More positive outlook for capital markets

19 December 2013

Higher infrastructure spending will lead to more activity in the GCC’s capital markets

With both public and private sector companies set to benefit from the GCC’s expected stronger economic growth, capital markets activity is likely to rise accordingly in 2014.

While gross domestic product (GDP) growth slowed to an estimated 3.7 per cent in 2013, it is projected to climb to 4.1 per cent in 2014, according to the Washington-based IMF.

An expected step-up in GCC governments’ infrastructure spending in particular could lead to more capital-raising activity over the next few years.

And as banks pull back their lending activities following tighter regulation across the globe, that could lead to more companies opting for capital-raising methods other than loans, such as issuing bonds or selling shares.

Compared with a few years ago, the capital markets have already deepened and this trend is also set to continue in 2014.

Saudi Arabia has traditionally been the biggest bourse, although other markets could now expand as a result of growth across the GCC.

Bond issuance

Bond and sukuk (Islamic bond) issuance in the region reached a peak in the first half of 2013, with more than $30bn raised by issuers from the Middle East and North Africa (Mena) region, according to UK financial services company Dealogic. That trend could continue in 2014.

“We expect that [bond] issuance out of the GCC will pick up, particularly in Dubai in order to finance the World Expo 2020 infrastructure projects, and Qatar for the Fifa World Cup in 2022, but also in order to meet regulatory requirements,” says Erini Tsekeridou, fixed income research analyst at Switzerland’s Bank Julius Baer. “Saudi Arabia is the most active issuer and we expect it to remain so, but Kuwait may fall behind.”

Investor appetite remains strong because of the region’s higher than average economic growth, adds Adel Afiouni, head of investor solutions and placement for Europe, the Middle East and Africa at Switzerland’s Credit Suisse.

“Most major GCC credits benefit from the strong regional economy and enjoy a healthy financial situation. They will therefore be keen to take advantage of that favourable position, and of investors’ appetite and their search for yield and for diversification.”

Over the past year, regional issuers took advantage of international investors’ increased willingness to look beyond more established countries. Western issuers currently offer low yields on bonds, causing a growing number of investors to seek out riskier, higher-yielding bonds from regions including the GCC. In addition, different classes of products such as sukuk could help investors diversify their portfolios and raise demand for further issuance. 

In 2013, sukuk represented a larger part of the region’s total fixed-income issuance, as pricing often turned out more favourable compared with conventional bonds. GCC issuance grew a solid 11 per cent in the year to 24 September to reach $14.8bn.

Sukuk demand

Demand for sukuk by corporate and infrastructure issuers in the Gulf is likely to continue growing at a double-digit pace in the coming year or two, despite weakness globally in the past year, according to US ratings service Standard & Poor’s.

“We expect demand for more sukuk issuances to stay strong as investors seek higher yields, in particular due to expectations of [the US Federal Reserve’s scaling back of its bond-purchasing programme] next year,” says Tsekeridou.

“As investors become more knowledgeable of sukuk bonds and their terms, the yield difference compared with Western names will play a significant role in the issuance out of the market.”

That is likely to include a wider variety of issuers. Government-related companies have traditionally led the way in the capital markets, but the past year has also seen activity from corporates for the first time. Once that accelerates, it is possible smaller, or more specialised, capital-raising initiatives will be launched, such as project-specific bonds or stock-market listings by companies in more volatile sectors.

Saudi Arabia’s Almarai Company and the UAE’s Majid al-Futtaim Group led the way for more corporate bond issues to follow. Both issued sukuk in the last quarter of 2013, opting for hybrid structures, which combine aspects of debt and equity.

“We certainly see a continued trend of issuers accessing capital markets for growth capital and refinancing requirements. The fact that users of capital now have a broad choice between different products and formats of capital is a very positive development,” says Christoph Paul, head of Mena debt capital markets at the US’ Morgan Stanley.

Demand from a strong investor base across the globe, which has broadened from emerging market-focused investors to sector- and industry-driven investors, will further help deepen the capital markets, according to Paul.

