The Saudi Stock Exchange (Tadawul) has registered a strong surge from the second half of 2013 onwards, making up for four years of single-digit growth.

Up 33 per cent over the past year, the bourse is benefiting from improved confidence in its listed firms, bringing its total value to $519bn at the end of April. Average daily turnover is SR8.9bn ($2.4bn), the highest in two years.

The market has been supported by companies’ strong revenues, which totalled SR469bn in 2013. The figure is slightly lower than in 2012, but still greatly surpasses the SR380bn registered during its previous peak in 2008.

Further growth

There is room for further gains as companies’ fundamental growth has yet to be fully appreciated by investors, according to an April research report by the local Al-Rajhi Capital. The Tadawul’s index performance over the past four years was about 3 per cent lower than collective earnings growth of 12 per cent.

While the Saudi market is only the fourth-best performer in the region – Dubai, Abu Dhabi and Qatar posted better results, growing 142 per cent, 55 per cent and 47 per cent respectively during the past year – that does not necessarily mean it lags badly behind in terms of catching up to the underlying growth. Rather, the performance of other markets has been boosted by positive sentiment over the UAE and Qatar being upgraded to emerging markets status by US index compiler MSCI from May.

Saudi Arabia’s top performers of the past year were non-oil sectors such as transport, tourism, retail, real estate, and food and agriculture, which rose 81 per cent, 78 per cent, 75 per cent, 62 per cent and 47 per cent respectively. Telecoms climbed 30 per cent as operators scaled down their international ambitions and strengthened their domestic focus.

Growth of real estate-related firms slowed in recent months, but activity is expected to pick up again as the government looks to ease visa requirements for new migrant workers. That is set to put an end to delays on construction schemes suffering staff shortages after a crackdown on illegal workers.

Banking and petrochemicals – the largest sectors on the Tadawul – registered slower growth of about 30 per cent during 2013. Banks’ earnings grew about 7 per cent in 2013, slightly lower than expected, as provisions rose by about 8 per cent, according to the local NCBCapital. But with loans increasing at a double-digit pace and banks well-protected against credit deterioration, continued growth is expected.

Meanwhile, lower product prices meant flat annual revenues for petrochemicals producers of SR225bn from 2011 to 2013, although that still represents a rise of about 25 per cent over 2010, according to Al-Rajhi Capital.

With the overall market looking promising and many valuations having caught up with the kingdom’s economic growth, investors will need to be more selective when picking stocks.

“Fundamentals are still supportive of the growth we’ve seen in the stock market over the past year, although some of it is fuelled by speculation,” says Asim Bukhtiar, head of research at Riyad Capital. “Some shares have rallied and there have been no announcements from the firms to support those increases, suggesting they’re profiting from positive sentiment surrounding the overall sector and market instead.”

New listings could absorb some of the excess liquidity in the market, with some large initial public offerings (IPOs) expected in 2014. “In Saudi Arabia, there are two major drivers [for listings]: the government pushing select [state] entities to share their wealth with the public; and family firms corporatising and creating liquidity for estate or inheritance planning purposes,” says Anil Menon, Middle East and North Africa mergers and acquisitions and IPO leader at the UK’s EY. “Companies in the real estate, construction and utilities sectors are expected to issue IPOs.”

The government is planning to sell 15 per cent of the kingdom’s largest lender, National Commercial Bank, through an IPO likely to fetch several billion dollars. Other offerings expected this year include Acwa Power and several healthcare firms.

Listing activity

“There were changes at the regulator that pushed some transactions away, but there will definitely be more this year,” says Khalid Nasser al-Muammar, CEO of investment bank Saudi Hollandi Capital.

In total, six companies are expected to float shares by the end of 2014, including several $300m deals, according to a banker. “There have been changes to streamline the IPO process and make it less lengthy,” he says. “The regulator is aiming to approve an application within several months.”

Another measure that could help the market develop is the government’s intention to open it up to foreigners. Although the financial community does not expect that to happen in the short term, there have been a few signs of progress as the Tadawul prepares for the change. In February 2013, Mohammed bin Abdulmalik al-Sheikh, a former legal adviser for the Washington-based World Bank, was appointed president of the Capital Markets Authority. The move was followed by an announcement that the kingdom was changing its weekend to Friday and Saturday to align its banks and businesses with the rest of the region.

The authority has also made efforts to stabilise the market and limit speculation on stocks. It has launched a regulation limiting share price fluctuation to 10 per cent a day, and has introduced a new calculation method that limits the effect a major last-minute trade could have on the share’s closing price. Several companies that did not disclose quarterly financial results on time have been given fines of up to SR100,000, although lack of corporate governance remains an issue. “Generally speaking, investors would like to see more disclosures in quarterly financial reports and greater engagement between companies’ management and the investment community,” says Bukhtiar. “The main challenge in attracting foreign investors will be to raise the transparency levels of listed companies.”

Once direct foreign investment is finally allowed, the kingdom’s steady economic growth is likely to attract plenty of interest, although geopolitical concerns could dampen enthusiasm. While international investors continue to wait for the Saudi market to open up, the exchange has made efforts to improve its regional appeal. This coincides with plans by other exchanges to harmonise their operations and cooperate more closely, such as the proposed merger of the Dubai Financial Market and the Abu Dhabi Securities Exchange (ADX). Collaboration with other regional exchanges gives firms the chance to tap into another market’s liquidity. The Tadawul is particularly attractive as it is the largest in the region.

In November 2013, the Tadawul and the ADX signed an agreement to explore the potential for dual listings and data sharing, and the development of new market initiatives. That was followed by a separate agreement with the Bahrain Bourse to increase the level of collaboration between the two exchanges.

“We’d like to see some kind of passporting mechanism launched in the GCC, which would allow investors access to the entire region through one account instead of having to deal with separate systems. The question is if authorities are willing to implement something on that scale. It’s more likely we’ll see consolidation of back office processes,” says an investor.

But as domestic liquidity remains high in the region’s largest stock market, authorities can afford to take their time before taking wider measures to open up the market.

Unless more regulation is introduced, it is up to the companies to decide whether they are willing to engage more with the investment community and revamp their operations to increase their appeal internationally. For now, the Saudi market is likely to persist with its strong domestic focus as more firms pursue listings and economic growth remains strong.