More uncertainty, more defensiveness

Transcription

1 GCC Strategy March 16th, 2011 Investment summary Uncertainty calls for defensiveness Last week, in the context of the geo-political uncertainty clouding the Middle East, we made the case for a defensive positioning of investment portfolios please refer to our strategy note entitled Investing during uncertain times. Updating our macro scenario Since then, two major developments took place: 1/ A Japanese natural disaster of gigantic proportion with major global, human and economic implications; 2/ Further political escalation and tensions in the Middle East, as pro-gaddafi forces gained momentum again in Libya and GCC forces entered Bahrain to support the ruling family. Japanese implications unclear In this note, we attempt to understand the macro implications of the Japanese disaster. As events are still unfolding, it is difficult to quantify the macroeconomic impact. However, it seems clear that the short term impact on the GCC and most of Japan s other trading partners will be negative, as production is constrained and essential infrastructure damaged. Short term negative, long term oil positive? Consequently, we expect demand for oil from the GCC to decline in the short term. However, over the medium term, GCC LNG and oil exporters are likely to benefit from the probable increase in demand for hydrocarbons from Japan as reconstruction gets underway. Ten stocks for more defensiveness From the perspective of regional investment, we reiterate our defensive stance in the context of increased uncertainty and volatility. In addition to the 14 yield picks we identified and published last week, we propose a list of ten best picks to play the defensive theme, within the fundamental coverage universe of Shuaa. Amer Halawi ahalawi@shuaacapital.com Khatija Haque khaque@shuaacapital.com

2 Contents PART 1: MACRO ASSESSMENT...3 JAPAN QUICK FACTS... 3 JAPAN S TRADE TIES WITH THE GCC... 3 SO WHAT IS THE IMPACT?... 4 RECENT EVENTS IN BAHRAIN BRING FURTHER UNCERTAINTY... 4 PART 2: STRATEGY IMPLICATIONS...5 FURTHER UNCERTAINTY FUELS DEFENSIVENESS... 5 NEGLIGIBLE IMPACT OF JAPAN ON OUR GCC COVERAGE UNIVERSE... 5 A FUNDAMENTAL PORTFOLIO FOR FURTHER DEFENSIVENESS... 6 March 16th,

3 Part 1: Macro assessment Japan quick facts At this early stage, it is difficult to assess the full economic impact of the events in Japan: Many factories and firms (including Toyota, Sony, Honda, and Canon) have shut down production for at least a few days. At least 5 refineries accounting for a combined oil processing capacity of 1.2mn b/d shut down when the earthquake hit and at least 2 are damaged. Ports infrastructure has been damaged and vessels carrying oil will likely have to be diverted. At least 10 nuclear reactors are reportedly offline, and may remain so for some time. In the short term, the decline in output is likely to result in a drop in demand for oil. This is what the market is pricing, with current Brent spot price at $112/b, off the recent high of nearly $118/b. However, as the recovery and reconstruction get underway, demand for hydrocarbons (both oil and natural gas) is likely to recover strongly especially as it may take several months or even years before the nuclear reactors are on-line again. Japan s trade ties with the GCC Japan is the world s third largest importer of oil, bringing in an average 3.7mn b/d in 2010 (Reuters). Almost 90% of such imports are from the Middle East, with the top two suppliers being Saudi Arabia and the UAE. Together, Saudi Arabia and the UAE account for half of Japan s total oil imports. Biggest oil providers to Japan in January 2011 Country mn barrels 1 Saudi Arabia UAE Qatar Iran Russia Kuwait 7.17 source: Steel Guru, March 9, 2011 Japan also imported 6.32mn metric tons of LNG in 2010 (Reuters). The country s exports to the GCC are essentially vehicles, steel and machinery. All GCC countries except Bahrain run trade surpluses with Japan. March 16th,

