World's largest oil exporting country is in the grip of a protracted adjustment to low crude prices
Saudi Arabian companies are faring better in an era of austerity than many investors feared, but they face more pain in the coming months as gains from cost-cutting and efforts to improve efficiency become more difficult.
The world's largest oil exporting country is in the grip of a protracted adjustment to low crude prices, which have caused a state budget deficit of nearly $100 billion and forced the government into spending cuts.
For decades, almost every corner of the economy has depended on lavish flows of petrodollars, so the austerity is bad news for Saudi corporate earnings.
Last December, the government announced its harshest set of measures so far, in the form of subsidy cuts that raised domestic prices of gasoline, electricity, water and the natural gas feedstock used by the petrochemicals industry.
The first-quarter earnings of listed Saudi companies, released over the last few weeks, show that many are managing to avoid a steep slide in profits.
The combined net profits of the 50 biggest companies by capitalisation, which account for the vast bulk of all earnings in the stock market, fell only 3.0 percent from a year ago to 19.88 billion riyals ($5.4 billion), Reuters calculations show.
That was much better than the expectations of many analysts, who had believed profits might drop at least as steeply as they did in full-year 2015, when earnings shrank 13.9 percent.
Nevertheless, there were big differences in first-quarter performance between individual sectors, with industries directly exposed to consumer demand, such as retailing, hit hard.
Statements by the companies attributed much of their better-than-expected earnings to cost-cutting and gains in operational efficiency - processes that cannot continue indefinitely if they want to grow. That suggests the decline in profits could accelerate later this year or next.
"Companies were able to benefit from the easy wins of cutting back on excess spending this time around," said Jassim al-Jubran, senior analyst at Aljazira Capital in Riyadh.
"But the next several quarters will prove companies will be scavenging for top-line growth and undergoing massive restructuring as they face further pressure from austerity."
Most of Saudi Arabia's 12 listed banks beat analysts' expectations in the first quarter as their combined earnings rose 0.6 percent to 10.01 billion riyals, a slowdown from 7.2 percent growth in all of 2015.
Provisions for bad loans, while generally slightly greater than a year earlier, were not as large as feared.
Many analysts, however, think provisions could rise in the coming quarters as austerity continues to hurt the economy. Major construction company Saudi Binladin Group, for example, has been laying off thousands of workers and bankers believe a restructuring of some of its debt is possible.
Another concern for banks is slowing deposit growth because of reduced inflows of petrodollars. Total bank deposits shrank 0.6 percent from a year earlier in March; as recently as last year, they were growing at double-digit rates.
"Many believe that 1Q16 results for banks in particular were a 'lagging' indicator, not forward-looking i.e. results are more reflective of pre-subsidy change days," said one Saudi economist who works with the government, declining to be named because he is not authorised to speak to media.
"In coming quarters you will start to see defaults increasing and banks getting into a mess, so results will worsen."
Earnings of the top 10 petrochemical companies shrank 8.9 percent in the first quarter to 4.33 billion riyals, but that was much better than in 2015, when low product prices due to cheap oil slashed their profits 36.9 percent.
Saudi Basic Industries Corp, one of the world's largest petrochemical groups, reported a 13.2 percent drop in first-quarter profit to 3.41 billion riyals, but that was better than analysts' average forecast of 2.84 billion.
"In general, gross margins were able to come ahead of expectations because producers were able to control costs, both operational and general," said Jubran.
So far, the impact of the subsidy cuts on petrochemical firms' margins has been far lower than analysts and even the companies themselves had expected, said Jubran. But he warned that some firms were still enjoying low feedstock prices and these would eventually rise in an environment of austerity.
"Part of the current strategy adopted by companies to improve efficiency and slash costs may prove to be unsustainable, because if current prices of feedstock, which some players continue to use at discounted prices, increase then margins will compress in future quarters."
The earnings of retailers reveal the effect of austerity on consumer demand in the kingdom, as some of its 10 million foreign workers are laid off and sent back to their home countries.
While there have been no major lay-offs of Saudi citizens so far, their purchasing power has been curbed by less generous bonuses and overtime payments, while economic uncertainty has made them more cautious about spending.
Retailing chain Fawaz Alhokair, which owns franchise rights for brands including Mango, Zara and Banana Republic, barely broke even in the January-March quarter with its net profit plunging 98 percent.
This drop was partly due to unusually strong sales in the year-ago quarter, when public employees received a bonus of two months' salary to mark the accession of King Salman, but it also reflected deteriorating consumer sentiment.
Mohammad al-Shammasi, head of asset management at Derayah Financial, said domestic-focused Saudi companies would face more pressure on their margins as consumers became more price-conscious and firms offered discounts to attract them.