Dubai has been stealing headlines in the past couple of months, unfortunately only spilling bad news.

 “Dubai World Seeks to Delay Debt Payments as Default Risk Soars” Bloomberg (Nov 26, 2009)

 “S&P downgrades ratings on four UAE banks” Arabian Business (Dec 3, 2009)

 “Dubai World asset sale nears, debt talks plod.” Reuters (Feb 3, 2010)

State-owned conglomerate, Dubai World, shocked global markets when it requested a standstill on its USD26 billion worth of debt. This wrote-off all signs of recovery, even though Abu Dhabi gave them a little help.

After a contraction of 3% in real GDP, the UAE is expected to grow 2% in 2010; the slowest rate in the GCC. This was due to lower oil prices along with collapse of the real estate. Moreover, Dubai debt issue is expected to pull down the economy as it accounts for 33% of UAE’s GDP.

CDS are not looking good

Dubai’s debt insurance has been gradually raising; they are up 130 bps this month. Dubai CDS rose above 600 bps for the first time since November; which means that in order to insure USD10 million it will cost USD 600,000.

Dubai is considered one of the riskiest sovereigns in the world, behind only Argentina, Venezuela, Ukraine and Pakistan.

Low inflation

The inflation in the UAE has hit a nine year low of 1.5%, primarily due to a decrease in the households category.

Equities

In relative terms, UAE equities might look cheap when compared to the emerging markets, as the UAE trades at a 7x P/E multiple against 13x for EM (2010E). Nevertheless, we have to adjust for various aspect to get a better “apples to apples” comparison. UAE’s debt-to-equity ratio is 83%, while the EM is 33%. If we take the assumption of raising equity to level the D/E ratio to 50%, UAE’s equities will trade at a P/E of 12x, which doesn’t look too attractive.

Below is a chart of Dubai Government holdings:

Related posts:

Dubai Default Implications

Burj Khalifa: The 10 Billion Effect

Reading the first couple of lines, one might think that investors should reverse all positions and exit the Doha SM.  However, I would recommend doing the exact opposite; overweight Qatar. It has the highest expected GDP growth, strong government support, moderate inflation levels, and cheap valuations. Qatar is the hottest place to be in 2010!

With a 47% increase in LNG exports, Qatar is expected to record the highest GDP growth globally (14%). The growth of 14% surpasses all GCC nations, BRICS, emerging and developed markets. The increase in LNG exports and GDP growth will have a direct affect on banks and petrochemical companies and will definitely enlarge overall corporate bottom line earnings.

Qatar had one of the highest inflation levels of 17% in 2008; nevertheless, Qatar is expected to record an increase of 1% only in inflation.

Strong economic prospects accompanied with relatively low valuation calls for a strong buy. DSM expected 2010 P/E is at 9.8x, higher than Dubai and Kuwait only which both have valid reasons to justify such low P/E multiples. Moreover, Qatar has both high dividend yields and ROE of 4.5% and 18% respectively.

Qatar and Saudi Arabia both have a positive outlook.

Our next stops will be Dubai and Kuwait.

As promised last week, I will discuss the 2010 macro outlook of the major GCC countries. Since Saudi Arabia is the largest economy in the GCC, I will begin with it.

Overall, Saudi’s economy is improving due to the hike in oil prices which increased export revenues and market sentiment.

The CPI decreased sharply from 11.1% in July ‘08 to 3.4% in October ’09, mainly due to the recession and the reduction in imported inflation. Credit Suisse estimates the nominal GDP to return to pre-crises levels in 2010. The rise in nominal GPD is higher than the increase in inflation, thus, boosting real GDP growth to 2.6% in 2010 and 4.7% 2011. Also, the fiscal and current account balances are expected to grow at a rate of 12% and 19% respectively.

Looking at the chart above, Saudi Arabia has the highest net external assets/GDP ratio of 80%. This constitutes a 70% positive difference from the Global EM. It is estimated that Saudi’s foreign assets to be around USD395 billion in ’09 and will grow by 25% in ‘10. Moreover, Saudi is considered a low leveraged economy where the government debt accounts for only 15% of the GDP.

One of the strong drivers of growth in Saudi Arabia is the implementation of their government-spending plan. This plan is focused on infrastructure projects with 63% of the total budged expenditure allocated to such projects. According to Bloomberg, in 2009 the Saudi Arabian General Investment Authority (SAGIA) announced that they will execute a USD400 billion infrastructure projects spending spree over the next five years. This year Saudi announced a USD144 billion planned expenditure in their 2010 budget. Government spending accounts for 30% of the total GDP.

On the equities side, Tadawul All-Share index’s listed companies are expected to show an increase of 30% in their 2010 bottom lines which beats its GCC peers.

Having said all that, I believe that Saudi Arabia will show positive returns this year especially in the consumer and banking sector.

After ending the rollercoaster ride that we saw in 2009, we remain cautious as we enter 2010. It is expected that the second half of the year will be a better performer than the first. The reason for that is due to the negative short-term outlook for the financial sector (higher costs of funding along with low margins). The financial sector is significant to GCC stock markets as it makes up more than 50% of the total market cap of these markets. There are reasons for optimism as the expected decrease in credit cost and increase in balance sheet growth (especially in Qatar and Saudi Arabia), it is expected that the second half of the year will improve. Due to Dubai’s debt issues, it will take investors some time to regain confidence in the market and deploy more investments.

Higher Cost of Borrowing = Lower Earnings

The aftermath of Dubai World’s restructuring added a couple of bps to the not so cheap cost of debt, and quasi government bonds are now priced equal to the corporate bonds. According the Credit Suisse analysis, each 100bps increase in the cost of corporate debt reduces 2010E earnings by 5% in the UAE and 7.2% in the KSA. This indicates how even the strongest economy in the GCC is vulnerable to the cost of borrowing.

Highly Levered

In mid 2007, GCC equities were the least levered in the world with net debt to equity of only 9%. However, currently they are the most levered equities with net debt to equity of 73%. Having said that, this adds more risk of capital infusion and dilution of current shareholders.

Interest Rates

Any increase in global interest rates will be positive, especially for the Saudi banking sector. A better financial sector translates into a surge in stock market returns. Credit Suisse’s Global Strategy team expects global rate hikes in the second half of the year.

Earnings Looks Good

On the earnings side, Qatar has not only the highest ROE in the GCC but also in the world. Qatar’s expected 2010 ROE is 17.7%. Furthermore, Qatar and Kuwait have the highest dividend yields in the GCC standing at 4.5% and 4.7% respectively.

Valuations at a Discount

The GCC is trading at a discount against its peers. The GCC is currently trading at a 2010E Price/Earnings multiple of 10x (GCC ex Saudi is 8.4x) which constitutes a 20% discount to Emerging Markets. In terms of Price/Book, the GCC is trading at a multiple of 1.5x which translates into a 20% discount to Emerging Markets. On the other hand, the high leverage (73% Debt-to-Equity) results in a 2010E EV/EBITDA of 9.2x which stands at a 40% premium to Emerging Markets.

In my next 4 articles I will write about each country’s outlook separately (Kuwait – UAE – Saudi – Qatar)