4 So what is the impact? The following table shows the extent to which the GCC countries trade with Japan. The figures reflect total trade, meaning the aggregation of both imports and exports. Japan as a percentage of total trade Percent Description Qatar 24.5 About 33% of Qatar's LNG exports and over half of crude oil exports go to Japan Kuwait 14.4 Japan is Kuwait's biggest oil buyer, taking 20% of total crude exports Oman 13.2 Japan imports 16% of Oman's total oil exports Saudi Arabia 12.3 More than 33% of Saudi oil exports go to Japan UAE % of UAE oil exports go to Japan Bahrain 4.5 Bahrain exports crude oil, petroleum and aluminum products Source: Haver Analytics, Embassies of Japan in Qatar & Bahrain, EIA, Deloitte,GulfBase.com, SHUAA Capital Although Saudi Arabia and the UAE are key oil suppliers to Japan, their exposure as a proportion of their total trade is manageable. Qatar and the smaller oil exporters (Kuwait and Oman) are more at risk because a higher proportion of their total trade is with Japan. It is very difficult to quantify the impact on export and budget revenues of the GCC oil exporters. The change in demand for oil will depend to a large extent on how quickly Japan can resume production, and how long the nuclear power generators will be shut down. The uncertainty is compounded by the volatility of oil prices, which are responding to current events in Japan, and to political uncertainty in the Middle East. Consequently, we are dealing with two unknowns: volume and price changes. In the short term, we expect a negative impact from lower oil export volumes to Japan. However, the impact on the balance of payments should be moderated by 1) higher than forecast oil and gas prices and 2) lower GCC imports on the back of production and supply disruptions following the earthquake. Over the medium term however, the GCC oil exporters stand to benefit from both higher export volumes as well as potentially higher oil prices. Oil prices are likely to reflect increased demand from Japan to offset the decline in nuclear power and/or continued political risk in the Middle East. Recent events in Bahrain bring further uncertainty The recent escalation in violence and the deployment of Saudi and UAE armed forces in Bahrain, at the request of the king, has added to regional uncertainty and risk aversion. The possibility of interference from Iran has not helped the situation. However, our core scenario remains that the GCC regimes will remain in place. Indeed, the GCC military support in Bahrain reinforces our view that the authorities in the region will resist all attempts at regime change. Nevertheless, the recent events suggest that the human cost could be high, and that the uncertainty could be prolonged. March 16th,

5 Part 2: Strategy implications Further uncertainty fuels defensiveness We have been recommending defensive regional investment positioning for two reasons: geopolitical uncertainty in the Middle East clouding company fundamentals, and the ensuing un-manageable volatility brought about by such uncertainty. Today, the political developments in the GCC (mainly military escalation in the streets of Bahrain), and the Japanese disaster bring additional uncertainty. At this stage, we maintain our core scenario of no regime change with a 50% probability. However, the events of the past week increase the probability of a longer period of unrest. To further uncertainty, we reply with further defensiveness in asset allocation. Negligible impact of Japan on our GCC coverage universe We have looked individually at the stocks we cover and this has resulted in a single conclusion: The direct impact from the Japanese situation seems immaterial or inexistent. Three exceptions merit additional comments: DP World, National Shipping and the petrochemical sector. DP World: No material impact Contributed by Kareem Murad DPW.DI, BUY, FV USD DP World has no operations in Japan, but may witness volume disruptions in their terminals in China (5 terminals only one of which is consolidated) and the UAE (Jebel Ali). Japan is a key trading partner for both the UAE (c. 11% of total trade) and China (c. 10% of total trade). However, these figures reflect total cargo including oil exports, and other non-container volumes. Globally, the container market segment is almost 15% of total port operations. At this point we are uncertain of the total container trade these terminals have with Japan, or the extent to which Japan s major ports were damaged. However, we believe that DP World container volume disruptions will be immaterial. In light of our view that volume disruption will be negligible, we have made no changes to our DP World estimates. We should shortly revise our estimates, however, to reflect company specific developments outside the scope of Japan. National Shipping: Positive impact expected, but unclear Contributed by Kareem Murad NSCSA 4030.SE, BUY, FV SAR NSCSA has a fleet of 17 Very Large Crude Carriers (VLCC); currently 11 of those are operating on the spot market and are exposed to the volatility of charter rates. In light of our view that GCC oil exporters could benefit from higher export volumes over the medium term, we believe that such higher volumes might translate into higher spot chartering rates, in turn positively reflecting on NSCSA s top line and profitability. We have made no change to our estimates at this point given the volatility of rates. A surge in spot chartering rates could potentially represent a good entry point into NSCSA for a rate volatility play. March 16th,

6 Petrochemicals: Two forces at play? Contributed by Jessica Estefane In the short term, we expect regional petrochemical players to benefit from the situation in Japan considering Japan is the world s fourth largest ethylene producer. We believe that production disruptions are likely to be offset by other petrochemical producers, including the US, Saudi Arabia and China. The key issue is one of spare capacity and utilization rates. In our view, Saudi Arabia is well placed to ramp up production of petrochemicals and benefit from supply disruptions in Japan. In addition, supply tightness is also likely to drive petrochemical prices upwards, profiting regional petrochemical players who enjoy a fixed cost base. However, demand from China for petrochemicals could decline in the near term, as Chinese exports to Japan, which use petrochemicals as feedstock, could be negatively affected. A fundamental portfolio for further defensiveness As we argued last week, asset allocation choices in the region are limited to cash or equities, and proper regional allocation models are difficult to implement. In this context, we proposed an overweight yield strategy which translated in selecting 14 stocks yielding an aggregate 7.5% and bearing an aggregate beta of 0.83, to shield from the current volatility. In addition, we believe that a complementary strategy should consist in over-allocating the stocks of fundamentally sound companies, for the longer-term. The premise is that the GCC is currently trading at low valuations relative to global peers, with superior growth prospects. We have filtered the buy recommendations of our analysts, and retained those which offer the strongest potential in the most defensive sectors. The result is the Shuaa Defensive Top 10, presented next. It deserves some additional comments. March 16th,

