Riyadh can afford slow reform

06 February 2012

Although the Capital Market Authority is considering allowing direct foreign ownership of Saudi shares, it will be in no hurry after the solid performance of the stock market in 2011

Key fact

The Tadawul All-Share Index closed 2011 3.07 per cent down on the end of 2010

Source: MEED

Investment managers are expecting Saudi Arabia to announce an end to the ban on direct foreign ownership of shares in listed companies, but full details and a date for the anticipated rule change have yet to emerge.

Against the background of a global economic recovery that is sluggish at best, the Saudi authorities are under little pressure to act quickly. They do not feel under competitive threat from the wider regional trend towards a liberalisation of ownership rules in markets such as the UAE and Qatar.

From the Saudi point of view, there is no specific impetus to act immediately

Paul Gamble, Jadwa Investment

Even so, there seems little doubt that change is on the way, as reports in the Saudi press made clear late last year. An opening up to large institutional investors, particularly from North America, Europe and Asia, seems a natural next step in the development of a deeper and more stable capital market in the kingdom.

Many local companies already exhibit the transparency and reporting standards required to stir the interest of foreign portfolio investors and then retain their loyalty as shareholders.

Tadawul’s solid performance

The Tadawul, the Saudi stock exchange, performed with resilience last year, despite the fragile state of the global economy. This indicates that the kingdom’s publicly listed businesses have the fundamental business value and earnings potential that international fund managers are looking for.

Saudi initial public offerings, 2011
 SectorOffer value (SRm)
Hail CementCement490
United ElectronicsRetail396
Saudi Integrated TelecomTelecoms350
Saudi EnayaInsurance160
United Wire FactoriesConstruction332
Source: Tadawul

The benchmark Tadawul All-Share Index (Tasi) closed 2011 at 6,417.73 points, 3.07 per cent down on the end of 2010. Market capitalisation ended the year down 4.12 per cent, at SR1,270.84bn ($338.89bn).

But trading activity was lively, with SR1,098.84bn of shares changing hands, representing a nearly 45 per cent rise on 2010. The actual number of shares traded rose by 46 per cent. The total number of transactions at 25.55 million was up 31 per cent year-on-year.

The most heavily traded sector was insurance, which accounted for more than a quarter of all transactions, while petrochemicals came second, ahead of food and agriculture. In terms of the value of shares traded, the petrochemicals sector dominated, led by heavyweight Saudi Basic Industries Corporation (Sabic).

The petrochemicals sector accounts for more than 29 per cent of the value of the Tadawul, a sign of its importance for the Saudi economy and its attraction for investors.

Value of shares traded on Tadawul
Source: Tadawul

Sabic was by far the most heavily traded individual stock, accounting for 13.92 per cent of all traded value and almost half the trading in petrochemicals stocks. It was followed by Saudi Kayan, with 3.88 per cent of trading activity. Alinma Bank was the third most heavily traded stock, followed by Al-Rajhi Bank and Yanbu National Petrochemical Company (Yansab).

However, in terms of value gained or lost, the best and worst performing stocks covered a range of sectors. The biggest loser was National Shipping Company of Saudi Arabia, which slumped by more than 30 per cent, while Zain KSA (telecoms), Tawuniya (insurance), Chemanol (petrochemicals) and Samba (banking) saw their shares lose more than 20 per cent of their value over the course of the year. By contrast Mubarrad, a leading transport company, topped the league for growth in stock worth, with a spectacular 179.3 per cent gain in share price in 2011. Tihama, the Jeddah-based media and communications group, came second with a 155.2 per cent rise in its share price.

Other strong performers that saw their share value rise 120-150 per cent in 2011 were Qassim Agriculture, Jazan Development and Saudi Arabian Refineries (Sarco).

Strong stocks in Saudi Arabia

In broad sectoral terms, petrochemicals stocks did well because of high prices for chemical products in global markets, supported by the continuing strong demand from Asia’s emerging economies.

Saudi banks also did well. They were able to increase lending activity, but at reduced levels of risk and therefore with a lower level of provisioning against potential bad debts. Cement was another solid performer, with sales underpinned by the kingdom’s infrastructure investment programme.

Tadawul market capitalisation
Source: Tadawul

Across the Tadawul, company earnings were mostly strong for the first nine months of 2011. The fourth quarter saw weaker results from many listed firms, but these figures did not emerge until early 2012 and the market already seems to have absorbed their impact and rebounded.

There were five initial public offerings (IPOs) during 2011: Hail Cement, Saudi Integrated Telecom, United Wire Factories, United Electronics and Saudi Enaya. By the end of 2011, the number of listed companies had risen to 150. In February 2011, the brokerage community was bolstered by the arrival of Merrill Lynch Saudi Arabia (part of the Bank of America Group). In November, the HSBC Amanah Saudi 20 exchange traded fund (ETF) was also listed on the Tadawul.

With such a diverse market representing a broad spread of sectors, the Tadawul could offer foreign investors the chance to benefit from the growth of the Saudi economy, as well as the strong performance of export industries such as petrochemicals.

For the kingdom’s major companies, international institutional investors could prove a useful source of stable long-term capital support.

Pace of reform for Saudi stock exchange

“A decision to allow foreign investors to directly own stocks listed on the Tadawul appears likely,” says Paul Gamble, head of research at the local Jadwa Investment.

He says that some technical issues remain to be resolved before the current restrictions can be lifted. But the technical difficulties are not major and can certainly be overcome.

“The key question is: do the Saudi authorities want to press ahead quickly with the reform?” says Gamble.

“From the Saudi point of view, there is no specific impetus to act immediately, rather than in a few months’ time. The Tadawul is by far the largest stock market in the Gulf and it contains a number of companies that would be attractive for foreign investors, irrespective of what is happening on other regional markets.

“Liberalisation of share ownership or company ownership rules in other GCC states does not really put [the Tadawul] under any competitive pressure.”

The kingdom’s regulator, the Capital Market Authority (CMA) and the government will take account of the wider international context as much as regional factors.

A first stage of stock market liberalisation took place in August 2008, when the CMA allowed foreigners to buy and benefit from shares listed on the Tadawul using swap agreements with Saudi intermediaries.

The impact on investment flows into Saudi Arabia was less positive than had been anticipated. This was largely because US investment bank Lehman Brothers collapsed a few weeks later, triggering the global financial crisis and a worldwide slump in investor confidence.

However, gradually, it became clear that the reform had not gone far enough to satisfy potential foreign investors. Some were reluctant to expend cash on shares that they would not legally own, regardless of the attractive financial returns on offer. Some major institutions are also barred from such transactions by their own in-house rules.

Resilient market

“This led CMA policymakers to conclude that further change, to allow direct foreign ownership of shares, would be beneficial. And conditions are now more favourable,” says Gamble.

“The Tasi has shown resilience over the past year, despite difficult global and regional conditions, losing only 3 per cent of its value and all of that has been recouped over the past few weeks. Saudi companies have become better at responding to the needs of potential investors. Things have really improved in terms of the quality and transparency of earnings data and most large listed companies now have investor relations departments.”

With giants such as Sabic, the attraction of the Saudi stock market for international investors is clear. But the Tadawul equally stands to gain.

At present, the Saudi stock market is dominated by retail investors, who often take a short-term position leading to speculation. Big foreign investors such as pension funds would likely take a longer-term view, bringing stability and depth to the market.

Although the UAE and Qatar are also looking to open their capital markets to foreign firms, as the largest and potentially most attractive market in the GCC, the kingdom can afford to take its time.

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