Let’s Talk GCC 2010 Outlook

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)

NOTE: all numbers and caption are taken from Credit Suisse: MENA Equity Strategy GCC Equities 2010.