Mena frontier markets could offer opportunities

Mena frontier markets could offer opportunities

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The elevation of the UAE and Qatar to MSCI emerging market status last year, followed swiftly by Saudi Arabia’s commitment to open up to foreign investors in 2015, succeeded in placing some of the largest and most liquid Mena markets firmly on global investors’ radar screens. The question now is where the next lucrative investment targets will emerge.

Plummeting oil prices have eroded some of the positive sentiment, but there are still bright spots emerging across the Middle East – notably those markets that are net oil importers and therefore stand to gain most from lower energy costs. The impact of the weaker energy prices – in the third week of January, Brent crude traded at its lowest level since April 2009 – is still working its way through the region’s equity markets. 

The Dubai Financial Market experienced the sharpest falls. Since its 2014 peak on May 5 it has lost around one-third of its value. But while declining energy prices do not automatically translate into plunging equity valuations, the large Gulf indices have all declined in recent months. 

At least for now, the weaker oil price has not smothered the resurgent pipeline of equity issuance – after all, energy-related stocks only account for 2% of the Mena region’s market capitalisation. Equity capital market issuance in the Middle East increased 173% from $4.2bn in 2013 to $11.4bn in 2014, according to Thomson Reuters data. It seems that there also remains healthy demand for securities. 

A late-December Reuters survey of 15 leading Middle East investment professionals found that the recent tumble has not turned funds away from stocks in the region. Almost half expected to raise overall equity allocations in the next three months against one-fifth that anticipated reducing them. Regional asset managers appear sanguine about the impact of the oil price. 

“On a fundamental basis, GCC governments are prepared to keep core spending going despite lower oil prices,” says Yong Wei Lee, head of Mena equities at Emirates NBD Asset Management. “The surpluses accumulated over the previous years of high oil prices will be able to fund any budget deficits that could arise. We expect oil prices to recover by the second half of 2015, so that should help with budgets.” 

It is an important factor as governments across the region each have their own break-even price for balancing their national budget. A sustained period of low prices – with the perhaps now permanent threat of US fracking supply being redoubled if the price rebounds – would inevitably constrain public spending and perhaps even lead to an increase in taxation. 

Adjusting expectations 

Beyond any direct economic effects, Lee predicts that the more likely impact would be indirect via its effect on sentiment. “Along with falling oil prices, this was negative for GCC equities late last year. But we have seen a marked improvement since the start of the year, in part due to the encouraging results for Q4, which should show no major curtailment in domestic demand,” he says.

Portfolio managers will also note that sliding markets also mean more favourable valuations, down from the bullish highs of early 2014, perhaps moving towards premiums lower than other emerging market stocks. 

“Those mutual funds that stick to a strict discipline of investing on sound principles should outperform the market in the medium to long term, unfazed by market gyrations,” says Lee. “Hence, investors who are prepared to take a medium to long-term view of the growth story in the region would still benefit by investing through mutual funds.” 

The general theme though is of a cooling down, says Tamer Mostafa Kamal, fund manager at UNB: “All Gulf states have seen a slowdown in turnover since the start of the year, and there are indications that IPOs will slow down if the markets keep in this stagnation phase.” 

The oil slump has changed consumers’ appetites, leading to a wait-and-see approach. “Investors are rebalancing their portfolios accordingly, and fixed income is proving a conservative tool for many investors, as is the traditional safe haven of physical real estate,” says Kamal. “Valuations should eventually go back to their historic norms, on a long-term perspective.” 

The Mena markets story is not just about oil price this year. Saudi Arabia is set to invite foreign investors to take direct positions on the Saudi stock market at some point during the first half of the year. That could also make a difference to the wider region, given the Riyadh exchange’s dominant size. 

“The Saudi market opening will have an ancillary impact on the wider region because investors that until now have not really focused on the Middle East will begin to, as the entire region comes on to their radar,” says Arindam Das, regional head, Middle East & Africa at HSBC. “As asset managers start to focus on the region, the smaller markets automatically benefit from the spillover effect.” 

EY figures show that new capital raised through IPOs in the Mena region totalled $11.5bn, the highest since 2008, although this was given a mighty fillip by the late 2014 $6.2bn float of Saudi Arabia’s National Commercial Bank. But there is likely to be a reduction in liquidity and demand for IPOs in the short term, at least until markets show clear signs of recovery, so it is unlikely to be another stellar year.

Egypt 

Certain Mena markets outside the Gulf are looking relatively more robust. Egypt stood out last year, proving to be the world’s best-performing bourse in 2014. The main Egyptian Stock Exchange index, the EGX 30, showed a 31% increase last year, and the MSCI index for Egypt has almost doubled since mid-2013. 

It provides a clear sign of growing investor confidence since president Mohammed Morsi was ousted in July 2013. The return of a measure of political stability under president Abdel Fatah al-Sisi has afforded a significant improvement in Egypt’s economic outlook. 

