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Thu 5 May 2011 06:36 PM

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Diary of an armchair investor

Another day, another contract win for Dubai’s Drake & Scull, writes Richard Dean in his weekly column

Diary of an armchair investor
Richard Dean

Sunday May 1: Sell in May and go away? Not this year

It’s a well-known adage for investors around the world: ‘Sell in May and go away.’ Globally, it could make sense this year. JD Steinhilber of IndexUniverse points out that since 1950, the Dow Jones Industrials Index has appreciated 7.4 percent on average between November and April, and just 0.4 percent between May and October.

But Haissam Arabi of Gulfmena Investments in Dubai says it may not hold for regional markets in 2011. “We are contrarian,” he tells me, particularly in the UAE and Qatar.

First, these markets are cheap – the rally in March and April only clawed back the panic selling that hit in January with regional uprisings. They still have to catch up with international peers.

Second, and more important, index provider MSCI will rule in June on promoting the UAE and Qatar to emerging markets status, from frontier markets. If it happens – and it’s not guaranteed – global fund managers who track the index will be forced to buy local stocks. Peter Gotke of BNY Mellon says Qatar alone would see an influx of at least $2bn from foreign investors.

The signs are good that it may finally happen. Speaking in Abu Dhabi this week, MSCI’s Manuel Rensink said he was “generally positive” about the prospects of an upgrade. And officials from the Abu Dhabi Stock Exchange say they have now ticked the final box by agreeing to implement so called Delivery vs Payment settlement system.

Armchair Insight: Hold off on that call to your broker, asking him dump your Gulf stocks for the summer.

Tuesday May 3: Drake & Scull is good value at Dhs1.05

Another day, another big contract win for Drake & Scull, the Dubai-based contractor. This time it’s an AED180m government deal in Abu Dhabi – taking Drake & Scull’s new business tally for the year close to AED3bn. And it’s only May! It seems nobody has told chief executive Khaldoun Tabari that half the region is plagued by unrest, with the offering half recovering from a real estate bubble.

So what’s Drake & Scull doing right? Pretty much everything. This year’s success is payback for years of hard work behind the scenes in three areas: finance, strategy and people.

The company has financial muscle thanks to a perfectly timed IPO back in summer 2008. It raised just over AED1bnin the last big Dubai share sale before the crash, giving it a strong balance sheet entering the downturn. Indeed, it’s now commonly known to as DSI, it’s ticker on the Dubai Financial Market.

On strategy, Tabari and his team have used this cash wisely, buying up a series of small companies. This has given them regional reach – he’s bought two competitors in Saudia Arabia, and one each in Qatar and Kuwait, getting a seat at the table in the four richest Gulf states.

For me, though, the transformational deal was in Germany. Drake & Scull bought a little known company called Passavant-Roediger for AED145m. Why so significant? Because it showed that Tabari’s acquisition spree wasn’t just an egotistical land-grab – it was about building a formidable company with world-class expertise that would give it a real edge over MENA rivals.

Which brings me to the nuts and bolts of the business. Drake & Scull is not a sexy company. The German acquisition gave Drake & Scull “wastewater, water and sludge treatment technologies.” Yuk. Hardly a trophy asset – not a football club or Mayfair hotel in sight. But it’s just the kind of roll-your-sleeves-up, get-your-hands-dirty stuff that delivers shareholder value. And I love it.

Finally, there’s the people. Part of the motivation for going public was to give key managers an incentive programme to keep them at Drake & Scull. Clever. For all these reasons, it has a backlog (industry jargon for order book) well over AED8bn.

So it’s a good company. But is now a good time to buy the stock? On the downside, plenty of good news is already priced in at AED1.05. Back in January, Morgan Stanley issued an Equal Weight rating on Drake & Scull, saying; “We expect [it] to benefit from infrastructure spend in KSA, Abu Dhabi and Qatar, but valuation looks full,” with a price/earnings ratio around 12 based on this year’s profit forecast.

As recently as March, analyst Roy Cherry at SHUAA Capital cut his rating from buy to hold, in a note titled ‘Backlog glory fades in the face of regional unrest’.

On balance, though, I’m a buyer of Drake & Scull at today’s price. It’s not going to double overnight, but it’s a great ‘buy and hold’ story to put in your kids’ college fund. Perhaps alongside the Saudi yoghurt make Almarai which I tipped a month ago at SR94 riyals, now even cheaper at SR91.

Armchair Insight: Let Drake & Scull do the dirty work while you make steady returns.

Thursday May 5: More good news for Drake & Scull from SHUAA

Roy Cherry clearly shares my optimism on Drake & Scull. Today he hiked his rating on the stock to ‘buy’, with a target price of AED1.29. I spoke with him to ask why the quick change of heart. Here’s what he said:

“There are three main reasons for the upgrade. Two relate to declining political risk, one relates to increased execution capacity in the company’s main market, Saudi Arabia,” says Cherry, a senior vice-president for research at SHUAA.
“In March we downgraded DSI to a hold rating due to the heightened risk on the back of unrest in Oman, Bahrain, Yemen and fears of similar events spreading to other key Gulf markets. We saw an increased risk in making investments across the region, which translated into a higher discount rate. This led us to cut our target price to AED0.93. Since then, we have seen a decline in political risk within Drake & Scull’s markets and clearly the unrest did not spread to other Gulf countries.”

So SHUAA has removed the five percent political risk premium applied to its discount rate. It also raised its terminal growth rate for DSI back to two percent, from zero. Cherry also likes the acquisition strategy.

“Drake & Scull has completed the acquisition of International Centre for Contracting Company in Saudi Arabia, which gives it more power and muscle to execute contracts and win new business there,” he says.

Armchair Insight: Based on Cherry’s new numbers, Drake & Scull’s price/earnings ratio is 9.2 this year and just 7 in 2012. That’s good value.


(*Richard Dean is a journalist, author and broadcaster living and working in Dubai. He may own an interest in some of the securities mentioned. The views are his own.)

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