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 Animesh Tulsyan Analyst +965 2224 8000 Ext: 4607 atulsyan@markaz.com 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 Q4 13 Update Subsequent to our note published in April 2013 we now publish an updated calculation for various equity risk premiums. Key findings include: The equity risk premium based on ratings has decreased across all markets. The primary reason for a decrease in ERP based on ratings is the reduction in ERP for United States. Bahrain saw a ratings downgrade in Q413. The ERP based on CDS spreads have also decreased across all GCC countries primarily due to reduction in ERP for United States. 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. There was not a significant difference in adjusted CDS for GCC countries in Q413 when compared with Q113. However for Bahrain adjusted CDS increased by 0.4% and for Oman adjusted CDS decreased by 0.2%. The ERP for Bahrain decreased from 7.5% in Mar-13 to 7.1% in Dec-13 while for Oman it has decreased from 7.0% to 5.9%. The implied ERP based on stock indices have decreased for all countries except for Kuwait where it increased marginally. Despite an increase in the levels of index, implied ERP for most countries has declined due to a higher estimate of risk free rate which reduces the excess returns derived from equity investments. For KSA, there is a reduction from 5.70% to 3.92% primarily due to a reduced estimate of corporate earnings growth rate and a higher estimate for risk free rate. ERP for Kuwait has increased from 6.15% to 6.34% while ERP for Abu Dhabi has decreased from 9.50% to 8.35%. Equity Risk Premium for GCC Countries ERP based on Country Implied ERP Rating ERP based on CDS Spread Mar-13 Dec-13 Mar-13 Dec-13 Mar-13 Dec-13 Bahrain 8.56% 8.52% 7.3% 6.7% 7.5% 7.1% Kuwait 6.15% 6.34% 6.3% 5.5% N.A. N.A. Oman 9.83% 9.29% 6.7% 5.8% 7.0% 5.9% Qatar 7.89% 6.80% 6.3% 5.5% 6.2% 5.3% KSA 5.70% 3.92% 6.5% 5.7% 6.2% 5.3% Abu Dhabi 9.50% 8.35% 6.3% 5.5% 6.2% 5.3% Dubai 7.49% 6.52% N.A. N.A. 7.8% 6.9% Source: Markaz Research
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 4.96% 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 4.96% Baa2 1.75% 6.7% Kuwait 4.96% Aa2 0.50% 5.5% Oman 4.96% A1 0.85% 5.8% Qatar 4.96% Aa2 0.50% 5.5% KSA 4.96% Aa3 0.70% 5.7% UAE 4.96% Aa2 0.50% 5.5% Abu Dhabi 4.96% Aa2 0.50% 5.5% 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. Country Risk Premium 5Yr CDS Adjusted CDS Total Equity Risk Premium Bahrain 4.96% 2.4% 2.1% 7.1% Oman 4.96% 1.2% 1.0% 5.9% Qatar 4.96% 0.6% 0.4% 5.3% KSA 4.96% 0.6% 0.3% 5.3% Abu Dhabi 4.96% 0.6% 0.3% 5.3% Dubai 4.96% 2.2% 2.0% 6.9% United States 0.2% Source: 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. 1 Aswath Damodaran-1 st Kuwait Financial Centre Markaz 2
MARKAZ RESEARCH The inputs required for calculation of Implied ERP were not readily available for GCC countries. 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 growth estimate makes it hard to determine the market s view on growth for the next 5 years. Implied Risk Premium for GCC Countries Country Index Level * Implied Equity Risk Premium KSA 8535.60 3.92% Kuwait 7549.52 6.34% Qatar 10379.59 6.80% Abu Dhabi 4290.30 8.35% Dubai 3369.81 6.52% Oman 6834.56 9.29% Bahrain 1248.86 8.52% Source: Thomson Reuters Eikon, Zawya, Markaz Research * As of 31-December-2013 Kuwait Financial Centre Markaz 3
Appendix 1: Historical Risk Premiums - Premium vs Bonds (% p.a.) MARKAZ RESEARCH Country 1963 2012 1900 2012 Australia 3.0 5.6 Belgium 1.3 2.3 Canada 1.0 3.4 Denmark 0.6 1.8 Finland 3.8 5.3 France -1.4 3.0 Germany N.A. 5.2 Ireland 2.7 2.6 Italy -2.4 3.4 Japan -1.0 4.8 Netherlands 3.0 3.3 New Zealand 2.2 3.7 Norway 2.8 2.2 South Africa 6.6 5.4 Spain 2.4 2.1 Sweden 4.8 2.9 Switzerland 1.7 2.0 U.K. 3.1 3.7 U.S. 2.3 4.2 World-ex U.S. 0.4 3.0 World 0.9 3.2 Europe 1.0 3.4 Source: Credit Suisse Global Investment Returns Yearbook 2013 Kuwait Financial Centre Markaz 4
Appendix 2: Market Risk Premium used for 51 countries Survey Results Country Average Median MARKAZ RESEARCH Number of answers USA 5.7 5.5 2,394 Spain 6.0 5.5 804 Germany 5.5 5.0 343 United Kingdom 5.5 5.0 247 Italy 5.7 5.5 205 France 6.1 6.0 134 Switzerland 5.6 5.5 113 Brazil 6.5 6.0 112 Canada 5.4 5.3 110 China 7.7 7.0 95 Portugal 6.1 5.9 52 Norway 6.0 6.0 51 Greece 7.3 6.0 50 Sweden 6.0 5.9 50 Belgium 6.1 6.0 48 Austria 6.0 5.8 47 Japan 6.6 6.4 28 Mexico 6.7 6.3 24 Argentina 10.6 6.8 20 Russia 7.3 7.0 18 Australia 6.8 5.8 17 Chile 5.0 5.5 17 Malaysia 7.6 7.5 13 India 8.5 8.8 12 Poland 6.3 6.5 12 Colombia 8.4 8.8 11 Korea(South) 7.0 6.9 11 Lituania 8.0 8.0 11 Hong Kong 7.4 6.5 9 Indonesia 7.8 8.0 9 Netherlands 6.0 5.8 9 Peru 6.5 6.8 9 Singapore 5.0 5.8 9 Czech Republic 6.5 7.0 8 New Zealand 5.4 5.8 8 Finland 6.8 6.0 7 Ireland 6.2 7.0 7 Taiwan 6.7 6.9 7 Bulgaria 8.0 8.4 6 Denmark 6.4 5.9 6 Hungary 8.2 8.7 6 Israel 6.4 7.0 6 South Africa 6.8 7.0 6 Bolivia 10.6 11.0 5 Egypt 9.2 9.0 5 Pakistan 16.0 16.3 5 Romania 8.1 8.8 5 Slovenia 7.4 8.4 5 Thailand 7.6 8.1 5 Turkey 8.2 9.4 5 Venezuela 11.2 11.8 5 Source: Pablo Fernandez - Market Risk Premium used in 51 countries in 2013: a survey with 6,237 answers Kuwait Financial Centre Markaz 5
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