By Salah Shamma
Companies urged to aim big and be bold despite Covid-19-related economic turmoil
Policymakers worldwide remain in a high wire balancing act of containing both Covid-19 and the resulting economic fallout.
Even with the relaxing of mobility restrictions, there will likely be a lingering impact on consumer behaviour and some permanent economic damage. This will weigh on global economic growth prospects beyond 2020.
Positively, Purchasing Managers’ Index (PMI) numbers have improved over the past two months in select MENA markets, bouncing back from their April lows, as business activity resumed. The UAE posted the strongest recovery followed by Egypt, with activity edging higher than the pre-pandemic February numbers. Saudi Arabia’s reading was relatively muted, but not declining.
The UAE’s economy has steadily improved since coming out of lockdown, but also become a victim of its own success.
Over the past few years, it has substantially developed non-oil sectors like real estate, hospitality, transportation and retail, which have seen the sharpest drop in demand due to Covid-19. This has been further exaggerated by lower oil prices and returning to pre-pandemic activity levels could take years.
These challenges aside, the country is in a better position to navigate the current pandemic than it was following the 2008 global financial crisis, having taken necessary steps to reform and diversify its economy.
Its recent policies to relax long-term residency requirements and foreign ownership limits should help mitigate some of the risks we see from slowed economic growth.
The country’s world class infrastructure, favourable geographic position as a global hub for commerce and tax haven status will also continue to position it as a desirable business location. It also scores high on value metrics and could attract long-term bargain hunters looking to accumulate positions at these levels. The Dubai Financial Market’s average price-to-book ratio, for example, is approaching levels last seen following 2008.
Any health breakthrough or a general normalisation of travel restrictions would also have a more material impact on the overall market since its economy is heavily reliant on tourism.
In Saudi Arabia, Covid-19 and lower oil prices have put its economy in an unenviable position, but we see signs of a recovery.
SANED, its government employment support programme, was established to help the private sector and Saudi workers cope with Covid-19 and has been critical in sharing the burden of corporate payrolls and stabilising unemployment.
We are also not concerned about the country’s liquidity position, as it has proved effective in using its vast resources to offset lower oil receipts, draw down savings and leverage its balance sheet to access international credit markets.
We maintain this view even though Saudi Arabia needs an oil price of $76 per barrel to balance its budget, according to recent IMF estimates, and the fact that expected deficits are hampering its ability to implement counter-cyclical measures against the pandemic. Additionally, while the private sector continues to grapple with mobility restrictions, lower demand and higher VAT, weekly point-of-sales data for some key categories, like apparel and electronics, has been increasing.
Longer term, we also expect consolidation to continue as companies look for synergies to boost bottom-line growth - weaker participants will be forced out as stronger franchises with liquid balance sheets gain market share.
Despite some of these positive signs, we cannot downplay the significant economic challenges facing Saudi Arabia.
Although hiring freezes, the suspension of capex and a 10 percent increase in VAT are helping to restore government finances, they will also weigh heavily on the country’s growth outlook.
Coupled with pandemic-led restrictions and a pressured demand outlook, the IMF expects the country’s GDP to contract by 6.8 percent in 2020 but recover to 3.1 percent growth in 2021. We anticipate that the economy will bounce back in 2021, as oil production increases and we see more normalisation, but in the meantime the country has a long road to a full recovery.
Taking stock of the current climate, MENA equity markets have rallied from their April lows, making us optimistic that the worst is over. That said, it remains an uphill battle, with earnings estimates gradually improving but revised down for the year.
In our experience, times of exceptional stress have provided good opportunities to reallocate capital and establish new entry points into quality names. Resilient sectors such as consumer staples, healthcare and technology are all benefitting from the Covid-19 pandemic, with social distancing measures accelerating the use of the services they provide.
Looking ahead, we continue to favour resilient businesses with the balance sheets and flexibility to adapt to today’s new reality. Moreover, we strongly believe companies that pursue big strategic moves through every phase of the economic cycle can increase their odds of outperforming peers in the longer term.