Kuwait Financial Centre Markaz R E S E A R C H Markaz Research is available on Bloomberg - Type MRKZ <Go> Thomson Research, Reuters Knowledge Nooz Zawya Investor ISI Emerging markets Capital IQ FactSet Research Connect TheMarkets.com M.R. Raghu CFA, FRM Head of Research +965 2224 8280 rmandagolathur@markaz.com N. C. Karthik Ramesh Manager - Research +965 224 8000 Ext : 4611 kramesh@markaz.com Nivas Lakshminarasimhan Analyst +965 2224 8000 Ext: 4606 nlakshminarasimhan@markaz.c om Kuwait Financial Centre K.P.S.C Markaz P.O. Box 23444, Safat 13095, Kuwait Tel: +965 2224 8000 Fax: +965 2242 5828 markaz.com GCC Sovereign Equity Risk Premium Q3 2014 Update Subsequent to our note published on July 2014, we now publish an updated calculation for various equity risk premiums. Key findings include: The equity risk premium based on ratings has increased marginally across all markets by 5bps as the underlying US ERP moved up by the same amount (5.43% as on Oct 1, 2014). The Moody s default spreads remained static in the third quarter. Moody s negative outlook on Bahrain continues unchanged, despite statements made by the Bahraini government to reduce its fiscal deficit and contain the rise in debt. Limited scope for additional revenue generation, pressures to increase public spending, and slow pace of subsidy reforms contributed to the status quo. Moody s issued a statement that Oman s recent Royal Decree, which requires national insurers to be listed on the Muscat Securities Market (MSM), is positive for companies, because it will improve their access to funds, strengthen their capital, make them more transparent, and enhance the overall financial strength of the Omani insurance market. The ERP based on CDS spreads have also increased across all GCC countries, primarily due to increase in ERP for United States. While the Bahrain ERP increased by close to 6bps, Oman s ERP rose by over 13bps. The CDS spreads are used to measure the default risk. Higher CDS spread indicate that there is greater default risk of the contract. Adjusted CDS is the difference in CDS spread for a particular country and the CDS spread for United States. Adjusted CDS for GCC countries did not vary much in Q3 2014, when compared with Q2 2014. For the markets under consideration, the increase in adjusted CDS varied from 8bps (Oman) to less than 1bps (Bahrain and Saudi Arabia). For Oman, adjusted CDS increased by 0.08 per cent, which led to the rise in ERP from 6.3 per cent in Jun-14 to 6.4 per cent in Sep-14. The implied ERP based on stock indices have increased for Oman, and decreased for the rest, barring Saudi Arabia and Bahrain, which stayed level. Abu Dhabi s implied ERP decreased by 33bps, as the 12 per cent rise in index levels was countered by the 10bps increase in long term bond rate. Fall in long term bond rate and rise in index levels, led to 8bps increase of implied ERP for Oman. Implied ERP of Kuwait dropped 13bps, despite a 9 per cent increase in index levels, as long term bond rate rose 12bps during the third quarter. Despite 20 and 28 per cent increase in index levels, implied ERP for Qatar and Dubai declined in the third quarter, due to increases in long term bond rate.
