Outlook on The Middle East and North Africa - Lazard Asset Management
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Outlook on The Middle East and FEB
North Africa 2020
Middle East and North Africa (MENA) equities had a strong year,
Summary driven by a number of positive developments including the inclusion
of Saudi Arabia and Kuwait into emerging markets indices, and the
• MENA equities were once successful initial public offering of Saudi Aramco on the local Tadawul
more driven by technical factors stock market following a long delay. The record-breaking listing
in 2019, particularly during secured Saudi Aramco’s position as the most valuable listed company
the first half of the year, as in history. The company is currently valued ahead of US technology
country inclusions into global
giants such as Apple, Microsoft, and Facebook. The listing was the
benchmarks drove strong passive
first milestone in the Saudi government’s path towards its objective
inflows into the region, especially
of diversifying the economy away from oil. As we expected, these
Saudi Arabia.
developments dominated broader market moves particularly during
• This has created dislocations the first half of the year, and were especially strong drivers for both the
in the MENA market and a Tadawul and the Boursa Kuwait stock exchanges, which rose 7.2% and
divergence in performance, 28.4% respectively over the year1.
both between large-cap and
Government intervention, either through the closing auctions
smaller-cap stocks and between
mechanism or by changing foreign ownership limits (FOL),
companies included in the MSCI
continues to be a noticeable factor affecting regional markets. Such
Emerging Markets Index and
those that are not. practices have been especially prominent in Saudi Arabia and Qatar,
predominantly with large-cap stocks and the financials sector, which
• We think it is likely that investor represent a significant portion of market indices. As a result, the
focus will shift away from majority of market outperformance was driven by a small number of
technical factors that have largely large-cap stocks.
dominated market moves back to
underlying company fundamentals
As the implementation of Saudi Arabia and Kuwait’s inclusions
and stock valuations over the comes to an end, we expect investors’ focus to return to company
course of 2020. In order to benefit fundamentals and underlying returns, instead of expected stock returns
from this shift we believe that as has been the case for the past couple of years. Saudi Arabia has one
companies that have stable final tranche for inclusion into the FTSE Emerging Markets Index
business models and visible remaining, which should be completed this quarter. Kuwait’s inclusion
cash flows present attractive into the MSCI Emerging Markets Index (MSCI EM) is due to take
opportunities, especially those place in a single tranche in May 2020.
with valuations at historical lows.
These technical factors meant that company fundamentals were
largely overlooked by investors in 2019, as we anticipated, with passive
inflows into the region spurred on by Saudi Arabia and Kuwait’s
inclusion into emerging markets indices, which broadly lifted large-cap stocks, as well as those companies directly impacted
by the index inclusions. Factors such as liquidity, size, and benchmark weight became strong determinants of overall market
direction. The result of this was a significant divergence between MSCI and non-MSCI related names, especially since the
upgrade of Saudi Arabia into the MSCI EM watch list in June 2017, with the former up 22.1% compared to a 1% move
for the latter2.
Strong technical factors have also meant that high quality growth stocks have become overvalued, reducing the number
of opportunities in this area, in our view. Our analysis shows that the expected internal rate of return (IRR) is below the
cost of equity, and certain structural challenges in some sectors are creating headwinds for growth. This, together with
the strong divergence in performance, will likely favour a rotation to value stocks, particularly in the small-cap space and
domestic markets that are undervalued compared to the rest of the region.
RD325922
We believe the most rewarding opportunities are likely to be positioned, which could help in closing the valuation gap that
found in companies where returns are driven by: has been persistent since it was announced that Saudi Arabia
1 Sustainable dividends supported by visible and sustainable cash would join the MSCI EM Index. The Saudi market is also
flows with the potential for growth in dividend payments currently trading at a significant premium to the MENA region
and other emerging markets (Exhibit 1).