In late 2014, the issue of Suez Canal investment certificates to retail investors met with a robust response, yielding the equivalent of $8.5bn within a week. Egypt started 2014 on a strong footing, with the constitutional referendum exerting a positive effect on the stock exchange, with the EGX30 up by about 9% in January alone. That was followed by presidential elections that saw al-Sisi come to power, in a move that markets again viewed positively. 

“The Egypt market went up by around 20% in the first half of 2014 and the big reform programme that was announced has created a lot of positive sentiment for investors,” says Ahmed Mokhtar, managing director of NBK Capital Asset Management Egypt. 

The al-Sisi economic reform programme includes the restructuring of a range of state subsidies as well as the unveiling of new investment plans and a revised tax law. This, together with $20bn in financial support from the Gulf States deposited at the Egyptian Central Bank, has given a massive boost to Cairo’s economic fortunes. Now the authorities are preparing to return to the international bond market, with plans to raise between $1bn and $1.5bn. 

Investors are focusing on resilient sectors that benefit from the economic reforms, with real estate and banking proving particularly attractive. “Property is seen as an inflation hedge and, with developers booking a lot of very decent sales, we see a lot of momentum in this sector. It will also benefit from the current devaluation of the currency,” says Mokhtar. “On the banking side, the loanto- deposit ratio is very low so the potential for growth, whether in consumer and retail banking or SMEs, is significant.” 

A growing number of Egyptian firms are looking to equity market issuance as a means of financing themselves. Around six or seven Egyptian IPOs could be placed over the course of 2015, focused on the standout sectors of real estate, telecoms, food and health.

“We expect a busy year on the IPO side, with a lot companies coming to the market via flotations and private placements. It is much needed as the market requires new listings to incentivise portfolio managers to invest more in the market,” says Mokhtar. 

Though investors have long-standing issues with Egypt, notably the difficulty in repatriating profits from the country, there is a strong feeling that progress is being made on the regulatory front. 

“Egypt is not new to the emerging market game. It has been there and seen it all before,” says HSBC’s Das. “Now, it is all about reviving investor interest and addressing their concerns about foreign exchange, that they would be able to repatriate their money as and when they wish to. If that comfort level can be restored, and of course politics and the economy continue to stabilise, there is no reason why Egypt cannot attract a lot of foreign interest.” 

Perhaps Cairo’s biggest challenge is managing volatility. On January 26, Egypt’s pound slipped to 7.43 to the US dollar, the weakest level it has been allowed to reach since auctions began in December 2012. The pound may have further to fall, but the central bank is watching events closely. Once parliamentary elections are completed in April, the political roadmap charted in mid-2013 will be complete. The stage will then be set for investors to participate more fully in Egypt’s recovery story. 

“We see an opportunity for accumulation and reallocation of portfolios. Investors should concentrate more on resilient sectors that are benefiting from the upside that will take place in promising sectors going forward,” says Mokhtar. 

Lebanon 

Lebanon, like Egypt, has also been battered by political headwinds in the past few years. Compared with Cairo, Beirut has further to go in building a convincing stabilisation narrative. Sectarian divisions, amplified by spillover effects from the crisis in Syria, have hit the Lebanese economy hard and stalled attempts at reform.

But, says Fadi Osseiran, general manager of Blominvest Bank, 2015 has started on a good footing with an 11% rise in the trading volume of shares over the last two weeks of January, compared with the same period last year. Last year the Beirut Stock Exchange was ranked the fifth best performing bourse in the Arab world by research outfit Bespoke Investment Group. 

“Some $68.5m in new equity was issued by local banks throughout the past year, adding to the vote of confidence in local capital markets. With banks looking into diversifying their income bases by expanding outwardly, this trend is likely to continue in 2015,” says Osseiran. 

On the sovereign debt side, the Lebanese government is looking at repeating the success of last year’s $1.4bn eurobond placement by allocating a new $1bn issue, notes Osseiran, which local banks are currently competing to underwrite. 

“Perhaps the most notable activity has been in M&A where some $400m worth of deals were undertaken in 2014, mostly among the banking sector and clearly paving the way for more deals in the coming years, given the central bank’s advocacy for consolidation in the Lebanese banking sector,” says Osseiran. 

While commentators also caution that there have not been new listings on the market and liquidity is still tight and volumes low, there is a sense now that Lebanon’s legendary ability to withstand political turbulence is still in evidence. 

“Lebanon stands out in the region when it comes to coping with uncertainties as it has a track record of weathering storms of stronger magnitude throughout the diverse political and security ridden periods of its history that has not been limited to the 2006 war,” says Osseiran. 

This has never been more apparent considering the continuing troubles in neighbouring countries, notably Syria, as it has so far remained insulated from adverse consequences. 