On stock markets, initial public offering (IPO) activity remained low in 2013, but that could change next year. With regional risk premiums having lowered compared with a year ago, it now costs less for companies to sell shares.

Abu Dhabi Investment Company (InvestAD) says future IPOs are likely to come from the consumer, financial, logistics and industrial sectors looking to address the region’s growing consumption needs.

“These sectors have developed almost from scratch over the last 20 years and have now reached a stage in their lifecycle where corporate consolidation will become a necessity for profitable growth,” InvestAD says in a report.

“Companies are finding IPOs useful not only to raise the capital necessary for acquisitions, but also to provide stock option incentives to attract and retain talent in highly competitive areas of the economy.”

New listings

Other areas likely to see more listings include the health and education sectors, which have been identified by GCC governments as priority areas for investment.

Last year’s IPOs by corporates such as Abu Dhabi’s Al-Noor Hospitals Group on the London Stock Exchange are set to pave the way for more local companies going public, with Damac Properties’ listing proving that even companies in more volatile sectors manage to get sufficient take-up from investors.

But it remains to be seen how many companies will list next year. Numerous firms will first need to greatly improve their corporate governance activities before they will be able to meet exchanges’ listing requirements.

The large companies that are ready for a listing are expected to continue looking abroad to tap larger pools of liquidity, but also to get away from the region’s stringent listing requirements, such as the need to float at least 55 per cent of a firm.

“Companies look for the best valuations they can get,” says Talal Ghandour, Mena head of equities at Bank of America Merrill Lynch. “No one wants to sit on an exchange and not be traded. Asia is a natural destination for a lot of these firms, as is London.”

Higher prices

Local exchanges cannot be completely written off, however. Government companies are more likely to list locally to support the development of the region’s stock markets. And the strong performances seen in 2013 could encourage local companies to look for a domestic listing rather than facing the uncertainty of whether they will be able to attract enough liquidity internationally.

By December, the Dubai Financial Market was up more than 80 per cent year-on-year, followed by Abu Dhabi (50 per cent), Kuwait (31 per cent), Qatar (nearly 25 per cent), Saudi Arabia (22 per cent), Egypt (18 per cent), Oman (17 per cent) and Bahrain (12 per cent). That led to higher valuations of GCC companies’ shares, which on average traded at a price-to-earnings ratio of 14 times in December, up from 12 times a year ago.

In addition, regional bourses are set to attract higher foreign investment as authorities increase their exchanges’ operational efficiency and scale, such as through a planned merger between the Abu Dhabi and Dubai bourses.

The upgrade of Qatar and the UAE by index compiler MSCI to emerging markets status is also set to attract more foreign investment, with about $350m from exchange-traded funds projected to flow into the two countries.

Stronger dollar

On a wider level, regional stocks could benefit from the global economic environment. With US monetary policy expected to lead to a stronger dollar, emerging markets countries face their currencies weakening. Mena countries, however, will be excluded from that as many are either pegged to the dollar or to a basket of currencies mainly exposed to the dollar.

Saudi Arabia is the most active issuer and we expect it to remain so, but Kuwait may fall behind

Erini Tsekeridou, Bank Julius Baer

“[The dollar-linked Mena countries have] a tactical advantage that could be there for quite some time if the US is the only meaningful economy that’s growing over the next few years,” says Michael Harris, head of Eastern Europe, the Middle East and Africa equity strategy at Bank of America Merrill Lynch.

With the region’s capital markets expected to attract a larger base of investors in 2014, that could convince companies to finally take the plunge and diversify their sources of funding beyond loans.

But authorities will still need to further deepen the markets to help companies list locally and continue to set a benchmark so a wider variety of companies can issue bonds.

The launch of the region’s first corporate bonds, as well as listings by companies in London last year, will hopefully set the stage for more companies tapping the markets in 2014.

Capital markets

Bond and sukuk issuance in the region reached a peak in the first half of 2013, with more than $30bn raised by Mena issuers

Source: Dealogic

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