2 Positive deleveraging supported by companies generating high
and stable free cash flows, which should increase the equity por- When running an IRR simulation for the Saudi Arabia market
tion of enterprise value while, assuming stable multiples assuming a holding period of 3 years, corporate earnings growth
of 10%, dividends being received (not reinvested), Saudi Arabia
3 A convergence towards intrinsic value for undervalued compa-
converges to a price-to-earnings ratio of 15x from the current
nies that have been overlooked due to broader technical factors
level of 19 (in line with the emerging markets average), and
Furthermore, any resolution to the political tension in Yemen, generated an implied IRR of 1.8%, which fell well below our
Iran, or Qatar, could represent significant potential upside to required rate of return.
the region’s equities.
The government seems to be moving ahead with its NTP plan,
Country Focus with the long awaited Saudi Aramco initial public offering
finally being completed in December, marking one of the largest
Saudi Arabia IPOs in history. This was the first key step in the government’s
Two major factors did, and might continue to impact the plan to diversify its economy away from oil. In addition, with
Saudi market: the inclusion into the MSCI EM Index and the the jump-start of many local projects including the Red Sea and
progression of the National Transformation Program (NTP). Qiddiya entertainment projects, local sentiment has improved
significantly, especially since most of the impact from the exodus
During 2019, there were two phases of MSCI EM inclusion and of expatriates appears to be over.
four of FTSE EM that took place. The market witnessed strong
performance ahead of the different phases of inclusion, reaching United Arab Emirates
a peak of 22% in May 2019, to close the year up only 7.2%1. From a macroeconomic perspective, the United Arab Emirates
Since the upgrade of Saudi Arabia to the MSCI EM watch list in (UAE) has a twin surplus, with both a 9.6% current account
June 2017, MSCI-related names were up 25%, versus a negative surplus in 2019 and a fiscal surplus of 0.6%3.
performance of -24.2% for non-MSCI related names2, which
shows that flows have been focused around inclusion within the Opening up to foreign investors remains a key theme in the
index. As we come towards the end of the inclusion phases, we UAE, whether on the stock market level or on the private
expect the focus to shift from technical factors to fundamentals. economy level. The introduction of new and more relaxed visa
We expect a rotation out of MSCI names into high quality schemes seems to aim to allow more expatriates to come to the
and attractively valued non-MSCI names, in which we are well UAE, and provide them with long-term security. In addition,
Exhibit 1
Saudi Arabia’s Equity Market Trades at a Premium to Other Emerging Markets
Price/Earnings
30
Trailing Forward
25
20
15
10
5
0
India
Morocco
KSA
Taiwan
Thailand
Malaysia
Indonesia
Brazil
Korea
Mexico
Philippines
Kuwait
Qatar
MSCI EM
Abu Dhabi
South Africa
Poland
Kenya
Budapest
EGX30
Istanbul
Dubai
Oman
Nigeria
Russia
As at 31 December 2019
Source: Bloomberg3
the removal of FOL for certain sectors could open the doors Oman
for higher foreign investment. On the stock market level, many Although Oman was one of the most impacted GCC countries
listed companies did open or are considering opening their FOL, by lower oil prices due to its higher breakeven oil prices and
which has resulted in a pickup in investors’ buying interest. lower reserves, we have been encouraged by recent on-the-ground
On a sector level, the banking sector consolidation is opening developments seen during our recent visit to Oman in October.
the path for an efficiency cost optimisation in both the low The investment programme in infrastructure (ports, airports,
interest rate and low growth environment. Dubai tourist etc.) is now almost concluded and therefore will require lower
numbers were up 4.9% year-on-year in 2019 (for the first 11 capex going forward, with returns expected to be generated in
months of the year), showing some interesting dynamics as both the short and medium term.
