-class profitability profile 21

23 Consumer Sector Figure 1: Only electronics retailers extra and Jarir (market consolidation) and grocery retailer Al Othaim (continued positive LFLs) delivered Y-o-Y revenue growth Y-o-Y revenue growth for Saudi companies under coverage 216 9M % 1 3% -3% -3% -3% 2% -2% -1% -5% -2 7% -2% 19% 14% 13% -6% -4% -1% -7% -7% -4% -2% 1% -8% -13% -38% Aldrees Almarai Budget Saudi extra Catering Farm Halwani Herfy Al Hokair* Jarir Nadec Al Othaim SADAFCO* Savola Shaker *showing calendar year figures for SADAFCO and Al Othaim as fiscal year ends in March Source: Company data Figure 2: Same names staged strongest earnings growth trends, as well as Almarai and Al Hokair on better margins Y-o-Y recurring earnings growth % 216 9M % 1-4% -8%-7% -32% N/M 17% -5% 3% -8% -34% -38% 38% 41% 9% 21% 18% 4 3% 13% 7% 17% N/M -6% -6% -8% -44% -65% Aldrees Almarai Budget Saudi extra Catering Farm Superstores Halwani Herfy Al Hokair* Jarir Nadec Al Othaim SADAFCO* Savola Shaker *showing calendar year figures for SADAFCO and Al Othaim as fiscal year ends in March Source: Company data 22

24 Consumer Sector Egypt consumption on the mend; margins to normalise We prefer Egyptian food names heading into 218e, as they are set to show earnings recovery after overcoming hurdles brought on by the EGP floatation in Nov 216. Sticky pricing and volume recovery (some signs evident in 3Q17) should drive accelerated net profit growth, particularly as prices were set with restoring 215 gross margin levels in mind. Falling interest rates, wage increases in 1Q18 and possible EGP strengthening should support a re-rating for most Egypt consumer stocks, especially food producers. Our top picks for Egypt are: - Monopoly cigarette producer Eastern Co., as we expect earnings growth momentum to remain strong on several rounds of price increases (the latest of which was post another tax change in Nov 217), which should support continued narrowing of large valuation discount to global peers. A key catalyst for 218 includes FTSE and MSCI EM inclusions (flows of cusd8-9mn in 1H18 as a result) - Leading dairy and juice player Juhayna is set for strong earnings recovery momentum as volumes normalise and promotions ease, especially with the bulk of list price increases out of the way. We see similar earnings recovery stories for other listed food producers - In contrast, carpet and rug exporter Oriental Weavers (our top pick for 217) should show more normalised growth in 218 as the EGP floatation benefits wear out. Leading automotive company, GB Auto, will likely face a lengthier recovery, given the effect of price hikes and relatively high ticket price vs. other staple producers and a stretched balance sheet (high leverage and working capital needs) Figure 3: Strong price-driven revenue growth in 217e as companies looked to offset devaluation related cost pressures Figure 4: Robust recurring earnings growth for exporter OW and cigarette producer EC, while food producers stumbled % 32% Domty 54% 52% Eastern Co.* 216 9M17 12% 24% 25% 9% 23% 18% 15% 65% Edita GB Auto Juhayna OW % -77% Domty 128% 163% Eastern Co.* 216 9M17-1% -37% 37% N/M -22% 1 44% 31% Edita GB Auto Juhayna OW *showing calendar year figures as fiscal year ends in June Source: Company data *showing calendar year figures as fiscal year ends in June Source: Company data 23