Saudi's strong fundamentals

The kingdom is sailing through the credit crunch thanks to rising forex reserves and little leverage.

As the US struggled with its massive banking sector bailout, Saudi Arabia quietly guaranteed the stability of its banks. The move was largely seen as a symbolic gesture to boost investor confidence in an economy that is fundamentally sound and a country that is home to some of the best-capitalised financial institutions in the Middle East.

Despite a strong economy, Saudi Arabia’s market has suffered from the global economic crisis along with the rest of the world. The Saudi stock exchange, known as the Tadawul, has today lost nearly half its value after peaking at about 11,700 in January 2008. Still, domestic demand continues unabated and Saudi Arabian banks remain some of the healthiest in the region, if not the world.

“The main culprit behind the disproportionate decline in Saudi equity prices is a widespread, albeit poorly justified, feeling that we in Saudi will be affected in a significant way by a global recession,” says Jamal Al Kishi, chief executive of Deutsche Securities Saudi Arabia. “Saudi Arabia itself is quite solid in terms of indigenous demand and liquidity. We have a young population that is growing, we have reasonable purchasing power and people want to own homes, consume and buy new cars.”

Motioning to indicate the entire kingdom, Al Kishi continues: “You would not be able to tell there is a global recession by walking into a car showroom or a Carrefour here”.

Saudi Arabia still offers a lot of value. The kingdom’s companies are strong and the country is growing. If anything, the current low Tadawul valuations create additional opportunities for investors in this global powerhouse.

Sound fundamentals
“Today you see low values in the Saudi market because you have the financial meltdown but if we were able to remove the weight of the current market conditions, we would see very strong companies,” says Fahad Almubarak, chairman of Morgan Stanley Saudi Arabia.

Most of Saudi Arabia’s banks and businesses have solid fundamentals. In a July 2008 business confidence report, Saudi British Bank found that 89% of business respondents are still bullish about the Saudi economy, predicting continued growth into 2009. Despite this bullish attitude, respondents identified high inflation, rising real estate costs and increasing difficulty borrowing money as the most prominent downward pressures on the Saudi economy.

Saudi banks lack of leverage and the country’s historic reliance on cash have helped them escape the credit crunch. “We’ve seen some liquidity dry up throughout the region but less so in Saudi Arabia because it really is more of a cash driven economy,” says Robert McKinnon, managing director at Al Mal Capital.

Standard & Poor’s gives Saudi Arabia’s banking sector a long-term rating of AA- with a stable outlook. The agency’s Banking Industry Country Risk Assessment, which assesses the strengths and weaknesses of a country’s banking systems, puts the kingdom in group three, the highest in the Gulf Cooperation Council and equal to the banking sectors of Austria and Japan.

Analysts described the Saudi Arabian Monetary Authority’s October 2008 decision to guarantee $40 billion in bank deposits as a largely symbolic measure to boost consumer confidence. Though few expect the kingdom will need to pay any of the $40 billion, the government did extend $2.67 billion in financing to Saudi Credit Bank to bolster its lending programme to low-income families.

The bank deposit guarantee is in line with what other central banks in the Gulf have done. In October 2008, the UAE guaranteed all deposits in domestic and foreign banks, and Kuwait’s cabinet moved to back all deposits in domestic banks after it was forced to bail out Gulf Bank after it made poor bets on euro-dollar currency derivatives.

“I don’t see any additional bank bailouts at the moment,” says McKinnon, when asked about the potential of a Gulf Bank-style failure in Saudi Arabia.

Some other Gulf economies are suffering stresses in their credit markets, but Habib Achkar, chief executive of Morgan Stanley in Riyadh, says Saudi Arabia is protected: “Here we do not have a credit problem. We do not have a lack of trust. The government, which is very wealthy, has surpluses and has been able to guarantee banks, guarantee deposits and injected deposits into local banks to offer additional liquidity for banks to continue their lending operations to small businesses, large businesses and individual consumers.”

Oil worries
Saudi banks and companies may be fundamentally sound but fears over the price of oil remain a concern – today a barrel of crude costs less than $50, down from a peak of almost $150 in July 2008. The precipitous decline in the price of oil has been far greater than anyone expected.

“The Saudi budget is based on anywhere from $45 to $55 [per barrel of oil] with a surplus, so they should be relatively comfortable with anything above $45 or $50,” says Bassam Yammine, chief executive of Credit Suisse Saudi Arabia. “The Saudi government is very aware of some issues that arose during the previous oil boom, so it is being careful to diversify the project and development spending. This will help to ensure that the economy rises out of the current market turbulence less affected than it would otherwise.”

Signs of eroding consumer confidence can be seen in the share price of the Saudi Basic Industries Corporation (Sabic), a petrochemicals company. As the largest traded company on the Tadawul, the SR124 ($33) drop in Sabic’s share price since January has helped to drag the whole market down with it. The company saw its third-quarter 2008 net profit fall to SR7.2 billion from SR7.4 billion for the same period a year earlier.

Today, Sabic shares trade near SR57, down from a high of SR181 a year ago.

While the fundamentals of Sabic are sound, the company still faces threat from a global recession. In a statement, Mohamed Al-Mady, the company’s chief executive, expressed concern over the global economy: “The expected global recession may lead to a decline in demand for products in most of the international markets.” Investors seem to agree.

Sabic and other petrochemical companies dominate the Tadawul. The sector makes up one-third of market activity, while the next largest segment is real estate at 9%. With this weighting, the decline in oil prices and any perceived decline in demand for petrochemical products weighs heavily on the exchange.

“Sabic is very much a global growth player and if global growth slows down, that will definitely affect the company and its valuation tremendously,” says McKinnon, explaining the effect of the global slowdown on the Tadawul. “If you think pricing is going to come down in the petrochemical universe, which has already happened, that will be a driver on such a large weight of the index that you’re going to see pull down.”

While down, Saudi Arabia’s foreign currency reserves remain strong. With the drop in the price of oil, Saudi Arabia’s foreign exchange reserves fell to $27.1 billion at the end of November 2008, down $7 billion from the end of September 2008.

The correction’s silver lining
In Saudi British Bank’s summer business climate survey, inflation topped businesses’ worries. That problem is now gone. The global economic crisis has stopped inflation -- after peaking in July, inflation fell to 9.5% in September. Additionally, Saudi companies are beginning to evaluate the opportunities to expand in the Gulf Cooperation Council region.

“A lot of the regional money that’s been invested outside the region may come back and the largest chunk of that money is Saudi,” says McKinnon. In 2007, Saudi Arabia saw a $978 million outflow in non-oil sector private capital while banks saw a $1.9 billion capital inflow.

Analysts predict that Saudi companies, now flush with cash, will be looking to expand in the GCC region. “Once we stabilise I would foresee interest in cross-border acquisitions,” says Morgan Stanley’s Achbar. “I think we’re going to see more Mena [Middle East and North Africa] cross-border but also for the very large groups we could see purchases of other very depressed assets in the world. But you need some confidence to return first.”

Saudi companies have value, the country is fiscally sound and, according to the IMF, 5.9% growth is predicted for 2008, up from 3.5% in 2007. While not entirely immune from the global financial crisis, as the Tadawul’s decline demonstrates, Saudi Arabia remains a solid investment for foreigners looking for some peace of mind.

As Morgan Stanley’s Almubarak puts it, “Everything is linked, but even with the correction of the Saudi market and what’s happening in the world, Saudi Arabia is a place of stability.”

This story first appeared in a Saudi Arabia supplement that was published together with the December/January issue of FinanceAsia magazine.

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