Dubai, Reuters—The opening of Saudi Arabia’s stock market to direct foreign investment early next year is set to coincide with a pick-up in earnings growth in the Kingdom, which has lagged the region in the past few years.
The combined net profits of Saudi Arabia’s leading companies are expected to rise 17 percent in 2014 and a further 11 percent in 2015, largely on the back of petrochemical producers and banks, although a number of companies in other sectors also promise strong growth.
Those figures are based on average forecasts from analysts surveyed by Reuters for 81 companies which accounted for 99 percent of the total profits of constituent companies in Saudi Arabia’s main equities index last year.
The outlook puts Saudi Arabia roughly on a par with Qatar, where profit growth is set to average 13 percent this year and next, and Abu Dhabi, which is expected to average 17 percent.
It’s a big improvement from Saudi Arabia’s zero profit growth in 2012 and a 6 percent increase last year. That poor performance was almost entirely due to weak profits at petrochemical firms, which saw product prices sag because of the economic slump in Europe.
Strong earnings will not necessarily translate into further fast rises for Saudi stock prices, which are already up 28 percent year-to-date having surged since the market opening plan was announced in July. Many fund managers think the market is no longer cheaply valued.
But the earnings picture does ensure that the market opening is likely to attract heavy investor activity.
Estimates for 45 stocks in MSCI’s Saudi Arabia index suggest the country’s earnings performance will outpace most of the emerging market universe, which the country could eventually join after the market opens up, depending on the decisions of international equity index compilers such as MSCI.
Saudi Arabia’s “earnings per share growth, at 13.5 percent compound annual growth rate for 2013–16, is above all other Eastern Europe, Middle East and Africa markets, other than Egypt,” Morgan Stanley said in a report last month, citing its own estimates.
In the petrochemicals sector, earnings are expected to jump 25 percent this year and then rise 9 percent in 2015, thanks in part to companies swinging to profitability after years of losses, including National Petrochemical Company, which launched a polypropylene plant in 2010, and Saudi Kayan Petrochemical Company, which started commercial production of specialized chemicals in 2011.
Companies such as Saudi Kayan and its parent Saudi Basic Industries (SABIC) which produce ethylene, the feed stock for most common plastics, are in especially favorable positions, analysts say. SABIC is one of the world’s biggest petrochemical firms.
“The ethylene market is very tight—since 2008 growth in demand has outpaced supply, and this should continue until 2017–2018, when new capacity comes online,” said Ahmed Shams El-Din, director of equity research at EFG Hermes in Cairo.
Analysts expect SABIC’s earnings, which account for about a quarter of the combined profit of all listed Saudi companies, to rise 12 percent this year after shrinking in 2012 and increasing just 2 percent in 2013.
On the other hand, the outlook is not very favorable for fertilizer producers such as Saudi Arabian Fertilizer Company (SAFCO), another SABIC affiliate; prices for their products are under pressure.
The fertilizer market “is oversupplied, China has flooded the market,” said Shams El-Din. Analysts on average expect SAFCO’s profit to rise 7 percent this year and 2 percent in 2015 after dropping 18 percent last year.
Meanwhile, earnings in the banking sector are forecast to rise 9 percent this year and 12 percent in 2015. Banque Saudi Fransi is seen as one of the key contributors, with its profit expected to jump by a third this year after dropping 20 percent last year.
“Saudi Fransi is showing a strong recovery in the first half, after recording very heavy loan loss provisions in the fourth quarter of 2013,” said Jaap Meijer, head of equity research at Arqaam Capital in Dubai.
Two other lenders expected to outperform the sector are Alinma Bank and Bank AlJazira, whose earnings are seen jumping 25 and 21 percent respectively this year. Alinma has been growing rapidly and has the highest capital adequacy ratio among listed banks, which will allow it to continue expanding.
“AlJazira has a much tighter capital base than Alinma,” Meijer said. “However, we do see the bank benefiting from increasing brokerage fees due to the opening of the Saudi market to qualified foreign investors. Going forward we do see potential for the bank to improve its net interest margin, as opposed to Alinma.”
Islamic deposits bearing no interest make up more than 60 percent of Saudi banks’ total deposits, according to Morgan Stanley, and this could provide a short-term boost to margins across the sector when the US Federal Reserve hikes interest rates—a process which most analysts expect to begin next year.
Saudi Arabia’s riyal is pegged to the dollar so its central bank usually matches interest rate moves by the Fed.
The Saudi stock market is attractive to foreign fund managers partly because it is more diverse than other Gulf markets, and includes companies ranging from real estate developers to retailers and food producers. Some firms in these sectors are booming.
Analysts expect Dar Al-Arkan, one of the leading property developers, to post profit growth of 34 percent this year, recovering from a 31 percent drop in 2013.
“Dar Al-Arkan stands to benefit from the growing real estate market in Saudi Arabia, driven by favorable demographics, government support to real estate and infrastructure, an undersupplied property market and, most importantly, [the] introduction of the new mortgage law” last year, Naeem Brokerage said in a report in July.
Saudi retailers and food producers enjoy access to the biggest market in the region: the Kingdom’s population of about 30 million makes up 60 percent of the total population of the six Gulf Cooperation Council member countries.
Analysts expect the profits of top food producers Savola Group and Almarai to rise 18 and 16 percent respectively this year. Retailer Fawaz Abdulaziz Alhokair is expected to lead its sector with earnings growth of 30 percent.
Earnings at many Saudi companies have been dampened since 2013 by national labor reforms designed to reduce the country’s dependence on foreign workers and push more Saudi citizens, who are paid higher salaries, into private sector jobs. A million foreigners are estimated to have left Saudi Arabia last year because of a crackdown on illegal workers.
The impact of the reforms may last for years, but it could start to fade next year as companies adjust and the government takes steps to cushion the impact on the private sector and improve the training and stability of Saudi workers.
Overall, Saudi companies’ profits still depend heavily on state spending, as they do elsewhere in the Gulf. One of the ideas behind opening the stock market is that activist foreign shareholders will press companies to become more efficient, and thus help to improve the quality of their profits.
“Profit margins in Saudi Arabia are propped up by the lack of competition in certain sectors, some of which also benefit from government support, either directly or indirectly,” Riyadh-based Jadwa Investment said in a report.
“In the longer term, as foreign investors take up stakes in Saudi companies, and hold management accountable for strategic decisions, this will, in turn, promote improvements in efficiency, including an improvement in the use of assets in generating sales and ultimately increasing return on equity.”