Chinese tourists rose to 6% of total visitors in 2019, up from
3% in 20144. Dubai Expo 2020 could give the economy a short- Fiscal reforms and the removal of subsidies has helped reduce
term boost, as 25 million visitors (11m already living in UAE deficits, and there are more to come (introduction of VAT,
and 14m from abroad) are expected to visit from more than 190 for example). Significant investments in oil and gas and the
countries, representing a potential 88% increase in tourist visits. petrochemical sector are expected to boost operations in the
short term (expanding oil and natural gas production, as well as
Local stock markets have failed to attract investors, as focus the launch of a large petrochemicals-focused joint venture with
shifted to other focus shifted to other markets receiving passive Kuwait). The Duqm area, which was highlighted as a key area
flows, resulting in liquidity coming down drastically. These by China in their Belt and Road Initiative initiative, has received
markets were caught in a perfect storm, with the negative significant Chinese investment.
sentiment around real estate, the slowdown in population
growth, and fall in business activity spooking potential investors. Oman has highlighted the potential to monetise some of their
operating assets through privatisation. Hence a listing of their
As a result, deep value in Dubai persisted as investors shifted major oil company would be probable, especially in light of the
their focus to index flows. Dubai is now trading at a price-to- recent Saudi Aramco IPO.
earnings ratio of 7.5x, a 25% discount to its historical average,
and a discount of 65% to Saudi Arabia and 50% to Qatar5. A Valuations in Oman appear too attractive to ignore, pressured
combination of low valuation, consensus negative sentiment, by some of the macro concerns facing the economy on the
and foreign investors’ capitulation is usually a leading indicator back of lower oil prices. Yet we believe these discounts are
of a market recovery, similar to what we saw in 2008 and 2011. not warranted for some of the high quality names. Our focus
remains on high quality companies, with high dividend yields
We are therefore positioned within companies that have stable that we believe are sustainable and might potentially grow.
business models and visible cash flows, trading at historical low
valuations. Egypt
Egypt could be the only market in our universe that may
Kuwait
deliver double-digit organic corporate growth in 2020
With a stable macro backdrop, Kuwait is expected to register a and accordingly could be the only real growth story in our
fiscal surplus of 6.7% and a current account surplus of 8.2% for universe from a geographic perspective. This is largely due to
the year 20196. Its fiscal breakeven oil price stands at $48, the improving economic conditions and headwinds from some price
lowest in the Gulf Cooperation Council (GCC). Historically, the adjustments following the devaluation.
political deadlock between the parliament and the government
resulted in a project execution rate as low as 48%. The recent The Egyptian pound appreciated more than 10% in 2019; we
government resignation in 2019 could potentially mean that the believe this is not sustainable in the long term and the currency
low execution rate of projects will continue. On the positive side, might reverse its appreciating trend in the medium-to-long
this could also mean that the fiscal stability may persist. term. A bet on further currency appreciation could prove risky,
hence we have a conservative approach in our future currency
Last June, MSCI announced that it would upgrade Kuwait to estimates.
EM status in May 2020, contingent on the implementation of
omnibus account structures and same National Investor Number Although Egypt seems like an attractive story from the surface,
(NIN) cross trades for international investors. In December, trying to allocate capital could be challenging. Our investable
MSCI announced the upgrade of Kuwait to EM status, after universe in Egypt is quite limited especially since we are
meeting the requirements mentioned above. uncertain about the return profile of the real estate sector, and
what we believe is a large exposure to government debt held by
The local stock market was the best-performing index within the banks. These two sectors currently represent around 65% of the
GCC, increasing 28.4% in 2019. This reflects the positioning market cap of the Egyptian stock market.
by investors ahead of the expected inflows from MSCI in May
2020. Valuations appear to be on the higher side, with the stock We are very positive on the health care, education, and services
market trading at an average price-to-earnings ratio of 17x, sectors in Egypt. This of course is a function of our selection
compared to a historical average of 12.5x. Our company analysis of stocks within these sectors and by no means indicates we are
also supports this view, showing little fundamental upside from positive on all the companies within these sectors.