Equity Risk Premium for GCC Countries ERP based on Country Implied ERP Rating MARKAZ RESEARCH ERP based on CDS Spread Jun-14 Sep-14 Jun-14 Sep-14 Jun-14 Sep-14 Bahrain 6.7% 6.7% 7.3% 7.3% 6.8% 6.9% Kuwait 6.0% 5.8% 5.9% 5.9% N.A. N.A. Oman 9.8% 9.9% 6.1% 6.1% 6.3% 6.4% Qatar 7.9% 7.6% 5.9% 5.9% 5.7% 5.8% KSA 5.0% 5.0% 6.0% 6.0% 5.7% 5.8% Abu Dhabi 9.6% 9.3% 5.9% 5.9% 5.7% 5.8% Dubai 7.2% 7.0% N.A. N.A. 6.8% 6.9% Source: Markaz Research Kuwait Financial Centre Markaz 2
MARKAZ RESEARCH Equity Risk Premium - Findings Estimating ERP using Default Spreads The ERP of GCC countries are arrived at by adding the default spread based on their credit rating. Method 1 - Sovereign Rating: Taking the latest US market equity risk premium of 5.43% 1, the ERP of GCC countries are arrived at by adding the default spread based on their credit rating. ERP for GCC Countries based on Credit Rating Country US Eq. Risk Premium Rating Default Spread Total Equity Risk Premium Bahrain 5.43% Baa2 1.90% 7.3% Kuwait 5.43% Aa2 0.50% 5.9% Oman 5.43% A1 0.70% 6.1% Qatar 5.43% Aa2 0.50% 5.9% KSA 5.43% Aa3 0.60% 6.0% UAE 5.43% Aa2 0.50% 5.9% Abu Dhabi 5.43% Aa2 0.50% 5.9% Source: Moody s, Aswath Damodaran, Markaz Research Method 2 Estimating ERP using CDS spreads: In this method, the CDS spread of a country s bond (adjusted for spread of risk free country) is considered as default spread instead of looking at the yield differentials of similarly rated bonds. Implied equity risk premium is an alternative approach to estimating risk premiums. ERP for GCC Countries based on CDS Spread US Eq. Risk 5Yr Adjusted Total Equity Risk Country Premium CDS CDS Premium Bahrain 5.43% 1.6% 1.4% 6.9% Oman 5.43% 1.2% 1.0% 6.4% Qatar 5.43% 0.5% 0.4% 5.8% KSA 5.43% 0.5% 0.3% 5.8% Abu Dhabi 5.43% 0.5% 0.3% 5.8% Dubai 5.43% 1.6% 1.4% 6.9% United States 0.2% Source: Aswath Damodaran, Thomson Reuters Eikon, Markaz Research Method 3: Implied Equity Risk Premium Implied equity risk premium is an alternative approach to estimating risk premiums. Assuming that stocks are correctly priced in, if we can estimate the expected cash flows from buying stocks, then we can estimate the expected rate of return on stocks by computing an internal rate of return (IRR). Subtracting out the risk free rate from IRR should yield an implied equity risk premium. The inputs required for calculation of Implied ERP were not readily available for GCC countries. Absence of sovereign bonds for some countries made the estimation of risk free rate and perpetual growth rate difficult. Also, the lack of consensus earnings 1 Aswath Damodaran-1 st Kuwait Financial Centre Markaz 3
MARKAZ RESEARCH growth estimate makes it hard to determine the market s view on growth for the next 5 years. The inputs required for calculation of Implied ERP were not readily available for GCC countries. Implied Risk Premium for GCC Countries Country Index Level * Implied Equity Risk Premium KSA 10,855 4.96% Kuwait 7,622 5.85% Qatar 13,728 7.64% Abu Dhabi 5,106 9.28% Dubai 5,043 7.05% Oman 7,484 9.86% Bahrain 1,476 6.66% Source: Thomson Reuters Eikon, Zawya, Markaz Research * As of 30-September-2014 Kuwait Financial Centre Markaz 4
Appendix 1: Historical Risk Premiums - Premium vs Bonds (% p.a.) MARKAZ RESEARCH Country 1964 2013 1900 2013 Australia 3.3 5.7 Belgium 1.2 2.4 Canada 1.2 3.5 Denmark 1.4 2.1 Finland 4.0 5.3 France -0.4 3.2 Germany 0.7 5.3 Ireland 2.3 2.6 Italy -1.9 3.4 Japan 0.0 5.1 Netherlands 3.1 3.4 New Zealand 2.4 3.9 Norway 3.2 2.4 South Africa 6.5 5.4 Spain 2.7 2.2 Sweden 4.9 3.1 Switzerland 2.1 2.1 U.K. 3.3 3.9 U.S. 2.7 4.5 World-ex U.S. 0.8 2.9 World 1.2 3.3 Europe 1.3 3.3 Source: Credit Suisse Global Investment Returns Yearbook 2014 Kuwait Financial Centre Markaz 5
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