By Mohammed Al Hashemi
Value and improving market fundamentals could produce a turnaround in sentiment for the two sectors, but equity investors take a long term view
Banks and petrochemicals stocks could be relative strong performers in the GCC in 2017 thanks to benchmark interest rate rises and a recovery in the global crude oil price, although slowing economic growth may weigh on regional markets.
Both sectors have suffered in the last couple of years due to the dramatic oil price decline. The knock-on effect of lower investment and economic growth hit banks, with loan growth slowing and provisioning for non-performing loans rising sharply. The region’s listed petrochemicals firms, which are concentrated in Saudi Arabia, found that lower oil prices eroded their natural advantage stemming from cheap feedstocks, as global peers became competitive.
Investors have been bearish on both sectors. For example, the Saudi Arabian banking sector is down just over 12 percent in the last two years, and the country’s petrochemicals sector is down just over 5 percent.
However, 2017 could see a turnaround in sentiment, as equities investors — who are primed to look ahead — search for value and improving fundamentals. GCC banks are currently trading at around nine times earnings and at 1.2 times book, while petrochemicals firms are trading at around 14 times earnings, with a dividend yield of 5.5 percent. In comparison, US petrochemicals firm Dupont trades at nearly 20 times forward earnings, with a dividend of 2 percent.
Banks are unlikely to see significant improvement in their operating environment in 2017, with the International Monetary Fund (IMF) forecasting GCC economic growth will slow to 2.3 percent, from 4 percent in 2016. But financial institutions across the region are firmly focussed on cutting costs and increasing efficiency.
The merger of First Gulf Bank (FGB) and National Bank of Abu Dhabi (NBAD), which is due to complete in the first quarter of 2017, should produce a dynamic, relatively lean banking giant in the region.
At the same time, if, as expected, the US Federal Reserve follows up on its December 2016 interest rate rise with a further two hikes in 2017, banks in this region should have the room to increase their net interest margins — with lending rates rising faster and sharper than deposit rates.
However, the benefits of interest rate rises are not uniform across the GCC banking sector. Saudi Arabian banks, which rely on retail customer deposits for a significant portion of their funding, are highly geared to interest rate movements and typically benefit more from higher rates. In contrast, UAE banks rely more on the competitive wholesale market for a significant portion of their funding, so their margins benefit much less from rising rates.
Meanwhile, Saudi Arabia’s petrochemicals producers start to regain some of their competitive advantage as the crude oil price recovers.
The recent accord reached by OPEC members to cut crude production in the first half of 2017 by 1.2 million barrels per day marked an important turning point in expectations for the price of crude oil. If OPEC members meet the newly agreed quotas, along with non-OPEC Russia, then we could see crude prices hovering in the $55 to $65 range over the next 12 months.
This appears to be the generally accepted cap; if prices were to rise and maintain above $65 per barrel, we could expect a notable ramp up in production by US shale oil producers.
Broadly speaking, in a rising interest rates environment, equities tend to fare better than bonds, and we could see the recent asset class rotation into stocks continue well into 2017. In this region, we expect the UAE and Saudi Arabian markets to outperform. From a macro perspective, both countries have implemented significant fiscal measures to reduce their budget deficits, and liquidity across the financial system has improved progressively in 2016. Despite the recent run up in these two markets, valuations remain attractive and offer further upside.
Mohammed Al Hashemi, Executive Director, Abu Dhabi Investment Company (Invest AD)