7 Shuaa Defensive Top 10 Company name Analyst Sector Country Listing RIC Last Close Target Price Upside 2011 Div Yield 2011 EPS Growth Beta 2011 P/E Market Cap Local cur, m Market Cap USD, m ADCB Sofia El Boury/Ghida Obeid Banks UAE Abu Dhabi ADCB.AD % 0.0% 203.0% ,544 3,143 Air Arabia Kareem Murad Transportation UAE Dubai AIRA.DU % 10.2% 3.5% , CBQ Sofia El Boury/Ghida Obeid Banks Qatar Doha COMB.QA % 10.4% 28.5% ,583 5,103 Dana Gas Jessica Estefane Utilities UAE Abu Dhabi DANA.AD % 0.0% 106.0% ,026 1,096 Du Simon Simonian/Rawan Oueidat Telecom UAE Dubai DU.DU % n/a 23.6%* ,577 3,697 Etisalat Simon Simonian/Rawan Oueidat Telecom UAE Abu Dhabi ETEL.AD n/a n/a 5.5% -1.0% ,572 23,570 FGB Sofia El Boury/Ghida Obeid Banks UAE Abu Dhabi FGB.AD % 3.5% 15.7% ,375 6,636 Mobily Simon Simonian/Rawan Oueidat Telecom KSA Riyadh 7020.SE % 6.5% 10.0% ,550 8,680 NBAD Sofia El Boury/Ghida Obeid Banks UAE Abu Dhabi NBAD.AD % 2.5% 8.2% ,385 7,456 UNB Sofia El Boury/Ghida Obeid Banks UAE Abu Dhabi UNB.AD % 3.0% 5.7% ,373 2,008 Average 49% 4.6% 42.2% ,965 6,239 Source: SHUAA Capital * The EPS growth for Du in 2011 is before government royalty March 16th,

8 Geographic concentration in the safest regional harbor Eighty percent of the selected names are listed in the UAE, while sixty percent are specifically listed in Abu Dhabi. This is not fortuitous, and has essentially two justifications. Doha 8% Geographic mix of the SHUAA defensive portfolio Weighted by market capitalisation Riyadh 14% Dubai 8% Doha 10% Equally weighted Riyadh 10% Dubai 20% Source: SHUAA Capital Abu Dhabi 70% Abu Dhabi 60% Firstly, we are looking for safe havens. Those are geographically likely to be found in the UAE at the present time. As we have already argued, the UAE is one of the countries with the least relative, regional geopolitical risk. In fact, Abu Dhabi looks globally like a relatively safe place to be. The popular belief has historically been that when the rest of the region suffers, the UAE benefits. Secondly, the UAE has been one of the least expensive markets in the region, if not globally single digit valuations for double digit growth, as we have repeatedly argued. This continues to be the case, as demonstrated by the numbers in our Defensive Top 10. Full weight on telecoms By sector, the concentration is also quite apparent, with the telecom sector representing 58% of our picks on a weighted basis. Sector mix of the SHUAA defensive portfolio Weighted by market capitalisation Utilities Transportation 2% 2% Equally weighted Transportation 10% Banks 39% Utilities 10% Telecom 30% Telecom 57% Banks 50% Source: SHUAA Capital The high representation of banks is a function of their relative over-weight in the GCC equity space. However, we highlight that they make up less than 40% of our portfolio on a market cap weighted basis. In addition, they are exclusively Abu Dhabi and Qatar based, with a largely domestic business in two of the wealthiest regional states. Finally, we estimate that the risk related to hot exposure of deposits on the balance sheets of these banks from difficult countries does exist (Egypt, Libya, Tunisia, etc.), but is minimal. March 16th,

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10 This page was intentionally left blank This document has been issued by SHUAA Capital for informational purposes only. This document is not and should not be construed as an offer or the solicitation of an offer to purchase or subscribe or sell any investment or subscribe to any investment management or advisory service. This document is not intended as investment advice as to the value of any securities or as to the advisability of investing in, purchasing, or selling any security. SHUAA Capital has based this document on information obtained from sources it believes to be reliable. It makes no guarantee, representation or warranty as to its accuracy or completeness and accepts no responsibility or liability in respect thereof or for any reliance placed by any person on such information. All opinions expressed herein are subject to change without notice. This document may not be reproduced or circulated without the prior written consent of SHUAA Capital.