DUBAI, (Reuters) – A flood of money into the bonds of Saudi Arabian property developer Dar Al Arkan is due to renewed confidence in the company’s ability to repay its debt, but also to a general scramble to buy Saudi assets as the economy booms.
The yield on the company’s $1 billion, 2.817 percent floating rate sukuk, due to mature this July, has plunged from above 25 percent at the start of January to around 8 percent now as it became clear the Islamic bond would be repaid on schedule.
That drop has probably run its course now, traders say, but the yield on the company’s 2015 maturity may have further to fall. It has already dropped to 10.7 percent from 14 percent at the start of the year. But the yield on the 2012 sukuk has returned to its 2011 low; a similar move by the 2015 sukuk would bring it to 10 percent.
“While there are concerns surrounding the development of the Saudi Arabian housing market, the sukuk offers one of the highest profit rates in the region at 10.75 percent, which makes them visible to investors,” said John Bates, head of fixed income at London-based asset manager Silk Invest.
RECOVERY
The recovery in confidence in Dar Al Arkan, the country’s biggest private property developer, has been dramatic. When the 2015 sukuk was issued in 2010, investor demand was sluggish and the company had to settle for raising $450 million instead of its target of $500-700 million.
Like other Saudi real estate firms, the company is now benefitting from a range of factors. One is government support for the industry; although Dar Al Arkan is not explicitly backed by the government, official action has convinced investors that authorities would like to see the company succeed.
Last October, the country’s Public Investment Fund approved a 4 billion riyal ($1.1 billion) facility to finance one of Dar’s biggest projects, the Qasr Khozam development in Jeddah, estimated to cost 12 billion riyals.
Strong Saudi economic growth last year, estimated by the finance ministry at 6.8 percent, and increased government spending to ease social tensions after the Arab Spring uprisings elsewhere in the region have also helped Dar Al Arkan.
The company reported a strong liquidity position at the end of 2011 with almost 2.5 billion riyals of cash reserves. It said this month that it would rely on expected sales of about 800 million riyals per quarter to help repay its 4.6 billion riyals of debt maturing this year.
“Dar generated almost $150 million in free cash flow in the fourth quarter alone, similar to what it added in totality in the past two years,” said Ghassan Chehayeb, research analyst at Exotix, an investment bank specialising in frontier markets.
Business is likely to remain strong this year. The government has set aside 250 billion riyals from its 2011 budget surplus to build 500,000 homes in the next few years; a shortage of supply for a young population — Jones Lang LaSalle estimates annual demand for housing to be between 150,000 and 200,000 units, much of it in the lower- and mid-income segments — means construction should be absorbed comfortably.
“The Saudi government’s initiatives to build homes and support infrastructure have further pushed positive sentiment in the name,” said Thomas Christie, fixed income trader at Rasmala Investment Bank in Dubai.
Economists polled by Reuters in December predicted Saudi Arabia’s gross domestic product growth would slow to a still-robust 4.0 percent this year. But the recent climb in global oil prices, and the possibility that Saudi crude production will expand to compensate for diminishing supply from sanctions-hit Iran, mean that growth estimate may well be too conservative — and that the government’s budget will stay comfortably in surplus, allowing it to continue financing real estate projects.
This ideal combination of factors is supporting a surge in Saudi equity prices, which may spill over into other assets such as real estate. The main stock index is up 12 percent so far this year at a 41-month high; Dar Al Arkan’s shares are up 29 percent but have not yet regained last year’s peak.
UPSIDE
Some analysts argue there is an additional two to three price points of upside in Dar Al Arkan’s 2015 bond, which is rated BB- by Standard & Poor’s, and that the sukuk could rally further after the repayment of the 2012 bond, which will reduce leverage and ease the company’s debt maturity schedule.
A comparison with other big real estate developers in the region appears to support the case. Dubai’s flagship developer, Emaar Properties has a $500 million, 8.5 percent sukuk maturing in 2016 which is rated B1 by Moody’s, one notch below the Dar sukuk. That bond is yielding 7.2 percent.
Abu Dhabi’s largest developer, Aldar, has a $1.3 billion, 10.75 percent conventional bond, rated B3 by Moody’s, maturing in 2014. It is yielding 6.4 percent.
“Compared to Emaar 2016s, the Dar 2015s offer almost 4 percent extra yield,” said Chehayeb.
He added that Z-spread analysis, comparing the relative value of the bonds, showed value in the Dar Al Arkan sukuk. “While a 300 basis points differential is acceptable, the current differential of 400 bps is still too wide.”
Each developer has its unique strengths; Dar Al Arkan has the demographic advantage of Saudi Arabia’s young population, which is expected to sustain strong demand in coming years, while Emaar is owned 32 percent by the government of Dubai and Aldar benefits from strong sovereign support.
“In terms of comparing it to Dubai/Emaar, the imminent Dar maturity poses fewer sector-wide challenges than those in Dubai, given its overall debt burden,” Silk Invest’s Bates said.
Dar Al Arkan’s weaknesses for investors include uncertainty over the quality of its land bank; it says it has about 35 million square metres (8,640 acres) of land, 85 percent of which are in the cities of Jeddah and Riyadh. Some 80 percent of the company’s assets of about 23 billion riyals are land plots in a country where analysts say properties are hard to value.
Valuations may become more uncertain, at least in the short term, as a result of Saudi regulatory changes. The consultative Shoura Council proposed imposing a tax on undeveloped plots of land, local media reported this month, which could push money out of unproductive land speculation into real estate development or other asset markets.
“For an investor who is positive about Saudi Arabia real estate, Dar is an attractive option. But the lack of clarity over the quality of its land bank is the top concern for any investor,” said a fixed income research analyst at a global bank operating in the region.
Regulatory changes could also help Dar Al Arkan, however. Some in the industry believe a long-awaited law facilitating mortgage lending could be passed this year, if the government can find ways to handle sensitive issues such as letting banks take away a borrower’s home if there is a default.
Home loans currently exist in Saudi Arabia, but many are salary-based with payments taken out of the home buyer’s salary when it enters his bank account, said Khan Zahid, chief economist at Riyad Capital. If passed, a mortgage law could increase activity greatly while stimulating the real estate market, he said.