current levels.4
We are paying slightly for growth in Egypt as we are comfortable
with the growth trajectory and visibility of that growth going Key Sector Outlooks
forward for the companies in which we invest. Telecom sector Consumer Sector
Qatar • High penetration rates, • Consumer spending still
challenges facing voice under pressure with signs
On the macroeconomic front, fiscal and current accounts revenues will be a of bottoming out occurring
headwind in the second half of 2019
remain positive, and Qatar has significant fiscal buffers
• Growth in data usage • Some companies in the
accumulated in the sovereign wealth fund, at an estimated continues to support sector offer what we
$320bn (165% of GDP)7. Efforts are ongoing to increase earnings believe is low downside
and free upside optionality
domestic production of selected food items in response to • Price rationalisation
on spending recovery
the embargo from Gulf states. Significant investment in supported by local
regulators should be
infrastructure should help give a boost to the economy as the supportive
country prepares for hosting the FIFA 2022 World Cup. In • Focus on healthy balance
addition, Qatar is planning to increase its Liquefied Natural Gas sheets, high free cash
flow (FCF), and sustainable
(LNG) production by 30% by 2025, which would help reduce dividends
the fiscal breakeven from $53 to $42/bbl and external breakeven
from $58 to $488. Despite the comfortable fiscal position, our Banking Sector Petrochemical Sector
recent meetings with Qatari companies confirm our negative • Net interest margin • Market is very bearish on
views on Qatar equities as low expected growth and returns do pressure should be a petrochemicals due to
general theme across negative expectations for
not justify the premium valuations. The market seems to be the region, especially on most product prices, as
trading on the expensive side, with a forward price-to-earnings corporate banks both supply and demand
ratio of 15x compared to a historical average of 12.5. The are facing some headwinds
• Balance sheet growth
possibility of reaching a political deal with other Gulf countries will be muted with main • Cyclical names usually
drivers being niche retail offer good entry points in
represents a positive upside risk. Another potential upside could exposures (such as downturns
occur if the government decides to use technical factors to mortgages in Saudi Arabia)
• Focus on cash flow
influence the market performance, similar to the 10-1 stock split • While mortgage generation; deleveraging
momentum is showing opportunities in the sector
or the FOL increase which was well received by investors. serious growth rates in
• Accounting profits do not
Saudi Arabia, it is worth
capture solid cash flow
Conclusion highlighting that loan-to-
value ratio (LTV) are close
generation ability of some
companies
to 100 percent especially
The significant influence that technical factors have had if we take some of the • In our opinion, potentially
across the MENA region has created hard-to-ignore valuation personal loans used to one of the best deleveraging
anomalies, pushing expensive growth stocks to even higher pay the equity portions of opportunities in the market
the mortgages. While we
levels, while also creating divergences between companies don’t foresee any imminent
recently promoted to international indices and those that deterioration in the quality
of mortgages, it is an area
were not, as well as across the market cap spectrum. While worth keeping an eye on
we understand the merits and benefits of being part of global especially with the lack of
long-term funding for such
indices, such as increased market efficiency, our current assets
observations indicate that markets are behaving less efficiently • Focus on capital generating
since attributes such as company size and liquidity were key businesses trading at a big
factors driving capital flows and allocations, which we believe mismatch between current
and justified book multiples
led to a disconnect between fundamentals and valuations.
We are firm believers that the intrinsic value of underlying
investments should be the most important factor in determining
long-term returns, therefore we seek to continue taking
advantage of the anomalies present in the current market
environment.Outlook on The Middle East and North Africa
This content represents the views of the author(s), and its conclusions may vary from those held elsewhere within Lazard Asset
Management. Lazard is committed to giving our investment professionals the autonomy to develop their own investment views, which
are informed by a robust exchange of ideas throughout the firm.
Notes
1 As of 31 December 2019. Source: Bloomberg.
2 As of 31 December 2019. Source: Bloomberg, Arqaam Research.
3 As of 31 December 2019. Source: Ministry of Finance.
4 As of 30 November 2019. Source: Dubai Department of Tourism and Commerce Marketing.
5 As of 22 January 2020. Source: Bloomberg.
6 As of 31 December 2019. Source: Source: Arqaam Research.
7 31 December 2019. Source: SWF Institute
8 31 December 2019. Source: Arqaam Research
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