“Within this context, we have witnessed increased interest in the diversified funds that we have been launching as AuMs have grown at a CAGR of 35% over the past six years to $650m, in addition to a 15% rise in yearly demand for our stock by global funds,” says Osseiran. 

The central bank Banque du Liban (BdL) continues to be involved in useful regulatory activism. During the 2008 financial crisis Lebanon became something of a safe haven for global funds due to the strict regulations passed by BdL that protected local banks from the consequences of toxic investments. 

“BdL has been at the forefront of passing regulations to advance and modernise local capital markets as well as promote startups and new businesses,” says Osseiran. 

“To this end, the central bank finalised the establishment of the Lebanese Capital Markets Authority (CMA), which started passing legislation for the development and regulation of capital markets activities, enhancing awareness by highlighting investment risks, safeguarding investor interests and increasing trading activity on the Beirut Stock Exchange by encouraging the listing of new stocks.” 

In parallel, the BdL issued Circular 331 as part of a national scheme to inject $400m in technology-related local startups. The initiative subsidises 75% of commercial banks’ investment in startup companies and incentivises banks to finance and partner in promising projects in the information and communications sector, with the ultimate aim of transforming successful ideas into investment opportunities. 

Beirut still faces major challenges, particularly with weaker foreign participation. Big moves on the Beirut bourse used be generated by strong overseas demand, from both Lebanese expatriates and Gulf investors. However, the Gulf investors pulled out a long time ago. 

Nassib Ghobril, head of research at Byblos Bank, says: “The stock market would be moved by supply-driven measures – in other words, if the government listed more companies and if privately held family firms chose to list. But there are no incentives to do so.” 

For local firms to start listing, the government would first need to begin the listing process for profitable state-owned assets such as the cellular phone networks or Middle East Airlines. Such listings could generate demand from institutional investors, which in turn would raise interest in the stock market and generate demand from new retail investors, says Ghobril. 

“Even with increased volume and value, privately-owned and family-owned businesses need to see clear rules and regulations that govern the stock market before considering listing their shares.” 

Regional investors are likely to be in the process of reallocating their portfolios in the wake of the oil price fall and political situations, exacerbated by the Ukraine- Russia situation. Blominvest’s Osseiran says this will bring to light the attractive valuation multiples of Lebanese equities, which trade at a 50% discount to their regional counterparts. 

“The same applies to a relative extent to fixed income instruments, as the Lebanese government has passed the test of default in more contested times,” he says. 

Lebanon’s challenges are symptomatic of many others across Mena frontier markets – the general lack of liquidity reflects the dominance of government institutions in the economy. 

Yet, from a longer-term perspective, there are still opportunities that will add value to portfolios, perhaps beyond listed securities. 

UNB’s Kamal says: “There will be a lot of value in private equity, because the nature of these regional frontier markets is that they are in the early phase. We see more interest in private equity than listed firms – they are much more attractive.” 

Overall, Mena-focused fund managers face a tough year working out in which direction markets are headed – a situation not helped by the eurozone’s continued travails, data from Asia suggesting a slowdown, weaker oil prices and political convulsions across Mena. But the ultimate prize is still worth fighting for – Kamal says: “There is a lot of liquidity waiting outside the markets until the direction becomes clear.”


Palestine

One of the better performing Mena region bourses in recent years is one that sits between Lebanon and Egypt – Palestine. Last September, FTSE put the country on its watch list for possible inclusion in its frontier markets list. It is a signal to the international investment community that it is contemplating a change of status for the country, which will be considered for the next annual country classification review that is to be announced in September 2015. The Palestine Exchange (PEX) has 48 listed firms, though its market capitalisation is small at just $3.2bn at the end of 2014. However, says PEX CEO Ahmad Aweidah, it remains the most open market in Arab world, with no restrictions on foreign ownership. “We reduced the settlement period from T+3 to T+2 and that has had a positive impact on the market credit rating. We also have full delivery-versus-payment (DVP).” Like other Mena markets, PEX has been affected by adverse political circumstances, with the Gaza bombing of 2014 followed by the recent move of the Israeli government to withhold tax revenue it owes to the Palestinian Authority. Al-Quds Index recorded an annual decrease of 5.5% last year. “Politics is overshadowing everything, and that is going to affect the market for the next three months at least,” says Aweidah. But the PEX chief says that in terms of company performance, financial results have been good. “The fundamentals are solid. The dividend yield is still quite good and prices have gone down so price-toearnings ratios are even lower.” Aweidah is working hard to convince MSCI and S&P to follow in FTSE’s footsteps and promote it to their respective watch lists for frontier indices. But he acknowledges that it will continue to struggle to overcome a Catch 22 situation. “You need liquidity in order to get people to notice you – but you can only get liquidity once they take notice of you,” he says.

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